Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2023

 

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______ to _______

 

Commission file number 000-54730

 

ITEM 9 LABS CORP.

(Exact name of registrant as specified in its charter)

 

Delaware (State or other jurisdiction of incorporation or organization)

96-0665018 (I.R.S. Employer Identification No.)

 

 

2111 E. Highland Ave., Suite B375, Phoenix, AZ 85016

(Address of principal executive offices and zip code)

 

1-833-867-6337

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑  No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2

 

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☑	Smaller reporting company	☑
Emerging growth company	☐

 

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

 

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

 

As of May 22, 2023, there were 101,756,183 shares of the issuer's common stock, $0.0001 par value per share, outstanding.

  

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain information included in this Quarterly Report on Form 10-Q and other filings of the Registrant under the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as well as information communicated orally or in writing between the dates of such filings, contains or may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements in this Quarterly Report on Form 10-Q, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from expected results. Among these risks, trends and uncertainties are the availability of working capital to fund our operations, the competitive market in which we operate, the efficient and uninterrupted operation of our computer and communications systems, our ability to generate a profit and execute our business plan, the retention of key personnel, our ability to protect and defend our intellectual property, the effects of governmental regulation, and other risks identified in the Registrant's filings with the Securities and Exchange Commission from time to time.

 

In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "could," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Although the Registrant believes that the expectations reflected in the forward-looking statements contained herein are reasonable, the Registrant cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither the Registrant, nor any other person, assumes responsibility for the accuracy and completeness of such statements. The Registrant is under no duty to update any of the forward-looking statements contained herein after the date of this Quarterly Report on Form 10-Q.

 

 

 

 

 

 

ITEM 9 LABS CORP.

FORM 10-Q

March 31, 2023

 

 

INDEX

 

		Page
Part I - Financial Information
Item 1.	Financial Statements	F-1
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	25
Part II - Other Information
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26
Item 3.	Defaults Upon Senior Securities	26
Item 4.	Mine Safety Disclosures	26
Item 5.	Other Information	26
Item 6.	Exhibits	27
Signatures		27
Certifications

 

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

INDEX		F-1
Condensed Consolidated Balance Sheets as of March 31, 2023 (Unaudited) and September 30, 2022		F-2
Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2023 and 2022		F-3
Unaudited Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Three and Six Months Ended March 31, 2023 and 2022		F-4
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2023 and 2022		F-5
Notes to Condensed Consolidated Financial Statements (Unaudited)		F-6

 

 

 

 

 

 

F-1

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

		March 31,				September 30,
		2023				2022
			(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	101,150			$	85,637
Accounts receivable, net			595,539				586,270
Inventory			2,640,763				2,464,222
Prepaid expenses and other current assets			343,984				417,096
Total current assets			3,681,436				3,553,225
Property and equipment, net			24,853,997				21,019,724
Right of use asset			912,767				938,687
Construction escrow deposits			4,784,752				7,717,908
Deposits			94,114				86,604
Other assets			3,600,754				655,598
Assets held for sale			6,815,000				6,815,000
Intangible assets, net			11,150,438				11,741,487
Goodwill			58,233,386				58,233,386
Total Assets		$	114,126,644			$	110,761,619
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable		$	6,920,331			$	6,422,196
Accrued payroll and payroll taxes			1,394,863				2,086,051
Accrued interest			6,389,259				3,070,415
Accrued expenses			1,748,939				3,328,222
Deferred revenue, current portion			174,997				219,992
Notes payable, current portion, net of discounts			21,521,790				15,924,033
Income tax payable			20,580				13,221
Operating lease liability, current portion			336,431				271,573
Convertible notes payable, net of discounts			3,129,172				3,750,000
Liabilities related to assets held for sale			5,500,000				5,500,000
Total current liabilities			47,136,362				40,585,703
Deferred revenue, net of current portion			419,608				335,859
Operating lease liability, net of current portion			600,849				682,752
Convertible notes payable, net of current portion and discounts			1,042,075				—
Notes payables, net of current portion and discounts			7,244,705				7,216,710
Total liabilities			56,443,599				48,821,024
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $.0001 per share, 2,000,000,000 shares authorized; 113,988,219 and 109,950,509 shares issued and 101,688,219 and 97,650,509 shares outstanding at March 31, 2023 and September 30, 2022			11,399				10,995
Additional paid-in capital			142,813,669				140,417,114
Accumulated deficit			(71,691,103	)			(65,016,698	)
Treasury stock			(13,450,000	)			(13,450,000	)
Total Item 9 Labs Corp. Stockholders' Equity			57,683,965				61,961,411
Non-controlling interest			(920	)			(20,816	)
Total Stockholders' Equity			57,683,045				61,940,595
Total Liabilities and Stockholders' Equity		$	114,126,644			$	110,761,619

 

 

 

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

 

F-2

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

		For the three months ended				For the three months ended				For the six months ended				For the six months ended
		March 31, 2023				March 31, 2022				March 31, 2023				March 31, 2022
Revenues, net		$	5,663,007			$	6,638,186			$	10,666,886			$	12,824,197
Cost of revenues			1,944,872				3,960,948				4,326,878				7,748,193
Gross profit			3,718,135				2,677,238				6,340,008				5,076,004
Operating expenses
Professional fees and outside services			1,157,858				556,721				2,013,518				1,214,166
Payroll and employee related expenses			2,202,639				3,055,244				4,392,463				5,205,950
Sales and marketing			385,022				613,902				672,971				1,053,338
Depreciation and amortization			378,008				442,477				757,364				881,612
Other operating expenses			890,615				786,167				1,385,164				1,632,835
Provision for (recovery of) bad debt			—				(5,000	)			—				(5,000	)
Total expenses			5,014,142				5,449,511				9,221,480				9,982,901
Loss from operations			(1,296,007	)			(2,772,273	)			(2,881,472	)			(4,906,897	)
Other income (expense)
Interest expense			(2,107,310	)			(1,097,373	)			(3,769,163	)			(2,307,763	)
Other income (expense)			—				318				3,485				318
Total other income (expense), net			(2,107,310	)			(1,097,055	)			(3,765,678	)			(2,307,445	)
Net loss, before income tax provision (benefit)			(3,403,317	)			(3,869,328	)			(6,647,150	)			(7,214,342	)
Income tax provision (benefit)			3,619				3,324				7,359				3,324
Net loss			(3,406,936	)			(3,872,652	)			(6,654,509	)			(7,217,666	)
Less: Net net income attributable to non-controlling interest			9,785				5,426				19,896				5,426
Net loss attributable to Item 9 Labs Corp.		$	(3,416,721	)		$	(3,878,078	)		$	(6,674,405	)		$	(7,223,092	)
Basic net loss per common share		$	(0.03	)		$	(0.04	)		$	(0.07	)		$	(0.08	)
Basic weighted average common shares outstanding			101,076,982				95,271,726				100,008,166				95,088,960
Diluted net loss per common share		$	(0.03	)		$	(0.04	)		$	(0.07	)		$	(0.08	)
Diluted weighted average common shares outstanding			101,076,982				95,271,726				100,008,166				95,088,960

 

 

 

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

 

 

F-3

 

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

THREE AND SIX MONTHS ENDED MARCH 31, 2023 AND 2022 

  

		Item 9 Labs Corp. Equity
										Additional																Non-
		Common Stock								Paid-in				Treasury Stock								Accumulated				Controlling
		Shares				Amount				Capital				Shares				Amount				(Deficit)				Interest				Total
Balance at September 30, 2021			107,074,417			$	10,707			$	133,414,830				(12,300,000	)		$	(13,450,000	)		$	(33,874,094	)		$	—			$	86,101,443
Stock issued for debt inducement			142,365				14				128,348				—				—				—				—				128,362
Warrants issued with debt			—				—				574,239				—				—				—				—				574,239
Beneficial conversion features			—				—				470,047				—				—				—				—				470,047
Issuance of shares for services			16,666				2				25,830				—				—				—				—				25,832
Stock based compensation			—				—				507,294				—				—				—				—				507,294
Stock issued on exercise of options			9,896				1				(1	)			—				—				—				—				—
Net loss			—				—				—				—				—				(3,345,014	)			—				(3,345,014	)
Balance at December 31, 2021			107,243,344				10,724				135,120,587				(12,300,000	)			(13,450,000	)			(37,219,108	)			—				84,462,203
Stock issued for cash, net			278,000				28				288,813				—				—				—				—				288,841
Stock issued for acquisition			69,892				7				64,993				—				—				—				—				65,000
Stock issued for licenses			300,000				30				335,970				—				—				—				—				336,000
Stock issued for debt issuance			25,000				2				24,998				—				—				—				—				25,000
Beneficial conversion features			—				—				25,000				—				—				—				—				25,000
Issuance of shares for services			335,159				34				328,466				—				—				—				—				328,500
Stock based compensation			—				—				1,091,560				—				—				—				—				1,091,560
Stock issued on exercise of options			18,033				2				(2	)			—				—				—				—				—
Non-controlling interest			—				—				—				—				—				—				15,633				15,633
Net loss			—				—				—				—				—				(3,878,078	)			5,426				(3,872,652	)
Balance at March 31, 2022			108,269,428			$	10,827			$	137,280,385				(12,300,000	)		$	(13,450,000	)		$	(41,097,186	)		$	21,059			$	82,765,085
Balance at September 30, 2022			109,950,509			$	10,995			$	140,417,114				(12,300,000	)		$	(13,450,000	)		$	(65,016,698	)		$	(20,816	)		$	61,940,595
Stock issued for debt conversion			1,164,032				116				309,463				—				—				—				—				309,579
Stock issued for debt issuance			1,045,000				105				246,715				—				—				—				—				246,820
Beneficial conversion features			—				—				5,000				—				—				—				—				5,000
Issuance of shares for services			142,723				14				49,986				—				—				—				—				50,000
Stock based compensation			—				—				1,053,190				—				—				—				—				1,053,190
Net loss			—				—				—				—				—				(3,257,684	)			10,111				(3,247,573	)
Balance at December 31, 2022			112,302,264				11,230				142,081,468				(12,300,000	)			(13,450,000	)			(68,274,382	)			(10,705	)			60,357,611
Stock issued for debt issuance			337,500				34				42,876				—				—				—				—				42,910
Issuance of stock for services			1,348,455				135				229,865				—				—				—				—				230,000
Stock based compensation			—				—				459,460				—				—				—				—				459,460
Net loss			—				—				—				—				—				(3,416,721	)			9,785				(3,406,936	)
Balance at March 31, 2023			113,988,219			$	11,399			$	142,813,669				(12,300,000	)		$	(13,450,000	)		$	(71,691,103	)		$	(920	)		$	57,683,045

 

 

 

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

 

 

F-4

 

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

		For the six months ended				For the six months ended
		March 31, 2023				March 31, 2022
Operating Activities:
Net loss		$	(6,654,509	)		$	(7,217,666	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation			166,315				146,078
Amortization of intangible assets			591,049				735,534
Amortization of right of use assets			128,263				29,964
Amortization of debt discounts			1,004,903				1,728,325
Common stock issued for services			280,000				271,925
Stock based compensation expense			1,512,650				1,598,854
Recovery of bad debt			—				(5,000	)
Employee retention credits received			(952,805	)			—
Loss on disposal of fixed assets			30,952				10,841
Changes in operating assets and liabilities:
Accounts receivable			(9,269	)			271,277
Inventory			(176,541	)			1,587,365
Prepaid expenses and other assets			(372,044	)			(234,057	)
Deposits			(7,510	)			(98,701	)
Accounts payable			817,087				1,810,603
Accrued payroll and payroll taxes			261,617				(32,658	)
Income tax payable			7,359				3,324
Accrued interest			1,736,294				324,397
Accrued expenses			684,767				(320,350	)
Deferred revenue			38,754				(209,996	)
Operating lease liability			(119,388	)			(26,247	)
Net Cash Provided by (Used in) Operating Activities			(1,032,056	)			373,812
Investing Activities:
Cash paid for acquisition			—				(70,724	)
Purchases of property, equipment and construction in progress			(5,331	)			(3,235,125	)
Cash received for note receivable			—				5,000
Cash received from construction escrow accounts			—				794,807
Cash acquired in acquisition			—				6,143
Cash paid to acquisition escrow accounts			—				(381,932	)
Purchase of license			—				(1,130,872	)
Net Cash Used in Investing Activities			(5,331	)			(4,012,703	)
Financing Activities:
Proceeds from the sale of common stock			—				288,841
Payment of debt discount			—				(35,750	)
Proceeds from the issuance of debt			1,585,000				3,980,762
Payment of debt			(532,100	)			(1,944,294	)
Net Cash Provided by Financing Activities			1,052,900				2,289,559
Net Increase (Decrease) in Cash			15,513				(1,349,332	)
Cash and cash equivalents- Beginning of Period			85,637				1,454,460
Cash and cash equivalents - End of Period		$	101,150			$	105,128
Supplemental disclosure of cash flow information:
Interest paid in cash		$	782,603			$	1,990,720
Income taxes paid in cash		$	—			$	—
Supplemental disclosure of non-cash investing and financing activities:
Stock issued for acquisitions		$	—			$	65,000
Stock issued for acquisition of a license		$	—			$	336,000
Stock and warrants issued for debt and acquisition		$	289,730			$	777,433
Non-controlling interest		$	—			$	15,633
Stock issuance costs paid in stock		$	—			$	89,645
Debt issued for acquisition of a license		$	—			$	200,000
Debt proceeds used to pay debt discounts		$	327,000			$	80,000
Transfer of accrued interest to debt		$	789,308			$	1,762
Land purchased with escrow funds and deposit		$	—			$	3,000,000
Stock issued to pay accounts payable and prepay expenses		$	280,000			$	292,500
Operating lease right of use asset and liability		$	515,858			$	603,542
Cancellation of operating lease right of use asset and liability		$	413,515			$	—
Beneficial conversion feature on convertible debt		$	5,000			$	495,047
Construction in progress paid with escrow funds		$	2,933,156			$	4,937,018
Stock issued for conversion of debt		$	309,579			$	—
Accrued debt discount fees		$	75,000			$	75,000
Debt discount amortization capitalized to construction in progress		$	1,041,448			$	1,763,399
Accounts payable and accrued liabilities capitalized in construction in progress		$	2,984,761			$	272,981
Debt proceeds used to fund other assets		$	2,500,000			$	—
Accounts payable converted debt		$	294,838			$	—

