NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
Note 1 – Description of Business and Summary of
Significant Accounting Policies
Description of Business
Item 9 Labs Corp. (“Item 9 Labs”
or the “Company”), formerly Airware Labs Corp., is a Delaware corporation. The Company was incorporated under the laws
of the State of Delaware on June 15, 2010 as Crown Dynamics Corp. On October 26, 2012, the Articles of Incorporation were amended
to reflect a name change to Airware Labs Corp, and on April 2, 2018, they were amended again to reflect the name change to Item
9 Labs Corp.
On October
18, 2018 the Company effected a 1 for 20 reverse stock split of the Company’s common stock. The par value and number of authorized
shares were not adjusted as a result of the reverse stock split. The total number of shares outstanding at the time of the split
was adjusted from 1,095,332,835 to 54,766,642. All share information in these financial statements has been retroactively adjusted
to reflect the effect of the reverse split.
On March 20, 2018, the Company closed on an
Agreement and Plan of Exchange (the “Agreement”) to acquire all of the membership interests of BSSD Group, LLC (“BSSD”),
an Arizona limited liability company formed on May 2, 2017, in exchange for newly issued restricted shares of the Company’s
common stock (the “Shares”), which represented approximately 75% of the issued and outstanding shares of the Company’s
common stock on a fully-diluted basis. The 40,355,771 Shares were distributed pro-rata to the BSSD members. As part of the Agreement,
the Company agreed to increase its authorized shares of common stock to two billion.
For accounting purposes the transaction was
recorded as a reverse recapitalization, with BSSD as the accounting acquirer. Consequently, the historical pre-merger financial
statements of BSSD are now those of the Company. In its determination that BSSD was the accounting acquirer, the Company considered
pertinent facts and circumstances, including the following: (i) the BSSD owners received the largest portion of the voting rights
of the combined entity; (ii) the management team of the combined entity is primarily comprised of owners or management of BSSD;
(iii) the continuing business of the combined entity will be the business of BSSD.
Through a licensing agreement, the Company
grows medical marijuana and produces cannabis related products at their facility in Pinal County, Arizona on behalf of licensed
medical marijuana dispensaries in the state of Arizona. Certain assets of the Company, consisting of five acres of land and a cultivation
facility, were contributed by the members of BSSD in May 2017 and were recorded at the historical carrying value (original cost
less any related accumulated depreciation) of the members as of the contribution date.
On September 12, 2018, the Company executed
a $1,500,000 promissory note (see Note 8) which was used to make a capital contribution into Strive Management, LLC, a Nevada
limited liability company (“Strive Management”). In exchange for the contribution, the Company received a 20% membership
interest in Strive Management. The remaining interests are held by three individuals one of which is the Company’s former
Chief Executive Officer. Through a management agreement with Strive Wellness of Nevada, LLC, a related party (the Company’s
former CEO is a member of this LLC), Strive Management will facilitate the cultivation, processing and distribution of marijuana
in Nevada. Strive Wellness of Nevada, LLC has been allocated cultivation, processing and distribution licenses from the state
of Nevada. The Company acquired the remaining membership interests in Strive Management in February 2020 as well as the licenses
owned by Strive Wellness of Nevada, LLC. As of June 30, 2020, the licenses have not been transferred to the Company, as the transfer
is awaiting regulatory approval. See Note 2.
In March 2020, the World Health Organization categorized Coronavirus Disease 2019
(“COVID-19”) as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency.
The services we provide are currently designated an essential critical infrastructure business under the President’s COVID-19
guidance, the continued operation of which is vital for national public health, safety and national economic security. The extent
of the impact of the COVID-19 outbreak on our operational and financial performance will depend on certain developments, including
the duration and spread of the outbreak, its impact on our customers and vendors, and the range of governmental and community
reactions to the pandemic, which are uncertain and cannot be fully predicted at this time.
Principles of Consolidation
Item
9 Labs consolidates all variable interest entities (“VIEs”) in which the Company is deemed to be the primary beneficiary
and all other entities in which it has a controlling voting interest. An entity is generally a VIE if it meets any of the
following criteria: (i) the entity has insufficient equity to finance its activities without additional subordinated financial
support from other parties, (ii) the equity investors cannot make significant decisions about the entity’s operations
or (iii) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the
entity or receive the expected returns of the entity and substantially all of the entity’s activities involve or are conducted
on behalf of the investor with disproportionately few voting rights. The Company periodically makes judgments in determining whether
its investees are VIEs and, for each reporting period, the Company assesses whether it is the primary beneficiary of any of its
VIEs. As of September 30, 2019, the Company is deemed the primary beneficiary of Strive Management because the entity has insufficient
equity to finance its activities without additional subordinated support. The interests in Strive Management held by non-controlling
members has been presented on the statement of operations and statement of stockholders’ equity as non-controlling interest.
See Note 2 and Note 9.
The condensed consolidated financial statements
include the accounts of the Company, its wholly-owned subsidiaries and variable interest entities in which the Company is the primary
beneficiary. Intercompany balances and transactions have been eliminated.
The accompanying unaudited condensed consolidated
financial statements of the Company as of June 30, 2020 have been prepared by us without audit pursuant to the rules and regulations
of the Securities and Exchange Commission (“SEC”) and do not include all the
information and notes necessary for a presentation of financial position and results of operations in accordance with GAAP and
should be read in conjunction with our September 30, 2019 audited financial statements filed with the SEC on our Form 10-K on January
14, 2020. It is management’s opinion that all material adjustments (consisting of normal recurring adjustments) have been
made, which are necessary for a fair financial statement presentation. We derived the September 30, 2019 condensed balance sheet
data from audited financial statements, however, we did not include all disclosures required by GAAP. The results for the interim
period are not necessarily indicative of the results to be expected for the year ending September 30, 2020.
Accounting Estimates
The preparation of financial statements in
conformity with Accounting Principles Generally Accepted in the United States of America (“GAAP”) requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.
Actual results could materially differ from those estimates. Significant estimates of the Company include but are not limited to
accounting for depreciation and amortization, current and deferred income taxes, deferred costs, accruals and contingencies, carrying
value of goodwill and intangible assets, collectability of notes receivable, the fair value of common stock and the estimated fair
value of stock options and warrants. Due to the uncertainties in the formation of accounting estimates, and the significance of
these items, it is reasonably possible that these estimates could be materially changed in the near term.
Cash and Cash Equivalents and Restricted
Cash
Cash represents cash on hand, demand deposits
placed with banks and other financial institutions and all highly liquid instruments purchased with a remaining maturity of three
months or less as of the purchase date of such investments. The Company maintains cash on deposit, which, can exceed federally
insured limits. The Company has not experienced any losses on such accounts nor believes it is exposed to any significant credit
risk on cash. Restricted cash represents funds held by a bank pending resolution of a dispute with a former officer of the Company.
The dispute was resolved during the nine months ended June 30, 2020 and the cash is no longer restricted.
