Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary
Statements
This
Form 10-Q contains financial projections and other “forward-looking statements,” as that term is used in federal securities
laws, about Grapefruit’s financial condition, results of operations and business. These statements include, among others,
statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements
may be made expressly in this Form 10-K. You can find many of these statements by looking for words such as “believes,”
“expects,” “anticipates,” “estimates,” or similar expressions used in this Form 10-K. These
forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be
materially different from any future results expressed or implied by us in those statements. The most important facts that could
prevent us from achieving our stated goals include, but are not limited to, the following:
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(a)
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volatility
or decline of our stock price;
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(b)
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potential
fluctuation in quarterly results;
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(c)
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our
failure to earn revenues or profits;
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(d)
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inadequate
capital to continue the business and barriers to raising the additional capital or to obtaining the financing needed to implement
our business plans;
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(e)
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failure
to make sales;
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(f)
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changes
in demand for our products and services;
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(g)
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rapid
and significant changes in markets;
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(h)
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litigation
with or legal claims and allegations by outside parties, causing us to incur substantial losses and expenses;
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(i)
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insufficient
revenues to cover operating costs;
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(j)
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dilution
in the ownership of the Company through the issuance by us of additional securities and the conversion of outstanding warrants,
notes and other securities;
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We
cannot assure that we will be profitable. We may not be able to develop, manage or market our products and services successfully.
We may not be able to attract or retain qualified executives and technology personnel. We may not be able to obtain customers
for our products or services. Our products and services may become obsolete. Government regulation may hinder our business. Additional
dilution in outstanding stock ownership will be incurred due to the issuance or exercise of more shares, warrants and other convertible
securities.
Because
the statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by
the forward-looking statements. We caution you not to place undue reliance on the statements, which speak only as of the date
of this Form 10-Q. The cautionary statements contained or referred to in this section should be considered in connection with
any subsequent written or oral forward-looking statements that we or persons acting on our behalf may make. We do not undertake
any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking
statements to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.
The
following discussion should be read in conjunction with our financial statements and notes to those statements. In addition to
historical information, the following discussion and other parts of this annual report contain forward-looking information that
involves risks and uncertainties.
Current
Overview
This
Form 10-Q is Grapefruit’s first regular report filed with the SEC since its reverse acquisition of IGNG on July 10, 2019.
Accordingly, to assist the reader to better understand Management’s Discussion and Analysis of Financial Condition and Results
of Operations, the following information about our business is provided.
Our
Company
Imaging3,
Inc. (OTCQB: IGNG) was incorporated on October 29, 1993 as Imaging Services, Inc. in the state of California. IGNG filed a certificate
of amendment of articles of incorporation to change its name to Imaging3, Inc. on August 20, 2002. From August 2002 until March
2019, IGNG was a development stage medical device company specializing in the development of a portable, proprietary, X-ray imaging
technology designed to produce 3D images in real time. IGNG’s devices were designed to operate flexibly to serve varying
imaging applications with less radiation exposure in a lower cost, lower weight and easily transportable format that does not
require specialized power sources when compared to currently available 3D imaging devices. IGNG was unable to raise sufficient
capital to commercialize its imaging technology. IGNG re-domiciled in Delaware by means of a merger of IGNG with and into the
IGNG’s wholly-owned subsidiary, Imaging3, Inc., a Delaware corporation (“IGNG-DE”) in March of 2018.
Share
Exchange
IGNG
began discussions with Grapefruit Boulevard Investments, Inc., a California corporation, on March 1, 2019, regarding the possible
reverse acquisition of IGNG by Grapefruit.
On
March 11, 2019, IGNG signed a non-binding letter of intent (“LOI”) to be acquired in a reverse acquisition via a share
exchange agreement to be completed at some later date (the “Acquisition”) by Grapefruit. Grapefruit holds licenses
issued by the State of California to manufacture and distribute cannabis products in California. Grapefruit commenced operations
in mid-2018 and has received more than $450,000 in revenue from operations since Grapefruit own and operate a manufacturing plant
and distribution center within the Coachillin’ Industrial Cultivation and Ancillary Canna Business Park in Desert Hot Springs
near Palm Springs in Riverside County, California (the “Coachillin Site”). On Thursday, March 7, 2019 Grapefruit obtained
its final permit and clearance from local authorities to commence operation of an ethanol extraction laboratory (the “Extraction
Lab”) at the Coachillin site and commenced extraction and post-production processing operations. The Extraction Lab is expected
to be able to produce both THC and CBD oils from either Biomass or unrefined biomass or crude oil.
Pursuant
to the terms of the LOI, IGNG and Grapefruit initiated negotiations intended to result in completion of a definitive Share Exchange
Agreement (the “Exchange Agreement”) encompassing all of the material terms of the Exchange Agreement during the second
quarter of 2019. Pursuant to the terms of the LOI, the Exchange Agreement provided, among other things, that upon conclusion of
the Acquisition, Grapefruit’s designees would own 81% of the then outstanding common shares of the Company and the Company’s
current shareholders would own 19% of such outstanding common shares. In addition, IGNG was required to settle certain outstanding
creditor obligations on terms acceptable to both Grapefruit and IGNG.
On
July 10, 2019, IGNG effectuated a Share Exchange pursuant to that certain Exchange Agreement. On the Closing Date, IGNG issued
to the Stakeholders an aggregate of three hundred sixty-two million, two hundred, twenty-nine thousand, one hundred and one (362,979,114)
newly issued shares of Common Stock of the Company, $0.001 par value, in exchange for 100% of the shares of Grapefruit’s
common stock. As a result, thereof, Grapefruit became a wholly owned subsidiary of IGNG.
