1.
Incorporation and Operations and Going Concern
Stem
Holdings, Inc. (“Stem” or the “Company”) is a Nevada corporation incorporated on June 7, 2016, and is a leading
omnichannel, vertically-integrated cannabis branded products and technology company with state-of-the-art cultivation, processing, extraction,
retail, distribution, and delivery-as-a-service (DaaS) operations throughout the United States. Stem’s family of award-winning
brands includes TJ’s Gardens™, TravisxJames™, and Yerba Buena™ flower and extracts; Cannavore™ edible confections;
and e-commerce delivery platforms provide direct-to consumer proprietary logistics and an omnichannel UX (user experience)/CX (customer
experience).
The
Company leases and operates in properties for use in the production, distribution and sales of cannabis and cannabis-infused products
licensed under the laws of the states of Oregon, Nevada, and California. As of June 30, 2023, Stem had ownership interests in 21 state
issued cannabis licenses including nine (9) licenses for cannabis cultivation, two (2) licenses for cannabis processing, one (1) license
for cannabis wholesale distribution, three (3) licenses for hemp production and (6) cannabis dispensary licenses.
The
Company has eight wholly-owned subsidiaries, including Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC, Stem Oregon Acquisitions
1, Corp., Stem Oregon Acquisitions 2, Corp., Stem Oregon Acquisitions 3, Corp., Stem Oregon Acquisitions 4 Corp., 2336034 Alberta Ltd.
Stem, through its subsidiaries, is currently in the process of seeking to be acquired by entities directly in the production and sale
of cannabis. Driven Deliveries, Inc., a former wholly-owned subsidiary, was sold during the quarter ended December 31, 2021 (see Note
3).
The
Company’s stock is publicly traded and is listed on the Canadian Securities Exchange under the symbol “STEM” and the
OTCQB exchange under the symbol “STMH”.
In
June 2021, the Company’s shareholders approved a proposal to amend the Company’s Articles of Incorporation to increase the
number of authorized common shares from 300,000,000 shares to 750,000,000 shares.
Going
Concern
On
June 30, 2023, the Company had approximate balances of cash and cash equivalents of $1.7 million, negative working capital of approximately
$2.1 million, and an accumulated deficit of $140.5 million.
These
unaudited condensed consolidated financial statements have been prepared on a going concern basis, which assumes that the Company will
be able to realize its assets and discharge its liabilities in the normal course of business.
While
the recreational use of cannabis is legal under the laws of certain States, the use and possession of cannabis is illegal under United
States Federal Law for any purpose, by way of Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970, otherwise
known as the Controlled Substances Act of 1970 (the “ACT”). Cannabis is currently included under Schedule 1 of the Act, making
it illegal to cultivate, sell or otherwise possess in the United States.
On
January 4, 2018, the office of the Attorney General published a memo regarding cannabis enforcement that rescinds directives promulgated
under former President Obama that eased federal enforcement. In a January 8, 2018 memo, Jefferson B. Sessions, then Attorney General
of the United States, indicated enforcement decisions will be left up to the U.S. Attorney’s in their respective states clearly
indicating that the burden is with “federal prosecutors deciding which cases to prosecute by weighing all relevant considerations,
including federal law enforcement priorities set by the Attorney General, the seriousness of the crime, the deterrent effect of federal
prosecution, and the cumulative impact of particular crimes on the community.” Subsequently, in April 2018, former President Trump
promised to support congressional efforts to protect states that have legalized the cultivation, sale, and possession of cannabis;
however, a bill has not yet been finalized in order to implement legislation that would, in effect, make clear the federal government
cannot interfere with states that have voted to legalize cannabis. Further in December 2018, the U.S. Congress passed legislation, which
the President signed on December 20, 2018, removing hemp from being included with Cannabis in Schedule I of the Act.
In
December 2019, an outbreak of a novel strain of coronavirus (COVID-19) originated in Wuhan, China, and has since spread to several other
countries, including the United States. On June 11, 2020, the World Health Organization characterized COVID-19 as a pandemic. In addition,
as of the time of the filing of this Annual Report on Form 10-K, several states in the United States have declared states of emergency,
and several countries around the world, including the United States, have taken steps to restrict travel. The existence of a worldwide
pandemic, the fear associated with COVID-19, or any, pandemic, and the reactions of governments in response to COVID-19, or any, pandemic,
to regulate the flow of labor and products and impede the travel of personnel, may impact our ability to conduct normal business operations,
which could adversely affect our results of operations and liquidity. Disruptions to our supply chain and business operations disruptions
to our retail operations and our ability to collect rent from the properties which we own, personnel absences, or restrictions on the
shipment of our or our suppliers’ or customers’ products, any of which could have adverse ripple effects throughout our business.