Accounts Receivable
Accounts receivable are reported at the amount
management expects to collect from outstanding balances. Differences between the amount due and the amount management expects to
collect are expensed in the results of operations in the period in which those differences are determined, with an offsetting entry
to a valuation allowance for accounts receivable.
Deferred Costs
Deferred costs consist of the costs directly
related to the production and cultivation of marijuana crops, cannabis oils, and cannabis concentrate products. Deferred costs
are relieved to cost of services as products are delivered to dispensaries.
Property and Equipment
Property and equipment are recorded at cost.
Depreciation is provided for on the straight-line method, over the estimated useful lives of the assets. Maintenance and repairs
that neither materially add to the value of the property nor appreciably prolong its life are charged to expense as incurred. Betterments
or renewals are capitalized when incurred. Gains and losses on the disposition of property and equipment are recorded in the period
incurred.
The estimated useful lives of property and
equipment are:
|
•
|
Cultivation
and manufacturing equipment 2-7 years
|
Notes and Other Receivables, net
Notes and other receivables are reported at
the amount management expects to collect from outstanding balances. Differences between the amount due and the amount management
expects to collect are reported in the results of operations in the period in which those differences are determined, with an
offsetting entry to a valuation allowance for receivables. Management assesses all receivables individually and in total, considering
historical credit losses as well as existing economic conditions to determine the likelihood of future credit losses. The Company
stops accruing interest on interest bearing receivables when the receivable is in default. There was a total valuation allowance
as of June 30, 2020 and September 30, 2019 of $376,430.
Impairment of Long-Lived Assets
We analyze long-lived assets, including property
and equipment and definite-lived intangible assets, for impairment whenever events or changes
in circumstances indicate that the carrying amounts may not be recoverable. We review the amortization method and estimated period
of useful life at least at each balance sheet date. We record the effects of any revision to operations when the change arises.
We recognize impairment when the estimated undiscounted cash flow generated by those assets is less than the carrying amount of
such assets. The amount of impairment is the excess of the carrying amount over the fair value of such assets, which is generally
calculated using discounted cash flows.
Intangible
Assets Subject to Amortization
Intangible
assets include trade name, customer relationships, website, a noncompete agreement and intellectual property obtained through
a business acquisition (see Note 2). Intangible assets acquired in a business combination are recognized at fair value using generally
accepted valuation methods deemed appropriate for the type of intangible asset acquired. Intangible assets with finite lives are
amortized over their estimated useful life and reported net of accumulated amortization, separately from goodwill. Amortization
is calculated on the straight-line basis using the following estimated useful lives:
|
•
|
Customer
relationships 2 years
|
|
•
|
Noncompete
agreement 4 months (settlement agreement)
|
|
•
|
Websites
and other intellectual property 5 years
|
Generally,
the Company utilizes the relief from royalty method to value trade name, the with or without method for valuing the customer
relationships, and the discounted cash flow method for valuing website and intellectual property.
Goodwill and Intangible Assets Not Subject
to Amortization
Goodwill represents the excess of the purchase
price paid for the acquisition of a business over the fair value of the net tangible and intangible assets acquired. Indefinite
life intangible assets represent licenses purchased for cultivation, processing and distribution of cannabis. Goodwill and indefinite
life intangibles are not subject to amortization and are tested annually for impairment, or more frequently if events or changes
in circumstances indicate that the carrying value of goodwill may not be recoverable. The goodwill included in these consolidated
condensed financial statements represents the amount of consideration paid above the amount of the individually identifiable assets
acquired. In assessing potential impairment, management first considers qualitative factors to determine if an impairment of goodwill
or indefinite life intangibles existed. Upon the determination of a likely impairment, management assesses the recorded goodwill
or indefinite life intangibles balance with the fair value of the business or assets acquired.
In addition to the annual impairment test,
we are required to regularly assess whether a triggering event has occurred which would require interim testing. We considered
the current and expected future economic and market conditions surrounding the COVID-19 pandemic and its impact on our operations.
Currently, we have determined that a triggering event has not occurred that would require an interim impairment test to be performed.
However, we refer you to our comment in the first section of this Note 1 as it relates to the impact of COVID-19 and certain economic
uncertainties.
Income Taxes
The Company accounts for income taxes under
FASB ASC 740, Income Taxes. Deferred income tax assets and liabilities are determined based upon differences between
financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Valuation allowances are established to reduce deferred tax assets to the
amount expected to be realized.
The Company files income tax returns in the
U.S. federal jurisdiction, and the State of Arizona. The Company is subject to U.S. federal, state, and local income tax examinations
by tax authorities. Generally all periods beginning on or after January 1, 2015 are open to examination by taxing authorities.
The Company believes it has no tax positions for which the ultimate deductibility is highly uncertain.
Revenue Recognition
On October 1, 2017,
the Company adopted ASC Topic 606, “Revenue from Contracts with Customers” (“ASC 606”) and all the related
amendments.
The core principle
of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount
that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASC 606 defines
a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required
within the revenue recognition process than previously required under GAAP, including identifying performance obligations in the
contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price
to each separate performance obligation.
All of the Company’s
revenue is associated with a customer contract that represents an obligation to perform services that are delivered at a single
point in time. Any costs incurred prior to the period in which the services are performed to completion are deferred and
recognized as cost of revenues in the period in which the performance obligations are completed. For the three and nine months
ended June 30, 2020 and 2019, substantially all of the Company’s revenue was generated from performance obligations completed
in the state of Arizona.
The Company recognizes
revenue as services are rendered. Services are considered complete upon successful delivery of the product to the dispensary as
the Company has no further performance obligations at this point in time and collection is reasonably assured. Under the performance
contract, the Company acts as an agent for the dispensary, does not own the marijuana products, cannot exchange the marijuana products,
prepares invoices for the dispensary and all employees that are in contact with marijuana products are dispensary agents of the
dispensary with which we have our contract. Given these facts and circumstances, it is the Company’s policy to record the
revenue related to the contract net of the amount retained by the dispensary. Per the dispensary contract, the Company was paid
85% of the wholesale market price of the marijuana products for the services rendered for the three and nine months ended June
30, 2019. The contract was amended in December 2019 and beginning in January 2020, the Company was paid 100% of the wholesale market
price of the marijuana for the services rendered. The contract called for monthly payments in the amount of $80,000 for the three
months ending March 31, 2020. Beginning April 1, 2020, the Company entered into a three year agreement with another dispensary,
which calls for monthly payments of $40,000. Prior to January 1, 2020, the Company recorded these revenues at the amount it expected
to collect, 85% of the total wholesale sales. Since January 1, 2020, the Company records revenue at the amount it expects to collect,
100% of the wholesale sales. The fees paid for operating under the contract are expensed to cost of revenues.
The Company’s
revenues accounted for under ASC 606 do not require significant estimates or judgments based on the nature of the Company’s
revenue stream. The sales price is generally fixed at the point of sale and all consideration from the contract is included in
the transaction price. The Company’s contracts do not include multiple performance obligations or variable consideration.