 

 

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

 

 

F-5

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 - Description of Business and Summary of Significant Accounting Policies

 

Description of Business

 

Item 9 Labs Corp. ("Item 9 Labs" or, including its subsidiaries, the "Company"), formerly Airware Labs Corp., is a Delaware corporation. The Company was incorporated under the laws of the State of Delaware on June 15, 2010 as Crown Dynamics Corp.

 

Item 9 Labs is a holding company, investing in cannabis and cannabis-related businesses. Its subsidiaries currently compete in two different market segments: (1) producing of cannabis and cannabis-derived products and technologies through its Item 9 Labs brand (“Cultivation”), which is currently distributed through out the State of Arizona in licensed medical and adult-use dispensaries; and (2) sell medical and adult-use cannabis dispensary franchises under its franchise brand “Unity Rd.” (“Franchising”).

 

In March 2021, the Company closed on the acquisition of OCG, Inc, dba Unity Rd., a dispensary franchisor, with the effect of OCG, Inc. becoming a wholly owned subsidiary of the Company. Unity Rd. has agreements with more than twenty (20) entrepreneurial groups to open more than thirty (30) Unity Rd. retail dispensary locations in more than ten (10) states. The majority of the locations are in the licensing process. We currently have two franchisees operating in Hartford, South Dakota and Boulder, Colorado. Unity Rd will be the vehicle to bring Item 9 Labs products across the United States and internationally, while keeping dispensaries locally owned and operated, empowering entrepreneurs to operate their business and contribute to their local communities. As the Unity Rd dispensaries achieve sufficient market penetration, Item 9 Labs aims to offer its products in those locations to expand the distribution footprint of its premium product offerings.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements of the Company as of March 31, 2023 have been prepared by us without audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and do not include all of the information and notes necessary for a presentation of financial position and results of operations in accordance with US GAAP and should be read in conjunction with our September 30, 2022 audited financial statements filed with the SEC on our Form 10-K on January 13, 2023. It is management's opinion that all material adjustments (consisting of normal recurring adjustments) have been made, which are necessary for a fair financial statement presentation. We derived the September 30, 2022 condensed consolidated balance sheet data from audited financial statements, however, we did not include all disclosures required by US GAAP. The results for the interim periods ended March 31, 2023 are not necessarily indicative of the results to be expected for the year ending September 30, 2023.

 

The condensed consolidated financial statements of the Company include the accounts of the Company, and its wholly-owned subsidiaries and a consolidated variable interest entity (“VIE”). Intercompany balances and transactions have been eliminated.

 

Item 9 Labs consolidates a VIE in which the Company is deemed to be the primary beneficiary.  An entity is generally a VIE if it meets any of the following criteria: (i) the entity has insufficient equity to finance its activities without additional subordinated financial support from other parties, (ii) the equity investors cannot make significant decisions about the entity’s operations or (iii) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity or receive the expected returns of the entity and substantially all of the entity’s activities involve or are conducted on behalf of the investor with disproportionately few voting rights. The Company makes significant judgments in determining whether an entity is a VIE and, for each reporting period, the Company assesses whether it is the primary beneficiary of the VIE.

 

Effective February 1, 2022, the Company was deemed the primary beneficiary of Elevated Connections, Inc. The equity in Elevated Connections, Inc. held by its stockholder has been presented on the balance sheet and the statement of operations as a non-controlling interest.

Accounting Estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could materially differ from those estimates. Significant estimates of the Company include but are not limited to accounting for depreciation and amortization, current and deferred income taxes, inventory, accruals and contingencies, carrying value of fixed assets, construction in progress, goodwill and intangible assets, the fair value of common stock and the estimated fair value of stock options and warrants. Due to the uncertainties in the formation of accounting estimates, and the significance of these items, it is reasonably possible that these estimates could be materially changed in the near term. 

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value with cost being determined on the first in first out method. Inventory primarily consists of the costs directly related to the production and cultivation of cannabis crops, cannabis oils, and cannabis concentrate products. Inventory is relieved to cost of revenues as products are delivered to dispensaries. Inventory consists primarily of labor, utilities, costs of raw materials, packaging, nutrients and overhead.

 

The Company routinely evaluates the carrying value of inventory for slow moving and potentially obsolete inventory and, when appropriate, will record an adjustment to reduce inventory to its estimated net realizable value.

 

Revenue Recognition

 

Cultivation revenue

 

The core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASC 606 defines a five-step process to achieve this core principle, including identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, including estimating the amount of variable consideration to include in the transaction price, allocating the transaction price to each separate performance obligation and recognizing revenue when (or as) the performance obligation is satisfied.

 

F-6

 

All of the Company's cultivation revenue is associated with a customer contract that represents an obligation to provide cannabis products that are delivered at a single point in time.  For the three months ended March 31, 2023 and 2022, 97% of the Company's net revenue was generated from performance obligations completed in the state of Arizona.

 

The Company recognizes revenue once the products are delivered. Revenue is considered earned upon successful delivery of the product to the dispensary as the Company has no further performance obligations at this point in time and collection is reasonably assured. The Company records revenue at the amount it expects to collect, 100% of the wholesale sales. Beginning April 1, 2020, the Company entered into a three-year agreement with a dispensary, which calls for monthly payments of $40,000 to be paid by the Company. The fees paid for operating under the contract are expensed to cost of revenues.

 

The Company's revenues accounted for under ASC 606 do not require significant estimates or judgments based on the nature of the Company's revenue stream. The sales price is generally fixed at the point of sale and all consideration from the contract is included in the transaction price. The Company's contracts do not include multiple performance obligations, variable consideration, a significant contract, rights of return or warranties.

 

Franchising revenue

 

The Company enters into franchise agreements and consulting agreements. The franchise agreement allows the franchisee to, among other things, establish a franchised outlet under the Company’s Unity Rd. brand. Under the consulting agreements, the Company assists customers with applying for and being awarded a retail cannabis license through the state license application process. The initial franchise fee and the consulting fee are due upon execution of the related agreement. These payments are deferred on the condensed consolidated balance sheet. The initial franchise fee is recognized into revenue ratably over the term of the agreement and the consulting fee is recognized at the time the performance obligation has been satisfied. Revenue recognized during the three months ended March 31, 2023 and 2022 that was included in deferred revenue at September 30, 2022 and 2021 was $6,248 and $204,998, respectively. Revenue recognized during the six months ended March 31, 2023 and 2022 that was included in deferred revenue at September 30, 2022 and 2021 was $61,246 and $209,996, respectively.

 

Disaggregation of Revenue

 

The following table presents our revenue disaggregated by source.

		Three months ended March 31,								Six months ended March 31,
		2023				2022				2023				2022
Cultivation segment
Flower		$	614,057			$	943,957			$	1,217,149			$	2,021,168
Vape products			4,258,825				4,655,541				8,005,795				8,904,891
Concentrates and other cannabis products			515,727				694,351				935,655				1,469,942
Accessories			101,806				64,040				142,905				103,106
			5,490,415				6,357,889				10,301,504				12,499,107
Franchising segment
Franchising revenue			59,133				228,080				160,985				258,498
Corporate
Dispensary sales revenue			113,459				33,322				204,397				33,322
Other			—				18,895				—				33,270
			113,459				52,217				204,397				66,592
		$	5,663,007			$	6,638,186			$	10,666,886			$	12,824,197

 

 

 

Net Loss Per Share 

 

Basic net loss per share does not include dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share reflects the potential dilution of securities that could share in the losses of an entity. Dilutive securities are not included in the weighted average number of shares when inclusion would be anti-dilutive. The following table summarizes the securities outstanding at March 31, 2023 and 2022 that were excluded from the diluted net loss per share calculation for the three and six months ended March 31, 2023 and 2022 because the effect of including these potential shares was antidilutive due to the Company’s net loss.

 

		2023				2022
Potentially dilutive common share equivalents
Options			9,040,096				6,237,693
Warrants			49,370,537				47,938,030
Convertible notes			23,912,551				2,661,571
Non-vested common stock			360,000				—
Potentially dilutive shares outstanding			82,683,184				56,837,294

 

 

Warrants, Conversion Options, Debt Discounts and Amendments

 

The Company analyzes warrants issued with debt to determine if the warrants are required to be bifurcated and accounted for at fair value at each reporting period. When bifurcation is not required, the Company records a debt discount, based on the relative fair values of the warrants and the debt, with a corresponding charge to equity unless the terms of the warrant require it to be classified as a liability. The warrants and corresponding note discounts are valued using the Black-Scholes option-pricing model. This model uses estimates of volatility, risk free interest rate and the expected term of the warrants, along with the current market price of the Company's stock, to estimate the value of the outstanding warrants. The Company estimates the expected term using an average of the contractual term and vesting period of the award. The expected volatility is measured using the average historical daily changes in the market price of the Company's common stock over the expected term of the award or, if earlier, since March 20, 2018, the day of the merger between BSSD Group LLC ("BSSD") and Airware Labs Corp, and the risk-free interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards.

  

The Company also analyzes conversion options embedded with debt to determine if the conversion options are required to be bifurcated and accounted for at fair value at each reporting period or to determine if there is a beneficial conversion feature. At March 31, 2023 and September 30, 2022, none of the conversion options embedded in the Company’s debt were required to be bifurcated.

 

F-7

 

The Company analyzes the terms of its debt amendments to determine if the changes made to the terms have affected the debt’s cash flows. If the debt’s cash flows have been affected, the Company then determines if the amendment should be accounted for as a troubled debt restructuring, an extinguishment or a modification and the appropriate accounting model is applied.

 

Segment Reporting

 

The Company defines operating segments as components about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company allocates its resources and assesses the performance of its sales activities based on the services performed by its subsidiaries. For the three and six months ended March 31, 2023 and 2022, the Company has identified two segments: the cultivation, production and sale of cannabis and cannabis derived products and technologies (“Cultivation”) and the sales of Unity Rd. franchises to dispensaries (“Franchising”).

 

Held for sale

The Company classifies long-lived assets or disposal groups and related liabilities as held-for-sale when management having the appropriate authority, generally our Board of Directors or certain of our Executive Officers, commits to a plan of sale, the disposal group is ready for immediate sale, an active program to locate a buyer has been initiated and the sale is probable and expected to be completed within one year. Once classified as held-for-sale disposal groups are valued at the lower of their carrying amount or fair value less estimated selling costs. Depreciation on these properties, if placed into service, is discontinued at the time they are classified as held for sale.

 

Employer Retention Credit

 

During the six months ended March 31, 2023, the Company received $952,805 of tax credits in accordance with the Employer Retention Credit (“ERC”) program, authorized by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as amended. The Company’s policy is to account for the ERC as a grant using guidance analogous to government grants found in IAS 20, Accounting for Government Grants and Disclosure of Government Assistance. In accordance with this guidance, the ERC is recognized as a reduction to Payroll and employee related expenses on the statement of operations when there is reasonable assurance that the Company will receive the ERC.

 

Leases

 

The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets and current and long-term operating lease liabilities on our condensed consolidated balance sheets. We currently do not have any material finance lease arrangements.

 

Operating lease ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. Generally, our leases do not provide an implicit rate. As such, we use our incremental borrowing rate in effect at the commencement date of the lease in determining the present value of future payments.

