NOTES TO UNAUDITED CONDENSED INTERIM FINANCIAL
STATEMENTS
Organization and Nature of Operations
Medicine Man Technologies, Inc. (“we,”
“us,” “our” or the “Company”) was incorporated in Nevada on March 20, 2014. On May 1, 2014, we entered
into a non-exclusive Technology License Agreement with Futurevision, Inc., f/k/a Medicine Man Production Corp., dba Medicine Man Denver
(“Medicine Man Denver”) pursuant to which Medicine Man Denver granted us a license to use all of the proprietary processes
that they had developed, implemented and practiced at their cannabis facilities relating to the commercial growth, cultivation, marketing
and distribution of medical and recreational marijuana pursuant to relevant state laws and the right to use and to license such information,
including trade secrets, skills and experience (present and future) (the “License Agreement”) for 10 years.
In 2017, the Company acquired additional cultivation
intellectual property through the acquisition of Success Nutrients™ and Pono Publications, including the rights to the book titled
“Three A Light” and its associated cultivation techniques, which have been part of the Company’s products and services
offerings since the acquisition. The Company acquired Two J’s LLC d/b/a The Big Tomato (“The Big Tomato”) in 2018, which
operates a retail location in Aurora, Colorado. It has been a leading supplier of hydroponics and indoor gardening supplies in the metro
Denver area since May 2001. The Company was focused on cannabis dispensary and cultivation consulting and providing equipment and nutrients
to cannabis cultivators until its first plant touching acquisition in April of 2020. In 2019, due to the changes in Colorado law permitting
non-Colorado resident and publicly traded investment into “plant-touching” cannabis companies, the Company made a strategic
decision to move toward direct plant-touching operations. The Company developed a plan to roll up a number of direct plant-touching dispensaries,
manufacturing facilities, and cannabis cultivations with a target to be one of the largest seed to sale cannabis businesses in Colorado.
In April 2020, the Company acquired its first plant-touching business, Mesa Organics Ltd. (“Mesa Organics”), which consists
of four dispensaries and one manufacturing infused products facility (“MIP”), d/b/a Purplebee’s.
On April 20, 2020, the Company rebranded and
since then conducts its business under the trade name, Schwazze. The corporate name of the Company continues to be Medicine Man
Technologies, Inc. Effective April 21, 2020, the Company commenced trading under the OTC ticker symbol SHWZ.
On December 17, 2020, the Company acquired the
assets of (i) Starbuds Pueblo LLC; and (ii) Starbuds Alameda LLC under the applicable Asset Purchase Agreements (“APAs”).
On December 18, 2020, the Company acquired the assets of (i) Starbuds Commerce City LLC; (ii) Lucky Ticket LLC; (iii) Starbuds Niwot LLC;
and (iv) LM MJC LLC under the applicable APAs.
On February 4, 2021, the Company acquired the
assets of Colorado Health Consultants LLC and Mountain View 44th LLC under the applicable APAs.
On March 2, 2021, the Company acquired the assets
of (i) Starbuds Aurora LLC, (ii) SB Arapahoe LLC; (iii) Citi-Med LLC; (iv) Starbuds Louisville LLC; and (v) KEW LLC under the applicable
APAs.
On July 21, 2021, the Company acquired the assets
of Southern Colorado Growers under the applicable APA.
From December 2020 through March 2021 the Company completed a private placement
of Series A Cumulative Convertible Preferred Stock (“Series A Preferred Stock”) for aggregate gross proceeds of $57.7
million dollars. In the private placement, the Company issued and sold an aggregate of 57,700
shares of Series A Preferred Stock at a price of $1,000
per share under securities purchase agreements with Dye Capital Cann Holdings II, LLC (“Dye Cann II”) and CRW Cann
Holdings, LLC (“CRW”) as well as subscription agreements with unaffiliated investors. Among other terms, each share of Series
A Preferred Stock (i) earns an annual dividend of 8%
on the “preference amount,” which initially is equal to the $1,000 per-share purchase price and subject to increase, by having
such dividends automatically accrete to, and increase, the outstanding preference amount; (ii) is entitled to a liquidation preference
under certain circumstances, (iii) is convertible into shares of the Company’s common stock by dividing the preference amount by
$1.20 per share under certain circumstances, and (iv) is subject to a redemption right or obligation under certain circumstances.
In addition, on December 16, 2020, the Company
issued and sold a Convertible Promissory Note and Security Agreement in the original principal amount of $5,000,000 to Dye Capital &
Company, LLC (“Dye Capital”). On February 26, 2021, Dye Capital converted all outstanding amounts under the note into 5,060
shares of Series A Preferred Stock.
The Company is focused on growing through internal
growth, acquisition, and new licenses in the Colorado cannabis market. The Company is focused on building the premier vertically integrated
cannabis company in Colorado. The company's leadership team has deep expertise in mainstream consumer packaged goods, retail, and product
development at Fortune 500 companies as well as in the cannabis sector. The Company has a high-performance culture and a focus on analytical
decision making, supported by data. Customer-centric thinking inspires the Company’s strategy and provides the foundation for the
Company’s operational playbooks.
The Company’s operations are organized into three different segments
as follows: (i) retail, consisting of retail locations for sale of cannabis products, (ii) wholesale, consisting of manufacturing, cultivation
and sale of wholesale cannabis products, nutrients for cannabis, and hydroponics and indoor gardening supplies, and (iii) other, consisting
of all other income and expenses, including those related to licensing and consulting services, facility design services, facility management
services, and corporate operations.
1.
|
Liquidity and Capital Resources
|
During the quarters ended September 30, 2021 and
2020, the Company primarily used revenues from its operations to fund its operations.
Cash and cash equivalents are carried at cost
and represent cash on hand, deposits placed with banks or other financial institutions and all highly liquid investments with an original
maturity of three months or less as of the purchase date. The Company had $21,168,816 and $1,231,235 classified as cash and cash equivalents
as of September 30, 2021, and December 31, 2020, respectively.
The Company maintains its cash balances with a
high-credit-quality financial institution. At times, such cash may be more than the insured limit of $250,000. The Company has not experienced
any losses in such accounts, and management believes the Company is not exposed to any significant credit risk on its cash and cash equivalents.
2.
|
Critical Accounting Policies and Estimates
|
Management’s Representation of Interim
Financial Statements
The accompanying unaudited consolidated financial
statements have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission
(“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted as allowed by such rules and
regulations, and management believes that the disclosures are adequate to make the information presented not misleading. These unaudited
consolidated financial statements include all of the adjustments, which in the opinion of management are necessary to a fair presentation
of the Company’s financial position and results of operations. All such adjustments are of a normal and recurring nature. Interim
results are not necessarily indicative of results for a full year. These unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements as of December 31, 2020 and 2019, as presented in the Company’s Annual
Report on Form 10-K filed on March 31, 2021 with the SEC.
Basis of Presentation
These accompanying financial statements have been
prepared in accordance with U.S. GAAP and pursuant to the rules and regulations of the SEC for interim financial statements. All intercompany
accounts and transactions are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity
with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty
involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Reclassifications
Certain prior period amounts have been reclassified
to conform to the current period presentation. These reclassifications had no impact on net earnings and financial position.
Fair Value Measurements
Fair value is defined as the exchange price that
would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset
or liability, in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair
value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three
levels of inputs, of which the first two are considered observable and the last unobservable, as follows:
Level 1 – Quoted prices
in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level
1 that are observable, either directly or indirectly, 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.
Level 3 – Unobservable inputs
that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities.
The Company’s financial instruments include
cash, accounts receivable, notes receivable, accounts payable and tenant deposits. The carrying values of these financial instruments
approximate their fair value due to their short maturities. The carrying amount of the Company’s debt approximates fair value because
the interest rates on these instruments approximate the interest rate on debt with similar terms available to us. The Company’s
derivative liability was adjusted to fair market value at the end of each reporting period, using Level 3 inputs.
The following is the Company’s assets and
liabilities measured at fair value on a recurring and nonrecurring basis at September 30, 2021 and December 31, 2020, using quoted prices
in active markets for identical assets (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs
(Level 3):
Schedule of fair value measurement
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2021
|
|
|
2020
|
|
Level 1 - Marketable Securities Available-for-Sale - Recurring
|
|
|
487,467
|
|
|
|
276,782
|
|
Marketable Securities at Fair Value on a
Recurring Basis
Certain assets are measured at fair value on a
recurring basis. The Level 1 position consists of an investment in equity securities held in Canada House Wellness Group, Inc., a publicly-traded
company whose securities are actively quoted on the Toronto Stock Exchange.