Fair Value of Financial Instruments
The carrying value of the Company’s financial
instruments, consisting of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair
value due to their short term to maturity (level 3 inputs). The Company’s receivable resulting from the sale of Airware,
notes receivable and notes payable approximate fair value based on borrowing rates currently available on notes with similar terms
and maturities (level 3 inputs).
ASC Topic 820, Fair Value Measurements, defines
fair value as the price that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Topic 820 also specifies a fair value hierarchy that requires an entity to
maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes
three levels of inputs that may be used to measure fair value as follows:
Level 1: Quoted prices in active markets for
identical assets or liabilities;
Level 2: Observable inputs other than Level
1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs
that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities;
and
Level 3: Valuation is generated from model-based
techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimate
of assumptions that market participants would use in pricing the asset or liability.
Net Loss Per Share
Basic loss per share does not include dilution
and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an
entity. Dilutive securities are not included in the weighted average number of shares when inclusion would be anti-dilutive. At
June 30, 2020 and September 30, 2019 there were 17,082,991 and 656,112 shares underlying convertible notes payable, warrants and
options, that were anti-dilutive, respectively.
Stock-Based Compensation
The Company accounts for its stock-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 stock-based payment awards made to employees and
directors. For stock options, the Company estimates the fair value using a closed option valuation (Black-Scholes) model. The estimated
fair value is then expensed over the requisite service period of the award which is generally the vesting period and the related
amount is recognized in the consolidated condensed statements of operations. The Company recognizes forfeitures at the time they
occur.
The Black-Scholes option-pricing model requires
the input of certain assumptions that require the Company’s judgment, including the expected term and the expected stock
price volatility of the underlying stock. The assumptions used in calculating the fair value of stock-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, stock-based compensation expense could be materially different
in the future.
Warrants and Debt Discounts
The Company bifurcates the value of warrants
issued with debt. This bifurcation results in the establishment of a debt discount, based on the relative fair values of the warrants
and the debt, with a corresponding charge to equity unless the terms of the warrant require it to be classified as a liability.
The warrants and corresponding note discounts are valued using the Black-Scholes valuation model. This model uses estimates of
volatility, risk free interest rate and the expected term of the warrants, along with the current market price of the Company’s
stock, to estimate the value of the outstanding warrants. The Company estimates the expected term using an average of the contractual
term and vesting period of the award. The expected volatility is measured using the average historical daily changes in the market
price of the Company’s common stock over the expected term of the award and the risk-free interest rate is equivalent to
the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards.
The following assumptions were used to estimate
the warrants issued during the quarter ended June 30, 2020:
Expected stock price volatility
|
|
186.00%
|
|
|
|
Expected dividend yield
|
|
0.00%
|
|
|
|
Risk-free interest rate
|
|
2.97%
|
|
|
|
Option life
|
|
2.5 years
|
Recently Issued Accounting Pronouncements
Adopted
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842). The update improves financial reporting about leasing transactions by requiring a lessee to record on the balance
sheet the assets and liabilities for the rights and obligations created by lease terms of more than 12 months. We adopted ASU 2016-02
effective October 1, 2019.The most significant change was related to the recognition of a right-of-use asset and lease liability
on our consolidated condensed balance sheet for our real estate operating lease. The impact on our results of operations and cash
flows is not material. See Note 10.
In January 2017, the FASB issued ASU 2017-01,
Business Combination (Topic 805). The update clarifies the definition of a business to assist entities with evaluating whether
transactions should be accounted for as acquisitions of assets of businesses. The Company adopted ASU 2017-01 on January 1, 2020
which impacted how the acquisition from February 2020 (Note 2) has been reported.
In July 2017, the FASB issued ASU 2017-11,
Earnings Per Share (Topic 260). The update changes the classification analysis of certain equity-linked financial instruments (or
embedded features) which contain down round features. The Company adopted ASU 2017-11 on January 1, 2020 which impacted how warrants
relating to debt was recorded.
Pending Adoption
In June 2016, the FASB issued ASU 2016-13,
Financial Instruments – Credit Losses (Topic 326), which provides guidance on measuring credit losses on financial instruments.
The amended guidance replaces current incurred loss impairment methodology of recognizing credit losses when a loss is probable
with a methodology that reflects expected credit losses and requires a broader range of reasonable and supportable information
to assess credit loss estimates. ASU 2016-13 is effective for us on October 1, 2023, with early adoption permitted on October 1,
2019. We are assessing the provisions of this amended guidance; however, the adoption of the standard is not expected to have a
material effect on our consolidated condensed financial statements.
There have been no other recent accounting pronouncements or changes
in accounting pronouncements that have been issued but not yet adopted that are of significance, or potential significance, to
us.
Note 2 –Business Combination/Acquisitions
On November
26, 2018, the Company’s wholly owned subsidiary AZ DP Holdings, LLC (“AZDP”) performed an acquisition of the
majority of the assets of Arizona DP Consulting, LLC (“AZDPC”), a consulting firm specializing in obtaining marijuana
dispensary permits and developing cannabis related business plans. The purchase price was $9,270,000, $1,500,000 in cash and 3,000,000
shares of restricted common stock having an aggregate value of $7,770,000 or $2.59 per share based on the market price of the
Company’s shares at the time the asset purchase agreement was executed. There were no significant costs relating to the
acquisition. Pursuant to the agreement, Sara Gullickson transitioned from President to CEO under a 3 year employment agreement
and became a member of the board of directors of the Company. Additionally, AZDP agreed to hire the employees of AZDPC and lease
its existing office space which required $3,200 of monthly rent through May 2019, which was subsequently extended through August
2019. The primary reason for the acquisition was to utilize the assets held by AZDPC to assist in the expansion of the Company.
In accordance
with ASC 805, Business Combinations, the Company accounted for the acquisition of AZDPC using the acquisition method of
accounting. The purchase price was allocated to specific identifiable intangible assets at their respective fair values at the
date of acquisition. There were no tangible assets or liabilities acquired.