 

When we have the option to extend the lease term, terminate the lease before the contractual expiration date, or purchase the leased asset, and if it is reasonably certain that we will exercise the option, we consider these options in determining the classification and measurement of the lease.

 

Recently Issued Accounting Pronouncements

 

Pending Adoption

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), which provides guidance on measuring credit losses on financial instruments. The amended guidance replaces current incurred loss impairment methodology of recognizing credit losses when a loss is probable with a methodology that reflects expected credit losses and requires a broader range of reasonable and supportable information to assess credit loss estimates. ASU 2016-13 is effective for the Company on October 1, 2023, with early adoption permitted on October 1, 2019. We are assessing the provisions of this amended guidance; however, the adoption of the standard is not expected to have a material effect on our condensed consolidated financial statements.

 

In August 2020, the FASB issued ASU No. 2020-06, Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40). This standard eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation. For public business entities, excluding entities eligible to be smaller reporting companies, it is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years using the fully retrospective or modified retrospective method. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023. Early adoption is permitted but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. We are currently evaluating the impact of adoption of this standard on the Company’s condensed consolidated financial statements and disclosures.

 

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This standard requires contract assets and contract liabilities acquired in a business combination to be recognized in accordance with Topic 606 as if the acquirer had originated the contracts. For public business entities, ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, including interim periods within those years and early adoption is permitted. We are currently evaluating the impact of adoption of this standard on the Company’s condensed consolidated financial statements and disclosures.

 

There have been no other recent accounting pronouncements or changes in accounting pronouncements that have been issued but not yet adopted that are of significance, or potential significance, to us.

 

 

F-8

 

Note 2 – Going Concern

 

The accompanying condensed consolidated financial statements have been prepared in conformity with US GAAP, which contemplates continuation of the Company as a going concern. The Company has not yet established an ongoing source of revenue sufficient to cover its operating costs and has incurred net losses since its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company’s planned ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion of the assets in the accompanying condensed consolidated balance sheets is dependent upon continued operations of the Company which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations. The Company operates in a new, developing industry with a variety of competitors. The Company is in default on numerous financial obligations and its property in Arizona is currently in the foreclosure process. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management’s plans in regard to these matters are described as follows:

 

Sales and Marketing. Historically, the Company has generated the majority of its revenues by providing the products it produces to dispensaries throughout the state of Arizona. The Company’s revenues have increased significantly since its inception in May 2017. Management will continue its plans to increase revenues in the Arizona market by providing superior products. Additionally, as capital resources become available, the Company plans to expand into additional markets outside of Arizona.

 

Financing. To date, the Company has financed its operations primarily with loans from third parties and shareholders, private placement financings and sales revenue. Management believes that with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will grow, thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there is no assurance that the Company’s overall efforts will be successful.

 

If the Company is unable to generate additional sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations are available. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

 

 

Note 3 – Inventory 

 

Inventory consisted of the following at March 31, 2023 and September 30, 2022.

 

		March 31,				September 30,
		2023				2022
Raw materials and work in process		$	1,320,760			$	1,209,892
Finished goods			994,714				835,420
Packaging and other			325,289				418,910
		$	2,640,763			$	2,464,222

 

 

Note 4 – Pending Acquisitions

 

The Herbal Cure pending acquisition

 

On March 11, 2022, the Company entered into an Asset Purchase Agreement with The Herbal Cure LLC (“Seller”), pursuant to which, the Company is purchasing certain assets from the Seller. The total purchase price for the assets to be acquired is $5,750,000, payable as follows:

 

  

	(i) Upon mutual execution and delivery of the Asset Purchase Agreement, the Company shall convey to the Seller a down payment in the amount of $250,000;
	(ii) At the Closing, the Company shall pay to Seller $3,700,000 in immediately available funds;
	(iii) $700,000 shall be financed by the Seller and paid pursuant to the terms and conditions of the Secured Promissory Note (the "Herbal Cure Note"), which interest shall accrue at a rate of 5% per annum, for a term of 18 months commencing on the Closing Date, and payable in even monthly installments until paid in full; and
	(iv) the Company shall pay the remainder of the purchase price in shares of its common stock on the Closing Date, in such amount of Shares as is the quotient of $1,100,000 divided by the product of the 10 day volume weighted average price of the shares as of the Closing Date, and 85%.

 

At March 31, 2023, the $250,000 down payment was paid and is included in Other Assets on the condensed consolidated balance sheets. At March 31, 2023, this acquisition has not yet been finalized. As such, the effects of this acquisition, which is expected to be accounted for under ASC 805, Business Combinations, have not been included in the Company’s condensed consolidated balance sheet or statement of operations as of and for the three and six months ended March 31, 2023. Given the current capital constraints of the Company and the market as a whole, it is unlikely that this acquisition will be closed.

 

Sessions pending acquisition

 

On May 18, 2022, the Company and its wholly owned subsidiary, OCG Management Ontario, Inc., a corporation formed under the laws of the Province of Ontario (“Purchaser”) solely for the purpose of completing this transaction, entered into a Share Purchase Agreement pursuant to which the Purchaser is purchasing all, but not less than all, of the issued and outstanding shares in the capital of Wild Card Cannabis Incorporated, a corporation formed under the laws of the Province of Ontario free and clear of all Liens from the Shareholders.

 

F-9

 

The total purchase price for the Shares is $12,800,000 (the "Purchase Price"), as adjusted, plus the Earnout Payment, if any (collectively, the “Purchase Price”) payable as follows:

 

	(i) The Company has delivered the Exclusivity Deposit in the amount of $156,902 to the Escrow Agent on March 4, 2022.
	(ii) At the Closing, Purchaser shall pay to Shareholders the Estimated Purchase Price of $12,800,000, as adjusted, in immediately available funds;
	(iii) $4,100,000, as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the First Earnout Period (the date that is 12 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the First Earnout Period is greater than or equal to the Target Net Revenue for the First Earnout Period; and
	(iv) $4,100,000, as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the Second Earnout Period (the date that is 24 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the Second Earnout Period is greater than or equal to the Target Net Revenue for the Second Earnout Period.

 

At March 31, 2023, the $156,902 Exclusivity Deposit has been paid and is included in Other Assets on the condensed consolidated balance sheets. In addition, at March 31, 2023, the Company has placed $3.0 million in a deposit account related to the potential financing for this acquisition. The $3.0 million deposit is included in Other assets on the condensed consolidated balance sheet. At March 31, 2023, this acquisition has not yet been finalized. As such, the effects of this acquisition, which is expected to be accounted for under ASC 805, Business Combinations, have not been included in the Company’s condensed consolidated balance sheet or statement of operations as of and for the three and six months ended March 31, 2023. The Company can provide no assurance that it will be successful in finalizing this acquisition.

 

 

Note 5 – Variable Interest Entity

 

In January 2022, the Company signed a Co-Management Agreement with a dispensary in Oklahoma for a term of three years. Under the terms of the Co-Management Agreement, the Company purchased substantially all of the assets of a dispensary, excluding cannabis and cannabis related products and licenses, and assumed the dispensary’s lease. Further, under the Co-Management Agreement, the Company is to operate, staff, and otherwise manage the day-to-day operations of the dispensary. The Company shall also pay all claims, costs and liabilities associated with operating the dispensary. See Note 14.

 

The terms of the Co-Management Agreement provide the Company with, in its judgment, the ability to manage and make decisions that most significantly affect the operations of Elevated Connections and to absorb losses that could potentially be significant to Elevated Connections. As such, the Company has consolidated Elevated Connections effective February 1, 2022. The purpose of Elevated Connections, as a licensed dispensary, is to hold the cannabis and cannabis related products and licenses of the dispensary.

 

The assets of the VIE cannot be used to settle obligations of the Company or its wholly owned subsidiaries. However, liabilities recognized as a result of consolidating the VIE do represent additional claims on the Company’s general assets.

 

The following table presents the carrying values of the assets and liabilities of the entity that is a VIE and consolidated by the Company at March 31, 2023 and September 30, 2022.

 

		March 31,				September 30,
		2023				2022
Assets
Current assets
Inventory		$	15,798			$	26,909
Total assets		$	15,798			$	26,909
Liabilities
Current liabilities
Income tax payable		$	20,580			$	13,221
Total liabilities		$	20,580			$	13,221

 

The following table presents the operations (after intercompany eliminations) of the entity that is a VIE and consolidated by the Company for the three and six months ended March 31, 2023.

		Three months ended March 31,								Six months ended March 31,
		2023				2022				2023				2022
Revenues, net		$	29,339			$	33,337			$	60,355			$	33,337
Cost of revenue			15,935				23,017				33,100				23,017
Gross profit			13,404				10,320				27,255				10,320
Income tax expense			3,619				3,324				7,359				3,324
Net income		$	9,785			$	6,996			$	19,896			$	6,996

 

 

F-10

 

Note 6 - Property and Equipment, Net

 

The following represents a summary of our property and equipment as of March 31, 2023 and September 30, 2022:

 

		March 31,				September 30,
		2023				2022
Cultivation and manufacturing equipment		$	674,374			$	612,137
Computer equipment and software			270,795				270,795
Leasehold improvements			63,788				63,788
Buildings and improvements			2,811,340				2,811,340
			3,820,297				3,758,060
Accumulated Depreciation			(943,788	)			(777,473	)
			2,876,509				2,980,587
Land			3,455,563				3,455,563
Construction on progress			18,521,925				14,583,574
Property and Equipment, Net		$	24,853,997			$	21,019,724

  

During the six months ended March 31, 2022, the Company completed the purchase of 44 acres of land from a related party for $3.0 million plus expenses. The land-owner is one of the original members of BSSD and a current employee of the Company.

 

Construction in progress relates to multiple capital projects ongoing during the six months ended March 31, 2023, including the construction of the Nevada facility and the expansion of the Arizona facility. Construction in progress also includes interest and fees on debt that is directly related to the financing of the Company’s capital projects.

 

Depreciation expense for the three months ended March 31, 2023 and 2022 was $83,746 and $74,710, respectively. Depreciation expense for the six months ended March 31, 2023 and 2022 was $166,315 and $146,078, respectively.

 

 

Note 7 – Debt

 

 Convertible Notes

 

							Maturity				Annual Interest				Balance at				Balance at				Conversion
				Effective Date			Date				Rate				March 31, 2023				September 30, 2022				Price
	C-2			3/23/2020			9/23/2020				15	%		$	1,100,000			$	1,100,000				See C-2
	C-3			8/15/2011			8/15/2012				8	%			—				20,000				$0.50
	C-7			9/29/2021			1/1/2023				10	%			325,000				275,000				0.35
	C-8			9/29/2021			1/1/2023				10	%			650,000				550,000				0.35
	C-9			10/1/2021			1/1/2023				10	%			975,000				825,000				0.35
	C-10			10/29/2021			5/31/2023				18	%			750,000				750,000				1.50
	C-11			2/21/2022			8/31/2022				24	%			230,000				230,000				1.10
	C-12			10/24/2022			10/24/2024				15	%			250,000				—				0.31
	C-13			12/13/2022			12/13/2024				15	%			50,000				—				0.25
	C-14			12/13/2022			12/13/2024				15	%			50,000				—				0.25
															4,380,000				3,750,000
					Less: unamortized discounts										(208,753	)			—
														$	4,171,247			$	3,750,000

  

(C-2) Convertible Viridis Note

 

On March 23, 2020 the Company borrowed proceeds from a related party, Viridis I9 Capital LLC (“Viridis”), in the amount of $1.1 million. The note is convertible at the lesser of a) $1.00 per share or, b) 20% discount to the ten day average closing price of the Company’s common stock, immediately prior to the conversion date. All principal and interest were due on the maturity date. At March 31, 2023 the Company was not in compliance with the terms of the Viridis note. The convertible Viridis note included a provision for the issuance of 5,000,000 warrants exercisable into the Company’s common stock. The exercise price on the warrants is $0.75 and the warrants have a term of 5 years.

 

(C-3) Other Convertible Note

 

The outstanding principal and accrued interest of C-3 was converted into 5,714 shares of the Company’s common stock during the six months ended March 31, 2023.

 

(C-7, C-8) Convertible Lucas Ventures and LGH Investments Notes

 

 

These two convertible notes were amended effective January 1, 2023 to, among other terms, extend the maturity date to June 30, 2023 and to pledge the Company’s Colorado Retail Marijuana License as security for the note. As part of the amendment for C-7, the Company increased the principal amount due on the note to $325,000. As part of the amendment for C-8, the Company issued 168,750 shares of common stock, valued at $21,455 and increased the outstanding principal balance to $650,000. The value of the stock issuance and the increase in principal amounts were recorded as a convertible debt discount and are being amortized to interest expense over the term of the notes.

