NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(
UNAUDITED
)
NOTE 1 NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Kush Bottles, Inc. (the Company) was incorporated in the state of Nevada on February 26, 2014. The Company specializes in the wholesale distribution of packaging supplies for the cannabis industry. The Companys wholly owned subsidiary Kim International Corporation (KIM), a California corporation, was originally incorporated as Hy Gro Economics Corporation ("Hy Gro") on December 2, 2010. On October 30, 2012, Hy Gro amended its articles of incorporation to reflect a name change to KIM International Corporation (KIM).
Recapitalization
On March 4, 2014, the shareholders of KIM exchanged all 10,000 of their common shares for 32,400,000 common shares of Kush Bottles, Inc. The operations of KIM became the operations of Kush after the share exchange and accordingly the transaction is accounted for as a recapitalization of KIM whereby the historical financial statements of KIM are presented as the historical financial statements of the combined entity.
Subsequent to the share exchange, the members of KIM owned 32,400,000 of shares of Companys common stock, effectively obtaining operational and management control of Kush. Kush had no operations prior to the share exchange. As a result of the recapitalization, KIM was the acquiring entity in accordance with ASC 805, Business Combinations. The accumulated losses of KIM were carried forward after the completion of the share exchange. Operations prior to the share exchange were those of KIM.
All reference to common stock shares and per share amounts have been restated to effect the recapitalization which occurred on March 4, 2014.
Acquisition of CMP Wellness, LLC
On May 1, 2017, the Company entered into an agreeement of merger agreement with Lancer West Enterprises, Inc, a California corporation, Walnut Ventures, a California corporation, Jason Manasse, an individual, and Theodore Nicols, an individual, pursuant to which each of Lancer West Enterprises, Inc and Walnut Ventures were merged with and into Merger Sub, with Merger Sub as the surviving corporation, resulting in the Companys indirect acquisition of CMP Wellness, LLC, a California limited liability company, which prior to the merger, was owned 100% by Lancer West Enterprises, Inc and Walnut Ventures. CMP Wellness, LLC is a distributor of vaporizers, cartridges and accessories.
The acquisition was accounted for using the acquisition method of accounting in accordance with ASC 805, Business Combinations.
The purchase price payable to Jason Manasse and Theodore Nicols at the closing of the merger in exchange for consummating the merger was comprised of an aggregate of $1,500,000 in cash, unsecured promissory notes in the aggregate principal amount of approximately $770,820, having a one-year maturity, and an aggregate of 7,800,000 restricted shares of the Companys common stock. The purchase price is subject to customary post-closing adjustments with respect to confirmation of the levels of working capital and cash held by CMP Wellness, LLC as of the closing. During the one year period following the closing, Jason Manasse and Theodore Nicols may become entitled to receive up to an additional approximately $1,905,000 in cash, in the aggregate, and approximately 4,740,960 shares of common stock of the Company, in the aggregate, based on the future performance of CMP Wellness, LLC (See Note 2).
7
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements and related notes include the activity of the Company and its wholly owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. All intercompany balances and transactions have been eliminated. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Our operating results for the three and nine month periods ended May 31, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ended August 31, 2017, or for any other period. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the Companys audited consolidated financial statements and accompanying notes for the fiscal year ended August 31, 2016.
The condensed consolidated balance sheet as of August 31, 2016 included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP. There have been no changes to our significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended August 31, 2016 that have had a material impact on our condensed consolidated financial statements and related notes.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Segments
The Company operates as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker, who is the chief executive officer, in deciding how to allocate resources and assessing performance. Over the past few years, the Company has completed a number of acquisitions. These acquisitions have allowed the Company to expand its offerings, presence and reach in various market segments. While the Company has offerings in multiple geographic locations for its products for the cannabis industry, including as a result of the Company's acquisitions, the Companys business operates in one operating segment because the majority of the Company's offerings operate similarly, and
the Companys chief operating decision maker evaluates the Companys financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.
Cash and Cash Equivalents
The Company considers cash and cash equivalents to consist of cash on hand and investments having an orginal maturity of 90 days or less that are readily convertible into cash. As of May 31, 2017 and August 31, 2016, the Company had $726,692 and $1,027,003, respectively.