Identifiable
intangible assets and goodwill consist of the following as of June 30, 2020:
|
|
Balance at
October 1, 2019
|
|
Additions
|
|
Amortization
|
|
Balance at
June 30, 2020
|
Trade
names
|
|
$
|
161,848
|
|
|
$
|
144,120
|
|
|
$
|
(12,930
|
)
|
|
$
|
293,038
|
|
Customer
relationships
|
|
|
181,250
|
|
|
|
—
|
|
|
|
(130,500
|
)
|
|
|
50,750
|
|
Licenses
|
|
|
—
|
|
|
|
6,744,679
|
|
|
|
—
|
|
|
|
6,744,679
|
|
Websites
and other intellectual property
|
|
|
1,144,277
|
|
|
|
—
|
|
|
|
(213,810
|
)
|
|
|
930,467
|
|
Non-compete
agreement
|
|
|
352,500
|
|
|
|
—
|
|
|
|
(352,500
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other intangible assets
|
|
|
1,839,875
|
|
|
|
6,888,799
|
|
|
|
(709,740
|
)
|
|
|
8,018,934
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
1,116,396
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,116,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,956,271
|
|
|
$
|
6,888,799
|
|
|
$
|
(709,740
|
)
|
|
$
|
9,135,330
|
|
On November 15, 2019, Ms. Sara Gullickson voluntarily
resigned as Chief Executive Officer and member of the Board of Directors of Item 9 Labs Corp. The resignation was not the result
of any disagreement with the Company on any matter relating to the Company’s operations, policies, or practices. Ms. Gullickson
and the Company have mutually agreed to amend the terms of the employment agreement and non-competition agreement between Ms. Gullickson
and the Company dated November 26, 2018 pursuant to which (i) the non-competition period shall be reduced from three (3) years
to four (4) months; (ii) Ms. Gullickson shall receive her full salary and health benefits for four (4) months from the resignation
date (a significantly reduced period of time); and (iii) Ms. Gullickson shall cancel and return to treasury an aggregate amount
2,300,000 restricted shares of Company Common Stock which were acquired by Gullickson pursuant to that certain Asset Purchase Agreement
dated November 26, 2018 by and between Arizona DP Consulting LLC, an Arizona limited liability company, as seller, and Gullickson
as the sole member of the seller on the one hand, and the Company and AZ DP Holdings, LLC, a Nevada limited liability company as
buyer, on the other hand. The returning of the stock was accounted for as a capital contribution and treasury stock transaction.
As such, there was no impact on total equity.
In exchange for the aforementioned terms,
the Company and Gullickson agreed to a release of claims against each other, among other things. The agreement contains representations
and warranties customary for agreements of this type.
In February 2020, the Company executed an agreement
with the other members of Strive Management, LLC to purchase the remaining 80% of Strive Management, LLC (“Strive”),
as well as the Nevada licenses its members held in another entity. The Company agreed to pay $500,000 in cash, $1,000,000 in an
unsecured note payable, 3,250,000 shares of the Company’s restricted common stock and issue 2,000,000 warrants exercisable
into the Company’s common stock. The warrants are to be issued upon the earlier of September 30, 2020 or three months following
the date on which each provisional certificate becomes a final certificate, which has not yet occurred. The warrants have a three
year term, exercise price of $1.13 and include down round provisions. In order to close the transaction, the Company borrowed $500,000
from Stockbridge Enterprises, a related party. The Company was to repay the loan by April 15, 2020. Subsequent to June 30, 2020,
this loan has not been repaid and is in default. Though the Company acquired the remaining portion of Strive, Strive was not considered
a business under ASC 805, Business Combinations, as it did not have a substantive process. As such, the Company is reporting the
transaction as an asset acquisition. As of June 30, 2020 $6,744,679 has been recorded to licenses relating to the transaction.
Note 3 - Property and Equipment, Net
The following represents a summary of our
property and equipment as of June 30, 2020 and September 30, 2019:
|
|
June
30,
|
|
September
30,
|
|
|
2020
|
|
2019
|
Cultivation
and manufacturing equipment
|
|
$
|
169,540
|
|
|
$
|
154,059
|
|
Construction in progress
|
|
|
4,124,740
|
|
|
|
4,060,297
|
|
Land
and building
|
|
|
3,095,646
|
|
|
|
3,093,549
|
|
|
|
|
7,389,926
|
|
|
|
7,307,905
|
|
Accumulated
Depreciation
|
|
|
(233,334
|
)
|
|
|
(137,483
|
)
|
|
|
$
|
7,156,592
|
|
|
$
|
7,170,422
|
|
Depreciation expense for the nine months ended
June 30, 2020 and 2019 was $96,330 and $39,122, respectively.
Note 4 – Sale of Airware Assets and
Investment in Health Defense LLC
On May 3, 2018, the Company entered into an
intellectual property sales agreement with Health Defense LLC. Pursuant to the terms of the agreement, the Company sold all of
the assets related to the former business of the Company, nasal dilator sales.
In consideration for entering into the agreement,
the Company was to receive: (i) $300,000 in cash at execution, (ii) $700,000 in cash within one year of execution and (iii) an
additional $300,000 by December 31, 2019.
As additional consideration, the Company was
given a 10% ownership interest in Health Defense LLC. This ownership is valued at $100,000 and is reflected on the consolidated
condensed balance sheets as Investment in Health Defense at June 30, 2020 and September 30, 2019.
As of June 30, 2020, management determined
that the receivable described above should be classified as long-term on the consolidated condensed balance sheets as the payments
have not been made as scheduled. Additionally, management has recorded an allowance on the receivable of $307,430 at June 30, 2020
and September 30, 2019.
Note 5 – Notes Receivable
On May 11, 2018, the Company entered into a
Promissory Note Agreement with a borrower in the principal amount of $150,000. This was a one year note with 20% non-compounded
annual interest payable at maturity. It is convertible at the discretion of the Company into a unit offering of the borrower at
a 15% discount. The note is personally guaranteed by the borrower. This note is in default and is on non-accrual status. The Company
is currently negotiating an amendment to the note.
On May 15, 2018, the Company entered into a
Promissory Note Agreement with a borrower in the principal amount of $60,000. This is a one year note with 15% non-compounded annual
interest payable at maturity. It is convertible at the discretion of the Company into an interest in a strategic partnership of
ownership and operations of a certain dispensary license. The note is personally guaranteed by the borrower. This note is in default
and is on non-accrual status. At June 30, 2020 and September 30, 2019, the principal and interest has been fully reserved in the
amount of $69,000.
At June 30, 2020 and September 30, 2019, the
Company has accrued $39,000 of interest receivable related to these notes which is included in notes and interest receivables on
the accompanying consolidated condensed balance sheets.
Note 6 – Short Term Notes Payable
Aeneas Venture Partners 3, LLC Note
On August 28, 2019, Item 9 Properties,
LLC, a Nevada limited liability company, and BSSD Group, LLC, an Arizona limited liability company, each wholly owned subsidiaries
of Item 9 Labs Corp. collectively, entered into a Loan Agreement of up to $2.5 million (the “Loan Agreement”) with Aeneas
Venture Partners 3, LLC, an Arizona limited liability company (the “Lender”).
Pursuant to the Loan Agreement, the Company
may make multiple borrowings under the Loan Agreement in the total aggregate principal amount of up to $2.5 million (the “Loan”)
for the purpose of completing development and construction on certain real property located in Pahrump, Nevada owned by the Company.
The Loan is a multiple advance credit facility. The Company drew $2,000,000 on August 28, 2019 and an additional $200,000 on November
26, 2019. Interest in the amount of 15% of the total amount borrowed (based on total draws) under the Loan will be paid in addition
to principal at the maturity date. The Loan has a term of sixty days from funding of the Loan and may be extended for additional
sixty days subject to the satisfaction of certain conditions including ten days’ notice and an extension loan fee of 15%
of the aggregate total of advances under the Loan. The Loan is secured by a first priority interest in the Company’s real
property located in Coolidge, Arizona, including improvements and personal property thereon (the “Property”) and includes
an unconditional guarantee by Item 9 Labs Corp. The 5-acre property has 20,000 square feet of buildings, housing the cultivation
and processing operations. On March 23, 2020, the Company paid $2,000,000 on the note and reached a settlement to bring the note
current. The settlement calls for monthly interest payments
of $22,000 and the principal balance of the note is due within one year. There is a prepayment penalty equal to all interest payments
due through October 1, 2020 if the note is paid in full prior to that date.