By
early June 2019, the Company had shifted its focus to manufacturing cannabis distillates and edibles and distribution of such
cannabis products.
The
Company is now focused on becoming a premier manufacturer and distributor of legal cannabis products in California. We will distribute
our own branded product lines as well as product produced by other manufacturers. We will continue to service the wholesale cannabis
marketplace by selling bulk Honey THC Oil, Flower and Trim to manufactures and other distributors throughout California. We will
also offer our expert cannabis advice to others in connection with their branding, compliance, packaging, extraction, edible manufacturing
and distribution logistics efforts.
The
Auctus Financing
In
addition to focusing the Company’s operations on execution of Grapefruit’s cannabis product business plan, the Company
is taking those steps necessary to complete its financing plan (the “Financing”) set forth in its Securities Purchase
Agreement (the “SPA”) and related documents entered into between the Company and Auctus Fund, LLC “Auctus”)
by which, subject to certain conditions precedent, Auctus is obligated to purchase up to $4,000,000.00 of Convertible Notes (the
“Notes”) to be issued by the Company to Auctus and to exercise up to $6,200,000.00 of common stock purchase warrants
(the “Warrants”) to be issued to Auctus by the Company pursuant to the SPA. Grapefruit has received $1.6 million of
gross proceeds as of September 30, 2019 and expects to receive an additional $2.0 million by the end of the year.
Industry
Overview
Global
consumer spending on legal cannabis in 2018 showed a growth rate of 20 percent in sales of cannabis in regulated markets. Cannabis
sales are on track to increase 36 percent to $14.9 billion in 2019 and reach $40 billion by 2024 according to the “State
of Legal Cannabis Markets” Report released by Arcview Market Research and BDS Analytics. This report points to growth in
the cannabis markets while underlining the challenges that face the sector. The “Total Cannabinoid Market” (“TCM”)
in the United States, which includes medical and recreational cannabis sales in regulated dispensaries, plus sales of FDA-approved
pharmaceuticals and hemp-based CBD products.
Most
notably, in 2018 the U.S. Food and Drug Administration (FDA) approved GW Pharmaceutical’s Epidiolex and passed the 2018
Farm Bill legalizing hemp and cannabidiol oil derived from hemp as long as it contained less than 0.3% THC. According to State
of Legal Cannabis Markets, 7th Edition, by Arcview Market Research and BDS Analytics, the 2018 Farm Bill allows pharmacies, extraction
labs, and general retailers to sell CBD-based products in all 50 states, which is expected to enhance the TCM. In the U.S. alone,
sales of CBD products in all channels are expected to reach $20 billion by 2024.
In
2018 the legal cannabis industry experienced one of its slowest annual expansion rates since Colorado launched the adult-use era
in 2014.
In
California, its legal spending on cannabis fell, from $3 billion in 2017 to $2.5 billion, in the year in which it implemented
an adult-use regulatory regime. A key takeaway from the California market is that highly restrictive regulations and high tax
rates are hurting the legal market’s ability to compete with the illicit market. The barriers to enter into the legal cannabis
market are also increasing in California because its temporary cannabis licensing scheme has ended. Currently any license applicant
must now wait a protracted amount of time before the applicant receives its license and must wait a year in some cases for the
application to make its way through the local and state licensing authorities.
According
to the “State of Legal Cannabis Markets” Report, other key trends in the United States Legal Cannabis Markets include:
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Total
legal cannabis spending in regulated dispensaries in the U.S. topped $9.8 billion in 2018, and is forecast to grow to $30
billion in 2024, a compound annual growth rate (CAGR) of 20 percent.
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Investment
capital raised by cannabis companies more than quadrupled to $14 billion in 2018, according to Viridian Capital Advisors.
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Despite
a 55 percent decline in 2018 in New Cannabis Ventures’ Global Cannabis Stock Index, the five largest Canadian licensed
producers closed the first quarter of 2019 at a combined market capitalization of $48 billion.
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A
total of 13 state markets will have passed the $1 billion mark in total annual legal cannabis spending by the end of 2024—by
the end of 2018, only three had done so (California, Colorado and Washington).
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Grapefruit’s
Competitive Advantage in the Industry
Grapefruit
holds its State of California provisional licensing from the Bureau of Cannabis Control and the California Department of Public
Health. The Company has its permanent annually renewable provisional license as opposed to a temporary license. The Company expects
the annual renewal to be a non-intrusive and scaled down as opposed to what the renewal process was previously. The Company is
one of the earliest registered distribution companies with the State of California to have an annually renewable license as opposed
to the temporary licenses previously granted. In January 2019, the State of California revised its cannabis regulations to restrict
the ability of companies to become licensed businesses.
California
has three distinct regulatory agencies that govern the issuance of cultivation licenses, manufacturing licenses and distribution
licenses. In order to foster the then-nascent commercial cannabis industry, the State of California initially allowed each regulatory
agency to grant temporary licensing to companies with very minimal regulatory requirements and oversight. In fact, a new or then-existing
cannabis company only had to show State Regulators that their local city was allowing their commercial cannabis business to operate
which was an uncomplicated task. A temporary license was a conditional license that allowed a cannabis business to engage in commercial
cannabis activity for a period of 120 days. The State granted operators 90-day extensions of their temporary license while final
cannabis regulations were being developed and officially implemented by the State.
