The accompanying notes are an integral part of these audited consolidated financial statements.
Notes
to Consolidated Financial Statements
1.
Incorporation and operations and Going Concern
Stem
Holdings, Inc. (the “Company”) is a Nevada corporation incorporated on June 7, 2016. The Company purchases, improves,
and leases properties for use in the cannabis production, distribution and sales industry as well as a cultivator providing cannabis
and cannabis-infused products licensed under the laws of the states of Oregon, Nevada, Oklahoma, with six current licenses for
cultivation, three for production, five for processing, one for wholesale and ten dispensary licenses. In addition, the Company
also procured a hemp license under the laws of Oregon. As of September 30, 2018, the Company has acquired 3 commercial properties
and leased a fourth property and has entered into leases to related entities for these four properties (see Note 10). Fiscal
year 2018 saw the near completion of buildout of these properties.
The
Company, through its operating subsidiaries (see below), is currently in the process of finalizing the investment in and acquisition
of entities that engage directly in the production and sale of cannabis, moving from a real estate focused entity with a cannabis
niche to a cannabis focused entity.
As
of September 30, 2018, the Company has incorporated 6 new subsidiaries –Stem Group Oklahoma, Inc., Stem Holdings Florida,
Inc. Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC., and Stem Agri, LLC.
The
Company’s stock is publicly traded and is listed on the Canadian Securities Exchange under the symbol “STEM”
and the OTCQB exchange under the symbol “STMH”.
Going
Concern
These
audited financial statements have been prepared on a going concern basis, which assumes that the Company will be able to realize
its assets and discharge its liabilities in the normal course of business. While the recreational use of cannabis is legal under
the laws of certain States, where the Company is currently finalizing the acquisition of entities or investment in entities that
directly produce or sell cannabis, the use and possession of cannabis is illegal under United States Federal law for any purpose,
by way of Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970, otherwise known as the Controlled Substances
Act of 1970 (the “ACT”). Cannabis is currently included under Schedule 1 of the Act, making it
illegal
to cultivate, sell or otherwise possess in the United States.
On
January 4, 2018 the office of the Attorney General published a memo regarding cannabis enforcement that rescinds directives promulgated
under former President Obama that eased federal enforcement. In a January 8, 2018 memo, Jefferson B. Sessions, then Attorney General
of the United States, indicated enforcement decisions will be left up to the U.S. Attorney’s in their respective states
clearly indicating that the burden is with
“federal prosecutors deciding which cases to prosecute by weighing all relevant
considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime, the deterrent
effect of federal prosecution, and the cumulative impact of particular crimes on the community.” Subsequently, in April
2018, President Trump promised to
support congressional efforts to protect states that have legalized the cultivation, sale
and possession of cannabis, however, a bill has not yet been finalized in order to implement legislation that would, in effect,
make clear the federal government cannot interfere with states that have voted to legalize cannabis. Further in December 2018,
the US Congress passed legislation, which the President signed on December 20, 2018, removing hemp from being included with Cannabis
in Schedule I of the Act.
These
conditions raise substantial doubt as to the Company’s ability to continue as a going concern should it complete its acquisitions
and investments, which it considers likely as of the date of these financial statements. Should the United States Federal Government
choose to begin enforcement of the provisions under the Act, the Company through its wholly owned subsidiaries could be prosecuted
under the Act and the Company may have to immediately cease operations and/or be liquidated upon their closing of the acquisition
or investment in entities that engage directly in the production and or sale of cannabis.
The
financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts,
or amount and classification of liabilities that might result from this uncertainty.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies
Basis
of preparation
The
consolidated balance sheet includes all of the accounts of the Company as of September 30, 2018, presented in accordance with
U.S. generally accepted accounting principles.
Principals
of Consolidation
The
accompanying consolidated financial statements include the accounts of Stem Holdings, Inc. and its wholly-owned subsidiaries,
Stem Group Oklahoma, Inc., Stem Holdings Florida, Inc., Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC., and Stem
Agri, LLC. All material intercompany accounts, transactions, and profits have been eliminated in consolidation. Our wholly owned
subsidiaries had no operations, assets or liabilities as of September 30, 2018.
Revenue
Recognition
The
Company recognizes rental revenue from tenants, including rental abatements, lease incentives and contractual fixed increases
attributable to operating leases, on a straight-line basis over the term of the related leases when collectability is reasonably
assured.
The
Company makes estimates of the collectability of its tenant receivables related to base rents, straight-line rent and other revenues.
In the current fiscal year, the Company began significant rental operations. The Company considers such things as historical bad
debts, tenant creditworthiness, current economic trends, facility operating performance, lease structure, developments relevant
to a tenant’s business, and changes in tenants’ payment patterns in its analysis of accounts receivable and its evaluation
of the adequacy of the allowance for doubtful accounts. Specifically, for straight-line rent receivables, the Company’s
assessment includes an estimation of a tenant’s ability to fulfill its rental obligations over the remaining lease term.
Real
Estate Acquisition Valuation
All
assets acquired and liabilities assumed in an acquisition of real estate are measured at their acquisition date fair values. The
acquisition value of land, building and improvements are included in real estate investments on the accompanying consolidated
balance sheets. Acquisition pursuit costs associated with asset acquisitions are capitalized. The Company has early adopted ASU
2017-01, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating
whether transactions should be accounted for as businesses acquisitions. As a result of early adopting ASU 2017-01, real estate
acquisitions did not meet the definition of a business combination and were deemed asset acquisitions, and the Company therefore
capitalized its acquisition pursuit costs associated with these acquisitions.
Reclassifications
Certain
amounts in the Company’s consolidated financial statements for prior periods have been reclassified to conform to the current
period presentation. These reclassifications have not changed the results of operations of prior periods.
Use
of estimates
The
preparation of these financial statements requires management to make judgments, estimates and assumptions that affect the application
of accounting policies and the reported amounts of assets, liabilities, income and expenses. Estimates and judgments used are
based on management’s experience and the assumptions used are believed to be reasonable given the circumstances that exist
at the time the financial statements are prepared. The significant estimates included in these financial statements are those
associated with the assumptions used to value equity instruments, valuation of its properties for impairment testing and the deferral
of rents. Actual results may differ from these estimates.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies (continued)
Instruments
to Purchase Common Stock and Other Derivative Financial Instruments
We
classify as equity any contracts that require physical settlement or net-share settlement or provide us a choice of net-cash settlement
or settlement in our own shares (physical settlement or net-share settlement) provided that such contracts are indexed to our
own stock. We classify as assets or liabilities any contracts that require net-cash settlement (including a requirement to net
cash settle the contract if an event occurs and if that event is outside our control) or give the counterparty a choice of net-cash
settlement or settlement in shares (physical settlement or net-share settlement). We assess the classification of instruments
issued to purchase our common stock and any other financial instrument at each reporting date to determine whether a change in
classification between assets and liabilities is required.
Cash
and cash equivalents
Cash
and cash equivalents include short-term investments with original maturities of three months or less and are recorded at cost,
which approximates fair market value given the short-term nature.
Concentrations
of Credit Risk
Financial
instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and our
deferred rents. As of September 30, 2018, the Company had deposits in a major financial institution in excess of the FDIC insurance
limit. The Company believes the risk of loss to be minimal as it maintains its cash balances at well capitalized financial institutions.
As of September 30, 2018, the Company had deferrals of rent due to free rent periods of approximately $1.4 million as it completes
the buildout of three of its properties. The Company is currently in the process of acquiring the entities that it currently rents
to and believes as of the date of these financial statements that it will acquire those entities, and because of this, no impairment
testing was performed due to the likelihood of success of that acquisition (see Note X). Should the Company be successful in its
acquisition of the renters, the deferred rental asset will eliminate against the liability held by the affiliates and therefore
no impairment would be necessary. Should the Company fail to acquire its renters in the upcoming fiscal year, then impairment
of the deferred rents could be likely.
Geographical
Concentrations
As
of September 30, 2018, the Company primarily rents to entities engaged in the production and sale of cannabis, which is only legal
for recreational use in 10 states, with lesser legalization, such as for medical use in an additional 21 states, as of the time
of these financial statements.
Carrying
value, recoverability and impairment of long-lived assets
The
Company follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC’)
360 to evaluate its long-lived assets with determinate lives. The Company’s long-lived assets, which include property and
equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Company does not test for impairment in the year of acquisition of properties so long as those properties
are acquired from unrelated third parties.
The
Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated
with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective
carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair
value is generally determined using the assets expected future discounted cash flows or market value, if readily determinable.
