The following are the results of our operations for the years ended
December 31, 2020, 2019 and 2018:
Revenue for the year ended December 31, 2020
was $48.3 million, which represents an increase of $31.3 million or 185% from $16.9 million for the year ended December 31, 2019.
Revenue growth in 2020 was primarily driven by an increase in cannabis production from our second greenhouse cultivation facility, which
commenced operations in Q1 2020 and expanded operational canopy from approximately 113,000 square feet at the end of December 2019,
to over 390,000 square feet by the 2020. Our cannabis retail dispensaries also contributed to year over year revenue growth, with a full
year of operations in 2020 versus less than 6 months of operations in 2019.
For the year ended December 31, 2019, revenue
was $16.9 million, which represents an increase of $8.0 million or 89% from $9.0 million for the year ended December 31, 2018. Revenue
growth in 2019 was primarily driven by an increase in cannabis production from our first greenhouse cultivation facility, which operated
at full capacity throughout 2019, and at partial capacity in 2018 while we ramped up operations. We began retail operations in Q3 2019,
opening one store and acquiring another, which also increased revenue from the prior year.
For the year ended December 31, 2018, revenue
was $9.0 million. Revenues during 2018 consisted primarily of bulk biomass sales produced from our first greenhouse cultivation facility.
For the year ended December 31, 2020, cost
of goods sold was $ 29.5 million, which represents an increase of $21.1 million or 249% from the prior year amount of $8.5 million. Cost
increases were primarily attributable to our expanding cannabis cultivation operation which grew over 300% from the prior year. Our cannabis
dispensaries also contributed to year over year cost increases, with a full year of operations in 2020 and less than 6 months of operations
in 2019.
For the year ended December 31, 2019, cost
of goods sold was $8.5 million, which represents an increase of $4.7 million or 126% from the prior year amount of $3.7 million. Cost
increases were primarily due to our grow operations being fully operational throughout 2019 and only partially operational in 2018. We
began retail operations in Q3 2019, opening one store and acquiring another, which also increased cost of goods sold from the prior year.
For the year ended December 31, 2018, cost
of goods sold was $3.7 million. Our cost of goods sold is a direct result of our grow operations during 2018.
For the year ended December 31, 2020, general
and administrative expenses was $18.6 million, which represents an increase of $9.3 million or 99% from the prior year amount of $9.4
million. General and administrative cost increases are primarily attributable to headcount additions required to support operational expansion
initiatives and include stock-based compensation, salary expenses, employee benefits, selling costs and incidental expenses related to
corporate, cultivation and retail operations.
For the year ended December 31, 2019, general
and administrative expenses was $9.4 million, which represents an increase of $6.3 million or 202% from the prior year amount of $3.1
million. General and administrative cost increases are primarily attributable to headcount additions required to support operational expansion
initiatives and include stock-based compensation, salary expenses, employee benefits, selling costs and incidental expenses related to
corporate, cultivation and retail operations.
For the year ended December 31, 2018, general
and administrative expenses was $ 3.1 million. General and administrative expenses include stock-based compensation, salary expenses,
employee benefits, selling costs and incidental expenses related to corporate, cultivation and retail operations.
For the year ended December 31, 2020, sales
and marketing expenses was $1.5 million, which represents an increase of $0.6 million or 63% from the prior year amount of $0.9 million.
Our cannabis dispensaries contributed to year over year cost increases, with a full year of operations in 2020 and less than 6 months
of operations in 2019. Sales and marketing expenses include advertising and promotions in various media outlets.
For the year ended December 31, 2019, sales
and marketing expenses was $0.9 million, which represents an increase of $0.8 million or 537% from the prior year amount of $0.1 million.
Marketing expenses increased year over year to support our retail operations, which began Q3 2019.
For the year ended December 31, 2018, we
incurred $0.1 million of sales and marketing expenses for general advertising and promotions in various media outlets.
For the year ended December 31, 2020, professional
fees were $2.0 million, which represents a decrease of $3.2 million or 61% from the prior year amount of $5.2 million. The decrease from
2019 was a result of the preparatory work performed in 2019 for business combinations, mergers and acquisitions. During 2020, we deliberately
curtailed the use of consultants.
For the year ended December 31, 2019, professional
fees were $5.2 million, which represents an increase of $3.3 million or 172% from the prior year amount of $1.9 million. The increase
from 2018 is a direct result of our merger and acquisition activity, capital raises, preparatory work required for business combinations
executed in 2020 and to support operational expansion initiatives.
For the year ended December 31, 2018, professional
fees were $ 1.9 million. Professional fees in 2018 represent fees paid to part time operational and accounting consultants and for legal
and advisory fees.
For the year ended December 31, 2020, net
other expenses were $4.2 million, which represents a increase of $2.9 million or 221% from the prior year amount of $1.3 million. The
increase from 2019 was a result of the increase in interest expense from our debt incurred during 2020 and an increase in our unrealized
losses on our equity method investments.
For the year ended December 31, 2019, net
other expenses were $1.3 million, which represents an increase of $1.0 million or 323% from the prior year amount of $0.3 million. The
increase from 2018 was primarily a result of the increase in our unrealized losses on our equity method investments.
For the year ended December 31, 2018, net
other expenses were $0.3 million. Net other expenses in 2018 is primarily represented by interest expense ($0.6 million), offset by interest
income of $0.3 million from our notes receivables.
Historically, our primary source of liquidity
has been capital contributions made by equity investors and debt issuances. We expect to generate positive cash flow from its operations
going forward and expects such positive cash flow to be its principal source of future liquidity. In the event sufficient cash flow is
not available from operating activities, we may continue to raise equity or debt capital from investors in order to meet liquidity needs.
Cash used in operating activities totaled $ 7.7
million in 2020. This was primarily driven by the net loss incurred of $16.7 million during the year, increases in accounts receivable
($3.5 million) and buildup of inventory ($3.8 million) resulting from increased operations. The use of cash in operations was offset by
the increase in trade payables and accrued liabilities ($1.9 million), increase in income taxes payable ($3.9 million), increases
in deferred tax liabilities, net ($1.3 million) and non-cash expense from interest capitalized to notes payable ($ 1.1 million), share-based
compensation ($2.5 million), accretion of debt discounts on loans ($1.1 million), loss on equity method investments ($2.1 million) and
depreciation and amortization ($2.6 million).
Cash used in operating activities totaled $3.4
million in 2019. This was primarily driven by the net loss incurred of $10.8 million during the year as a result from increased operations.
The use of cash in operations was offset by the increase in trade payables and accrued liabilities ($3.2 million) and non-cash expense
from share-based compensation ($1.9 million), unrealized loss on equity method investments ($1.1 million) and depreciation and amortization
($1.5 million).
Cash used in operating activities totaled $0.9
million in 2018. This was primarily driven by the net loss incurred of $1.4 million during the year, increases in accounts receivable
($0.5 million) and buildup of inventory ($0.8 million) resulting from increased operations. The use of cash in operations was offset by
non-cash expense from share-based compensation ($0.8 million) and depreciation and amortization ($0.8 million).
Cash used in investing activities totaled $ 7.7
million in 2020. This was primarily driven by the purchase of property and equipment ($3.9 million) purchase of investments ($2.9 million)
and issuance of notes receivables ($1.1 million).
Cash used in investing activities totaled $15.8
million in 2019. This was primarily driven by the purchase of property and equipment ($5.7 million), purchase of investments ($5.1 million),
issuance of notes receivables ($3.5 million) and cash paid for an acquisition ($1.9 million).
Cash used in investing activities totaled $14.8
million in 2018. This was primarily driven by the purchase of property and equipment ($12.7 million) and the purchase of investments ($3.2
million). Cash outflows from investing activities were offset by repayments on notes receivables during the year ($1.1 million).
Cash provided by financing activities totaled
$17.3 million in 2020. This was primarily driven by cash proceeds from the issuance of notes and convertible notes payable during the
year ($18.4 million) which was offset by payments on notes payable ($1.1 million).
Cash provided by financing activities totaled
$8.1 million in 2019. This was primarily driven by cash proceeds from the issuance of notes payable during the year ($1.7 million), cash
contributions from investors ($8.1 million) offset by payments of notes payable during the year ($0.9 million).
Cash provided by financing activities totaled
$23.9 million in 2018. This was primarily driven by cash proceeds from the issuance of notes and convertible notes payable during the
year ($9.9 million), cash contributions from investors ($16.4 million) offset by payments of distributions to shareholders during the
year ($2.0 million).
As previously noted, our primary source of liquidity
has been capital contributions and debt capital made available from investors. We expect to generate positive cash flow from its operations
going forward and expects such positive cash flow to be its principal source of future liquidity. In the event sufficient cash flow is
not available from operating activities, we may continue to raise equity capital from investors in order to meet liquidity needs. We do
not have any committed sources of financing, nor significant outstanding capital expenditure commitments.
We have contractual obligations to make future
payments, including debt agreements and lease agreements from third parties and related parties.
Reposition Investments, LLC, a Texas limited liability
company (“Reposition”) and an affiliate of our shareholder, agreed to make a $1,000,000 unsecured bridge loan to us at an
interest rate of 8% per annum to fund us until the initial close of senior notes offering, pursuant to that certain promissory note, dated
as of January 24, 2020, issued by us in favor of Reposition. In February 2020, we executed and delivered to Reposition, and
Reposition accepted, documentation in substantially the form of the approved senior secured convertible notes to cancel and reissue the
bridge note as part of the senior convertible notes offering. Accordingly, as of December 31, 2020, the Reposition bridge note is
no longer outstanding, and Reposition’s senior convertible note balance of $1,000,000 principal balance is included as a component
of convertible notes noted above. As of December 31, 2020 and 2019, no amounts were due under the original notes.
In 2018, Magu Farm LLC issued approximately $9,925,000
in secured promissory notes convertible into equity interests in Magu Investment Fund (collectively, the “Magu Farm Convertible
Notes”) to certain lenders who are affiliates of our shareholders (collectively, the “Magu Farm Lenders,” and individually,
a “Magu Farm Lender”).
On October 7, 2019, Magu Farm LLC and Magu
Investment Fund notified each Magu Farm Lender of Magu Investment Fund’s intention to merge with and into us at the closing of a
roll-up transaction (the “Roll-Up”). Subsequent to such notification, effective as of October 7, 2019, each Magu Farm
Lender other than Kings Bay Investment Company Ltd., a Cayman Islands company (“KBIC”), entered into a letter agreement pursuant
to which such Magu Farm Lender, among other things, (a) converted its respective Magu Farm Convertible Note with an aggregate value
of $8,000,000 into equity interests in Magu Investment Fund and (b) agreed to terminate both the co-lending agreement and its respective
security interest as defined in the agreement. All accrued and unpaid interest were paid prior to conversion. KBIC balance which was not
converted remained. Effective as of March 1, 2020, KBIC assigned the note (the “Kings Bay Note”) to Kings Bay Capital
Management Ltd., a Cayman Islands company (“KBCM”).
Effective as of April 10, 2020, KBCM and
us entered into an assignment, novation and note modification agreement and a security agreement, pursuant to which, among other things,
(a) the company assumed all of Magu Farm LLC’s rights, duties, liabilities and obligations under the Kings Bay Note, (b) the
Kings Bay Note was modified, among other things, such that KBCM has the right to convert the Kings Bay Note into Class A Shares at
the same conversion price accorded to the other Magu Farm Lenders, and (c) the obligations under the Kings Bay Note were secured
by a pledge of our subsidiaries’ securities but expressly subordinated to the holders of the senior convertible notes. As a result
of the modification, we recorded an loss on extinguishment of debt due to modification for approximately $389,000 which is included as
a component of other income, net in the accompanying consolidated statement of operations. As of December 31, 2020 and 2019, the
balance due to KBCM is $2,189,264 and $1,925,000, respectively.
On October 5, 2019, G&H Supply Company
LLC issued a promissory note in the original principal amount of $315,000 in favor of the Graham S. Farrar Living Trust established February 2,
2000 (the “Farrar Trust”), an affiliate of Graham Farrar (the “Original G&H / Farrar Note”). Effective as
of February 20, 2020, we executed and delivered to the Farrar Trust, and the Farrar Trust accepted, documentation in substantially
the form of the approved forms of note offering documents to cancel and reissue the loan evidenced by the Original G&H / Farrar Note
as part of the convertible debt offering. As of December 31, 2020 and 2019, the balance of these notes was $0, and $316,262, respectively.
In connection with the Incubation, Beach Front
Properties, LLC, a California limited liability company (“BFP”), advanced to Magu Capital loans in the aggregate principal
amount of $400,000 (the “BFP Loans”), which BFP Loans were documented by that certain promissory note dated as of June 7,
2017 and that certain promissory note dated as of March 22, 2018 (together, the “BFP Notes”), and the remaining monetary
portion of the BFP Loans was not previously documented but intended by BFP and Magu Capital to be advanced under the same terms as set
forth in the BFP Notes. Magu Capital used the proceeds of the BFP Loans to pay certain of our expenses. Effective as of June 30,
2020: (a) Magu Capital assigned to us, we assumed and Magu Capital was released from, all of Magu Capital’s rights, duties
and obligations under the BFP Loans; and (b) we executed and delivered to BFP, and BFP accepted, documentation in substantially the
form of the approved convertible debt offering.
Effective January 1, 2019, we and Magu Capital
LLC, a California limited liability company (“Magu Capital”), entered into a services and incubation agreement (the “Services
and Incubation Agreement”), pursuant to which Magu Capital agreed to perform certain advisory and business “incubation”
services for us (and incur certain fees and expenses on behalf of us as part of and as performance for such services) (collectively, the
“Incubation”) in consideration of our agreement to issue to Magu Capital, upon a date certain following the closing of the
Roll-Up as reasonably determined by our board of directors, a warrant to purchase a fixed number of Class A Shares at an agreed upon
strike price and no later than three years following the grant date.
On July 23, 2020, we issued to Magu Capital
a warrant to purchase exercise shares (the “Magu Capital Warrant”), in full satisfaction of our obligations under the Services
and Incubation Agreement to compensate Magu Capital for the Incubation. The value of the warrants was fair valued at approximately $ 427,000.
We recorded a gain on extinguishment of the liability in the amount of approximately $573,000 which is recorded as a component of other
income in the accompanying consolidated statement of operations. The balance due to Magu Capital as of December 31, 2020 and 2019
was $0 and$1,773,879, respectively and is included as a component of accounts payable and accrued liabilities in the consolidated and
combined balance sheet.
In January 2020, we as part of the roll up
and re-organization: (a) issued to APP Investment Advisors LLC, a California limited liability company (“APP Investment Advisors”),
an affiliate of certain significant shareholders, 9,047,226 shares of our Class B common stock (“Class B Shares”),
in exchange for certain management services rendered by APP Investment Advisors for AP Investment Fund; and (b) issued to Magu Capital,
an affiliate of certain significant shareholders, 23,248,044 Class B Shares, in exchange for certain management services rendered
by Magu Capital for CA Brand Collective, Magu Investment Fund and MG Padaro Fund.
We have an agreement with certain related parties
which provide asset management services. Fees are paid quarterly. For the year ended December 31, 2020, 2019 and 2018, we incurred
expenses of approximately $0, $822,000 and $590,000, respectively.
None.
Unless otherwise disclosed elsewhere in this Shell
Company Report, we are not aware of any trends, uncertainties, demands, commitments or events that are reasonably likely to have a material
adverse effect on our revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information
to be not necessarily indicative of future operating results or financial conditions.
The preparation of the consolidated and combined
financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the dates of the consolidated and combined financial statements and the reported amounts of total net revenue
and expenses during the reporting period. We regularly evaluate significant estimates and assumptions related to the consolidation or
non-consolidation of variable interest entities, estimated useful lives, depreciation of property and equipment, amortization of intangible
assets, inventory valuation, share-based compensation, business combinations, goodwill impairment, long-lived asset impairment, purchased
asset valuations, fair value of financial instruments, compound financial instruments, derivative liabilities, deferred income tax asset
valuation allowances, incremental borrowing rates, lease terms applicable to lease contracts and going concern. These estimates and assumptions
are based on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue,
costs and expenses that are not readily apparent from other sources. The actual results we experience may differ materially and adversely
from these estimates. To the extent there are material differences between the estimates and actual results, our future results of operations
will be affected.
Depreciation of property and equipment is dependent
upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment of these assets
is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful
lives of assets.
Amortization of intangible assets is dependent
upon estimates of useful lives and residual values which are determined through the exercise of judgment. Intangible assets that have
indefinite useful lives are not subject to amortization and are tested annually for impairment, or more frequently if events or changes
in circumstances indicate that they might be impaired. The assessment of any impairment of these assets is dependent upon estimates of
recoverable amounts that take into account factors such as economic and market conditions.
For purposes of the impairment test, long-lived
assets such as property, plant and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the
lowest level for which identifiable independent cash flows are available (“asset group”). We review long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order to
determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first
to determine whether the long-lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset to
the sum of its future undiscounted cash flows using entity- specific assumptions generated through the asset’s use and eventual
disposition. If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded.
If the carrying amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step
2) is required. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying
value of the asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection
and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies,
at the date of evaluation. The reversal of impairment losses is prohibited.
We adopted Audit Standards Update (“ASU”)
2016-02, “Leases (Topic 842)” (“ASC 842”) using the full retrospective approach, which provides a method for recording
existing leases at adoption using the effective date as its date of initial application. Accordingly, we have recorded our leases at our
inception. We elected the package of practical expedients provided by ASC 842, which forgoes reassessment of the following upon adoption
of the new standard: (1) whether contracts contain leases for any expired or existing contracts, (2) the lease classification
for any expired or existing leases, and (3) initial direct costs for any existing or expired leases. In addition, we elected an accounting
policy to exclude from the balance sheet the right-of-use assets and lease liabilities related to short-term leases, which are those leases
with a lease term of twelve months or less that do not include an option to purchase the underlying asset that we are reasonably certain
to exercise.
We apply judgment in determining whether a contract
contains a lease and if a lease is classified as an operating lease or a finance lease. We apply judgement in determining the lease term
as the non-cancellable term of the lease, which may include options to extend or terminate the lease when it is reasonably certain that
we will exercise that option. All relevant factors that create an economic incentive for it to exercise either the renewal or termination
are considered. We reassess the lease term if there is a significant event or change in circumstances that is within our control and affect
our ability to exercise or not to exercise the option to renew or to terminate. In adoption of ASC 842, we applied the practical expedient
which applies hindsight in determining the lease term and assessing impairment of right-of-use assets by using its actual knowledge or
current expectation as of the effective date. We also applied judgment in allocating the consideration in a contract between lease and
non-lease components. It considers whether we can benefit from the right-of-use asset either on its own or together with other resources
and whether the asset is highly dependent on or highly interrelated with another right of-use asset. Lessees are required to record a
right of use asset and a lease liability for all leases with a term greater than twelve months. Lease liabilities and their corresponding
right-of-use assets are recorded based on the present value of lease payments over the expected remaining lease term. The incremental
borrowing rate is determined using estimates which are based on the information available at commencement date and determines the present
value of lease payments if the implicit rate is unavailable.
Deferred tax assets and liabilities are recorded
for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in
the combined balance sheet. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to
tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more
likely than not that some or all of the deferred tax assets will not be realized.
We follow accounting guidance issued by the Financial
Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes. Under this guidance,
we assess the likelihood of the financial statement effect of a tax position that should be recognized when it is more likely than not
that the position will be sustained upon examination by a taxing authority based on the technical merits of the tax position, circumstances,
and information available as of the reporting date.
We evaluate and accounts for conversion options
embedded in our convertible instruments in accordance with ASC 815, “Accounting for Derivative Instruments and Hedging Activities”.
Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host
instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which
(a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and
the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument
is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
We account for convertible instruments (when we
determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance ASC 470, “Accounting
for Convertible Securities with Beneficial Conversion Features”, as those professional standards pertain to “Certain Convertible
Instruments”. Accordingly, we record, when necessary, discounts to convertible notes for the intrinsic value of conversion options
embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of
the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over
the term of the related debt to their earliest date of redemption. We also record when necessary deemed dividends for the intrinsic value
of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying common stock at
the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides that generally,
if an event is not within the entity’s control could or require net cash settlement, then the contract shall be classified as an
asset or a liability.
We evaluate our agreements to determine if such
instruments have derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted
for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with
changes in the fair value reported in the Consolidated Statements of Operations. In calculating the fair value of derivative liabilities,
we use a valuation model when Level 1 inputs are not available to estimate fair value at each reporting date. The classification of derivative
instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting
period. Derivative instrument liabilities are classified in the Consolidated Balance Sheets as current or non-current based on whether
or not net-cash settlement of the derivative instrument could be required within twelve months of the Consolidated Balance Sheets date.
Business combinations are accounted for using
the acquisition method. The consideration transferred in a business combination is measured at fair value at the date of acquisition.
Acquisition related transaction costs are expensed as incurred and included in the consolidated and combined statements of operations.
Identifiable assets and liabilities, including intangible assets, of acquired businesses are recorded at their fair value at the date
of acquisition. When we acquire control of a business, any previously held equity interest also is remeasured to fair value. The excess
of the purchase consideration and any previously held equity interest over the fair value of identifiable net assets acquired is goodwill.
If the fair value of identifiable net assets acquired exceeds the purchase consideration and any previously held equity interest, the
difference is recognized in the Consolidated and combined Statements of Operations immediately as a gain on acquisition.
Contingent consideration is measured at its acquisition-date
fair value and included as part of the consideration transferred in a business combination. We allocate the total cost of the acquisition
to the underlying net assets based on their respective estimated fair values. As part of this allocation process, we identify and attribute
values and estimated lives to the intangible assets acquired. These determinations involve significant estimates and assumptions regarding
multiple, highly subjective variables, including those with respect to future cash flows, discount rates, asset lives, and the use of
different valuation models, and therefore require considerable judgment. Our estimates and assumptions are based, in part, on the availability
of listed market prices or other transparent market data. These determinations affect the amount of amortization expense recognized in
future periods. We base our fair value estimates on assumptions we believes to be reasonable but are inherently uncertain. Contingent
consideration that is classified as equity is not remeasured at subsequent reporting dates and its subsequent settlement is accounted
for within equity. Contingent consideration that is classified as an asset or a liability is remeasured at subsequent reporting dates
in accordance with ASC 450, “Contingencies”, as appropriate, with the corresponding gain or loss being recognized in earnings
in accordance with ASC 805.
We have a share-based compensation plan comprised
of stock options (“Options”) and stock appreciation rights (“SARs”). Options provide the right to the purchase
of one Series A Common share per option. Stock appreciation rights provide the right to receive cash from the exercise of such right
based on the increase in value between the exercise price and the fair market value of our Series A Common shares at the time of
exercise. We have issued both incentive stock options and non-qualified stock options.
We account for our share-based awards in accordance
with ASC Subtopic 718-10, “Compensation – Stock Compensation,” which requires fair value measurement on the grant date
and recognition of compensation expense for all share-based payment awards made to employees and directors, including restricted share
awards. For stock options, we estimate the fair value using a closed option valuation (Black-Scholes) model. When there are market-related
vesting conditions to the vesting term of the share-based compensation, we use a valuation model to estimate the probability of the market-related
vesting conditions being met and will record the expense. The fair value of restricted share awards is based upon the quoted market price
of the common shares on the date of grant. The fair value is then expensed over the requisite service periods of the awards, net of estimated
forfeitures, which is generally the performance period and the related amount is recognized in the consolidated and combined statements
of operations.
The fair value models require the input of certain
assumptions that require our judgment, including the expected term and the expected share price volatility of the underlying share. The
assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, but these estimates
involve inherent uncertainties and the application of judgment. As a result, if factors change resulting in the use of different assumptions,
share-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture
rate and only recognize expense for those shares expected to vest. If the actual forfeiture rate is materially different from management’s
estimates, the share-based compensation expense could be significantly different from what we have recorded in the current period.
All financial instruments are required to be
measured at fair value on initial recognition, plus, in the case of a financial asset or financial liability not at FVTPL, transaction
costs that are directly attributable to the acquisition or issuance of the financial asset or financial liability. Transaction costs
of financial assets and financial liabilities carried at FVTPL are expensed in profit or loss. Financial assets and financial liabilities
with embedded derivatives are considered separately when determining whether their cash flows are solely payment of principal and interest.
Financial assets that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual
cash flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at
the end of the subsequent accounting periods. All other financial assets including equity investments are measured at their fair values
at the end of subsequent accounting periods, with any changes taken through profit and loss or other comprehensive income (irrevocable
election at the time of recognition). For financial liabilities measured subsequently at FVTPL, changes in fair value due to credit risk
are recorded in other comprehensive income.