Accounts Receivable
Trade accounts receivable are carried at their estimated collectible amounts. Trade credit is generally extended on a short-term basis, thus trade receivables do not bear interest. Trade accounts receivables are periodically evaluated for collectability based on past credit history and their current financial condition. The Companys allowance for doubtful accounts was $2,000 as of May 31, 2017 and August 31, 2016, respectively.
Inventory
Inventories are stated at the lower of cost or net realizable value using the first-in first out (FIFO) method. The Companys inventory consists of finished goods of $3,130,246 and $1,142,458 as of
May 31, 2017
and August 31, 2016, respectively.
8
Property and Equipment
Property and equipment is recorded at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, after the asset is placed in service. Asset lives range from 3 to 7 years. Gains and losses from the retirement or disposition of property and equipment are included in operations in the period incurred. Maintenance and repairs are expensed as incurred.
Fair Value of Financial Instruments
The fair value of certain of our financial instruments, including cash and cash equivalents, receivables, other current assets, accounts payable, accrued compensation and employee benefits, other accrued liabilities and notes payable, approximate their carrying amounts because of the short-term maturity of these instruments.
Concentration of Risk
The Companys financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, and accounts receivable. Collateral is not required for accounts receivable. The Company maintains an allowance for its doubtful accounts receivable. This allowance is based upon historical loss patterns, the number of days that billings are past due and an evaluation of the potential risk of loss associated with delinquent accounts. Receivables are written-off and charged against its recorded allowance when the Company has exhausted collection efforts without success.
Intangible Assets acquired through Business Combinations
Intangible assets that have a definite life are amortized over their estimated useful lives and intangible assets with an indefinite life are assessed for impairment at least annually. Each period, the Company evaluates the estimated remaining useful life of its intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization.
Impairment Assessment
The Company evaluates intangible assets and long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. This includes but is not limited to significant adverse changes in business climate, market conditions, or other events that indicate an asset's carrying amount may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate. If the undiscounted cash flows used in the test for recoverability are less than the carrying amount of these assets, the carrying amount of such assets is reduced to fair value. The Company evaluates and tests the recoverability of its goodwill for impairment at least annually during its fourth quarter of each fiscal year or more often if and when circumstances indicate that goodwill may not be recoverable. There was no impairment of intangible assets, long-lived assets or goodwill during the three and nine months ended May 31, 2017 and 2016.
9
Business Combinations
The Company uses its best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. The Companys estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed, with the corresponding offset to goodwill. In addition, uncertain tax positions and tax-related valuation allowances are initially established in connection with a business combination as of the acquisition date. The Company continues to collect information and reevaluates these estimates and assumptions quarterly and records any adjustments to the Companys preliminary estimates to goodwill provided that the Company is within the measurement period. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Companys condensed consolidated statements of operations.
Earnings (Loss) Per Share
The Company computes net loss per share under Accounting Standards Codification subtopic 260-10, "Earnings per Share" (ASC 260-10). Basic net income (loss) per common share is computed by dividing net loss by the weighted average number of shares of common stock. Diluted net loss per share is computed using the weighted average number of common and common stock equivalent shares outstanding during the period.
Basic earnings per share are computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are computed by dividing net earnings by the sum of (a) the weighted average number of shares of common stock outstanding during the period and (b) the potentially dilutive securities outstanding during the period. Stock options are the only potentially dilutive securities; and the number of dilutive options is computed using the treasury stock method.
The following table sets forth the calculation of basic and diluted earnings per share:
|
|
|
|
|
|
|
Three months ended
|
|
Nine months ended
|
|
May 31,
|
May 31,
|
|
May 31,
|
May 31,
|
|
2017
|
2016
|
|
2017
|
2016
|
Net income (loss)
|
$
6,119
|
$
23,284
|
|
$
(151,545)
|
$
39,981
|
Weighted average common shares outstanding for
|
|
|
|
|
|
basic EPS
|
51,805,930
|
46,525,540
|
|
50,458,416
|
46,667,750
|
Net effect of dilutive options
|
1,528,302
|
1,052,787
|
|
-
|
1,052,787
|
Weighted average common shares outstanding for
|
|
|
|
|
|
diluted EPS
|
53,334,232
|
47,578,327
|
|
50,458,416
|
47,720,537
|
Basic earnings (loss) per share
|
$
0.00
|
$
0.00
|
|
$
(0.00)
|
$
0.00
|
Diluted earnings (loss) per share
|
$
0.00
|
$
0.00
|
|
$
(0.00)
|
$
0.00
|
Comprehensive Income (loss)
Comprehensive income (loss) is the change in the Companys equity (net assets) during each period from transactions and other events and circumstances from non-owner sources. During the quarters ended May 31, 2017 and 2016, the Company had no elements of comprehensive income or loss.