If long- lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter
than originally estimated, the net book values of the long-lived assets are depreciated and amortized over the newly determined
remaining estimated useful lives.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies (continued)
Carrying
value, recoverability and impairment of long-lived assets (cont’d)
The
Company considers the following to be some examples of important indicators that may trigger an impairment review: (i) significant
under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant
changes in the manner or use of assets or in the Company’s overall strategy with respect to the manner or use of the acquired
assets or changes in the Company’s overall business strategy; (iii) significant negative industry or economic trends; (iv)
increased competitive pressures; (v) a significant decline in the Company’s stock price for a sustained period of time;
and (vi) regulatory changes. The Company evaluates assets for potential impairment indicators at least annually and more frequently
upon the occurrence of such events.
As
of September 30, 2018, the Company performed its impairment analysis of its properties and determined that based on its valuation
performed for the Mulino Farm project, an impairment in the value of its building and improvements was required, due to the nature
of the property, its location and the specialized improvements the Company added to the property over the course of the fiscal
year ended September 30, 2018. Based on its valuation, the Company has recorded an impairment of $784,000 as of September 30,
2018 (see Note 3) for the Mulino Farm property which is included in general and administrative expenses line item on the Statement
of Operations
Capitalization
of Project Costs
The
Company’s policy is to capitalize all costs that are directly identifiable with a specific property, would be capitalized
if the Company had already acquired the property, and when the property, or an option to acquire the property, is being actively
sought after, and either funds are available or will likely become available in order to exercise their option. All amounts shown
capitalized prior to acquisition of a property are included under the caption of Project Costs in the balance sheet.
Income
Taxes
Income
taxes are provided for the tax effects of transactions reported in the financial statements and consist of currently due plus
deferred taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting carrying amounts
and the respective tax bases of assets and liabilities and are measured using tax rates and laws that are expected to be in effect
when the differences are expected to be recovered or settled. Valuation allowances are provided against deferred tax assets if
it is more likely than not that the deferred tax assets will not be realized.
The
Company follows the guidance of FASB ASC 740-10 which relates to the Accounting for Uncertainty in Income Taxes, which seeks to
reduce the diversity in practice associated with the accounting and reporting for uncertainty in income tax positions. This interpretation
prescribes a comprehensive model for financial statement recognition, measurement, presentation and disclosure of uncertain tax
positions taken or expected to be taken in income tax returns.
Fair
value of financial instruments
As
defined in the authoritative guidance, fair value is 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.
To
estimate fair value, the Company utilizes market data or assumptions that market participants would use in pricing the asset or
liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can
be readily observable, market corroborated or generally unobservable.
The
authoritative guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (“Level 1”
measurements) and the lowest priority to unobservable inputs (“Level 3” measurements). The three levels of the fair
value hierarchy are as follows:
Level
1 — Observable inputs such as quoted prices in active markets at the measurement date for identical, unrestricted assets
or liabilities.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies (continued)
Fair
value of financial instruments (cont’d)
Level
2 — Other inputs that are observable, directly or indirectly, such as quoted prices in markets that are not active, or inputs
which are observable, either directly or indirectly, for substantially the full term of the asset or liability.
Level
3 — Unobservable inputs for which there is little or no market data and which the Company makes its own assumptions about
how market participants would price the assets and liabilities.
In
instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level
input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of
a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset
or liability.
Beneficial
Conversion Feature
The
Company issued convertible notes that have conversion prices that create an embedded beneficial conversion feature on the issuance
date. A beneficial conversion feature exists on the date a convertible note is issued when the fair value of the underlying common
stock to which the note is convertible into is in excess of the remaining unallocated proceeds of the note after first considering
the allocation of a portion of the note proceeds to the fair value of any attached equity instruments, if any related equity instruments
were granted with the debt, on a relative fair market basis. The Company estimates the fair value of its common stock using the
most recent selling price available. The intrinsic value of the beneficial conversion feature is recorded as a debt discount with
a corresponding amount to additional paid-in capital. The debt discount is amortized to interest expense over the life of the
note using the effective interest method.
Earnings
per share
The
Company presents basic and diluted per share amounts (“EPS”) data for its common shares. Basic EPS is calculated by
dividing the profit or loss attributable to common shareholders of the Company by the weighted average number of common shares
outstanding during the period. Diluted loss per share is calculated based on the weighted-average number of outstanding common
shares plus the effect of dilutive potential common shares, using the treasury stock method. The Company’s calculation of
diluted net loss per share excludes potential common shares as of September 30, 2018 as the effect would be anti-dilutive (i.e.
would reduce the loss per share).
As of September 30, 2018, the Company has 4,116,249 shares issuable upon note conversion, options and warrants exercisable into
the common stock of the Company outstanding.
Advertising
Costs
The
Company follows the policy of charging the cost of advertising to expense as incurred. Advertising expense was $ 49,948 for the
twelve months ended September 30, 2018 and $35,557 for the twelve months ended September 30, 2017.
Emerging
Growth Company
The
Company has elected to be an emerging growth company as defined under the Jumpstart Our Business Startups Act of 2012 (“Jobs
Act”). Included with this election, the Company has also elected to use the provisions within the Jobs Act that allow companies
that go public to continue to use the private company adoption date rules for new accounting policies. Should the Company obtain
revenues in excess of $1 billion on an annual basis, have its non-affiliated market capitalization increase to over $700 million
as of the last day of its second quarter, or raise in excess of $1 billion in public offerings of its equity or instruments directly
convertible into its equity, it will forfeit its status under the Jobs Act as an emerging growth company.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies (continued)
Property
and Equipment
Property
and equipment is stated at cost less accumulated depreciation and is depreciated using the straight-line method over the assets’
estimated useful life as follows:
Buildings
|
20 years
|
Leasehold improvements
|
Shorter of term of lease or economic life of improvement
|
Furniture and equipment
|
5 years
|
Signage
|
5 years
|
Software and related
|
5 years
|
Normal
maintenance and repairs for equipment are charged to expense as incurred, while significant improvements are capitalized.
Related
parties
Parties
are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control,
are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company,
its management, members of the immediate families of principal owners of the Company and its management and other parties with
which the Company may deal with if one party controls or can significantly influence the management or operating policies of the
other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.
Recent
Accounting Guidance
On
August 29, 2018, the FASB issued ASU 2018-15
, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s
Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract
(“ASU 2018-15”),
which align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract
with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements
that include an internal use software license). ASU 2018-15 is effective for fiscal years beginning after December 15, 2019 and
interim periods within those fiscal years. Early adoption of the amendments is permitted including adoption in any interim period.
The amendments in ASU 2018-15 should be applied either retrospectively or prospectively to all implementation costs incurred after
the date of adoption. We are currently evaluating the impact of this standard on our consolidated financial statements, including
accounting policies, processes, and systems.
On
August 28, 2018, the FASB issued ASU 2018-13,
Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements
for Fair Value Measurement
(“ASU 2018-13”), which changes the fair value measurement disclosure requirements of
ASC 820. ASU 2018-13 is effective for all entities for fiscal years beginning after December 15, 2019, including interim periods
therein. Early adoption is permitted for any eliminated or modified disclosures upon issuance of ASU 2018-13. We are currently
evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and
systems.
In
June 2018, the FASB issued ASU 2018-07, C
ompensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based
Payment Accounting
(“ASU 2018-07”). ASU 2018-07 expands the guidance in Topic 718 to include share-based payments
for goods and services to non-employees and generally aligns it with the guidance for share-based payments to employees. The amendments
are effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. We are currently
evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and
systems.
In
May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers
. The standard provides companies
with a single model for use in accounting for revenue arising from contracts with customers and will replace most existing revenue
recognition guidance in U.S. GAAP when it becomes effective, including industry-specific revenue guidance. The standard specifically
excludes lease contracts. The ASU allows for the use of either the full or modified retrospective transition method and will be
effective for the Company on October 1, 2019, at which time the Company expects to adopt the updated standard using the modified
retrospective approach. However, as the majority of the Company’s revenue is from rental income related to leases, the ASU
will not have a material impact on the consolidated financial statements. Related disclosures will be provided and/or updated
pursuant to the requirements of the ASU.
In
February 2016, the FASB issued ASU No. 2016-02,
Leases
. The standard amends the existing lease accounting
guidance and requires lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases
that have a duration of one year or less) on their balance sheets. Lessees will continue to recognize lease expense in a
manner similar to current accounting. For lessors, accounting for leases under the new guidance is substantially the same as in
prior periods, but eliminates current real estate-specific provisions and changes the treatment of initial direct costs. Entities
are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest
comparable period presented, with an option to elect certain transition relief. Full retrospective application is prohibited.
