HISTORY AND OUTLOOK
We were incorporated on March 31, 2011 as Adelt Design, Inc. to manufacture and
market carpet binding art. Production and marketing of carpet binding art never
commenced. On November 20, 2014, we adopted amended and restated articles of
incorporation, thereby changing our name to CLS Holdings USA, Inc. Effective
December 10, 2014, we effected a reverse stock split of our issued and
outstanding common stock at a ratio of 1-for-0.625 (the "Reverse Split"),
wherein 0.625 shares of our common stock were issued in exchange for each share
of common stock issued and outstanding.
On April 29, 2015, the Company, CLS Labs and the Merger Sub consummated the
Merger, whereby the Merger Sub merged with and into CLS Labs, with CLS Labs
remaining as the surviving entity. As a result of the Merger, we acquired the
business of CLS Labs and abandoned our previous business. As such, only the
financial statements of CLS Labs are included herein.
CLS Labs was originally incorporated in the state of Nevada on May 1, 2014 under
the name RJF Labs, Inc. before changing its name to CLS Labs, Inc. on October
24, 2014. It was formed to commercialize a proprietary method of extracting
cannabinoids from cannabis plants and converting the resulting cannabinoid
extracts into concentrates such as oils, waxes, edibles and shatter.
On April 17, 2015, CLS Labs took its first step toward commercializing its
proprietary methods and processes by entering into agreements through its wholly
owned subsidiary, CLS Labs Colorado, with certain Colorado entities. During
2017, we suspended our plans to proceed with the Colorado Arrangement due to
regulatory delays and have not yet determined if or when we will pursue them
again.
We have been issued a U.S. patent with respect to our proprietary method of
extracting cannabinoids from cannabis (hemp) plants and converting the resulting
cannabinoid extracts into concentrates such as oils, waxes, edibles and shatter.
These concentrates may be ingested in a number of ways, including through
vaporization via electronic cigarettes, and used for a variety of pharmaceutical
and other purposes. Internal testing of this extraction method and conversion
process has revealed that it produces a cleaner, higher quality product and a
significantly higher yield than the cannabinoid extraction processes currently
existing in the marketplace. We have not yet commercialized our proprietary
process and the extraction and production process utilized in the patent is
currently prohibited in Nevada. The Company is currently pursuing options to
generate revenue from the patent, including the possible sale of the patent.
We intend to generate revenues through: (i) the processing of cannabis for
others, and (ii) the purchase of cannabis (or cultivation through our joint
venture) and the processing and sale of cannabis-related products. We plan to
accomplish this through the acquisition of companies, the creation of joint
ventures, through licensing agreements, and through fee-for-service arrangements
with growers and dispensaries of cannabis products. We believe that we have
established a position as one of the premier cannabinoid extraction and
processing companies in the industry. We have already created our own brand of
concentrates for consumer use, which we sell wholesale to cannabis dispensaries.
We believe that we have created a "gold standard" national brand by
standardizing the testing, compliance and labeling of our products in an
industry currently comprised of small, local businesses with erratic and
unreliable product quality, testing practices and labeling. We also plan to
offer consulting services through Cannabis Life Sciences Consulting, LLC, which
will generate revenue by providing consulting services to cannabis-related
businesses, including growers, dispensaries and laboratories, and driving
business to our processing facilities. Finally, we intend to grow through select
acquisitions in secondary and tertiary markets, targeting newly regulated states
that we believe offer a competitive advantage. Our goal at this time is to
become a successful regional cannabis company.
On December 4, 2017, we entered into the Acquisition Agreement with Alternative
Solutions to acquire the outstanding equity interests in the Oasis LLCs.