Fair Value of Financial Instruments
The carrying amounts of cash and current assets
and liabilities approximate fair value because of the short-term maturity of these items. These fair value estimates are subjective in
nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions
could significantly affect these estimates. Available-for-sale securities are recorded at current market value as of the date of this
report.
Accounts Receivable
The Company extends unsecured credit to its customers
in the ordinary course of business. These accounts receivable relates to the Company’s wholesale and other revenue segments. Accounts
receivable are recorded when a milestone is reached at a point in time resulting in funds being due for delivered goods or services, and
where payment is reasonably assured. Wholesale revenues are generally collected within 14 to 30 days after invoice is sent. Consulting
revenues are generally collected from 30 to 60 days after the invoice is sent.
The following table depicts the composition of
our accounts receivable as of September 30, 2021, and December 31, 2020:
Schedule of Accounts Receivable
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
Accounts receivable - trade
|
|
$
|
3,665,566
|
|
|
$
|
1,315,188
|
|
Accounts receivable - related party
|
|
|
–
|
|
|
|
80,494
|
|
Accounts receivable - litigation, non-current
|
|
|
3,063,968
|
|
|
|
3,063,968
|
|
Allowance for doubtful accounts
|
|
|
(135,046
|
)
|
|
|
(44,808
|
)
|
Total accounts receivable
|
|
$
|
6,594,488
|
|
|
$
|
4,414,842
|
|
The Company establishes an allowance for doubtful
accounts based on management’s assessment of the collectability of trade receivables. A considerable amount of judgment is required
in assessing the amount of the allowance. The Company makes judgments about the creditworthiness of each customer based on ongoing credit
evaluations and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition
of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be required.
Notes Receivable
On March 12, 2021, the Company sold equipment
to Colorado Cannabis. The terms of sale included a zero interest note receivable, payable $11,944 on the first of each month for 24 months.
As of September 30, 2021, the outstanding balance, including penalties for late payments, on the notes receivable with Colorado Cannabis
totaled $179,167.
Prepaid
Expenses and Other Assets (Current and Non-Current)
Prepaid expenses and other assets as of
September 30, 2021 and December 31, 2020 were $3,027,097
and $666,079, respectively. As of
September 30, 2021, this balance included $2,579,035
in prepaid expenses and $448,062
in security deposits. As of December 31, 2020, other assets included $345,777
in prepaid expenses, $268,423
in tax receivable, and $51,879
in security deposits. Prepaid expenses were primarily comprised of insurance premiums, membership dues, conferences and seminars,
and other general and administrative costs.
Goodwill and Intangible Assets
Goodwill represents the future economic benefit
arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the
Company’s acquisitions is attributable to the value of the potential expanded market opportunity with new customers. Intangible
assets have either an identifiable or indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line
basis over their economic or legal life, whichever is shorter. The Company’s amortizable intangible assets consist of licensing
agreements, product licenses and registrations, and intellectual property or trade secrets. Their estimated useful lives range from 10
to 15 years.
Goodwill and indefinite-lived assets are not amortized
but are subject to annual impairment testing unless circumstances dictate more frequent assessments. The Company performs an annual impairment
assessment for goodwill during the fourth quarter of each year and more frequently whenever events or changes in circumstances indicate
that the fair value of the asset may be less than the carrying amount. Goodwill impairment testing is a two-step process performed at
the reporting unit level. Step one compares the fair value of the reporting unit to its carrying amount. The fair value of the reporting
unit is determined by considering both the income approach and market approaches. The fair values calculated under the income approach
and market approaches are weighted based on circumstances surrounding the reporting unit. Under the income approach, the Company determines
fair value based on estimated future cash flows of the reporting unit, which are discounted to the present value using discount factors
that consider the timing and risk of cash flows. For the discount rate, the Company relies on the capital asset pricing model approach,
which includes an assessment of the risk-free interest rate, the rate of return from publicly traded stocks, the Company’s risk
relative to the overall market, the Company’s size and industry and other Company-specific risks. Other significant assumptions
used in the income approach include the terminal value, growth rates, future capital expenditures and changes in future working capital
requirements. The market approaches use key multiples from guideline businesses that are comparable and are traded on a public market.
If the fair value of the reporting unit is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying
amount exceeds its fair value, then the second step must be completed to measure the amount of impairment, if any. Step two calculates
the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets of the reporting unit from the
fair value of the reporting unit as calculated in step one. In this step, the fair value of the reporting unit is allocated to all of
the reporting unit’s assets and liabilities in a hypothetical purchase price allocation as if the reporting unit had been acquired
on that date. If the carrying amount of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized in an amount
equal to the excess.
Determining the fair value of a reporting unit
is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates, strategic plans,
and future market conditions, among others. There can be no assurance that the Company’s estimates and assumptions made for purposes
of the goodwill impairment testing will prove to be accurate predictions of the future. Changes in assumptions and estimates could cause
the Company to perform an impairment test prior to scheduled annual impairment tests.
The Company performed its annual fair value assessment
as of December 31, 2020, on its subsidiaries with material goodwill and intangible asset amounts on their respective balance sheets and
determined that no impairment exists. No additional factors or circumstances existed as of September 30, 2021 that would indicate impairment.
Long-Lived Assets
The Company evaluates the recoverability of its
long-lived assets whenever events or changes in circumstances have indicated that an asset may not be recoverable. The long-lived asset
is grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other
groups of assets and liabilities. If the sum of the projected undiscounted cash flows is less than the carrying value of the assets, the
assets are written down to the estimated fair value.
The Company evaluated the recoverability of its
long-lived assets on December 31, 2020 on its subsidiaries with material amounts on their respective balance sheets and determined that
no impairment exists.
Accounts Payable
Accounts payable as of September 30, 2021 and
December 31, 2020 were $1,040,610 and $3,557,460, respectively and were comprised of trade payables for various purchases and services
rendered during the ordinary course of business.
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities as of September
30, 2021 and December 31, 2020 were $11,660,237 and $2,705,445, respectively. As of September 30, 2021, this was comprised of accrued
payroll of $632,965, operating expenses of $5,442,254, and accrued dividends on preferred stock of $5,585,018. As of December 31, 2020,
accrued expenses and other liabilities was comprised of customer deposits of $26,826, accrued payroll of $1,154,887, and operating expenses
of $1,523,732.
Revenue Recognition and Related Allowances
The Company’s revenue recognition policy
is significant because the amount and timing of revenue is a key component of our results of operations. Certain criteria are required
to be met in order to recognize revenue. If these criteria are not met, then the associated revenue is deferred until is the criteria
are met. When consideration is received in advance of the delivery of goods or services, a contract liability is recorded. Revenue contracts
are identified when accepted from customers and represent a single performance obligation to sell the Company’s products to a customer.
The Company has three main revenue streams: retail;
wholesale; and other.
Retail and wholesale sales are recorded at the
time that control of the products is transferred to customers. In evaluating the timing of the transfer of control of products to customers,
the Company considers several indicators, including significant risks and rewards of products, its right to payment, and the legal title
of the products. Based on the assessment of control indicators, sales are generally recognized when products are delivered to customers.
Other revenue consists of other income and expenses,
including related to, licensing and consulting services, facility design services, facility management services, the Company’s Three
A Light™ publication, and corporate operations. Revenue is recognized when the obligations to the client are fulfilled which is
determined when milestones in the contract are achieved and target harvest yields are exceeded or earned upon the completion of the seminar.
The Company also recognizes expense reimbursement from clients as revenue for expenses incurred during certain jobs.
Costs of Goods and Services Sold
Costs of goods and services sold are comprised
of related expenses incurred while supporting the implementation and sales of the Company’s products and services.
General and Administrative Expenses
General and administrative expense are comprised
of all expenses not linked to the production or advertising of the Company’s services.
Advertising and Marketing Costs
Advertising and marketing costs are expensed as
incurred and totaled $250,568 and $559,161 for the three and nine months ended September 30, 2021, respectively, as compared to $ $172,539
and $638,335, respectively, for the three and nine months ended September 30, 2020.