If we need to close any of our facilities or a critical number of our employees become too ill to work, our production ability could
be materially adversely affected in a rapid manner. Similarly, if our customers experience adverse consequences due to COVID-19, or any
other, pandemic, demand for our products could also be materially adversely affected in a rapid manner. Global health concerns, such
as COVID-19, could also result in social, economic, and labor instability in the markets in which we operate. Any of these uncertainties
could have a material adverse effect on our business, financial condition, or results of operations.
These
conditions raise substantial doubt as to the Company’s ability to continue as a going concern. Should the United States Federal
Government choose to begin enforcement of the provisions under the “ACT”, the Company through its wholly owned subsidiaries
could be prosecuted under the “ACT” and the Company may have to immediately cease operations and/or be liquidated upon its
closing of the acquisition or investment in entities that engage directly in the production and or sale of cannabis.
Management
believes that the Company has access to capital resources through potential public or private issuances of debt or equity securities.
However, if the Company is unable to raise additional capital, it may be required to curtail operations and take additional measures
to reduce costs, including reducing its workforce, eliminating outside consultants, and reducing legal fees to conserve its cash in amounts
sufficient to sustain operations and meet its obligations. The Company is also in the process of seeking business combinations by entities
directly in the production and sale of cannabis. These matters raise substantial doubt about the Company’s ability to continue
as a going concern. The accompanying consolidated financial statements do not include any adjustments that might become necessary should
the Company be unable to continue as a going concern.
2.
Summary of Significant Accounting Policies
Basis
of Presentation
The
Company’s consolidated financial statements been prepared in accordance with accounting principles generally accepted in the United
States (“GAAP”). The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.
All material intercompany accounts and transactions have been eliminated during the consolidation process. The Company manages its operations
as a single segment for the purposes of assessing performance and making operating decisions.
The
accompanying interim condensed consolidated financial statements are unaudited. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements contain all the normal recurring adjustments necessary to present fairly the financial position
and results of operations as of and for the periods presented. The interim results are not necessarily indicative of the results to be
expected for the full year or any future period.
Certain
information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities
and Exchange Commission (“SEC”). The Company believes that the disclosures are adequate to make the interim information presented
not misleading. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial
statements and the notes thereto included in the Company’s Report on Form 10-K filed on January 13, 2023, for the year ended September
30, 2022.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the application
of accounting policies and the reported amounts of assets, liabilities, income, and expenses. The most significant estimates included
in these consolidated financial statements are those associated with the assumptions used to value equity instruments, valuation of its
long live assets for impairment testing, valuation of intangible assets, and the valuation of inventory. These estimates and assumptions
are based on current facts, historical experience and various other factors believed to be reasonable given the circumstances that exist
at the time the financial statements are prepared. Actual results may differ materially and adversely from these estimates. To the extent
there are material differences between the estimates and actual results, the Company’s future results of operations will be affected.
Reclassifications
Certain
amounts in the Company’s consolidated financial statements for prior periods have been reclassified to conform to the current period
presentation. These reclassifications have not changed the results of operations of prior periods.
Principles
of Consolidation
The
Company’s policy is to consolidate all entities that it controls by ownership of a majority of the outstanding voting stock. In
addition, the Company consolidates entities that meet the definition of a variable interest entity (“VIE”) for which it is
the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a VIE that most significantly
impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits
from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third
party’s holding of equity interest is presented as noncontrolling interests in the Company’s Consolidated Balance Sheets
and Consolidated Statements of Changes in Stockholders’ Equity. The portion of net loss attributable to the noncontrolling interests
is presented as net loss attributable to noncontrolling interests in the Company’s Consolidated Statements of Operations.