10
Revenue Recognition
It is the Companys policy that revenues from product sales is recognized in accordance with ASC 605 "Revenue Recognition". Four basic criteria must be met before revenue can be recognized; (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on managements judgments regarding fixed nature in selling prices of the products delivered and the collectability of those amounts. The Company has not implemented any specific rebate programs. Provisions for discounts to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. During the three month period ended May 31, 2017 and 2016, we had provisions for sales discounts of $40,806 and $25,203, respectively. The Company has not established a formal customer incentive program, but considers and accomodates discounts to certain customers on a case by case basis, including by way of example, for volume shipping or for certain new customers with orders over a specific discretionary dollar threshold.
As of May 31, 2017 and August 31, 2016, the Company had a refund allowance of $0. Consistent with ASC 605-15-25-1, the Company considers factors such as historical return of products, estimated remaining shelf life, price changes from competitors, and introductions of competing products in establishing a refund allowance. The Company recognizes revenues as risk and title to products transfers to the customer (which generally occurs at the time shipment is made), the sales price is fixed or determinable, and collectability is reasonably assured. The Company defers any revenue for which the product was not delivered or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or no refund will be required.
Warranty Costs
The Company has not had any historical warranty related expenditures from the sales of its products, which if incurred would result in the return of any defective products by customers.
Share-based Compensation
The Company account for its stock based award in accordance with Accounting Standards Codification subtopic 718-10, "Compensation", which requires fair value measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including restricted stock awards. The Company estimates the fair value of stock using the stock price on the date of the approval of the award. The fair value is then expensed over the requisite service periods of the awards, which is generally the performance period and the related amount is recognized in the consolidated statements of operations.
Advertising
The Company conducts advertising for the promotion of its products and services. In accordance with ASC Topic 720-35-25, advertising costs are charged to operations when incurred.
Income Taxes
The Company accounts for income taxes in accordance with accounting guidance now codified as FASB ASC 740, "Income Taxes," which requires that the Company recognize deferred tax liabilities and assets based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit (expense) results from the change in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all deferred tax assets will not be realized.
11
The Company applies the provisions of ASC 740, "Accounting for Uncertainty in Income Taxes". The ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements. The ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The ASC provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company did not identify any material uncertain tax positions on returns that have been filed or that will be filed. The Company did not recognize any interest or penalties for unrecognized tax benefits during the three and nine months ended May 31, 2017 and the fiscal year ended August 31, 2016, nor were any interest or penalties accrued as of May 31, 2017 and August 31, 2016.
Fair Value of Financial Instruments
The Company adopted ASC 820 which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under this standard certain assets and liabilities must be measured at fair value, and disclosures are required for items measured at fair value.
The Company currently does not have non-financial assets or non-financial liabilities that are required to be measured at fair value on a recurring basis. The Companys financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels are as follows:
Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. The fair value of the Companys cash is based on quoted prices and therefore classified as Level 1.
Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 - Unobservable inputs that reflect managements assumptions about the assumptions that market participants would use in pricing the asset or liability.
Application of Valuation Hierarchy
A financial instruments categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodology used to measure fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
The Company has a contingent consideration liability of $1,785,375, which consists of contingent cash consideration of $1,735,375 resulting from the acquisition of CMP (Note 2), and $50,000 resulting from the acquisition of a web domain (Note 6). The contingent consideration liability is calculated based on the weighted average probability of meeting certain milestones. This liability is remeasured at each reporting period. The Company had no financial assets or liabilities that are measured at fair value on a recurring basis as of August 31, 2016.
12
The following table summarizes, for assets or liabilities measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement at
Reporting Date Using
|
Description
|
|
May 31, 2017
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Notes payable:
|
|
|
|
|
|
|
|
|
Contingent consideration liability
|
|
$
|
1,785,375
|
|
|
$
-
|
|
|
|
|
1,785,375
|
|
|
$
-
|
|
|
|
The Company classifies its contingent consideration liability within Level 2 as the valuation inputs are based on quoted market prices and market observable data. During the three months ended May 31, 2017, the Company did not recognize any change in the fair value of its contingent consideration liability of $1,785,375 from its inception date of May 1, 2017 and May 3, 2017.