We apply fair value accounting for all financial
assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements
on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and
liabilities that are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact
and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks
inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy,
which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest
level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices in active markets for identical
assets or liabilities.
Level 2 – Observable inputs other
than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities
in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term
of the assets or liabilities.
Level 3 – Inputs that are generally
unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset
or liability.
We assess all information available, including
on a forward-looking basis the expected credit loss associated with our assets carried at amortized cost. The impairment methodology applied
depends on whether there has been a significant increase in credit risk. To assess whether there is a significant increase in credit risk,
we compare the risk of a default occurring on the asset at the reporting date with the risk of default at the date of initial recognition
based on all information available, and reasonable and supportive forward-looking information. For accounts receivable only, we apply
the simplified approach as permitted by ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments.” The simplified approach to the recognition of expected losses does not require us to track the changes
in credit risk; rather, we recognize a loss allowance based on lifetime expected credit losses at each reporting date from the date of
the trade receivable.
Expected credit losses are measured as the difference
in the present value of the contractual cash flows that are due to us under the contract, and the cash flows that we expect to receive.
We assess all information available, including past due status, credit ratings, the existence of third-party insurance, and forward-looking
macro-economic factors in the measurement of the expected credit losses associated with its assets carried at amortized cost. We measure
expected credit loss by considering the risk of default over the contract period and incorporates forward-looking information into its
measurement.
In December 2019, the FASB issued ASU 2019-
12, “Simplifying the Accounting for Income Taxes” which eliminates certain exceptions related to the approach for intra-period
tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for
outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. ASU 2019-12 is effective
for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. We are currently evaluating the
adoption date and impact, if any, adoption will have on our consolidated and combined financial position and consolidated and combined
results of operations.
In January 2020, the FASB issued ASU 2020-01,
“Investments—Equity Securities (Topic 321)”, “Investments— Equity Method and Joint Ventures (Topic 323)”,
and “Derivatives and Hedging (Topic 815)”, which is intended to clarify the interaction of the accounting for equity securities
under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward
contracts and purchased options accounted for under Topic 815. ASU 2020-01 is effective for us beginning January 1, 2021. We are
currently evaluating the adoption date and impact, if any, adoption will have on our consolidated and combined financial position and
consolidated and combined results of operations.
In August 2020, the FASB issued ASU
2020-06, “Debt — Debt With Conversion and Other Options (Subtopic 470-20)” and “Derivatives and Hedging —
Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own
Equity”, which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including
convertible instruments and contracts on an entity’s own equity. ASU 2020-06 is effective for us for fiscal years beginning after
December 15, 2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15,
2020, and interim periods within those fiscal years. Adoption is applied on a modified or full retrospective transition approach. We are
currently evaluating the adoption date and impact, if any, adoption will have on our consolidated and combined financial position and
consolidated and combined results of operations.
Our financial instruments consist of cash and
cash equivalents, accounts receivables, investments, notes receivable trade payables, accrued liabilities, operating lease liabilities
and notes payable. All assets and liabilities for which fair value is measured or disclosed in the financial statements are categorized
within the fair value hierarchy. This is described, as follows, based on the lowest level input that is significant to the fair value
measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical
assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other
than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for
identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs
for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Credit risk is the risk of a potential loss to
us if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure at December 31,
2020 and 2019 is the carrying values of cash and cash equivalents, restricted cash, accounts receivable, and due from related party. We
do not have significant credit risk with respect to our customers. All cash and cash equivalents are placed with major U.S. financial
institutions. We provide credit to our customers in the normal course of business and has established credit evaluation and monitoring
processes to mitigate credit risk but has limited risk as the majority of our sales are transacted with cash.
Liquidity risk is the risk that we will not be
able to meet our financial obligations associated with financial liabilities. We manage liquidity risk through the management of its capital
structure. Our approach to managing liquidity risk is to ensure that we will have sufficient liquidity to settle obligations and liabilities
when due. As of December 31, 2020 and 2019, cash generated from ongoing operations was not sufficient to fund operations and growth
strategy as discussed above in “Financial Condition, Liquidity and Capital Resources.”
Our operating results and financial position are
reported in U.S. dollars. Some of our financial transactions are denominated in currencies other than the U.S. dollar. The results of
our operations are subject to currency transaction and translation risks. Our main risk is associated with fluctuations in Canadian dollars.
We hold cash in U.S. dollars, investments denominated in U.S. dollars, debt denominated in U.S. dollars and equity denominated in U.S.
and Canadian dollars. Such assets and liabilities denominated in currencies other than the U.S. dollar are translated based on the Company’s
foreign currency translation policy. As of December 31, 2020 and 2019, we had no hedging agreements in place with respect to foreign
exchange rates. We have not entered into any agreements or purchased any instruments to hedge possible currency risks at this time.
Interest rate risk is the risk that the fair value
or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear
interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a
limited interest rate fair value risk.
Price risk is the risk of variability in fair
value due to movements in equity or market prices. Our investments are susceptible to price risk arising from uncertainties about their
future outlook, future values and the impact of market conditions. The fair value of investments held in privately-held entities are based
on a market approach, which uses prices and other relevant information generated by market transactions involving identical or comparable
assets or liabilities.
The following management’s discussion and
analysis (“MD&A”) of the financial condition and results of the operations of Mercer Park Brand Acquisition Corp. (“Brand”,
the “Corporation”, “we”, “our” or “us”) constitutes management’s review of the factors
that affected the Corporation’s financial and operating performance for the three months ended March 31, 2021. This MD&A was
written to comply with the requirements of National Instrument 51-102 – Continuous Disclosure Obligations. This discussion
should be read in conjunction with the audited financial statements as at December 31, 2020 and for the year ended December 31, 2020,
and the related notes thereto, as well as the condensed interim financial statements as at March 31, 2021 and for the three months ended
March 31, 2021, and the related notes thereto. Results are reported in United States dollars, unless otherwise noted. In the opinion of
management, all adjustments (which consist only of normal recurring adjustments) considered necessary for a fair presentation have been
included. The results presented for the three months ended March 31, 2021, are not necessarily indicative of the results that may be expected
for any future period. The financial statements and the financial information contained in this MD&A were prepared in accordance with
accounting principles generally accepted in the United States of America (“GAAP”). Further information about the Corporation
and its operations can be obtained on www.sedar.com.
The Corporation intends to focus its search for
target businesses that operate branded product businesses in cannabis and/or cannabis-adjacent industries; however, the Corporation is
not limited to a particular industry or geographic region for purposes of completing its Qualifying Transaction (as defined below). Please
refer to the Corporation’s latest annual information form for risk factors and regulatory information (the “AIF”) regarding
the cannabis industry.
This MD&A contains certain forward-looking
information and forward-looking statements, as defined in applicable securities laws (collectively referred to herein as “forward-looking
statements”). These statements relate to future events or the Corporation’s future performance. All statements other than
statements of historical fact are forward-looking statements. Often, but not always, forward-looking statements can be identified by the
use of words such as “plans”, “expects”, “is expected”, “budget”, “scheduled”,
“estimates”, “continues”, “forecasts”, “projects”, “predicts”, “intends”,
“anticipates” or “believes”, or variations of, or the negatives of, such words and phrases, or statements that
certain actions, events or results “may”, “could”, “would”, “should”, “might”
or “will” be taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other
factors that may cause actual results to differ materially from those anticipated in such forward-looking statements. The forward-looking
statements in this MD&A speak only as of the date of this MD&A or as of the date specified in such statement. The following table
outlines certain significant forward-looking statements contained in this MD&A and provides the material assumptions used to develop
such forward-looking statements and material risk factors that could cause actual results to differ materially from the forward-looking
statements.
Inherent in forward-looking statements are risks,
uncertainties, and other factors beyond the Corporation’s ability to predict or control. Please also refer to those risk factors
referenced in the “Risk Factors” section below and in the AIF. Readers are cautioned that the above chart does not contain
an exhaustive list of the factors or assumptions that may affect the forward-looking statements, and that the assumptions underlying such
statements may prove to be incorrect. Actual results and developments are likely to differ, and may differ materially, from those expressed
or implied by the forward-looking statements contained in this MD&A.
Forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause the Corporation’s actual results, performance, or achievements to be materially
different from any of its future results, performance or achievements expressed or implied by forward-looking statements. All forward-looking
statements herein are qualified by this cautionary statement. Accordingly, readers should not place undue reliance on forward-looking
statements. The Corporation undertakes no obligation to update publicly or otherwise revise any forward-looking statements whether because
of new information or future events or otherwise, except as may be required by law. If the Corporation does update one or more forward-looking
statements, no inference should be drawn that it will make additional updates with respect to those or other forward-looking statements,
unless required by law.
Brand is a corporation which was incorporated
for the purpose of effecting an acquisition of one or more businesses or assets, by way of a merger, amalgamation, arrangement, share
exchange, asset acquisition, share purchase, reorganization, or any other similar business combination involving the Corporation (a “Qualifying
Transaction”). The Corporation’s business activities are carried out in a single business segment.
On May 13, 2019, the Corporation completed its
initial public offering (the “Offering”) of 40,250,000 Class A Restricted Voting Units (including 5,250,000 Class A Restricted
Voting Units issued pursuant to the exercise in full of the over-allotment option) at $10.00 per Class A Restricted Voting Unit. Each
Class A Restricted Voting Unit consisted of one Class A restricted voting share (“Class A Restricted Voting Share”) of the
Corporation and one-half of a share purchase warrant (each, a “Warrant”). In accordance with the Corporation’s articles,
each Class A Restricted Voting Share, unless previously redeemed, will be automatically converted into one Subordinate Voting Share following
the closing of a Qualifying Transaction. All Warrants will become exercisable at a price of $11.50 per share, commencing 65 days after
the completion of a Qualifying Transaction, and will expire on the day that is five years after the completion of a Qualifying Transaction
or may expire earlier if a Qualifying Transaction does not occur within the permitted timeline of 21 months (or 24 months if we have executed
a letter of intent, agreement in principle or definitive agreement for a Qualifying Transaction within 21 months but have not completed
the Qualifying Transaction within such 21-month period) (“Permitted Timeline”) (subject to extension, as further described
herein) from the closing of the Offering or if the expiry date is accelerated. Each Whole Warrant is exercisable to purchase one Class
A Restricted Voting Share (which, following the closing of the Qualifying Transaction, would become one Subordinate Voting Share).
In connection with the Offering, the
Corporation granted the underwriter a 30-day non-transferable option to purchase up to an additional 5,250,000 Class A Restricted Voting
Units, at a price of $10.00 per Class A Restricted Voting Unit, to cover over-allotments, if any, and for market stabilization purposes.
The overallotment option was exercised prior to the close of the initial public offering. As a result of the exercise of the over-allotment
option, the Founders, (as defined below) own an aggregate of 10,089,750 Class B Shares, including 109,000 Class B Units and 9,810,000
Founders’ Warrants (as defined below).
Concurrent with the completion of the
Offering, Mercer Park Brand, L.P. (formerly Mercer Park CB II, L.P.) (the “Sponsor”), a limited partnership formed under the
laws of the State of Delaware, indirectly controlled by Mercer Park, L.P., a privately-held family office based in New York, New York
and Charles Miles and Sean Goodrich (or persons or companies controlled by them) (collectively with the Sponsor, the “Founders”)
purchased an aggregate of 10,089,750 Class B Shares, consisting of 10,069,750 Class B Shares purchased by the Sponsor, 10,000 Class B
Shares purchased by Charles Miles, and 10,000 Class B Shares purchased by Sean Goodrich. In addition, the Sponsor purchased an aggregate
of 9,810,000 Warrants (“Founders’ Warrants”) at $1.00 per Founders’ Warrant.
Upon closing of the Qualifying Transaction,
the Class B Shares would, in accordance with the Corporation’s articles, convert on a 100-for-1 basis into Multiple Voting Shares.
Each Class A Restricted Voting Unit
commenced trading on May 13, 2019 on the Neo Exchange Inc. (the “Exchange”) under the symbol “BRND.U” and separated
into Class A Restricted Voting Shares and Warrants on June 24, 2019, which trade under the symbols “BRND.A.U”, and “BRND.WT”,
respectively. The Class B Shares issued to the Founders will not be listed prior to the completion of the Qualifying Transaction.
The proceeds of $402,500,000 from the
Offering are held by Odyssey Trust Company, as Escrow Agent, in an escrow account (the “Escrow Account”) at a Canadian chartered
bank or subsidiary thereof, in accordance with the escrow agreement. Subject to applicable law and payment of certain taxes, permitted
redemptions and certain expenses, as further described herein, none of the funds held in the Escrow Account will be released to the Corporation
prior to the closing of a Qualifying Transaction. The escrowed funds will be held to enable the Corporation to (i) satisfy redemptions
made by holders of Class A Restricted Voting Shares (including in the event of a Qualifying Transaction, or an extension to the Permitted
Timeline to up to 36 months with shareholder approval from the holders of Class A Restricted Shares and the Corporation’s board
of directors, or in the event a Qualifying Transaction does not occur within the Permitted Timeline), (ii) fund a Qualifying Transaction
with the net proceeds following payment of any such redemptions and deferred underwriting commissions, and/or (iii) pay taxes on amounts
earned on the escrowed funds and certain permitted expenses. Such escrowed funds and all amounts earned, subject to such obligations and
applicable law, will be assets of the Corporation. These escrowed funds will also be used to pay the deferred underwriting commissions
in the amount of $16,100,000, 75% of which will be payable by the Corporation to the underwriter only upon the closing of a Qualifying
Transaction (subject to availability, failing which any short fall would be required to be made up from other sources) and the remaining
25% of which (or, if a lesser amount, the balance of the non-redeemed shares' portion of the Escrow Account, less tax liabilities on amounts
earned on the escrowed funds and certain expenses directly related to redemptions) will be payable by the Corporation as it sees fit,
including for payment to other agents or advisors who have assisted with or participated in the sourcing, diligence and completion of
its Qualifying Transaction.
In connection with consummating a Qualifying
Transaction, the Corporation will require approval by a majority of the directors unrelated to the Qualifying Transaction. In connection
with the Qualifying Transaction, holders of Class A Restricted Voting Shares will be given the opportunity to elect to redeem all or a
portion of their Class A Restricted Voting Shares at a per share price, payable in cash, equal to the pro-rata portion per Class A Restricted
Voting Share of: (A) the escrowed funds available in the Escrow Account at the time immediately prior to the redemption deposit timeline,
including interest and other amounts earned thereon; less (B) an amount equal to the total of (i) applicable taxes payable by the Corporation
on such interest and other amounts earned in the Escrow Account and (ii) actual and expected direct expenses related to the redemption,
each as reasonably determined by the Corporation, subject to certain limitations. Each holder of Class A Restricted Voting Shares, together
with any affiliate of such holder or any other person with whom such holder or affiliate is acting jointly or in concert, will be subject
to a redemption limitation of an aggregate 15% of the number of Class A Restricted Voting Shares issued and outstanding. Class B Shares
will not be redeemable in connection with a Qualifying Transaction or an extension to the Permitted Timeline and holders of Class B Shares
shall not be entitled to access the Escrow Account should a Qualifying Transaction not occur within the Permitted Timeline.
If the Corporation is unable to complete
its Qualifying Transaction within the Permitted Timeline (or within an extension of the Permitted Timeline), the Corporation will be required
to redeem each of the Class A Restricted Voting Shares. The Corporation’s Warrants (including the Warrants underlying the Class
A Restricted Voting Units and the Class B Units and the Founders’ Warrants) will expire worthless. In such case, each holder of
a Class A Restricted Voting Share will receive for an amount, payable in cash, equal to the pro-rata portion per Class A Restricted Voting
Share of: (A) the Escrow Account, including any interest and other amounts earned; less (B) an amount equal to the total of (i) any applicable
taxes payable by the Corporation on such interest and other amounts earned in the Escrow Account, (ii) any taxes of the Corporation arising
in connection with the redemption of the Class A Restricted Voting Shares, and (iii) up to a maximum of $50,000 of interest and other
amounts earned to pay actual and expected expenses related to the dissolution and certain other related costs as reasonably determined
by the Corporation. The underwriter will have no right to the deferred underwriting commissions held in the Escrow Account in such circumstances.
On February 2, 2020, the Corporation
announced that it has an executed letter of intent in connection with a potential transaction, which would, if consummated, qualify as
its qualifying transaction. Accordingly, the Corporation will be permitted until May 13, 2021 (24 months following the closing of its
initial public offering) to conclude its qualifying transaction. After quarter-end, the Corporation has sought an extension to the permitted
timeline, see Subsequent Events, below.
On March 24, 2021, the Corporation began
trading on the OTCQX® Best Market, under the ticker ‘MRCQF’.
The Corporation has not conducted commercial
operations and it is focused on the identification and evaluation of businesses or assets to acquire and there were no notable events
that occurred during the reporting periods presented.
For the three months ended March 31,
2021, the Corporation earned interest income of $60,900 (three months ended March 31, 2020 - $1,495,772) and reported a loss of $1,348,294
($0.13 basic and diluted loss per Class B Share) (three months ended March 31, 2020, income of $1,336,473 ($0.13 basic and diluted income
per Class B Share)). The expenses for the three months ended March 31, 2021 primarily related to general and administrative expenses of
$1,328,203, foreign exchange loss of $26,199, travel of $54,792, current income tax recovery of $244,184 and deferred income tax of $244,184.
The expenses for the three months ended March 31, 2020 primarily related to general and administrative expenses of $164,180, foreign exchange
gain of $4,881, travel of $nil, current income tax recovery of $nil and deferred income tax of $nil. Current liabilities as of March 31,
2021 total $1,843,980 (December 31, 2020 - $745,813). Shareholders’ deficiency as of March 31, 2021 is comprised of Class B Shares,
unlimited, 10,198,751 issued of $nil (December 31, 2020 - $nil), additional paid-in-capital of ($11,684,284) (December 31, 2020 - ($11,684,284))
and retained earnings of $2,430,543 (December 31, 2020 - $3,778,837) for a net amount of ($9,253,741) (December 31, 2020 – ($7,905,447))
in shareholders’ deficiency.
Commitments and contingencies as of
March 31, 2021 total $402,500,000 (December 31, 2020 - $402,500,000). It is comprised of Class A Restricted Voting Shares subject to redemption,
40,250,000 shares (at a redemption value of $10.00 per share).
Working capital, which consists of current
assets less current liabilities, is $3,353,497 (December 31, 2020 - $2,559,062) as of March 31, 2021. Management believes the Corporation’s
working capital is sufficient for the Corporation to meet its ongoing obligations and meet its objective of completing a Qualifying Transaction.
The weighted average number of Class
B Shares outstanding for the three months ended March 31, 2021 was 10,198,751 (three months ended March 31, 2020 – 10,198,751).
Results of Operations
The following are the results of our operations
for the three months ended March 31, 2021 compared to three months ended March 31, 2020:
| | |
2021 | | |
2020 | |
| Revenues, Net | |
$ | 15,240,281 | | |
$ | 6,449,327 | |
| Cost of Goods Sold | |
| 9,798,285 | | |
| 4,985,843 | |
| | |
| | | |
| | |
| Gross Profit | |
| 5,441,996 | | |
| 1,463,484 | |
| | |
| | | |
| | |
| Operating Expenses: | |
| | | |
| | |
| General and Administrative | |
| 5,835,731 | | |
| 4,107,858 | |
| Sales and Marketing | |
| 488,535 | | |
| 354,425 | |
| Professional Fees | |
| 3,352,751 | | |
| 645,046 | |
| Depreciation and Amortization | |
| 724,454 | | |
| 531,405 | |
| | |
| | | |
| | |
| Total Operating Expenses | |
| 10,401,471 | | |
| 5,638,734 | |
| | |
| | | |
| | |
| Loss from Operations | |
| (4,959,475 | ) | |
| (4,175,250 | ) |
| | |
| | | |
| | |
| Other Expense (Income): | |
| | | |
| | |
| Interest Expense | |
| 1,010,428 | | |
| 363,069 | |
| Interest Income | |
| (16,086 | ) | |
| (98,341 | ) |
| (Income) Loss on Investments | |
| (1,388 | ) | |
| 19,197 | |
| (Gain) Loss on Change in Fair Value of Derivative Liabilities | |
| (671,000 | ) | |
| 129,699 | |
| Loss on Disposition of Subsidiary | |
| 6,090,339 | | |
| - | |
| Other Expense (Income), Net | |
| 6,024 | | |
| (14,813 | ) |
| | |
| | | |
| | |
| Total Other Expense, Net | |
| 6,418,317 | | |
| 398,811 | |
| | |
| | | |
| | |
| Loss from Operations Before Provision for Income Taxes | |
| (11,377,792 | ) | |
| (4,574,061 | ) |
| Provision for Income Taxes | |
| 1,776,001 | | |
| 566,593 | |
| Net Loss | |
$ | (13,153,793 | ) | |
$ | (5,140,654 | ) |
Revenue
Revenue for the three months ended March 31,
2021 was $15.2 million, which represents an increase of $8.8 million or 136% from $6.4 million for the three months ended March 31,
2020. The increase in revenue was primarily due to an increase in cannabis production from the Company’s second greenhouse cultivation
facility, which commenced operations in Q1 2020. The expansion of the cultivation facility was increased from 113,000 square feet during
2020 to over 390,000 square feet by the end of 2020. The Company’s wholesale and wholesale CPG revenue increased by $7.2 million
or 230% for the three months ended March 31, 2021 from the three months ended March 31, 2020. The Company’s cannabis retail
dispensaries also contributed consistent revenue growth, and had an increase of $1.6 million, or 49%, in retail sales during the three
months ended March 31, 2021 compared to retail sales during the comparative period in the prior year.
Cost of Goods Sold and Gross Profit
Cost of goods sold for the three months ended
March 31, 2021 was $9.7 million, an increase of $4.8 million, or 97%, compared with $4.9 million for the three months ended March 31,
2020. Gross profit for the three months ended March 31, 2021 was $5.4 million, representing a gross margin of 36%, compared with
a gross profit of $1.4 million, representing a gross margin of 23% for the three months ended March 31, 2020. The increase in cost
of goods sold was primarily attributable to the Company’s increase in revenues during the three months ended March 31, 2021
which resulted in increased cost of goods sold. The Company’s gross profit for the three months ended March 31, 2021 as a percentage
of revenues improved compared to the same period in the prior year as a result of the Company’s continual improvement in efficiencies
in relation to its cultivation facilities during the year ended 2020 through March 31, 2021.
Total Operating Expenses
Total operating expenses for the three months
ended March 31, 2021 was $10.4 million, an increase of $4.7 million, or 84%, compared to total expenses of $5.6 million for the three
months ended March 31, 2020. The increase in total expenses was attributable to the factors described below.
General and administrative expenses for the three
months ended March 31, 2021 and March 31, 2020 was $5.8 million and $4.1 million, respectively, an increase of $1.7 million,
or 42%. The increase in general and administrative expenses is primarily attributed to the Company’s initiatives of operational
expansion and used to support corporate, cultivation and retail operations which resulted in an increase in salaries and wages of $1.0
million and an increase in stock based compensation of $1.0 million during the three months ended March 31, 2021.
Sales and marketing expenses for the three months
ended March 31, 2021 and March 31, 2020 were $0.5 million and $0.4 million, respectively, an increase of $0.1 million, or 38%.
The increase in sales and marketing expenses is primarily attributed to the increase in the Company’s efforts related to digital
media and marketing research expenses of $0.1 million. Sales and marketing expenses include trade marketing, point of sale marketing for
our CPG product lines and promotions in various media outlets.
Professional fees for the three months ended March 31,
2021 and March 31, 2020 was $3.4 million and $0.6 million, respectively, an increase of $2.7 million, or 420%. During the first quarter
of 2021, the Company recognized increased legal fee of $0.7 million coupled with increased accounting and consulting professional fees
of $2.0 million related to the preparation of the merger with Mercer Park.
Depreciation and amortization for the three months
ended March 31, 2021 and March 31, 2020 was $0.7 million and $0.5 million, respectively, an increase of $0.2 million, or 28%.
The increase is attributed to the growth of the Company’s operations through acquisitions and purchase of additional $1.3 million
of fixed assets during the three months ended March 31, 2021.