On
January 1, 2019, the State of California eliminated the temporary cannabis licensing scheme. The impact of this regulatory restriction
prevents all new cannabis companies from starting their operations without first applying for, and obtaining, a provisional license
from the appropriate regulatory agency. The same regulatory restriction prevents existing, but unregulated, cannabis companies
from continuing to engage in commercial cannabis operations without shutting down while applying for, and obtaining, an annual
license from the appropriate regulatory agency. The elimination of the temporary license scheme significantly thinned out the
number of commercial cannabis businesses operating in the State. This was due to the regulatory requirements required to apply
for an annual license which include compliance with the California Environmental Quality Act, provision of a Hazardous Waste Disposal
Plan and the multitude of other regulatory requirements to operate a compliant cannabis business.
The
regulatory changes have impacted the ability of new businesses to enter the marketplace and compete with Grapefruit. However,
none of Grapefruit’s commercial cannabis businesses have been impacted by the regulatory changes to the marketplace.
Grapefruit
owns two acres of fully entitled cannabis real property located in the Coachillin’ Industrial Cultivation and Ancillary
Canna-Business Park. Grapefruit understood the State’s regulatory burdens and expense for commercial cannabis businesses
to successfully operate. For example, the State requires cannabis business to provide 24 hour-per-day on-site armed security for
their facility. This is a shared expense of the property Coachillin property owners. In addition, Coachillin property owners pay
agricultural power rates of nine (9) cents per kilowatt hour which is significantly less than what others pay for power. The location
within Coachillin allows the Company to apply for and hold every cannabis license available under the California Cannabis laws.
Grapefruit
intends on building out the real property into a distribution, manufacturing and high-tech cultivation facility to further its
goal to become a seed to sale, fully vertically integrated Cannabis and CBD product Company.
Grapefruit’s plans include an indoor 22,000 square foot multi-tiered canopy and adjoining tissue culture rooms. The canopy
is estimated to produce thousands of pounds of the highest quality indoor cultivars of cannabis annually.
The
Coachillin’ property owners’ association, which Grapefruit is a part of, will feature a unique drive through retail
cannabis dispensary right off highway 10 on the way to Coachella and Palm Springs. Grapefruit will have the right to sell its
cannabis products directly to the public through the drive through dispensary. Coachillin’ will also feature a cannabis
hotel and music stadium and other visitor areas. By
Grapefruit locating in Coachillin, the company gains instant exposure to thousands of hotel guests and other cannabis visitors
that will visit the Coachillin’ cannabis friendly resort over time. Grapefruit believes that the canna-tourism industry
will mature to be similar to the wine industry and can capitalize on this industry by virtue of its location within the Canna-business
park.
Distribution
Grapefruit
initially obtained its California wholesale recreational and medicinal cannabis distribution license on January 4, 2018. Thereafter,
Grapefruit met all of its ongoing regulatory requirements and filed its application for an annual distribution license. In May
2019, Grapefruit was granted its provisional distribution license, thereby acquiring the regulatory foundation necessary to expand
its distribution business. From July 2018 through the first quarter of 2019, Grapefruit used its distribution license to sell
bulk cannabis flowers and trim to other distributors and to manufacturers to satisfy their own raw materials requirements. In
addition, Grapefruit sold flowers, vape cartridges and concentrates to licensed retailers throughout California.
In
California, cannabis cultivators and manufactures are prohibited from selling their products – e.g., flowers or edibles
- directly into the marketplace. These companies are required to use a licensed distributor, such as Grapefruit. Grapefruit’s
distribution license affords it a twofold strategic advantage: first, to market and sell its own cannabis product lines to retailers
throughout California; and second to buy and resell bulk cannabis oil, flower and trim as an unfettered middleman to any properly
licensed customer anywhere in California that it identifies a profit opportunity.
Additionally,
after marijuana plants are mature, they’re harvested within a certain time frame to keep the product fresh. Throughout the
growth cycle and during this specific time period after the plant has been harvested, a grower will trim the plant of its leaves,
focusing mostly on the remaining buds. Specifically speaking, trim is defined as the excess snipping of leaves from buds of marijuana
plants. Note that leftover product can still be used to make extractions, tinctures, hash and edibles, so growers and trimmers
alike can always increase sales with a larger product offering.
Manufacturing
The
Company owns a fully licensed ethanol extraction facility in the City of Desert Hot Springs, CA. The Company owns and operates
a Type 6 Ethanol Extraction Plant which removes the essential cannabis compounds, such as THC Distillate, that we, and others
use, to produce cannabis products.
Grapefruit’s
extraction lab produces high quality distillate or “Honey Oil” from trim that Grapefruit sources utilizing its distribution
license as set forth above. THC Honey Oil is a fundamental cannabis commodity which serves as the active ingredient in products
from infused edibles to tinctures/creams to the cartridges used in vapes or e-cigarettes. Honey Oil sells in the wholesale marketplace
at approximately $6,250 to $8,800.00 per liter. Pricing is dependent on quantity purchased as well as other market factors such
as the availability and cost of the underlying trim – the raw cannabis material from which Grapefruit produces oil. Grapefruit
began extraction operations in May 2019. Plans are in place to expand production through the purchase of additional extraction
equipment which we expect will to allow the lab to produce two (2) to four (4) liters per day of finished Honey Oil by the end
of 2019. Grapefruit chose to set up its extraction laboratory in the City of Desert Hot Springs because the City does not tax
the manufacture of oil by Grapefruit at its Desert Hot Springs extraction facility, thereby providing Grapefruit with an additional
competitive advantage.