Recently Issued Accounting Pronouncements
In January 2017, the FASB issued Accounting Standards Update No. 2017-04,
Simplifying the Test for Goodwill Impairment
("ASU 2017-04"). ASU 2017-04 simplifies the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. ASU 2017-04 is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019, and should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not anticipate the adoption of ASU 2017-04 will have a material impact on its consolidated financial statements.
In January 2017, the FASB issued Accounting Standards Update No. 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business
(ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. This guidance will be effective for the Company in the first fiscal quarter of 2018 on a prospective basis, and early adoption is permitted. The Company does not expect the standard to have a material impact on our consolidated financial statements.
In August, 2016, the FASB issued Accounting Standards Update No. 2016-15,
Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)
(ASU 2016-15). The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under ASC Topic 230,
Statement of Cash Flows
. The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. The Company has not yet completed the analysis of how adopting this guidance will affect its consolidated financial statements.
13
In May 2016, accounting guidance was issued to clarify the not yet effective revenue recognition guidance issued in May 2014. This additional guidance does not change the core principle of the revenue recognition guidance issued in May 2014, rather, it provides clarification of accounting for collections of sales taxes as well as recognition of revenue (i) associated with contract modifications, (ii) for noncash consideration, and (iii) based on the collectability of the consideration from the customer. The guidance also specifies when a contract should be considered completed for purposes of applying the transition guidance. The effective date and transition requirements for this guidance are the same as the effective date and transition requirements for the guidance previously issued in 2014, which is effective for interim and annual periods beginning on or after December 15, 2017.
The new standard also permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The Companys management currently anticipates adopting the standard using the modified retrospective method. While management is still in the process of completing the analysis on the impact this guidance will have on the Companys consolidated financial statements, related disclosures, and its internal controls over financial reporting.
The Company has not yet determined whether the impact that this new guidance will be material to its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
CompensationStock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. The amendments in this update change existing guidance related to accounting for employee share-based payments affecting the income tax consequences of awards, classification of awards as equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the potential impact of the adoption of this standard
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the consolidated balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the consolidated income statement. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the potential impact of the adoption of this standard.
In January 2016, the FASB issued ASU 2016-01,
Recognition and Measurement of Financial Assets and Financial Liabilities
. The amendments in this update revise the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The amendments are effective for annual reporting periods after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the potential impact of the adoption of this standard.
Other Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures
14
NOTE 2 ACQUISITION OF CMP WELLNESS, LLC
On May 1, 2017 (Merger Date), the Company and KBCMP, Inc., a Delaware corporation and newly formed wholly-owned subsidiary of the Company (Merger Sub), entered into an Agreement of Merger (the Merger Agreement) with Lancer West Enterprises, Inc, a California corporation and Walnut Ventures, a California corporation, pursuant to which each of Lancer West Enterprises, Inc and Walnut Ventures were merged with and into Merger Sub, with Merger Sub as the surviving corporation, resulting in the Companys indirect acquisition of CMP Wellness, LLC (CMP), a California limited liability company, which prior to the merger, was owned 100% by Lancer West Enterprises, Inc and Walnut Ventures. Membership interest in CMP was the sole and only asset of Lancer West Enterprises, Inc and Walnut Ventures. As a result, CMP became a wholly-owned subsidiary of the Company. CMP is a distributor of vaporizers, cartridges and accessories.
The Companys Directors believed the acquisition of CMP and the product offerings of CMP leveraged the Companys existing product development program and provided the Company with the possibility of generating near term revenue and operating cash flow, as well as establishing a commercial platform whereby other cannabis industry-support products may be accessed in the future. Going forward, the existing product offering and other product licensing opportunities, will be the basis of the Company's long-term product portfolio.
The acquisition consideration consisted of a cash payment of $1,500,000, unsecured promissory notes in the aggregate principal amount of approximately $770,820, having a one-year maturity, and an aggregate of 7,800,000 restricted shares of the Companys common stock (equal to 13% of the Companys common stock outstanding as of May 31, 2017). During the one-year period following the closing, the two sellers of CMP may become entitled to receive up to an additional $1,905,000 in cash, in the aggregate, and 4,740,960 shares of common stock of the Company, in the aggregate, based on the gross profit generated by CMP for the period from May 1, 2017 to April 30, 2018. Per the terms of the Merger Agreement, post-closing adjustments to CMPs working capital is directly offset to the unsecured promissory notes payable. Management has estimated that the preliminary post-closing working capital adjustments amounted to $110,604, which management estimates will result in a decrease of the unsecured promissory notes payable from $770,820 to $660,216. In accordance with ASC 805, management has evaluated the estimated fair value of the contingent consideration based a probability-weighted assessment of the occurrence of CMP reaching certain gross profit earnout targets. The Company recorded a contingent liability for the contingent cash consideration of $1,735,375 and recorded contingent equity consideration of $10,763,760. The fair value of the contingent equity consideration is recorded in additional paid in capital.