Stock Based Compensation
The Company accounts for share-based payments
pursuant to ASC 718, Stock Compensation and, accordingly, the Company records compensation expense for share-based awards based
upon an assessment of the grant date fair value for stock options using the Black-Scholes option pricing model.
Stock compensation expense for stock options is
recognized over the vesting period of the award or expensed immediately under ASC 718 and Emerging Issues Task Force (“EITF”)
96-18 when stock or options are awarded for previous or current service without further recourse.
Share-based expense paid through direct stock
grants is expensed as occurred. Since the Company’s common stock is publicly traded, the value is determined based on the number
of shares of common stock issued and the trading value of the common stock on the date of the transaction.
On June 20, 2018, the Financial Accounting Standards
Board (“FASB”) issued ASU 2018-07 which simplifies the accounting for share-based payments granted to nonemployees for goods
and services. Under the ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based
payments granted to employees. Previously, share-based payment arrangements to nonemployees were accounted for under ASC 718, while nonemployee
share-based payments issued for goods and services were accounted for under ASC 505-50. Before the amendment, the major difference for
the Company (but not limited to) was the determination of measurement date, which generally is the date on which the measurement of equity
classified share-based payments becomes fixed. Equity classified share-based payments for employees was fixed at the time of grant. Equity-classified
nonemployee share-based payment awards are no longer measured at the earlier of the date which a commitment for performance by the counterparty
is reached or the date at which the counterparty’s performance is complete. They are now measured at the grant date of the award,
which is the same as share-based payments for employees. The Company adopted the requirements of the new rule as of January 1, 2019, the
effective date of the new guidance.
The Company recognized $1,228,764 and $3,865,588
in expense for stock-based compensation from common stock options and common stock issued to employees, officers, and directors during
the three and nine months ended September 30, 2021, respectively, and $1,453,986 and $5,815,808 in expenses for stock-based compensation
from the issuance of common stock to employees, officers, directors and/or contractors during the three and nine months ended September
30, 2020, respectively.
Income Taxes
ASC 740, Income Taxes requires the use of the
asset and liability method of accounting for income taxes. Under the asset and liability method of ASC 740, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases.
Deferred tax assets are regularly assessed to
determine the likelihood they will be recovered from future taxable income. A valuation allowance is established when we believe it is
more likely than not the future realization of all or some of a deferred tax asset will not be achieved. In evaluating our ability to
recover deferred tax assets within the jurisdiction which they arise, we consider all available positive and negative evidence. Factors
reviewed include the cumulative pre-tax book income for the past three years, scheduled reversals of deferred tax liabilities, our history
of earnings and reliability of our forecasts, projections of pre-tax book income over the foreseeable future, and the impact of any feasible
and prudent tax planning strategies.
The Company assesses all material positions taken
in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge
by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability,
and the tax benefit to be recognized is measured at the largest amount of benefit that is greater than 50 percent likely of being realized
upon ultimate settlement. We recognize the impact of a tax position in our financial statements only if that position is more likely than
not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Tax authorities regularly
examine our returns in the jurisdictions in which we do business, and we regularly assess the tax risk of our return filing positions.
Due to the complexity of some of the uncertainties, the ultimate resolution may result in payments that are materially different from
our current estimate of the tax liability. These differences, as well as any interest and penalties, will be reflected in the provision
for income taxes in the period in which they are determined.
As the Company operates in the cannabis industry,
it is subject to the limits of the Internal Revenue Code (“IRC”) Section 280E under which the Company is only allowed to deduct expenses
directly related to sales of product. This results in permanent differences between ordinary and necessary business expenses deemed non-allowable
under IRC Section 280E.
Right of Use Assets and Lease Liabilities
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842). The standard requires lessees to recognize almost all leases on the balance sheet as a Right-of-Use (“ROU”)
asset and a lease liability and requires leases to be classified as either an operating or a finance type lease. The standard excludes
leases of intangible assets or inventory. The standard became effective for the Company beginning January 1, 2019. The Company adopted
ASC 842 using the modified retrospective approach, by applying the new standard to all leases existing at the date of initial application.
Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under ASC 842, while prior period
amounts have not been adjusted and continue to be reported in accordance with our historical accounting under ASC 840. The Company elected
the package of practical expedients permitted under the standard, which also allowed the Company to carry forward historical lease classifications.
The Company also elected the practical expedient related to treating lease and non-lease components as a single lease component for all
equipment leases as well as electing a policy exclusion permitting leases with an original lease term of less than one year to be excluded
from the ROU assets and lease liabilities.
Under ASC 842, the Company determines if an arrangement
is a lease at inception. ROU assets and liabilities are recognized at commencement date based on the present value of remaining lease
payments over the lease term. For this purpose, the Company considers only payments that are fixed and determinable at the time of commencement.
As most of the Company's leases do not provide an implicit rate, the Company estimated the incremental borrowing rate in determining the
present value of lease payments. The ROU asset also includes any lease payments made prior to commencement and is recorded net of any
lease incentives received. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably
certain that the Company will exercise such options.
Operating leases are included in operating lease
ROU assets and operating lease liabilities, current and non-current, on the Company's consolidated balance sheets.
3.
|
Recent Accounting Pronouncements
|
The Company has implemented all new accounting
pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new pronouncements
that have been issued that might have a material impact on its financial position or results of operations except as noted below:
In January 2017, the FASB issued ASU 2017-01,
Clarifying the Definition of a Business (Topic 805), which changes the definition of a business to assist entities with evaluating
when a set of transferred assets and activities is a business. The guidance requires an entity to evaluate if substantially all of the
fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so,
the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive
process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606. The ASU is effective
for annual reporting periods beginning after December 15, 2017, and for interim periods within those years. Adoption of this ASU did not
have a significant impact on the Company’s consolidated results of operations, cash flows and financial position.
In December 2019, the FASB issued ASU 2019-12,
Income Taxes (Topic 740), which enhances and simplifies various aspects of the income tax accounting guidance, including requirements
such as tax basis step-up in goodwill obtained in a transaction that is not a business combination, ownership changes in investments,
and interim-period accounting for enacted changes in tax law. The amendment became effective for public companies with fiscal years beginning
after December 15, 2020. The Company is evaluating the impact of this amendment on its consolidated financial statements.
In February 2020, the FASB issued ASU 2020-02,
Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting
Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), which
amends the effective date of the original pronouncement for smaller reporting companies. ASU 2016-13 and its amendments will be effective
for the Company for interim and annual periods in fiscal years beginning after December 15, 2022. The Company believes the adoption will
modify the way the Company analyzes financial instruments, but it does not anticipate a material impact on results of operations. The
Company is in the process of determining the effects adoption will have on its consolidated financial statements.
4.
|
Property and Equipment
|
Property and equipment are recorded at cost,
net of accumulated depreciation and are comprised of the following:
Property and equipment table
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2021
|
|
|
2020
|
|
Furniture and fixtures
|
|
$
|
254,490
|
|
|
$
|
228,451
|
|
Leasehold improvements
|
|
|
662,839
|
|
|
|
90,314
|
|
Machinery and tools
|
|
|
1,779,411
|
|
|
|
1,456,752
|
|
Land and buildings
|
|
|
2,935,000
|
|
|
|
–
|
|
Office equipment
|
|
|
250,833
|
|
|
|
104,059
|
|
Software
|
|
|
1,983,356
|
|
|
|
1,308,387
|
|
Work in process
|
|
|
2,570,512
|
|
|
|
269,414
|
|
|
|
$
|
10,436,441
|
|
|
$
|
3,457,377
|
|
Less: Accumulated depreciation
|
|
|
(1,631,093
|
)
|
|
|
(872,579
|
)
|
Total property and equipment, net of depreciation
|
|
$
|
8,805,348
|
|
|
$
|
2,584,798
|
|
Depreciation on equipment is provided on a straight-line
basis over its expected useful lives at the following annual rates.
Schedule of property and equipment useful lives
|
|
Furniture and fixtures
|
3-5 years
|
Leasehold improvements
|
Lesser of the lease term or estimated useful life
|
Machinery and tools
|
5 years
|
Office equipment
|
3 years
|
Software
|
3-5 years
|
Depreciation
expense for the three and nine months ended September 30, 2021 was $364,399
and $818,174,
respectively.