Total Other Expense, Net
Total other expense for the three months ended
March 31, 2021 and 2020 was $6.4 million and $0.4 million, respectively, an increase of $6.0 million, or 1509%. The increase in total
other expense was due to $6.0 million expensed during the three months ended March 31, 2021 due to the deconsolidation of Field Investment
Co, LLC a subsidiary and its subsidiaries Field Taste Matters, Inc., ATES Enterprises, LLC, and Zero One Seven Management, LLC for
de minimis consideration to an unrelated party coupled with an increase of interest expense of $0.6 million offset by a change in fair
value of derivative liabilities of $0.8 million compared to the same period in the prior year.
Provision for Income Taxes
The provision for income taxes for the three months
ended March 31, 2021 was $1.8 million, an increase of $1.2 million, or 213%, compared to provision for income taxes of $0.6 million
for the three months ended March 31, 2020. The increase in provision for income taxes was directly impacted by the Company’s
increase in operations and revenues for the current period.
Non-GAAP Financial Measures
Earnings before interest, taxes, depreciation,
and amortization (EBITDA) and Adjusted EBITDA are non-GAAP measures and do not have standardized definitions under U.S. GAAP. The Company
has provided the non-GAAP financial measures, which are not calculated or presented in accordance with U.S. GAAP, as supplemental information
and in addition to the financial measures that are calculated and presented in accordance with U.S. GAAP and may not be comparable to
similar measures presented by other issuers. These supplemental non-GAAP financial measures are presented because management has evaluated
the financial results both including and excluding the adjusted items and believe that the supplemental non-GAAP financial measures presented
provide additional perspective and insights when analyzing the core operating performance of the business. These supplemental non-GAAP
financial measures should not be considered superior to, as a substitute for or as an alternative to, and should only be considered in
conjunction with, the U.S. GAAP financial measures presented herein. Accordingly, the Company has included below reconciliations of the
supplemental non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with
U.S. GAAP.
The following table provides a reconciliation of the Company’s
net loss to Adjusted EBITDA (non-GAAP):
| | |
2021 | | |
2020 | |
| Net Loss (GAAP) | |
$ | (13,153,793 | ) | |
$ | (5,140,654 | ) |
| Depreciation and Amortization | |
| 724,454 | | |
| 531,405 | |
| Interest Expense | |
| 1,010,428 | | |
| 363,069 | |
| Income Tax Expense | |
| 1,776,001 | | |
| 566,593 | |
| EBITDA | |
| (9,642,910 | ) | |
| (3,679,587 | ) |
| Adjustments: | |
| | | |
| | |
| Shared-Based Compensation | |
| 1,606,462 | | |
| 556,692 | |
| (Income) Loss on Equity Method Investments | |
| (1,388 | ) | |
| 19,197 | |
| (Gain) Loss on Change in Fair Value of Derivative Liabilities | |
| (671,000 | ) | |
| 129,699 | |
| Other Non-Recurring Items: | |
| | | |
| | |
| Acquisition Related Professional Fees | |
| 3,186,451 | | |
| 239,751 | |
| Loss on Disposition of Subsidiary | |
| 6,090,339 | | |
| - | |
| Adjusted EBITDA (non-GAAP) | |
$ | 567,954 | | |
$ | (2,734,248 | ) |
Adjusted EBITDA (non-GAAP)
Adjusted EBITDA, a non-GAAP measure which excludes
depreciation and amortization, interest expense, income taxes, share-based compensation, (income) loss on equity method investments, (gain)
loss on change in fair value of derivative liabilities, acquisition related professional fees, and loss on disposition of subsidiary was
$0.5 million for the three months ended March 31, 2021 compared to a $2.7 million loss for the three months ended March 31,
2020. The increase in adjusted EBITDA of $3.2 million is due to higher gross profit partially offset by higher operating expenses.
Liquidity and Capital Resources
Overview
Historically, GH Group’s primary source
of liquidity has been capital contributions made by equity investors and debt issuances. GH Group expects to generate positive cash flow
from its operations going forward and expects such positive cash flow to be its principal source of future liquidity. Liquidity risk is
the risk that the Company will not be able to meet its financial obligations associated with financial liabilities. The Company manages
liquidity risk through the management of its capital structure. The Company’s approach to managing liquidity is to ensure that it
will have sufficient liquidity to settle obligations and liabilities when due. In the event sufficient cash flow is not available from
operating activities, GH Group may continue to raise equity or debt capital from investors in order to meet liquidity needs.
Financial Condition
Cash Flows
The following table summarizes GH Group’s
consolidated statement of cash flows from continuing operations for the three months ended March 31, 2021 and 2020:
| | |
2021 | | |
2020 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | |
| | | |
| | |
| NET CASH USED IN OPERATING ACTIVITIES | |
$ | (945,124 | ) | |
$ | (5,247,564 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES: | |
| | | |
| | |
| NET CASH USED IN INVESTING ACTIVITIES | |
| (1,727,889 | ) | |
| (3,274,691 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES: | |
| | | |
| | |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | |
| 9,748,392 | | |
| 9,451,887 | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | |
| 7,075,379 | | |
| 929,632 | |
| Cash and Cash Equivalents, Beginning of Period | |
| 4,535,251 | | |
| 2,631,886 | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | |
$ | 11,610,630 | | |
$ | 3,561,518 | |
Cash Flow from Operating Activities
Net cash used in operating activities was $0.9
million for the three months ended March 31, 2021, a decrease of $4.3 million, or 82%, compared to $5.2 million for the three months
ended March 31, 2020. The decrease in cash used was primarily due to an increase of $4.0 million of gross margin.
Cash Flow Used in Investing Activities
Net cash used in investing activities was $1.7
million for the three months ended March 31, 2021, a decrease of $1.6 million, or 47%, compared to $3.3 million for the three months
ended March 31, 2020. This was primarily driven by the decrease in issuance of notes receivables in the amount of $1.1 million during
the three months ended March 31, 2020, compared to nil during the current period.
Cash Flow Provided by Financing Activities
Net cash provided by financing activities totaled
$9.7 million for the three months ended March 31, 2021, an increase of $0.3 million, or 3%, compared to $9.4 million for the three
months ended March 31, 2020. This was primarily driven by cash proceeds from the issuance of notes and convertible notes payable
during the current period of $12.5 million, compared to $9.6 million during the first quarter of 2020. Cash proceeds provided during the
current period were offset by payments on notes and convertible notes during the current period of $0.6 million, compared to $0.2 million
during the first quarter of 2020.
As previously noted, GH Group’s primary
source of liquidity has been capital contributions and debt capital made available from investors. GH Group expects to generate positive
cash flow from its operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the
event sufficient cash flow is not available from operating activities, GH Group may continue to raise equity capital from investors in
order to meet liquidity needs. GH Group does not have any committed sources of financing, nor significant outstanding capital expenditure
commitments.
Contractual Obligations
GH Group has contractual obligations to make future payments, including
debt agreements and lease agreements from third parties and related parties.
The following table summarizes such obligations as of March 31,
2021:
| | |
2021 | | |
2022 | | |
2023- 2024 | | |
After 2024 | | |
Total | |
| | |
(remaining) | | |
| | |
| | |
| | |
| |
| Notes Payable from Third Parties and Related Parties | |
$ | 10,004,848 | | |
$ | 2,048,764 | | |
$ | 25,830,228 | | |
$ | 52,528 | | |
$ | 37,936,368 | |
| Leases Obligations | |
| 472,306 | | |
| 633,127 | | |
| 1,270,379 | | |
| 2,980,019 | | |
| 5,355,831 | |
| Total Contractual Obligations | |
$ | 10,477,154 | | |
$ | 2,681,891 | | |
$ | 27,100,607 | | |
$ | 3,032,547 | | |
$ | 43,292,199 | |
On June 29, 2021, over $37,600,000 of Notes Payable was converted
to equity.
Transactions with Related Parties During the Three Months Ended
March 31, 2021
Private Placement
On January 8, 2020, the board of directors
approved approximately $17,500,000 of private placement of Senior Convertible Notes. On January 4, 2021, the board of directors approved
an increase of the Senior Convertible Notes offering to $22,599,844. The Senior Convertible Notes are automatically converted in the event
of a Qualified Equity Financing (“QEF”) at the better of an 80% discount or a valuation cap of $250,000,000 or may be optionally
converted at the election of the holder. The Senior Convertible Notes bear cash interest at a rate of 4% per year paid quarterly and generally
accrue interest at a rate of 4.3% per year. The Senior Convertible Note holders were issued a security interest in the stock and membership
interests held by the Company in its subsidiaries. As of March 31, 2021 and December 31, 2020, the balance due under these Senior
Convertible Notes from related parties was $2,088,331 and $2,049,037, respectively.
Magu Farm Lenders Debt Transactions
In 2018, Magu Farm LLC issued approximately $9,925,000
in secured promissory notes convertible into equity interests in Magu Investment Fund (collectively, the “Magu Farm Convertible
Notes”) to certain lenders who are affiliates of shareholders of the Company (collectively, the “Magu Farm Lenders,”
and individually, a “Magu Farm Lender”)
On October 7, 2019, Magu Farm LLC and Magu
Investment Fund notified each Magu Farm Lender of Magu Investment Fund’s intention to merge with and into the Company at the closing
of the Roll-Up. Subsequent to such notification, effective as of October 7, 2019, each Magu Farm Lender other than Kings Bay Investment
Company Ltd., a Cayman Islands company (“KBIC”), entered into a letter agreement pursuant to which such Magu Farm Lender,
among other things, (a) converted its respective Magu Farm Convertible Note with an aggregate value of $8,000,000 into equity interests
in Magu Investment Fund and (b) agreed to terminate both the Co-Lending Agreement and its respective security interest as defined
in the agreement. All accrued and unpaid interest were paid prior to conversion. Effective as of March 1, 2020, KBIC assigned its
Magu Farm Convertible Notes (“Kings Bay Note”) to Kings Bay Capital Management Ltd., a Cayman Islands company (“KBCM”).
Effective as of April 10, 2020, KBCM and
the Company entered into an Assignment, Novation and Note Modification Agreement and a Security Agreement, pursuant to which, among other
things, (a) the company assumed all of Magu Farm LLC’s rights, duties, liabilities and obligations under the Kings Bay Note,
(b) the Kings Bay Note was modified, among other things, such that KBCM has the right to convert the Kings Bay Note into Class A
Shares at the same conversion price accorded to the other Magu Farm Lenders, and (c) the obligations under the Kings Bay Note were
secured by a pledge of the securities of Glass House’s subsidiaries but expressly subordinated to the holders of the Senior Convertible
Notes. As of March 31, 2021 and December 31, 2020, the balance due to KBCM is $2,158,195 and $2,189,264, respectively.
BFP Debt Transaction
On February 22, 2021, Beach Front Properties,
LLC, a California limited liability company (“BFP”), issued $2,000,000 in promissory note to the Company. The debt
matures in February 2023 and bears interest at 15.00 percent per year. As of March 31, 2021 and December 31, 2020, the
balance was $2,029,932 and nil, respectively.
Qualified Equity Financing
In March 2021, the Company began to raise
Series A Preferred Stock Financing round of $12,000,000. The Preferred Stock will carry an annual 15.00 percent cumulative dividend
in year 1. During March 2021, the Company raised $2,125,000 from related parties. Until the financing round closes, the amount raised
through March 31, 2021 was recorded as short-term debt. As of March 31, 2021 and December 31, 2020, the note payable balance
was $2,138,223 and nil, respectively.
Asset Management Fees
The Company has an agreement with certain related
parties which provide asset management services. Fees are paid quarterly. For the three months ended March 31, 2021 and 2020, the
Company incurred expenses of nil and nil, respectively.
Critical Accounting Estimates
Use of Estimates
The preparation of the unaudited Condensed Interim
Consolidated Financial Statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the dates of unaudited Condensed Interim Consolidated Financial Statements and the reported amounts
of total net revenue and expenses during the reporting period. The Company regularly evaluates significant estimates and assumptions related
to the consolidation or non-consolidation of variable interest entities, estimated useful lives, depreciation of property and equipment,
amortization of intangible assets, inventory valuation, share-based compensation, business combinations, goodwill impairment, long-lived
asset impairment, purchased asset valuations, fair value of financial instruments, compound financial instruments, derivative liabilities,
deferred income tax asset valuation allowances, incremental borrowing rates, lease terms applicable to lease contracts and going concern.
These estimates and assumptions are based on current facts, historical experience and various other factors that the Company believes
to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets
and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results
the Company experiences may differ materially and adversely from these estimates. To the extent there are material differences between
the estimates and actual results, the Company’s future results of operations will be affected.
Estimated Useful Lives and Depreciation of Property and Equipment
Depreciation of property and equipment is dependent
upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment of these assets
is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful
lives of assets.
Estimated Useful Lives and Amortization of Intangible Assets
Amortization of intangible assets is dependent
upon estimates of useful lives and residual values which are determined through the exercise of judgment. Intangible assets that have
indefinite useful lives are not subject to amortization and are tested annually for impairment, or more frequently if events or changes
in circumstances indicate that they might be impaired. The assessment of any impairment of these assets is dependent upon estimates of
recoverable amounts that take into account factors such as economic and market conditions.
Impairment of Long-Lived Assets
For purposes of the impairment test, long-lived
assets such as property, plant and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the
lowest level for which identifiable independent cash flows are available (“asset group”). The Company reviews long-lived assets
for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order
to determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first
to determine whether the long-lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset to
the sum of its future undiscounted cash flows using entity-specific assumptions generated through the asset’s use and eventual disposition.
If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded. If the carrying
amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step 2) is required.
The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying value of the
asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection and fair
value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies, at the
date of evaluation. The reversal of impairment losses is prohibited.
Leased Assets
As a result of the adoption of Audit Standards
Update (“ASU”) 2016-02, “Leases (Topic 842)” (“ASC 842”) using the full retrospective approach, which
provides a method for recording existing leases at adoption using the effective date as its date of initial application. Accordingly,
the Company has recorded its leases at inception of the Company. The Company elected the package of practical expedients provided by ASC
842, which forgoes reassessment of the following upon adoption of the new standard: (1) whether contracts contain leases for any
expired or existing contracts, (2) the lease classification for any expired or existing leases, and (3) initial direct costs
for any existing or expired leases. In addition, the Company elected an accounting policy to exclude from the balance sheet the right-of-use
assets and lease liabilities related to short-term leases, which are those leases with a lease term of twelve months or less that do not
include an option to purchase the underlying asset that the Company is reasonably certain to exercise.
The Company applies judgment in determining whether
a contract contains a lease and if a lease is classified as an operating lease or a finance lease. The Company applies judgement in determining
the lease term as the non-cancellable term of the lease, which may include options to extend or terminate the lease when it is reasonably
certain that the Company will exercise that option. All relevant factors that create an economic incentive for it to exercise either the
renewal or termination are considered. The Company reassesses the lease term if there is a significant event or change in circumstances
that is within its control and affects its ability to exercise or not to exercise the option to renew or to terminate. In adoption of
ASC 842, the Company applied the practical expedient which applies hindsight in determining the lease term and assessing impairment of
right-of-use assets by using its actual knowledge or current expectation as of the effective date. The Company also applies judgment in
allocating the consideration in a contract between lease and non-lease components. It considers whether the Company can benefit from the
right-of-use asset either on its own or together with other resources and whether the asset is highly dependent on or highly interrelated
with another right of-use asset. Lessees are required to record a right of use asset and a lease liability for all leases with a term
greater than twelve months. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease
payments over the expected remaining lease term. The incremental borrowing rate is determined using estimates which are based on the information
available at commencement date and determines the present value of lease payments if the implicit rate is unavailable.
Income Taxes
Deferred tax assets and liabilities are recorded
for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in
the combined balance sheet. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to
tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more
likely than not that some or all of the deferred tax assets will not be realized.
The Company follows accounting guidance issued
by the Financial Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes.
Under this guidance, the Company assesses the likelihood of the financial statement effect of a tax position that should be recognized
when it is more likely than not that the position will be sustained upon examination by a taxing authority based on the technical merits
of the tax position, circumstances, and information available as of the reporting date.
Convertible Instruments
The Company evaluates and accounts for conversion
options embedded in its convertible instruments in accordance with ASC 815, “Accounting for Derivative Instruments and Hedging Activities”.
Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host
instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which
(a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and
the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument
is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
The Company accounts for convertible instruments
(when it has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance ASC 470,
“Accounting for Convertible Securities with Beneficial Conversion Features”, as those professional standards pertain to “Certain
Convertible Instruments”. Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value
of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at
the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed dividends
for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying
common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides
that generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be
classified as an asset or a liability.
Derivative Liabilities
The Company evaluates its agreements to determine
if such instruments have derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that
are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting
date, with changes in the fair value reported in the unaudited Condensed Interim Consolidated Statements of Operations. In calculating
the fair value of derivative liabilities, the Company uses a valuation model when Level 1 inputs are not available to estimate fair value
at each reporting date. The classification of derivative instruments, including whether such instruments should be recorded as liabilities
or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the unaudited Condensed
Interim Consolidated Balance Sheets as current or non-current based on whether or not net-cash settlement of the derivative instrument
could be required within twelve months of the Consolidated Balance Sheets date.
Business Combinations
Business combinations are accounted for using
the acquisition method. The consideration transferred in a business combination is measured at fair value at the date of acquisition.
Acquisition related transaction costs are expensed as incurred and included in the unaudited Condensed Interim Consolidated Statements
of Operations. Identifiable assets and liabilities, including intangible assets, of acquired businesses are recorded at their fair value
at the date of acquisition. When the Company acquires control of a business, any previously held equity interest also is remeasured to
fair value. The excess of the purchase consideration and any previously held equity interest over the fair value of identifiable net assets
acquired is goodwill. If the fair value of identifiable net assets acquired exceeds the purchase consideration and any previously held
equity interest, the difference is recognized in the unaudited Condensed Interim Consolidated Statements of Operations immediately as
a gain on acquisition.
Contingent consideration is measured at its acquisition-date
fair value and included as part of the consideration transferred in a business combination. The Company allocates the total cost of the
acquisition to the underlying net assets based on their respective estimated fair values. As part of this allocation process, the Company
identifies and attributes values and estimated lives to the intangible assets acquired. These determinations involve significant estimates
and assumptions regarding multiple, highly subjective variables, including those with respect to future cash flows, discount rates, asset
lives, and the use of different valuation models, and therefore require considerable judgment. The Company’s estimates and assumptions
are based, in part, on the availability of listed market prices or other transparent market data. These determinations affect the amount
of amortization expense recognized in future periods. The Company bases its fair value estimates on assumptions it believes to be reasonable
but are inherently uncertain. Contingent consideration that is classified as equity is not remeasured at subsequent reporting dates and
its subsequent settlement is accounted for within equity. Contingent consideration that is classified as an asset or a liability is remeasured
at subsequent reporting dates in accordance with ASC 450, “Contingencies”, as appropriate, with the corresponding gain or
loss being recognized in earnings in accordance with ASC 805.
Share-Based Compensation
The Company has a share-based compensation plan
comprised of stock options (“Options”) and stock appreciation rights (“SARs”). Options provide the right to the
purchase of one Series A Common share per option. Stock appreciation rights provide the right to receive cash from the exercise of
such right based on the increase in value between the exercise price and the fair market value of Series A Common shares of the Company
at the time of exercise. The Company has issued both incentive stock options and non-qualified stock options.
The Company accounts for its share-based awards
in accordance with ASC Subtopic 718-10, “Compensation – Stock Compensation”, which requires fair value measurement on
the grant date and recognition of compensation expense for all share-based payment awards made to employees and directors, including restricted
share awards. For stock options, the Company estimates the fair value using a closed option valuation (Black-Scholes) model. When there
are market-related vesting conditions to the vesting term of the share-based compensation, the Company uses a valuation model to estimate
the probability of the market-related vesting conditions being met and will record the expense. The fair value of restricted share awards
is based upon the quoted market price of the common shares on the date of grant. The fair value is then expensed over the requisite service
periods of the awards, net of estimated forfeitures, which is generally the performance period and the related amount is recognized in
the Condensed Interim Consolidated Statements of Operations.
The fair value models require the input of certain
assumptions that require the Company’s judgment, including the expected term and the expected share price volatility of the underlying
share. The assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, but
these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change resulting in the use of
different assumptions, share-based compensation expense could be materially different in the future. In addition, the Company is required
to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the actual forfeiture rate is
materially different from management’s estimates, the share-based compensation expense could be significantly different from what
the Company has recorded in the current period.
Financial Instruments
Measurement
All financial instruments are required to be measured
at fair value on initial recognition, plus, in the case of a financial asset or financial liability not at FVTPL, transaction costs that
are directly attributable to the acquisition or issuance of the financial asset or financial liability. Transaction costs of financial
assets and financial liabilities carried at FVTPL are expensed in profit or loss. Financial assets and financial liabilities with embedded
derivatives are considered separately when determining whether their cash flows are solely payment of principal and interest. Financial
assets that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual cash
flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at the
end of the subsequent accounting periods. All other financial assets including equity investments are measured at their fair values at
the end of subsequent accounting periods, with any changes taken through profit and loss or other comprehensive income (irrevocable election
at the time of recognition). For financial liabilities measured subsequently at FVTPL, changes in fair value due to credit risk are recorded
in other comprehensive income.
Fair Value
The Company applies fair value accounting for
all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial
statements on a recurring basis. The Company defines fair value as the price that would be received from selling an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements
for assets and liabilities that are required to be recorded at fair value, the Company considers the principal or most advantageous market
in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing
the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated
by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization
within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices in active markets for identical
assets or liabilities.
Level 2 – Observable inputs other
than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities
in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term
of the assets or liabilities.
Level 3 – Inputs that are generally
unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset
or liability.
Impairment
The Company assesses all information available,
including on a forward-looking basis the expected credit loss associated with its assets carried at amortized cost. The impairment methodology
applied depends on whether there has been a significant increase in credit risk. To assess whether there is a significant increase in
credit risk, the Company compares the risk of a default occurring on the asset at the reporting date with the risk of default at the date
of initial recognition based on all information available, and reasonable and supportive forward-looking information. For accounts receivable
only, the Company applies the simplified approach as permitted by ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments”. The simplified approach to the recognition of expected losses does not require
the Company to track the changes in credit risk; rather, the Company recognizes a loss allowance based on lifetime expected credit losses
at each reporting date from the date of the trade receivable.
Expected credit losses are measured as the difference
in the present value of the contractual cash flows that are due to the Company under the contract, and the cash flows that the Company
expects to receive. The Company assesses all information available, including past due status, credit ratings, the existence of third-party
insurance, and forward-looking macro-economic factors in the measurement of the expected credit losses associated with its assets carried
at amortized cost. The Company measures expected credit loss by considering the risk of default over the contract period and incorporates
forward-looking information into its measurement.
Changes in Accounting Policies Including Adoption
In December 2019, the FASB issued ASU 2019-12,
“Simplifying the Accounting for Income Taxes” (“ASU 2019-12”), which eliminates certain exceptions related to
the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition of
deferred tax liabilities for outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes.
ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company
adopted ASU 2019-12 on January 1, 2021. The adoption of the standard did not have a material impact on the Company’s unaudited
Condensed Interim Consolidated Financial Statements.
In January 2020, the FASB issued ASU 2020-01,
“Investments—Equity Securities (Topic 321)”, “Investments—Equity Method and Joint Ventures (Topic 323)”,
and “Derivatives and Hedging (Topic 815)” (“ASU 2020-01”), which is intended to clarify the interaction of the
accounting for equity securities under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and
the accounting for certain forward contracts and purchased options accounted for under Topic 815. The Company adopted ASU 2020-01 on January 1,
2021. The adoption of the standard did not have a material impact on the Company’s unaudited Condensed Interim Consolidated Financial
Statements.
In August 2020, the FASB issued ASU 2020-06,
“Debt — Debt With Conversion and Other Options (Subtopic 470-20)” and “Derivatives and Hedging — Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”
(“ASU 2020-06”), which simplifies the accounting for certain financial instruments with characteristics of liabilities and
equity, including convertible instruments and contracts on an entity’s own equity. ASU 2020-06 is effective for the Company for
fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal
years beginning after December 15, 2020, and interim periods within those fiscal years. Adoption is applied on a modified or full
retrospective transition approach. The Company early adopted ASU 2020-06 on January 1, 2021. The adoption of the standard did not
have a material impact on the Company’s unaudited Condensed Interim Consolidated Financial Statements.