Pursuant to the Acquisition Agreement, as amended, we paid a non-refundable
deposit of $250,000 upon signing, which was followed by an additional payment of
$1,800,000 on February 5, 2018, for an initial 10% of Alternative Solutions and
each of the subsidiaries. At the closing of our purchase of the remaining 90% of
the ownership interests in Alternative Solutions and the Oasis LLCs, which
occurred on June 27, 2018, we paid the following consideration: $5,995,543 in
cash, a $4.0 million promissory note due in December 2019, and $6,000,000 in
shares of our common stock. The cash payment of $5,995,543 was less than the
$6,200,000 payment originally contemplated because we assumed an additional
$204,457 of liabilities. The Oasis Note, which was repaid in full in December
2019, was secured by all of the membership interests in Alternative Solutions
and the Oasis LLCs and by the assets of the Oasis LLCs. At that time, we applied
for regulatory approval to own an interest in the Oasis LLCs, which approval was
received on June 21, 2018. Just prior to closing, the parties agreed that we
would instead acquire all of the membership interests in Alternative Solutions,
the parent of the Oasis LLCs, from its members, and the membership interests in
the Oasis LLCs owned by members other than Alternative Solutions. We received
final regulatory approval to own our interest in the Oasis LLCs through
Alternative Solutions under the final structure of the transaction on April 26,
2022.
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On October 31, 2018, the Company, CLS Massachusetts, Inc., a Massachusetts
corporation and a wholly-owned subsidiary of the Company ("CLS Massachusetts"),
and In Good Health, Inc., a Massachusetts corporation ("IGH"), entered into an
Option Agreement (the "IGH Option Agreement"). Under the terms of the IGH Option
Agreement, CLS Massachusetts had an exclusive option to acquire all of the
outstanding capital stock of IGH (the "IGH Option") during the period beginning
on the earlier of the date that is one year after the effective date of the
conversion and December 1, 2019 and ending on the date that was 60 days after
such date. (See Note 3 for more detail).
On October 31, 2018, as consideration for the IGH Option, we made a loan to IGH,
in the principal amount of $5,000,000, subject to the terms and conditions set
forth in that certain loan agreement, dated as of October 31, 2018 between IGH
as the borrower and the Company as the lender. The loan was evidenced by a
secured promissory note of IGH, which bore interest at the rate of 6% per annum
and was to mature on October 31, 2021.
On February 4, 2020, CLS Massachusetts exercised the IGH Option and IGH
subsequently asserted that CLS Massachusetts' exercise was invalid. By letter
dated February 26, 2020, we informed IGH that as a result of its breaches of the
IGH Option, which remained uncured, an event of default had occurred under the
IGH Note. We advised IGH that we were electing to cause the IGH Note to bear
interest at the default rate of 15% per annum effective February 26, 2020 and to
accelerate all amounts due under the IGH Note. On February 27, 2020, IGH
informed CLS Massachusetts that it did not plan to make further payments under
the IGH Note on the theory that the break-up fee excused additional payments.
On June 14, 2021, the parties to the IGH lawsuit entered into a confidential
settlement agreement to resolve the action and a secured promissory note dated
and executed by IGH in favor of us and effective June 11, 2021 (the "IGH
Settlement Note"). Pursuant to the IGH Settlement Note, IGH paid us $3,000,000,
$1,000,000 of which was paid on or before July 12, 2021. The remaining
$2,000,000 and accrued interest was paid in 12 equal monthly installments, which
began on August 12, 2021. During the year ended May 31, 2022, we received
$2,740,820 under the IGH Settlement Note, which included $2,666,670 in principal
and $74,150 in accrued interest. During the nine months ended February 28, 2023,
we received $348,165 was due under the IGH Settlement Note, which included
$333,333 in principal and $14,382 in accrued interest. As of February 28, 2023,
the IGH Settlement Note has been paid in full. We record amounts paid under the
IGH Settlement Note as gains when payments are received.