 

 

F-11

 

(C-9) Convertible Tysadco Note

 

This note was amended effective January 1, 2023 to, among other terms, extend the maturity date to June 30, 2023 and to pledge the Company’s Colorado Retail Marijuana License as security for the note. As part of the amendment, the Company issued 168,750 shares of common stock, valued at $21,455 and increased the outstanding principal amount to $975,000. The value of the stock issuance and the increase in principal amount were recorded as a convertible debt discount and are being amortized to interest expense over the term of the note.

 

(C-10) Convertible *Individual* Note

 

This note was amended effective March 31, 2023 to, among other terms, extend the maturity date to May 31, 2024 and to increase the interest rate to 17.5%. As part of this amendment, combined with the amendments for notes (x) and (dd) below, the Company agreed to pay an extension fee of $75,000 on June 1, 2023. This extension fees was accrued at March 31, 2023 and the resulting discount is being amortized to interest expense over the term of the notes.

 

(C-11) Convertible *Individual* Note

 

At March 31, 2023, Note C-11 was in default and the Company is working with the lenders to cure the default. As a result of the default, the Company is accruing an additional $2,500 of monthly default interest.

 

(C-12) *Individual* Note

 

On October 24, 2022, the Company entered into a Secured Convertible Promissory Note in the amount of $250,000, which is payable at maturity on October 24, 2024. Interest on the note is 15% per annum and is payable quarterly. This note is secured by a first priority security interest in all assets of OCG Management Ontario Inc., a wholly owned subsidiary of the Company, until such time as the pending Sessions acquisition is finalized (see Note 4). Upon the finalization of the pending Sessions acquisition, this note will be secured by a second priority security interest in all assets of OCG Management Ontario, Inc. The outstanding principal and any accrued interest are convertible into shares of the Company’s common stock at $0.31 per share. The Company issued 75,000 shares of its common stock, valued at $15,000, as part of the note agreement. The debt and shares of common stock were recorded at their relative fair values. The resulting discount of $15,000 is amortized to interest expense over the term of the debt.

 

(C-13) *Individual* Note

 

On December 13, 2022, the Company entered into a Secured Convertible Promissory Note in the amount of $50,000, with a member of its board of directors. The note is payable at maturity on December 13, 2024. Interest on the note is 15% per annum and is payable quarterly. This note is secured by a first priority security interest in all assets of OCG Management Ontario Inc., a wholly owned subsidiary of the Company, until such time as the pending Sessions acquisition is finalized (see Note 4). Upon the finalization of the pending Sessions acquisition, this note will be secured by a second priority security interest in all assets of OCG Management Ontario, Inc. The outstanding principal and any accrued interest is convertible into shares of the Company’s common stock at $0.25 per share. The Company issued 10,000 shares of its common stock, valued at $2,500, as part of this note agreement. The debt included a beneficial conversion feature after consideration of the relative fair value of the shares of common stock. The debt and shares of common stock were recorded at their relative fair values, along with the beneficial conversion feature. The resulting discount of $5,000 is amortized to interest expense over the term of the debt.

 

(C-14) *Individual* Note

 

On December 13, 2022, the Company entered into a Secured Convertible Promissory Note in the amount of $50,000, which is payable at maturity on December 13, 2024. Interest on the note is 15% per annum and is payable quarterly. This note is secured by a first priority security interest in all assets of OCG Management Ontario Inc., a wholly owned subsidiary of the Company, until such time as the pending Sessions acquisition is finalized (see Note 4). Upon the finalization of the pending Sessions acquisition, this note will be secured by a second priority security interest in all assets of OCG Management Ontario, Inc. The outstanding principal and any accrued interest is convertible into shares of the Company’s common stock at $0.25 per share. The Company issued 10,000 shares of its common stock, valued at $2,500, as part of this note agreement. The debt included a beneficial conversion feature after consideration of the relative fair value of the shares of common stock. The debt and shares of common stock were recorded at their relative fair values, along with the beneficial conversion feature. The resulting discount of $5,000 is amortized to interest expense over the term of the debt.

 

The future minimum payments of the Company’s convertible debt obligations as of March 31, 2023 are as follows. The unamortized discount will be amortized through December 2024.

 

Year ended
March 31,				Amount
	2024			$	3,280,000
	2025				1,100,000
					4,380,000
	Unamortized discount				(208,753	)
					4,171,247
	Less: current portion				(3,129,172	)
				$	1,042,075

  

 

 

F-12

 

Notes Payable

 

						Maturity		Annual Interest				Balance at				Balance at
				Effective Date		Date		Rate				March 31, 2023				September 30, 2022				Secured by
	f			5/1/2020		11/1/2023			10	%		$	1,386,370			$	1,386,370			2nd DOT AZ property
	h			5/1/2020		5/1/2023			15	%			283,666				283,666			N/A
	l			7/22/2022		7/31/2023			36	%			2,362,354				1,823,405			Future revenues; shares of Company stock
	o			3/19/2021		4/1/2024			10	%			255,803				637,114			N/A
	p			2/1/2021		7/15/2023			15	%			167,739				220,590			N/A
	q			8/6/2021		3/1/2023			16	%			13,500,000				13,500,000			1st AZ property and other personal property
	r			8/6/2021		3/1/2023			16	%			5,500,000				5,500,000			1st NV property and other personal property
	s			9/30/2021		12/31/2021			18	%			—				500,000			Restricted common stock
	u			11/2/2022		7/18/2024			25	%			553,618				548,082			Future revenues
	w			3/4/2022		5/21/2024			15	%			6,203,930				5,253,256
	x			3/10/2022		5/31/2024			18	%			250,000				250,000			N/A
	y			3/2/2022		8/1/2023			5	%			145,388				165,388			N/A
	z			7/20/2022		4/30/2023			36	%			576,965				426,558			Future revenues
	aa			10/28/2022		1/31/2023			70	%			2,000,000				—			Deposit account holding the funds
	bb			11/2/2022		3/28/2023			41	%			691,931				—			Future revenues
	cc			10/26/2022		11/16/2022			71	%			326,680				—			Deposit account holding the funds
	dd			11/3/2022		5/3/2023			18	%			500,000				—			N/A
	ee			11/1/2022		12/20/2022			1	%			25,922				—			N/A
	ff			2/17/2023		11/1/2025			18	%			241,594				—			N/A
													34,971,960				30,494,429
				Less: liabilities related to assets held for sale									(5,500,000	)			(5,500,000	)
					Less: unamortized discounts								(705,465	)			(1,853,686	)
												$	28,766,495			$	23,140,743

  

(f) Viridis AZ

 

On September 13, 2018, the Company entered into a Loan and Revenue Participation Agreement with Viridis Group I9 Capital LLC ("Viridis"), a related party, in which Viridis agreed to loan the Company up to $1.2 million for the expansion of the Company's Arizona property. In exchange for the loan, Viridis was to be repaid in the form of waterfall revenue participation schedules. Viridis was to receive 5% of the Company's gross revenues from the Arizona operations until the loan was repaid, 2% until repaid 200% of the amount loaned, and 1% of gross revenues in perpetuity or until a change in control. The loan was originally collateralized with a Deed of Trust on the Company's 5-acre parcel in Coolidge, AZ and its two 10,000 square foot buildings. In August 2019, Viridis agreed to subordinate its first priority Deed of Trust and move into a 2^nd position. At that time, the loan was amended to include 6% annualized interest.

 

On May 1, 2020, under a troubled debt restructuring, the Company renegotiated the $1,200,000 note payable. As part of the restructuring, the Company issued 1,555,556 warrants exercisable into the Company's common stock. The warrants have an exercise price of $1.00 and a term of 5 years. Accrued interest in the amount of $186,370 was added to the principal balance of the note, making the total principal $1,386,370. Interest only payments of $11,553 shall be paid monthly until November 1, 2020 at which time monthly principal and interest payments of $28,144 are required for 36 months, with a balloon payment of all outstanding principal and interest due upon the note's maturity. The note also entitles Viridis to a gross revenue participation of the Arizona Operations equal to 1% of the gross sales (up to $20,000 monthly) upon the maturity of the note and for the subsequent 5 year period. The debt and warrants were recorded at their relative fair values. The resulting discount is amortized to interest expense over the term of the debt. At March 31, 2023 the Company was not in compliance with the terms of the Viridis AZ note.

 

(h) Viridis (unsecured)

 

The Company's subsidiary, BSSD Group, LLC borrowed $269,000 from Viridis, a related party, in December 2019. This note bears annualized interest at 15%. On May 1, 2020, under a troubled debt restructuring, the Company renegotiated the $269,000 note payable. Accrued interest in the amount of $14,666 was added to the principal balance of the note, making the total principal $283,666. As part of the restructuring, the Company issued 400,000 warrants exercisable into the Company's common stock. The warrants have an exercise price of $.05 and a term of 5 years. Payments of principal and interest in the amount of $9,833 are due monthly, with a balloon payment of all outstanding principal and interest is due upon the note's maturity. The debt and warrants were recorded at their relative fair values. The resulting discount is amortized to interest expense over the term of the debt. At March 31, 2023 the Company was not in compliance with the terms of this note.

 

(o) OCG Officers Debt

 

As part of the OCG transaction in March 2021, the Company assumed the debt that OCG, Inc. owed to its officers. Principal and interest payments are due monthly with a balloon payment of all outstanding principal and interest due at maturity. One of these officers is a director and officer of the Company. See Note 10.

 

F-13

 

(p) Stockbridge Amended Debt

 

In February 2021, the Company and Stockbridge Enterprises, a related party, under a troubled debt restructuring, agreed to restructure and settle its outstanding notes. The total outstanding balance of $1,660,590, including accrued interest, were to be repaid under a new promissory note, calling for a down payment of $300,000 (paid at time of signing), $120,000 monthly payments for 11 months with the remaining balance of $40,590 payable on February 1, 2022. This agreement was amended to extend the maturity date to March 31, 2022 and starting with the October 1, 2021 payment, the loan payments are interest only at an interest rate of 15% per annum until January 25, 2022. Principal payments in the amount of $50,000 were due on January 25, 2022, February 15, 2022 and March 15, 2022, with a final payment of the remaining principal and accrued interest due on March 31, 2022. Upon closing of an equity raise of at least $750,000, the Company will repay the outstanding balance plus any accrued interest immediately. As part of the amendment, the Company issued 164,744 warrants to purchase the Company’s common stock. The warrants have a two-year period and an exercise price of $1.00. The resulting discount of $58,352 was fully amortized to interest expense during the year ended September 30, 2022.

 

Effective March 31, 2022, the debt was amended to extend the maturity date to June 30, 2022, interest payments were due on April 1, May 1 and June 1, 2022. Principal payments in the amount of $50,000 were due on April 15, May 15 and June 15, 2022 and a final balloon payment of outstanding principal and interest in the amount of $223,972 was due on June 30, 2022. On January 20, 2023, the Company and Stockbridge Enterprises, a related party, entered into the third amendment of the outstanding promissory note. The amendment calls for monthly principal and interest payments of $25,000 with a final balloon payment of all outstanding principal and interest of $102,156 due at maturity on July 15, 2023. Subsequent to March 31, 2023, this note was in default and the Company is working with the lender to cure the default.

 

(q, r) Pelorus Notes

 

The Company entered into two notes payable with Pelorus Fund REIT, LLC in August 2021. The total $19,000,000 borrowing has a term of 18 months. Interest only payments in the amount of $253,333 are due monthly and all outstanding principal and interest are due on the maturity date. Upon payment in full of these notes, an exit fee of 1% of the then outstanding balance is payable to the lender. The Company has accrued this success fee and it was amortized to interest expense over the term of the notes. The notes included warrants to purchase a total of 2,850,000 shares of the Company’s common stock for $1.75 per share, with a 3.5 year term. The debt and warrants were recorded at their relative fair values. The resulting discount was amortized to interest expense over the term of the debt. The Pelorus notes are currently in default.

 

On March 30, 2023, the Company and the Company’s Board of Directors became aware that Pelorus Fund REIT, LLC (“Pelorus”) filed a Notice of Trustee’s Sale on March 16, 2023 with respect to the Construction Loan and Security Agreement dated as of August 25, 2021 by and between 938287AZ and Pelorus and the trust deed recorded October 29, 2021. The Company had been in discussions with Pelorus to restructure the loan and to avoid the Foreclosure, but those discussions have not yet resulted in an agreement. As of the date of the filing of this Form 10-Q none of the Company, the Board or the Company’s management have received any formal notice from Pelorus or any regulatory bodies regarding this Foreclosure.

 

The Company has taken steps to protect its interests in the property, including retaining legal counsel to represent the Company in the Foreclosure, which is set to occur June 16, 2023. The Company is currently evaluating the potential impact of the Foreclosure on its financial statements, liquidity, and operations. See Item 3. Defaults Upon Senior Securities in Part II, Other Information, of this Form 10-Q.