Stockbridge/Viridis
Note
In
connection with the $2,000,000 payment on the note described above, on March 23, 2020 the Company borrowed debt proceeds from
two related parties, Stockbridge Enterprises and Viridis I9 Capital LLC. The $2,200,000 borrowing is unsecured, has a term of
six months, and accrues interest at a rate of 10% per year. All principal and interest are due on the maturity date. The debt
includes a provision for the issuance of 10,000,000 warrants exercisable into the Company’s common stock. The exercise price
on the warrants is $.75 and the warrants have a term of 5 years. The debt and warrants were recorded at their relative fair values.
The resulting discount is being amortized to interest expense over the term of the debt. The balance of the debt, discount, amortized
discount and accrued interest are as follows at June 30, 2020.
Principal
balance
|
$ 2,200,000
|
Discount
|
796,572
|
Amortization
|
928,716
|
Accrued
interest
|
59,671
|
Stockbridge
Note
The
Company entered into an additional note with Stockbridge Enterprises, a related party in February 2020. The $500,000 borrowing
had a term of 60 days and bears interest at 6% per year. All principal and interest are due on the maturity date. The note includes
a provision for the issuance of 500,000 warrants exercisable into the Company’s common stock. The warrants have an exercise
price of $.75 and a term of 5 years. The note contains provisions to reduce the exercise price each month if the note is in default.
The note went into default in April 2020. The warrant value was determined using a $.05 exercise price as it is management’s
estimate that the note will be repaid after July 1, 2020, the date the exercise price on the warrants reduces to $.05. The resulting
discount will be amortized to interest expense over the term of the note. The balance of the note, discount, amortized discount
and accrued interest is as follows at June 30, 2020.
Principal
balance
|
$ 400,000
|
Discount
|
—
|
Amortization
|
257,094
|
Accrued
interest
|
14,466
|
In
June 2020, the Company executed on a short-term financing arrangement. The proceeds of $873,000 are being utilized to further
expand the production capabilities of the Arizona Operations. 30 payments of $40,500 are due weekly and the arrangement matures
in January 2021.
Note 7 – Unsecured Convertible Notes
Payable
In the reverse recapitalization disclosed in
Note 1, the Company assumed one unsecured convertible note payable with principal balance totaling $20,000 which was due in August
2012, carries an interest rate of 8% and is convertible including accrued interest to common stock at $.50 per share, which would
be approximately 63,000 shares as of June 30, 2020 and September 30, 2019. As of June 30, 2020 and September 30, 2019, this unsecured
convertible note payable is considered in default and has been presented as a current liability on the consolidated condensed balance
sheets.
In June 2020, the Company issued an unsecured
convertible note payable with a principal balance totaling $50,000, which will be due in March 2021. Interest payments of $1,000
(24% per annum) are due monthly. The note entitles the holder to convert any portion of the debt into shares of common stock of
the Company at any time during the note term at $1.00 per share which would be approximately 50,000 shares as of June 30, 2020.
There is no prepayment penalty.
Note 8 – Long Term Debt
On September 13, 2018, the Company entered
into a Loan and Revenue Participation Agreement with Viridis Group I9 Capital LLC (“Viridis”) in which Viridis has
agreed to loan the Company up to $2.7 million for the expansion of the Company’s Arizona and Nevada properties (see Note
12). As of September 30, 2018, the Company received $1,500,000 of proceeds from Viridis in the form of a promissory note. The $1,500,000
proceeds were utilized to acquire a 20% ownership in Strive Management, LLC as described in Notes 1 and 9, and is collateralized
with a Deed of Trust on the Company’s approximately 5 acre property and construction in progress. In exchange for the loan,
Viridis was to be repaid in the form of waterfall revenue participation schedules. Viridis was to receive 5% of the Company’s
gross revenues from the Nevada operations until the loan is repaid, 2% until repaid 200% of the amount loaned, and 1% of gross
revenues in perpetuity or until a change in control. Payments on the loan will commence 90 days after the Nevada operation begins
earning revenue. Parties acknowledge that the Company was expected to own only 51% of the Nevada operations and therefore Viridis’
revenue participation is limited to the Company’s interest. On February 14, 2020, the Company acquired the remaining 80%
membership interest in Strive Management, LLC. Therefore, the revenue participation payments will be based on 100% of the revenues
of the Company’s Nevada operations. The operations in Nevada have not yet begun as of the date of this filing. On August
26, 2019, the loan was amended to include 6% annualized interest in exchange for Viridis subordinating its debt to another lender.
On May 1, 2020, under a troubled debt restructuring,
the Company renegotiated the $1,500,000 note payable. As part of the restructuring, the Company issued 1,944,444 warrants exercisable
into the Company’s common stock. The exercise price on the warrants is $1.00 and they have a term of 5 years. Accrued interest
in the amount of $64,849 was added to the principal balance of the note, making the total principal $1,564,849. Interest only
payments of $13,040 shall be paid monthly until 3 months following the commencement date of the Nevada Operations at which time
monthly principal and interest payments of $33,962 will be required for 36 months, with a balloon payment of $761,007 due upon
the note’s maturity. The note also entitles Viridis to a gross revenue participation of the Nevada Operations equal to 1%
of the gross sales (up to $20,000 monthly) upon the maturity of the note and for the subsequent 5 year period. The debt and warrants
were recorded at their relative fair values. The resulting discount will be amortized to interest expense over the term of the
debt. The balance of the debt, discount, amortized discount and accrued interest is as follows at June 30, 2020.
Principal balance
|
$ 1,564,849
|
Discount
|
696,408
|
Amortization
|
34,820
|
Accrued interest
|
37,276
|
The additional $1,200,000 of proceeds drawn
during the year ended September 30, 2019 were utilized to construct an additional 10,000 square foot cultivation and processing
facility in Arizona that became operational in June 2019. The loan was originally collateralized with a Deed of Trust on the Company’s
5 acre parcel in Coolidge, AZ and its two 10,000 square foot buildings. In August 2019, Viridis agreed to subordinate its first
priority Deed of Trust and move into a 2nd position. The proceeds were received as construction draws between November
2018 and January 2019. In exchange for the loan, Viridis will be repaid in the form of waterfall revenue participation schedules.
Viridis shall receive 5% of the Company’s gross revenues from the Arizona operations until the loan is repaid, 2% until repaid
200% of the amount loaned, and 1% of gross revenues in perpetuity or until a change in control. Payments on the loan will commence
90 days after the Arizona operation begins earning revenue. Interest on the notes accrue monthly at a 2.9% annual rate. On August
26, 2019, the loan was amended to include 6% annualized interest in exchange for Viridis subordinating its debt to another lender.