On October 20, 2021, the Company entered into a management services agreement
(the "Quinn River Joint Venture Agreement") through its 50% owned subsidiary,
Kealii Okamalu, with CSI Health MCD LLC ("CSI") and a commission established by
the authority of the Tribal Council of the Fort McDermitt Paiute and Shoshone
Tribe ("Tribe"). The purpose of the Quinn River Joint Venture Agreement is to
establish a business (the "Quinn River Joint Venture") to grow, cultivate,
process, and sell cannabis and related products. The Quinn River Joint Venture
Agreement has an initial term of 10 years plus a 10 year renewal option from the
date the first cannabis crop produced is harvested and sold. Pursuant to the
Quinn River Joint Venture Agreement, Kealii Okamalu is expected to eventually
lease approximately 20-30 acres of the Tribe's land located along the Quinn
River at a cost of $3,500 per quarter. Additionally, pursuant to the terms of
the Quinn River Joint Venture Agreement, Kealii Okamalu has managed the design,
finance and construction of a cannabis cultivation facility on such tribal lands
("the Cultivation Facility"). Kealii Okamalu also manages the ongoing operations
of the Cultivation Facility and related business, including, but not limited to,
the cultivation of cannabis crops, personnel staffing, product packaging,
testing, marketing and sales. Packaged products are branded as "Quinn River
Farms." The Company will provide up to 10,000 square feet of warehouse space at
its Las Vegas facility for the Quinn River Joint Venture product, and has
preferred vendor status, including the right to purchase cannabis flower and the
business's cannabis trim at favorable prices. Kealii Okamalu is expected to
contribute up to $6 million (the "Invested Amount") towards the construction of
the Cultivation Facility and the working capital for the Quinn River Joint
Venture. This amount will be repaid from the portion of the net profits of the
Quinn River Joint Venture otherwise payable to CSI and the Tribe at the rate of
$750,000 per quarter for eight quarters. After repayment of the Invested Amount,
Kealii Okamalu will receive one-third of the net profits of the Quinn River
Joint Venture.
The Company is the manager of and holds a 50% ownership interest in Kealii
Okamalu. Kealii Okamalu is a VIE which the Company consolidates. The Quinn River
Joint Venture is not a legal entity but rather a business operated by Kealii
Okamalu. The Company uses the equity method of accounting to record one-third of
the profit or loss generated by the Quinn River Joint Venture, which accrues to
Kealii Okamalu. Since the Company is a 50% owner of Kealii Okamalu, 50% of the
profit or loss of Kealii Okamalu is recorded as minority interest in the
Company's statement of operations.
During the year ended May 31, 2022, Kealii Okamalu made cash investments in the
aggregate amount of $581,714 in the Quinn River Joint Venture. The Company also
purchased $949,939 of fixed assets for use by the Quinn River Joint Venture
which are on the balance sheet of Kealii Okamalu. During the year ended May 31,
2022, the Quinn River Joint Venture recorded a loss in the amount of $336,416.
One-third of this amount, or $112,139, was charged to the financial statements
of Kealii Okamalu and recorded as a loss on equity investment in the Company's
financial statements for the year ended May 31, 2022, reducing the Company's
equity investment in the Quinn River Joint Venture from $581,714 to $469,575 at
May 31, 2022.
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During the nine months ended February 28, 2023, Kealii Okamalu made investments
in the aggregate amount of $1,249,273 in the Quinn River Joint Venture; this
amount was reduced by $952,125 representing the value of inventory transferred
from the Quinn River Joint Venture to the Company. The Company also purchased
$84,327 of fixed assets for use by the Quinn River Joint Venture which are on
the balance sheet of Kealii Okamalu. During the nine months ended February 28,
2023, the Quinn River Joint Venture recorded a loss in the amount of $526,761.
One-third of this amount, or $176,587, was charged to the financial statements
of Kealii Okamalu and recorded as a loss on equity investment in the Company's
financial statements for the nine months ended February 28, 2023. The Company's
net equity investment in the Quinn River Joint Venture was $590,137 at February
28, 2023
COVID-19 Update
Since mid-2019 there have been many uncertainties regarding the Novel
Coronavirus ("COVID-19") pandemic, including the scope of scientific and health
issues, the anticipated duration of the pandemic, and the extent of local and
worldwide social, political, and economic disruption. The COVID-19 pandemic has
had far-reaching impacts on many aspects of our operations, directly and
indirectly, including consumer behavior, customer store traffic, production
capabilities, timing of product availability, our people, and the market
generally. The COVID-19 pandemic has resulted in regional quarantines, labor
stoppages and shortages, changes in consumer purchasing patterns, mandatory or
elective shut-downs of restaurants, retail locations and other public
gatherings, disruptions to supply chains, including the inability of our
suppliers and service providers to deliver materials and services on a timely
basis, or at all, severe market volatility, liquidity disruptions, and overall
economic instability, which, in many cases, have had adverse impacts on our
business, financial condition and results of operations.
In light of the situation relating to the COVID-19 pandemic, we took certain
precautionary measures intended to help minimize the risk to our Company,
employees, and customers, including the following:
? We
identified
safety
precautions
that we
implemented
in our
facilities
from March
2020, and
into 2022.