Intangible assets as of September 30, 2021 and
December 31, 2020 were comprised of the following:
Intangible assets
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
License Agreements
|
|
$
|
94,287,580
|
|
|
$
|
1,667,700
|
|
Tradename
|
|
|
4,560,000
|
|
|
|
350,000
|
|
Customer Relationships
|
|
|
5,150,000
|
|
|
|
1,055,000
|
|
Non Compete
|
|
|
1,205,000
|
|
|
|
120,000
|
|
Product License and Registration Agreements
|
|
|
–
|
|
|
|
57,300
|
|
Trade Secret
|
|
|
32,500
|
|
|
|
32,500
|
|
|
|
$
|
105,235,080
|
|
|
$
|
3,282,500
|
|
Less: accumulated amortization
|
|
|
(7,162,110
|
)
|
|
|
(200,456
|
)
|
Total intangible assets, net of amortization
|
|
$
|
98,072,970
|
|
|
$
|
3,082,044
|
|
Amortization
expense for the three and nine months ended September 30, 2021 was $2,609,987 and
$6,961,654,
respectively.
In 2019, the Company entered into certain employment
agreements with key officers that contained contingent consideration provisions based upon the achievement of certain market condition
milestones. The Company determined that each of these vesting conditions represented derivative instruments.
On January 8, 2019, the Company granted the right
to receive 500,000 shares of restricted common stock to an officer and director, which will vest at such time that the Company’s
stock price appreciates to $8.00 per share with defined minimum average daily trading volume thresholds. The rights expire January 8,
2022.
On April 23, 2019, the Company granted the right
to receive 1,000,000 shares of restricted common stock to an officer and director, which will vest at such time that the Company’s
stock price appreciates to $8.00 per share with defined minimum average daily trading volume thresholds. On February 25, 2020, the director
resigned from his remaining positions with the Company and forfeited his right to the contingent consideration. As a result, the Company
recorded a gain of $1,462,636 as a component of other income (expense), net on the financial statements in the first quarter of 2020.
On
June 11, 2019, the Company granted the right to receive 1,000,000
shares of restricted common stock to an officer, which will vest
at such time that the Company’s stock price appreciates to $8.00 per share with defined minimum average daily trading volume thresholds.
On May 3, 2021, the Company executed an agreement whereby the officer relinquished the 1,000,000 shares of restricted common stock. and
as a result, recorded a gain of $1,509,117 as a component of other income (expense), net on the financial statements in the second quarter
of 2021.
The Company accounts for derivative instruments
in accordance with the US GAAP accounting guidance under ASC 815, Derivatives and Hedging Activities. The Company estimated the
fair value of these derivatives at the respective balance sheet dates using the Black-Scholes option pricing model based upon the following
inputs: (i) stock price on the date of grant ranging between $1.32 - $3.75, (ii) a risk-free interest rate ranging between 1.45% - 2.57%
and (iii) an expected volatility of the price of the underlying common stock ranging between 145% - 201%.
As of September 30, 2021, the fair value of these
derivative liabilities is $79,730. The change in the fair value of derivative liabilities for the three months ended September 30, 2021
was $356,824, resulting in an aggregate unrealized gain on derivative liabilities. The change in the fair value of the derivative liabilities
for the nine months ended September 30, 2021 was $967,751, resulting in an aggregated unrealized gain on derivative liabilities.
7.
|
Related Party Transactions
|
Transactions Involving Former Directors, Executive
Officers or Their Affiliated Entities
During the year ended December 31, 2020, the Company
recorded sales to Medicine Man Denver, totaling $997,262. The Company had an accounts receivable balance with Medicine Man Denver totaling
$72,109 as of December 31, 2020. The Company’s former Chief Executive Officer, Andy Williams, maintains an ownership interest in
Medicine Man Denver. Effective February 25, 2020 he was no longer an officer of the Company and therefore no longer a related party. As
such, he is not included as a related party with respect to sales and accounts receivable from Medicine Man Denver during the period ended
September 30, 2021.
During the year ended December 31, 2020, the Company
recorded sales to MedPharm Holdings LLC (“MedPharm”) totaling $73,557. The Company had a net accounts receivable balance with
MedPharm totaling $5,885 as of December 31, 2020. The Company’s former Chief Executive Officer, Andy Williams, maintains an ownership
interest in MedPharm. Effective February 25, 2020 he was no longer an officer of the Company and therefore no longer a related party.
As such, he is not included as a related party with respect to sales and accounts receivable from MedPharm during the period ended September
30, 2021.
Also, during the year ended December 31,
2019, the Company made loans to MedPharm totaling $767,695
evidenced by promissory notes with original maturity dates ranging from September 21, 2019 through January 19, 2020 and all bearing
interest at 8% per annum. On August 1, 2020, the Company entered into a Settlement Agreement and Mutual Release (the
“Settlement Agreement”) with MedPharm pursuant to which (i) the parties agreed that the outstanding amount owed by
MedPharm to the Company was $767,695
of principal and $47,161
in accrued and unpaid interest, (ii) MedPharm paid the Company $100,000
in cash, (iii) Andrew Williams returned 175,000
shares of the Company’s common stock to the Company, as partial repayment of the outstanding balance at a value of $1.90 per
share. These shares are held in treasury. The remaining outstanding principal and interest
of $181,911
due and payable by MedPharm under the Settlement Agreement was to be paid out in bi-weekly installments of product by scheduled
deliveries through June 30, 2021. This amount was paid off on April 19, 2021.
During the year ended December 31, 2020, the
Company recorded sales to Baseball 18, LLC (“Baseball”) totaling $14,605,
to Farm Boy, LLC (“Farm Boy”) totaling $16,125,
to Emerald Fields LLC (“Emerald Fields”) totaling $16,605,
and to Los Sueños Farms (“Los Sueños”) totaling $52,244.
As of December 31, 2020 the Company had net accounts payable balances with Baseball of $31,250,
and with Farm Boy of $93,944.
One of the Company’s former Chief Operating Officers and directors, Robert DeGabrielle, owns the Colorado retail marijuana
cultivation licenses for Farm Boy, Baseball, Emerald Fields, and Los Sueños. Effective June 19, 2020 he was no longer an
officer of the Company and therefore no longer a related party. As such, he is not included as a related party with respect to sales
and accounts receivable from Baseball, Farm Boy, Emerald Fields, or Los Sueños during the period ended September 30, 2021.
Transactions with Entities Affiliated with
Justin Dye
The Company has participated in several transaction
involving Dye Capital, Dye Capital Cann Holdings, LLC (“Dye Cann I”) and Dye Cann II. Justin Dye, the Company’s Chief
Executive Officer, one of its directors, and the largest beneficial owner of the Company’s common stock and Series A Preferred Stock,
controls Dye Capital and Dye Capital controls Dye Cann I and Dye Cann II. Dye Cann I is the largest holder of the Company’s outstanding
common stock. Dye Cann II is a significant holder of the Series A Preferred Stock. Mr. Dye has sole voting and dispositive power over
the securities held by Dye Capital, Dye Cann I, and Dye Cann II.
The Company entered into a Securities Purchase
Agreement with Dye Cann I on June 5, 2019, (as amended, the “Dye Cann I SPA”) pursuant to which the Company agreed to sell
to Dye Cann I up to between 8,187,500 and 10,687,500 shares of the Company’s common stock in several tranches at $2.00 per share
and warrants to purchase 100% of the number of shares of common stock sold at a purchase price of $3.50 per share. At the initial closing
on June 5, 2019, the Company sold to Dye Cann I 1,500,000 shares of common stock and warrants to purchase 1,500,000 shares of common stock
for gross proceeds of $3,000,000, and the Company has consummated subsequent closings for an aggregate of 9,287,500 shares of common stock
and warrants to purchase 9,287,500 shares of common stock for aggregate gross proceeds of $18,575,000 to the Company. The terms of the
Dye Cann I SPA are disclosed in the Company’s Current Report on Form 8-K filed on June 6, 2019. The Company and Dye Cann I entered
into a first amendment to the Dye Cann I SPA on July 15, 2019, as described in the Company’s Current Report on Form 8-K filed on
July 17, 2019, a second amendment to the Dye Cann I SPA on May 20, 2020, as described in the Company’s Current Report on Form 8-K
filed on May 22, 2020, and a Consent, Waiver and Amendment on December 16, 2020, as described in the Company’s Current Report on
Form 8-K filed on December 23, 2020. At the time of the initial closing under the Dye Cann I SPA, Justin Dye became a director and the
Company’s Chief Executive Officer.