Interest of $317,816 has been accrued as of March 31, 2020.
On May 1, 2020, under a troubled debt restructuring,
the Company renegotiated the $1,200,000 note payable. As part of the restructuring, the Company issued 1,555,556 warrants exercisable
into the Company’s common stock. The exercise price on the warrants is $1.00 and they have a term of 5 years. Accrued interest
in the amount of $186,370 was added to the principal balance of the note, making the total principal $1,386,370. Interest only
payments of $11,553 shall be paid monthly until November 1, 2020 at which time monthly principal and interest payments of $28,144
will be required for 36 months, with a balloon payment of $678,596 due upon the note’s maturity. The note also entitles
Viridis to a gross revenue participation of the Arizona Operations equal to 1% of the gross sales (up to $20,000 monthly) upon
the maturity of the note and for the subsequent 5 year period. The debt and warrants were recorded at their relative fair values.
The resulting discount will be amortized to interest expense over the term of the debt. The balance of the debt, discount, amortized
discount and accrued interest is as follows at June 30, 2020.
Principal balance
|
$ 1,386,370
|
Discount
|
583,581
|
Amortization
|
29,179
|
Accrued interest
|
36,588
|
The Company’s subsidiary, BSSD Group,
LLC borrowed $269,000 from Viridis Group in December 2019. This note bore annualized interest at 15%. On May 1, 2020, under a
troubled debt restructuring, the Company renegotiated the $269,000 note payable. As part of the restructuring, the Company issued
400,000 warrants exercisable into the Company’s common stock. The warrants have an exercise price of $.75 and a term of
5 years. The agreement contains provisions to reduce the exercise price each month the note is not paid in full. The warrant value
was determined using a $.05 exercise price as it is management’s estimate that the note will be repaid after September 30,
2020, the date the exercise price on the warrants reduces to $.05. The resulting discount is being amortized to interest expense
over the term of the note. Accrued interest in the amount of $14,666 was added to the principal balance of the note, making the
total principal $283,666. Payments of principal and interest in the amount of $9,833 are due monthly until the note’s maturity
on May 1, 2023. The debt and warrants were recorded at their relative fair values. The resulting discount will be amortized to
interest expense over the term of the debt. The balance of the debt, discount, amortized discount and accrued interest is as follows
at June 30, 2020.
Principal balance
|
$ 283,666
|
Discount
|
142,812
|
Amortization
|
8,401
|
Accrued interest
|
7,013
|
Strive Note
In connection with the license acquisition
described in Note 2, the Company entered into a note payable with the sellers in February 2020. The $1,000,000 note has a term
of two years starting September 30, 2020 and bears interest at 2% per year. A principal payment in the amount of $500,000 is due
on the earlier of October 10, 2020 or three months following the date on which each provisional certificate becomes a final certificate.
Due to the low stated interest rate on the note, management imputed additional interest on the note. The balance of the note,
discount, amortized discount and accrued interest is as follows at June 30, 2020:
Principal balance
|
$ 1,000,000
|
Discount
|
124,053
|
Amortization
|
27,508
|
Accrued interest
|
—
|
Note 9 – Variable Interest Entity
As of September 30, 2019, the Company determined
that it held a variable interest in Strive Management due to the Company being its sole source of capital. Further, the Company
had agreed to raise $4,000,000 on Strive Management’s behalf through promissory note agreements that the Company will guarantee.
No funds have been raised as of the date of these consolidated condensed financial statements. If the funds are not raised, the
additional 31% interest due to the Company upon operational approval from the State of Nevada as discussed in Note 1 would have
been subject to reclamation by the other members of Strive Management. The Company has been determined to be the primary beneficiary
of Strive Management as the Company has the power to direct the activities that significantly impact Strive Management’s
economic performance and the obligation to absorb losses. Strive Management’s financial statements as of June 30, 2020 and
for the nine months ending June 30, 2020 and 2019 have been consolidated with the Company.
As discussed in Note 2, the Company completed
the purchase of the remaining ownership interests of Strive Management LLC in February 2020.
Note 10 – Leases
The Company leases its corporate office from
an entity controlled by the CEO of the Company, under an operating lease. The lease is for a term of 5 years beginning September
1, 2019. The following is a schedule by fiscal year of future minimum payments required under the lease together with their present
value as of June 30, 2020:
|
|
Future Minimum
|
|
|
Payments
|
|
2020
|
|
|
$
|
41,267
|
|
|
2021
|
|
|
|
80,013
|
|
|
2022
|
|
|
|
82,114
|
|
|
2023
|
|
|
|
84,215
|
|
|
2024
|
|
|
|
78,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
366,572
|
|
|
|
|
|
|
|
|
|
less imputed interest
|
|
|
|
(140,756
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
225,816
|
|
As of the inception of the lease, the lease
liability and right of use asset was recorded at $268,359, the amount of the present value of all lease payments. To calculate
the lease liability and right of use asset, the Company used a 20% discount rate, the approximate interest rate the Company believes
it could borrow at.
Amortization in the amount of $60,557 has been
recorded against the right of use asset, leaving a balance of $207,802 as of June 30, 2020. Payments in the amount of $42,543 have
been recorded against the lease liability, leaving a balance of $225,816 as of June 30, 2020.
Note 11 - Concentrations
For the
three and nine months ended June 30, 2020 and 2019, substantially all of the Company’s revenue were generated from a single
customer.
Note 12 - Commitments and Contingencies
The production and possession of marijuana
is prohibited by the United States of America, though the state of Arizona allows these activities to be performed at licensed
facilities such as BSSD. If the federal government decides to enforce the Controlled Substances Act, it could have a material adverse
effect on our business. However, the Company does not currently believe the federal prohibition of these activities will negatively
impact the business. As such, the Company has not elected to record a related accrual contingency.
On April 20, 2018, the Company entered into
an agreement for the purchase of approximately 44 acres of land from an affiliate of a founding member of BSSD. The purchase price
of the property is $3,000,000, payable as follows; (i) $200,000 deposited with escrow agent as an initial earnest money deposit,
(ii) on or before February 1, 2019, the Company will deposit an additional $800,000 into escrow as additional earnest money deposit
and (iii) the balance of the purchase price shall be paid via a promissory note. The earnest money amounts are non-refundable.
The Company has negotiated an amendment to this agreement that will spread the $800,000 payment over the course of 4 months. As
of the date of these financial statements, $600,000 has been deposited in escrow which has been classified as a long-term asset
on the consolidated condensed balance sheet as of June 30, 2020 and September 30, 2019.
On June 26, 2018, the Company entered into
a contractor agreement with Chase Herschman pursuant to which he will provide services in exchange for $120,000 annually, payable
each month; up to $420,000 in common stock options which shall vest upon the occurrence of certain benchmarks as described in the
contractor agreement and a commission of 1% of the gross profits of the Nevada Operations of the Company. The term of the agreement
is a period of three years. This agreement was terminated in May 2020. The Company had an outstanding balance owed on the contract
totaling $45,000 as of June 30, 2020.