? Although
our
facilities
continued
to operate,
we
evaluated
their
operations
in case we
had to shut
down
operations
temporarily
at any time
in the
future.
During the year ended December 31, 2022, we made the determination that COVID-19
possessed no continued serious risk to our employees and our business, and we
returned to operating under pre-COVID-19 protocols.
Results of Operations for the Three Months Ended February 28, 2023 and February
28, 2022
The table below sets forth our select expenses as a percentage of revenue for
the applicable periods:
Three Months Three Months
Ended Ended
February 28, 2023 February 28, 2022
Revenue 100 % 100 %
Cost of Goods Sold 44 % 48 %
Gross Margin 56 % 52 %
Selling, General, and Administrative Expenses 53 % 63 %
Gain on Settlement of Notes Receivable - % 9 %
Provision for Income Tax 9 % 6 %
The table below sets forth certain statistical and financial highlights for the
applicable periods:
Three Months Three Months
Ended Ended
February 28, 2023 February 28, 2022
Number of Customers Served (Dispensary) 77,859 66,016
Revenue $ 5,437,302 $ 5,588,266
Gross Profit $ 3,018,693 $ 2,887,106
Gain on Note Receivable $ - $ 522,246
Net Loss $ (899,515 ) $ (992,268 )
EBITDA (1) $ 504,615 $ 100,595
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(1) EBITDA is a non-GAAP financial performance measures and should not be
considered as alternatives to net income(loss) or any other measure
derived in accordance with GAAP. This non-GAAP measure has limitations as
an analytical tool and should not be considered in isolation or as
substitutes for analysis of our financial results as reported in
accordance with GAAP. Because not all companies use identical
calculations, these presentations may not be comparable to other similarly
titled measures of other companies. As required by the rules of the SEC,
we provide below a reconciliation of this non-GAAP financial measure
contained herein to the most directly comparable measure under GAAP.
Management believes that EBITDA provides relevant and useful information,
which is widely used by analysts, investors and competitors in our
industry as well as by our management. By providing this non-GAAP
profitability measure, management intends to provide investors with a
meaningful, consistent comparison of our profitability measures for the
periods presented.
Reconciliation of net loss for the three months ended February 28, 2023 and 2022
to EBITDA:
Three Months Three Months
Ended Ended
February 28, 2023 February 28, 2022
Net Loss attributable to CLS Holdings, Inc. $ (899,515 ) $ (992,268 )
Add:
Interest expense, net $ 648,957 $ 589,692
Provision for income taxes $ 516,252 $ 324,265
Depreciation and amortization $ 238,921 $ 178,906
EBITDA $ 504,615 $ 100,595
Revenues
We had revenue of $5,437,302 during the three months ended February 28, 2023, a
decrease of $150,964, or 3%, compared to revenue of $5,588,266 during the three
months ended February 28, 2022. Our cannabis dispensary accounted for
$3,529,261, or 65%, of our revenue for the three months ended February 28, 2023,
an increase of $196,032, or 6%, compared to $3,333,229 during the three months
ended February 28, 2022. Dispensary revenue increased during the third quarter
of fiscal year 2023 because our average sales per day increased from $37,036
during the third quarter of fiscal year 2022 to $39,214 during the third quarter
of fiscal year 2023. Our cannabis production accounted for $1,908,041, or 35%,
of our revenue for the three months ended February 28, 2023, a decrease of
$346,996 or 15%, compared to $2,255,037 for the three months ended February 28,
2022. The decrease in production revenues for the third quarter of fiscal year
2023 was primarily due to the fact that the overall cannabis market in Nevada
has seen a decrease in wholesale pricing, coupled with a slowdown in
nonessential expenditures that comes with inflation and an uncertain economy.