THC
Distillate is an all-purpose product that is used in the manufacture of everything from cannabis edibles to “e-cigarette”
vape carts to tinctures, to creams and pre-rolled cannabis “joints”. We sell our distillate in California to companies
that manufacturer their own product lines of edibles and/or vape cards. We also intend to use our own Distillate to produce our
branded line of edibles and vape carts to allow us to control the quality of our product lines. We also manufacture marijuana
cigarettes (which we market as pre-rolls) for sale into the retail marketplace. This manufacturing process is streamlined through
the use of machinery and our employees who inspect each marijuana cigarette to ensure quality control. We have partnered with
different manufactures in California to manufacture our line of branded products we intend to distribute and/or sell into the
marketplace. We do not restrict our needs to a single manufacturer or distribution company as we maintain ongoing relationships
with Tier 1 vendors across the cannabis eco-system.
Branding
We
package and brand cannabis products. . One of the key elements to our branding strategy is performing an analysis on a product’s
competitor(s) currently in the retail space and working to make our product stand out. We work on pricing strategies, boutique
branding elements and other ways to differentiate when shelf space gets limited and retailers slow down on taking certain product
classes.
Sugar
Stoned
Grapefruit
acquired the Sugar Stoned® brand in the winter of 2018 for use through the winter
of 2021. We began the manufacturing process and research and development process for our
products immediately, and recently began to sell and distribute Sugar Stoned branded products throughout California. Retail cannabis
product consumers can purchase Sugar Stoned infused gummies that have been tested and are certified to be pesticide and heavy
metal free by a third-party laboratory before being released at retail. Sugar Stoned brand is now a Grapefruit portfolio
brand consisting of a premium quality cannabis infused gummy line with eight different flavors: Blue Raspberry, Cherry, Grape,
Peach, Pineapple, Sour Apple, Strawberry and Watermelon.
Rainbow
Dreams
Grapefruit
recently launched a new life-style brand designed specifically for the recreational cannabis marketplace called “Rainbow
Dreams.” The Rainbow Dreams brand captures the “anything goes party vibe” of the 1970s by offering an array
of cannabis products such as a line of vape cartridges with unique cannabis strains combined with all natural flavors for a no-burn
experience compared to the traditional or earlier generation cartridges which burn at much higher temperatures and provide the
user with a burning sensation when inhaling. Rainbow Dreams fills a niche in the marketplace – a top shelf quality product
line that we expect to be competitively priced. We are currently developing THC and CBD infused gummies and mints which expect
to incorporate into the Rainbow Dreams product line and make available for sale by the end of 2019.
We
are also in the process of preparing to introduce several cannabis infused offerings and a new line of THC and CBD vaporizer cartridges
in the third quarter of 2019.
Intellectual
Property
The
Company expects to file trademark requests with the State of California in the first quarter of 2020 relating to some of the Company’s
brands and products.
The
Company currently maintains a portfolio of trade secrets relating to the formulas for its CBD gummies, vaporization cartridges
and oils.
Tolling
We
expect to enter into toll processing agreements by which cultivators will provide us with their dried biomass (i.e., Trim) which
we then process at our extraction facility into finished distillate. In exchange, we provide 50% of the finished product to the
cultivator. The cultivator is free to use our distribution service to sell their finished product or transfer the finished product
to another distributor.
Packaging
We
provide packaging services to re-integrate formally unlicensed products back into the legal marketplace. The space on packaging
is limited due to compliance laws. We spend a significant amount of time working out these issues in a pre-production phase. Our
goal is to keep a brand’s original design work while complying with al the government regulations. We devote serious efforts
to re-brand an unlicensed product to quickly and efficiently re-integrate it into the retail space.
Marketing
and Sales
We
have retained employees with cannabis-related experience in product manufacturing, branding, marketing and retail sales in the
State of California. We have a strategic relationship with a full service traditional and digital marketing agency that will promote
our company and products. We have a multi-pronged approach to marketing our Company and its branded product lines: (1) social
media – including Instagram, Facebook and Twitter; (2) influencers who are expected to promote our branded products directly
to recreational cannabis users; (3) attendance at specific industry events that are designed to promote our company to both macro
and micro targeted audiences; (4) targeted radio advertising designed to reach the recreational marketplace and static marketing
(e.g., well placed bill board advertising); and (5) use of our sales force for the personal touch required to obtain shelf-space
in all recreational and medicinal dispensaries.
The
Company employs inside salespersons for retail, and outside sales people for wholesale purchases. Additionally, the Company
maintains an online digital platform where customers may purchase the Company’s products.
Sources
and Availability of Raw Materials; Principal Suppliers
In
general, raw materials essential to our business are readily available from multiple sources. So far, we have been able to source
the materials required to manufacture our THC Distillate as well as our edibles and vape cartridges. Our products use both non-cannabis
and cannabis raw materials. We have the entire United States for the sourcing non-cannabis raw materials – such as terpenes,
which are the compounds from plant extracts that provide the unique flavor profile in cannabis products, and cells, which are
the industry standard vaporization carts. The California cannabis marketplace is diverse, and we have developed the relationships
with other companies to ensure the consistent availability of the raw materials.
Because
we have no direct control over these suppliers, interruptions or delays in the products and services provided by these parties
may be difficult to remedy in a timely fashion. In addition, if such suppliers are unable or unwilling to deliver the necessary
products or raw materials, we may be unable to redesign or adapt our technology to work without such raw materials or products
or find alternative suppliers or manufacturers. In such events, we could experience interruptions, delays, increased costs or
quality control problems, or be unable to sell the applicable products, all of which could have a significant adverse impact on
our revenue.
Competition
The
cannabis industry is subject to significant competition and pricing pressures. We may experience significant competitive pricing
pressures as well as competitive products and services providers. Several significant competitors may offer products and/or services
with prices that may match or are lower than ours. We believe that the products and services we offer are generally competitive
with those offered by other cannabis companies. It is possible that one or more of our competitors could develop a significant
research advantage over us that allows them to provide superior products or pricing, which could put us at a competitive disadvantage.