The
accompanying consolidated financial statements include the accounts of Stem Holdings, Inc. and its wholly owned subsidiaries, Stem Holdings
Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC, Stem Oregon Acquisitions 2 Corp., Stem Oregon Acquisitions 3 Corp., Stem Oregon Acquisitions
4 Corp., 7LV USA Corporation, and Stem Oregon Acquisitions 1 Corp., which was subsequently divested. In addition, the Company has consolidated
YMY Ventures, WCV, LLC and NVD RE, Inc. under the variable interest requirements.
Cash
and Cash Equivalents
The
Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash
equivalents. Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash
equivalents. The Company’s cash is primarily maintained in checking accounts. These balances may, at times, exceed the U.S.
Federal Deposit Insurance Corporation insurance limits. As of June 30, 2023, and September 30, 2022, the Company had no cash
equivalents or short-term investments. In accordance with certain secured debentures received this quarter in the amount of
$545,000, the Company set up and deposited this amount into a IOLTA trust account held in escrow to securitize these instruments
(see Note 12). The Company has not experienced any losses on deposits of cash and cash equivalents to date.
Accounts
Receivable
Accounts
receivable is shown on the face of the consolidated balance sheets, net of an allowance for doubtful accounts. The Company analyzes the
aging of accounts receivable, historical bad debts, customer creditworthiness and current economic trends, in determining the allowance
for doubtful accounts. The Company does not accrue interest receivable on past due accounts receivable. As of June 30, 2023, and September
30, 2022, the reserve for doubtful accounts was $79 for both periods.
Inventory
Inventory
is comprised of raw materials, finished goods and work-in-progress such as pre-harvested cannabis plants and by-products to be extracted.
The costs of growing cannabis including but not limited to labor, utilities, nutrition, and irrigation, are capitalized into inventory
until the time of harvest.
Inventory
is stated at the lower of cost or net realizable value, determined using weighted average cost. Cost includes expenditures directly related
to manufacturing and distribution of the products. Primary costs include raw materials, packaging, direct labor, overhead, shipping and
the depreciation of manufacturing equipment and production facilities determined at normal capacity. Manufacturing overhead and related
expenses include salaries, wages, employee benefits, utilities, maintenance, and property taxes.
Net
realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion,
disposal, and transportation. At the end of each reporting period, the Company performs an assessment of inventory obsolescence to measure
inventory at the lower of cost or net realizable value. Factors considered in the determination of obsolescence include slow-moving or
non-marketable items.
Prepaid
Expenses and Other Current Assets
Prepaid
expenses consist of various payments that the Company has made in advance for goods or services to be received in the future. These prepaid
expenses include consulting, advertising, insurance, and service or other contracts requiring up-front payments.
Property
and Equipment
Property,
equipment, and leasehold improvements are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. Repairs and maintenance expenditures that do not extend the useful lives of related
assets are expensed as incurred.
Expenditures
for major renewals and improvements are capitalized, while minor replacements, maintenance, and repairs, which do not extend the asset
lives, are charged to operations as incurred. Upon sale or disposition, the cost and related accumulated depreciation are removed from
the accounts and any gain or loss is included in operations. The Company continually monitors events and changes in circumstances that
could indicate that the carrying balances of its property, equipment and leasehold improvements may not be recoverable in accordance
with the provisions of ASC 360, “Property, Plant, and Equipment.” When such events or changes in circumstances are present,
the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered
through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets,
the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets. See “Note
3 – Property, Equipment and Leasehold Improvements”.
Property
and equipment are stated at cost less accumulated depreciation. Depreciation is provided on a straight-line method over the estimated
useful lives of the assets. The Company estimates useful lives as follows:
Schedule
of Estimated Useful Life of Assets
| Buildings |
20
years |
| Leasehold
improvements |
Shorter
of term of lease or economic life of improvement* |
| Furniture
and equipment |
5
years |
| Signage |
5
years |
| Software
and related |
5
years |
Impairment
of Long-Lived Assets
The
Company reviews the carrying value of its long-lived assets, which include property and equipment, for indicators of impairment whenever
events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. The Company considers
the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or
losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use
of assets or in the Company’s overall strategy with respect to the manner or use of the acquired assets or changes in the Company’s
overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant
decline in the Company’s stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates assets
for potential impairment indicators at least annually and more frequently upon the occurrence of such events. The Company does not test
for impairment in the year of acquisition of properties, as long as those properties are acquired from unrelated third parties.