Cost of Goods Sold
Our cost of goods sold for the three months ended February 28, 2023 was
$2,418,609, a decrease of $282,551, or 10%, compared to cost of goods sold of
$2,701,160 for the three months ended February 28, 2022. The decrease in cost of
goods sold for the three months ended February 28, 2023 was due primarily to our
ability to leverage partner relationships for better pricing and the overall
market's price contraction. Cost of goods sold was 44% of sales during the three
months ended February 28, 2023 resulting in a gross margin of 56%. Cost of goods
sold was 48% for the three months ended February 28, 2022 resulting in a gross
margin of 52%. Gross margin exceeded our target of 50% for the third quarter of
fiscal year 2023. Cost of goods sold during the third quarter of the 2023 fiscal
year primarily consisted of $2,102,515 of product cost, $184,288 of state and
local fees and taxes, and $131,625 of supplies and materials.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SG&A, decreased by $631,777, or
approximately 18%, to $2,860,914 during the three months ended February 28,
2023, compared to $3,492,691 for the three months ended February 28, 2022. The
decrease in SG&A expenses for the three months ended February 28, 2023 was
primarily due to the Company's efforts to reduce travel, advertising, insurance,
legal and office-related expenses, which included charitable contributions,
outsourced IT, repairs and maintenance and equipment expense.
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SG&A expense during the three months ended February 28, 2023 was primarily
attributable to an aggregate of $2,388,527 in costs associated with operating
the Oasis LLCs, a decrease of $188,419 compared to $2,576,946 during the third
quarter of fiscal 2022. The major components of the $194,385 decrease in SG&A
associated with the operation of the Oasis LLCs during the three months ended
February 28, 2023 compared to the three months ended February 28, 2022 were as
follows: sales and marketing costs of $115,214 compared to $299,154; lease,
facilities and office costs of $576,493 compared to $662,294; and insurance
costs of $82,299 compared to $100,112. Sales and marketing costs decreased due
to a concerted effort to reduce professional outsourced marketing programs. The
decrease in SG&A expense for the third quarter was partially offset by increases
in payroll and related costs of $1,412,706 compared to $1,220,960; depreciation
and amortization of $163,837 compared to $104,396; and professional fees of
$96,952 compared to $68,714. Payroll costs increased during the third quarter of
fiscal 2023 primarily due to increases in salaries of our employees related to
the national labor shortage and due to an increase in the number of employees in
our manufacturing division as we planned for the rollout of our pre-roll
division.
Finally, SG&A decreased by $442,923 during the three months ended February 28,
2023 as a result of a decrease in the expenses associated with the ongoing
implementation of other aspects of our business plan and our general corporate
overhead to $472,387 from $915,310 during the three months ended February 28,
2022. The major components of this decrease compared to the third quarter of
fiscal 2022 was a decrease in expenses related to the November 2021 Debenture
Offering of $411,298, there is no comparable expense in the current period.
Gain on Settlement of Note Receivable
During the three months ended February 28, 2023, we recorded a gain on the
settlement of the IGH Settlement Note in the amount of $0 compared to $522,246
for the third quarter of 2022. This gain on the settlement arose after IGH
notified us on February 27, 2021, that it did not plan to make further payments
in accordance with the terms of the IGH Note on the theory that the Break-Up Fee
excused such additional payments. We vehemently disagreed and litigation ensued.
On June 14, 2021, the parties to the IGH lawsuit entered into a confidential
settlement agreement to resolve the action and executed the $3,000,000 IGH
Settlement Note. Pursuant to the IGH Settlement Note, IGH paid us $1,000,000 on
or before July 21, 2021. The remaining $2,000,000 and accrued interest was paid
in 12 equal monthly installments, and the final installment was paid in July
2022.
Loss on Equity Investment
During the three months ended February 28, 2023, we had income on equity
investment in the amount of $22,476; there was no comparable transaction in the
prior period. The Company, through its 50% owned subsidiary Kealii Okamalu, owns
a one-third interest in the Quinn River Joint Venture. The second quarter of
fiscal 2023 loss represents our share of the results of the Quinn River Joint
Venture.
Interest Expense, Net
Our interest expense was $648,957 for the three months ended February 28, 2023,
an increase of $59,265, or 10%, compared to $589,692 for the three months ended
February 28, 2022. The increase in interest expense was primarily due to the
original issue discount associated with the 2021 Debentures in the amount of
$185,081 which was amortized to interest expense during the three months ended
February 28, 2023 compared to $93,145 charged during the third quarter of the
prior fiscal year. The increase in net interest expense for the third quarter of
fiscal 2023 was partially offset by a net decrease in interest expense of
$38,270 in connection with the Company's loans and convertible debentures, due
primarily to the conversion of $11,343,619 in principal of convertible
debentures. In addition, the increase in net interest expense for the third
quarter of fiscal 2023 was partially offset by a decrease in the amortization of
discounts on debentures in the amount of $11,720.