On September 13, 2018, the Company entered
into a Loan and Revenue Participation Agreement with Viridis Group I9 Capital LLC (“Viridis”). Viridis agreed to make
secured loans of up to $2.7 million to the Company which is represented by two separate notes, one for the construction and enhancement
of the Company’s Arizona property and one for the Company’s proposed ventures in Nevada. In exchange for the loans,
Viridis will be repaid in the form of waterfall revenue participation schedules. Viridis shall receive 5% of the Company’s
gross revenues from each of the Company’s Arizona and Nevada operations, respectively, until the loan is repaid, 2% until
repaid 200% of the amount loaned, and 1% of gross revenues in perpetuity or until a change in control.
Under the terms of the Loan and Revenue Participation
Agreement, upon a change in control of the Company, Viridis will be entitled to receive 200% of the principal amount of the loans
to the Company computed after considering previous revenue participation payments through the date of change of control and 1%
of the aggregate sales price or consideration received in the change in control transaction.
As of June 30, 2020, the Company received the
$1,500,000 and invested the funds in Strive Management (see Notes 2, 8 and 9). The remaining $1,200,000 has been provided by Viridis
directly to contractors of the Arizona property from an account owned and controlled by Viridis. The notes were amended on May
1, 2020, altering the revenue participation. See Note 8 for updated terms.
On July
1, 2019, the Company entered into a three year agreement with a concert venue to be the name sponsor for the venue. In exchange,
the Company issued 45,457 shares of restricted common stock valued at $200,000 ($4.40/share) and is to pay $5,000 monthly for the
first 12 months and $60,000 in July 2020 and 2021. Due to COVID-19, the concert venue has not been open since March 2020. In June
2020, the Company and the venue cancelled the agreement with an effective date of March 11, 2020.
The Company
entered into a 60 month lease with VGI Citadel LLC to rent office space for its corporate headquarters which began on September
1, 2019. The lease payments total $6,478 monthly for the first twelve months, include all utilities and an estimated amount for
common area maintenance and real estate taxes. The monthly lease rate increases to $6,653, $6,828, $7,003, and $7,178 for years
two through five, respectively.
Note 13– Related Party Transactions
As discussed
in Note 1, on March 20, 2018, the Company issued 40,355,771 shares of common stock to the members of BSSD for their membership
interests.
As discussed
in Note 12, the Company has entered into an agreement as of April 20, 2018 for the purchase of land. The land owner is one of the
original members of BSSD and a current employee of the Company.
As discussed
in Note 14, on May 8, 2018, the Company issued 22,500 options for the purchase of common stock to three board members.
As discussed
in Notes 8 and 12, the Company has entered into Loan and Revenue Participation Agreement and Promissory Notes with Viridis. The
two members of Viridis were elected to the Company’s board of directors in December 2018 and January 2020 and one is currently
the Company’s CEO.
As discussed
in Note 8, BSSD Group, LLC, a wholly owned subsidiary of the Company entered into a loan agreement with Viridis.
As discussed
in Note 2, the Company issued 3,000,000 of restricted common stock as part of the asset purchase agreement dated November 26, 2018.
As part of November 15, 2019 settlement agreement, Gullickson returned 2,300,000 share of stock to the Company.
During
the three months ended December 31, 2018, the Company issued 3,000,000 shares of restricted common stock to Viridis I9 Capital
LLC, an LLC in which, Andrew Bowden, director and CEO of the Company is a member. The sales price was $1.00 per share with net
proceeds of $3,000,000.
The Company
has a construction management agreement with the Viridis Group to oversee the Nevada construction project totaling $20,000 monthly.
The Company owes Viridis $60,000 for these services as of June 30, 2020 and September 30, 2019.
As discussed
in Note 6, the Company has notes payable to Viridis I9 Capital LLC and Stockbridge Enterprises in the amount of $2,200,000.
As discussed
in Note 6, the Company has a note payable to Stockbridge Enterprises in the amount of $400,000.
As discussed
in Note 12, the Company has a lease agreement with VGI Capital LLC. A member of VGI Capital was elected to the Company’s
board of directors on December 21, 2018 and is currently the Company’s CEO.
Included
in our accounts payable at June 30, 2020 and September 30, 2019 is approximately $90,000 and $160,000, respectively in amounts
due to related parties.
Note 14 - Stockholders’ Equity
Common Stock
During the nine months ended June 30, 2019,
the Company raised $5,400,003 via private placements. The selling price for 5,000,000 shares was $1 per share and the selling price
for 266,669 was $1.50 per share for a total of 5,266,669 shares of common stock issued.
As discussed
in Note 2, during the nine months ended June 30, 2019, the Company issued 3,000,000 shares of restricted common stock, valued at
$7,770,000 as consideration for the acquisition of the majority of the assets in AZ DP Consulting, LLC.
In the
nine months ended June 30, 2019, in the normal course of business, the Company issued 135,000 shares of restricted common stock,
valued at $456,700 as consideration for various consulting contracts.
In the
nine months ended June 30, 2019, the Company issued 9,615 shares of restricted common stock to employees, valued at $25,000.
In the
nine months ended June 30, 2020, in the normal course of business, the Company issued 55,618 shares of restricted common stock,
valued at $132,106 as consideration for various contracts, including venue sponsorships, marketing, and investor relations.
As discussed
in Note 2, during the nine months ended June 30, 2020, the Company agreed to issue 3,250,000 shares of restricted common stock,
valued at $3,507,000 as part of an asset acquisition. The stock has been reserved, though certain criteria must be met for the
issuance to occur.
In the
nine months ended June 30, 2020, the Company issued 26,282 shares of restricted common stock to employees, valued at $75,000.
Warrants
As of June 30, 2020, there are 16,675,000 warrants
for purchase of the Company’s common stock outstanding. 14,400,000 warrants were issued during the nine months ended June
30, 2020. Warrants outstanding as of June 30, 2020 are as follows:
|
|
Common Shares Issuable Upon
Exercise of Warrants
|
|
Exercise Price of Warrants
|
|
Date Issued
|
|
Expiration Date
|
|
|
|
|
|
|
|
|
|
Warrants issued by predecessor
|
|
|
175,000
|
|
|
$
|
2.00
|
|
|
3/31/2015
|
|
|
8/31/2020
|
|
Warrants issued by predecessor
|
|
|
100,000
|
|
|
$
|
1.00
|
|
|
7/28/2016
|
|
|
7/28/2021
|
|
Warrants issued related to asset acquisition
|
|
|
2,000,000
|
|
|
$
|
1.13
|
|
|
9/30/2020
|
*
|
|
9/30/2023
|
|
Warrants issued related to debt financing
|
|
|
500,000
|
|
|
$
|
0.05
|
|
|
2/14/2020
|
|
|
2/14/2025
|
|
Warrants issued related to debt financing
|
|
|
5,000,000
|
|
|
$
|
0.75
|
|
|
3/23/2020
|
|
|
3/23/2025
|
|
Warrants issued related to debt financing
|
|
|
5,000,000
|
|
|
$
|
0.75
|
|
|
3/23/2020
|
|
|
3/23/2025
|
|
Warrants issued related to debt financing
|
|
|
400,000
|
|
|
$
|
0.05
|
|
|
5/1/2020
|
|
|
4/30/2025
|
|
Warrants issued related to debt financing
|
|
|
1,944,444
|
|
|
$
|
1.00
|
|
|
5/1/2020
|
|
|
4/30/2025
|
|
Warrants issued related to debt financing
|
|
|
1,555,556
|
|
|
$
|
1.00
|
|
|
5/1/2020
|
|
|
4/30/2025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance of Warrants at June 30, 2020
|
|
|
16,675,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
|
|
|
14,675,000
|
|
|
|
|
|
|
|
|
|
|
|
* - date is in the future as the Company
is obligated to issue the warrants on September 30, 2020. These warrants are reflected in the warrants to be issued in the Unaudited
Consolidated Condensed Statements of Stockholders’ Equity.