The Company granted Dye Cann I certain demand
and piggyback registration rights with respect to the shares of common stock sold under the Dye Cann I SPA and issuable upon exercise
of the warrants sold under the Dye Cann I SPA. The Company also granted Dye Cann I the right to designate one or more individuals for
election or appointment to the Company’s board of directors (the “Board”) and Board observer rights. Further, under
the Dye Cann I SPA, until June 5, 2022, if the Company desires to pursue debt or equity financing, the Company must first give Dye Cann
I an opportunity to provide a proposal to the Company with the terms upon which Dye Cann I would be willing to provide or secure such
financing. If the Company does not accept Dye Cann I’s proposal, the Company may pursue such debt or equity financing from other
sources but Dye Cann I has a right to participate in such financing to the extent required to enable Dye Cann I to maintain the percentage
of the Company’s common stock (on a fully-diluted basis) that it then owns, in the case of equity securities, or, in the case of
debt, a pro rata portion of such debt based on the percentage of the Company’s common stock (on a fully-diluted basis) that it then
owns.
The Company entered into a Securities Purchase
Agreement (as amended, the “Dye Cann II SPA”) with Dye Cann II on November 16, 2020 pursuant to which the Company agreed
to sell to Dye Cann II shares of Series A Preferred Stock in one or more tranches at a price of $1,000 per share. The terms of the Dye
Cann II SPA are disclosed in the Company’s Current Report on Form 8-K filed on December 23, 2020. The Company and Dye Cann II entered
into an amendment to the Dye Cann II SPA on December 16, 2020, as described in the Company’s Current Report on Form 8-K filed on
December 23, 2020, a second amendment to the Dye Cann II SPA on February 3, 2021, as described in the Company’s Form 8-K filed
on February 9, 2021, and a third amendment to the Dye Cann II SPA on March 30, 2021, as described under Item 9B of the Company’s
Annual Report on Form 10-K for the year ended December 31, 2021. The Company issued and sold to Dye Cann II 7,700 shares of Series A
Preferred Stock on December 16, 2020, 1,450 shares of Series A Preferred Stock on December 18, 2020, 1,300 shares of Series Preferred
Stock on December 22, 2020, 3,100 shares of Series A Preferred Stock on February 3, 2021, 3,800 shares of Series A Preferred Stock on
March 2, 2021 and 4,000 shares of Series A Preferred Stock on March 30, 2021. As a result, the Company issued and sold an aggregate of
21,350 shares of Series A Preferred Stock to Dye Cann II for aggregate gross proceeds of $21,350,000.
The Company granted Dye Cann II certain demand
and piggyback registration rights with respect to the shares of common stock issuable upon conversion of the Series A Preferred Stock
under the Dye Cann II SPA. Further, the Company granted Dye Can II the right to designate one or more individuals for election or appointment
to the Board and Board observer rights.
On December 16, 2020, the Company entered into
a Secured Convertible Note Purchase Agreement with Dye Capital and issued and sold to Dye Capital a Convertible Note and Security Agreement
in the principal amount of $5,000,000 as described in the Company’s Current Report on Form 8-K filed on December 23, 2020. On February
26, 2021, Dye Capital elected to convert the $5,000,000 principal amount and the $60,250 of accrued but unpaid interest under the Convertible
Promissory Note and Security Agreement under its terms and Dye Capital and the Company entered into a Conversion Notice and Agreement
pursuant to which the Company issued 5,060 shares of Series A Preferred Stock to Dye Capital and also paid Dye Capital $230.97 in cash
in lieu of issuing any fractional shares of Series Preferred Stock upon conversion, as described in the Company’s Current Report
on Form 8-K filed on March 4, 2021.
The Company previously reported the terms of the
Series A Preferred Stock in the Company’s Current Report on Form 8-K filed on December 23, 2020 and under Item 1 of this Report,
which disclosure is incorporated herein by reference.
During the year ended December 31, 2020, the Company
recorded expenses of $66,264 with Tella Digital. As of September 30, 2021 the Company recorded expenses of $188,354 for the nine month
period. Tella Digital provides on-premise digital experience solutions for our retail dispensary locations. Mr. Dye is an indirect part owner and serves as Chairman of Tella Digital.
Nirup Krishnamurthy, Chief Operating Officer, is also an indirect part owner in Tella Digital.
Transactions with CRW and Affiliated Entities
On February 26, 2021, the Company entered
into a Securities Purchase Agreement (the “CRW SPA”) with CRW pursuant to which the Company issued and sold 25,350
shares of Series A Preferred Stock to CRW at a price of $1,000 per share for aggregate gross proceeds of $25,350,000.
The transaction made CRW a beneficial owner of more than 5% of the Company’s common stock. The Company granted CRW certain
demand and piggyback registration rights with respect to the shares of common stock issuable upon conversion of the Series A
Preferred Stock under the CRW SPA. On the same date, the Company entered into a letter agreement with CRW, granting CRW the right to
designate one individual for election or appointment to the Board and Board observer rights. Under the letter agreement, for as long
as CRW has the right to designate a Board member, if the Company, directly or indirectly, plans to issue, sell or grant any
securities or options to purchase any of its securities, CRW has a right to purchase its pro rata portion of such securities, based
on the number of shares of Series A Preferred Stock beneficially held by CRW on the applicable date on an as-converted to common
stock basis divided by the total number of shares of common stock outstanding on such date on an as-converted, fully-diluted basis
(taking into account all outstanding securities of the Company regardless of whether the holders of such securities have the right
to convert or exercise such securities for common stock at the time of determination). Further, under the letter agreement, the
Company will pay CRW Capital, LLC, the sole manager of CRW and a holder of a carried interest in CRW, a monitoring fee equal to
$150,000 in monthly installments of $10,000. On March 14, 2021, the Board appointed Jeffrey A. Cozad as a director to fill a vacancy
on the Board. Mr. Cozad is a manager and owns 50% of CRW Capital, LLC, and he shares voting and disposition power over the shares of
Series A Preferred Stock held by CRW. Mr. Cozad and his family members indirectly own membership interests in CRW. The Company
previously reported the terms of the CRW SPA and the CRW letter agreement in the Company’s Current Report on Form 8-K filed
March 4, 2021.
Transactions with Entities Affiliated with Brian Ruden
The Company has participated in several transactions
involving entities owned or affiliated with Brian Ruden, one of its directors and a beneficial owner of more than 5% of the Company’s
common stock and a beneficial owner of more than 5% of the Series A Preferred Stock.
Between December 17, 2020 and March 2, 2021, the
Company’s wholly-owned subsidiary SBUD, LLC acquired the Star Buds assets. The Company previously reported the terms of the applicable
purchase agreements and related amendments in the Company’s Current Reports on Form 8-K filed June 8, 2020, September 21, 2020,
December 22, 2020, and March 8, 2021.
The aggregate purchase price for the Star Buds
assets was $118,000,000, paid as follows: (i) $44,250,000 in cash at the applicable closings, (ii) $44,250,000 in deferred cash, also
referred to in this report as “seller note(s),” (iii) 29,500 shares of Series A Preferred Stock, of which 25,075 shares were
issued at the applicable closings and 4,425 shares are held in held in escrow and will be released post-closing to either Star Buds or
the Company depending on post-closing adjustments to the purchase price. In addition, the Company issued warrants to purchase an aggregate
of 5,531,250 shares of the Company’s common stock to the sellers. As of September 30, 2021, the Company owed an aggregate principal amount
of $44,250,000 under the seller notes. The Company has not paid any principal and has paid an aggregate of $3,010,887 of interest on the
seller notes as of September 30, 2021. Mr. Ruden’s interest in the aggregate purchase price for the Star Buds assets is as follows: (i)
$13,727,490 in cash at the applicable closings, (ii) $13,727,490 in seller notes, (iii) 9,152 shares of Series A Preferred Stock, of which
7,779 shares were issued at the applicable closings and 1,373 shares are held in held in escrow and will be released post-closing to either
Mr. Ruden or the Company depending on post-closing adjustments to the purchase price. In addition, the Company issued warrants to purchase
an aggregate of 1,715,936 shares of the Company’s common stock to Mr. Ruden. The Company has paid Mr. Ruden an aggregate of $929,913
in interest on his seller notes as of September 30, 2021.