The acquisition is accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification Topic 805, Business Combinations (ASC 805). As such, CMPs assets acquired and liabilities assumed are recorded at their acquisition-date fair values.
The results of operations of CMP were consolidated beginning on the date of the merger.
Acquisition-related transaction costs are not included as a component of consideration transferred, but are accounted for as an expense in the period in which the costs are incurred. Any excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed is allocated to goodwill.
Pursuant to ASC 805, the contingent consideration was recorded at its estimated fair value as of the acquisition date. The subsequent accounting for contingent consideration depends on whether the contingent consideration is classified as a liability or equity. The portion of contingent consideration classified as equity is not remeasured in subsequent accounting periods. However, contingent consideration classified as a liability is remeasured to its fair value at the end of each reporting period and the change in fair value is reflected in income or expense during that period. Any changes within the measurement period resulting from facts and circumstances that existed as of the acquisition date may result in retrospective adjustments to the provisional amounts recorded at the acquisition date.
15
The equity consideration received by CMP members was calculated based on the negotiated price per share of common stock of the Company of $2.50, which approximated the quoted market price on the acquisition date. The contingent equity consideration was also calculated based on the negotiated price per share of common stock of the Company of $2.50, which approximated the quoted market price. The total preliminary acquisition consideration used in preparing the unaudited condensed consolidated financial statements is as follows:
|
|
Acquisition Consideration:
|
|
Cash
|
$
1,500,000
|
Fair value of common shares issued to CMP members
|
19,500,000
|
Promissory notes
|
660,216
|
Estimated fair value contingent cash consideration
|
1,735,375
|
Estimated fair value contingent equity consideration
|
10,763,760
|
Total estimated acquisition consideration
|
$
34,159,351
|
As of May 31, 2017, the Company has not revised the initial probability-weighted assessment of the contingent consideration. In accordance with the provisions of FASB ASC 805, the following table presents the preliminary allocation of the total fair value of consideration transferred, as discussed above, to the acquired tangible and intangible assets and assumed liabilities of CMP Wellness based on their estimated fair values as of the closing date of the transaction, measurement period adjustments recorded since that date and the adjusted allocation of the total fair value:
|
|
|
|
|
|
|
May 1, 2017
|
|
Measurement Period
|
|
May 31, 2017
|
|
(As initially reported)
|
|
Adjustments (1)
|
|
(As adjusted)
|
Accounts receivable
|
$
735,513
|
|
$
-
|
|
$
735,513
|
Inventory
|
655,970
|
|
-
|
|
655,970
|
Prepaid expenses
|
206,874
|
|
-
|
|
206,874
|
Fixed assets
|
1,737
|
|
-
|
|
1,737
|
Deposits
|
6,261
|
|
-
|
|
6,261
|
Accounts payable and accrued liabilities
|
(105,124)
|
|
-
|
|
(105,124)
|
Total identifiable net assets
|
1,501,231
|
|
-
|
|
1,501,231
|
Goodwill
|
32,658,120
|
|
-
|
|
32,658,120
|
Total fair value of consideration
|
$
34,159,351
|
|
$
-
|
|
$
34,159,351
|
|
|
(1)
|
The measurement period adjustments may be recorded for a period of 12 months following the acquisition date and will primarily reflect changes in the fair value of the consideration transferred. The measurement period adjustments will be made to reflect facts and circumstances existing as of the merger date and did not result from intervening events subsequent to the merger date.
|
Pro Forma Impact of the CMP Wellness, LLC Acquisition
The following unaudited summary pro forma financial information for the three and nine months ended May 31, 2017 and 2016 has been presented for illustrative purposes only and does not purport to represent what the Companys results of operations would have been if the acquisition had occurred as presented, or to project the Companys results of operations for any future periods. The pro forma financial information was prepared assuming the acquisition occurred as of September 1, 2015. The pro forma adjustments are based on available information and certain assumptions that management believes are reasonable, including those pertaining to revenue, operating expenses, income taxes, and depreciation expense.