Financial Instruments and Other Instruments
Fair Value of Financial Instruments
GH Group’s financial instruments consist
of cash and cash equivalents, accounts receivables, investments, notes receivable, trade payables, accrued liabilities, operating lease
liabilities, derivatives, notes payable, acquisition consideration of assets and liabilities. All assets and liabilities for which fair
value is measured or disclosed in the financial statements are categorized within the fair value hierarchy. This is described, as follows,
based on the lowest level input that is significant to the fair value measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical
assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other
than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for
identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs
for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Other Risks and Uncertainties
Credit Risk
Credit risk is the risk of a potential loss to
the Company if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure
as of March 31, 2020 and December 31, 2020 is the carrying values of cash and cash equivalents, accounts receivable, due from
related party. The Company does not have significant credit risk with respect to its customers. All cash and cash equivalents are placed
with major U.S. financial institutions. The Company provides credit to its customers in the normal course of business and has established
credit evaluation and monitoring processes to mitigate credit risk but has limited risk as the majority of its sales are transacted with
cash.
Liquidity Risk
Liquidity risk is the risk that the Company will
not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management
of its capital structure. The Company’s approach to managing liquidity risk is to ensure that it will have sufficient liquidity
to settle obligations and liabilities when due. As of March 31, 2021 and December 31, 2020, cash generated from ongoing operations
was not sufficient to fund operations and growth strategy as discussed above in “Liquidity and Capital Resources ”.
Interest Rate Risk
Interest rate risk is the risk that the fair value
or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear
interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a
limited interest rate fair value risk.
Price Risk
Price risk is the risk of variability in fair
value due to movements in equity or market prices. The Company’s investments are susceptible to price risk arising from uncertainties
about their future outlook, future values and the impact of market conditions. The fair value of investments held in privately-held entities
are based on a market approach, which uses prices and other relevant information generated by market transactions involving identical
or comparable assets or liabilities.
Cautionary Note Regarding Forward-Looking Information
This MD&A contains certain forward-looking
information and forward-looking statements, as defined in applicable securities laws (collectively referred to herein as “forward-looking
statements”). These statements relate to future events or the Company’s future performance. All statements other than statements
of historical fact are forward-looking statements. Often, but not always, forward-looking statements can be identified by the use of words
such as “plans”, “expects”, “is expected”, “budget”, “scheduled”, “estimates”,
“continues”, “forecasts”, “projects”, “predicts”, “intends”, “anticipates”
or “believes”, or variations of, or the negatives of, such words and phrases, or statements that certain actions, events or
results “may”, “could”, “would”, “should”, “might” or “will” be
taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause
actual results to differ materially from those anticipated in such forward-looking statements. Forward looking statements include, but
are not limited to: statements concerning the completion of, and matters relating to, the various proposed transactions discussed by the
Company herein and the expected timing related thereto; the expected operations, financial results and condition of the Company; general
economic trends; the regulatory and legal environment relating to cannabis in the United States; any potential future legalization of
adult-use and/or medical marijuana under U.S. federal law; expectations of market size and growth in the United States and the States
the Company operates; cannabis cultivation, production and extraction capacity estimates and projections; additional funding requirements;
statements based on the Company’s Q1 2021 financial statements; the Company’s future objectives and strategies to achieve
those objectives; the Company’s estimated cash flow, capitalization and adequacy thereof; and other statements with respect to management’s
beliefs, plans, estimates and intentions, and similar statements concerning anticipated future events, results, circumstances, performance
or expectations that are not historical facts.
The material assumptions used to develop such
forward-looking statements, include, without limitation: the anticipated completion of the acquisition of the Greenhouse Option; the completion
of the anticipated merger of the Company with certain subsidiary entities of Element 7 and that Element 7 will be successful in applying
for the licenses; the anticipated receipt of any required regulatory approvals and consents; the expectation that no event, change or
other circumstance will occur that could give rise to the termination of definitive agreements entered into or to be entered into in connection
with the transactions discussed herein; that no unforeseen changes in the legislative and operating frameworks for the Company will occur;
that the Company will meet its future objectives and priorities; that the Company will have access to adequate capital to fund its future
projects and plans; that the Company’s future projects and plans will proceed as anticipated; that there will be no material adverse
changes in the U.S. legal and regulatory environment relating to cannabis, customer growth, pricing, usage; data based on good faith estimates
that are derived from management’s knowledge of the industry and other independent sources; and assumptions concerning general economic
and industry growth rates, commodity prices, currency exchange and interest rates and competitive intensity.
Inherent in forward-looking statements are risks,
uncertainties, and other factors beyond the Corporation’s ability to predict or control. Factors that could cause such differences
include, but are not limited to: cannabis is a controlled substance under applicable legislation; the enforcement of cannabis laws could
change; differing regulatory requirements across State jurisdictions may hinder economies of scale; legal, regulatory or other political
change; the unpredictable nature of the cannabis industry; regulatory scrutiny; the impact of regulatory scrutiny on the ability to raise
capital; anti-money laundering laws and regulations; any reclassification of cannabis or changes in U.S. controlled substances and regulations;
restrictions on the availability of favourable locations; enforceability of contracts; general regulatory and licensing risks; California
regulatory regime and transfer and grant of licenses; limitations on ownership of licenses; regulatory action from the Food and Drug Administration;
competition; ability to attract and retain customers; unfavourable publicity or consumer perception; results of future clinical research
and/or controversy surrounding vaporizers and vaporizer products; limited market data and difficulty to forecast; constraints on marketing
products; effects of the COVID-19 pandemic; execution of the Company’s business strategy; reliance on management; the Greenhouse
Option Acquisition and/or Element 7 Merger may not be completed or, if completed, may not be successful; ability to establish and maintain
effective internal control over financial reporting; competition from synthetic production and technological advances; fraudulent or illegal
activity by employees, contractors and consultants; product liability and recalls; risks related to product development and identifying
markets for sale; dependence on suppliers, manufacturers, and contractors; reliance on inputs; reliance on equipment and skilled labour;
service providers; litigation; intellectual property risks; information technology systems, cyber-attacks, security, and privacy breaches;
bonding and insurance coverage; transportation; energy costs; risks inherent in an agricultural business; management of growth; risks
of leverage; future acquisitions or dispositions; difficulty attracting and retaining personnel; and past performance not being indicative
of future results.
Readers are cautioned that the factors outlined
herein are not an exhaustive list of the factors or assumptions that may affect the forward-looking statements, and that the assumptions
underlying such statements may prove to be incorrect. Actual results and developments are likely to differ, and may differ materially,
from those expressed or implied by the forward-looking statements contained in this MD&A. Forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the Corporation’s actual results, performance, or achievements
to be materially different from any of its future results, performance or achievements expressed or implied by forward-looking statements.
All forward-looking statements herein are qualified by this cautionary statement. The forward-looking statements in this MD&A speak
only as of the date of this MD&A or as of the date specified in such statement. Accordingly, readers should not place undue reliance
on forward-looking statements. The Company undertakes no obligation to update publicly or otherwise revise any forward-looking statements
whether because of new information or future events or otherwise, except as may be required by law. If the Company does update one or
more forward-looking statements, no inference should be drawn that it will make additional updates with respect to those or other forward-looking
statements, unless required by law.
Management’s
Discussion and Analysis of Financial Condition and Results of Operations for the Year Ended December 31, 2020 and the
Period from April 16, 2019 – Mercer Park Brand Acquisition Corp.
Introduction
The following management’s discussion and
analysis (“MD&A”) of the financial condition and results of the operations of Mercer Park Brand Acquisition Corp. (“Brand”,
the “Corporation”, “we”, “our” or “us”) constitutes management’s review of the factors
that affected the Corporation’s financial and operating performance for the year ended December 31, 2020. This MD&A was
written to comply with the requirements of National Instrument 51- 102 – Continuous Disclosure Obligations. This discussion
should be read in conjunction with the audited financial statements for the year ended December 31, 2020 and from the April 16,
2019 (Incorporation Date) to December 31, 2019, and the related notes thereto. Results are reported in United States dollars, unless
otherwise noted. In the opinion of management, all adjustments (which consist only of normal recurring adjustments) considered necessary
for a fair presentation have been included. The results presented for the year ended December 31, 2020, are not necessarily indicative
of the results that may be expected for any future period. The financial statements and the financial information contained in this MD&A
were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Further
information about the Corporation and its operations can be obtained on www.sedar.com.
The Corporation intends to focus its search for
target businesses that operate branded product businesses in cannabis and/or cannabis-adjacent industries; however, the Corporation is
not limited to a particular industry or geographic region for purposes of completing its Qualifying Transaction (as defined below). Please
refer to the Corporation’s latest annual information form for risk factors and regulatory information (the “AIF”) regarding
the cannabis industry.
Cautionary Note Regarding Forward-Looking Information
This MD&A contains certain forward-looking
information and forward-looking statements, as defined in applicable securities laws (collectively referred to herein as “forward-looking
statements”). These statements relate to future events or the Corporation’s future performance. All statements other than
statements of historical fact are forward-looking statements. Often, but not always, forward-looking statements can be identified by the
use of words such as “plans”, “expects”, “is expected”, “budget”, “scheduled”,
“estimates”, “continues”, “forecasts”, “projects”, “predicts”, “intends”,
“anticipates” or “believes”, or variations of, or the negatives of, such words and phrases, or statements that
certain actions, events or results “may”, “could”, “would”, “should”, “might”
or “will” be taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other
factors that may cause actual results to differ materially from those anticipated in such forward-looking statements. The forward-looking
statements in this MD&A speak only as of the date of this MD&A or as of the date specified in such statement. The following table
outlines certain significant forward-looking statements contained in this MD&A and provides the material assumptions used to develop
such forward-looking statements and material risk factors that could cause actual results to differ materially from the forward-looking
statements.
| Forward-looking statements |
Assumptions |
Risk factors |
| The Corporation expects to complete a Qualifying Transaction (as defined below). |
The Corporation expects to identify an asset or business/businesses to acquire and close a Qualifying Transaction, on terms favourable to the Corporation. |
The Corporation’s inability to find a target to complete a Qualifying Transaction within the Permitted Timeline (as defined below). If we are unable to consummate our Qualifying Transaction within the Permitted Timeline, we will be required to redeem 100% of the outstanding Class A Restricted Voting Shares (as defined below), as described herein. |
| The Corporation’s ability to meet its working capital needs at the current level for the twelve-month period ending December 31, 2021. |
The operating activities of the Corporation for the twelve-month period ending December 31, 2021, and the costs associated therewith, will be consistent with the Corporation’s current expectations; debt and equity markets, exchange and interest rates and other applicable economic conditions favourable to the Corporation. |
Changes in debt and equity markets; timing and availability of external financing on acceptable terms; increases in costs; regulatory compliance and changes in regulatory compliance and other local legislation and regulation; interest rate and exchange rate fluctuations; changes in economic conditions; impact of COVID-19 and timing of a Qualifying Transaction. |
Inherent in forward-looking statements are risks,
uncertainties, and other factors beyond the Corporation’s ability to predict or control. Please also refer to those risk factors
referenced in the “Risk Factors” section below and in the AIF. Readers are cautioned that the above chart does not contain
an exhaustive list of the factors or assumptions that may affect the forward-looking statements, and that the assumptions underlying such
statements may prove to be incorrect. Actual results and developments are likely to differ, and may differ materially, from those expressed
or implied by the forward-looking statements contained in this MD&A.
Forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause the Corporation’s actual results, performance, or achievements to be materially
different from any of its future results, performance or achievements expressed or implied by forward-looking statements. All forward-looking
statements herein are qualified by this cautionary statement. Accordingly, readers should not place undue reliance on forward-looking
statements. The Corporation undertakes no obligation to update publicly or otherwise revise any forward-looking statements whether because
of new information or future events or otherwise, except as may be required by law. If the Corporation does update one or more forward-looking
statements, no inference should be drawn that it will make additional updates with respect to those or other forward-looking statements,
unless required by law.
Description of Business
Brand is a corporation which was incorporated
for the purpose of effecting an acquisition of one or more businesses or assets, by way of a merger, amalgamation, arrangement, share
exchange, asset acquisition, share purchase, reorganization, or any other similar business combination involving the Corporation (a “Qualifying
Transaction”). The Corporation’s business activities are carried out in a single business segment.
The Corporation was incorporated on April 16,
2019 under the Business Corporations Act (British Columbia), commenced operations on April 16, 2019. The head office of the
Sponsor (as defined below) is located at 590 Madison Avenue, 26th Floor, New York, New York, 10022.
On May 13, 2019, the Corporation completed
its initial public offering (the “Offering”) of 40,250,000 Class A Restricted Voting Units (including 5,250,000 Class A
Restricted Voting Units issued pursuant to the exercise in full of the over-allotment option) at $10.00 per Class A Restricted Voting
Unit. Each Class A Restricted Voting Unit consisted of one Class A restricted voting share (“Class A Restricted Voting
Share”) of the Corporation and one-half of a share purchase warrant (each, a “Warrant”). In accordance with the Corporation’s
articles, each Class A Restricted Voting Share, unless previously redeemed, will be automatically converted into one Subordinate
Voting Share following the closing of a Qualifying Transaction. All Warrants will become exercisable at a price of $ 11.50 per share,
commencing 65 days after the completion of a Qualifying Transaction, and will expire on the day that is five years after the completion
of a Qualifying Transaction or may expire earlier if a Qualifying Transaction does not occur within the permitted timeline of 21 months
(or 24 months if we have executed a letter of intent, agreement in principle or definitive agreement for a Qualifying Transaction within
21 months but have not completed the Qualifying Transaction within such 21-month period) (“Permitted Timeline”) (subject to
extension, as further described herein) from the closing of the Offering or if the expiry date is accelerated. Each Whole Warrant is exercisable
to purchase one Class A Restricted Voting Share (which, following the closing of the Qualifying Transaction, would become one Subordinate
Voting Share).
In connection with the Offering, the Corporation
granted the underwriter a 30- day non-transferable option to purchase up to an additional 5,250,000 Class A Restricted Voting Units,
at a price of $10.00 per Class A Restricted Voting Unit, to cover over-allotments, if any, and for market stabilization purposes.
The over-allotment option was exercised prior to the close of the initial public offering. As a result of the exercise of the over-allotment
option, the Founders, (as defined below) own an aggregate of 10,089,750 Class B Shares, including 109,000 Class B Units and
9,810,000 Founders’ Warrants (as defined below).
Concurrent with the completion of the Offering,
Mercer Park CB II, L.P. (the “Sponsor”), a limited partnership formed under the laws of the State of Delaware, indirectly
controlled by Mercer Park, L.P., a privately-held family office based in New York, New York and Charles Miles and Sean Goodrich (or persons
or companies controlled by them) (collectively with the Sponsor, the “Founders”) purchased an aggregate of 10,089,750 Class B
Shares, consisting of 10,069,750 Class B Shares purchased by the Sponsor, 10,000 Class B Shares purchased by Charles Miles,
and 10,000 Class B Shares purchased by Sean Goodrich. In addition, the Sponsor purchased an aggregate of 9,810,000 Warrants (“Founders’
Warrants”) at $1.00 per Founders’ Warrant.
Upon closing of the Qualifying Transaction, the
Class B Shares would, in accordance with the Corporation’s articles, convert on a 100-for-1 basis into Multiple Voting Shares.
Each Class A Restricted Voting Unit commenced
trading on May 13, 2019 on the Neo Exchange Inc. (the “Exchange”) under the symbol “BRND.U” and separated
into Class A Restricted Voting Shares and Warrants on June 24, 2019, which trade under the symbols “BRND.A.U”, and
“BRND.WT”, respectively. The Class B Shares issued to the Founders will not be listed prior to the completion of the
Qualifying Transaction.
The proceeds of $402,500,000 from the Offering
are held by Odyssey Trust Company, as Escrow Agent, in an escrow account (the “Escrow Account”) at a Canadian chartered bank
or subsidiary thereof, in accordance with the escrow agreement. Subject to applicable law and payment of certain taxes, permitted redemptions
and certain expenses, as further described herein, none of the funds held in the Escrow Account will be released to the Corporation prior
to the closing of a Qualifying Transaction. The escrowed funds will be held to enable the Corporation to (i) satisfy redemptions
made by holders of Class A Restricted Voting Shares (including in the event of a Qualifying Transaction, or an extension to the Permitted
Timeline to up to 36 months with shareholder approval from the holders of Class A Restricted Shares and the Corporation’s board
of directors, or in the event a Qualifying Transaction does not occur within the Permitted Timeline), (ii) fund a Qualifying Transaction
with the net proceeds following payment of any such redemptions and deferred underwriting commissions, and/or (iii) pay taxes on
amounts earned on the escrowed funds and certain permitted expenses. Such escrowed funds and all amounts earned, subject to such obligations
and applicable law, will be assets of the Corporation. These escrowed funds will also be used to pay the deferred underwriting commissions
in the amount of $16,100,000, 75% of which will be payable by the Corporation to the underwriter only upon the closing of a Qualifying
Transaction (subject to availability, failing which any short fall would be required to be made up from other sources) and the remaining
25% of which (or, if a lesser amount, the balance of the non-redeemed shares' portion of the Escrow Account, less tax liabilities on amounts
earned on the escrowed funds and certain expenses directly related to redemptions) will be payable by the Corporation as it sees fit,
including for payment to other agents or advisors who have assisted with or participated in the sourcing, diligence and completion of
its Qualifying Transaction.
In connection with consummating a Qualifying Transaction,
the Corporation will require approval by a majority of the directors unrelated to the Qualifying Transaction. In connection with the Qualifying
Transaction, holders of Class A Restricted Voting Shares will be given the opportunity to elect to redeem all or a portion of their
Class A Restricted Voting Shares at a per share price, payable in cash, equal to the pro-rata portion per Class A Restricted
Voting Share of: (A) the escrowed funds available in the Escrow Account at the time immediately prior to the redemption deposit timeline,
including interest and other amounts earned thereon; less (B) an amount equal to the total of (i) applicable taxes payable by
the Corporation on such interest and other amounts earned in the Escrow Account and (ii) actual and expected direct expenses related
to the redemption, each as reasonably determined by the Corporation, subject to certain limitations. Each holder of Class A Restricted
Voting Shares, together with any affiliate of such holder or any other person with whom such holder or affiliate is acting jointly or
in concert, will be subject to a redemption limitation of an aggregate 15% of the number of Class A Restricted Voting Shares issued
and outstanding. Class B Shares will not be redeemable in connection with a Qualifying Transaction or an extension to the Permitted
Timeline and holders of Class B Shares shall not be entitled to access the Escrow Account should a Qualifying Transaction not occur
within the Permitted Timeline.
If the Corporation is unable to complete its Qualifying
Transaction within the Permitted Timeline (or within an extension of the Permitted Timeline), the Corporation will be required to redeem
each of the Class A Restricted Voting Shares. The Corporation’s Warrants (including the Warrants underlying the Class A
Restricted Voting Units and the Class B Units and the Founders’ Warrants) will expire worthless. In such case, each holder
of a Class A Restricted Voting Share will receive for an amount, payable in cash, equal to the pro-rata portion per Class A
Restricted Voting Share of: (A) the Escrow Account, including any interest and other amounts earned; less (B) an amount equal
to the total of (i) any applicable taxes payable by the Corporation on such interest and other amounts earned in the Escrow Account,
(ii) any taxes of the Corporation arising in connection with the redemption of the Class A Restricted Voting Shares, and (iii) up
to a maximum of $50,000 of interest and other amounts earned to pay actual and expected expenses related to the dissolution and certain
other related costs as reasonably determined by the Corporation. The underwriter will have no right to the deferred underwriting commissions
held in the Escrow Account in such circumstances.
Overall Performance
The Corporation has not conducted commercial operations
and it is focused on the identification and evaluation of businesses or assets to acquire and there were no notable events that occurred
during the reporting periods presented.
For the year ended December 31, 2020, the
Corporation earned interest income of $1,742,747 and reported income of $947,346 ($0.09 basic and diluted income per Class B Share).
From the Incorporation Date to December 31, 2019, the Corporation earned interest income of $3,296,977 and reported income of $2,831,491
($0.31 basic and diluted income per Class B Share). The expenses for the year ended December 31, 2020 primarily related to general
and administrative expenses of $702,259, foreign exchange loss of $43,142, travel of $50,000, current income tax recovery of $114,990
and deferred income tax of $ 114,990. The expenses from the Incorporation date to December 31, 2019 primary relate to general and
administrative expenses of $ 381,137, foreign exchange gain of $651, travel of $85,000, current income tax of $713,425 and deferred income
tax recovery of $713,425.
Current liabilities as of December 31, 2020
total $745,813 (December 31, 2019 - $1,030,396). Shareholders’ deficiency as of December 30, 2020 is comprised of Class B
Shares, unlimited, 10,198,751 issued of $nil (December 31, 2019 - $nil), additional paid-in-capital of ($11,684,284) (December 31,
2019 - ($11,684,284)) and retained earnings of $3,778,837 (December 31, 2019 - $2,831,491) for a net amount of ($7,905,447) (December 31,
2019 – ($8,852,793)) in shareholders’ deficit.
Commitments and contingencies as of December 31,
2020 total $402,500,000 (December 31, 2019 - $402,500,000). It is comprised of Class A Restricted Voting Shares subject to redemption,
40,250,000 shares (at a redemption value of $10.00 per share).
Working capital, which consists of current assets
less current liabilities, is $2,559,062 (December 31, 2019 - $3,237,735) as of December 31, 2020. Management believes the Corporation’s
working capital is sufficient for the Corporation to meet its ongoing obligations and meet its objective of completing a Qualifying Transaction.
The weighted average number of Class B Shares
outstanding for the year ended December 31, 2020 was 10,198,751 (December 31, 2019 – 9,253,693).
Liquidity and Capital Resources
| Marketable securities held in an escrow account | |
December 31, 2020 | |
| United States Treasury Bills | |
$ | 407,509,774 | |
| Accrued interest | |
$ | 26,301 | |
| Restricted cash | |
$ | 981 | |
| Total marketable securities held in an escrow account | |
$ | 407,537,056 | |
| | |
| | |
| Per Class A Restricted Voting Shares subject to redemption | |
$ | 10.00 | |
| | |
| | |
| Cash held outside the escrow account | |
$ | 2,095,023 | |
We intend to use substantially all the funds held
in the Escrow Account, including interest (which interest shall be net of taxes payable and certain expenses) to consummate a Qualifying
Transaction. To the extent that, after redemptions, our share capital or debt is used, in whole or in part, as consideration to consummate
a Qualifying Transaction, the remaining proceeds held in the Escrow Account may be used as working capital to finance the operations of
the target business or businesses, make other acquisitions and/or pursue a growth strategy.
As of December 31, 2020, we had cash held
outside of our Escrow Account of $2,095,023, which is available to fund our working capital requirements, including any further transaction
costs that may be incurred. We expect to generate negative cash flow from operating activities in the future until our Qualifying Transaction
is completed and we commence income generation. We intend to employ a proactive acquisition targeting strategy that identifies potential
acquisition targets that align with the Corporation’s investment objectives. Consistent with this strategy, we have identified the
following general criteria and guidelines that we believe are important in evaluating prospective acquisition targets:
| |
· |
Opportunity to consolidate a highly fragmented marketplace where even the largest brands represent less than 10% market share. |
| |
· |
Ability to build an institutional-quality cannabis corporation focused on brands and branded products. |
| |
· |
Companies with strong marketing and brand development expertise. Companies that will benefit from a defined branding strategy. |
| |
· |
Companies with additional, strategic capabilities-such as distribution, manufacturing, or product development-that support brand value. |
| |
· |
Orphaned or underinvested brands within existing companies. |
| |
· |
Companies exhibiting growth and profitability performance that could be enhanced through improved access to capital and financial expertise. |
| |
|
|
| |
· |
Opportunity to provide rescue financing for undercapitalized operators. Companies that will benefit from being a public company. |
Management seeks to ensure that our operational
and administrative costs are minimal prior to the completion of a Qualifying Transaction, with a view to preserving the Corporation’s
working capital.
We do not believe that we will need to raise additional
funds to meet expenditures required for operating our business until the consummation of our Qualifying Transaction. We believe that we
will have sufficient available funds outside of the Escrow Account to operate the business. However, we cannot be assured that this will
be the case. To the extent that the Corporation may require additional funding for general ongoing expenses or in connection with sourcing
a proposed Qualifying Transaction, we may seek funding by way of unsecured loans from our Sponsor and/or its affiliates, up to a maximum
aggregate principal amount equal to 10% of the escrowed funds, subject to the consent of the Exchange, which loans would, unless approved
otherwise by the Exchange, bear interest at no more than the prime rate plus 1%. Our Sponsor will not have recourse under such loans against
the amounts in escrow. Such loans will collectively be subject to a maximum principal amount of 10% of the escrowed funds and may be repayable
in cash following the closing of a Qualifying Transaction and may only be convertible into Class B Shares and/or Warrants in connection
with the closing of a Qualifying Transaction, subject to Exchange consent.