Mr. Ruden was a part-owner of each of the Star
Buds companies that sold assets to SBUD, LLC. Mr. Ruden owned 50% of Colorado Health Consultants LLC, 50% of Starbuds Aurora LLC, 50%
of Starbuds Pueblo LLC, 50% of Starbuds Alameda LLC, 48% of SB Arapahoe LLC, 36% of Starbuds Commerce City LLC, 30% of Starbuds Louisville
LLC, 25% of Starbuds Niwot LLC, 16.66% of Lucky Ticket LLC, 15% of KEW LLC, and 10% of LM MJC LLC.
In connection with acquiring the Star Buds assets
for our Pueblo West, Niwot, Commerce City, Lakeside, Arapahoe and Aurora locations, SBUD LLC entered into a lease with each of 428 S.
McCulloch LLC, Colorado Real Estate Holdings LLC, 5844 Ventures LLC, 5238 W 44th LLC, 14655 Arapahoe LLC and Montview Real
Estate LLC, on substantially the same terms. Each of the leases is for an initial three-year term. The lease with 428 S. McCulloch LLC
is for the Company’s Pueblo West Star Buds location and was effective on December 17, 2020. The lease with Colorado Real Estate
Holdings LLC and 5844 Ventures LLC is for the Company’s Niwot and Commerce City Star Buds location, respectively, and was effective
on December 18, 2020. The lease with 5238 W 44th LLC is for the Company’s Lakeside Star Buds location and was effective
on February 3, 2021. The lease with 14655 Arapahoe LLC and Montview Real Estate LLC is for the Company’s Arapahoe and Aurora locations,
respectively, and was effective on March 2, 2021. The 428 S McCulloch LLC, 5844 Ventures LLC and 5238 W 44th LLC provides for
a monthly rent payment of $5,000 with an aggregate of $180,000 during the initial term of the leases. The Colorado Real Estate Holdings
LLC lease provides for a monthly rent payment of $6,779 with an aggregate of $244,044 during the initial term of the lease. The 14655
Arapahoe LLC lease provides for a monthly rent payment of $12,367 with an aggregate of $445,212 during the initial term of the lease.
The Montview Real Estate LLC lease provides for a monthly rent of $6,250 with an aggregate of $225,000 during the initial term of the
lease. During 2020, SBUD LLC made aggregate rent payments of $10,000. Between January 1, 2021 and September 30, 2021, SBUD LLC made aggregate
rent payments of $328,109. In addition, SBUD LLC must pay each landlord’s expenses and disbursements incurred in connection with
the ownership, operation, maintenance, repair and replacement of the premises. SBUD LLC has the option to renew each lease for two additional
three-year terms with escalation. The Company has an option to purchase the premises at fair market value at any time during the lease
term and also has a right of first refusal if the landlords desire to sell the premises to a third party.
On December 17, 2020, SBUD, LLC entered into a
Trademark License Agreement with Star Brands LLC under which Star Brands LLC licenses certain trademarks to SBUD, LLC effective as of
the closing of the acquisitions of all of the Star Buds assets. SBUD LLC has no payment obligation under this agreement. Mr. Ruden is
a part-owner of Star Brands LLC.
In connection with the Star Buds acquisitions,
the Company granted Mr. Ruden and Naser Joudeh the right designate individuals for election or appointment to the Board.
Transactions with John Sacun
The Company sold material on behalf of John Sacun
of $50,578. This transaction occurred due to orders placed prior to acquisition by the Company which needed to be fulfilled to the customer.
An agreement was reached to provide payment to Mr. Sacun for the profit associated with the sale.
As of September 30, 2021, and December 31,
2020, respectively, the Company had $4,518,125
and $2,090,886 of
finished goods inventory. As of September 30, 2021, the Company had $5,598,515
of work in process and $561,741
of raw materials. As of December 31, 2020, the Company had $500,917
of work in process and $27,342
of raw materials. The Company uses the FIFO inventory valuation method. As of September 30, 2021 and December 31, 2020, the
Company did not
recognize any impairment for obsolescence within its inventory.
On June 3, 2017, the Company issued an aggregate
of 7,000,000 shares of its common stock for 100% ownership of both Success Nutrients and Pono Publications. The Company utilized purchase
price accounting stating that net book value approximates fair market value of the assets acquired. The purchase price accounting resulted
in $6,301,080 of goodwill.
On July 21, 2017, the Company issued 2,258,065
shares of its common stock for 100% ownership of Denver Consulting Group (“DCG”). The Company utilized purchase price accounting
stating that net book value approximates fair market value of the assets acquired. The purchase price accounting resulted in $3,003,226
of goodwill.
On September 17, 2018, we closed the acquisition
of The Big Tomato. The Company issued an aggregate of 1,933,329 shares of its common stock for 100% ownership of The Big Tomato. The Company
utilized purchase price accounting stating that net book value approximates fair market value of the assets acquired. The purchase price
accounting resulted in the Company valuing the investment as $3,000,000 of goodwill.
On April 20, 2020, the Company closed the acquisition
of Mesa Organics. The aggregate purchase price after working capital adjustments was $2,609,500 of cash and 2,554,750 shares of the Company’s
Common Stock. The Company accounted for the transaction utilizing purchase price accounting stating that the book value approximates the
fair market value of the assets acquired. The purchase price accounting resulted in the Company valuing the investment as $2,147,613 of
goodwill.
From December 2020 through March 2021, the Company
closed the acquisition of thirteen Star Buds dispensaries and one cultivation facility. The aggregate purchase price was $118,000,000.
The Company accounted for the transaction utilizing purchase price accounting stating that the book value approximates the fair market
value of the assets acquired. The purchase price accounting resulted in the Company valuing the investment as $27,054,025 of goodwill.
On July 21, 2021 the Company closed the acquisition
of Southern Colorado Growers. The Company utilized purchase price accounting stating that net book value approximates fair market value
of the assets acquired. The purchase price accounting resulted in $585,000 of goodwill.
As of September 30, 2021, the Company
had $42,090,944 of goodwill, which consisted of $6,301,080
from Success Nutrients and Pono Publications, $3,003,226
from DCG, $3,000,000
from The Big Tomato, $2,147,613
from Mesa Organics, $27,054,025
from Star Buds, and $585,000
from Southern Colorado Growers.
Term Loan — On February 26, 2021, the Company
entered into a Loan Agreement with SHWZ Altmore, LLC and GGG Partners LLC, as collateral agent. Upon execution of the Loan
Agreement, the Company received $10,000,000.
In connection with the Company’s acquisition of Southern Colorado Growers, an additional $5,000,000
was added to the Loan Agreement. The term loan incurs 15%
interest per annum, due quarterly on March 1, June 1, September 1, and December 1 of each year. Principal payments begin on June 1,
2023 in the amount of $750,000,
with the remainder of the principal due upon maturity on February
26, 2025.
Under the terms of the loan, the Company must comply with certain restrictions.
These include customary events of default and specified representations as well as various financial ratio requirements including, (i)
a consolidated fixed charge coverage ratio of at least 1.3 at the end of each fiscal quarter beginning in the first quarter of 2022, and
(ii) a minimum of $3,000,000 in a deposit account in which the lender has a security interest. As of September 30, 2021, the Company was
in compliance with the requirements described above.
Seller Notes — As part of the acquisition
of the Star Buds assets, the Company entered into a deferred payment arrangement with the sellers for $44,250,000. The deferred payment
arrangement incurs 12% interest per annum, payable on the 1st of every month through November 2025. Principal payments are
due as follows: $13,901,759 on December 17, 2025, $3,474,519 on February 3, 2026, and $26,873,722 on March 2, 2026.
Leases with an initial term of 12 months or less
are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. Leases
with a term greater than one year are recognized on the balance sheet at the time of lease commencement or modification of an ROU operating
lease asset and a lease liability, initially measured at the present value of the lease payments. Lease costs are recognized in the income
statement over the lease term on a straight-line basis. ROU assets represent our right to use an underlying asset for the lease term and
lease liabilities represent our obligation to make lease payments arising from the lease.
The Company's leases consist of real estate leases
for office spaces. The Company elected to combine the lease and related non-lease components for its operating leases.