Provision for Income Taxes
We recorded a provision for income taxes in the amount of $516,252 during the
three months ended February 28, 2023 compared to $324,265 during the three
months ended February 28, 2022. Although we have net operating losses that we
believe are available to us to offset this entire tax liability, which arises
under Section 280E of the Code because we are a cannabis company, as a
conservative measure, we have accrued this liability.
Net Loss
For the reasons above, our net loss for the three months ended February 28, 2023
was $1,029,906 compared to a net loss of $997,296 for the three months ended
February 28, 2022, an increase of $32,610, or 3%.
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Non-Controlling Interest
During the three months ended February 28, 2023 and 2022, the loss associated
with the non-controlling interest in Kealii Okamalu was $130,391 and $5,028,
respectively. This amount is comprised of the third-party portion of the
operating loss of the Quinn River Joint Venture and our loss on equity
investment.
Net Loss Attributable to CLS Holdings USA, Inc.
Our net loss attributable to CLS Holdings USA, Inc. for the three months ended
February 28, 2023 was $899,515 compared to a net loss of $992,268 for the three
months ended February 28, 2022, a decrease of $92,753 or 9%.
Results of Operations for the Nine Months Ended February 28, 2023 and February
28, 2022
The table below sets forth our select expenses as a percentage of revenue for
the applicable periods:
Nine Months Ended Nine Months Ended
February 28, 2023 February 28, 2022
Revenue 100 % 100 %
Cost of Goods Sold 48 % 48 %
Gross Margin 52 % 52 %
Selling, General, and Administrative Expenses 55 % 57 %
Gain on Settlement of Notes Receivable 2 % 13 %
Loss on Extinguishment of Debt 38 % -
Provision for Income Tax 9 % 5 %
The table below sets forth certain statistical and financial highlights for the
applicable periods:
Nine Months Ended Nine Months Ended
February 28, 2023 February 28, 2022
Number of Customers Served (Dispensary) 244,547 195,994
Revenue $ 17,556,406 $ 16,502,978
Gross Profit $ 9,063,334 $ 8,513,161
Gain on Note Receivable $ (348,165 ) $ (2,218,574 )
Net (Loss) Income $ (10,263,947 ) $ (910,141 )
Loss on Extinguishment of Debt $ 6,659,359 $ -
EBITDA (1) $ (5,971,273 ) $ 1,834,706
(1) EBITDA is a non-GAAP financial performance measures and should not be
considered as an alternative to net income(loss) or any other measure
derived in accordance with GAAP. This non-GAAP measure has limitations as
an analytical tool and should not be considered in isolation or as
substitutes for analysis of our financial results as reported in
accordance with GAAP. Because not all companies use identical
calculations, these presentations may not be comparable to other similarly
titled measures of other companies. As required by the rules of the SEC,
we provide below a reconciliation of this non-GAAP financial measure
contained herein to the most directly comparable measure under GAAP.
Management believes that EBITDA provides relevant and useful information,
which is widely used by analysts, investors and competitors in our
industry as well as by our management. By providing this non-GAAP
profitability measure, management intends to provide investors with a
meaningful, consistent comparison of our profitability measures for the
periods presented.
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Reconciliation of net loss for the nine months ended February 28, 2023 and 2022
to EBITDA:
Nine Months Ended Nine Months Ended
February 28, 2023 February 28, 2022
Net Loss attributable to CLS Holdings, Inc. $ (10,263,947 ) $ (909,141 )
Add:
Interest expense, net
$ 2,024,532 $ 1,416,164
Provision for income taxes $ 1,552,028 $ 792,322
Depreciation and amortization $ 716,114 $ 535,361
EBITDA $ (5,971,273 ) $ 1,834,706
Revenues
We had revenue of $17,556,406 during the nine months ended February 30, 2032, an
increase of $1,053,428, or 6%, compared to revenue of $16,502,978 during the
nine months ended February 28, 2022. Our cannabis dispensary accounted for
$11,210,622, or 64%, of our revenue for the nine months ended February 28, 2023,
an increase of $540,419, or 5%, compared to $10,670,203 during the nine months
ended February 28, 2022. Dispensary revenue increased during the first nine
months of fiscal year 2023 because our average sales per day increased from
$39,085 during the first nine months of fiscal year 2022 to $41,065 during the
first nine months of fiscal year 2023. Our cannabis production accounted for
$6,345,784, or 36%, of our revenue for the nine months ended February 28, 2023,
an increase of $513,009 or 9%, compared to $5,832,775 for the nine months ended
February 28, 2022. The increase in production revenues for the first nine months
of fiscal year 2023 was primarily due to an increase in our THC distillate sales
of almost $1,000,000, as well as sales to 10 new dispensaries and significant
increases in existing customer order size and frequency. These improvements
occurred as a result of our addition of a new sales director, an improvement in
our product mix, the introduction of new products, and the procurement of higher
quality materials. The increase was also due to greater revenue from third
parties for whom we manufactured and processed their products.