16
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
For the Nine Months Ended
|
|
|
|
May 31,
|
|
May 31,
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenues
|
$
7,117,612
|
|
$
3,068,973
|
|
$
17,035,227
|
|
$
7,773,438
|
Income from operations
|
552,623
|
|
121,666
|
|
1,151,462
|
|
445,347
|
Net income
|
774,214
|
|
116,396
|
|
1,583,245
|
|
427,415
|
|
|
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
|
Basic
|
|
$
0.01
|
|
$
0.00
|
|
$
0.03
|
|
$
0.01
|
Diluted
|
$
0.01
|
|
$
0.00
|
|
$
0.03
|
|
$
0.01
|
NOTE 3 CONCENTRATIONS OF RISK
Supplier Concentrations
The Company purchases inventory from various suppliers and manufacturers. For the nine months ended May 31, 2017 and 2016, two vendors accounted for approximately 22% and 32%, respectively, of total inventory purchases.
Customer Concentrations
During the nine months ended May 31, 2017 and 2016, there were no customers which represented over 10% of the Companys revenues.
NOTE 4 RELATED-PARTY TRANSACTIONS
The Company leases its California and Colorado facilities from related parties. During the nine months ended May 31, 2017 and 2016, the Company made rent payments of $152,100 and $127,800, respectively, to these related parties.
NOTE 5 PROPERTY AND EQUIPMENT
The major classes of fixed assets consist of the following as of May 31, 2017 and August 31, 2016:
|
|
|
|
|
May 31,
|
|
August 31,
|
|
2017
|
|
2016
|
Machinery and equipment
|
$
848,684
|
|
$
147,577
|
Vehicles
|
144,845
|
|
116,592
|
Office Equipment
|
100,285
|
|
71,507
|
Leasehold improvements
|
71,545
|
|
63,323
|
|
1,165,359
|
|
398,999
|
Accumulated Depreciation
|
(236,876)
|
|
(125,402)
|
|
$
928,483
|
|
$
273,597
|
Depreciation expense was $124,393 and $58,278, for the nine months ended May 31, 2017 and 2016, respectively.
17
NOTE 6 INTANGIBLE ASSETS
On May 3, 2017, the Company acquired a web domain and $26,716 of inventory from RUB Acquisition, LLC (Seller) in exchange for cash consideration of $150,000 and 200,000 restricted shares of the Companys common stock.
During the one-year period following the closing, the Seller may become entitled to receive up to an additional $100,000 in cash and 400,000 shares of common stock of the Company if certain contingent milestones are achieved.
The Company accounted for the contingent consideration based upon a probability-weighted assessment of the occurrence of triggering events outlined in the asset purchase agreement.
The Company recorded a contingent liability for the contingent cash consideration of $50,000 and recorded contingent equity consideration of $466,000. The fair value of the contingent equity consideration is recorded in additional paid in capital.
The fair value of the equity consideration issued at closing and the fair value of the contingent equity consideration was based on the closing price of the Companys stock on May 3, 2017, which was $2.33.
The total preliminary asset acquisition consideration used in preparing the unaudited condensed consolidated financial statements is as follows:
|
|
Asset Acquisition Consideration:
|
|
Cash
|
$
150,000
|
Fair value of common shares issued to seller
|
466,000
|
Estimated fair value contingent cash consideration
|
50,000
|
Estimated fair value contingent equity consideration
|
466,000
|
Total estimated acquisition consideration
|
$
1,132,000
|
The following table summarizes the allocation of the fair values of the assets acquired:
|
|
Inventory
|
$
26,716
|
Finite-lived intangible assets:
|
|
Domain name
|
1,105,284
|
Net assets acquired
|
1,132,000
|
Total fair value of consideration
|
$
1,132,000
|
The Company determined that the web domain has an estimated useful life of five (5) years. Accordingly, amortization expense of $18,421 was recorded for the three-month period ended May 31, 2017 and is included in depreciation and amortization expense on the unaudited condensed consolidated statements of operations.