Discussion of Operations
Three Months Ended December 31, 2020 Compared to Three Months
Ended December 31, 2019
The Corporation’s net loss totaled $ 144,116
for the three months ended December 31, 2020, with basic and diluted loss per Class B Share of $0.01. Activities for this period
principally related to general and administrative expenses of $202,157, foreign exchange gain of $2,451, travel of $50,000, current income
tax recovery of $135,887 and deferred income tax of $114,990. These expenses were offset by interest income of $84,693.
The Corporation’s net income totaled $1,412,880
for the three months ended December 31, 2019, with basic and diluted income per Class B Share of $0.16. Activities for this
period principally related to general and administrative expenses of $100,398, foreign exchange loss of $2,963, travel of $85,000, current
income tax of $713,425 and deferred income tax recovery of $713,425. These expenses were offset by interest income of $1,601,241.
Interest Income
Since completion of the Offering, the Corporation’s
activity has been limited to the evaluation of business acquisition targets, and we do not expect to generate any operating income until
the closing and completion of a Qualifying Transaction. In the interim, we expect to generate small amounts of non-operating income in
the form of interest income on cash and short-term investments, including restricted cash and short-term investments held in escrow. As
of December 31, 2020, all funds held in escrow were included in United States Treasury Bills, except for $981 held in a restricted
cash account. Interest income on these investments is not expected to be significant in view of the current low interest rates.
During the three months ended December 31,
2020, the Corporation earned interest income of $84,693 (three months ended December 31, 2019 - $1,601,241).
General and Administrative Expenses
The Corporation’s general and administrative
expenses consist of costs required to maintain its public company status in good standing, and expenses incurred to evaluate and identify
companies, businesses, assets, or properties for potential acquisition in connection with the Corporation’s Qualifying Transaction.
General and administrative costs were $202,157 for the three months ended December 31, 2020. General and administrative costs were
$100,398 for the three months ended December 31, 2019.
Year Ended December 31, 2020 Compared to the Incorporation
Date to December 31, 2019
The Corporation’s net income totaled $947,346
for the year ended December 31, 2020, with basic and diluted income per Class B Share of $0.09. Activities for this period principally
related to general and administrative expenses of $702,259, foreign exchange loss of $43,142, travel of $50,000, current income tax recovery
of $114,990 and deferred income tax expense of $114,990. These expenses were offset by interest income of $1,742,747.
The Corporation’s net income totaled $2,831,491
from the Incorporation Date to December 31, 2019, with basic and diluted income per Class B Share of $ 0.31. Activities for
this period principally related to general and administrative expenses of $381,137, foreign exchange gain of $651, travel of $85,000,
current income tax of $713,425 and deferred income tax recovery of $713,425. These expenses were offset by interest income of $3,296,977.
Interest Income
Since completion of the Offering, the Corporation’s
activity has been limited to the evaluation of business acquisition targets, and we do not expect to generate any operating income until
the closing and completion of a Qualifying Transaction. In the interim, we expect to generate small amounts of non-operating income in
the form of interest income on cash and short-term investments, including restricted cash and short-term investments held in escrow. As
of December 31, 2020, all funds held in escrow were included in United States Treasury Bills, except for $981 held in a restricted
cash account. Interest income on these investments is not expected to be significant in view of the current low interest rates.
During the year ended December 31, 2020,
the Corporation earned interest income of $1,742,747. During the period from the Corporation’s commencement of operations on the
Incorporation Date to December 31, 2019 the Corporation earned interest income of $3,296,977.
General and Administrative Expenses
The Corporation’s general and administrative
expenses consist of costs required to maintain its public company status in good standing, and expenses incurred to evaluate and identify
companies, businesses, assets, or properties for potential acquisition in connection with the Corporation’s Qualifying Transaction.
General and administrative costs were $702,259 for the year ended December 31, 2020. General and administrative costs were $381,137
from the Incorporation Date to December 31, 2019.
Off-Balance Sheet Arrangements
As of the date of this filing, the Corporation
does not have any off- balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the results
of operations or financial condition of the Corporation including, without limitation, such considerations as liquidity and capital resources
that have not previously been discussed.
Proposed Transactions
Although the Corporation has commenced the process
of identifying potential acquisitions with a view to completing a Qualifying Transaction, the Corporation has not yet entered into a definitive
agreement. See “Subsequent Event”, below.
Selected Quarterly Information
A summary of selected information for each of the quarters presented
below is as follows:
| | |
| | |
| |
Basic and Diluted | |
| | |
| | |
| |
Loss | |
| | |
Income | | |
Net (Loss) Income |
| |
per Class B Share | |
| | |
($) | | |
($) |
| |
($)
(8) | |
| December 31, 2020 | |
| - | | |
$ | (144,116 |
)(7) | |
| (0.01 | ) |
| September 30, 2020 | |
| - | | |
$ | (161,569 |
)(6) | |
| (0.02 | ) |
| June 30, 2020 | |
| - | | |
$ | (83,442 |
)(5) | |
| (0.01 | ) |
| March 31, 2020 | |
| - | | |
$ | 1,336,473 |
(4) | |
| 0.13 | |
| December 31, 2019 | |
| - | | |
$ | 1,412,880 |
(3) | |
| 0.16 | |
| September 30, 2019 | |
| - | | |
$ | 1,611,697 |
(2) | |
| 0.16 | |
| Incorporation date to June 30, 2019 | |
| - | | |
$ | (193,086 |
)(1) | |
| (0.03 | ) |
Notes:
(1)
From the Incorporation date to June 30, 2019, the Corporation earned interest income of $40.00 and reported a loss of
$193,086 ($0.03 basic and diluted loss per Class B Share). The loss in the current period primary related to general and administrative
expenses of $191,614 and foreign exchange of $1,512;
(2)
For the three months ended September 30, 2019, the Corporation earned interest income of $1,695,696 and reported income
of $1,611,697 ($0.16 basic and diluted income per Class B Share). The income in the current period primary related to general and
administrative expenses of $89,125 and foreign exchange gain of $5,126;
(3)
For the three months ended December 31, 2019, the Corporation earned interest income of $1,601,241 and reported income
of $1,412,880 ($0.16 basic and diluted income per Class B Share). The income in the current period primary related to general and
administrative expenses of $100,398, travel of $85,000, foreign exchange loss of $2,963, current income tax of $713,425 and deferred income
tax recovery of $713,425;
(4)
For the three months ended March 31, 2020, the Corporation earned interest income of $1,495,772 and reported income
of $1,336,473 ($0.13 basic and diluted income per Class B Share). The income in the current period primary related to general and
administrative expenses of $164,180 and foreign exchange income of $4,881;
(5)
For the three months ended June 30, 2020, the Corporation earned interest income of $49,036 and reported a loss of $83,442
($0.01 basic and diluted loss per Class B Share). The loss in the current period primary related to general and administrative expenses
of $83,493, foreign exchange loss of $28,088 and a current tax expense of $20,897;
(6)
For the three months ended September 30, 2020, the Corporation earned interest income of $113,246 and reported a loss
of $161,569 ($0.02 basic and diluted loss per Class B Share). The loss in the current period primary related to general and administrative
expenses of $252,429 and foreign exchange loss of $22,386;
(7)
For the three months ended December 31, 2020, the Corporation earned interest income of $84,693 and reported a loss
of $144,116 ($0.01 basic and diluted income per Class B Share). The loss in the current period primary related to general and administrative
expenses of $202,157, foreign exchange gain of $2,451, travel of $50,000, current income tax recovery of $135,887 and deferred income
tax of $114,990; and
(8)
Per share amounts are rounded to the nearest cent, therefore aggregating quarterly amounts may not reconcile to year-to-date
per share amounts.
Related Party Transactions
In May 2019, the Corporation entered into
an administrative services agreement with the Sponsor for an initial term of 18 months, subject to possible extension, for office space,
utilities, and administrative support, which may include payment for services of related parties, for, but not limited to, various administrative,
managerial, or operational services or to help effect a Qualifying Transaction. The Corporation has agreed to pay $10,000 per month, plus
applicable taxes for such services. As of December 31, 2020, the Corporation accrued $205,000 (December 31, 2019 - $85,000)
in respect of these services.
On May 13, 2019, the Sponsor executed a make
whole agreement and undertaking in favour of the Corporation, whereby the Sponsor agreed to indemnify the Corporation in certain limited
circumstances where the funds held in the Escrow Account are reduced to below $10.00 per Class A Restricted Voting Share.
For the year ended December 31, 2020, the
Corporation paid professional fees of $26,256 (April 19, 2019 (date of incorporation) to December 31, 2019 - $12,926) to Marrelli
Support Services Inc. (“Marrelli Support”), an organization of which the Corporation's Chief Financial Officer is Managing
Director. These services were incurred in the normal course of operations for general accounting and financial reporting matters. As of
December 31, 2020, Marrelli Support was owed $9,034 (December 31, 2019 - $2,214) and was included in accounts payable and accrued
liabilities on the Corporation's balance sheet.
During the year ended December 31, 2020,
the Corporation paid professional fees and disbursements of $106 (April 19, 2019 (date of incorporation) to December 31, 2019
- $nil) to DSA Filing Services Limited (“DSA Filing”), an organization which Carmelo Marrelli, the Chief Financial Officer
of the Corporation, controls. These services were incurred in the normal course of operation of filing matters to adhere to the Corporation’s
continuous disclosure obligations and these amounts are included in public company filing and listing costs. As of December 31, 2020,
DSA Filing was owed $nil by the Corporation (December 31, 2019 - $nil) and these amounts were included in accounts payable and accrued
liabilities.
During the year ended December 31, 2020,
the Corporation paid professional fees and disbursements of $1,116 (April 19, 2019 (date of incorporation) to December 31, 2019
- $nil) to Marrelli Press Release Services Limited (“Marrelli Services Limited”), an organization which Carmelo Marrelli,
the Chief Financial of the Corporation, controls. These services were incurred in the Corporation’s normal course of operations
in adherence with its continuous disclosure obligations and these amounts are included in public company filing and listing costs. As
of December 31, 2020, Marrelli Services Limited was owed $nil (December 31, 2019 - $nil) and these amounts were included in
accounts payable and accrued liabilities.
From April 16, 2019 (Date of Incorporation)
to December 31, 2019 and for the year ended December 31, 2020, Ayr Strategies Inc. ("Ayr"), a company with common
management, incurred travel costs on behalf of the Corporation. As of December 31, 2020, the Corporation owed Ayr $135,000 (December 31,
2019 - $85,000) and which included in due to related parties on the Corporation's balance sheets. This is based on a cash-call-basis from
Ayr.
New standards not yet adopted, and interpretations issued but not
yet effective
The Corporation does not believe that any accounting
standards that have been recently issued but which are not yet effective would have a material effect on the Financial Statements if such
accounting standards were currently adopted.
Accounting Policies and Critical Accounting Estimates
The preparation of the Corporation’s financial
statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities,
and items in net income or loss and the related disclosure of contingent assets and liabilities. Critical accounting estimates represent
estimates made by management that are, by their very nature, uncertain. The Corporation evaluates its estimates on an ongoing basis. Such
estimates are based on assumptions that the Corporation believes are reasonable under the circumstances, and these estimates form the
basis for making judgments about the carrying value of assets and liabilities and the reported amount of items in net income or loss that
are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Warrant Valuation
Pursuant to the Offering, the Corporation issued
Warrants. Estimating the fair value of warrants requires determining the most appropriate valuation model that is dependent on the terms
and conditions of the warrant. The Corporation applies an option-pricing model to measure the fair value of the Warrants issued. Application
of the option-pricing model requires estimates in expected dividend yields, expected volatility in the underlying assets and the expected
life of the warrant. These estimates may ultimately be different from amounts subsequently realized, resulting in an overstatement or
understatement of net income or loss.
Income Tax
The determination of the Corporation’s income
taxes, and other tax assets and liabilities requires interpretation of complex laws and regulations. Judgment is required in determining
whether deferred income tax assets should be recognized on the balance sheet. Deferred income tax assets, including those arising from
unutilized tax losses, require management to assess the likelihood that the Corporation will generate taxable income in future periods
to utilize recognized deferred tax assets. Estimates of future taxable income are based on forecasted cash flows from operations and the
application of existing laws in each applicable jurisdiction. Future taxable income is also significantly dependent upon the Corporation
completing a Qualifying Acquisition, the underlying structure of a Qualifying Acquisition, and the resulting nature of operations. To
the extent that future cash flows and/or the probability, structure and timing, and the nature of operations of a future Qualifying Acquisition
differ significantly from estimates made, the ability of the Corporation to realize a deferred tax asset could be materially impacted.
Controls and Procedures
The Corporation’s Chief Executive Officer
and Chief Financial Officer are responsible for establishing and maintaining disclosure controls and procedures and internal control over
financial reporting as defined in the Canadian Securities Administrators’ National Instrument 52-109, “Certification of
Disclosure in Issuer’s Annual and Interim Filings”.
Under their supervision, the Chief Executive Officer
and Chief Financial Officer have implemented disclosure controls and procedures and internal controls over financial reporting appropriate
for the nature of operations of the Corporation. Disclosure controls and procedures are designed to ensure that information required to
be disclosed by the Corporation in the reports it files or submits under securities legislation is recorded, processed, summarized and
reported on a timely basis and that such information is accumulated and reported to management, including the Corporation’s Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow required disclosures to be made in a timely fashion. Internal
controls over financial reporting are designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with IFRS. The Corporation’s design of its internal controls
over financial reporting is based on the principles set out in the “Internal Control – Integrated Framework (2013)”
issued by The Committee of Sponsoring Organizations of the Treadway Commission (COSO)”.
In accordance with National Instrument 52-109
- Certification of Disclosure in Issuers’ Annual and Interim Filings, the Corporation has filed certificates signed by its
Chief Executive Officer and the Chief Financial Officer certifying certain matters with respect to the design of disclosure controls and
procedures and the design of internal control over financial reporting as of December 31, 2020.
Financial Instruments
The Corporation follows the guidance in ASC 820
for its financial assets and liabilities that are re-measured and reported at fair value at each reporting period, and non-financial assets
and liabilities that are re-measured and reported at fair value at least annually.
The fair value of the Corporation’s financial
assets and liabilities reflects management’s estimate of amounts that the Corporation would have received in connection with the
sale of the assets or paid in connection with the transfer of the liabilities in an orderly transaction between market participants at
the measurement date. In connection with measuring the fair value of its assets and liabilities, the Corporation seeks to maximize the
use of observable inputs (market data obtained from independent sources) and to minimize the use of unobservable inputs (internal assumptions
about how market participants would price assets and liabilities). The following fair value hierarchy is used to classify assets and liabilities
based on the observable inputs and unobservable inputs used in order to value the assets and liabilities:
Level
1: Quoted prices in active markets for identical assets or liabilities. An active market for an asset or liability is a market
in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing
basis.
Level
2: Observable inputs other than Level 1 inputs. Examples of Level 2 inputs include quoted prices in active markets for similar
assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active.
Level
3: Unobservable inputs based on our assessment of the assumptions that market participants would use in pricing the asset or
liability.
The following table presents information about
the Corporation’s assets that are measured at fair value on a recurring basis on December 31, 2020 and 2019, and indicates
the fair value hierarchy of the valuation inputs the Corporation utilized to determine such fair value:
| | |
Carrying value as of | | |
| | |
| | |
| |
| | |
December 31, 2020 | | |
Level 1 (*) | | |
Level 2 (*) | | |
Level 3 (*) | |
| | |
($) | | |
($) | | |
($) | | |
($) | |
| Assets | |
| | | |
| | | |
| | | |
| | |
| Marketable securities held in an escrow account | |
| 407,537,056 | | |
| 407,537,056 | | |
| nil | | |
| nil | |
(*) Fair values as of December 31, 2020
The Corporation is exposed to financial risks
due to the nature of its business and the financial assets and liabilities that it holds. The Corporation’s overall risk management
strategy seeks to minimize potential adverse effects of the Corporation’s financial performance. In particular, the Corporation
intends to only invest the proceeds deposited in the Escrow Account in instruments that are the obligation of, or guaranteed by, the federal
government of the United States of America or Canada. The Corporation believes this to be a low-risk strategy until the Corporation completes
a Qualifying Transaction.
Market risk
Market risk is the risk that a material loss may
arise from fluctuations in the fair value of a financial instrument. For purposes of this disclosure, the Corporation segregates market
risk into three categories: fair value risk, interest rate risk and currency risk.
Fair value risk
Fair value risk is the potential for loss from
an adverse movement, excluding movements relating to changes in interest rates and foreign exchange rates, because of changes in market
prices. The Corporation is exposed to minimal fair value risk.
Interest rate risk
Interest rate risk relates to the risk that the
fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Due to the fixed
interest rate on the Corporation's restricted cash and short-term balance held in escrow, its exposure to interest rate risk is nominal.
Currency risk
Currency risk relates to the risk that the fair
value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates relative to the Corporation’s
presentation currency of the United States dollar. The Corporation does not currently have any exposure risk as the Corporation transacts
minimally in any currency other than the United States dollar.
Capital Management
(a) The Corporation defines the capital that
it manages as its shareholders’ deficiency, net of its Class A Restricted Voting Shares subject to redemption. The following
table summarizes the carrying value of the Corporation’s capital as of December 31, 2020:
| | |
$ | |
| Shareholders’ deficiency | |
| (7,905,447 | ) |
| Class A Restricted Voting Shares subject to redemption | |
| 402,500,000 | |
| Balance, December 31, 2020 | |
| 394,594,553 | |
The Corporation’s primary objective in managing
capital is to ensure capital preservation to benefit from acquisition opportunities as they arise.
(b) Liquidity
As of December 31, 2020, the Corporation
had $2,095,023 (December 31, 2019 - $4,127,262) in cash and cash equivalents. The Corporation expects to incur significant costs
in pursuit of its acquisition plans.
To the extent that the Corporation may require
additional funding for general ongoing expenses or in connection with sourcing a proposed Qualifying Transaction, the Corporation may
obtain such funding by way of unsecured loans from the Sponsor and/or its affiliates, subject to consent of the Exchange, which loans
would, unless approved otherwise by the Exchange, bear interest at no more than the prime rate plus 1%. The Sponsor would not have recourse
under such loans against the Escrow Account, and thus the loans would not reduce the value of such Escrow Account. Such loans would collectively
be subject to a maximum principal amount of 10% of the escrowed funds and may be repayable in cash following the closing of a Qualifying
Transaction and may only be convertible into Class B Shares and/or Warrants in connection with the closing of a Qualifying Transaction
subject to Exchange consent.
Otherwise, and subject to any relief granted by
the Exchange, the Corporation may seek to raise additional funds through a rights offering in respect of shares available to its shareholders,
in accordance with the requirements of applicable securities legislation, and subject to placing the required funds raised in the Escrow
Account in accordance with applicable Exchange rules.
Outlook
For the immediate future, the Corporation intends
to identify and evaluate potential Qualifying Transactions. The Corporation continues to monitor its spending and will amend its plans
based on business opportunities that may arise in the future.
Share Capital
As of the date of this MD&A, the Corporation
had 40,250,000 Class A Restricted Voting Shares of the Corporation issued and outstanding. In addition, the Corporation had an aggregate
of 10,089,751 Class B Shares, 109,000 Class B Units and 29,989,500 Warrants issued and outstanding.
Risk Factors
Please refer to the Corporation’s AIF for
information on the risk factors to which the Corporation is subject. In addition, see “Cautionary Note Regarding Forward-Looking
Information” above.
Contingency
The outbreak of the novel strain of coronavirus,
specifically identified as “COVID-19”, has resulted in governments worldwide enacting emergency measures to combat the spread
of the virus. These measures, which include the implementation of travel bans, self-imposed quarantine periods and social distancing,
have caused material disruption to businesses globally resulting in an economic slowdown. Global equity markets have experienced significant
volatility and weakness. It is uncertain what impact this volatility and weakness will have on the Corporation’s securities held
at fair value and short-term investments. Governments and central banks have reacted with significant monetary and fiscal interventions
designed to stabilize economic conditions. The duration and impact of the COVID-19 pandemic is unknown at this time, as is the efficacy
of the government and central bank interventions. It is not possible to reliably estimate the length and severity of these developments
and the impact on the financial results and condition of the Corporation in future periods, including the ability of the Corporation to
complete a Qualifying Transaction.
Subsequent Event
On February 2, 2020, the Corporation announced
that it has an executed letter of intent in connection with a potential transaction, which would, if consummated, qualify as its qualifying
transaction. Accordingly, the Corporation will be permitted until May 13, 2021 (24 months following the closing of its initial public
offering) to conclude its qualifying transaction. The letter of intent is non-binding and proceeding with the transaction is subject to
several conditions, including, among others, satisfactory due diligence and the negotiation and execution of a definitive agreement. The
Corporation intends to disclose additional details regarding the transaction following the entry into a definitive agreement, if applicable.
There can be no assurance that a definitive agreement will be completed.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations for the Years Ended December 31, 2020, December 31, 2019 and December 31,
2018 – GH Group, Inc.
Overview
GH Group, Inc. (“GH Group” or
the “Company”), is a vertically integrated cannabis company that operates in the state of California. The Company cultivates,
manufactures, and distributes cannabis consumer packaged goods, primarily to third-party retail stores in the state of California. The
Company also owns and operates retail cannabis stores in the state of California.
Through these activities, GH Group has established
the foundation for its ultimate strategy – to create the preeminent California cannabis brand company through a fully vertically
integrated commercial cannabis company engaged in all licensed verticals – (i) cultivation; (ii) manufacturing; (iii) distribution;
and (iv) retail – and providing customers with consistently high-quality products across a range of trusted and recognizable
brands.
See “Description of Business” for
an overview of the GH Group and “Regulatory Overview” for details regarding the California regulatory framework.
Recent Developments
Acquisition of Farmacy Berkeley
On January 1, 2021 the Company completed
an acquisition of 100% of the equity interests of iCANN, LLC d/b/a Farmacy Berkeley (“iCANN”) a licensed retail cannabis
company located in Berkeley, California. Pursuant to the terms of the merger agreement between as subsidiary of the Company and iCANN
the following occurred: (i) the Company elected to convert earlier issued convertible notes with principal amount of $2,00,000 and
accrued interest of $45,321 into equity interests of iCANN; (ii) the Company paid $400,000 in cash to four holders of iCANN equity
interests: (iii) the Company issued 7,554,679 Series A Common shares to holders of iCANN equity interests; and (iv) the
Company issued an additional 500,000 Series A Common shares to brokers and consultants.
Greenhouse Option Acquisition
GH Group is seeking to acquire (and subsequently
exercise) an option to acquire the land and buildings on which a greenhouse is located in southern California (the “Greenhouse
Option Acquisition”). GH Group is currently conducting due diligence on the Greenhouse Option Acquisition.
The Greenhouse Option Acquisition involves the
proposed acquisition of an option to acquire a greenhouse (land and building) (collectively, the “Greenhouse”). The Greenhouse
is currently leased by one or more farmers from its owner to grow non-cannabis crops. At the time of acquiring the Greenhouse, the current
owner granted the prior owner (the “Optionholder”) an option (the “Greenhouse Option”) to acquire the Greenhouse
for approximately $120 million. The Greenhouse is uniquely suited to meet the license requirements for cannabis cultivation in southern
California. The Filer and GH Group are interested in this opportunity and are in discussions with the Optionholder for the purchase of
the Greenhouse Option (either directly or by acquiring 100% of the equity in the entity that owns the Greenhouse). They believe, as does
the Optionholder, that the Greenhouse would have substantial value if repurposed for cannabis production. In connection with completing
the Greenhouse Option Acquisition, GH Group intends to apply for a license to use the Greenhouse to produce cannabis. The proposed transaction
is as follows:
| |
(a) |
GH Group would acquire the Greenhouse Option from the Optionholder for approximately $100 million (before including any earn-out consideration), and then exercise it at a cost of approximately $120 million, payable in cash. The $100 million would be payable in common or subordinate voting shares of the Filer (or shares of a subsidiary exchangeable therefor) at a value of $10.00 per share. |
| |
(b) |
Once licensed, GH Group would commence a phased construction project to alter the Greenhouse to produce cannabis in lieu of its current function of growing non-cannabis crops. |
| |
(c) |
In addition, GH Group would retain the Optionholder, who GH Group considers to be a greenhouse operations expert, in a consulting or employment capacity, and would agree to pay him up to $75 million as an earnout as part of the purchase price for the Greenhouse Option Acquisition based on the success of the construction project and the performance of the proposed cannabis operations at the Greenhouse |
The Element Acquisition
GH Group is seeking to acquire a series of related
limited liability companies that are currently in the application stage for 17 cannabis retail dispensary licenses for locations in California
(the “Element Acquisitions”). GH Group is currently conducting due diligence on the Element Acquisitions.