The standard will be effective for the Company on October 1, 2020; however, early adoption of the ASU is permitted. While
the Company is currently evaluating the effect that the updated standard will have on our consolidated financial statements and
related disclosures, we expect to adopt the guidance on its effective date, at which time we anticipate recognizing right-of-use
assets and related lease liabilities on our consolidated balance sheets related to ground leases for any communities where we
are the lessee.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
2.
Summary of significant accounting policies (continued)
Recent
Accounting Guidance
In
June 2016, the FASB issued ASU 2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
(“ASU 2016-13”). ASU 2016-13 provides guidance for recognizing credit losses on financial
instruments based on an estimate of current expected credit losses model. The amendments are effective for fiscal years beginning
after December 15, 2019. We are currently evaluating the impact of this standard on our consolidated financial statements, including
accounting policies, processes, and systems.
In
February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
(“ASU 2016-02”). ASU 2016-02 requires that lessees
recognize assets and liabilities for leases with lease terms greater than twelve months in the statement of financial position
and also requires improved disclosures to help users of financial statements better understand the amount, timing and uncertainty
of cash flows arising from leases. The FASB issued subsequent amendments to improve and clarify the implementation guidance of
Topic 842. The amendments are effective for fiscal years beginning after December 15, 2018. We are currently evaluating the impact
of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
In
May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
. The core principle of this
amendment is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount
that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The FASB
issued subsequent amendments to improve and clarify the implementation guidance of Topic 606. This standard is effective for annual
reporting periods beginning after December 15, 2017. We are currently evaluating the impact of this standard on our consolidated
financial statements, including accounting policies, processes, and systems.
3.
Property, Plant & Equipment
At
September 30 property and equipment consisted of the following:
|
|
2018
|
|
|
2017
|
|
Automobile
|
|
$
|
18,275
|
|
|
$
|
18,275
|
|
Signage
|
|
|
19,118
|
|
|
|
19,118
|
|
Furniture and equipment
|
|
|
1,199,303
|
|
|
|
102,890
|
|
Leasehold improvements
|
|
|
2,718,519
|
|
|
|
1,573,044
|
|
Buildings and property improvements
|
|
|
4,719,742
|
|
|
|
1,622,550
|
|
Land
|
|
|
300,000
|
|
|
|
-
|
|
Software and related
|
|
|
58,518
|
|
|
|
52,190
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
9,033,475
|
|
|
|
3,388,067
|
|
|
|
|
|
|
|
|
|
|
Accumulated depreciation and amortization
|
|
|
(708,676
|
)
|
|
|
(129,217
|
)
|
Property, plant and equipment, net
|
|
$
|
8,324,799
|
|
|
$
|
3,258,850
|
|
On
November 1, 2016, the Company acquired certain real property located at 1027 Willamette Street, Eugene, OR 97401 (the “Property”)
for a total cash purchase price plus closing costs of approximately $918,000.
On
February 6, 2017, the Company acquired certain real property located at 7827 SE Powell Blvd, Portland, OR 97206 (the “Property”)
for a total purchase price plus closing costs of approximately $656,498.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
3.
Property, Plant & Equipment (continued)
As
part of the consideration for closing on the property, the Company issued a short term note payable to the seller in the Amount
of approximately $304,000. The note is non-interest bearing and requires four monthly payments of $75,000 plus a final payment
for the remaining amount due immediately thereafter plus fees. Due to the short-term nature of the note, the Company has not imputed
any interest as it would be immaterial to the results for the period.
In
January 2018, the Company acquired certain property located at 14336 South Union Hall Road, Mulino Oregon 97042 for a total purchase
price of approximately $1,555,500 which includes credits issued by the seller for prior rental payments and additional improvements
on the property made by the Company. As part of the consideration for the purchase, the Company issued the seller a note for $1.2
million with a 2% interest rate and monthly payments beginning in July 2018 of $13,500 for a period of 19 months with a final
balloon payment payable in January 2020 of approximately $957,000. The Company did not record a premium to the market rate of
the note as it was immaterial at issuance.
Depreciation, amortization and impairment
expense (see Note 2) was $1,363,460 for the twelve months ended September 30, 2018 and $126,264 for 2017.
4.
Investment in equity method investees
In
April 2018, the Company received a 37.5% interest in NVD RE Corp. (“NVD”) upon its issuance to NVD of a commitment
to contribute $1.275 million to NVD. As of September 30, 2018, the Company had fully funded its commitment. NVD used the funds
provided to date by the Company to acquire an under construction cannabis indoor grow building located near Las Vegas, Nevada
and to continue the buildout of the property. The Company has no further commitment to fund the entity beyond its initial equity
purchase commitment. NVD will lease its facilities upon completion to YMY Ventures, LLC (see Note 5).
For
the period from acquisition through September 30, 2018, NVD had only minimal startup and buildout operations, which were not apportioned
to these financials statements as of September 30, 2018 due to immateriality. As of September 30, 2018, the condensed balance
sheet of NVD is shown below:
Assets
|
|
$
|
1,282,541
|
|
Liabilities
|
|
|
-
|
|
Total equity
|
|
$
|
1,282,541
|
|
5.
Due from Affiliates
In
September 2018, the Company entered into an agreement to acquire 50% of the membership interest of YMY Ventures LLC (“YMY”).
YMY is a startup operation located near Las Vegas, Nevada and owns a license for the production and sale of cannabis.
The purchase price for the 50% interest is $750,000 with the first $375,000 paid into escrow upon signing, with
the final $375,000 due upon closing, which under the agreement occurs when the license is transferred by the Nevada Department
of Taxation and receipt of approval in transfer of ownership by the Division of Public and Behavioral Health of the City
of North Las Vegas. As of September 30, 2018, the Company had funded the $375,000 into escrow and had provided the joint venture
with additional funds primarily in the form of payments for work performed to acquire the license from the Nevada Department of
Taxation in the amount of approximately $201,000. As of September 30, 2018 and the date of these financial statements, neither
the license nor the transfer of membership interest had been issued or approved, however, the Company believes the license and
transfer will be granted in FY 2019. In the event that no license is approved for transfer then the agreement automatically
unwinds and the Company will receive the funds held in escrow and will have a claim for refund against YMY for amounts paid to
obtain the license. Because of the automatic unwinding of the agreement in the event that the license grant or membership transfer
are not approved, which are both outside the control of the Company and YMY, this has not been recorded as an equity method investment
as of September 30, 2018, but as a due from affiliate. In the event of the failure of the license to be transferred,
approximately $201,000 of the Company’s investment is at risk.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
5.
Due from Affiliates (continued)
In
July 2018, the Company entered into an agreement to acquire a 25% interest in East Coast Packers LLC (“ECP”) for the
purchase price of $1.5 million, payable in the amount of $500,000 in cash at closing and a note for $1 million. All amounts are
payable to ECP. At the time of closing, ECP was a dormant Florida LLC, but owned a citrus fruit dealer license active for
the 2015-2016 growing season. This qualified ECP under newly enacted legislation in the state of Florida to apply for a license
to produce and sell medical cannabis. Until such time as ECP is granted a medical cannabis license, the $500,000 paid into ECP
may only be expended by ECP in acquiring a medical cannabis license. As of September 30, 2018 and the date of these financial
statements, no license had been granted, however, the Company believes the license will be issued in FY 2019. In the event that
ECP is unable to obtain the medical license, the agreement unwinds in full, the membership interest is returned to the seller
and all amounts paid in not expended on the acquisition of the license are to be refunded to the Company along with cancellation
of the $1 million note. Because the issuance of the license is outside the control of the Company and ECP and because the agreement
unwinds in full in the event the license is not issued, this has not been recorded as an equity method investment as of September
30, 2018, but as a due from affiliate. In the event of the failure to obtain the license the approximately $500,000 cash
investment is at risk.
6.
Notes Payable and Advances
Equipment
financing
In
November 2017, the Company entered into a promissory note in the amount of $21,749 from a vendor of the Company to finance the
acquisition of a security electronics system in one of its properties. The promissory note bears an interest rate of 18% per annum
and also contains a 10% servicing fee. The note matures 24 months after issuance and is secured by certain security electronics
purchased with proceeds of the note. As of September 30, 2018, the obligation outstanding is $14,950.