 

(s) Viridis $500,000

 

On September 30, 2021, the Company borrowed $500,000 from Viridis Group I9 Capital LLC, a related party. The proceeds of the debt were used to make a payment on the then outstanding unpaid payroll tax liability. The debt and warrants were recorded at their relative fair values. The resulting discount in the amount of $284,534 was amortized to interest expense over the term of the debt. During the six months ended March 31, 2023, this debt and related accrued interest were combined with other Viridis outstanding debt and related accrued interest into one Unsecured Promissory Note. See (w) below.

 

(u) Lendspark

 

On November 2, 2022, the Company entered into a third short-term financing arrangement with Lendspark. The proceeds of $0.58 million were used to repay the previous Lendspark short-term financing. Payments of $7,967 are due weekly until $0.725 million has been repaid. This results in an effective interest rate of 25%. Fees in the amount of $12,000 have been recorded as a discount and are being amortized to interest expense over the term of the arrangement.

 

(w) Viridis note

 

Effective December 1, 2022, the Company entered into an Unsecured Promissory Note with Viridis Group Holdings, LLC, a related party. The purpose of the Unsecured Promissory Note was to agree upon the terms for the short term loans that this related party had previously provided to the Company. Including interest accrued from the date of the short-term loans to the effective date of the agreement, the principal amount of the Unsecured Promissory Note is $6,203,930. Interest only payments in the amount $82,396 will begin on May 21, 2023 with a final balloon payment of all outstanding principal and interest to be paid at maturity on May 21, 2024.

 

(x) *Individual* Note

 

On March 10, 2022, the Company entered into a short-term promissory note for $250,000. The short-term promissory note was due and payable in monthly payments of interest only, with all principal and any accrued and unpaid interest due at maturity. Effective September 30, 2022, this note was amended to extend the maturity date to March 31, 2023. As part of the amendment, the Company issued 100,000 shares of its common stock, valued at $40,000. This note was amended effective March 31, 2023 to, among other terms, extend the maturity date to May 31, 2024 and to decrease the interest rate to 17.5%. As part of this amendment, combined with the amendments for notes (C-10) above and (dd) below, the Company agreed to pay an extension fee of $75,000 on June 1, 2023. This extension fees was accrued at March 31, 2023 and the resulting discount is being amortized to interest expense over the term of the notes.

 

(y) Nebrina Adams County Note

 

Effective with the close of the Adams County acquisition, the Company entered into a note for $200,000 with the seller as part of the purchase price. The note is payable in six installments on the last day of each three-month period following the Closing Date. At March 31, 2023, this note was in default. 

 

(aa) *Individual* Note

 

On October 28, 2022, the Company entered into a Secured Short Term Promissory Note in the amount of $2.0 million. Principal and interest in the amount of $2.35 million was due at maturity on January 31, 2023. The Company issued 650,000 shares of its common stock, valued at $166,819, to the lender as part of the note agreement. The debt and shares of common stock were recorded at their relative fair values. The resulting discount of $166,819 was amortized to interest expense over the term of the debt. Subsequent to March 31, 2023, the maturity date of this note was extended to the earlier of: (1) June 1, 2023; or (2) the outcome of the Sessions transaction, whether it closes or, alternatively, is terminated.

 

F-14

 

(bb) Lendspark 2 Note

 

On November 2, 2022, the Company entered into a short-term financing arrangement with Lendspark. The Company received proceeds of $750,000. Payments of $1,720 were paid daily for the first three months, and were extended through May 19, 2023, and then payments of $19,658 are to be paid daily until a total of $862,500 has been repaid.

 

(cc) Viridis Note

 

On October 26, 2022, the Company entered into a Secured Short Term Promissory Note with Viridis Group I9 Capital LLC, a related party, in the amount of $500,000. The note was due on November 16, 2022 and carried an interest rate of $1.94 per day per $1,000 outstanding. In addition, the note required a principal payment of $150,000 on November 4, 2022. The Secured Short Term Promissory Note is currently in default and the Company is working with the lender to cure the default.

 

(dd) *Individual* Note

 

On November 3, 2022, the Company entered into a short-term promissory note in the amount of $500,000. Interest only payments are due monthly and all principal and any unpaid interest are due at maturity. The Company issued 300,000 shares of its common stock, valued at $60,000, to the lender as part of the note agreement. The debt and shares of common stock were recorded at their relative fair values. The resulting discount of $60,000 is amortized to interest expense over the term of the debt. This note was amended effective March 31, 2023 to, among other terms, extend the maturity date to May 31, 2024 and to decrease the interest rate to 17.5%. As part of this amendment, combined with the amendments for notes (C-10) and (x) above, the Company agreed to pay an extension fee of $75,000 on June 1, 2023. This extension fees was accrued at March 31, 2023 and the resulting discount is being amortized to interest expense over the term of the notes.

 

(ee) VGI Citadel Note

 

As part of the lease termination of the Company’s corporate office (see Note 9), the Company entered into a note payable with VGI Citadel LLC, a related party, for $25,922, the amount of rent owed at the time of termination. The note carries an interest rate of 1% per annum, compounding weekly, and matured on December 20, 2022. This note is currently in default and the Company is working with the lender to cure the default.

 

(ff) Accounts payable converted to a Note

 

On February 17, 2023, the Company converted outstanding accounts payable owed to a single vendor to a note payable in the amount of $256,415. Principal and interest payments in the amount of $10,000 are due monthly.

 

The future minimum payments of the Company’s notes payable obligations as of March 31, 2023 are as follows. The unamortized discount will be amortized through July 2024.

 

Year ended
March 31,		Amount
2024		$	27,727,256
2025			7,185,514
2026			59,190
			34,971,960
Less: liabilities related to assets held for sale			(5,500,000	)
Less: unamortized discount			(278,831	)
Less: imputed interest			(426,634	)
			28,766,495
Less: current portion			(21,521,790	)
		$	7,244,705

  

A summary of interest expense for the three and six months ended March 31, 2023 and 2022 is as follows.

		Three months ended March 31,								Six months ended March 31,
		2023				2022				2023				2022
Amortization of debt discounts		$	1,136,185			$	1,626,013			$	2,089,261			$	3,491,724
Stated interest paid or accrued			2,051,950				1,361,523				4,059,245				2,565,455
Finance charges and other interest			14,916				2,178				22,161				2,995
			3,203,051				2,989,714				6,170,667				6,060,174
Less: interest capitalized to construction in progress			(1,095,741	)			(1,892,341	)			(2,401,504	)			(3,752,411	)
		$	2,107,310			$	1,097,373			$	3,769,163			$	2,307,763

 

 

Note 8 - Concentrations

 

For the six months ended March 31, 2023 and 2022, 97% and 98%, respectively, of the Company's revenue was generated from a single customer. Given the agreement with the license holder, although the Company’s products are distributed to numerous dispensaries throughout Arizona, all sales are made through the license holder. The Company's wholly owned subsidiary provides cannabis products to this customer under a three-year Cultivation Management Services Agreement that commenced on April 1, 2020. This agreement has been extended through August 11, 2023. Provisions of the agreement require 30-day written notice to terminate except for the following circumstances, in which case the agreement is cancellable with no notice: (i) uncured default; (ii) gross negligence, intentional, or willful misconduct by either party; (iii) federal or state enforcement action against either party; (iv) any change or revocation of state or local law that has the effect of prohibiting the legal operation of the Cultivation Facility; (v) the dispensary license renewal is not approved; (vi) the dispensary fails to maintain its dispensary license in good standing with the regulators resulting in the revocation of the dispensary license. Two of our license holder’s customers that the Company’s products are distributed to account for approximately 50% and 11%, respectively, of our cultivation revenue for the six months ended March 31, 2023. Should our products no longer be distributed to these customers of our license holder, it would have a material adverse effect on our operations.

 

 

F-15

 

Note 9 - Commitments and Contingencies

 

The production and possession of cannabis is prohibited on a national level by the Controlled Substances Act, though the state of Arizona allows these activities to be performed at licensed facilities such as BSSD. If the federal government decides to change its policy on the enforcement of the Controlled Substances Act, it would have a material adverse effect on our business.

 

The Company entered into a 60 month lease with VGI Citadel LLC, a related party, to rent office space for its corporate headquarters which began in June 2019. The monthly lease payments were $6,478 for the first twelve months and include all utilities and an estimated amount for common area maintenance and real estate taxes. The monthly lease payments increase to $6,653, $6,828, $7,003, and $7,178 for years two through five, respectively. Rent expense for the three months ended March 31, 2023 and 2022 on this lease was nil and $20,957, respectively. Rent expense for the six months ended March 31, 2023 and 2022 on this lease was $6,348 and $44,157, respectively. Interest was imputed using a discount rate of 20%. The lease does not include renewal options.

 

The Company and VGI Citadel LLC entered into an Agreement to Terminate Lease for its corporate offices which called for the termination of the lease with VGI Citadel LLC, a related party, effective December 20, 2022.

 

In February 2022, the Company assumed a lease to rent approximately 3,100 square feet of retail space in Oklahoma City, Oklahoma as part of the Oklahoma City acquisition. The lease calls for base rent payments of $21 per square foot ($5,483), plus a prorated share of taxes, insurance and common area maintenance expenses, per month and increasing each year by 3% through the end of the lease term on February 28, 2029. The lease may be extended for two additional 5 year periods. Rent expense for the three months ended March 31, 2023 and 2022 on this lease was $16,541 and $14,277, respectively. Rent expense for the six months ended March 31, 2023 and 2022 on this lease was $44,641 and $14,277, respectively. Interest was imputed using a discount rate of 18%. Subsequent to March 31, 2023, the Company has closed this dispensary.

 

In March 2022, the Company assumed a lease to rent approximately 2,650 square feet of retail space in Adams County, Colorado as part of the Adams County acquisition. The lease calls for base rent payments of $15,450, plus a prorated share of operating costs of the building, per month and escalate each year to $15,913 in the final year which ends on February 1, 2024. The lease may be extended for one additional 3 year period. Rent expense for the three months ended March 31, 2023 and 2022 on this lease was $50,830 and $16,048, respectively. Rent expense for the six months ended March 31, 2023 and 2022 on this lease was $101,313 and $16,048, respectively. Interest was imputed using a discount rate of 18%. Subsequent to March 31, 2023, the Company is past due on its May 2023 lease payment.

 

In September 2021, the Company signed a seven-year lease to rent approximately 3,000 square feet of retail space in Biddeford, Maine. The lease calls for base rent payments of $6,604, plus taxes and operating expenses, per month for the first year and escalate each year to $7,886 per month in year seven. The lease may be extended for two terms of 5 years each. The commencement of this lease was contingent upon the issuance and receipt of a license and city approval. The agreement will terminate if the contingency is not met. At March 31, 2023, the contingency was not met and the lease was terminated. As such, the Company has removed the remaining balance of the right of use asset and liability from the condensed consolidated balance sheet. Rent expense for the three and six months ended March 31, 2023 on this lease was $22,677. Interest was imputed using a discount rate of 18%.

 

In October 2021, the Company entered into a commercial lease agreement to rent 12,000 square feet located in Denver, Colorado. The lease has a term of five years with escalating monthly base rent beginning at $6,354 and escalating each year to $7,295 in year five. Commencement of the lease was contingent upon the Company receiving an approved retail license within 120 days from October 22, 2021. The agreement was to terminate if the contingency was not met. As of March 31, 2023, the contingency has been met and the Company has recorded the right of use asset and liability to the condensed consolidated balance sheet at March 31, 2023. Rent expense for the three and six months ended March 31, 2023 on this lease was $20,779 and $41,673, respectively. Interest was imputed using a discount rate of 18%. At and subsequent to March 31, 2023, the Company is past due on its monthly lease payments.

 

In March 2023, the Company entered into a commercial lease agreement to rent 6,159 square feet located in Phoenix, Arizona. The lease has a term of 27 months with escalating monthly base rent beginning at $13,601 plus parking fees and escalating each to $14,114 plus parking fees in the second year. The Company has recorded the right of use asset and liability to the condensed consolidated balance sheet at March 31, 2023 in the amount of $283,861. Rent expense for the three and six months ended March 31, 2023 on this lease was $13,091. Interest was imputed using a discount rate of 18%.

 

The future lease payments are as follows.

 

Year ended
March 31,				Amount
	2024			$	478,262
	2025				327,665
	2026				189,326
	2027				127,725
	2028				78,958
	Thereafter				74,179
					1,276,115
	Less: imputed interest				(338,835	)
					937,280
	Less: current portion:				(336,431	)
				$	600,849

  

As of March 31, 2023 and September 30, 2022, the Company has accrued unpaid payroll taxes and estimated penalties and interest of approximately $730,000 and $1,450,000, respectively, and is included in accrued payroll and payroll taxes in the accompanying condensed consolidated balance sheets. During the six months ended March 31, 2023, the Company received approximately $953,000 of Employee Retention Credits ("ERCs") that were used to reduce the unpaid payroll tax liability. In addition, as a result of the ERCs, the Company reduced its accrued payroll tax liability in the amount of approximately $316,000 related to the reduction of estimated penalties and interest. The ERCs were recorded to payroll and employee related expenses and the reduction of the estimated penalties and interest was recorded to other operating expenses on the condensed consolidated statement of operations. At March 31, 2023, an asset for the overpayment of certain payroll taxes was recorded to other assets on the condensed consolidated balance sheet in the amount of approximately $150,000.