The
Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the
related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying
amounts. In cases where estimated future net undiscounted cash flows are less than the carrying value, an impairment loss is recognized
equal to an amount by which the carrying value exceeds the fair value of the asset or asset group. Fair value is generally determined
using the assets expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined
to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values
of the long-lived assets are depreciated and amortized prospectively over the newly determined remaining estimated useful lives.
Equity
Method Investments
Investments
in unconsolidated affiliates are accounted for under the equity method of accounting, as appropriate. The Company accounts for investments
in limited partnerships or limited liability corporations, whereby the Company owns a minimum of 5.0% of the investee’s outstanding
voting stock, under the equity method of accounting. These investments are recorded at the amount of the Company’s investment and
adjusted each period for the Company’s share of the investee’s income or loss, and dividends paid.
During
the nine months ended June 30, 2023, the Company recorded $0 of investee losses.
Asset
Acquisitions
The
Company has adopted ASU 2017-01, which clarifies the definition of a business with the objective of adding guidance to assist entities
with evaluating whether transactions should be accounted for as businesses acquisitions. As a result of adopting ASU 2017-01, acquisitions
of real estate and cannabis licenses do not meet the definition of a business combination and were deemed asset acquisitions, and the
Company therefore capitalized these acquisitions, including its costs associated with these acquisitions.
Goodwill
and Intangible Assets
Goodwill.
Goodwill represents the excess acquisition cost over the fair value of net tangible and intangible assets acquired. Goodwill is not
amortized and is subject to annual impairment testing on or between annual tests if an event or change in circumstance occurs that would
more likely than not reduce the fair value of a reporting unit below its carrying value. In testing for goodwill impairment, the Company
has the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination
that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality
of events and circumstances, the Company concludes that it is not more likely than not that the fair value of a reporting unit is less
than its carrying amount, then performing the two-step impairment test is not required. If the Company concludes otherwise, the Company
is required to perform the two-step impairment test. The goodwill impairment test is performed at the reporting unit level by comparing
the estimated fair value of a reporting unit with its respective carrying value. If the estimated fair value exceeds the carrying value,
goodwill at the reporting unit level is not impaired. If the estimated fair value is less than the carrying value, further analysis is
necessary to determine the amount of impairment, if any, by comparing the implied fair value of the reporting unit’s goodwill to
the carrying value of the reporting unit’s goodwill. No goodwill impairment expense was incurred for the nine months ended June
30, 2023, and 2022, respectively.
Intangible
Assets. Intangible assets deemed to have finite lives are amortized on a straight-line basis over their estimated useful lives, where
the useful life is the period over which the asset is expected to contribute directly, or indirectly, to our future cash flows. Intangible
assets are reviewed for impairment on an interim basis when certain events or circumstances exist. For amortizable intangible assets,
impairment exists when the carrying amount of the intangible asset exceeds its fair value. At least annually, the remaining useful life
is evaluated. During the nine months ended June 30, 2023, the Company entered into an asset purchase agreement which included the sale
of intangible assets of approximately $222,000. Intangible assets of $471,000 and 0 were impaired for the nine months ended June 30,
2023, and 2022, respectively.
An
intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events
or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment
exists when the carrying amount exceeds its fair value. In testing for impairment, the Company has the option to first perform a qualitative
assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely
than not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required
to perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of
the asset that is amortized over the remaining useful life of that asset, if any. Subsequent reversal of impairment losses is not permitted.
Business
Combinations
The
Company applies the provisions of ASC 805 in the accounting for acquisitions. ASC 805 requires the Company to recognize separately from
goodwill the assets acquired, and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date
is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the
liabilities assumed. While the Company uses its best estimates and assumptions to accurately apply preliminary value to assets acquired
and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, these estimates are inherently
uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date,
the Company records adjustments in the current period, rather than a revision to a prior period. Upon the conclusion of the measurement
period or final determination of the values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments
are recorded in the consolidated statements of operations. Accounting for business combinations requires management to make significant
estimates and assumptions, especially at the acquisition date, including estimates for intangible assets, contractual obligations assumed,
restructuring liabilities, pre-acquisition contingencies, and contingent consideration, where applicable. Although the Company believes
the assumptions and estimates made have been reasonable and appropriate, they are based in part on historical experience and information
obtained from management of the acquired companies and are inherently uncertain. Unanticipated events and circumstances may occur that
may affect the accuracy or validity of such assumptions, estimates, or actual results.