Effective
April 29, 2018, the Company entered into a 36-month premium finance agreement in consideration for a John Deere Gator Tractor
in the principal amount of $15,710. The note bears no annual interest rate and requires the Company to make thirty-six monthly
payments of $442 over the term of the note. As of September 30, 2018, the obligation outstanding is $13,717. No amount was recorded
for the premium for the non-interest bearing feature of the note as it was immaterial. The note is secured by the equipment financed.
Effective
May 29, 2018, the Company entered into a 24-month premium finance agreement in consideration for a MT85 wide track loader in the
principal amount of $27,844.00. The note bears no annual interest rate and requires the Company to make 24 monthly payments of
$1,160 over the term of the note. As of September 30, 2018, the obligation outstanding is $24,364. No amount was recorded for
the premium for the non-interest bearing feature of the note as it was immaterial. The note is secured by the equipment financed.
Due
to related parties
As
of September 30, 2018, related parties had advanced cash and equipment, on a due on demand, unsecured and undocumented basis,
to the Company in the amount of $33,600.
Insurance
financing
In
February 2018, the Company entered into a 10-month premium finance agreement in partial consideration for an insurance policy
in the principal amount of $252,445. The note bears an annual interest rate of 5.75% and requires the Company to make ten monthly
payments of $22,105 over the term of the note. As of September 30, 2018, the obligation outstanding is $66,314.
Effective
March 2, 2018, the Company entered into a 10-month premium finance agreement in partial consideration for an insurance policy
in the principal amount of $14,390. The note bears an annual interest rate of 5.75% and requires the Company to make ten monthly
payments of $904 over the term of the note. As of September 30, 2018, the obligation outstanding is $2,712.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
6.
Notes Payable and Advances (continued)
Insurance
financing (cont’d)
Effective
July 31, 2018, the Company entered into a 9-month premium finance agreement in partial consideration for an insurance policy in
the principal amount of $54,701.55. The note bears an annual interest rate of 7.99% and requires the Company to make nine monthly
payments of $4,435 over the term of the note. As of September 30, 2018, the obligation outstanding is $31,047.
Short
term notes and advances
The
Company issued a $100,000 promissory note dated December 7, 2017 to an accredited investor which matured on March 7, 2018 and
has an annual rate of interest at 24%. Both principal and interest is due at maturity. The promissory note ranks senior to all
obligations not designated as a primary obligation by the Company. As an inducement to issue the promissory note, the Company
granted the holder warrants to acquire 20,833 shares of the Company’s common stock. The warrants have an exercise price
of $2.40 per underlying common share and are exercisable for 2 years from the anniversary date of issuance (see Note 6). This
obligation was fully repaid on March 28, 2018.
The
significant assumptions used to value the warrants granted in the twelve months ended September 30, 2018 are as follows:
Fair value of underlying common shares
|
|
$
|
2.40
|
|
Exercise price
|
|
$
|
2.40
|
|
Dividend yield
|
|
|
-
|
|
Historical volatility
|
|
|
181.4
|
%
|
Risk free interest rate
|
|
|
1.47
|
%
|
In
September 2018, an investor interested in the then ongoing private placement of convertible notes (see below) advanced the Company
$168,000 on an unsecured basis and then entered discussions with Company regarding the form of the note. As of September 30, 2018,
the Company and the investor had not come to terms and the investor did not agree to the terms of the notes. The Company has treated
the amount as an unsecured advance, due on demand. As of September 30, 2018 and the date of these financial statements, no demand
had been made and the Company continues to negotiate with the investor.
Mortgages
payable
On
February 28, 2018, the Company executed a $550,000 mortgage payable on the Willamette property to acquire additional funds. The
mortgage bears interest at 15% per annum. Monthly interest only payments began March 1, 2018 and continue each month thereafter
until paid. The entire unpaid balance is due on March 1, 2020, the maturity date of the mortgage, and is secured by the underlying
property. The Company paid costs of approximately $28,000 to close on the mortgage. The mortgage terms do not allow participations
by the lender in either the appreciation in the fair value of the mortgaged real estate project or the results of operations of
the mortgaged real estate project. The note has been cross guaranteed by the CEO and Director of the Company.
On
April 4, 2018, the Company executed a $314,000 mortgage payable on the Powell property to acquire additional funds. At closing
$75,000 of the proceeds was put into escrow. The mortgage bears interest at 15% per annum. Monthly interest only payments began
May 1, 2018 and continue each month thereafter until paid. The entire unpaid balance is due on April 1, 2020, the maturity date
of the mortgage, and is secured by the underlying property. The Company plaid costs of approximately $19,000 to close on the mortgage.
The mortgage terms do not allow participations by the lender in either the appreciation in the fair value of the mortgaged real
estate project or the results of operations of the mortgaged real estate project. The note has been cross guaranteed by the CEO
and Director of the Company.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
6.
Notes Payable and Advances (continued)
Mortgages
payable (continued)
On
January 16, 2018 the Company consummated a “Contract for Sale” for a Farm Property in Mulino OR (the
“Mulino Property”). The purchase price was $1,700,000 which was reduced by a rental credit of approximately
$135,000 which is equivalent to nine months’ rent at $15,000 a month and an additional credit of $9,500 for additional
work done on the property. In connection with the purchase of the property, the Company made a cash payment as down payment
plus payment of closing costs in the amount of $370,637 and issued a promissory note in the amount of $1,200,000 with a
maturity of January 2020. The Company will pay monthly installments of principal and interest (at a rate of 2% per annum) in
the amount of $13,500, commencing in July 2018 through the maturity date (January 2020), at which time the entire unpaid
principal balance and any remaining accrued interest shall be due and payable in full. No amount was recorded for the
premium for the below market rate feature of the note as it was immaterial. The note is secured by a deed of trust on the
property. The Company performed an analysis and determined that the rate obtained was below market, however, no premium was recorded as the Company determined
it was immaterial.
Debt
maturities for instruments with terms greater than 1 year as of September 30, 2018 are as follows:
Year:
|
|
|
|
2019
|
|
$
|
169,988
|
|
2020
|
|
|
1,909,446
|
|
2021
|
|
|
3,097
|
|
2022
|
|
|
-
|
|
|
|
$
|
2,082,531
|
|
7.
Convertible debt
The
Company issued a $100,000 promissory note dated December 1, 2017 to an accredited investor which matured on March 1, 2018 and
has an annual rate of interest at 24%. Both principal and interest is due at maturity. The promissory note ranks senior to all
obligations not designated as a primary obligation by the Company. As an inducement to issue the promissory note, the Company
granted the holder warrants to acquire 20,833 shares of the Company’s common stock. The warrants have an exercise price
of $2.40 per underlying common share and are exercisable for 2 years from the anniversary date of issuance (see Note 6) and were
valued at approximately $46,000 and amortized to interest expense over the life of the initial note. On March 1, 2018, pursuant
to the First Amendment to Loan Agreement and Promissory note, the parties agreed to extend the maturity date on the note for one
more year (see Note 10) which includes the following terms; (1) interest payment of $6,000 due from the original note is to be
paid (2) interest rate decreases from an annual rate of 24% to 8% (3) the Company has the right to prepay the note combined with
accrued interest at any time prior to maturity (4) the lender has the right to call the note together with accrued interest not
less than 30 days written notice to the Company (5) at any time prior to maturity of the note, lender has the option to convert
the indebtedness with accrued interest into the Company’s common stock at the rate of $2.40 a share (see Note 12).
At issuance, the Company determined that there was no beneficial conversion feature. The Company considered the amendment an extinguishment,
however, its determination was that the reduction in interest was offset by the inclusion of the conversion feature and therefore
no gain or loss on extinguishment was required.
The
significant assumptions used to value the warrants granted in the twelve months ended September 30, 2018 are as follows:
Fair value of underlying common shares
|
|
$
|
2.40
|
|
Exercise price
|
|
$
|
2.40
|
|
Dividend yield
|
|
|
-
|
|
Historical volatility
|
|
|
181.0
|
%
|
Risk free interest rate
|
|
|
1.45
|
%
|
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
7.
Convertible debt (continued)
In
May and June 2018, the Company issued senior unsecured convertible debentures totaling $1,500,000 to accredited investors
which matures May 2019 (see Note 10) and has an annual rate of interest at 8%. Accrued interest is payable quarterly in
arrears on the fifth day of each calendar quarter. Interest is payable either in cash or in common shares of the Company
based on the average closing price of the Company’s common shares for the 20 trading days prior to the payment date.