 

There are no material pending legal proceedings, other than the Foreclosure discussed in Note 7 (q, r) above, in which the Company or any of its subsidiaries is a party or in which any director, officer or affiliate of the Company, any owner of record or beneficially of more than 5% of any class of its voting securities, or security holder is a party adverse to us or has a material interest adverse to the Company.

 

 

F-16

 

Note 10 - Related Party Transactions

 

As discussed in Note 6, the Company completed the purchase of 44 acres of land from a related party for $3.0 million plus expenses. The land-owner is one of the original members of BSSD and a current employee of the Company.

 

As discussed in Note 7, the Company has entered into various loan agreements with Viridis or its related entities. A member of Viridis serves on the Company’s board of directors.

 

As discussed in Note 7, the Company has a loan agreement with Stockbridge Enterprises. Stockbridge Enterprises holds more than 5% of the Company’s common stock.

 

As discussed in Note 7, the Company has a convertible loan agreement with a member of the Company’s board of directors.

 

As discussed in Note 7, as part of the OCG transaction in March 2021, the Company assumed the debt that OCG, Inc. owed to its officers. One of these officers is a director and officer of the Company. This officer’s note had a maturity date of April 1, 2024 and an interest rate of 10% per annum. Principal and interest payments were due monthly with a balloon payment of all outstanding principal and interest due at maturity. On November 2, 2022, the outstanding amount owed on this note of $289,579 was converted at $0.25 per share into 1,158,318 shares of the Company’s common stock.

 

As discussed in Note 9, the Company previously had a lease agreement with VGI Capital LLC. As part of the lease termination, the Company entered into a note payable with VGI Citadel LLC. See Note 7. One member of VGI Capital LLC serves on the Company’s board of directors.

 

During the three months ended March 31, 2023 and 2022, the Company purchased cultivation supplies from a related party in the amount of $0 and $18,715, respectively. During the six months ended March 31, 2023 and 2022, the Company purchased cultivation supplies from a related party in the amount of $0 and $31,708, respectively. This related party is owned by the parent of a stockholder that holds more than 5% of the Company’s common stock.

 

Included in our accounts payable at March 31, 2023 and September 30, 2022 is approximately $174,000, and $243,000, respectively in amounts due to related parties.

 

In February 2023, the Company entered into an Executive Employment Agreement (“Agreement”) with its Chief Operating Officer. The Agreement is for a period of two years and contains provisions customary with similar agreements including a six month severance and non-competition period upon a termination without cause. Compensation under the Agreement provides for an annual salary of $225,000, a signing bonus of $50,000 paid in the Company’s common stock and a transaction bonus in the event that the Company closes a transaction in which there is a Change of Control. During February 2023, 319,900 shares of the Company’s common stock were issued for payment of the signing bonus.

 

 

Note 11 – Assets Held for Sale

 

During the year ended September 30, 2022, as a result of a shift in the Company’s business plan, the Company approved a plan to sell its newly constructed Nevada facility and the related cannabis licenses. The Company controls these cannabis licenses through the Asset and Equity Purchase and Contribution Agreement dated February 14, 2020. This sale is expected to occur in the next 12 months. The assets held for sale are recorded at fair value less cost to sell. Fair value was determined based on the value included in a prior letter of intent. The following assets and liability are included under “Corporate” in Note 13.

 

		March 31,
		2023
Assets held for sale
Construction in progress - land and building		$	9,646,612
Licenses			6,703,981
			16,350,593
Valuation allowance			(9,535,593	)
		$	6,815,000
Liabilities related to assets held for sale
Debt		$	5,500,000

 

 

Note 12 - Stockholders' Equity

 

Warrants

 

The following table summarizes the Company’s warrant activity for the six months ended March 31, 2023:

 

		Common Shares Issuable Upon Exercise of Warrants				Weighted Average Exercise Price				Weighted Average Contractual Term in Years				Aggregate Intrinsic Value
Balance of warrants at September 30, 2022			49,870,537			$	2.05				3.7			$	315,000
Warrants granted			2,300,000				0.50				2.0
Forfeited/Cancelled			(2,800,000	)			2.57				3.4
Balance of warrants at March 31, 2023			49,370,537			$	1.95				3.6			$	45,000

 

 

(1)

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of the Company’s common stock as of March 31, 2023, for those awards that have an exercise price currently below the closing price as of March 31, 2023. Awards with an exercise price above the closing prices as of March 31, 2023 are considered to have no intrinsic value.

 

F-17

 

The following range of assumptions were used to estimate the fair value of warrants issued during the six months ended March 31, 2023, using the Black-Scholes option-pricing model.

 

		Six months ended
		March 31, 2023
Expected stock price volatility			127%
Risk-free interest rate			4%
Expected term (years)			2.0
Expected dividend yield			0%
Black-scholes value			$0.23

  

Stock Options

 

On June 21, 2019, the Company’s shareholders voted to approve the 2019 Equity Incentive Plan (the “2019 Plan”). Pursuant to the 2019 Plan, the maximum aggregate number of Shares available under the Plan through awards is the lesser of: (i) 6,000,000 shares, increased each anniversary date of the adoption of the plan by 2 percent of the then-outstanding shares, or (b) 10,000,000 shares. The maximum contractual term of the award is 10 years. The vesting period for options outstanding at March 31, 2023 ranges from vesting immediately to three years.

 

The following table summarizes the Company’s stock option activity for the six months ended March 31, 2023:

 

		Common Shares Issuable Upon Exercise of Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term in Years				Aggregate Intrinsic Value (1)
Balance of Options at September 30, 2022			8,594,805			$	1.08				8.3			$	33,162
Options granted			656,656				0.28				8.1				—
Forfeited/Cancelled			(211,365	)			0.70				—				—
Balance of Options at March 31, 2023			9,040,096			$	0.98				7.9			$	7,653
Exercisable at March 31, 2023			5,054,599			$	1.06				7.1			$	6,190
Unvested at March 31, 2023			3,985,497			$	0.86

 

 

			Number of Options				Weighted Average Grant Date Fair Value
Unvested at March 31, 2023			3,985,497			$	0.83
Granted during the three months ended March 31, 2023			656,656			$	0.31
Forfeited during the three months ended March 31, 2023			211,365			$	0.63

 

 

 

(1)

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of the Company’s common stock as of March 31, 2023, for those awards that have an exercise price currently below the closing price as of March 31, 2023. Awards with an exercise price above the closing prices as of March 31, 2023 are considered to have no intrinsic value.

 

  

The following range of assumptions were used to estimate the fair value of stock options granted during the six months ended March 31, 2023, using the Black-Scholes option-pricing model. 

 

		Six months ended
		March 31, 2023
Expected stock price volatility		151% - 158%
Risk-free interest rate		3.7% - 4.3%
Expected term (years)		2.5 - 5.0
Expected dividend yield		0%
Black-scholes value		$0.12 - $0.37

 

During the three months ended March 31, 2023 and 2022, the Company recognized compensation expense of $459,460 and $1,091,560, respectively. During the six months ended March 31, 2023 and 2022, the Company recognized compensation expense of $1,512,650 and $1,598,854, respectively. At March 31, 2023, there was $1,994,370 of total unrecognized compensation cost. This unrecognized cost is expected to be recognized over the weighted average vesting period of approximately 1 year. 

 

 

F-18

 

Note 13 – Segment Information

 

The Company has identified two segments: the cultivation, production and sale of cannabis products (Cultivation) and the sales of Unity Rd. franchises to dispensaries (Franchising). The following tables presents segment information at and for the three and six months ended March 31, 2023 and 2022.

 

		Cultivation				Franchising				Corporate				Total
Six months ended March 31, 2023
Revenues from external customers		$	10,301,504			$	160,985			$	204,397			$	10,666,886
Operating income (loss)			4,441,067				(1,371,518	)			(5,951,021	)			(2,881,472	)
Interest expense			716,394				6,103				3,046,666				3,769,163
Depreciation and amortization			53,540				594,065				109,759				757,364
Additions to property, equipment and construction in progress			—				—				4,000,588				4,000,588
Three months ended March 31, 2023
Revenues from external customers		$	5,490,414			$	59,133			$	113,460			$	5,663,007
Operating income (loss)			2,685,824				(691,228	)			(3,290,603	)			(1,296,007	)
Interest expense			347,246				1,885				1,758,179				2,107,310
Depreciation and amortization			26,770				294,837				56,401				378,008
At March 31, 2023
Property, equipment and construction in progress, net		$	340,155			$	15,547			$	24,498,295			$	24,853,997
Total assets (after intercompany eliminations)			3,629,770				66,660,086				43,836,788				114,126,644
Six months ended March 31, 2022
Revenues from external customers		$	12,499,107			$	258,498			$	66,592			$	12,824,197
Operating income (loss)			3,009,817				(1,703,385	)			(6,213,329	)			(4,906,897	)
Interest expense			157,062				43,216				2,107,485				2,307,763
Depreciation and amortization			62,532				601,525				217,555				881,612
Additions to property, equipment and construction in progress			—				50,797				13,220,286				13,271,083
Three months ended March 31, 2022
Revenues from external customers		$	6,357,890			$	228,080			$	52,216			$	6,638,186
Operating income (loss)			1,440,522				(744,246	)			(3,468,549	)			(2,772,273	)
Interest expense			156,866				20,406				920,101				1,097,373
Depreciation and amortization			31,267				300,786				110,424				442,477
At March 31, 2022
Property, equipment and construction in progress, net		$	627,009			$	77,346			$	23,305,384			$	24,009,739
Total assets (after intercompany eliminations)			6,804,504				67,876,897				46,192,548				120,873,949

 

 

Note 14 - Subsequent Events 

 

Subsequent to March 31, 2023 the following events have occurred.

 

On May 16, 2023, the Company entered into a Separation Agreement and General Release (the “Agreement”) with the Company’s Chief Executive Officer, Michael Weinberger. The Agreement provides for thirty (30) equal biweekly installments of $7,500 and payment of Mr. Weinberger’s previously unreimbursed expenses. Further, Mr. Weinberger is to remain on the Company employee benefit plan, including health insurance for the duration of the period until Mr. Weinberger has been paid in full under the Agreement. Finally, Mr. Weinberger is to receive his 2023 fiscal year option to purchase up to 200,000 shares of the Company’s common stock with a strike price based on the current 10-day VWAP. These options vest over a two (2) year period and have a term of five (5) years. The Chairman of the Company’s Board of Directors, Douglas Bowden, will serve as the Company’s Interim Chief Executive Officer.

 

The Company received debt proceeds of $250,000 from an individual, with interest only payments due weekly. The terms of this debt are still being finalized.

 

The Company issued 67,964 shares of common stock for services.

 

 

 

 

 

F-19

 

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended September 30, 2022 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company's Annual Report on Form 10-K for the year ended September 30, 2022, filed with the Securities and Exchange Commission (the "SEC") on January 13, 2023.

 

Forward-Looking Statements

 

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the securities Exchange Act of 1934, as amended, (the "Exchange Act"), which are subject to the "safe harbor" created by those sections. The words "anticipated," "believes," "estimates," "expects," "intends," "may," "plans," "projects," "will," "should," "could," "predicts," "potential," "continue," "would," and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this quarterly report on Form 10-Q. You should carefully consider these risks and uncertainties described and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

 

Overview

 

Item 9 Labs Corp. (OTCQX: INLB) is a vertically integrated cannabis operator and dispensary franchisor delivering premium products from its large-scale cultivation and production facilities in the United States. The award-winning Item 9 Labs brand specializes in best-in-class products and user experience across several cannabis categories. The company also offers a unique dispensary franchise model through the national Unity Rd. retail brand. Easing barriers to entry, the franchise provides an opportunity for both new and existing dispensary owners to leverage the knowledge, resources, and ongoing support needed to thrive in their state compliantly and successfully. Item 9 Labs brings the best industry practices to markets nationwide through distinctive retail experience, cultivation capabilities, and product innovation. The veteran management team combines a diverse skill set with deep experience in the cannabis sector, franchising, and the capital markets to lead a new generation of public cannabis companies that provide transparency, consistency, and well-being.

 

The award-winning Item Nine Labs brand seeks to offer best-in-class products and user experience across several cannabis categories. The product catalog includes an extensive range of premium cannabis products comprised of responsibly cultivated flower, Orion vape technology, concentrates and more. The highly regarded brand has received more than thirty-five (35) wins and podium placements in Arizona marijuana competitions, including Cannabis Cup, Errl Cup and 710 Degree Cup, across its suite of high-quality cannabis products. Item Nine Labs has delivered over 3 million packaged goods in its history, and over 330,000 units during the quarter ended March 31, 2023.