NOTE 7 ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
|
|
|
|
|
May 31,
|
|
August 31,
|
|
2017
|
|
2016
|
Customer deposits
|
$
302,450
|
|
$
260,409
|
Accrued compensation
|
139,003
|
|
178,769
|
Credit card liabilities
|
141,875
|
|
67,813
|
Deferred rent
|
27,286
|
|
18,810
|
Sales tax payable
|
20,197
|
|
23,300
|
Other accrued expenses
|
13,626
|
|
-
|
|
$
644,437
|
|
$
549,101
|
18
NOTE 8 NOTES PAYABLE
As partial consideration for the acquisition of CMP, the Company issued the sellers unsecured promissory notes totaling $770,820. Management has estimated that the preliminary post-closing working capital adjustments amounted to $110,604, which management estimates will result in a decrease of the unsecured promissory notes payable from $770,820 to $660,216. The promissory notes mature on May 1, 2018 and bear interest at an annual rate of 1.15%. The notes and accrued and unpaid interest are payable in quarterly installments beginning August 1, 2017. The principal balance of $660,216 is recognized in the current portion of notes payable in the consolidated balance sheet as of May 31, 2017.
The estimated contingent cash consideration of $50,000 for the web domain acquisition, and the contingent cash consideration of $1,735,375 for the CMP acquisition is included in long-term notes payable on the consolidated balance sheet as of May 31, 2017.
NOTE 9 STOCKHOLDERS' EQUITY
Preferred Stock
The authorized preferred stock is 10,000,000 shares with a par value of $0.001. As of May 31, 2017 and August 31, 2016, the Company has no shares of preferred stock issued or outstanding.
Common Stock
The authorized common stock is 265,000,000 shares with a par value of $0.001. As of May 31, 2017 and August 31, 2016, 58,280,739 and 48,300,162 shares were issued and outstanding, respectively.
During the nine months ended May 31, 2017, the Company sold 1,766,250 shares of its common stock to investors in exchange for cash of $3,009,897.
Share-based Compensation
The Company recorded stock compensation expense of $522,226 and $60,100 for the nine month periods ended May 31, 2017 and 2016, respectively, in connection with the issuance of shares of common stock and options to purchase common stock.
During the nine month period ended May 31, 2017, the Company issued 163,770 shares of common stock to consultants in exchange for $211,531 of services rendered and $169,955 of prepaid services, for a total of $381,486. The $211,531 of services rendered is included in stock compensation expense on the condensed consolidated statements of operations for the nine month period ended May 31, 2017. The $169,955 of prepaid services is included in prepaid expenses and other current assets on the condensed consolidated balance sheet as of May 31, 2017.
19
Stock Options
The Company estimates the fair value of share-based compensation utilizing the Black-Scholes option pricing model, which is dependent upon several variables such as the expected option term, expected volatility of our stock price over the expected option term, expected risk-free interest rate over the expected option term, expected dividend yield rate over the expected option term, and an estimate of expected forfeiture rates. The Company believes this valuation methodology is appropriate for estimating the fair value of stock options granted to employees and directors which are subject to ASC Topic 718 requirements. These amounts are estimates and thus may not be reflective of actual future results, nor amounts ultimately realized by recipients of these grants. The Company recognizes compensation on a straight-line basis over the requisite service period for each award. The following table summarizes the assumptions the Company utilized to record compensation expense for stock options granted during the nine months ended
May 31, 2017
and 2016:
|
|
|
|
|
May 31, 2017
|
|
May 31, 2016
|
Expected term (years)
|
1-4
|
|
4
|
Expected volatility
|
60%
|
|
60%
|
Weighted-average volatility
|
60%
|
|
60%
|
Risk-free interest rate
|
0.85%-1.57%
|
|
1.20%
|
Dividend yield
|
0%
|
|
0%
|
Expected forfeiture rate
|
33%
|
|
33%
|
The expected life is computed using the simplified method, which is the average of the vesting term and the contractual term. The expected volatility is based on management's analysis of historical volatility for comparable companies. The risk-free interest rate is based on the U.S. Treasury yields with terms equivalent to the expected term of the related option at the time of the grant. While the Company believes these estimates are reasonable, the compensation expense recorded would increase if the expected life was increased, a higher expected volatility was used, or if the expected dividend yield increased.