Contingent
Consideration
The
Company accounts for “contingent consideration” according to FASB ASC 805, “Business Combinations” (“FASB
ASC 805”). Contingent consideration typically represents the acquirer’s obligation to transfer additional assets or equity
interests to the former owners of the acquiree if specified future events occur or conditions are met. FASB ASC 805 requires that contingent
consideration be recognized at the acquisition-date fair value as part of the consideration transferred in the transaction. FASB ASC
805 uses the fair value definition in Fair Value Measurements, which defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As defined in FASB
ASC 805, contingent consideration is (i) an obligation of the acquirer to transfer additional assets or equity interests to the former
owners of an acquiree as part of the exchange for control of the acquiree, if specified future events occur or conditions are met or
(ii) the right of the acquirer to the return of previously transferred consideration if specified conditions are met.
Warrant
Liability
The
Company accounts for certain common stock warrants outstanding as a liability at fair value and adjusts the instruments to fair value
at each reporting period. This liability is subject to re-measurement at each balance sheet date until exercised, and any change in fair
value is recognized in the Company’s consolidated statements of operations. The fair value of the warrants issued by the Company
has been estimated using a Black Scholes model.
Embedded
Conversion Features
The
Company evaluates embedded conversion features within convertible debt to determine whether the embedded conversion feature(s) should
be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in the statement
of operations. If the conversion feature does not require recognition of a bifurcated derivative, the convertible debt instrument is
evaluated for consideration of any beneficial conversion feature (“BCF”) requiring separate recognition. When the Company
records a BCF, the intrinsic value of the BCF is recorded as a debt discount against the face amount of the respective debt instrument
(offset to additional paid-in capital) and amortized to interest expense over the life of the debt.
Income
Taxes
The
provision for income taxes is determined in accordance with ASC 740, “Income Taxes”. The Company files a consolidated United
States federal income tax return. The Company provides for income taxes based on enacted tax law and statutory tax rates at which items
of income and expense are expected to be settled in our income tax return. Certain items of revenue and expense are reported for Federal
income tax purposes in different periods than for financial reporting purposes, thereby resulting in deferred income taxes. Deferred
taxes are also recognized for operating losses that are available to offset future taxable income. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be realized. The Company has incurred net operating losses for
financial-reporting and tax-reporting purposes. As of June 30, 2023, and September 30, 2022, such net operating losses were offset entirely
by a valuation allowance.
The
Company recognizes uncertain tax positions based on a benefit recognition model. Provided that the tax position is deemed more likely
than not of being sustained, the Company recognizes the largest amount of tax benefit that is greater than 50.0% likely of being ultimately
realized upon settlement. The tax position is derecognized when it is no longer more likely than not of being sustained. The Company
classifies income tax related interest and penalties as interest expense and selling, general and administrative expense, respectively,
on the consolidated statements of operations.
In
December 2017, the Tax Cuts and Jobs Act (TCJA or the Act) was enacted, which significantly changes U.S. tax law. In accordance with
ASC 740, “Income Taxes”, the Company is required to account for the new requirements in the period that includes the date
of enactment. The Act reduced the overall corporate income tax rate to 21.0%, created a territorial tax system (with a one-time mandatory
transition tax on previously deferred foreign earnings), broadened the tax base and allowed for the immediate capital expensing of certain
qualified property.
Revenue
Recognition
The
Company recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration
which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an
entity determines are within the scope of Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic
606), the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations
in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract;
and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only applies the five-step model to
contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services
it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company
assesses the goods or services promised within each contract and determines those that are performance obligations and assesses whether
each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated
to the respective performance obligation when (or as) the performance obligation is satisfied.
Revenue
for the Company’s product sales has not been adjusted for the effects of a financing component as the Company expects, at contract
inception, that the period between when the Company’s transfers control of the product and when the Company receives payment will
be one year or less. Product shipping and handling costs are included in cost of product sales.
The
following policies reflect specific criteria for the various revenue streams of the Company:
Cannabis
Dispensary, Cultivation and Production
Revenue
is recognized upon transfer of retail merchandise to the customer upon sale transaction, at which time its performance obligation is
complete. Revenue is recognized upon delivery of product to the wholesale customer, at which time the Company’s performance obligation
is complete. Terms are generally between cash on delivery to 30 days for the Company’s wholesale customers.