Cost of Goods Sold
Our cost of goods sold for the nine months ended February 28, 2023 was
$8,493,072, an increase of $503,255, or 6%, compared to cost of goods sold of
$7,989,817 for the nine months ended February 28, 2022. The increase in cost of
goods sold for the nine months ended February 28, 2023 was due primarily to an
increase in revenue and more aggressive competitive discounts. Cost of goods
sold was 48% of sales during the nine months ended February 28, 2023 resulting
in a gross margin of 52%. Cost of goods sold was 48% for the nine months ended
February 28, 2022 resulting in a gross margin of 52%. Costs of goods sold as a
percentage of revenue remained the same as the prior period. Gross margin
exceeded our target of 50% for the first nine months of fiscal year 2023. Cost
of goods sold during the first nine months of the 2023 fiscal year primarily
consisted of $7,436,279 of product cost, $583,491 of state and local fees and
taxes, and $415,558 of supplies and materials.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SG&A, increased by $127,857, or
approximately 1%, to $9,568,775 during the nine months ended February 28, 2023,
compared to $9,440,918 for the nine months ended February 28, 2022. The increase
in SG&A expenses for the nine months ended February 28, 2023 was primarily due
to increases in costs associated with operating the Oasis LLCs.
SG&A expense during the nine months ended February 28, 2023 was primarily
attributable to an aggregate of $7,877,316 in costs associated with operating
the Oasis LLCs, an increase of $459,663 compared to $7,417,653 during the first
nine months of fiscal 2022. The major components of the $459,663 increase in
SG&A associated with the operation of the Oasis LLCs during the nine months
ended February 28, 2023 compared to the nine months ended February 28, 2022 were
as follows: payroll and related costs of $4,239,052 compared to $3,363,573;
professional fees of $488,778 compared to $215,227; depreciation and
amortization of $491,354 compared to $309,684; lease, facilities and office
costs of $1,948,396 compared to $1,819,549; and taxes and licensure of $143,358
compared to $62,309. Payroll costs increased during the first nine months of
fiscal 2023 primarily due to increases in salaries of our employees related to
the national labor shortage and due to an increase in the number of employees in
our manufacturing division as we planned for the rollout of our pre-roll
division. Professional fees increased primarily due to legal fees related to the
restructuring of debt and the implementation of a reverse stock split. Lease,
facilities and office costs increased due to our efforts to prepare our
facilities for the new pre-roll division by purchasing equipment and
implementing compliance procedures applicable to this new division. These
increases were partially offset by a decrease in sales and marketing costs of
$581,388 due to a concerted effort to reduce professional outsourced marketing
programs.
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Finally, SG&A decreased by $331,242 during the nine months ended February 28,
2023 as a result of a decrease in the expenses associated with the ongoing
implementation of other aspects of our business plan and our general corporate
overhead to $1,691,460 from $2,022,702 during the nine months ended February 28,
2022. The major component of this decrease was a decrease in expenses related to
the November 2021 Debenture Offering of $411,298, there is no comparable expense
in the current period. Payroll costs also decreased by $213,689 during the nine
months ended February 28, 2023 compared to the prior period. The decrease in
SG&A expenses for the first nine months of fiscal 2023 was partially offset by
an increase in professional fees in the amount of $292,232 associated with
former counsel's last series of invoices before termination. The Company is
actively disputing the amount of fees charged by our prior legal counsel.