The Element Acquisitions involve the proposed
acquisitions of 100% of the shares owned by Element 7 Inc. (“Element 7”) of a company or series of related companies that
are currently in the application stage for licenses for 17 cannabis retail dispensaries in California. None of the licenses have been
obtained. The Filer and GH Group are interested in this opportunity and are in the process of negotiating a non-binding memorandum of
understanding with Element 7. The proposed transaction is as follows:
| |
(a) |
GH Group would acquire, directly or indirectly, the shares of the limited liability company or series of related companies currently applying for the licenses from Element 7 for a value of approximately $1,500,000 for each license, up to a maximum amount of $25,500,000 for all 17 license applications. |
| |
(b) |
The proposed up to $25,500,000 purchase price to be paid by the Filer or GH Group for the Element Acquisitions is proposed to be paid in newly-issued common or subordinate voting shares of the Filer (or shares of a subsidiary exchangeable therefor) at a value of $10.00 per share. |
| |
(c) |
The purchase of each entity currently applying for a license would be subject to the satisfaction of certain conditions, which may be waived in GH Group’s discretion. In the event such conditions are not satisfied in respect of any such purchase, GH Group would not be obligated to purchase such entity, and the price would be reduced accordingly. |
Major Business Lines and Geographies
GH Group views its financial results under one
business line – the creation of dominant, extensible CPG products and brands through cannabis cultivation, production, and sales.
GH Group generates all of its revenue in the State of California.
While many cannabis businesses prioritized brand
building and customer acquisition before securing a reliable product flow, the Company believes that in a consumer- focused CPG space,
consistent delivery of high-quality product at an attractive price point is a first principle, and a prerequisite for any other activity.
Cannabis Cultivation, Production, and Sales
GH Group operates greenhouse cultivation facilities
in Carpinteria and Santa Barbara, California. GH Group’s production facility is located in Lompoc, California.
GH Group generates revenue by selling its products
both to its own and third-party dispensaries in California, including both raw cannabis, cannabis oil, and cannabis consumer goods. GH
Group’s dispensaries are located in Santa Barbara and Santa Ana, California.
Geographic Areas
All of GH Group’s revenue is derived from the California cannabis
market.
Market Update and Objectives
The state of California represents the largest
single market for cannabis in the U.S., with over $7 billion in revenues in 2020 and an adult population of over 31 million. The California
market is highly fragmented, with over 6,000 cultivation licenses in operation, over 1,000 distribution licenses over 700 operational
dispensaries and greater than 1,000 brands. With this backdrop, GH Group looks to use scale in cultivation and distribution (through its
own dispensaries and third party retailers) to achieve economies of scale that allow GH Group to outperform competitors and build superior
brand awareness and loyalty.
Results of Operations
The following are the results of our operations for the year ended
December 31, 2020, 2019 and 2018:
| | |
2020 | | |
2019 | | |
2018 | |
| Revenue, Net | |
$ | 48,259,601 | | |
$ | 16,941,426 | | |
$ | 8,967,286 | |
| Cost of Goods Sold | |
| 29,519,143 | | |
| 8,461,551 | | |
| 3,749,373 | |
| Gross Profit | |
| 18,740,458 | | |
| 8,479,875 | | |
| 5,217,913 | |
| Expenses: | |
| | | |
| | | |
| | |
| General and Administrative | |
| 18,637,477 | | |
| 9,354,591 | | |
| 3,094,857 | |
| Sales and Marketing | |
| 1,489,664 | | |
| 912,842 | | |
| 143,216 | |
| Professional Fees | |
| 2,040,004 | | |
| 5,196,993 | | |
| 1,913,865 | |
| Depreciation and Amortization | |
| 2,576,263 | | |
| 1,455,780 | | |
| 767,567 | |
| Total Expenses | |
| 24,743,408 | | |
| 16,920,206 | | |
| 5,919,505 | |
| Loss from Operations | |
| (6,002,950 | ) | |
| (8,440,331 | ) | |
| (701,592 | ) |
| Other Expense (Income): | |
| | | |
| | | |
| | |
| Interest Expense | |
| 2,179,137 | | |
| 636,762 | | |
| 597,427 | |
| Interest Income | |
| (115,572 | ) | |
| (443,523 | ) | |
| (308,591 | ) |
| Loss on Investments | |
| 2,126,112 | | |
| 1,147,968 | | |
| 166,059 | |
| Loss (Income) on Change in Fair Value of Derivative Liabilities | |
| 251,663 | | |
| - | | |
| - | |
| Other Expense (Income), Net | |
| (203,345 | ) | |
| (19,419 | ) | |
| (202,397 | ) |
| Total Other Expense | |
| 4,237,995 | | |
| 1,321,788 | | |
| 252,498 | |
| Loss from Operations Before Provision for Income Taxes | |
| (10,240,945 | ) | |
| (9,762,119 | ) | |
| (954,090 | ) |
| Provision for Income Taxes | |
| 6,418,533 | | |
| 972,520 | | |
| 357,352 | |
| Net Loss | |
| (16,659,478 | ) | |
| (10,734,639 | ) | |
| (1,311,442 | ) |
| Net Income (Loss) Attributable to Non-Controlling Interest | |
| - | | |
| (511,465 | ) | |
| 211,396 | |
| Net Loss Attributable to Shareholders / Members of GH Group | |
$ | (16,659,478 | ) | |
$ | (10,223,174 | ) | |
$ | (1,522,838 | ) |
Revenue
2020
Revenue for the year ended December 31, 2020
was $48.3 million, which represents an increase of $31.3 million or 185% from $16.9 million for the year ended December 31, 2019.
Revenue growth in 2020 was primarily driven by an increase in cannabis production from the Company’s second greenhouse cultivation
facility, which commenced operations in Q1 2020 and expanded operational canopy from approximately 113,000 square feet at the end of December 2019,
to over 390,000 square feet by the 2020. The Company’s cannabis retail dispensaries also contributed to year over year revenue growth,
with a full year of operations in 2020 versus less than 6 months of operations in 2019.
2019
For the year ended December 31, 2019, revenue
was $16.9 million, which represents an increase of $8.0 million or 89% from $9.0 million for the year ended December 31, 2018. Revenue
growth in 2019 was primarily driven by an increase in cannabis production from the Company’s first greenhouse cultivation facility,
which operated at full capacity throughout 2019, and at partial capacity in 2018 while the Company ramped up operations. The Company began
retail operations in Q3 2019, opening one store and acquiring another, which also increased revenue from the prior year.
2018
For the year ended December 31, 2018, revenue
was $9.0 million. Revenues during 2018 consisted primarily of bulk biomass sales produced from the Company’s first greenhouse cultivation
facility.
Cost of Goods Sold
2020
For the year ended December 31, 2020, cost
of goods sold was $ 29.5 million, which represents an increase of $21.1 million or 249% from the prior year amount of $8.5 million. Cost
increases were primarily attributable to the Company’s expanding cannabis cultivation operation which grew over 300% from the prior
year. The Company’s cannabis dispensaries also contributed to year over year cost increases, with a full year of operations in 2020
and less than 6 months of operations in 2019.
2019
For the year ended December 31, 2019, cost
of goods sold was $8.5 million, which represents an increase of $4.7 million or 126% from the prior year amount of $3.7 million. Cost
increases were primarily due to the Company’s grow operations being fully operational throughout 2019 and only partially operational
in 2018. The Company began retail operations in Q3 2019, opening one store and acquiring another, which also increased cost of goods sold
from the prior year.
2018
For the year ended December 31, 2018, cost
of goods sold was $3.7 million. The Company’s cost of goods sold is a direct result of the Company’s grow operations during
2018.
General and Administrative
2020
For the year ended December 31, 2020, general
and administrative expenses was $18.6 million, which represents an increase of $9.3 million or 99% from the prior year amount of $9.4
million. General and administrative cost increases are primarily attributable to headcount additions required to support operational expansion
initiatives and include stock-based compensation, salary expenses, employee benefits, selling costs and incidental expenses related to
corporate, cultivation and retail operations.
2019
For the year ended December 31, 2019, general
and administrative expenses was $9.4 million, which represents an increase of $6.3 million or 202% from the prior year amount of $3.1
million. General and administrative cost increases are primarily attributable to headcount additions required to support operational expansion
initiatives and include stock-based compensation, salary expenses, employee benefits, selling costs and incidental expenses related to
corporate, cultivation and retail operations.
2018
For the year ended December 31, 2018, general
and administrative expenses was $ 3.1 million. General and administrative expenses include stock-based compensation, salary expenses,
employee benefits, selling costs and incidental expenses related to corporate, cultivation and retail operations.
Sales & Marketing
2020
For the year ended December 31, 2020, sales
and marketing expenses was $1.5 million, which represents an increase of $0.6 million or 63% from the prior year amount of $0.9 million.
The Company’s cannabis dispensaries contributed to year over year cost increases, with a full year of operations in 2020 and less
than 6 months of operations in 2019. Sales and marketing expenses include advertising and promotions in various media outlets.
2019
For the year ended December 31, 2019, sales
and marketing expenses was $0.9 million, which represents an increase of $0.8 million or 537% from the prior year amount of $0.1 million.
Marketing expenses increased year over year to support the Company’s retail operations, which began Q3 2019.
2018
For the year ended December 31, 2018, The
Company incurred $0.1 million of sales and marketing expenses for general advertising and promotions in various media outlets.
Professional Fees
2020
For the year ended December 31, 2020, professional
fees were $2.0 million, which represents a decrease of $3.2 million or 61% from the prior year amount of $5.2 million. The decrease from
2019 was a result of the preparatory work performed in 2019 for business combinations, mergers and acquisitions. During 2020, the Company
deliberately curtailed the use of consultants.
2019
For the year ended December 31, 2019, professional
fees were $5.2 million, which represents an increase of $3.3 million or 172% from the prior year amount of $1.9 million. The increase
from 2018 is a direct result of the Company’s merger and acquisition activity, capital raises, preparatory work required for business
combinations executed in 2020 and to support operational expansion initiatives.
2018
For the year ended December 31, 2018, professional
fees were $ 1.9 million. Professional fees in 2018 represent fees paid to part time operational and accounting consultants and for legal
and advisory fees.
Other Expense
2020
For the year ended December 31, 2020, net
other expenses were $4.2 million, which represents a increase of $2.9 million or 221% from the prior year amount of $1.3 million. The
increase from 2019 was a result of the increase in interest expense from our debt incurred during 2020 and an increase in our unrealized
losses on our equity method investments.
2019
For the year ended December 31, 2019, net
other expenses were $1.3 million, which represents a increase of $1.0 million or 323% from the prior year amount of $0.3 million. The
increase from 2018 was primarily a result of the increase in our unrealized losses on our equity method investments.
2018
For the year ended December 31, 2018, net
other expenses were $0.3 million. Net other expenses in 2018 is primarily represented by interest expense ($0.6 million), offset by interest
income of $0.3 million from our notes receivables.
Liquidity and Capital Resources
Overview
Historically, GH Group’s primary source
of liquidity has been capital contributions made by equity investors and debt issuances. GH Group expects to generate positive cash flow
from its operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the event sufficient
cash flow is not available from operating activities, GH Group may continue to raise equity or debt capital from investors in order to
meet liquidity needs.
Financial Condition
Cash Flows
The following table summarizes GH Group’s
consolidated statement of cash flows from continuing operations for the year end December 31:
| | |
2020 | | |
2019 | | |
2018 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH USED IN OPERATING ACTIVITIES | |
$ | (7,697,679 | ) | |
$ | (3,434,706 | ) | |
$ | (909,209 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH USED IN INVESTING ACTIVITIES | |
| (7,719,045 | ) | |
| (15,788,070 | ) | |
| (14,845,042 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | |
| 17,320,089 | | |
| 8,080,108 | | |
| 23,873,520 | |
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | |
| 1,903,366 | | |
| (11,142,668 | ) | |
| 8,119,269 | |
| Cash and Cash Equivalents, Beginning of Period | |
| 2,631,886 | | |
| 13,774,554 | | |
| 5,655,285 | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | |
$ | 4,535,251 | | |
$ | 2,631,886 | | |
$ | 13,774,554 | |
Cash Flow Provided by Operating Activities
2020
Cash used in operating activities totaled $ 7.7
million in 2020. This was primarily driven by the net loss incurred of $16.7 million during the year, increases in accounts receivable
($3.5 million) and buildup of inventory ($3.8 million) resulting from increased operations. The use of cash in operations was offset by
the increase in trade payables and accrued liabilities ($1.9 million), increase in income taxes payable ($3.9 million), Increases
in deferred tax liabilities, net ($1.3 million) and non-cash expense from interest capitalized to notes payable ($ 1.1 million), share-based
compensation ($2.5 million), accretion of debt discounts on loans ($1.1 million), loss on equity method investments ($2.1 million) and
depreciation and amortization ($2.6 million).
2019
Cash used in operating activities totaled $3.4
million in 2019. This was primarily driven by the net loss incurred of $10.8 million during the year as a result from increased operations.
The use of cash in operations was offset by the increase in trade payables and accrued liabilities ($3.2 million) and non-cash expense
from share-based compensation ($1.9 million), unrealized loss on equity method investments ($1.1 million) and depreciation and amortization
($1.5 million).
2018
Cash used in operating activities totaled $0.9
million in 2018. This was primarily driven by the net loss incurred of $1.4 million during the year, increases in accounts receivable
($0.5 million) and buildup of inventory ($0.8 million) resulting from increased operations. The use of cash in operations was offset by
non-cash expense from share-based compensation ($0.8 million) and depreciation and amortization ($0.8 million).
Cash Flow Provided by (Used in) Investing Activities
2020
Cash used in investing activities totaled $ 7.7
million in 2020. This was primarily driven by the purchase of property and equipment ($3.9 million) purchase of investments ($2.9 million)
and issuance of notes receivables ($1.1 million).
2019
Cash used in investing activities totaled $15.8
million in 2019. This was primarily driven by the purchase of property and equipment ($5.7 million), purchase of investments ($5.1 million),
issuance of notes receivables ($3.5 million) and cash paid for an acquisition ($1.9 million).
2018
Cash used in investing activities totaled $14.8
million in 2018. This was primarily driven by the purchase of property and equipment ($12.7 million) and the purchase of investments ($3.2
million). Cash outflows from investing activities were offset by repayments on notes receivables during the year ($1.1 million).
Cash Flow Provided by (Used in) Financing Activities
2020
Cash provided by financing activities totaled
$17.3 million in 2020. This was primarily driven by cash proceeds from the issuance of notes and convertible notes payable during the
year ($18.4 million) which was offset by payments on notes payable ($1.1 million).
2019
Cash provided by financing activities totaled
$8.1 million in 2019. This was primarily driven by cash proceeds from the issuance of notes payable during the year ($1.7 million), cash
contributions from investors ($8.1 million) offset by payments of notes payable during the year ($0.9 million).
2018
Cash provided by financing activities totaled
$23.9 million in 2018. This was primarily driven by cash proceeds from the issuance of notes and convertible notes payable during the
year ($9.9 million), cash contributions from investors ($16.4 million) offset by payments of distributions to shareholders during the
year ($2.0 million).
As previously noted, GH Group’s primary
source of liquidity has been capital contributions and debt capital made available from investors. GH Group expects to generate positive
cash flow from its operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the
event sufficient cash flow is not available from operating activities, GH Group may continue to raise equity capital from investors in
order to meet liquidity needs. GH Group does not have any committed sources of financing, nor significant outstanding capital expenditure
commitments.
Contractual Obligations
GH Group has contractual obligations to make future
payments, including debt agreements and lease agreements from third parties and related parties.
The following table summarizes such obligations as of December 31,
2020:
| | |
2021 | | |
2022 | | |
2023 - 2024 | | |
After 2024 | | |
Total | |
| Notes Payable from Third Parties and Related Parties | |
$ | 601,187 | | |
$ | - | | |
$ | 2,189,264 | | |
$ | 22,839,551 | | |
$ | 25,630,002 | |
| Leases obligations | |
| 731,354 | | |
| 745,094 | | |
| 1,526,302 | | |
| 1,231,207 | | |
| 4,233,957 | |
| Total Contractual Obligations | |
$ | 1,332,541 | | |
$ | 745,094 | | |
$ | 3,715,566 | | |
$ | 24,070,758 | | |
$ | 29,863,959 | |
Transactions with Related Parties
Reposition Debt Transactions
Reposition Investments, LLC, a Texas limited liability
company (“Reposition”) and an affiliate of a shareholder of the Company, agreed to make a $1,000,000 unsecured bridge loan
to the Company at an interest rate of 8% per annum to fund the Company until the initial close of Senior Notes Offering, pursuant to that
certain Promissory Note, dated as of January 24, 2020, issued by the Company in favour of Reposition. In February 2020, the
Company executed and delivered to Reposition, and Reposition accepted, documentation in substantially the form of the approved Senior
Secured Convertible Notes to cancel and reissue the bridge note as part of the Senior Convertible Notes Offering. Accordingly, as of December 31,
2020, the Reposition Bridge Note is no longer outstanding and Repositions Senior Convertible Note balance of $1,000,000 principal balance
is included as a component of convertible notes noted above. As of December 31, 2020 and 2019, no amounts were due under the original
notes.
Magu Farm Lenders Debt Transactions
In 2018, Magu Farm LLC issued approximately $9,925,000
in secured promissory notes convertible into equity interests in Magu Investment Fund (collectively, the “Magu Farm Convertible
Notes”) to certain lenders who are affiliates of shareholders of the Company (collectively, the “Magu Farm Lenders,”
and individually, a “Magu Farm Lender”)
On October 7, 2019, Magu Farm LLC and Magu
Investment Fund notified each Magu Farm Lender of Magu Investment Fund’s intention to merge with and into the Company at the closing
of the Roll-Up. Subsequent to such notification, effective as of October 7, 2019, each Magu Farm Lender other than Kings Bay Investment
Company Ltd., a Cayman Islands company (“KBIC ”), entered into a letter agreement pursuant to which such Magu Farm
Lender, among other things, (a) converted its respective Magu Farm Convertible Note with an aggregate value of $8,000,000 into equity
interests in Magu Investment Fund and (b) agreed to terminate both the Co-Lending Agreement and its respective security interest
as defined in the agreement. All accrued and unpaid interest were paid prior to conversion. KBIC balance which was not converted remained.
Effective as of March 1, 2020, KBIC assigned the Kings Bay Note to Kings Bay Capital Management Ltd., a Cayman Islands company (“KBCM”).
Effective as of April 10, 2020, KBCM and
the Company entered into an Assignment, Novation and Note Modification Agreement and a Security Agreement, pursuant to which, among other
things, (a) the company assumed all of Magu Farm LLC’s rights, duties, liabilities and obligations under the Kings Bay Note,
(b) the Kings Bay Note was modified, among other things, such that KBCM has the right to convert the Kings Bay Note into Class A
Shares at the same conversion price accorded to the other Magu Farm Lenders, and (c) the obligations under the Kings Bay Note were
secured by a pledge of the securities of GH Group’s subsidiaries but expressly subordinated to the holders of the Senior Convertible
Notes. As a result of the modification, the Company recorded an loss on extinguishment of debt due to modification for approximately $389,000
which is included as a component of other income, net in the accompanying consolidated statement of operations. As of December 31,
2020 and 2019, the balance due to KBCM is $2,189,264 and $1,925,000, respectively.
Graham S. Farrar Living Trust – Related Party
On October 5, 2019, G&H Supply Company
LLC issued a promissory note in the original principal amount of $315,000 in favour of the Graham S. Farrar Living Trust established February 2,
2000 (the “Farrar Trust”), an affiliate of Graham Farrar (the “Original G&H / Farrar Note”).
Effective as of February 20, 2020, GH Group executed and delivered to the Farrar Trust, and the Farrar Trust accepted, documentation
in substantially the form of the approved Forms of Note Offering Documents to cancel and reissue the loan evidenced by the Original G&H
/ Farrar Note as part of the convertible debt offering. As of December 31, 2020 and 2019, the balance of these notes was $0, and
$316,262, respectively.
BFP Debt Transactions
In connection with the Incubation, Beach Front
Properties, LLC, a California limited liability company (“BFP”), advanced to Magu Capital loans in the aggregate principal
amount of $400,000 (the “BFP Loans”), which BFP Loans were documented by that certain promissory note dated as of June 7,
2017 and that certain promissory note dated as of March 22, 2018 (together, the “BFP Notes”), and the remaining monetary
portion of the BFP Loans was not previously documented but intended by BFP and Magu Capital to be advanced under the same terms as set
forth in the BFP Notes. Magu Capital used the proceeds of the BFP Loans to pay certain expenses of the Company. Effective as of June 30,
2020: (a) Magu Capital assigned to the Company, the Company assumed and Magu Capital was released from, all of Magu Capital’s
rights, duties and obligations under the BFP Loans; and (b) the Company executed and delivered to BFP, and BFP accepted, documentation
in substantially the form of the approved convertible debt offering.
Incubation Services
Effective January 1, 2019, GH Group and Magu
Capital LLC, a California limited liability company (“Magu Capital”), entered into a Services and Incubation Agreement
(the “Services and Incubation Agreement”), pursuant to which Magu Capital agreed to perform certain advisory and business
“incubation” services for GH Group (and incur certain fees and expenses on behalf of GH Group as part of and as performance
for such services) (collectively, the “Incubation”) in consideration of GH Group’s agreement to issue to Magu
Capital, upon a date certain following the closing of the Roll-Up as reasonably determined by the board of directors of GH Group, a warrant
to purchase a fixed number of Class A Shares at an agreed upon strike price and no later than three years following the grant date.
On July 23, 2020, GH Group issued to Magu
Capital a Warrant to Purchase Exercise Shares (the “Magu Capital Warrant”), in full satisfaction of GH Group’s
obligations under the Services and Incubation Agreement to compensate Magu Capital for the Incubation. The value of the warrants was fair
valued at approximately $ 427,000. The Company recorded a gain on extinguishment of the liability in the amount of approximately $573,000
which is recorded as a component of other income in the accompanying consolidated statement of operations. The balance due to Magu Capital
as of December 31, 2020 and 2019 was $0 and$1,773,879, respectively and is included as a component of accounts payable and accrued
liabilities in the consolidated and combined balance sheet.
Issuance of Class B Shares for Management Services
In January 2020, The Company as part of the
roll up and re-organization: (a) issued to APP Investment Advisors LLC, a California limited liability company (“APP Investment
Advisors”), an affiliate of certain significant shareholders, 9,047,226 shares of Class B common stock of GH Group (“Class B
Shares”), in exchange for certain management services rendered by APP Investment Advisors for AP Investment Fund; and (b) issued
to Magu Capital, an affiliate of certain significant shareholders, 23,248,044 Class B Shares, in exchange for certain management
services rendered by Magu Capital for CA Brand Collective, Magu Investment Fund and MG Padaro Fund.
Asset Management Fees
The Company has an agreement with certain related
parties which provide asset management services. Fees are paid quarterly. For the year ended December 31, 2020, 2019 and 2018, the
Company incurred expenses of approximately $0, $822,000 and $590,000, respectively.
Critical Accounting Estimates
Use of Estimates
The preparation of the consolidated and combined
financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the dates of the consolidated and combined financial statements and the reported amounts of total net revenue
and expenses during the reporting period. The Company regularly evaluates significant estimates and assumptions related to the consolidation
or non-consolidation of variable interest entities, estimated useful lives, depreciation of property and equipment, amortization of intangible
assets, inventory valuation, share-based compensation, business combinations, goodwill impairment, long-lived asset impairment, purchased
asset valuations, fair value of financial instruments, compound financial instruments, derivative liabilities, deferred income tax asset
valuation allowances, incremental borrowing rates, lease terms applicable to lease contracts and going concern. These estimates and assumptions
are based on current facts, historical experience and various other factors that the Company believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue,
costs and expenses that are not readily apparent from other sources. The actual results the Company experiences may differ materially
and adversely from these estimates. To the extent there are material differences between the estimates and actual results, the Company’s
future results of operations will be affected.