Stock Options
On May 8, 2018, the Company granted 22,500
stock options to board members. The options are exercisable at $2.40 per share with a ten year term. The options will vest equally
over three years unless there is a change of control of the Company at which time any unvested options vest immediately. As of
June 30, 2020 and September 30, 2019, there are 294,991 stock options outstanding.
The Company determines the fair value of stock
options issued on the date of grant using the Black-Scholes option-pricing model.
There was no options activity during the nine
months ended June 30, 2020 and 2019.
Note 15 – Merger
On February 27, 2020, Item 9 Labs Corp.,
a Delaware corporation (“Company”), and an unnamed wholly owned subsidiary (“Merger Sub”), entered into
an Agreement and Plan of Merger (the “Agreement”) with OCG Inc., a Colorado corporation (“Target”),
pursuant to which the Merger Sub will be merged with and into the Target in a reverse triangular merger with the Target continuing
as the surviving entity as a wholly-owned direct subsidiary of the Company (“Merger”). Effective upon the completion
of the Merger, the Target shareholders shall become stockholders of the Company through the receipt of the Merger Consideration
as defined below. Each of the parties referred to above may be referred to herein as a “Party” and collectively
as the “Parties”.
Merger Consideration
On the terms
and subject to the conditions set forth in the Agreement, upon the completion of the Merger, the Target Shareholders shall become
stockholders of the Company through the receipt of an aggregate 30,000,000 restricted shares of the Common Stock of the Company
(“Merger Consideration”).
Upon closing
of the Merger, and subject to the terms and conditions of the Agreement, the Merger Sub shall be merged with and into the Target
(the Target following the Merger is sometimes referred to in this Agreement as the “Surviving Corporation”),
the separate existence of the Merger Sub shall cease, and the Target shall survive the Merger. The Surviving Corporation will possess
all properties, rights, privileges, powers, and franchises of the Target and Merger Sub, and all of the claims, obligations, liabilities,
debts and duties of the Target and Merger Sub will become the claims, obligations, liabilities, debts and duties of the Surviving
Corporation.
Governance
of the Combined Company
Upon closing
of the Merger, Target may nominate, and the Company agrees to appoint, two persons designated by Target to the Company’s
Board of Directors.
Conditions
to the Merger
The
parties’ obligation to consummate the Merger is subject to the satisfaction or waiver of customary closing conditions
for both parties, including (i) the adoption of the Agreement by the requisite vote of the stockholders of Target, (ii) the
adoption of the Agreement by the requisite vote of the stockholders of the Company, (iii) the approval of the issuance of
shares of the Company’s Common Stock as Merger Consideration; (iv) and an appropriate level of Director and Officers
Liability Insurance shall be in place, and (v) certain other customary conditions
relating to the parties’ representations and warranties in the Agreement and the performance of their respective obligations.
The consummation of the Merger is subject to a financing contingency that the Company must raise approximately $2,000,000.
The Company has made customary representations
and warranties in the Agreement. The Agreement also contains customary covenants and agreements, including covenants and agreements
relating to the conduct of the Company’s business between the date of the signing of the Agreement and the closing of the
transactions contemplated under the Agreement.
The Merger
is conditioned on the accuracy and correctness of the representations and warranties made by the other party on the date of the
Agreement and on the Closing Date (as defined in the Agreement) or, if applicable, an earlier date (subject to certain “materiality”
and “material adverse effect” qualifications set forth in the Agreement with respect to such representations and warranties)
and the performance by the other party in all material respects of its obligations under the Merger Agreement.
Under
the Agreement, each of the Company and Target have agreed to use commercially reasonable efforts to consummate the Merger, including
using best efforts to obtain all required regulatory approvals.
Note 16 - Subsequent Events
In July 2020, the Company issued 107,683 incentive
stock options to employees. The options vest over two years and have an exercise price of $0.87.
On July 31, 2020, Michael Paul Keskey joined
the board of directors. In conjunction with Mr. Keskey joining the board, Ronald Miller resigned as chairman of the board, and
Mr. Keskey and Doug Bowden accepted appointments to serve as co-chairmen.
In July 2020, the five founding members of
Item 9 Labs each returned 2,000,000 shares of common stock to treasury. The total number of shares returned was 10,000,000. As
part of the debt financing in March 2020 the Company issued 10,000,000 warrants to purchase shares of the Company. The founders
decided to return the shares to treasury as to prevent the remaining shareholders from dilution.
In July 2020, the Company issued 129,059 shares
of common stock in exchange for services valued at approximately $125,000.
Note 17 – Going Concern
The accompanying consolidated condensed financial
statements have been prepared in conformity with GAAP, which contemplate continuation of the Company as a going concern. The Company
has not yet established an ongoing source of revenue sufficient to cover its operating costs and has incurred net losses since
its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company’s planned
ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion
of the assets in the accompanying consolidated condensed balance sheets is dependent upon continued operations of the Company which
in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations.
The Company operates in a new, developing industry with a variety of competitors. These factors raise substantial doubt about the
Company’s ability to continue as a going concern. As a result, the Company’s independent registered public accounting
firm included an emphasis-of-matter paragraph with respect to the consolidated financial statements for the year ended September
30, 2019, expressing uncertainty regarding the Company’s assumption that it will continue as a going concern.
In order to continue as a going concern, the
Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt.
Management’s plans in regard to these matters are described as follows:
Sales and Marketing. Historically, the Company
has generated the majority of its revenues by providing its products to dispensaries throughout the state of Arizona. The Company’s
revenues have increased significantly since its inception in May 2017. Management will continue its plans to increase revenues
in the Arizona market by providing superior products. Additionally, as capital resources become available, the Company plans to
expand into additional markets outside of Arizona, with construction of a cultivation and processing facility underway in Nevada.
Financing. To date, the Company has financed
its operations primarily with loans from shareholders, private placement financings and sales revenue. Management believes that
with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will grow significantly,
thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there
is no assurance that the Company’s overall efforts will be successful.
If the Company is unable to generate significant
sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations,
and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations
are available. The consolidated condensed financial statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be
necessary should the Company be unable to continue as a going concern.