The Company’s operating leases include options
to extend or terminate the lease, which are not included in the determination of the ROU asset or lease liability unless reasonably certain
to be exercised. The Company's operating leases have remaining lease terms of less than two years. The Company’s lease agreements
do not contain any material residual value guarantees or material restrictive covenants.
As the Company's leases do not provide an implicit
rate, we used an incremental borrowing rate based on the information available at the lease commencement date in determining the present
value of lease payments. The discount rate used in the computations ranged between 6% and 12%.
Balance
Sheet Classification of Operating Lease Assets and Liabilities
Balance Sheet Classification Table
|
|
|
|
|
|
|
|
|
Balance Sheet Line
|
|
September 30, 2021
|
|
Asset
|
|
|
|
|
|
|
Operating lease right of use assets
|
|
Noncurrent assets
|
|
$
|
3,626,617
|
|
Liabilities
|
|
|
|
|
|
|
Lease liabilities
|
|
Noncurrent liabilities
|
|
$
|
3,807,306
|
|
Lease Costs
The table below summarizes the components of lease costs for the nine
months ended September 30, 2021.
Operating Lease Costs
|
|
|
|
|
|
Nine Months Ended September 30, 2021
|
|
Operating lease costs
|
|
$
|
1,023,267
|
|
Maturities of Lease Liabilities
Maturities of lease liabilities as of September
30, 2021 are as follows:
Maturities of Lease Liabilities
|
|
|
|
|
2021 fiscal year
|
|
$
|
4,439,713
|
|
Less: Interest
|
|
|
281,227
|
|
Present value of lease liabilities
|
|
$
|
4,158,486
|
|
The following table presents the Company’s future minimum lease
obligation under ASC 842 as of September 30, 2021:
Future minimum lease obligations
|
|
|
|
|
2021 fiscal year
|
|
$
|
370,131
|
|
2022 fiscal year
|
|
|
1,479,393
|
|
2023 fiscal year
|
|
|
1,354,595
|
|
2024 fiscal year
|
|
|
723,590
|
|
2025 fiscal year
|
|
|
333,356
|
|
Total
|
|
$
|
4,261,065
|
|
The Company is authorized to issue two classes
of stock, designated preferred stock and common stock.
Preferred Stock
The number of shares of preferred stock authorized
is 10,000,000, par value $0.001 per share. The preferred stock may be divided into such number of series as the Board may determine. The
Board is authorized to determine and alter the rights, preferences, privileges and restrictions granted and imposed upon any wholly unissued
series of preferred stock, and to fix the number and designation of shares of any series of preferred stock. The Board, within limits
and restrictions stated in any resolution of the Board, originally fixing the number of shares constituting any series may increase or
decrease, but not below the number of such series then outstanding, the shares of any subsequent series.
The Company had 82,838 shares of Series A Preferred
Stock issued and outstanding and 4,428 in escrow as of September 30, 2021 and 18,327 shares of Series A Preferred Stock issued and outstanding
and 1,389 in escrow as of December 31, 2020. Among other terms, each share of Series A Preferred Stock (i) earns an annual dividend of
8% on the “preference amount,” which initially is equal to the $1,000 per-share purchase price and subject to increase, by
having such dividends automatically accrete to, and increase, the outstanding preference amount; (ii) is entitled to a liquidation preference
under certain circumstances, (iii) is convertible into shares of the Company’s common stock by dividing the preference amount by
$1.20 per share under certain circumstances, and (iv) is subject to a redemption right or obligation under certain circumstances.
Common Stock
The Company is authorized to issue 250,000,000
shares of common stock at a par value of $0.001.
The Company had 45,139,297
shares of common stock issued, and 44,400,853
shares of common stock outstanding, 517,044
of treasury stock and 221,400 of stock in escrow as of September 30, 2021, and 42,601,773
shares of common stock issued, and 42,169,041
shares of common stock outstanding and 432,732
of treasury stock as of December 31, 2020.
Common Stock Issued in Private Placements
During the year ended December 31, 2020, the Company
issued 187,500 shares of common stock and warrants to purchase 187,500 shares of common stock, for gross proceeds of $375,000.
Common
Stock Issued as Compensation to Employees, Officers,
and Directors
On April 3, 2020, the Company cancelled 500,000
shares of common stock, with vesting conditions represented as derivative instruments. These shares were incorrectly issued as restricted
shares instead of restricted stock units to an officer of the Company, Paul Dickman, on January 8, 2019.
For
the year ended December 31, 2020, the Company issued 406,895 shares
of common stock valued at $497,301 to
employees, officers, and directors as compensation.
During the nine months ended
September 30, 2021, the Company issued 323,530
shares of common stock valued at $557,998
to employees, and directors as compensation.
Common and Preferred Stock Issued as Payment
for Acquisitions
On April 20, 2020, the Company issued 2,554,750
shares of common stock valued at $4,167,253 for the acquisition of Mesa Organics, Ltd.
On December 17, 2020, the Company issued 2,862 shares
of Series A Preferred Stock valued at $2,861,994
of which 430
shares of Series A Preferred Stock valued at $387,000
were placed in escrow, and on December 18, 2020, the Company issued 6,404 shares
of Series A Preferred Stock valued at $6,403,987
of which 959 shares
of Series A Preferred Stock valued at $863,100
were placed in escrow, for the acquisition of Star Buds assets.
On February 3, 2021, the Company issued 2,319
shares of Series A Preferred Stock valued at $2,318,998 of
which 349
shares of Series A Preferred Stock valued at $314,100
were placed in escrow and on March 3, 2021, the Company issued 17,921 shares
of Series A Preferred Stock valued at $17,920,982
of which 2,690
shares of Series A Preferred Stock valued at $2,421,000
were placed in escrow for the acquisition of Star Buds assets.
On July 21, 2021, the Company issued 2,213,994
shares of common stock valued at $5,377,786 of which 221,400 shares valued at $537,779 were placed in escrow for the acquisition of Southern
Colorado Growers.
Warrants
The Company accounts for common stock purchase
warrants in accordance with ASC 480, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s
Own Stock, Distinguishing Liabilities from Equity. The Company estimates the fair value of warrants at date of grant using the Black-Scholes
option pricing model. There is a moderate degree of subjectivity involved when using option pricing models to estimate the warrants, and
the assumptions used in the Black Scholes option-pricing model are moderately judgmental.
During the nine months ended September 30,
2021, the Company issued warrants to purchase an aggregate of 3,793,530 shares
of common stock as purchase consideration for the acquisition of certain Star Buds assets. These warrants have an exercise price of
$1.20 per
share and expiration dates five years from the date of issuance. In addition, the Company issued a warrant to purchase an aggregate
of 1,500,000 shares of common stock to an accredited investor in connection with entering into a loan agreement. This warrant has an
exercise price of $2.50 per
share and expires five years from the date of issuance. The Company estimated the fair value of these warrants at date of grant
using the Black-Scholes option pricing model using the following inputs: (i) stock price on the date of grant of $1.20 and
$2.50,
respectively, (ii) the contractual term of the warrant of 5
years, (iii) a risk-free interest rate ranging between 0.21%
- 1.84%
and (iv) an expected volatility of the price of the underlying common stock ranging between 157.81%
- 195.00%.
The following table reflects the change in common
stock purchase warrants for the nine months ended September 30, 2021:
Schedule of warrant activity
|
|
|
|
|
|
|
Number of shares
|
|
Balance as of January 1, 2021
|
|
|
11,725,220
|
|
Warrants exercised
|
|
|
–
|
|
Warrants forfeited
|
|
|
–
|
|
Warrants issued
|
|
|
5,293,530
|
|
Balance as of September 30, 2021
|
|
|
17,018,750
|
|
Option Repricing
On December 15, 2020, the Board repriced certain
outstanding stock options issued to the Company’s current employees. The repriced stock options had original exercise prices ranging
from $1.52 per share to $3.83 per share. All of these stock options to current employees were repriced to have an exercise price of $1.26
per share, which was the closing price of the Company’s common stock on December 15, 2020. Each of the options has a new 10-year
term from the repricing date.
The Company has three identifiable segments
as of September 30, 2021; (i) retail, (ii) wholesale and (iii) and other. The retail segment represents our dispensaries which sell
merchandise directly to customers via retail locations and e-commerce portals. The wholesale segment represents our manufacturing,
cultivation, and wholesale business which sells merchandise to customers via e-commerce portals, a retail location, and manufacturing
facility. The other segment derives its revenue from licensing and consulting agreements with cannabis related entities, in addition
to fees from seminars and expense reimbursements included in other revenue on the Company’s financial statements.