The
Company’s sales environment is somewhat unique, in that once the product is sold to the customer (retail) or delivered (wholesale)
there are essentially no returns allowed or warranty available to the customer under the various state laws.
Delivery
| 1) |
Identify
the contract with a customer |
The
Company sells retail products directly to customers. In these sales there is no formal contract with the customer. These sales have commercial
substance and there are no issues with collectability as the customer pays the cost of the goods at the time of purchase or delivery.
| 2) |
Identify
the performance obligations in the contract |
The
Company sells its products directly to consumers. In this case these sales represent a performance obligation with the sales and any
necessary deliveries of those products.
| 3) |
Determine
the transaction price |
The
sales that are done directly to the customer have no variable consideration or financing component. The transaction price is the cost
that those goods are being sold for plus any additional delivery costs.
| 4) |
Allocate
the transaction price to performance obligations in the contract |
For
the goods that the Company sells directly to customers, the transaction price is allocated between the cost of the goods and any delivery
fees that may be incurred to deliver to the customer.
| 5) |
Recognize
revenue when or as the Company satisfies a performance obligation |
For
the sales of the Company’s own goods the performance obligation is complete once the customer has received the product.
Leases
On
October 1, 2020, the Company adopted ASC 842 and elected to apply the new standard at the adoption date and recognize a cumulative effect
as an adjustment to retained earnings. Upon calculation the effect on retained earnings was immaterial and no adjustment was deemed necessary.
Leases with an initial term of twelve months or less are not recorded on the balance sheet. For lease agreements entered into or reassessed
after the adoption of Topic 842, we combine the lease and non-lease components in determining the lease liabilities and right of use
(“ROU”) assets.
Our
lease agreements generally do not provide an implicit borrowing rate; therefore, an internal incremental borrowing rate is determined
based on information available at lease commencement date for purposes of determining the present value of lease payments. We used the
incremental borrowing rate on June 30, 2023, for all leases that commenced prior to that date. In determining this rate, which is used
to determine the present value of future lease payments, we estimate the rate of interest we would pay on a collateralized basis, with
similar payment terms as the lease and in a similar economic environment.
Under
Topic 842, operating lease expense is generally recognized evenly over the term of the lease. Lease costs were approximately $323,000
and $1,010,000, respectively for the three and nine months ended June 30, 2023, and approximately $331,000 and $763,000, respectively
for the three and nine months ended June 30, 2022. The Company has nine operating leases consisting with remaining lease terms ranging
from 7 months to 167 months.
Lease
Costs
Schedule
of Lease Costs
| | |
Nine Months Ended | | |
Nine Months Ended | |
| | |
June 30, 2023 | | |
June 30, 2022 | |
| Components of total lease costs: | |
| | | |
| | |
| Operating lease expense | |
$ | 1,010 | | |
$ | 763 | |
| Total lease costs | |
$ | 1,010 | | |
$ | 763 | |
Lease
positions as of June 30, 2023
ROU
lease assets and lease liabilities for our operating leases were recorded in the consolidated condensed balance sheet as follows:
Schedule
of Right-of-Use Assets and Liabilities
| | |
June 30, 2023 | |
| Assets | |
| | |
| Right of use asset | |
$ | 7,819 | |
| Total assets | |
$ | 7,819 | |
| | |
| | |
| Liabilities | |
| | |
| Operating lease liabilities – short term | |
$ | 442 | |
| Operating lease liabilities – long term | |
| 7,626 | |
| Total lease liability | |
$ | 8,068 | |
Lease
Terms and Discount Rate
Schedule
of Lease Terms and Discount Rate
| Weighted average remaining lease term (in years) – operating lease | |
| 11.80 | |
| Weighted average discount rate – operating lease | |
| 10.74 | % |
Cash
Flows
Schedule
of Cash Flow Related to Lease
| | |
Nine Months Ended | |
| | |
June 30, 2023 | |
| Cash paid for amounts included in the measurement of lease liabilities: | |
| | |
| ROU amortization | |
$ | 1,010 | |
| Cash paydowns of operating liability | |
$ | (1,010 | ) |
The
future minimum lease payments under the leases are as follows:
Schedule
of Future Minimum Lease Payments
| | |
| | |
| 2023 | |
$ | 331 | |
| 2024 | |
| 1,272 | |
| 2025 | |
| 1,252 | |
| 2026 | |
| 1,271 | |
| 2027 | |
| 1,080 | |
| Thereafter | |
| 9,828 | |
| Total future minimum lease payments | |
| 15,034 | |
| Less: Lease imputed interest | |
| (6,966 | ) |
| Total | |
$ | 8,068 | |
Disaggregation
of Revenue
In
the nine months ended June 30, 2023, revenue reported was primarily from the sale of cannabis and related products accounted for under
ASC 606.