Continued pricing pressure or improvements in research and shifts in customer preferences away from natural supplements could
adversely impact our customer base or pricing structure and have a material and adverse effect on our business, financial condition,
results of operations and cash flows.
Additionally,
CBD is a naturally occurring cannabinoid constituent of cannabis. It was discovered in 1940 and is known to exhibit neuroprotective
properties in many experimental systems. However, development of CBD as a drug has been confounded by the following: 1) low potency;
2) a large number of molecular targets; 3) marginal pharmacokinetic properties; and 4) designation as a schedule 1 controlled
substance. We view that companies specializing in the sale, distribution and manufacturing of CBD based products as some of our
stronger competitors based on recent laws and regulatory schemes.
Government
Approvals and Regulations
The
formulation, manufacturing, processing, labeling, packaging, advertising and distribution of our products are subject to regulation
by several federal agencies, including the Food and Drug Administration (“FDA”), the Federal Trade Commission (“FTC”),
the Consumer Product Safety Commission, the U.S. Department of Agriculture (“USDA”) and the Environmental Protection
Agency (“EPA”). These activities are also regulated by various agencies of the states and localities in which our
products are sold. The FDA regulates the processing, formulation, safety, manufacture, packaging, labeling and distribution of
dietary supplements (including vitamins, minerals, and herbs) and cosmetics, whereas the FTC has jurisdiction to regulate the
advertising of these products.
The
FDA’s Good Manufacturing Practices (“GMP”) regulations require dietary supplements to be prepared, packaged
and held in compliance with strict rules, and require quality control provisions similar to those in the GMP regulations for drugs.
The FDA could in the future choose to inspect one of our facilities for compliance with these regulations and could cause non-compliant
products made or held in the facility to be subject to FDA enforcement actions.
The
FDA has broad authority to enforce the provisions of the FDCA and their regulation of foods, dietary supplements and cosmetics
may increase or become more restrictive in the future. Additional legislation could be passed which would impose substantial new
regulatory requirements for dietary supplements, potentially raising our costs and hindering our business.
Our
advertising is subject to regulation by the Federal Trade Commission, or FTC, under the Federal Trade Commission Act. In recent
years the FTC has initiated numerous investigations of dietary supplement and weight loss products and companies. Additionally,
some states also permit advertising and labeling laws to be enforced by private attorney generals, who may seek relief for consumers,
seek class action certifications, seek class wide damages and product recalls of products sold by us. Any of these types of adverse
actions against us by governmental authorities or private litigants could have a material adverse effect on our business, financial
condition and results of operations.
In
addition to FDA and FTC regulations, our products may face further regulation under the Single Convention on Narcotic Drugs 1961,
which governs international trade and domestic control of narcotic substances including cannabis extracts. Countries may interpret
and implement their treaty obligations in a way that creates a legal obstacle to our obtaining marketing approval for our products
in those countries. These countries may not be willing or able to amend or otherwise modify their laws and regulations to permit
our products to be marketed, or achieving such amendments to the laws and regulations may take a prolonged period of time. In
the case of countries with similar obstacles, we would be unable to market our product candidates in countries in the near future
or perhaps at all if the laws and regulations in those countries do not change.
Additionally,
the Company is also subject to California law regarding dissemination of information via advertising. Mainly, these rules and
regulations relate to directing advertisements to people aged 21 years and older. The type of advertising the Company expects
to conduct and pursue is similar to how alcohol companies direct their advertising and marketing efforts.
Controlled
Substance Regulation
At
some point our products may be developed and be subject to U.S. controlled substance laws and regulations and failure to comply
with these laws and regulations, or the cost of compliance with these laws and regulations, may adversely affect the results of
our business operations, both during clinical development and post approval, and our financial condition.
Certain
products we may develop could contain controlled substances as defined in the federal Controlled Substances Act of 1970, or CSA.
Controlled substances that are pharmaceutical products are subject to a high degree of regulation under the CSA, which establishes,
among other things, certain registration, manufacturing quotas, security, recordkeeping, reporting, import, export and other requirements
administered by the DEA. The DEA classifies controlled substances into five schedules: Schedule I, II, III, IV or V substances.
Schedule I substances by definition have a high potential for abuse, not currently “accepted medical use” in
the United States, lack accepted safety for use under medical supervision, and may not be prescribed, marketed or sold in the
United States. Pharmaceutical products approved for use in the United States may be listed as Schedule II, III, IV or V, with
Schedule II substances considered to present the highest potential for abuse or dependence and Schedule V substances the lowest
relative risk of abuse among such substances. Schedule I and II drugs are subject to the strictest controls under the CSA, including
manufacturing and procurement quotas, security requirements and criteria for importation. In addition, dispensing of Schedule
II drugs is further restricted. For example, they may not be refilled without a new prescription. We do not intend to produce
“controlled substances” at this time, due to regulatory complications.
Employees
As of September 30, 2019, we had 14 full-time
employees. Grapefruit has 4 employees at its lab facilities. One of the lab employees is responsible for managing onsite operations
at the Warehouse. Grapefruit has a total of 5 inside sales and branding employees as well as 2 employees for operational support.
Finally, the Company has 3 outside salespeople located in Northern California. These salespeople are in charge of
Grapefruit’s bulk flower and trim sales. Our employees are not represented by a labor union or other collective bargaining
groups at this point in time, and we consider relations with our employees to be good. We currently plan to retain and utilize
the services of outside consultants for additional research, testing, regulatory, legal compliance and other services on an as
needed basis.