 

 

With its national Unity Rd. retail dispensary franchise brand, the Company believes it offers a unique value proposition through both the sale of Item Nine Labs products and its Unity Rd dispensary franchise model. Easing barriers to entry, the franchise approach seeks to provide an opportunity for both new and existing dispensary owners to leverage the knowledge, resources, and ongoing support needed to compliantly thrive in their state. With many years of experience in the legal cannabis industry and franchising, Unity Rd.’s standard operating procedures guide franchise partners through every operational function of the business. The dispensary franchise ranked in the top five (5) out of seven hundred (700) submissions for MJBizDaily magazine’s ranking of the top cannabis retail leaders in the nation and has earned high placements in several trade industry lists. Unity Rd. has agreements with more than twenty (20) entrepreneurial groups to open more than thirty (30) Unity Rd. retail dispensary locations in more than ten (10) states. The majority of the locations are in the licensing process. The Company makes its best efforts to obtain these dispensary licenses, though it can make no assurances that the licenses will be awarded. We currently have two franchisees operating in Hartford, South Dakota and Boulder, Colorado. Additionally, the Company has one (1) dispensary owned and operated by its wholly owned subsidiary in North Denver, CO.

 

On March 11, 2022, the Company entered into an Asset Purchase Agreement with The Herbal Cure LLC, a Colorado limited liability company, pursuant to which the Company is purchasing certain assets. Effective upon the completion of the sale, which has not occurred as of the date of this filing, the licenses, contracts and certain personal property to operate a licensed medicinal and recreational cannabis dispensary will be delivered to the Company. The total purchase price is $5,750,000, as to which $250,000 is to be paid upon execution of the Asset Purchase Agreement, $3,700,000 payable at closing, $700,000 shall be financed by seller pursuant to a Secured Promissory Note and the remainder of the purchase prices shall be paid in shares of the Company’s common stock on the closing date. The Secured Promissory Note shall accrue interest at 5% per annum and have a term of 18 months, commencing on the closing date, payable in even monthly installments until paid in full. The shares of the Company’s common stock to be issued shall be in such an amount as is the quotient of $1,100,000 divided by the product of the 10-day volume weighted average price of the shares as of the closing date and 85%. Given the current capital constraints of the Company and the market as a whole, it is unlikely that this acquisition will be closed.

 

20

 

On May 18, 2022, Item 9 Labs Corp., a Delaware corporation (“Company”), and OCG Management Ontario, Inc., a corporation formed under the laws of the Province of Ontario (“Purchaser”) and a wholly owned subsidiary of the Company incorporated solely for the purpose of completing the transaction, entered into a Share Purchase Agreement (the “Agreement”) with Steven Fry, Najla Guthrie, Darryl Allen, Louis Laskovski, each an individual residing in the Province of Ontario, and 2628146 Ontario Ltd., a corporation formed under the laws of the Province of Ontario, and 11949896 Canada Inc., a corporation formed under the federal laws of Canada (together, the “Shareholders”), pursuant to which Purchaser is purchasing all (but not less than all) of the issued and outstanding shares in the capital of Wild Card Cannabis Incorporated, a corporation formed under the laws of the Province of Ontario, (“Shares”) free and clear of all Liens from the Shareholders. The total purchase price for the Shares is $12,800,000 (the “Purchase Price”), as adjusted, plus the Earnout Payment, if any (collectively, the “Purchase Price”) payable as follows: (i) The Company has delivered the Exclusivity Deposit in the amount of $156,902 to the Escrow Agent on March 4, 2022; (ii) At the Closing, Purchaser shall pay to Shareholders the Estimated Purchase Price of $12,800,000, as adjusted, in immediately available funds; (iii)  $4,100,000, as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the First Earnout Period (the date that is 12 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the First Earnout Period is greater than or equal to the Target Net Revenue for the First Earnout Period; and (iv)  $4,100,000, as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the Second Earnout Period (the date that is 24 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the Second Earnout Period is greater than or equal to the Target Net Revenue for the Second Earnout Period. The Company can provide no assurance that it will be successful in finalizing this acquisition.

 

 

Results of Operations

 

		Six months ended March 31,
		2023				2022				$ Change				% Change
Revenues, net		$	10,666,886			$	12,824,197			$	(2,157,311	)			-17	%
Cost of revenues			4,326,878				7,748,193				(3,421,315	)			-44	%
Gross profit			6,340,008				5,076,004				1,264,004				25	%
Operating expenses
Professional fees and outside services			2,013,518				1,214,166				799,352				66	%
Payroll and employee related expenses			4,392,463				5,205,950				(813,487	)			-16	%
Sales and marketing			672,971				1,053,338				(380,367	)			-36	%
Depreciation and amortization			757,364				881,612				(124,248	)			-14	%
Other operating expenses			1,385,164				1,632,835				(247,671	)			-15	%
Provision for bad debt			—				(5,000	)			5,000				100	%
Total operating expenses			9,221,480				9,982,901				(761,421	)			-8	%
Loss from operations			(2,881,472	)			(4,906,897	)			2,025,425				-41	%
Other expense, net			(3,765,678	)			(2,307,445	)			(1,458,233	)			63	%
Net loss, before income tax provision (benefit)			(6,647,150	)			(7,214,342	)			567,192				-8	%
Income tax provision (benefit)			7,359				3,324				4,035				0	%
Net loss			(6,654,509	)			(7,217,666	)			563,157				-8	%
Less: Net loss attributable to non-controlling interests			19,896				5,426				14,470				100	%
Net loss attributable to Item 9 Labs Corp.		$	(6,674,405	)		$	(7,223,092	)		$	548,687				-8	%

 

 

		Three months ended March 31,
		2023				2022				$ Change				% Change
Revenues, net		$	5,663,007			$	6,638,186			$	(975,179	)			-15	%
Cost of revenues			1,944,872				3,960,948				(2,016,076	)			-51	%
Gross profit			3,718,135				2,677,238				1,040,897				39	%
Operating expenses
Professional fees and outside services			1,157,858				556,721				601,137				108	%
Payroll and employee related expenses			2,202,639				3,055,244				(852,605	)			-28	%
Sales and marketing			385,022				613,902				(228,880	)			-37	%
Depreciation and amortization			378,008				442,477				(64,469	)			-15	%
Other operating expenses			890,615				786,167				104,448				13	%
Provision for (recovery of) bad debt			—				(5,000	)			5,000				100	%
Total operating expenses			5,014,142				5,449,511				(435,369	)			-8	%
Income (loss) from operations			(1,296,007	)			(2,772,273	)			1,476,266				-53	%
Other expense, net			(2,107,310	)			(1,097,055	)			(1,010,255	)			92	%
Net income (loss), before income tax provision (benefit)			(3,403,317	)			(3,869,328	)			466,011				-12	%
Income tax provision (benefit)			3,619				3,324				295				0	%
Net income (loss)			(3,406,936	)			(3,872,652	)			465,716				-12	%
Less: Net loss attributable to non-controlling interests			9,785				5,426				4,359				100	%
Net loss attributable to Item 9 Labs Corp.		$	(3,416,721	)		$	(3,878,078	)		$	461,357				-12	%

 

 

Revenues

 

 

The decrease in revenue for the three and six months ended March 31, 2023 was primarily due to the effects of the Arizona cannabis market stabilizing, causing price compression, as well as the Company’s addition of product lines with lower unit sales prices. The impact of the changing market conditions in Arizona was countered by an increase in the number of units sold during the three and six month periods compared to the same periods in the prior year.

 

 

21

 

Cost of Revenues

 

Cost of revenues consist primarily of labor, materials, supplies and utilities. Cost of revenues as a percentage of revenues was 34% and 41% for the three and six months ended March 31, 2023 compared to 60% for the three and six months ended March 31, 2022. This is primarily the result of decreases in the unit costs the Company pays for materials resulting from additional competition in material suppliers. Management will remain focused on reducing costs through bulk purchasing, implementing additional efficiencies in production and making additional investments in property and equipment.

 

Gross Profit

 

The increase in gross profit as a percentage of revenue for the three and six months ended March 31, 2023 was due to decreases in cost of revenue being greater than the decreases in revenue. As the Company experienced decreases in its unit sales price due to increased competition, so too did the Company’s suppliers, though the decreased costs have proven to be greater than the decreased unit sales prices. As a result, and given the production efficiencies achieved in previous quarters, the Company has been able to increase gross profit on decreased revenues.

 

Operating Expenses

 

Professional fees and outside services increased for the three and six months ended March 31, 2023 compared to the three and six months ended March 31, 2022 primarily due to the amount accrued for consulting services received related to the Company’s employee retention credits, legal fees incurred on the pending Sessions acquisition and legal and consulting fees incurred related to the default on the Pelorus debt. The increase in consulting services was offset by a decrease in consulting services related to cannabis licensing.

 

Payroll expenses decreased when comparing the three and six months ended March 31, 2023 and the three and six months ended March 31, 2022. Payroll and employee related expenses increased during the six months ended March 31, 2023 as a result of an accrual for expenses incurred related to our change in Chief Executive Officer. These additional expenses were offset by the Employee Retention Credits ("ERCs") received during the current six month period and a reduction of employee headcount. Payroll and employee related expenses decreased during the three months ended March 31, 2023 as a result of decreased stock based compensation expense and a reduction of employee headcount.

 

Sales and marketing expenses decreased due to a decrease of promotional items and a general decrease in spending on third party marketing vendors during the three and six months ended March 31, 2023.

 

The decrease in depreciation and amortization is due primarily to a decrease in amortization expense as a result of the intangible asset impairment recorded during the year ended September 30, 2022.

 

Other operating expenses decreased during the six months ended March 31, 2023 compared to the same period of the prior year primarily due to the reversal of penalties and interest on previously unpaid payroll taxes as a result of receiving the ERCs during the six months ended March 31, 2023. Other operating expenses during the three months ended March 31, 2023 were consistent with those of the same period of the prior year.

 

Total operating expenses as a percentage of gross profit decreased from 204% and 189% for the three and six months ended March 31, 2022 compared to 134% and 145% for the three and six months ended March 31, 2023. Management believes this ratio will decrease for profit center segments going forward due to management’s plans to continue to decrease operating expenses and as the expectation is that revenues will grow at a higher rate than operating expenses.

 

Other Expense, net 

 

Other expenses consist primarily of interest expense of $2,107,310 and $3,769,163 for the three and six months ended March 31, 2023 and $1,097,373 and $2,307,763 for the three and six months ended March 31, 2022. The increase in interest expense was primarily the result of the interest expense and amortization of discounts on the debt financing the Nevada construction. The interest and discount amortization expense related to the Nevada construction debt was capitalized into construction in progress during the first three months of the six months ended March 31, 2022. As the Nevada expansion is substantially complete, the related interest and discount amortization are recorded to interest expense for all of the six months ended March 31, 2023. In addition, the Company incurred additional interest expense on the debt financing the Nevada construction during the six months ended March 31, 2023 as a result of the debt going into default during the year ended September 30, 2022 and incurring default interest and other fees. Further, additional interest expense was incurred during the three and six months ended March 31, 2023 as a result of the additional debt incurred subsequent to April 1, 2022.

 

Adjusted EBITDA

 

Management uses the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, stock-related compensation expense, acquisition-related costs, employee retention credits and other adjustments, or “Adjusted EBITDA,” to evaluate the Company’s performance.  Adjusted EBITDA is a non-GAAP measure that is also frequently used by analysts, investors and other interested parties to evaluate the market value of companies considered to be in similar businesses. The Company suggests that Adjusted EBITDA be viewed in conjunction with its reported financial results or other financial information prepared in accordance with accounting principles generally accepted in the United States, or “US GAAP.”

 

The following table reflects the reconciliation of net loss to Adjusted EBITDA for the three and six months ended March 31, 2023 and 2022:

 

		Three months ended March 31,								Six months ended March 31,
		2023				2022				2023				2022
Net loss		$	(3,406,936	)		$	(3,872,652	)		$	(6,654,509	)		$	(7,217,666	)
Depreciation and amortization			378,008				613,902				757,364				881,612
Interest expense			2,107,310				1,097,373				3,769,163				2,307,763
Income tax expense			3,619				3,324				7,359				3,324
Stock-based expense			539,460				1,363,485				1,792,650				1,870,779
Acquisition related costs			776,739				23,676				867,978				23,676
Employee retention credits			—				—				(952,805	)			—
Adjusted EBITDA		$	398,200			$	(770,892	)		$	(412,800	)		$	(2,130,512	)

 

22

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity and Capital Resources

 

The Company’s primary need for liquidity is to fund working capital requirements of its business, capital expenditures, acquisitions, debt service, and for general corporate purposes. The Company’s primary source of liquidity is funds generated from revenues, financing activities and from private placements. The Company’s ability to fund its operations, to make planned capital expenditures, to make planned acquisitions, to make scheduled debt payments, and to repay or refinance indebtedness depends on its future operating performance and cash flows, which are subject to prevailing economic conditions and financial, business and other factors, some of which are beyond the Company’s control.