The principal is payable at the earlier to occur of: 1) five days after the company has received in aggregate at least
five million of new equity investment since the date of this debenture; or 2) the maturity date. The debenture ranks senior
to all obligations not designated as a primary obligation by the Company. At any time prior to maturity of the note, the
holder has the option to convert the indebtedness with accrued interest into the Company’s common stock at the rate of
$2.50 a share, with standard anti-dilution protection (see Note 12). At issuance, the Company determined that there
was no beneficial conversion feature.
At
September 30, 2018, the Company issued nine senior unsecured convertible debentures totaling $975,000 executed in September of
2018 to accredited investors which mature in March 2019 (see Note 10) and has an annual rate of interest at 8% and includes a
beneficial conversion feature which allows the holder to convert the note into common stock at a conversion price of $2.50 per
share. In connection with these convertible notes, the Company issued warrants expiring three years from the date of issuance
which allows the holders to purchase 97,500 shares of common stock at 2.50 per share, with standard anti-dilution protection (see
Note 12). Accrued interest is payable in cash or common stock based on the market price at the date of payment which is at
the sole discretion of the Company. The Company may prepay the debenture in whole or part at any time without being required to
pay any penalty or premium for such privilege. The obligation evidenced by this note is subordinate to all obligations
which are specifically designated by Company as priority obligations and pari passu to all obligations not so designated. At issuance,
the Company determined that, on a relative fair value basis, the warrants and beneficial conversion feature had a value of approximately
$435,000, which is being amortized on the effective interest method over the life of the notes. As of September 30, 2018, two
note holders had signed and been issued their notes, but had not yet tendered the cash to the Company in the amount of $150,000,
which has been shown on the balance sheet as of September 30, 2018 as Note payable subscription receivable. The two holders funded
their commitments in October 2018 and November 2018.
The
significant assumptions used to value the warrants granted, apart from the relative fair value calculation, in the twelve
months ended September 30, 2018 are as follows:
Fair value of underlying common shares
|
|
$
|
2.685
|
|
Exercise price
|
|
$
|
2.50
|
|
Dividend yield
|
|
|
-
|
|
Historical volatility
|
|
|
216.2
|
%
|
Risk free interest rate
|
|
|
2.7
|
%
|
The
table below shows the net amount outstanding as of September 30, 2018, after unamortized discount under the convertible notes:
Convertible Notes, Net of Discount
|
|
|
|
$100,000 convertible promissory note
|
|
$
|
100,000
|
|
$1.5 million senior convertible promissory notes
|
|
|
1,500,000
|
|
$975,000 senior convertible promissory notes
|
|
|
975,000
|
|
Unamortized discount
|
|
|
(380,210
|
)
|
|
|
$
|
2,194,790
|
|
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
8.
Income Taxes
The
income tax expense (benefit) consisted of the following for the fiscal year ended September 30, 2018 and 2017:
|
|
|
September 30,
2018
|
|
|
|
September 30,
2017
|
|
Total current
|
|
$
|
-
|
|
|
$
|
-
|
|
Total deferred
|
|
|
-
|
|
|
|
-
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
The
following is a reconciliation of the expected statutory federal income tax provision to the actual income tax benefit for the
fiscal year ended September 30, 2018 and 2017:
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Federal statutory rate
|
|
$
|
(1,911,000
|
)
|
|
$
|
(934,000
|
)
|
State taxes, net of federal benefit
|
|
|
-
|
|
|
|
-
|
|
Effect of change in US Tax rates for deferral items
|
|
|
989,000
|
|
|
|
208,000
|
|
Other
|
|
|
44,000
|
|
|
|
-
|
|
Change in valuation allowance
|
|
|
878,000
|
|
|
|
726,000
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
In
the table above, the expected tax benefit is calculated at the 2017 statutory rate of 34%. The effect for temporary timing differences
are also calculated at the 34% statutory rate effective for fiscal year ended September 30, 2018. Long-term temporary differences
are calculated at the 25% statutory rate effective for years ending on or after December 31, 2018.
Significant
components of the Company’s deferred tax assets and liabilities were as follows for the fiscal year ended September 30,
2018 and 2017:
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
2,212,000
|
|
|
$
|
546,000
|
|
Equity based compensation
|
|
|
204,000
|
|
|
|
204,000
|
|
Impairment of loan receivable
|
|
|
75,000
|
|
|
|
75,000
|
|
Depreciation
|
|
|
-
|
|
|
|
6,000
|
|
Total deferred tax assets
|
|
|
2,491,000
|
|
|
|
831,000
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
857,000
|
|
|
|
-
|
|
Deferred revenue
|
|
|
-
|
|
|
|
75,000
|
|
Total deferred tax liabilities
|
|
|
857,000
|
|
|
|
75,000
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
1,634,000
|
|
|
|
756,000
|
|
Less valuation allowance
|
|
|
(1,634,000
|
)
|
|
|
(756,000
|
)
|
Net deferred tax assets (liabilities)
|
|
$
|
-
|
|
|
$
|
-
|
|
At
September 30, 2018, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately
$8,196,000. The federal and state net operating loss carryforwards will expire beginning in 2036.
During
the fiscal year ended September 30, 2018 and 2017, the Company recognized no amounts related to tax interest or penalties related
to uncertain tax positions. The Company is subject to taxation in the United States and various state jurisdictions. The Company
currently has no years under examination by any jurisdiction.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
9.
Shareholders’ Equity
In
2016, the Company adopted a plan to allow the Company to compensate prospective and current employees, directors and consultants
through the issuance of equity instruments of the Company. The plan has an effective life of 10 years. The plan is administered
by the board of directors of the Company until such time as the board transfers responsibility to a committee of the board. The
plan is limited to issuing common shares of the Company up to 15% of the total shares then outstanding. No limitations exist on
any other instruments issuable under the plan. In the event of a change in control of the Company, all unvested instruments issued
under the plan become immediately vested.
Preferred
shares
The
Company has two series of preferred shares designated with no preferred shares issued and outstanding as of September 30,
2018.
Common
shares
On
July 13, 2018, a meeting of the stockholders of the Company took place, and the stockholders adopted a resolution authorizing
the Board of Directors, in its sole discretion, to amend the Company’s Articles of Incorporation to increase the number
of authorized shares of Company Common Stock from 100,000,000 to 300,000,000.
The
holders of common shares are not entitled to receive dividends at this time, however, are entitled to one vote per share at meetings
of the Company.
Private
placements
The
Company received subscriptions in private placement offerings completed for the following shares for the twelve months ended September
30, 2018:
●
|
For
the twelve months ended September 30, 2018, 2,688,834 common shares were issued
at $2.40 per share to unaffiliated investors raising gross cash proceeds (including collection
of $100,000 subscription receivable from September 30, 2017 – see below) of $6,560,941.
|
|
|
●
|
During
the twelve months ended September 30, 2018, the Company began the process of registering
shares of common stock for trading under the securities laws of Canada. As part of that
process, certain founders were notified that they had to contribute additional amounts
for their shares. In the twelve months ended September 30, 2018, two founders contributed
an additional $9,933 towards their founders’ shares as part of the requirements
of the securities regulators of Canada.
|
|
|
●
|
For
the twelve months ended September 30, 2017, 50,000 common shares were issued at $0.15
per share to and unaffiliated investor raising gross cash proceeds of $7,500.
|
|
|
●
|
For
the twelve months ended September 30, 2017, 1,362,363 common shares were issued
at $2.40 per share to unaffiliated investors raising gross cash proceeds (not including
$100,000 subscription receivable outstanding as of September 30, 2017) of $3,151,074.
In addition, the Company collected on outstanding subscription receivables from the prior
year of $1,170,000.
|
Subscription
receivable
On
September 27, 2017, the Company received a subscription for 41,667 shares in the amount of $100,000. The funds were received by
the Company in October 2017.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
9.
Shareholders’ Equity (continued)
Common
Stock issuances for compensation:
During
the twelve months ended September 30, 2018, the Company entered into several consulting agreements, and as part of these agreements
agreed to issue a total of 395,000 shares of common stock ranging in price between $1.95 and $2.40 per share in payment for consulting
services provided to the Company. For issuances covering 250,000 shares, the Company capitalized the amounts to prepaid expense
and amortized the expense over the period of the agreement.
During
the twelve months ended September 30, 2018, as part of several employment contracts, the Company agreed to issue a total of 660,416
shares of common stock which were valued at $2.40 per share to employees and directors for services provided. Certain issuances
contained vesting provisions and based on this, the Company is amortizing the fair value recorded over the vesting
period. Included in the grant total above, grants for 150,000 shares contained deferral provisions, for which the Company recorded
the gross amount of the grant to prepaid expense and is amortizing that cost over the deferral period.