Estimated Useful Lives and Depreciation of Property and Equipment
Depreciation of property and equipment is dependent
upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment of these assets
is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful
lives of assets.
Estimated Useful Lives and Amortization of Intangible Assets
Amortization of intangible assets is dependent
upon estimates of useful lives and residual values which are determined through the exercise of judgment. Intangible assets that have
indefinite useful lives are not subject to amortization and are tested annually for impairment, or more frequently if events or changes
in circumstances indicate that they might be impaired. The assessment of any impairment of these assets is dependent upon estimates of
recoverable amounts that take into account factors such as economic and market conditions.
Impairment of Long-Lived Assets
For purposes of the impairment test, long-lived
assets such as property, plant and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the
lowest level for which identifiable independent cash flows are available (“asset group”). The Company reviews long-lived assets
for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order
to determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first
to determine whether the long-lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset to
the sum of its future undiscounted cash flows using entity- specific assumptions generated through the asset’s use and eventual
disposition. If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded.
If the carrying amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step
2) is required. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying
value of the asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection
and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies,
at the date of evaluation. The reversal of impairment losses is prohibited.
Leased Assets
The Company adopted Audit Standards Update (“ASU”)
2016-02, “Leases (Topic 842)” (“ASC 842”) using the full retrospective approach, which provides a method for recording
existing leases at adoption using the effective date as its date of initial application. Accordingly, the Company has recorded its leases
at inception of the Company. The Company elected the package of practical expedients provided by ASC 842, which forgoes reassessment of
the following upon adoption of the new standard: (1) whether contracts contain leases for any expired or existing contracts, (2) the
lease classification for any expired or existing leases, and (3) initial direct costs for any existing or expired leases. In addition,
the Company elected an accounting policy to exclude from the balance sheet the right-of-use assets and lease liabilities related to short-term
leases, which are those leases with a lease term of twelve months or less that do not include an option to purchase the underlying asset
that the Company is reasonably certain to exercise.
The Company applies judgment in determining whether
a contract contains a lease and if a lease is classified as an operating lease or a finance lease. The Company applies judgement in determining
the lease term as the non-cancellable term of the lease, which may include options to extend or terminate the lease when it is reasonably
certain that the Company will exercise that option. All relevant factors that create an economic incentive for it to exercise either the
renewal or termination are considered. The Company reassesses the lease term if there is a significant event or change in circumstances
that is within its control and affects its ability to exercise or not to exercise the option to renew or to terminate. In adoption of
ASC 842, the Company applied the practical expedient which applies hindsight in determining the lease term and assessing impairment of
right-of-use assets by using its actual knowledge or current expectation as of the effective date. The Company also applies judgment in
allocating the consideration in a contract between lease and non-lease components. It considers whether the Company can benefit from the
right-of-use asset either on its own or together with other resources and whether the asset is highly dependent on or highly interrelated
with another right of-use asset. Lessees are required to record a right of use asset and a lease liability for all leases with a term
greater than twelve months. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease
payments over the expected remaining lease term. The incremental borrowing rate is determined using estimates which are based on the information
available at commencement date and determines the present value of lease payments if the implicit rate is unavailable.
Income Taxes
Deferred tax assets and liabilities are recorded
for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in
the combined balance sheet. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to
tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more
likely than not that some or all of the deferred tax assets will not be realized.
The Company follows accounting guidance issued
by the Financial Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes.
Under this guidance, the Company assesses the likelihood of the financial statement effect of a tax position that should be recognized
when it is more likely than not that the position will be sustained upon examination by a taxing authority based on the technical merits
of the tax position, circumstances, and information available as of the reporting date.
Convertible Instruments
The Company evaluates and accounts for conversion
options embedded in its convertible instruments in accordance with ASC 815, “Accounting for Derivative Instruments and Hedging Activities”.
Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host
instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which
(a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and
the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument
is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
The Company accounts for convertible instruments
(when it has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance ASC 470,
“Accounting for Convertible Securities with Beneficial Conversion Features”, as those professional standards pertain to “Certain
Convertible Instruments”. Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value
of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at
the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed dividends
for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying
common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides
that generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be
classified as an asset or a liability.
Derivative Liabilities
The Company evaluates its agreements to determine
if such instruments have derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that
are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting
date, with changes in the fair value reported in the Consolidated Statements of Operations. In calculating the fair value of derivative
liabilities, the Company uses a valuation model when Level 1 inputs are not available to estimate fair value at each reporting date. The
classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated
at the end of each reporting period. Derivative instrument liabilities are classified in the Consolidated Balance Sheets as current or
non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the Consolidated
Balance Sheets date. Critical estimates and assumptions used in the model are discussed in “Note 12 - Derivative Liabilities”.
Business Combinations
Business combinations are accounted for using
the acquisition method. The consideration transferred in a business combination is measured at fair value at the date of acquisition.
Acquisition related transaction costs are expensed as incurred and included in the consolidated and combined statements of operations.
Identifiable assets and liabilities, including intangible assets, of acquired businesses are recorded at their fair value at the date
of acquisition. When the Company acquires control of a business, any previously held equity interest also is remeasured to fair value.
The excess of the purchase consideration and any previously held equity interest over the fair value of identifiable net assets acquired
is goodwill. If the fair value of identifiable net assets acquired exceeds the purchase consideration and any previously held equity interest,
the difference is recognized in the Consolidated and combined Statements of Operations immediately as a gain on acquisition. See “Note
8 – Business Acquisitions” for further details on business combinations.
Contingent consideration is measured at its acquisition-date
fair value and included as part of the consideration transferred in a business combination. The Company allocates the total cost of the
acquisition to the underlying net assets based on their respective estimated fair values. As part of this allocation process, the Company
identifies and attributes values and estimated lives to the intangible assets acquired. These determinations involve significant estimates
and assumptions regarding multiple, highly subjective variables, including those with respect to future cash flows, discount rates, asset
lives, and the use of different valuation models, and therefore require considerable judgment. The Company’s estimates and assumptions
are based, in part, on the availability of listed market prices or other transparent market data. These determinations affect the amount
of amortization expense recognized in future periods. The Company bases its fair value estimates on assumptions it believes to be reasonable
but are inherently uncertain. Contingent consideration that is classified as equity is not remeasured at subsequent reporting dates and
its subsequent settlement is accounted for within equity. Contingent consideration that is classified as an asset or a liability is remeasured
at subsequent reporting dates in accordance with ASC 450, “Contingencies”, as appropriate, with the corresponding gain or
loss being recognized in earnings in accordance with ASC 805.
Share-Based Compensation
The Company has a share-based compensation plan
comprised of stock options (“Options”) and stock appreciation rights (“SARs”). Options provide the right to the
purchase of one Series A Common share per option. Stock appreciation rights provide the right to receive cash from the exercise of
such right based on the increase in value between the exercise price and the fair market value of Series A Common shares of the Company
at the time of exercise. The Company has issued both incentive stock options and non-qualified stock options.
The Company accounts for its share- based awards
in accordance with ASC Subtopic 718-10, “Compensation – Stock Compensation”, which requires fair value measurement on
the grant date and recognition of compensation expense for all share-based payment awards made to employees and directors, including restricted
share awards. For stock options, the Company estimates the fair value using a closed option valuation (Black-Scholes) model. When there
are market-related vesting conditions to the vesting term of the share-based compensation, the Company uses a valuation model to estimate
the probability of the market-related vesting conditions being met and will record the expense. The fair value of restricted share awards
is based upon the quoted market price of the common shares on the date of grant. The fair value is then expensed over the requisite service
periods of the awards, net of estimated forfeitures, which is generally the performance period and the related amount is recognized in
the consolidated and combined statements of operations.
The fair value models require the input of certain
assumptions that require the Company’s judgment, including the expected term and the expected share price volatility of the underlying
share. The assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, but
these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change resulting in the use of
different assumptions, share-based compensation expense could be materially different in the future. In addition, the Company is required
to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the actual forfeiture rate is
materially different from management’s estimates, the share-based compensation expense could be significantly different from what
the Company has recorded in the current period.
Financial Instruments
Measurement
All financial instruments are required to be measured
at fair value on initial recognition, plus, in the case of a financial asset or financial liability not at FVTPL, transaction costs that
are directly attributable to the acquisition or issuance of the financial asset or financial liability. Transaction costs of financial
assets and financial liabilities carried at FVTPL are expensed in profit or loss. Financial assets and financial liabilities with embedded
derivatives are considered separately when determining whether their cash flows are solely payment of principal and interest. Financial
assets that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual cash
flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at the
end of the subsequent accounting periods. All other financial assets including equity investments are measured at their fair values at
the end of subsequent accounting periods, with any changes taken through profit and loss or other comprehensive income (irrevocable election
at the time of recognition). For financial liabilities measured subsequently at FVTPL, changes in fair value due to credit risk are recorded
in other comprehensive income.
Fair Value
The Company applies fair value accounting for
all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial
statements on a recurring basis. The Company defines fair value as the price that would be received from selling an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements
for assets and liabilities that are required to be recorded at fair value, the Company considers the principal or most advantageous market
in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing
the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated
by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization
within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices in active markets for identical
assets or liabilities.
Level 2 – Observable inputs other
than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities
in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term
of the assets or liabilities.
Level 3 – Inputs that are generally
unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset
or liability.
Impairment
The Company assesses all information available,
including on a forward-looking basis the expected credit loss associated with its assets carried at amortized cost. The impairment methodology
applied depends on whether there has been a significant increase in credit risk. To assess whether there is a significant increase in
credit risk, the Company compares the risk of a default occurring on the asset at the reporting date with the risk of default at the date
of initial recognition based on all information available, and reasonable and supportive forward-looking information. For accounts receivable
only, the Company applies the simplified approach as permitted by ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments”. The simplified approach to the recognition of expected losses does not require
the Company to track the changes in credit risk; rather, the Company recognizes a loss allowance based on lifetime expected credit losses
at each reporting date from the date of the trade receivable.
Expected credit losses are measured as the difference
in the present value of the contractual cash flows that are due to the Company under the contract, and the cash flows that the Company
expects to receive. The Company assesses all information available, including past due status, credit ratings, the existence of third-party
insurance, and forward-looking macro-economic factors in the measurement of the expected credit losses associated with its assets carried
at amortized cost. The Company measures expected credit loss by considering the risk of default over the contract period and incorporates
forward-looking information into its measurement.
Changes in Accounting Policies Including Adoption
In December 2019, the FASB issued ASU 2019-
12, “Simplifying the Accounting for Income Taxes” which eliminates certain exceptions related to the approach for intra-period
tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for
outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. ASU 2019-12 is effective
for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating
the adoption date and impact, if any, adoption will have on its consolidated and combined financial position and consolidated and combined
results of operations.
In January 2020, the FASB issued ASU 2020-01,
“Investments—Equity Securities (Topic 321)”, “Investments— Equity Method and Joint Ventures (Topic 323)”,
and “Derivatives and Hedging (Topic 815)”, which is intended to clarify the interaction of the accounting for equity securities
under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward
contracts and purchased options accounted for under Topic 815. ASU 2020-01 is effective for the Company beginning January 1, 2021.
The Company is currently evaluating the adoption date and impact, if any, adoption will have on its consolidated and combined financial
position and consolidated and combined results of operations.
In August 2020, the FASB issued ASU 2020-06,
“Debt — Debt With Conversion and Other Options (Subtopic 470-20)” and “Derivatives and Hedging — Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”,
which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. ASU 2020-06 is effective for the Company for fiscal years beginning after December 15,
2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2020,
and interim periods within those fiscal years. Adoption is applied on a modified or full retrospective transition approach. The Company
is currently evaluating the adoption date and impact, if any, adoption will have on its consolidated and combined financial position and
consolidated and combined results of operations.
Financial Instruments and Other Instruments
Fair Value of Financial Instruments
GH Group’s financial instruments consist
of cash and cash equivalents, accounts receivables, investments, notes receivable trade payables, accrued liabilities, operating lease
liabilities and notes payable. All assets and liabilities for which fair value is measured or disclosed in the financial statements are
categorized within the fair value hierarchy. This is described, as follows, based on the lowest level input that is significant to the
fair value measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical
assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other
than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for
identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs
for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Other Risks and Uncertainties
Credit Risk
Credit risk is the risk of a potential loss to
the Company if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure
at December 31, 2020 and 2019 is the carrying values of cash and cash equivalents, restricted cash, accounts receivable, and due
from related party. The Company does not have significant credit risk with respect to its customers. All cash and cash equivalents are
placed with major U.S. financial institutions. The Company provides credit to its customers in the normal course of business and has established
credit evaluation and monitoring processes to mitigate credit risk but has limited risk as the majority of its sales are transacted with
cash.
Liquidity Risk
Liquidity risk is the risk that the Company will
not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management
of its capital structure. The Company’s approach to managing liquidity risk is to ensure that it will have sufficient liquidity
to settle obligations and liabilities when due. As of December 31, 2020 and 2019, cash generated from ongoing operations was not
sufficient to fund operations and growth strategy as discussed above in “Financial Condition, Liquidity and Capital Resources”.
Currency Risk
The operating results and financial position of
the Company are reported in U.S. dollars. Some of the Company’s financial transactions are denominated in currencies other than
the U.S. dollar. The results of the Company’s operations are subject to currency transaction and translation risks. The Company’s
main risk is associated with fluctuations in Canadian dollars. The Company holds cash in U.S. dollars, investments denominated in U.S.
dollars, debt denominated in U.S. dollars and equity denominated in U.S. and Canadian dollars. Such assets and liabilities denominated
in currencies other than the U.S. dollar are translated based on the Company’s foreign currency translation policy. As of December 31,
2020 and 2019, the Company had no hedging agreements in place with respect to foreign exchange rates. The Company has not entered into
any agreements or purchased any instruments to hedge possible currency risks at this time.
Interest Rate Risk
Interest rate risk is the risk that the fair value
or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear
interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a
limited interest rate fair value risk.
Price Risk
Price risk is the risk of variability in fair
value due to movements in equity or market prices. The Company’s investments are susceptible to price risk arising from uncertainties
about their future outlook, future values and the impact of market conditions. The fair value of investments held in privately-held entities
are based on a market approach, which uses prices and other relevant information generated by market transactions involving identical
or comparable assets or liabilities.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations for the Period Ended August 31, 2019 and the Year Ended December 31, 2018 –
Bud and Bloom
Overview
Bud and Bloom (“the Company”) consists
of the combined financial statements of Saint Gertrude Management Company, LLC (“SGMC”) and Bud and Bloom (“BNB”).
The Company is a cannabis company that operates a dispensary in the city of Santa Ana, California.
See “Description of Business” for
an overview of the Company and “Regulatory Overview” for details regarding the California regulatory framework.
Recent Developments
Acquisition by GH Group, Inc.
On August 31, 2019, GH Group, Inc (“GH
Group”). completed the acquisition of the Company for aggregate consideration of $1,912,000 which is comprised of all cash at closing.
Major Business Lines and Geographies
The Company views its financial results under
one business line – the procurement and sale of cannabis retail products in the city of Santa Ana, California.
Geographic Areas
All of the Company’s revenue is derived from the city of Santa
Ana, California cannabis market.
Market Update and Objectives
The state of California represents the largest
single market for cannabis in the U.S., with over $7 billion in revenues in 2020 and an adult population of over 31 million. The California
market is highly fragmented, with over 6,000 cultivation licenses in operation, over 1,000 distribution licenses over 700 operational
dispensaries and greater than 1,000 brands. With this backdrop, and with the acquisition of the Company by GH Group, GH Group along with
its other retail dispensaries look to expand its retail presence and brand name that allow GH Group to outperform competitors and build
superior brand awareness and loyalty.
Results of Operations
The following are the results of our operations
for the period end August 31, 2019 and the year ended December 31, 2018:
| | |
2019 | | |
2018 | |
| Revenues, Net | |
$ | 3,809,773 | | |
$ | 4,249,638 | |
| Cost of Goods Sold | |
| 2,232,857 | | |
| 2,890,836 | |
| Gross Profit | |
| 1,576,916 | | |
| 1,358,802 | |
| Expenses: | |
| | | |
| | |
| General and Administrative | |
| 920,442 | | |
| 1,350,857 | |
| Sales and Marketing | |
| 129,010 | | |
| 173,918 | |
| Professional Fees | |
| 70,592 | | |
| 127,500 | |
| Depreciation and Amortization | |
| 62,374 | | |
| 90,238 | |
| Total Expenses | |
| 1,182,418 | | |
| 1,742,513 | |
| Income (Loss) from Operations | |
| 394,498 | | |
| (383,711 | ) |
| Other Expense (Income): | |
| | | |
| | |
| Interest Expense | |
| 354,162 | | |
| 256,343 | |
| Other Income, Net | |
| (34,742 | ) | |
| (5,092 | ) |
| Total Other Expense | |
| 319,420 | | |
| 251,252 | |
| Income (Loss) from Operations Before Provision for Income Taxes | |
| 75,078 | | |
| (634,962 | ) |
| Provision for Income Taxes | |
| 430,205 | | |
| 250,493 | |
| | |
| | | |
| | |
| Net Loss | |
$ | (355,127 | ) | |
$ | (885,455 | ) |
Revenue
For the period ended August 31, 2019
For the period ended August 31, 2019, revenue
was $3.8 million ($5.7 million annualized, which represents an increase of $1.5 million or 34% annualized from $4.2 million for the year
ended December 31, 2018. Revenue growth in 2019 was primarily driven by an increase in awareness of the Company’s operations.
The Company began operations in Q1 of 2018.
For the year ended December 31, 2018
For the year ended December 31, 2018, revenue
was $4.2 million. Revenues during 2018 consists of all retail products sold at its Santa Ana, California location which began sales in
Q1 2018.
Cost of Goods Sold
For the period ended August 31, 2019
For the period ended August 31, 2019, cost
of goods sold was $2.2 million, which represents an increase of $3.3 million or 16% annualized from the prior year amount of $2.9 million.
Cost of goods sold growth in 2019 was primarily driven by an increase in awareness of the Company’s operations. The Company began
operations in Q1 of 2018.
For the year ended December 31, 2018
For the year ended December 31, 2018, cost
of goods sold was $2.9 million. The Company’s cost of goods sold is a direct result of the Company’s retail operations during
2018.
General and Administrative
For the period ended August 31, 2019
For the period ended August 31, 2019, general
and administrative expenses was $0.9 million, which represents a negligible increase (less than 2% increase on an annualized basis) from
$1.4 million in 2018.
For the year ended December 31, 2018
For the year ended December 31, 2018, general
and administrative expenses was $1.4 million. General and administrative expenses include salary expenses, employee benefits, selling
costs and incidental expenses related to its retail operations.
Sales & Marketing
For the period ended August 31, 2019
For the period ended August 31, 2019, sales
and marketing expenses was $0.1 million, which represents an increase of $0.2 million or 11% annualized from the prior year amount of
$0.2 million. Marketing expenses increased year over year to support the Company’s retail operations, which began Q1 2018.
For the year ended December 31, 2018
For the year ended December 31, 2018, The
Company incurred $0.2 million of sales and marketing expenses for general advertising and promotions in various media outlets.
Professional Fees
For the period ended August 31, 2019
For the period ended August 31, 2019, professional
fees were $0.1 million, which represents a negligible increase on an annualized basis from $0.1 million in 2018.
For the year ended December 31, 2018
For the year ended December 31, 2018, professional
fees were $ 0.1 million. Professional fees in 2018 represent fees paid to part time operational and accounting consultants and for legal
and advisory fees.
Other Expense
For the period ended August 31, 2019
For the period ended August 31, 2019, net
other expenses were $0.3 million, which represents a increase of $0.2 million or 91% annualized from the prior year amount of $0.3 million.
The increase from 2018 was primarily a result of the increase in our interest expense due to increased debt borrowings in 2019.
For the year ended December 31, 2018
For the year ended December 31, 2018, net
other expenses were $0.3 million. Net other expenses in 2018 is primarily represented by interest expense ($0.3 million).
Liquidity and Capital Resources
Overview
Historically, the Company’s primary source
of liquidity has been capital contributions by investors and debt issuances. The Company expects to generate positive cash flow from its
operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the event sufficient cash
flow is not available from operating activities, GH Group may continue to fund the Company from its capital resources in order to meet
liquidity needs.
Financial Condition
Cash Flows
The following table summarizes the Company’s
combined statement of cash flows from operations for the year end period ended August 31, 2019 and the year ended December 31,
2018:
| | |
2019 | | |
2018 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | |
| | | |
| | |
| | |
| | | |
| | |
| NET CASH PROVIDED BY OPERATING ACTIVITIES | |
$ | 231,512 | | |
$ | 110,911 | |
| | |
| | | |
| | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | |
| | | |
| | |
| | |
| | | |
| | |
| NET CASH USED IN INVESTING ACTIVITIES | |
| (13,632 | ) | |
| (15,600 | ) |
| | |
| | | |
| | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | |
| | | |
| | |
| | |
| | | |
| | |
| NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES | |
| (62,219 | ) | |
| 17,383 | |
| | |
| | | |
| | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | |
| 155,660 | | |
| 112,694 | |
| Cash and Cash Equivalents, Beginning of Period | |
| 234,630 | | |
| 121,936 | |
| | |
| | | |
| | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | |
$ | 390,291 | | |
$ | 234,630 | |
Cash Flow Provided by Operating Activities
For the period ended August 31, 2019
Cash provided by operating activities totaled
$0.2 million for the period ended August 31, 2019. This was primarily driven by the net loss incurred of $0.4 million during the
period ended August 31, 2019. The use of cash in operations was offset by the increase in income taxes payable ($0.3 million) and
non-cash expense of amortization of debt discount ($0.2 million).
For the year ended December 31, 2018
Cash provided by operating activities totaled
$0.1 million in 2018. This was primarily driven by the net loss incurred of $0.9 million during the year, offset by increases in accounts
payable and accrued liabilities ($0.3) million, increases in income taxes payable ($0.2 million), reduction of inventory ($0.1 million)
and non-cash expense from depreciation ($0.1 million) and non-cash interest expense capitalized to notes payable ($0.2 million)
Cash Flow Used in Investing Activities
For the period ended August 31, 2019
Cash used in investing activities totaled $0.01
million for the period ended August 31, 2019 all related to the purchase of property equipment.
For the year ended December 31, 2018
Cash used in investing activities totaled $0.02
million for 2018 all related to the purchase of property and equipment.
Cash Flow (Used In) Provided by Financing Activities
For the period ended August 31, 2019
Cash used in financing activities totaled $0.1
million for the period ended August 31, 2019. This was primarily driven by cash payments on notes payable to related parties ($0.1
million).
For the year ended December 31, 2018
Cash provided by financing activities totaled
$0.02 million for 2018. This was primarily driven by cash proceeds from the issuance of notes payable during the period ($0.05 million),
offset by payments on notes payable ($0.03 million).
As previously noted, the Company’s primary
source of liquidity has been capital contributions and debt capital made available from investors. The Company expects to generate positive
cash flow from its operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the
event sufficient cash flow is not available from operating activities, GH Group may continue to fund the Company from its capital resources
in order to meet liquidity needs. The Company does not have any committed sources of financing, nor significant outstanding capital expenditure
commitments.
Contractual Obligations
The Company has contractual obligations to make
future payments, including debt agreements and lease agreements from third parties and related parties.
The following table summarizes such obligations as of August 31,
2019:
| | |
2020 | | |
2021 | | |
2022 - 2023 | | |
After 2023 | | |
Total | |
| Notes Payable | |
$ | 2,720,457 | | |
$ | - | | |
$ | - | | |
$ | - | | |
$ | 2,720,457 | |
| Leases | |
| 121,800 | | |
| 372,654 | | |
| 779,184 | | |
| 1,627,602 | | |
| 2,901,240 | |
| Total Contractual Obligations | |
$ | 2,842,257 | | |
$ | 372,654 | | |
$ | 779,184 | | |
$ | 1,627,602 | | |
$ | 5,621,697 | |
Transactions with Related Parties
Related Party Debt
The loans to related parties with an outstanding
balance of $2,720,457 and $2,421,675 as of August 31, 2019 and December 31, 2018, respectively, were originally issued in October 2016
and matures in October 2021. The holders have the option to convert all but not less than all the outstanding principal and unpaid
accrued interest into 50 percent of issued and authorized units of the Company.
On August 31, 2019, the owners of the Company
forgave their notes payable due by the Company in the amount of $250,129. The note payable forgiven by the owners of the Company was recorded
as a non-cash contribution to the Company.