The
following information represents segment activity for the three-month periods ended September 30, 2021 and September 30, 2020:
Schedule
of Segment Reporting Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months Ended
|
|
|
For the Three
Months Ended
|
|
|
|
30-September-2021
|
|
|
30-September-2020
|
|
|
|
Retail
|
|
|
Wholesale
|
|
|
Other
|
|
|
Total
|
|
|
Retail
|
|
|
Wholesale
|
|
|
Other
|
|
|
Total
|
|
Revenues
|
|
|
20,741,863
|
|
|
|
11,022,520
|
|
|
|
70,922
|
|
|
|
31,835,305
|
|
|
|
1,135,820
|
|
|
|
6,273,899
|
|
|
|
20,655
|
|
|
|
7,430,374
|
|
Cost
of goods and services
|
|
|
(9,469,080
|
)
|
|
|
(7,258,213
|
)
|
|
|
(52,020
|
)
|
|
|
(16,779,313
|
)
|
|
|
(614,763
|
)
|
|
|
(3,870,475
|
)
|
|
|
(163,672
|
)
|
|
|
(4,648,910
|
)
|
Gross profit
|
|
|
11,272,782
|
|
|
|
3,764,308
|
|
|
|
18,903
|
|
|
|
15,055,992
|
|
|
|
521,057
|
|
|
|
2,403,424
|
|
|
|
(143,017
|
)
|
|
|
2,781,464
|
|
Intangible
assets amortization
|
|
|
2,525,875
|
|
|
|
79,855
|
|
|
|
2,552
|
|
|
|
2,608,282
|
|
|
|
–
|
|
|
|
1,530
|
|
|
|
135
|
|
|
|
1,665
|
|
Depreciation
|
|
|
(56,543
|
)
|
|
|
83,725
|
|
|
|
224,131
|
|
|
|
364,399
|
|
|
|
131,903
|
|
|
|
4,505
|
|
|
|
89,950
|
|
|
|
226,358
|
|
Net
income (loss)
|
|
|
5,168,758
|
|
|
|
3,123,377
|
|
|
|
(7,323,379
|
)
|
|
|
968,756
|
|
|
|
183,306
|
|
|
|
1,893,813
|
|
|
|
(4,991,285
|
)
|
|
|
(2,914,211
|
)
|
Segment assets
|
|
|
129,912,570
|
|
|
|
41,075,819
|
|
|
|
23,742,906
|
|
|
|
194,731,295
|
|
|
|
237,524
|
|
|
|
(188,123
|
)
|
|
|
(3,365,733
|
)
|
|
|
3,316,332
|
)
|
The
following information represents segment activity for the nine-month periods ended September 30, 2021 and September 30, 2020:
|
|
For The Nine
Months Ended
|
|
|
For The Nine
Months Ended
|
|
|
|
30-September-2021
|
|
|
30-September-2020
|
|
|
|
Retail
|
|
|
Wholesale
|
|
|
Other
|
|
|
Total
|
|
|
Retail
|
|
|
Wholesale
|
|
|
Other
|
|
|
Total
|
|
Revenues
|
|
|
54,083,880
|
|
|
|
27,654,965
|
|
|
|
165,416
|
|
|
|
81,904,261
|
|
|
|
1,868,279
|
|
|
|
12,909,025
|
|
|
|
1,280,533
|
|
|
|
16,057,837
|
|
Cost
of goods and services
|
|
|
(26,532,199
|
)
|
|
|
(17,950,322
|
)
|
|
|
(210,244
|
)
|
|
|
(44,692,765
|
)
|
|
|
(1,091,848
|
)
|
|
|
(8,122,860
|
)
|
|
|
(689,423
|
)
|
|
|
(9,904,131
|
)
|
Gross profit
|
|
|
27,551,680
|
|
|
|
9,704,644
|
|
|
|
(44,827
|
)
|
|
|
37,211,496
|
|
|
|
776,431
|
|
|
|
4,786,165
|
|
|
|
591,110
|
|
|
|
6,153,706
|
|
Intangible
assets amortization
|
|
|
6,745,121
|
|
|
|
211,222
|
|
|
|
5,311
|
|
|
|
6,961,654
|
|
|
|
–
|
|
|
|
4,557
|
|
|
|
403
|
|
|
|
4,960
|
|
Depreciation
|
|
|
130,749
|
|
|
|
237,638
|
|
|
|
449,787
|
|
|
|
818,174
|
|
|
|
208,351
|
|
|
|
9,098
|
|
|
|
99,883
|
|
|
|
317,332
|
|
Net
income (loss)
|
|
|
13,210,770
|
|
|
|
8,456,852
|
|
|
|
(19,978,333
|
)
|
|
|
1,689,289
|
|
|
|
106,517
|
|
|
|
3,342,360
|
|
|
|
(14,338,059
|
)
|
|
|
(10,889,228
|
)
|
Segment
assets
|
|
|
129,912,570
|
|
|
|
41,075,819
|
|
|
|
23,742,906
|
|
|
|
194,731,295
|
|
|
|
1,967,680
|
|
|
|
20,595,696
|
|
|
|
10,133,257
|
|
|
|
32,696,633
|
|
The following table summarizes the
Company’s income tax expense and effective tax rates for the three months and nine months ended September 30, 2021 and
September 30, 2020:
Components of income tax expense
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2021
|
|
|
2020
|
|
Income (loss) before income taxes
|
|
$
|
2,281,573
|
|
|
$
|
(2,914,211
|
)
|
Income tax expense
|
|
|
1,312,817
|
|
|
|
–
|
|
Effective tax rate
|
|
|
57.54%
|
|
|
|
0%
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2021
|
|
|
2020
|
|
Income (loss) before income taxes
|
|
$
|
3,687,194
|
|
|
$
|
(10,889,228
|
)
|
Income tax expense
|
|
|
1,997,905
|
|
|
|
–
|
|
Effective tax rate
|
|
|
54.18%
|
|
|
|
0%
|
|
The Company has computed its provision for income
taxes under the discrete method which treats the year-to-date period as if it were the annual period and determines the income tax expense
or benefit on that basis. The discrete method is applied when application of the estimated annual effective tax rate is impractical because
it is not possible to reliably estimate the annual effective tax rate. We believe that, at this time, the use of this discrete method
is more appropriate than the annual effective tax rate method as the estimated annual effective tax rate method is not reliable due to
the high degree of uncertainty in estimating annual pre-tax income due to the early growth stage of the business.
Due to its cannabis operations, the Company is
subject to the limitations of IRC Section 280E under which the Company is only allowed to deduct
expenses directly related to sales of product. This results in permanent differences between ordinary and necessary business expenses
deemed non-allowable under IRC Section 280E.
The effective tax rate for the three months and
nine months ended September 30, 2021 varies from the three months and nine months ended September 30, 2020 primarily due to IRC Section
280E. The Company acquired plant-touching cannabis operations during 2020 and 2021 and these plant-touching operations are subject to
the limitations of IRC Section 280E. In April 2020, the Company acquired its first plant-touching business, Mesa Organics. Prior to this
acquisition, the Company was not subject to IRC Section 280E.
In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The Company's valuation allowance represents the amount of tax benefits that are likely to not be realized. Management assesses the need
for a valuation allowance each period and continues to have a full valuation allowance on its deferred tax assets as of September 30, 2021.
The Federal statute of limitation remains open
for the 2017 tax year to present. The state statute of limitation remains open for the 2016 tax year to present.
In accordance with FASB ASC 855-10, Subsequent
Events, the Company has analyzed its operations subsequent to September 30, 2021 to the date these consolidated financial statements
were issued, and has determined that it does not have any material subsequent events to disclose in these consolidated financial statements,
exclusive of those noted below.
On November 15, 2021, the Company signed definitive
documents to acquire the assets of Smoking Gun, LLC and Smoking Gun Land Company, LLC (“Smoking Gun”).
Total consideration for the acquisition will be
$4 million in cash and 100,000 shares of Schwazze common stock upon closing. The acquisition is expected to close during the fourth quarter
of 2021, subject to closing conditions and covenants customary for this type of transaction, including, without limitation, obtaining
Colorado Marijuana Enforcement Division and local licensing approval.