As
of September 30, 2018 the Company had remaining prepaid expense related to these issuances in the amount of $838,159 all of which
will amortize to stock based compensation in the year ended September 30, 2019.
In
the year ended September 30, 2017, the Company granted 250,000 shares of common stock to certain employees and consultants and
valued the grants at $2.40 per share. The Company recorded stock-based compensation in the year ended September 30, 2017 in the
amount of $600,000 for these issuances.
Option
Issuances for compensation:
During
the twelve months ended September 30, 2018, the Company entered into several employment agreements, and as part of these agreements
agreed to issue a total of 1,660,416 options to purchase the common stock of the Company, with an exercise price of $2.40 per
share and terms ranging between 3 to 4 years. As of September 30, 2018, options to acquire 40,416 lacked approval at the board
level and were therefore not considered granted for US GAAP accounting purposes as of September 30, 2018. Pursuant
to these agreements, 1,347,500 options have vested as of September 30, 2018. In total, the Company recorded employee compensation
option expense of $3,013,470 as a result of these options in the twelve months ended September 30, 2018.
During
the twelve months ended September 30, 2018, the Company entered into certain consulting agreements, and as part of that agreement
for professional services, agreed to issue a total of 785,000 options to purchase the common stock of the Company, with all options
having an exercise price ranging between $2.40 and $4.00 per share and terms ranging from 3 to 5 years. Pursuant to the agreements,
110,000 options have vested as of September 30, 2018. As a result of the issuance of these options, the Company recorded
option-based consulting expense of $152,750 in the fiscal year ended September 30, 2018. For one of the option grants for 300,000
shares, the contract stipulated that the terms of the option were to be determined by the board of directors of
the Company. As of September 30, 2018, the board had not stipulated the terms for the award and therefore the award was not considered
as granted for US GAAP accounting purposes.
During
the twelve months ended September 30, 2017, the Company entered into three separate consulting agreements, and as part of those
agreements for professional services, agreed to issue a total of 400,000 options to purchase the common stock of the Company,
with an exercise price of $2.40 per share and a term of 4 years. Pursuant to the first agreement to issue options to acquire a
total of 200,000 of the Company’s common stock, options to acquire 100,000 shares vested immediately, options to acquire
50,000 shares that vest 6 months upon a registration statement being declared effective in which the underlying shares to the
options are registered and the final option to acquire 50,000 shares vests 1 year after a registration statement is declared effective
in which the underlying shares to the option are registered connection with the execution of a consulting agreement. Pursuant
to the second consulting agreement, 100,000 options vested immediately and pursuant to the third consulting agreement, one third
of option to acquire the 100,000 options vests immediately and the remaining two thirds vest monthly for the next 30 months which
equals 2,222 a month. In the third consulting agreement, the Company agreed to issue options for a total of 100,000 shares of
stock of the Company, with immediately vesting of all underlying shares, for consulting and professional services.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
9.
Shareholders’ Equity (continued)
Option
Issuances for compensation (continued)
In
total, the Company recorded stock-based compensation expense to the consultants of approximately $562,000 as a result of these
options in the twelve months ended September 30, 2017. In the year ended September 30, 2018, for option grants that had not yet
vested as of September 30, 2017, the Company recorded additional compensation expense of $210,942.
During
the period ended September 30, 2017, the Company entered into two separate employment agreements, both dated June 1, 2017, with
the Company’s CEO and CFO, respectively. As part of those agreements, the Company agreed to issue a total of 150,000 options
to purchase the common stock of the Company, with an exercise price of $2.40 per share and a term of 3 years. Pursuant to these
agreements, 150,000 shares vested immediately. In total, the Company recorded stock-based compensation expense to the officers
of $276,000 as a result of these options for the twelve months ended September 30, 2017.
During
the year ended September 30, 2017, the Company entered into agreements to engage two additional board members. As part of their
engagement packages, the Company offered to the two options to acquire 100,000 shares of common stock of the Company, with an
exercise price of $2.40 per share and term of 1 year. The options vest 12,500 per quarter over four quarters from the date of
issuance. In total the Company recorded stock-based compensation expense of approximately $37,000 in the year ended September
30, 2017.
The
significant assumptions used to value the options granted in the twelve months ended September 30, 2018 and 2017 are as follows:
|
|
For fiscal years ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Fair value of underlying common shares
|
|
$
|
2.23 to $4.00
|
|
|
$
|
2.40
|
|
Exercise price
|
|
$
|
2.40 to $4.15
|
|
|
$
|
2.40
|
|
Dividend yield
|
|
|
0.0
|
%
|
|
|
0
|
%
|
Historical volatility
|
|
|
179% to 349
|
%*
|
|
|
98.8% to 204
|
%*
|
Risk free interest rate
|
|
|
1.975% to 2.91
|
%
|
|
|
1.16% to 1.93
|
%
|
*
the Company has used the historic volatility of the average of a basket of 6 companies engaged in providing both ancillary type
services and direct production and sale to the cannabis industry as an approximation of its expected volatility.
A
summary of the change in stock purchase options outstanding for the period ended September 30, 2018 and 2017 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Contractual
|
|
|
|
Options
|
|
|
Exercise
|
|
|
Grant Date
|
|
|
Life
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Fair Value
|
|
|
(Years)
|
|
Balance – September 30, 2016
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Options issued
|
|
|
650,000
|
|
|
|
2.40
|
|
|
$
|
1.88
|
|
|
|
2.76
|
|
Options expired/cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Options exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance – September 30, 2017
|
|
|
650,000
|
|
|
|
2.40
|
|
|
|
1.88
|
|
|
|
2.76
|
|
Options issued
|
|
|
2,105,000
|
|
|
|
2.59
|
|
|
|
2.44
|
|
|
|
3.02
|
|
Options expired/cancelled
|
|
|
(10,000
|
)
|
|
|
2.40
|
|
|
|
-
|
|
|
|
-
|
|
Options exercised
|
|
|
(160,000
|
)
|
|
|
2.40
|
|
|
|
-
|
|
|
|
-
|
|
Balance – September 30, 2018
|
|
|
2,585,000
|
|
|
$
|
2.55
|
|
|
$
|
2.31
|
|
|
|
2.79
|
|
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
9.
Shareholders’ Equity (continued)
Option
Issuances for compensation (continued)
The
following table shows information on our vested and unvested options outstanding during the years ended September 30, 2018 and
2017:
|
|
|
|
|
|
|
|
Average
|
|
|
Contractual
|
|
|
|
Options
|
|
|
Exercise
|
|
|
Grant Date
|
|
|
Life
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Fair Value
|
|
|
(Years)
|
|
Balance – September 30, 2016, unvested
|
|
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Options issued
|
|
|
650,000
|
|
|
|
2.40
|
|
|
|
1.88
|
|
|
|
2.76
|
|
Options vested
|
|
|
(
423,889
|
)
|
|
|
2.40
|
|
|
|
1.93
|
|
|
|
2.97
|
|
Options expired/cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance – September 30, 2017, unvested
|
|
|
226,111
|
|
|
|
2.40
|
|
|
|
1.78
|
|
|
|
2.36
|
|
Options issued
|
|
|
2,105,000
|
|
|
|
2.59
|
|
|
|
2.44
|
|
|
|
3.02
|
|
Options vested
|
|
|
(
1,609,164
|
)
|
|
|
2.68
|
|
|
|
2.39
|
|
|
|
3.0
|
|
Options expired/cancelled
|
|
|
(
10,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance – September 30, 2018, unvested
|
|
|
711
,947
|
|
|
$
|
2.92
|
|
|
$
|
2.87
|
|
|
|
3.49
|
|
All
options outstanding had no intrinsic value as of September 30, 2018 and 2017.
Warrants
issued for compensation and debt related issuance
The
Company issued warrants to acquire 139,166 shares of the Company’s common stock during the year ended September 30,
2018 in connection with promissory notes and convertible promissory notes issued (see Note 6).
In
the year ended September 30, 2018 the Company issued a consultant a warrant to acquire 20,000 shares of its common stock as part
of the compensation package within the consulting agreement. The warrant was issued with an exercise price of $2.40 per share
and a term of 2 years.
The
following table shows the warrants outstanding as of September 30, 2018:
|
|
Warrants
|
|
|
|
Outstanding
|
|
Balance – September 30, 2017
|
|
|
-
|
|
Warrants issued
|
|
|
159,166
|
|
Warrants expired/cancelled
|
|
|
-
|
|
Warrants exercised
|
|
|
-
|
|
Balance – September 30, 2018
|
|
|
159,166
|
|
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
10.