Subsequent to August 31, 2019 as part of
the acquisition by GH Group, Inc., $2,720,457 of related party convertible debt was converted to equity of the Company subsequent
to the sale of the Company.
Related Party Operating Leases
The Company leases property from a related party
under an operating lease agreement that specifies minimum rentals. The lease expires in October 2027 and contains certain renewal
provisions. The Company records rent expense on a straight-line basis. As of August 31, 2019 and December 31, 2018, deferred
rent was $220,018 and $210,602, respectively. The Company’s rent expense was approximately $249,000 and $374,000 for the period
ended August 31, 2019 and the year ended December 31, 2018, respectively and recorded in general and administrative expenses
in the accompanying statements of operations.
Critical Accounting Estimates
Use of Estimates
The preparation of the combined financial statements
in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the dates of the combined financial statements and the reported amounts of total net revenue and expenses during the reporting period.
The Company regularly evaluates significant estimates and assumptions related to the consolidation or non-consolidation of variable interest
entities, estimated useful lives, depreciation of property and equipment, inventory valuation, long-lived asset impairment, fair value
of financial instruments, compound financial instruments, deferred income tax asset valuation allowances, incremental borrowing rates,
lease terms applicable to lease contracts and going concern. These estimates and assumptions are based on current facts, historical experience
and various other factors that the Company believes to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily
apparent from other sources. The actual results the Company experiences may differ materially and adversely from these estimates. To the
extent there are material differences between the estimates and actual results, the Company’s future results of operations will
be affected.
Estimated Useful Lives and Depreciation of Property and Equipment
Depreciation of property and equipment is dependent
upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment of these assets
is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful
lives of assets.
Impairment of Long-Lived Assets
For purposes of the impairment test, long-lived
assets such as property and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the lowest
level for which identifiable independent cash flows are available (“asset group”). The Company reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order to
determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first
to determine whether the long- lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset
to the sum of its future undiscounted cash flows using entity-specific assumptions generated through the asset’s use and eventual
disposition. If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded.
If the carrying amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step
2) is required. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying
value of the asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection
and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies,
at the date of evaluation. The reversal of impairment losses is prohibited.
Income Taxes
Deferred tax assets and liabilities are recorded
for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in
the combined balance sheet. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to
tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more
likely than not that some or all of the deferred tax assets will not be realized.
The Company follows accounting guidance issued
by the Financial Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes.
Under this guidance, the Company assesses the likelihood of the financial statement effect of a tax position that should be recognized
when it is more likely than not that the position will be sustained upon examination by a taxing authority based on the technical merits
of the tax position, circumstances, and information available as of the reporting date.
Convertible Instruments
The Company evaluates and accounts for conversion
options embedded in its convertible instruments in accordance with ASC 815, “Accounting for Derivative Instruments and Hedging Activities”.
Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host
instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which
(a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and
the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument
is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
The Company accounts for convertible instruments
(when it has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance ASC 470,
“Accounting for Convertible Securities with Beneficial Conversion Features”, as those professional standards pertain to “Certain
Convertible Instruments”. Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value
of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at
the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed dividends
for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying
common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides
that generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be
classified as an asset or a liability.
Changes in Accounting Policies Including Adoption
In December 2019, the FASB issued ASU 2019-
12, “Simplifying the Accounting for Income Taxes” which eliminates certain exceptions related to the approach for intra-period
tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for
outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. ASU 2019-12 is effective
for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating
the adoption date and impact, if any, adoption will have on its combined financial position and combined results of operations.
In January 2020, the FASB issued ASU 2020-01,
“Investments—Equity Securities (Topic 321)”, “Investments— Equity Method and Joint Ventures (Topic 323)”,
and “Derivatives and Hedging (Topic 815)”, which is intended to clarify the interaction of the accounting for equity securities
under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward
contracts and purchased options accounted for under Topic 815. ASU 2020-01 is effective for the Company beginning January 1, 2021.
The Company is currently evaluating the adoption date and impact, if any, adoption will have on its combined financial position and combined
results of operations.
In August 2020, the FASB issued ASU 2020-06,
“Debt — Debt With Conversion and Other Options (Subtopic 470-20)” and “Derivatives and Hedging — Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”,
which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. ASU 2020-06 is effective for the Company for fiscal years beginning after December 15,
2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2020,
and interim periods within those fiscal years. Adoption is applied on a modified or full retrospective transition approach. The Company
is currently evaluating the adoption date and impact, if any, adoption will have on its combined financial position and combined results
of operations.
Financial Instruments and Other Instruments
Fair Value of Financial Instruments
The Company’s financial instruments consist
of cash and cash equivalents, trade payables, accrued liabilities and notes payable. All assets and liabilities for which fair value is
measured or disclosed in the financial statements are categorized within the fair value hierarchy. This is described, as follows, based
on the lowest level input that is significant to the fair value measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical
assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other
than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for
identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs
for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Other Risks and Uncertainties
Credit Risk
Credit risk is the risk of a potential loss to
the Company if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure
at June 29, 2019 is the carrying values of cash and cash equivalents, restricted cash, accounts receivable, and due from related
party. The Company does not have significant credit risk with respect to its customers. All cash and cash equivalents are placed with
major U.S. financial institutions. The Company provides credit to its customers in the normal course of business and has established credit
evaluation and monitoring processes to mitigate credit risk but has limited risk as the majority of its sales are transacted with cash.
Liquidity Risk
Liquidity risk is the risk that the Company will
not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management
of its capital structure. The Company’s approach to managing liquidity risk is to ensure that it will have sufficient liquidity
to settle obligations and liabilities when due. As of June 29, 2019, cash generated from ongoing operations was not sufficient to
fund operations and growth strategy as discussed above in “Financial Condition, Liquidity and Capital Resources”.
Currency Risk
The operating results and financial position of
the Company are reported in U.S. dollars. Some of the Company’s financial transactions are denominated in currencies other than
the U.S. dollar. The results of the Company’s operations are subject to currency transaction and translation risks. The Company’s
main risk is associated with fluctuations in Canadian dollars. The Company holds cash in U.S. dollars, investments denominated in U.S.
dollars, debt denominated in U.S. dollars and equity denominated in U.S. and Canadian dollars. Such assets and liabilities denominated
in currencies other than the U.S. dollar are translated based on the Company’s foreign currency translation policy. As of June 29,
2019 and June 30, 2018, the Company had no hedging agreements in place with respect to foreign exchange rates. The Company has not
entered into any agreements or purchased any instruments to hedge possible currency risks at this time.
Interest Rate Risk
Interest rate risk is the risk that the fair value
or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear
interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a
limited interest rate fair value risk.
Price Risk
Price risk is the risk of variability in fair
value due to movements in equity or market prices. The Company’s investments are susceptible to price risk arising from uncertainties
about their future outlook, future values and the impact of market conditions. The fair value of investments held in privately-held entities
are based on a market approach, which uses prices and other relevant information generated by market transactions involving identical
or comparable assets or liabilities.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations for the Years Ended December 31, 2020, 2019 and 2018 – iCann
Overview
iCann, LLC (“the Company”) is a cannabis company that operates
a dispensary in the city of Berkley, California.
See “Description of Business” for
an overview of the Company and “Regulatory Overview” for details regarding the California regulatory framework.
Recent Developments
Acquisition by GH Group, Inc.
On January 1, 2021, GH Group, Inc. (“GH
Group”) completed the acquisition of 100% of the Company’s equity interests. Pursuant to the terms of the agreement, GH Group
elected to convert its earlier issued convertible notes with a principal amount of $2,000,000 and accrued interest of $45,309 into equity
interests of the Company, paid $400,000 in cash to four holders of the Company’s equity interests, issued 7,554,679 Class A
Common shares to the holders of the Company’s equity interests; and issued an additional 500,000 Class A Common shares to the
Company’s brokers and consultants.
Major Business Lines and Geographies
The Company views its financial results under
one business line – the procurement and sale of cannabis retail products in the city of Berkley, California.
Geographic Areas
All of the Company’s revenue is derived from the city of Berkley,
California cannabis market.
Market Update and Objectives
The state of California represents the largest
single market for cannabis in the U.S., with over $7 billion in revenues in 2020 and an adult population of over 31 million. The California
market is highly fragmented, with over 6,000 cultivation licenses in operation, over 1,000 distribution licenses over 700 operational
dispensaries and greater than 1,000 brands. With this backdrop, and with the acquisition of the Company by GH Group, GH Group along with
its other retail dispensaries look to expand its retail presence and brand name that allow GH Group to outperform competitors and build
superior brand awareness and loyalty.
Results of Operations
The following are the results of our operations for the years ended
December 31, 2020, 2019 and 2018:
| | |
2020 | | |
2019 | | |
2018 | |
| Revenues, Net | |
$ | 3,607,307 | | |
$ | - | | |
$ | - | |
| Cost of Goods Sold | |
| 2,621,272 | | |
| - | | |
| - | |
| Gross Profit | |
| 986,035 | | |
| - | | |
| - | |
| Expenses: | |
| | | |
| | | |
| | |
| General and Administrative | |
| 1,798,289 | | |
| 60,142 | | |
| 44,771 | |
| Sales and Marketing | |
| 166,784 | | |
| 9,736 | | |
| 2,728 | |
| Professional Fees | |
| 71,570 | | |
| 293,208 | | |
| 220,735 | |
| Depreciation and Amortization | |
| 108,672 | | |
| - | | |
| - | |
| Total Expenses | |
| 2,145,315 | | |
| 363,086 | | |
| 268,234 | |
| Loss from Operations | |
| (1,159,280 | ) | |
| (363,086 | ) | |
| (268,234 | ) |
| Other Expense (Income): | |
| | | |
| | | |
| | |
| Interest Expense | |
| 327,104 | | |
| 12,169 | | |
| - | |
| Interest Income | |
| - | | |
| (68 | ) | |
| (127 | ) |
| Other Expense, Net | |
| 32,566 | | |
| - | | |
| - | |
| Total Other Expense (Income), Net | |
| 359,670 | | |
| 12,101 | | |
| (127 | ) |
| Loss from Operations Before Provision for Income Taxes | |
| (1,518,950 | ) | |
| (375,187 | ) | |
| (268,107 | ) |
| Provision for Income Taxes | |
| 207,868 | | |
| 800 | | |
| 800 | |
| Net Loss | |
$ | (1,726,818 | ) | |
$ | (375,987 | ) | |
$ | (268,907 | ) |
Revenue
For the year ended December 31, 2020
For the year ended December 31, 2020, revenue
was $3.6 million, an increase from $0 million for the year ended December 31, 2019. The Company began retail sales in February 2020.
Cost of Goods Sold
For the year ended December 31, 2020
For the year ended December 31, 2020, cost
of goods sold was $2.6 million, an increase from $0 million for the year ended December 31, 2019. The Company began retail sales
in February 2020.
General and Administrative
For the year ended December 31, 2020
For the year ended December 31, 2020, general
and administrative expenses was $1.8 million, an increase of $1.7 million or 2,890% from the prior year amount of $0.1 million. The increase
in general and administrative expenses is due to the Company having started sales and ramping up operations in February 2020. In
the prior year, the Company was not fully operational and had minor operations.
For the year ended December 31, 2019 and 2018
For the year ended December 31, 2019, general
and administrative expenses was $0.1 million, a negligible increase from 2018. In 2019 and in 2018, the Company was not fully operational
and had minor operations.
Sales & Marketing
For the year ended December 31, 2020
For the year ended December 31, 2020, sales
and marketing expenses was $0.2 million, which represents an increase of $0.2 million or 1,613% from the prior year amount of $0.0 million.
Marketing expenses increased year over year to support the Company’s retail operations, which began February 2020.
For the year ended December 31, 2019 and 2018
For the year ended December 31, 2019 and
2018, sales and marketing expenses was negligible as the Company had not begun operations until February 2020.
Professional Fees
For the year ended December 31, 2020
For the year ended December 31, 2020, professional
fees were $0.1 million, which represents a decrease of $0.2 million or 76% from $0.3 million in 2019. The decline in professional fees
in 2019 was a result of the Company expending much of its up front costs in 2019 and 2018 to start the Company and obtain the cannabis
license.
For the year ended December 31, 2019 and 2018
For the year ended December 31, 2019 professional
fees were $0.3 million, which represents an increase of $0.1 million or 33% from $0.2 million in 2018. Professional fees for 2019 and
2018 represents fees paid to consultants, outside accountants and legal fees related to starting up the Company and the process of obtaining
the cannabis license.
Liquidity and Capital Resources
Overview
Historically, the Company’s primary source
of liquidity has been capital contributions by investors and debt issuances. The Company expects to generate positive cash flow from its
operations going forward and expects such positive cash flow to be its principal source of future liquidity. In the event sufficient cash
flow is not available from operating activities, GH Group may continue to fund the Company from its capital resources in order to meet
liquidity needs.
Financial Condition
Cash Flows
The following table summarizes the Company’s
combined statement of cash flows from operations for the year end year ended December 31, 2020, 2019 and 2018:
| | |
2020 | | |
2019 | | |
2018 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH USED IN OPERATING ACTIVITIES | |
$ | (661,124 | ) | |
$ | (319,990 | ) | |
$ | (298,528 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH USED IN INVESTING ACTIVITIES | |
| (117,238 | ) | |
| (546,727 | ) | |
| (137,352 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES: | |
| | | |
| | | |
| | |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | |
| 900,000 | | |
| 876,000 | | |
| 452,350 | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | |
| 121,638 | | |
| 9,283 | | |
| 16,470 | |
| Cash and Cash Equivalents, Beginning of Period | |
| 37,290 | | |
| 28,007 | | |
| 11,537 | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | |
$ | 158,928 | | |
| 37,290 | | |
$ | 28,007 | |
Cash Flow Used In Operating Activities
For the year ended December 31, 2020
Cash used in operating activities totaled $0.7
million for the year ended December 31, 2020. This was primarily driven by the net loss incurred of $1.7 million during the year
ended December 31, 2020. The use of cash in operations was offset by the increase in accounts payable and accrued liabilities ($0.8
million).
For the year ended December 31, 2019
Cash used in operating activities totaled $0.3
million for the year ended December 31, 2019. This was primarily driven by the net loss incurred of $0.4 million during the year
ended December 31, 2019. Cash flows from other operating activities during the year ended December 31, 2019 was negligible.
For the year ended December 31, 2018
Cash used in operating activities totaled $0.3
million for the year ended December 31, 2018. This was primarily driven by the net loss incurred of $0.3 million during the year
ended December 31, 2018. Cash flows from other operating activities during the year ended December 31, 2018 was negligible.
Cash Flow Used in Investing Activities
For the year ended December 31, 2020
Cash used in investing activities totaled $0.1
million for the year ended December 31, 2020 all related to the purchase of property equipment.
For the year ended December 31, 2019
Cash used in investing activities totaled $0.5
million for the year ended December 31, 2019 all related to the purchase of property equipment.
For the year ended December 31, 2018
Cash used in investing activities totaled $0.1
million for the year ended December 31, 2018 all related to the purchase of property equipment.
Cash Flow Provided by Financing Activities
For the year ended December 31, 2020
Cash provided by financing activities totaled
$0.9 million for the year ended December 31, 2020. This was primarily driven by the issuance of convertible debt during the year
($0.9 million).
For the year ended December 31, 2019
Cash provided by financing activities totaled
$0.9 million for the year ended December 31, 2019. This was primarily driven by the issuance of convertible debt during the year
($1.13 million), offset by a payment of a distribution to a member ($0.3 million).
For the year ended December 31, 2018
Cash provided by financing activities totaled
$0.5 million for the year ended December 31, 2018. This was primarily driven by a contribution ($0.5 million) from a member during
the year.
As previously noted, the Company’s primary
source of liquidity has been capital contributions and debt capital made available from investors and members. The Company expects to
generate positive cash flow from its operations going forward and expects such positive cash flow to be its principal source of future
liquidity. In the event sufficient cash flow is not available from operating activities, GH Group may continue to fund the Company from
its capital resources in order to meet liquidity needs. The Company does not have any committed sources of financing, nor significant
outstanding capital expenditure commitments.
Contractual Obligations
The Company has contractual obligations to make future payments, on
related party lease agreements.
The following table summarizes such obligations as of December 31,
2020:
| | |
2021 | | |
2022 | | |
2023 -
2024 | | |
After
2024 | | |
Total | |
| Leases | |
$ | 240,000 | | |
$ | 240,000 | | |
$ | 480,000 | | |
$ | 1,460,000 | | |
$ | 2,420,000 | |
| Total Contractual Obligations | |
$ | 240,000 | | |
$ | 240,000 | | |
$ | 480,000 | | |
$ | 1,460,000 | | |
$ | 2,420,000 | |
Transactions with Related Parties
The Company leases property from a related party
under a operating lease agreement that specifies minimum rentals. The lease expires in January 2031 and contains certain renewal
provisions. The Company’s rent expense was $220,000, $4,955 and $12,576 for the years ended December 31, 2020, 2019 and 2018,
respectively, and is recorded in general and administrative expenses in the accompanying combined statements of operations.
The Company had various loans with related parties
throughout 2020, 2019 and 2018. The outstanding balances of $0, $125,500, and $95,500 as of December 31, 2020, 2019 and 2018, respectively,
were due on demand and bear no interest. During the year ended December 31, 2020, to induce the holders to convert their amounts
due to equity of the Company, the Company agreed to increase the amounts due in the form of additional interest in the amount of $32,300.
The total balance converted to equity during the year ended December 31, 2020 was $157,800.
Critical Accounting Estimates
Use of Estimates
The preparation of the combined financial statements
in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the dates of the combined financial statements and the reported amounts of total net revenue and expenses during the reporting period.
The Company regularly evaluates significant estimates and assumptions related to the consolidation or non-consolidation of variable interest
entities, estimated useful lives, depreciation and amortization of property and equipment, inventory valuation, long-lived asset impairment,
fair value of financial instruments, compound financial instruments, deferred income tax asset valuation allowances, incremental borrowing
rates, lease terms applicable to lease contracts and going concern. These estimates and assumptions are based on current facts, historical
experience and various other factors that the Company believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are
not readily apparent from other sources. The actual results the Company experiences may differ materially and adversely from these estimates.
To the extent there are material differences between the estimates and actual results, the Company’s future results of operations
will be affected.
Estimated Useful Lives and Depreciation and Amortization of Property
and Equipment
Depreciation and amortization of property and
equipment is dependent upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment
of these assets is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions
and the useful lives of assets.
Impairment of Long-Lived Assets
For purposes of the impairment test, long-lived
assets such as property and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the lowest
level for which identifiable independent cash flows are available (“asset group”). The Company reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order to
determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first
to determine whether the long-lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset to
the sum of its future undiscounted cash flows using entity-specific assumptions generated through the asset’s use and eventual disposition.
If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded. If the carrying
amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step 2) is required.
The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying value of the
asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection and fair
value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies, at the
date of evaluation. The reversal of impairment losses is prohibited.
Income Taxes
Deferred tax assets and liabilities are recorded
for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in
the combined balance sheet. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to
tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more
likely than not that some or all of the deferred tax assets will not be realized.
The Company follows accounting guidance issued
by the Financial Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes.
Under this guidance, the Company assesses the likelihood of the financial statement effect of a tax position that should be recognized
when it is more likely than not that the position will be sustained upon examination by a taxing authority based on the technical merits
of the tax position, circumstances, and information available as of the reporting date.
Convertible Instruments
The Company evaluates and accounts for conversion options embedded
in its convertible instruments in accordance with ASC 815, “Accounting for Derivative Instruments and Hedging Activities”.
Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host
instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which
(a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and
the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument
is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
The Company accounts for convertible instruments
(when it has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance ASC 470,
“Accounting for Convertible Securities with Beneficial Conversion Features”, as those professional standards pertain to “Certain
Convertible Instruments”. Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value
of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at
the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed dividends
for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying
common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides
that generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be
classified as an asset or a liability.
Changes in Accounting Policies Including Adoption
In August 2018, the FASB issued ASU 2018-13,
Fair Value Measurement (Topic 820) Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which
modifies the disclosure requirements on fair value measurements. The updated guidance is effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for any removed or modified disclosures.
The adoption of this ASU during the year ended December 31, 2020 had no material impact on these financial statements.
In December 2019, the FASB issued ASU 2019-12,
“Simplifying the Accounting for Income Taxes” which eliminates certain exceptions related to the approach for intra-period
tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for
outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. ASU 2019-12 is effective
for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating
the adoption date and impact, if any, adoption will have on its combined financial position and combined results of operations.
In August 2020, the FASB issued ASU 2020-06,
“Debt — Debt With Conversion and Other Options (Subtopic 470-20)” and “Derivatives and Hedging — Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”,
which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. ASU 2020-06 is effective for the Company for fiscal years beginning after December 15,
2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2020,
and interim periods within those fiscal years. Adoption is applied on a modified or full retrospective transition approach. The Company
is currently evaluating the adoption date and impact, if any, adoption will have on its combined financial position and combined results
of operations.
Issued in February 2016, ASU No. 2016-02
established ASC Topic 842, Leases, as amended by subsequent ASUs on the topic, which sets out the principles for the recognition, measurement,
presentation and disclosure of leases for both lessees and lessors. ASU 2016-02 requires lessees to apply a two-method approach, classifying
leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase. Lessees
are required to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months. Leases with a term
of 12 months or less will be accounted for similar to existing guidance for operating leases. Lessees will recognize expense based on
the effective interest method for finance leases or on a straight-line basis for operating leases. The accounting applied by the lessor
is largely unchanged from that applied under the existing lease standard. The Company will be required to record a right-of-use asset
and lease liability equal to the present value of the remaining minimum lease payments and will continue to recognize expense on a straight-line
basis upon adoption of this standard. The Company expects to record a decrease in long-term prepaid rent, reduction in its deferred rents,
and an increase in lease liabilities and right of use assets upon adoption. The Company does not expect any impact to members’ equity
(deficit) upon transition. ASU 2016-02 is effective for reporting periods beginning after December 15, 2020 for non-public entities.
Financial Instruments and Other Instruments
Fair Value of Financial Instruments
The Company’s financial instruments consist
of cash and cash equivalents, trade payables, accrued liabilities and notes payable. All assets and liabilities for which fair value is
measured or disclosed in the financial statements are categorized within the fair value hierarchy. This is described, as follows, based
on the lowest level input that is significant to the fair value measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical
assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other
than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for
identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs
for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Other Risks and Uncertainties
Credit Risk
Credit risk is the risk of a potential loss to
the Company if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure
at December 31, 2020, 2019 and 2018 is the carrying values of cash and cash equivalents, restricted cash, accounts receivable, and
due from related party. The Company does not have significant credit risk with respect to its customers. All cash and cash equivalents
are placed with major U.S. financial institutions. The Company provides credit to its customers in the normal course of business and has
established credit evaluation and monitoring processes to mitigate credit risk but has limited risk as the majority of its sales are transacted
with cash.
Liquidity Risk
Liquidity risk is the risk that the Company will
not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management
of its capital structure. The Company’s approach to managing liquidity risk is to ensure that it will have sufficient liquidity
to settle obligations and liabilities when due. As of December 31, 2020, 2019 and 2018, cash generated from ongoing operations was
not sufficient to fund operations and growth strategy as discussed above in “Financial Condition, Liquidity and Capital Resources”.
Currency Risk
The operating results and financial position of
the Company are reported in U.S. dollars. Some of the Company’s financial transactions are denominated in currencies other than
the U.S. dollar. The results of the Company’s operations are subject to currency transaction and translation risks. The Company’s
main risk is associated with fluctuations in Canadian dollars. The Company holds cash in U.S. dollars, investments denominated in U.S.
dollars, debt denominated in U.S. dollars and equity denominated in U.S. and Canadian dollars. Such assets and liabilities denominated
in currencies other than the U.S. dollar are translated based on the Company’s foreign currency translation policy. As of December 31,
2020, 2019 and 2018, the Company had no hedging agreements in place with respect to foreign exchange rates. The Company has not entered
into any agreements or purchased any instruments to hedge possible currency risks at this time.
Interest Rate Risk
Interest rate risk is the risk that the fair value
or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear
interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a
limited interest rate fair value risk.
Price Risk
Price risk is the risk of variability in fair
value due to movements in equity or market prices. The Company’s investments are susceptible to price risk arising from uncertainties
about their future outlook, future values and the impact of market conditions. The fair value of investments held in privately-held entities
are based on a market approach, which uses prices and other relevant information generated by market transactions involving identical
or comparable assets or liabilities.