 

 

The accompanying condensed consolidated financial statements have been prepared in conformity with US GAAP, which contemplates continuation of the Company as a going concern. The Company has not yet established an ongoing source of revenue sufficient to cover its operating costs and has incurred net losses since its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company’s planned ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion of the assets in the accompanying condensed consolidated balance sheets is dependent upon continued operations of the Company which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations. The Company is in default on numerous financial obligations and its property in Arizona is currently in the foreclosure process. The Company operates in a new, developing industry with a variety of competitors. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management’s plans in regard to these matters are described as follows:

 

Sales and Marketing. Historically, the Company has generated the majority of its revenues by providing the products it produces to dispensaries throughout the state of Arizona. The Company’s revenues have increased significantly since its inception in May 2017. Management will continue its plans to increase revenues in the Arizona market by providing superior products. Additionally, as capital resources become available, the Company plans to expand into additional markets outside of Arizona. The Company believes that it will continue reducing the overall costs of revenues and costs of revenues will increase at a lower rate than revenues in future periods, which is expected to lead to increased profit margins.

 

Financing. To date, the Company has financed its operations primarily with loans from third parties and shareholders, private placement financings and sales revenue. Management believes that with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will grow, thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there is no assurance that the Company’s overall efforts will be successful.

 

If the Company is unable to generate additional sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations, and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations are available. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

 

As of March 31, 2023, the Company had $101,150 of cash and cash equivalents and negative working capital of ($43,454,926) (current assets minus current liabilities), compared with $85,637 of cash and cash equivalents and negative working capital of ($37,032,478) as of September 30, 2022. The decrease of $6,422,448 in the Company’s working capital is primarily due to increases in the amount of the Company’s debt maturing within the next 12 months. The decrease is also due to decreases in the Company’s inventory and prepaid balances and increases in the Company’s other operating liabilities. The $13,513 decrease in cash and cash equivalents was primarily due to the net cash used in operating activities offset by proceeds from the issuance of debt. The Company is an early-stage growth company. It is generating cash from sales and is investing its capital reserves in current operations and new acquisitions that are expected to generate additional earnings in the long term. The Company expects that its cash on hand and cash flows from operations, along with private and/or public financing, will be adequate to meet its capital requirements and operational needs for the next 12 months, although no assurance can be given that private and/or public financing can be obtained on terms acceptable to the Company, or at all.

 

Cash Flows

 

The following table summarizes the sources and uses of cash for each of the periods presented:

 

		Six months ended March 31,
		2023				2022				$ Change				% Change
Net cash used in operating activities		$	(1,032,056	)		$	373,812			$	(1,405,868	)			-376	%
Net cash used in investing activities			(5,331	)			(4,012,703	)			4,007,372				-100	%
Net cash provided by financing activities			1,052,900				2,289,559				(1,236,659	)			-54	%
Net increase (decrease) in cash and cash equivalents		$	15,513			$	(1,349,332	)		$	1,364,845				-101	%

 

Operating Activities

 

During the six months ended March 31, 2023, operating activities used $1,032,056 of cash and cash equivalents, primarily resulting from a net loss of $6,654,509 which was offset by net cash provided by operating assets and liabilities of $2,861,126. There was significant non-cash activity that contributed to the net loss totaling $2,761,327 including depreciation and amortization of $885,627, amortization of debt discount of $1,004,903, and stock-based compensation of $1,792,650. These non-cash expenses were offset by the non-cash employee retention credits of $952,805.

 

 

During the six months ended March 31, 2022, operating activities provided $373,812 of cash and cash equivalent, primarily resulting from a net loss of $7,217,666 which was offset by net cash provided by operating assets and liabilities of $3,173,658. There was significant non-cash activity that contributed to the net loss totaling $4,516,521 including depreciation and amortization of $911,576, amortization of debt discount of $1,728,325, and stock-based compensation of $1,870,779. 

 

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Investing Activities

 

During the six months ended March 31, 2023, investing activities used $5,331 of cash and cash equivalents, consisting entirely of purchases of property, equipment and construction in progress.

 

During the six months ended March 31, 2022, investing activities used $4,012,703 of cash and cash equivalents, consisting primarily of $3,235,125 in purchases of property, equipment and construction in progress, the purchase of a dispensary license in the amount of $1,130,872 and cash paid to acquisition escrow accounts of $381,932, offset by $794,807 of cash received from the escrow deposit accounts. 

 

Financing Activities

 

During the six months ended March 31, 2023, financing activities provided $1,052,900, consisting of $1,585,000 in proceeds from the issuance of debt and offset by $532,100 of debt payments made.

 

During the six months ended March 31, 2022, financing activities provided $2,289,559, consisting of $3,980,762 in proceeds from the issuance of debt, $288,841 in proceeds from the issuance of stock and offset by $1,944,294 in debt payments made.

 

Given that our cash needs are strongly driven by our growth requirements, we also intend to maintain a cash reserve for other risk contingencies that may arise.

 

We intend to meet our cash requirements for the next 12 months through the use of the cash we have on hand and through business operations, future equity financing, debt financing, or other sources, which may result in further dilution in the equity ownership of our shares. We are also in discussions with various potential capital partners to provide additional debt capital for accretive acquisitions. We do not have any other arrangements in place to complete any private placement financings of debt and equity. There is no assurance that we will be successful in finding a capital partner to provide additional debt capital or any other such financings on terms that will be acceptable to us.

 

Off-Balance Sheet Arrangements

 

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

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of our condensed consolidated financial statements requires us to make estimates and judgements that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. Critical accounting policies and estimates in these condensed consolidated financial statements are those related to revenue recognition, valuation of options, warrants and debt discounts, carrying value of intangible assets subject to amortization, infinite life intangible assets and goodwill, stock-based compensation, and income taxes. We base our estimates on historical experience, our observance of trends in particular areas, and information or valuations and various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying value of assets and liabilities that may not be readily apparent from other sources. Actual amounts could differ significantly from amounts previously estimated. For a discussion of our critical accounting policies, refer to Part I, item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended September 30, 2022. Management believes that there have been no material changes in our critical accounting policies during the three months ended March 31, 2023.

 

Recently Issued Accounting Pronouncements

 

See Note 1 to our condensed consolidated financial statements, included in Part I, Item 1, Financial Information for this quarterly report on Form 10-Q.

 

 

Contractual Obligations

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by our company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management carried out an evaluation under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act"). Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2023.

 

 

Identified Material Weaknesses

 

A material weakness in our internal control over financial reporting is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.

 

Management identified the following material weaknesses during its assessment of internal controls over financial reporting, which are primarily due to the size of the Company and available resources:

 

	•	lack of properly controlled segregation of duties
	•	lack of risk assessment procedures on internal control to detect financial reporting risks in a timely manner; and
	•	lack of documentation on policies and procedures that are critical to the accomplishment of financial reporting objectives.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting subsequent to the fiscal year ended September 30, 2022, which were identified in connection with our management's evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations of the Effectiveness of Disclosure Controls and Internal Controls

 

 Our management, including our Principal Executive Officer and Principal Financial Officer, does not expect that our disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

 

The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. 

 

 

 

 

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PART II - OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

 

From time to time, the Company may become subject to various legal proceedings that are incidental to the ordinary conduct of its business. Although the Company cannot accurately predict the amount of any liability that may ultimately arise with respect to any of these matters, it makes provision for potential liabilities when it deems them probable and reasonably estimable. These provisions are based on current information and legal advice and may be adjusted from time to time according to developments. See Item 3. Defaults Upon Senior Securities below.

 

 

ITEM 1A.

RISK FACTORS

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Unless otherwise indicated, all of the following sales or issuances of Company securities were conducted under the exemption from registration as provided under Section 4(2) of the Securities Act of 1933 (and also qualified for exemption under 4(5), formerly 4(6) of the Securities Act of 1933, except as noted below). All of the shares issued were issued in transactions not involving a public offering, are considered to be restricted stock as defined in Rule 144 promulgated under the Securities Act of 1933 and stock certificates issued with respect thereto bear legends to that effect.  

 

1.

Quarterly Issuances:

 

The Company issued 337,500 shares of common stock related to debt amendments and 1,348,455 shares of common stock were issued for services during the three months ended March 31, 2023.

 

2.

Subsequent Issuances:

 

Subsequent to March 31, 2023, the Company issued 67,964 shares of common stock for services.

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

On March 30, 2023, Item 9 Labs Corp., a Delaware corporation (the “Company”), and its wholly owned subsidiary, 938287AZ, LLC (“938287AZ”), an Arizona limited liability company (collectively, the Company and 938287AZ are referred to as the “Borrower”), and the Company’s Board of Directors (the “Board”), became aware that Pelorus Fund REIT, LLC, a Delaware limited liability company (“Pelorus”) filed a Notice of Trustee’s Sale on March 16, 2023 (the “Foreclosure”) with respect to that certain Construction Loan and Security Agreement dated as of August 25, 2021 (the “Loan Agreement”) by and between 938287AZ and Pelorus (the “Pelorus Notice”) and the trust deed recorded October 29, 2021. The Company had been in discussions with Pelorus to restructure the loan and to avoid the Foreclosure, but those discussions have not yet resulted in an agreement. As of the date of the filing of this Form 10-Q, none of the Company, the Board or the Company’s management have received any formal notice from Pelorus or any regulatory bodies regarding this Foreclosure.

 

The Company has taken steps to protect its interests in the property, including retaining legal counsel to represent the Company in the Foreclosure, which is set to occur June 16, 2023. The Company is currently evaluating the potential impact of the Foreclosure on its financial statements, liquidity, and operations. The Company will provide additional information as it becomes available.

 

The Company previously disclosed that the Loan Agreement was in default in a Form 10-Q filed with the SEC on February 14, 2023 and Form 10-K for year ended September 30, 2022 filed with the SEC on January 13, 2023, as well as in a Form 8-K on March 7, 2023.

 

The foregoing description of the Loan Agreement is not complete and is qualified in its entirety by reference to the full text of the Loan Agreement, a copy of which was filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 31, 2021, which report is incorporated herein by reference.  The Company is not aware of any other foreclosure actions involving the Company or any of its subsidiaries.

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

N/A.

 

 

ITEM 5.

OTHER INFORMATION

 

N/A.

  

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ITEM 6.

EXHIBITS

 

The exhibits required to be filed herewith by Item 601 of Regulation S-K, as described in the following index of exhibits, are attached hereto unless otherwise indicated as being incorporated by reference, as follows:

 

	Exhibit
	Number		Description of Exhibit
	3.01a		Articles of Incorporation dated June 15, 2010		Filed with the SEC on May 12, 2011 as part of our Registration Statement on Form S-1/A.
	3.01b		Certificate of Amendment to Articles of Incorporation dated October 22, 2012		Filed with the SEC on November 13, 2012 as part of our Current Report on Form 8-K
	3.01c		Certificate of Amendment to Articles of Incorporation dated March 15, 2018		Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
	3.01d		Certificate of Amendment to Articles of Incorporation dated March 19, 2018		Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
	3.01e		Certificate of Amendment to Articles of Incorporation dated April 3, 2018		Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
	3.01f		Certificate of Amendment to Articles of Incorporation dated October  9, 2018		Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
	3.02		Bylaws		Filed with the SEC on May 12, 2011 as part of our Registration Statement on Form S-1/A.
	31.01		Certification of Principal Executive Officer Pursuant to Rule 13a-14		Filed herewith.
	31.02		Certification of Principal Financial Officer Pursuant to Rule 13a-14		Filed herewith.
	32.01		CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act		Filed herewith.
	32.02		CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act		Filed herewith.
	101.INS*		Inline XBRL Instance Document		Filed herewith.
	101.SCH*		Inline XBRL Taxonomy Extension Schema Document		Filed herewith.
	101.CAL*		Inline XBRL Taxonomy Extension Calculation Linkbase Document		Filed herewith.
	101.LAB*		Inline XBRL Taxonomy Extension Labels Linkbase Document		Filed herewith.
	101.PRE*		Inline XBRL Taxonomy Extension Presentation Linkbase Document		Filed herewith.
	101.DEF*		Inline XBRL Taxonomy Extension Definition Linkbase Document		Filed herewith.
	104*		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

 

 

 

 

*Pursuant to Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Item 9 Labs Corp.
Date: May 22, 2023	By:	/s/ Douglas Bowden
	Name: Title:	Douglas Bowden Interim Chief Executive Officer (Principal Executive Officer)

 

 

Date: May 22, 2023	By:	/s/ Robert Mikkelsen
	Name: Title:	Robert Mikkelsen Chief Financial Officer (Principal Financial Officer)

 

 

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