Properties
We
own approximately two acres of real property located in the Coachillin’ Industrial Cultivation and Ancillary Canna-Business
Park in Desert Hot Springs, located on the extension of North Canyon Rd., approximately 10 miles north of the center of Palm Springs.
We intend on building a fully integrated distribution, manufacturing and cultivation facility to
become a seed to sale, fully vertically integrated Cannabis and CBD product Company.
Additionally,
our cannabis and CBD extraction laboratory and distribution facility are located in the same Canna-Business Park. On September
1, 2018, the Company entered into a three-year lease for approximately 2,268 square feet which commenced on March 1, 2018. Monthly
lease payments are approximately $1,134.
Critical
Accounting Policies
Use
of Estimates – The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates,
assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
as of the date of our financial statements and the reported amounts of revenues and expenses during the periods presented.
We
make our estimate of the ultimate outcome for these items based on historical trends and other information available when our
financial statements are prepared. We recognize changes in estimates in accordance with the accounting rules for the estimate,
which is typically in the period when new information becomes available. We believe that our significant estimates, assumptions
and judgments are reasonable, based upon information available at the time they were made. Our actual results could differ from
these estimates, making it possible that a change in these estimates could occur in the near term. The company’s most significant
estimates related to useful life for depreciation, the value of impaired assets, and provision for income taxes require us to
make judgements that affect the recorded amounts.
Fair
Value of Financial Instruments – We value our financial assets and liabilities using fair value measurements. Fair
value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Assets and liabilities measured at fair value are categorized based on whether
the inputs are observable in the market and the degree that the inputs are observable. The categorization of financial instruments
within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement. The hierarchy
is prioritized into three levels (with Level 3 being the lowest) defined as follows:
Level
1: Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level
2: Observable inputs other than prices included in Level 1, such as quoted prices for similar assets and liabilities in active
markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are
observable or can be corroborated with observable market data.
Level
3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the
assets and liabilities. This includes certain pricing models, discounted cash flow methodologies, and similar techniques that
use significant unobservable inputs.
The
carrying amount of our cash and cash equivalents approximates fair value because of the short-term nature of the instruments.
Investments in non-marketable equity securities are carried at cost less other-than-temporary impairments. The carrying amount
of our notes payable at September 30, 2019, approximates their fair values based on comparable borrowing rates available to the
company.
There
have been no changes in Level 1, Level 2, and Level 3 categorizations and no changes in valuation techniques for these assets
or liabilities for the nine months ended September 30, 2019 and 2018.
Inventory
– Inventory is comprised of raw material, work in process and finished goods. Raw materials consist of biomass of
trim and flower, which is stated at the lower of cost or net realizable value using first-in-first out method of accounting. Work
in process represented crude oil infused with high potency of THC. The cost of the work in process crude oil is recorded at the
lower of average cost or net realizable value based upon an average cost method. The cost of finished goods is recorded at lower
of cost or market.
We
periodically review the value of our inventory and provide a write-down of inventory based on our assessment of the market conditions.
Any write-down is charged to cost of revenues.
Property,
Plant and Equipment, net – Our property and equipment are recorded at cost. Assets held under capital leases are
capitalized at the commencement of the lease at the lower of the present value of minimum lease payments at the inception of the
lease or fair value. Maintenance and repairs are expensed as incurred. Depreciation is computed using the straight-line method
over estimated useful lives of four to seven years, and amortization is computed using the straight-line method over the life
of the applicable lease. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation
are removed from our accounts and any resulting gain or loss is reflected in our consolidated statements of operations.
Land
Improvements – Our land improvements are recorded at cost provided by our property association. These costs will
continue to be capitalized until construction has been completed. Land improvements will not be depreciated after the construction
has been completion by the property association.
Long-Lived
Assets Impairment Assessment – Our long-lived assets are subject to an impairment test if there is an indicator
of impairment. The carrying value and ultimate realization of these assets is dependent upon our estimates of future earnings
and benefits that we expect to generate from their use. If our expectations of future results and cash flows are significantly
diminished, other long-lived assets may be impaired and the resulting charge to operations may be material. When we determine
that the carrying value of intangibles or other long-lived assets may not be recoverable based upon the existence of one or more
indicators of impairment, we use the projected undiscounted cash flow method or realizable value to determine whether an impairment
exists, and then measure the impairment using discounted cash flows.
Revenue
Recognition –
Our
products currently include high quality distillate oil, bulk whole flower, and marijuana cigarettes.
We
recognize revenue as earned when the four revenue recognition criteria have been met, which includes:
i)
Existence of a persuasive evidence of an arrangement;
ii)
Delivery of product to a customer;
iii)
Fixed or determinable sales price; and
iv)
Collection is reasonably assured.
Cost
of Goods Sold –Our cost of goods sold includes the costs directly attributable to revenue recognized and includes
expenses related to the production, packaging and labeling of cannabis products; personnel-related costs, fees for third-party
services, such as testing and transportation costs related to our distribution services.
Research
and Development Expenses – Research and development (“R&D”) costs are charged to expense as incurred.
Our R&D expenses include, but are not limited to, consulting service fees and materials and supplies used in the development
of our proprietary products and services.
General
and Administrative Expenses – General and administrative expenses consist primarily of personnel-related costs,
fees for professional and consulting services, travel costs, rent, bad debt expense, general corporate costs, and other costs
of administration such as human resources, finance and administrative roles.
Income
Taxes – Income tax assets and liabilities are recorded using the asset and liability method. Under the asset and
liability method, tax assets and liabilities are recognized for the tax consequences attributable to differences between financial
statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating loss and
tax credit carryovers. Future tax assets and liabilities are measured using the enacted tax rates expected to apply when the asset
is realized, or the liability settled. The effect on future tax assets and liabilities of a change in tax rates is recognized
in income in the period that enactment occurs. To the extent that we do not consider it more likely than not that a future tax
asset will be recovered, we will provide a valuation allowance against the excess.