During the nine months ended May 31, 2017 and 2016, the Company issued 2,940,000 and 520,000 stock options, respectively, pursuant to the Companys 2016 Stock Incentive Plan, which was adopted on February 9, 2016. A summary of the Companys stock option activity during the nine month period ended May 31, 2017 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
|
|
Average
|
|
Remaining
|
|
Aggregate
|
|
No. of
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
Options
|
|
Price
|
|
Term
|
|
Value
|
Balance Outstanding, August 31, 2016
|
2,039,000
|
|
$
0.57
|
|
5.41 years
|
|
$
2,283,680
|
Granted
|
2,940,000
|
|
$
2.36
|
|
9.75 years
|
|
-
|
Exercised
|
(57,500)
|
|
$
1.07
|
|
-
|
|
-
|
Forfeited
|
(226,500)
|
|
$
1.12
|
|
-
|
|
-
|
Balance Outstanding, May 31, 2017
|
4,695,000
|
|
$
1.66
|
|
7.91 years
|
|
$
2,544,265
|
Exercisable, May 31, 2017
|
1,493,576
|
|
$
0.46
|
|
4.13 years
|
|
$
2,593,725
|
The weighted-average grant-date fair value of options granted during the nine months ended
May 31, 2017 and 2016
, was $0.96 and $0.46, respectively. The weighted-average grant-date fair value of options forfeited during the nine months ended
May 31, 2017
was $0.51.
During the nine months ended May 31, 2017, the Company issued 40,000 shares of common stock in exchange for $44,000, pursuant to stock option exercises. In addition, the Company issued 10,557 shares of common stock pursuant to cashless exercises of 17,500 stock options.
20
A summary of the status of the Companys non-vested options as of August 31, 2016, and changes during the nine month period ended May 31, 2017, is presented below:
|
|
|
|
|
|
|
Weighted
|
|
|
|
Average
|
|
No. of
|
|
Grant-Date
|
|
Options
|
|
Fair Value
|
Nonvested at August 31, 2016
|
909,000
|
|
$
221,227
|
Granted
|
2,940,000
|
|
1,887,590
|
Vested
|
(421,076)
|
|
(205,076)
|
Forfeited
|
(226,500)
|
|
(76,817)
|
Nonvested at May 31, 2017
|
3,201,424
|
|
$
1,826,924
|
As of May 31, 2017, there was $1,826,924 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.9 years. The total fair value of shares vested during the nine month period May 31, 2017 is $310,859. This amount is included in stock compensation expense on the consolidated statements of operations.
NOTE 10 COMMITMENTS AND CONTINGENCIES
Lease
The Companys corporate head-quarters and primary distribution center is located in Santa Ana, California. In August 2017, the Companys Santa Ana lease will be terminated and the Company will move its corporate headquarters from Santa Ana, California to Garden Grove, California. The new California facility lease expires on August 1, 2022 and requires escalating monthly payments that range between $24,480 and $28,379. As part of the acquisition of CMP on May 1, 2017, the Company assumed the lease for CMPs facility located in Lawndale, California. The lease expires in January 2019, and requires escalating monthly payments that range between $4,031 and $4,143. On April 1, 2016, the Company entered into a new sublease agreement for a facility located in Woodinville, Washington. The lease commenced on July 15, 2016 and expires on January 31, 2020, and requires escalating monthly payments that range between $14,985 and $16,022. Effective April 10, 2015, the Company assumed the facility lease in Denver, Colorado, which is the headquarters of operations for its wholly-owned subsidiary, Dank. On September 1, 2016, the Colorado facility lease was amended to include additional office space. The lease runs through March 31, 2020 and requires escalating monthly payments, ranging between $4,800 and $7,300. During the nine months ended May 31, 2017 and 2016, the Company recognized $288,789 and $153,625, respectively, of rental expense, related to its office, retail and warehouse space.
Minimum future commitments under non-cancelable operating leases and other obligations were as follows:
|
|
Year ended August 31,
|
|
2017
|
$
108,418
|
2018
|
613,718
|
2019
|
601,102
|
2020
|
444,420
|
2021
|
322,604
|
Thereafter
|
332,278
|
|
$
2,422,540
|
Other Commitments
In the ordinary course of business, the Company may enter into contractual purchase obligations and other agreements that are legally binding and specify certain minimum payment terms. The Company had no such agreements as of
May 31, 2017
.
21
Litigation
The Company may be subject to legal proceedings and claims which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity. The Company had no pending legal proceedings or claims as of
May 31, 2017
.
NOTE 11 SUBSEQUENT EVENTS
Subsequent to
May 31, 2017
and through the date of this filing, there were no material subsequent events.
22