The
following table illustrates our revenue by type related to the three months ended June 30, 2023, and 2022 respectively:
Schedule
of Disaggregation of Revenue
| Three Months Ended June 30, | |
2023 | | |
2022 | |
| Revenue | |
| | | |
| | |
| Wholesale | |
$ | 841 | | |
$ | 1,126 | |
| Retail | |
| 3,774 | | |
| 3,630 | |
| Rental | |
| - | | |
| - | |
| Other | |
| 13 | | |
| 66 | |
| Total revenue | |
| 4,628 | | |
| 4,822 | |
| Discounts and returns | |
| (798 | ) | |
| (651 | ) |
| Net Revenue | |
$ | 3,830 | | |
$ | 4,171 | |
The
following table illustrates our revenue by type related to the nine months ended June 30, 2023, and 2022 respectively:
| Nine Months Ended June 30, | |
2023 | | |
2022 | |
| Revenue | |
| | | |
| | |
| Wholesale | |
$ | 2,639 | | |
$ | 3,256 | |
| Retail | |
| 11,431 | | |
| 11,217 | |
| Other | |
| 47 | | |
| 106 | |
| Total revenue | |
| 14,117 | | |
| 14,579 | |
| Discounts and returns | |
| (2,334 | ) | |
| (2,062 | ) |
| Net Revenue | |
$ | 11,783 | | |
$ | 12,517 | |
Geographical
Concentrations
As
of June 30, 2023, the Company is primarily engaged in the production and sale of cannabis, which is only legal for recreational use in
19 states and D.C., with lesser legalization, such as for medical use in an additional 18, as of the time of these consolidated financial
statements. In addition, the United States Congress has passed legislation, specifically the Agriculture Improvement Act of 2018 (also
known as the “Farm Bill”) that has removed production and consumption of hemp and associated products from Schedule 1 of
the Controlled Substances Act.
Cost
of Goods Sold
Cost
of sales represents costs directly related to manufacturing and distribution of the Company’s products. Primary costs include raw
materials, packaging, direct labor, overhead, shipping and handling and the depreciation of manufacturing equipment and production facilities.
Manufacturing overhead and related expenses include salaries, wages, employee benefits, utilities, maintenance, and property taxes. The
Company recognizes the cost of sales as the associated revenues are recognized.
Fair
Value of Financial Instruments
As
defined in the authoritative guidance, fair value is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.
To
estimate fair value, the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability,
including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable,
market corroborated or generally unobservable.
The
authoritative guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives
the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (“Level 1” measurements)
and the lowest priority to unobservable inputs (“Level 3” measurements). The three levels of the fair value hierarchy are
as follows:
Level
1 — Observable inputs such as quoted prices in active markets at the measurement date for identical, unrestricted assets or liabilities.
Level
2 — Other inputs that are observable, directly, or indirectly, such as quoted prices in markets that are not active, or inputs
which are observable, either directly or indirectly, for substantially the full term of the asset or liability.
Level
3 — Unobservable inputs for which there is little or no market data and which the Company makes its own assumptions about how market
participants would price the assets and liabilities.
In
instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input
that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Stock-based
Compensation
The
Company accounts for share-based payment awards exchanged for services at the estimated grant date fair value of the award. Stock options
issued under the Company’s long-term incentive plans are granted with an exercise price equal to no less than the market price
of the Company’s stock at the date of grant and expire up to ten years from the date of grant. These options generally vest on
the grant date or over a one-year period.
The
Company estimates the fair value of stock option grants using the Black-Scholes option pricing model and the assumptions used in calculating
the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application
of management’s judgment.
Expected
Term - The expected term of options represents the period that the Company’s stock-based awards are expected to be outstanding
based on the simplified method, which is the half-life from vesting to the end of its contractual term.
Expected
Volatility - The Company computes stock price volatility over expected terms based on its historical common stock trading prices.