We
follow the provisions of ASC 740, Income Taxes. Because of ASC 740, we make a comprehensive review of our portfolio of
tax positions in accordance with recognition standards established by ASC 740.
When
tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities,
while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately
sustained. The benefit of a tax position is recognized in our consolidated financial statements in the period during which, based
on all available evidence, we believe it is more likely than not that the position will be sustained upon examination, including
the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions.
Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that
is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits
associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized
tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable
to the taxing authorities upon examination.
We
have created our tax provision leveraging known tax court cases involving various marijuana dispensaries and other cannabis related
businesses, including the section of the IRS Tax code of 280E. The U.S. Tax Code Section 280E is the federal statute that states
that a business engaging in the trafficking of a Schedule I or II controlled substance, which includes cannabis and cannabis related
products, are barred from taking the tax deductions or credits in their federal tax returns which are not considered as part of
the business’ cost of goods sold. Given the guidance offered by the Tax code 280E we have prepared our tax provision according
to this tax code.
Interest
and penalties associated with unrecognized tax benefits, if any, are classified as interest expense and penalties and are included
in selling, general and administrative expenses in our consolidated statements of operations.
On
December 22, 2017, the U.S. Tax Cuts and Jobs Act was enacted. U.S. tax reform introduced many changes, including lowering the
U.S. corporate tax rate to 21 percent, changes in incentives, provisions to prevent U.S. base erosion and significant changes
in the taxation of international income, including provisions which allow for the repatriation of foreign earnings without U.S.
tax. The enactment of U.S. tax reform had no significant impact on our income taxes for the years ended April 30, 2019 and 2018,
respectively.
Commitments
and Contingencies – Certain conditions may exist as of the date our financial statements are issued, which may result
in a loss, but which will only be resolved when one or more future events occur or fail to occur. We assess such contingent liabilities,
and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings
that are pending against us or unasserted claims that may result in such proceedings, we evaluate the perceived merits of the
legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
If
the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability
can be estimated, the estimated liability would be accrued in our consolidated financial statements. If the assessment indicates
that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated,
then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material,
would be disclosed.
Loss
contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee
would be disclosed.
Net
Loss Per Share – We compute net loss per share in accordance with ASC 260, Earnings per Share. Under the
provisions of ASC 260, basic net loss per share includes no dilution and is computed by dividing the net loss available to common
stockholders for the period by the weighted average number of shares of common stock outstanding during the period. Diluted net
loss per share takes into consideration shares of common stock outstanding (computed under basic net loss per share) and potentially
dilutive securities that are not anti-dilutive.
Cash
and Cash Equivalents – The Company considers all highly liquid investment securities with remaining maturities at
the date of purchase of three months or less to be cash equivalents. Cash equivalents may be invested in money market funds, certificates
of deposit or other interest-bearing accounts.
Concentration
of Credit Risk – Financial instruments that potentially subject us to credit risk consist of cash. We maintain our
cash with high credit quality financial institutions; at times, such balances with any one financial institution may not be insured
by the FDIC.
Accounts
Receivable and Revenue – For the nine months ended September 30, 2019, one customer represented approximately 100%
of the net revenues. The accounts receivable balance was $0 as of September 30, 2019, and December 31, 2018.
Recently
Issued Accounting Pronouncements – From time to time, the FASB or other standards setting bodies issue new accounting
pronouncements. Updates to the FASB ASCs are communicated through issuance of an Accounting Standards Update (“ASU”).
Unless otherwise discussed, we believe that the impact of recently issued guidance, whether adopted or to be adopted in the future,
is not expected to have a material impact on our condensed consolidated financial statements upon adoption.
Recently
Issued Accounting Pronouncements Not Yet Adopted
In
February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes existing guidance on accounting for leases
in “Leases (Topic 840)” and generally requires all leases to be recognized in the consolidated balance sheet. ASU
2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018; early adoption is permitted.
The provisions of ASU 2016-02 are to be applied using a modified retrospective approach. The Company is currently evaluating the
impact ASU 2016-02 will have on its financial statements.
In
August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) — Deferral of the Effective
Date (ASU 2015-14), which defers the effective date of ASU 2014-09 for one year and permits early adoption as early
as the original effective date of ASU 2014-09. The new revenue standard may be applied retrospectively to each prior period presented
or retrospectively with the cumulative effect recognized as of the date of adoption. In 2016, the FASB issued additional guidance
to clarify the implementation guidance (ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent
Considerations; ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and
Licensing; and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical
Expedients). The Company is currently evaluating the impact ASU 2015-14 will have on its financial statements.
In
August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to
the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU 2018-13 removes, modifies and
adds certain disclosure requirements in Topic 820 “Fair Value Measurement”. ASU 2018-13 eliminates certain disclosures
related to transfers and the valuations process, modifies disclosures for investments that are valued based on net asset value,
clarifies the measurement uncertainty disclosure, and requires additional disclosures for Level 3 fair value measurements. ASU
2018-13 is effective for the Company for annual and interim reporting periods beginning July 1, 2020. The Company is currently
evaluating the impact ASU 2018-13 will have on its financial statements.