Commitments and contingencies
As noted earlier
in Note 1, the Company, through entities it invests in and is negotiating to acquire (see below) will be in the near future engaging
in a business that constitutes an illegal act under the laws of the United States Federal Government.
This
raises several possible issues which may impact the Company’s overall operations, not the least of which are related to
traditional banking and other key operational risks.
Since cannabis remains illegal
on the federal level, and most traditional banks are federally insured, those financial institutions will not service cannabis
businesses. In states where medical or recreational marijuana is legal, dispensary owners, manufacturers, and anybody who “touches
the plant”, continue to face a host of operational hurdle. While local, state-chartered banks and credit unions now accept
cannabis commerce, there remains a reluctance by traditional banks to do business with them. Aside from a huge inconvenience
and the need to find creative ways to manage financial flow, payroll logistics, and payment of taxes, this also poses tremendous
risks to controls as a result of operating a lucrative business in cash. This lack of access to traditional banking may inhibit
industry growth.
Despite
the uncertainties surrounding the Federal government’s position on legalized marijuana, the Company does not believe these
risks will have a substantive impact on its planned operations in the near term.
In
July 2016, the Company entered into a 10-year lease for a commercial building from an unrelated third party in Springfield, Oregon.
At the time the original lease was entered into, the Company had expected to close on significant subscriptions from its private
placement. However, when those did not immediately materialize, the Company entered into an agreement with the landlord to cancel
the lease and in addition, paid the landlord $15,000 not to rent out the property until such time the Company could enter into
a new lease. In September 2016, the Company entered into a new 10-year lease with the landlord that commenced in November 2016.
The lease requires the Company to pay a base rental fee of $7,033 plus an additional estimated $315 per month in real estate taxes
in which the base rental fee escalates each year by approximately 2%. All taxes (including reconciling real estate taxes), maintenance
and utilities are included at the end of each year as a one-time payment. In addition, the Company also remitted $14,000 for a
security deposit to the landlord. No amounts have been recorded for deferred rent in these financial statements as the amount
was deemed immaterial by the Company. The Company has subleased this space pursuant to a 10-year lease. On February 22, 2018,
both parties executed a lease addendum that adds contiguous property for 12,322 square feet. The term commences November 1, 2017
and continues through November 31, 2026 at a rate of $3,525 a month that escalates after the first year. The Company subleases
this property to a related party (see disclosures below under “Springfield Suites”). As of September 30, 2018, the
total subrental income to be received by the Company over the life of the sublease is approximately $8.9 million.
In
March 2018, the Company entered into a 3-year lease for the occupancy of the Company’s corporate office located in Boca
Raton, Florida. The lease requires the Company to pay a base rental fee of $3,024 per month with yearly increases thereafter.
All taxes, maintenance and utilities are billed separately.
During
the twelve months ended September 30, 2018, the Company incurred total rent expense of $210,231. As of September 30, 2018, the
Company has recorded a long-term asset for the straight lining of rent under the rental leases to the cannabis operators of approximately
$1,442,335. As of the date of these financial statements, the Company is in negotiations to acquire the entities that lease its
properties (see below).
The
following table includes our commitment under this lease and its amendment over the following five years as of September 30, 2018
(excluding amounts receivable under the sublease with a related party described below):
Year:
|
|
|
|
2019
|
|
$
|
167,788
|
|
2020
|
|
|
188,795
|
|
2021
|
|
|
173,525
|
|
2022
|
|
|
160,665
|
|
Thereafter
|
|
|
698,716
|
|
|
|
$
|
1,389,489
|
|
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
10.
Commitments and contingencies (continued)
In
August 2016, the Company and certain shareholders of the Company entered into a “Multi Party” Agreement, in which
the Company became obligated to lease or acquire three separate real estate assets, and separately, if certain events occur, additional
real estate assets held by entities related to those shareholders. The Agreement also gives the Company the right of first refusal
in regard to certain properties owned by the persons and entities affiliated with the parties of the Agreement so long as certain
targets are met.
Certain
shareholders of the Company have organized entities that operate directly in the cannabis industry, and the Company leases
its properties to these entities. In addition, the Multi Party Agreement has requirements for the purchase of certain
properties from the related parties to the agreement upon certain milestones being reached (see Note 12). The Multi Party
Agreement also requires that in the event that the US Government amends Title 21 of the United States Code, otherwise known
as the Controlled Substances Act, to remove cannabis as a Schedule I drug, and the Company raises more than $10 million in
equity and merger funding, the Company is required to enter into agreements to acquire those related entities and issue such
equity that the shareholders of the related entities obtain 75% of the then issued and outstanding equity of the Company,
regardless of the profitability or financial condition of the related entities at the time of their acquisition. At the time
of these financial statements, the Company was in negotiations with these entities to amend the multiparty agreement in order
to acquire the Company’s prior to removal of cannabis from Schedule 1 of the Act. The Company believes the acquisition
of these entities will become probable in the near future in FY 2019.
On
July 16, 2018, the Company began trading its common stock under the ticker symbol “STEM” on the Canadian Securities
Exchange (the “
CSE
”).
Property
Rental Agreements
All
of the income leases below are to entities that are related to the Company through common ownership.
1027
Willamette
In
July 2017, the Company entered into an operating lease agreement with a marijuana dispensary (the “Lessee”) to move
into the Company’s acquired property located at 1027 Willamette Street in Eugene, Oregon. The lease agreement is for a base
term of ten years (see note below) and a monthly rent obligation of $13,800, subject to annual increases of 3% per year, plus
an amount for additional rent based on final buildout costs incurred by the Company. The lease is a double net lease with maintenance
and real property taxes to be paid by the Tenant and insurance costs paid by the Company. The Company provided the tenant with
one month of free rent.
Upon
the expiration of the term of ten years, the Lessee has the option to renew the lease agreement for one five-year term, on the
same terms as provided in the lease agreement.
Springfield
In
July 2017, the Company entered into a lease agreement for its property and warehouse building located at 800 N 42
nd
street in Springfield, Oregon. The lease agreement is for a term of ten years (see note below) and a monthly rent obligation of
$64,640, subject to annual increases of 3% per year plus an amount for additional rent based on final buildout costs incurred
by the Company. The lease is a double net lease with maintenance and real property taxes to be paid by the Tenant and insurance
costs paid by the Company. Rent payments commence on the date the growing season ends, which the Company currently estimates will
occur in September 2018, and thus expects payments to begin in January 2019. The Company has treated this period as a free rental
period for accounting purposes.
Upon
the expiration of the term of ten years, the Lessee has the option to renew the lease agreement for five-year term, on the same
terms as provided in the lease agreement.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
10.
Commitments and contingencies (continued)
Property
Rental Agreements (continued)
14336
S. Union Hall Road, Mulino
In
July 2017, the Company entered into a lease agreement for its property located at 14336 South Union Hall Road in Mulino,
Oregon. The lease agreement is for a term of ten years (see note below) and a monthly rent obligation of $18,750, subject to
annual increases of 3% per year plus an amount for additional rent based on final buildout costs incurred by the Company. The
lease is a double net lease with maintenance and real property taxes to be paid by the Tenant and insurance costs paid
by the Company. Rent payments will begin at the of the first growing season, which the Company currently estimates will occur
in September 2018, and thus payments will commence in March 2019. The Company expects to treat such period as a free rental
period for accounting purposes. At the time rental payments begin, the total of base rent and additional rent will not be
less than $1.00 per foot for light assisted greenhouse and $.25 per usable square foot for un-light assisted greenhouse or
outdoor grow space.
Upon
the expiration of the term of ten years, the Lessee has the option to renew the lease agreement for five-year term, on the same
terms as provided in the lease agreement.
7827
SE Powell
In
July 2017, the Company entered into a lease agreement for its acquired property located at 7827 SE Powell Blvd. in Portland, Oregon.
The lease agreement is for a term of ten years and a monthly rent obligation of $6,523, subject to annual increases of 3% per
year. Maintenance and real property taxes to be paid by the Tenant and insurance paid by the Company. Additional rents
will be added to pay landlord back for tenant improvements by the end of the first term of the lease, payments will include annual
interest at 12% compounded monthly. Rent payments commence on the date the growing season ends, which the Company currently estimates
will occur in February 2019, and thus expects payments to begin in November 2018. The Company has treated this period as a free
rental period for accounting purposes.
Upon
the expiration of the term of ten years, the Lessee has the option to renew the lease agreement for five-year term, on the same
terms as provided in the lease agreement.