Risk-Free
Interest Rate - The Company bases the risk-free interest rate on the implied yield available on U. S. Treasury zero-coupon issues
with an equivalent remaining term.
Expected
Dividend - The Company has never declared or paid any cash dividends on its common shares and does not plan to pay cash dividends
in the foreseeable future, and, therefore, uses an expected dividend yield of zero in its valuation models.
Effective
January 1, 2017, the Company elected to account for forfeited awards as they occur, as permitted by Accounting Standards Update (“ASU”)
2016-09. Ultimately, the actual expenses recognized over the vesting period will be for those shares that vested. Prior to making this
election, the Company estimated a forfeiture rate for awards at 0%, as the Company did not have a significant history of forfeitures.
Earnings
(Loss) per Share
ASC
260, Earnings Per Share, requires dual presentation of basic and diluted earnings per share (“EPS”) with a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic
EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the
entity.
Basic
net loss per share of common stock excludes dilution and is computed by dividing net loss by the weighted average number of shares of
common stock outstanding during the period. Diluted net loss per share of common stock reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity unless inclusion of such shares would be anti-dilutive. Since the Company has only
incurred losses, basic and diluted net loss per share is the same. Securities that could potentially dilute loss per share in the future
that were not included in the computation of diluted loss per share as of June 30, 2023, and September 30, 2022, are as follows:
Schedule
of Computation of Diluted Loss
| Potentially dilutive share-based instruments: | |
June 30, 2023 | | |
September 30, 2022 | |
| Convertible notes | |
| 124,237,230 | | |
| 34,736,220 | |
| Options to purchase common stock | |
| 9,030,685 | | |
| 5,518,185 | |
| Unvested restricted stock awards | |
| - | | |
| - | |
| Warrants to purchase common stock | |
| 20,818,536 | | |
| 65,783,059 | |
| Anti-dilutive Securities | |
| 154,086,451 | | |
| 106,037,464 | |
The
company has determined that the amount of interest expense and gains and losses for the derivative liabilities associated with the Company’s
convertible notes is immaterial and inclusion would be anti-dilutive and has therefore not included an Earnings Per Share table recording
the diluted earnings.
Advertising
Costs
The
Company follows the policy of charging the cost of advertising to expense as incurred. Advertising expense was approximately $25,000
and $47,000 three months ended June 30, 2023, and 2022, respectively. Advertising expense was approximately $95,000 thousand and $217,000
for nine months ended June 30, 2023, and 2022, respectively.
Related
parties
Parties
are related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or
are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the
immediate families of principal owners of the Company and its management and other parties with which the Company may deal with if one
party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting
parties might be prevented from fully pursuing its own separate interests.
Segment
reporting
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly
by the chief operating decision maker, or decision–making group in deciding how to allocate resources and in assessing performance.
The Company’s chief operating decision–maker is its chief executive officer. The Company currently operates in one segment.
Recent
Accounting Guidance
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments (“ASU 2016-13”). ASU 2016-13 provides guidance for recognizing credit losses on financial instruments based on
an estimate of current expected credit losses model. The amendments are effective for fiscal years beginning after December 15, 2019.
Recently, the FASB issued the final ASU to delay adoption for smaller reporting companies to calendar year 2023. The Company is currently
assessing the impact of the adoption of this ASU on its financial statements.
In
January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures
(Topic 323), and Derivative and Hedging (Topic 815), which clarifies the interaction of rules for equity securities, the equity method
of accounting, and forward contracts and purchase options on certain types of securities. The guidance clarifies how to account for the
transition into and out of the equity method of accounting when considering observable transactions under the measurement alternative.
The ASU is effective for annual reporting periods beginning after December 15, 2020, including interim reporting periods within those
annual periods, with early adoption permitted. The adoption of this standard did not have a material impact on the Company’s consolidated
financial statements and related disclosures.
In
August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and
Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an
Entity’s Own Equity. This ASU amends the guidance on convertible instruments and the derivatives scope exception for contracts
in an entity’s own equity, and also improves and amends the related EPS guidance for both Subtopics. The ASU will be effective
for smaller reporting companies for annual reporting periods beginning after December 15, 2022, and interim periods within those
annual periods and early adoption is permitted. We are currently evaluating the impact of the new guidance on our consolidated
financial statements.