In
May 2019, the FASB issued ASU 2019-06, Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805),
and Not-for-Profit Entities (Topic 958): Extending the Private Company Accounting Alternatives on Goodwill and Certain Identifiable
Intangible Assets to Not-for-Profit Entities. ASU 2019-06 modifies the testing goodwill for impairment annually and requires
amortization of goodwill over 10 years or less, on a straight-line basis. Testing for impairment is now based upon a triggering
event. ASU is effective as of the date of the pronouncement. The Company is currently evaluating the impact ASU 2019-06 will have
on its financial statements.
Recently
Issued Accounting Pronouncements Adopted
In
March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU affects entities
that issue share-based payment awards to their employees. The ASU is designed to simplify several aspects of accounting for share-based
payment award transactions which include – the income tax consequences, classification of awards as either equity or liabilities,
classification on the statement of cash flows and forfeiture rate calculations. ASU 2016-09 will become effective for the Company
in the first quarter of fiscal 2018.
Other
Accounting Factors
The
effects of inflation have not had a material impact on our operation, nor are they expected to in the immediate future.
Results
of Operations for the Nine Months Ended September 30, 2019 as compared to the Nine Months Ended September 30, 2018.
The
following sets forth selected items from our statements of operations for six months ended September 30, 2019 and for the six
months ended September 30, 2018.
|
|
Nine Months
Ended
September 30, 2019
|
|
|
Nine Months
Ended
September 30, 2018
|
|
Net revenues
|
|
$
|
332,041
|
|
|
$
|
130,880
|
|
Cost of goods sold
|
|
|
543,999
|
|
|
|
130,028
|
|
Gross Profit
|
|
|
(211,958
|
)
|
|
|
852
|
|
Research and development
|
|
|
|
|
|
|
108,794
|
|
General and administrative expenses
|
|
|
959,360
|
|
|
|
123, 019
|
|
Income (loss) from operations
|
|
|
(1,171,318
|
)
|
|
|
(230,961
|
)
|
Total other income (expenses)
|
|
|
(2,396,550
|
)
|
|
|
(87,210
|
)
|
Net loss attributable to noncontrolling interest
|
|
|
(9,468
|
)
|
|
|
-
|
|
Net income (loss)
|
|
$
|
(3,577,336
|
)
|
|
$
|
(318,179
|
)
|
Our initial operations began in August of
2018 and our first sales of our product occurred in July of 2018. In April of 2019 our production facilities in Coachillin’
became fully operational. Revenue for the nine months ended September 30, 2019 was $332,041 compared to $130,880 for the corresponding
period in 2018, an increase of $201,161, or 154%%. The increase was primarily due to increase in sales of bulk trim sales of $324,000
offset by a decrease in distribution services of $88,000 and retail sales of $39,000.
Cost of goods sold for the nine months ended
September 30, 2019 were $543,999 compared to $130,028 for the corresponding period in 2018, an increase of $413,970. The increase
was primarily due to the increase in sales for 2019.
Our resulting gross profit for the nine months
ended September 30, 2019 and 2018 was $(211,988) and $852, respectively, during this initial emerging business ramp in
sales, we used pricing strategies to obtain market penetration. We expect this strategy to continue for the near future while
achieving significantly improved gross margins during 2020.
Our general and administrative expenses for
the nine months ended September 30, 2019 were $959,360 compared to $123,019 for the corresponding period in 2018, The increase
in expense is primarily due to legal and accounting costs associated with Grapefruit becoming a public company.
Other expense for the nine months ended September
30, 2019 primarily reflects the change in value of derivative instruments.
Our resulting net losses for the nine
months ended September 30, 2019 and 2018 were $3,577,336 and $535,759, respectively.
Liquidity and Capital Resources
Our cash position increased to $467,387 as
of September 30, 2019 from $65,922 as of December 31, 2018. The increase in cash was primarily due to the issuance of debt in connection
with the consummation of our Share Exchange Agreement. Our total current assets increased to $845,350 as of September 30, 2019,
from $166,745 as of December 31, 2018. Included in current assets as of September 30, 2019 is $361,597 of raw materials, work in
process, and finished goods inventory which we expect to turn over within the next two quarters.
Our total current liabilities increased to
$4,486,138 as of September 30, 2019 from $767,013 as of December 31, 2018. This increase is primarily due to the liabilities
assumed with Share Exchange agreement transaction.
During the nine months ended September 30,
2019, we used $(1,329.965) of net cash for operating activities, as compared cash provided by operations of $197,067 used during
the nine months ended September 30, 2018. Net cash provided by investing activities during the nine months ended September 30,
2019 was $164,804, as compared to $1,488,202 during the nine months ended September 30, 2018. Net cash provided by financing activities
during the nine months ended September 30, 2019 was $1,518,409, as compared to $1,080,027 during the nine months ended September
30, 2018.
We expect our working capital requirements
in the next twelve months to be met primarily by the proceeds of issuance of debt, convertible instruments and other securities
to our existing creditor, shareholders, and other investors, as well as from cash flow from operations. We expect to need additional
working capital from outside sources to cover our anticipated operating expenses. There is no assurance that the Company will be
able to raise sufficient additional capital or financing to continue in business or to effectively execute its business plan.
Going Concern Qualification
We have incurred significant losses from operations,
and such losses are expected to continue. In their report on our financial statements as of and for the fiscal year ended April
30, 2019, our auditors have expressed substantial doubt about our ability to continue as a going concern. In addition, we have
limited working capital. The foregoing raises substantial doubt about our ability to continue as a going concern. Management’s
plan includes, among other things, by issuance of debt and by seeking additional equity
financing by selling our equity securities. We cannot guarantee that additional capital and/or debt financing will be available
when and to the extent required, or that if available it will be on terms acceptable to us. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty. The “Going Concern Qualification” may make
it substantially more difficult for us to raise capital.
Off-Balance Sheet Arrangements
None.