The
following table shows the expected net rental payments to be received under the leases noted above as of September 30:
Year:
|
|
|
|
|
2019
|
|
|
$
|
789,845
|
|
2020
|
|
|
|
1,275,532
|
|
2021
|
|
|
|
1,313,928
|
|
2022
|
|
|
|
1,353,466
|
|
Thereafter
|
|
|
|
9,569,105
|
|
|
|
|
$
|
14,301,876
|
|
11.
Merger of Patch International, Inc.
In
November 2016, the Company entered into an agreement to acquire 100% of the issued and outstanding shares of Patch International,
Inc. (“Patch”). In order to close the transaction, Patch was required to submit for approval to certain Canadian government
courts, hold a general meeting of its shareholders and have the shareholders vote to approve the merger, and certain other customary
requirements. As of the time of the agreement, Patch did not have any operations, and is considered a dormant entity. The Company
issued shares of its common stock based on a price of $2.40 per common share, with the number of shares issued based on the amount
of cash held at the time of closing of the transaction, converted from Canadian dollars into US dollars. In addition, the Company
has agreed to issue to Patch shareholders additional shares at the same $2.40 per share in the event that the Company collects
on a fully reserved receivable in the amount of $500,000 owed to Patch by a related party. As of the date of the acquisition and
of these financial statements, the Company considers the receivable uncollectible (as did Patch, which reserved 100% of the outstanding
receivable in its audited financial statements) and does not anticipate issuing additional shares for its collection.
On
January 20, 2017, the Patch Shareholders held their general meeting and they voted to be acquired by the Company. On January 23,
2017, the Company issued 1,048,762 of its shares to acquire 100% of the issued and outstanding shares of Patch for consideration
in the amount of $2,452,058. Two shareholders, representing less than 2% of Patch shares outstanding have chosen to not vote for
the merger. Under Canadian law, the Company was required to purchase these shares for cash consideration in the amount $53,534.53
US dollars. The Company has treated the payment to acquire the dissenter shares as a reduction in the cash acquired.
The
Company has not accounted for the acquisition of Patch as a business combination, but in essence as a private placement, because
Patch was a dormant entity with its only asset being cash, with no liabilities (they were required to be fully extinguished prior
to the completion of the merger), and with no operations other than incurred professional fees to remain a public entity in Canada.
Stem
Holdings, Inc.
Notes
to Consolidated Financial Statements
12.
Subsequent events
In
October 2018, the Company entered into an Asset Purchase Agreement (“APA”) to acquire certain assets and assume certain
liabilities of Yerba Oregon, LLC. The purchase price for the assets and assumption of liabilities is the greater of $4.613 million
or multiples of 2018 and 2019 EBITDA of Yerba Oregon LLC, as required under the APA. Payment of the purchase price is as follows
upon successful closing of the APA: $350,000 in cash at closing, a promissory note in the amount of $400,000 and the remainder
in common shares of the Company based on the lesser of 85% of the average closing price of the stock as traded in the over the
counter market 30 days prior to closing or $2.40 per share. The Company deposited into escrow with an attorney, upon signing the
APA, 1,931,506 shares of its common stock. Closing of the APA is subject to certain requirements, including the issuance of state
and local licenses, which is outside the control of the Company and the seller, which as of the date of these financial statements,
had yet to be issued. Yerba Oregon, LLC operates a wholesale cannabis production and sales operation.
On December 27, 2018, the Company entered
into an Agency Agreement with respect to a private offering of up to 10,000 special warrants of the Company (the “CD
Special Warrants”) for aggregate gross proceeds of up to $10,000,000 (in Canadian funds, denoted herein as “C”)
(the “Offering”). In addition, on December 27, 2018, the Company closed the first tranche of the Offering consisting
of 3,121 CD Special Warrants at a price of C$1,000 per CD Special Warrant for aggregate gross proceeds of C$3,121,000.
Each CD Special Warrant will be exchanged
(with no further action on the part of the holder thereof and for no further consideration) for one convertible debenture
unit of the Company (a “Convertible Debenture Unit”), on the earlier of: (i) the third business day after the date
on which both (A) a receipt (the “Receipt”) for a (final) prospectus (the “Qualification Prospectus”)
qualifying the distribution of the Convertible Debentures (as defined below) and Warrants (as defined below) issuable upon exercise
of the CD Special Warrants has been issued by the applicable securities regulatory authorities in the Canadian jurisdictions in
which purchasers of the CD Special Warrants are resident (the “Canadian Jurisdictions”), and (B) a registration statement
(the “Registration Statement”) registering the resale of the common shares underlying the Convertible Debentures and
Warrants has been declared effective by the U.S. Securities and Exchange Commission (the “Registration”)
;
and (ii) the date that is six months following the closing of the Offering.
The Company has also provided certain registration
rights to purchasers of the CD Special Warrants.
Each Convertible Debenture Unit is
comprised of C$1,000 principal amount 8.0% senior unsecured convertible debenture (each, a “Convertible Debenture”)
of the Company and 167 common share purchase warrants of the Company (each, a “Warrant”). Each Warrant entitles
the holder to purchase one common share of the Company (each, a “Warrant Share”) at an exercise price of C$3.90
per Warrant Share for a period of 24 months following the closing of the Offering.
The Company has agreed to use its best efforts to obtain the Receipt and Registration
within six months following the closing of the Offering. In the event that the Receipt and Registration have not been obtained
on or before 5:00 p.m. (PST) on the date that is 120 days following the closing of the Offering, each unexercised CD Special Warrant
will thereafter entitle the holder thereof to receive, upon the exercise thereof and at no additional cost, 1.05 Convertible Debenture
Units per CD Special Warrant (instead of 1.0 Convertible Debenture Unit per CD Special Warrant). Until the Receipt and Registration
have been obtained, securities issued in connection with the Offering (including any underlying securities issued upon conversion
or exercise thereof) will be subject to a 6-month hold period from the date of issue.
The
brokered portion of the Offering (C$2,247,000) was completed by a syndicate of agents (collectively, the “Agents”).
The Company paid the Agents a cash commission equal
to 7.0% of the gross proceeds raised in the first tranche of the brokered portion of the Offering. As additional consideration,
the Company issued the Agents such number of non-transferable broker convertible debenture special warrants (the “
Broker
CD Special Warrants
”) as is equal to 7.0% of the number of CD Special Warrants sold under the first tranche of the brokered
portion of the Offering. Each Broker CD Special Warrant shall be exchanged, on the same terms as the CD Special Warrants, into
broker warrants of the Company (the “
Broker Warrants
”). Each Broker Warrant entitles the holder to acquire
one Convertible Debenture Unit at an exercise price of C$1,000, until the date that is 24 months from the closing date of the
Offering. The distribution of the Broker Warrants issuable upon the exchange of the Broker CD Special Warrants shall also be qualified
under the Qualification Prospectus and the resale of the common shares underlying the Broker Warrants will be registered under
the Registration Statement. The Company also paid the lead agent a corporate finance fee equal to C$100,000, payable as to C$50,000
in cash and as to $50,000 in common shares of the Company at a price per share of C$3.00.
In
October 2018, the Company issued an inducement offer to the holders of its convertible debentures such that the Company agreed
to reduce the conversion price to $1.80 per share if the holders agreed to convert immediately. All holders of the convertible
notes agreed to the inducement. As of the date these financial statements, the Company had issued 1,152,568 shares of its common
stock in satisfaction of the conversion with another approximately 280,000 shares issuable.
In November and December 2018, the Company
determined that Milestone’s 2 and 3 had been reached within the Multi-Party agreement (see Note 10) and therefore had issued
457,191 shares of its common stock in satisfaction of the requirement to issue common shares covering 20% of the cash expended
by the seller to purchase and improve the property and is currently negotiating with the owner of the property, a director of
the Company, in regards to an allocation of cash and mortgage principal in satisfaction of the purchase price of $4.395 million
required, which the Company expects to close on in March 2019.
From October 1, 2018 through the date of
these financial statements, the Company issued 425,000 shares of its common stock in satisfaction of compensation provisions within
certain consulting agreements.
In November 2018, consultants exercised outstanding options and acquired 187,500
shares of the Company’s common stock.
In
November 2018, a board member of the Company and several outside investors provided the Company with $3.5 million in cash to be
dispensed to an entity being setup by the Company, and which has yet to open a checking account, which will be primarily
owned and controlled by the board member, upon that entity completing its setup and opening up of a checking account.
In
October and November 2018, the Company was advanced $270,000 by NVD in order to disperse those funds to its contractors for its
buildout. As of the date of these financial statements, the funds were fully dispersed by the Company to the contractors of NVD.