Loss on Equity Investment
During the nine months ended February 28, 2023, we had a loss on equity
investment in the amount of $176,587; there was no comparable transaction in the
prior period. The Company, through its 50% owned subsidiary Kealii Okamalu, owns
a one-third interest in the Quinn River Joint Venture. The Quinn River Joint
Venture completed its first harvest during the nine months ended February 28,
2023, and the Company purchased inventory in the amount of $952,124 from the
Quinn River Joint Venture.
Gain on Settlement of Note Receivable
During the nine months ended February 28, 2023, we recorded a gain on the
settlement of the IGH Settlement Note in the amount of $348,165 compared to
$2,218,574 for the first nine months of fiscal 2022. This gain on the settlement
arose after IGH notified us on February 27, 2021, that it did not plan to make
further payments in accordance with the terms of the IGH Note on the theory that
the Break-Up Fee excused such additional payments. We vehemently disagreed and
litigation ensued. On June 14, 2021, the parties to the IGH lawsuit entered into
a confidential settlement agreement to resolve the action and executed the
$3,000,000 IGH Settlement Note. Pursuant to the IGH Settlement Note, IGH paid us
$1,000,000 on or before July 21, 2021. The remaining $2,000,000 and accrued
interest was paid in 12 equal monthly installments, and the final installment
was paid in July 2022.
Loss on Extinguishment of Debt
During the nine months ended February 28, 2023, certain of our convertible
debentures were amended to: (i) permit mandatory conversion of $11,343,619 in
principal plus $189,061 in accrued interest into units at a reduced rate of
$0.285 per unit; (ii) decrease the conversion price of the remaining debentures
to $0.40 per unit; (iii) reduce the mandatory conversion VWAP provision from
$2.40 to $0.80; (iv) change the maturity date so that half of the remaining
balance matures on December 31, 2023 and the remaining on December 31, 2024. We
recognized a loss on the amendment of the debt in the amount of $6,659,359 in
connection with these amendments during the first half of fiscal 2023. There was
no comparable transaction in the prior year.
Gain on Settlement of Debt
During the nine months ended February 28, 2023, our U.S. Convertible Debenture 4
in the amount $599,101 in principal and accrued interest in the amount of
$3,283, went into default. We entered into a forbearance agreement with the
lender, whereby we would pay the amount of $600,000 in installments beginning
with a $150,000 payment on November 2, 2022 and $50,000 payments each month
thereafter through August of 2023. As a result of this agreement, we recognized
a gain on the settlement of debt in the amount of $2,384. There is no comparable
transaction in the prior period.
Interest Expense, Net
Our interest expense was $2,024,532 for the nine months ended February 28, 2023,
an increase of $608,368, or 43%, compared to $1,416,164 for the nine months
ended February 28, 2022. The increase in interest expense was primarily due to
the original issue discount associated with the 2021 Debentures in the amount of
$555,243 which was amortized to interest expense during the nine months ended
February 28, 2023 compared to $91,936 charge during the first nine months of the
prior fiscal year. In addition, the increase in net interest expense for the
first nine months of fiscal 2023 was also attributable to a net increase in
interest expense of $156,781 in connection with the Company's loans and
convertible debentures, driven by an increase in interest expense and financing
fees associated with short-term loan in the amount of $370,126. The increase in
net interest expense for the first nine months of fiscal 2023 was partially
offset by a decrease in the amortization of discounts on debentures in the
amount of $11,720.
Provision for Income Taxes
We recorded a provision for income taxes in the amount of $1,552,028 during the
nine months ended February 28, 2023 compared to $793,322 during the nine months
ended February 28, 2022. Although we have net operating losses that we believe
are available to us to offset this entire tax liability, which arises under
Section 280E of the Code because we are a cannabis company, as a conservative
measure, we have accrued this liability.
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Net Loss
Our net loss for the nine months ended February 28, 2023 was $10,567,398
compared to a net loss of $918,669 for the nine months ended February 28, 2022,
an increase of $9,648,729 or 1,050%. The net loss amount was primarily due to
the loss on extinguishment of debt in the amount of $6,659,359 and interest
expense in the amount of $2,024,532.
Non-Controlling Interest
During the nine months ended February 28, 2023 and 2022, loss associated with
the non-controlling interest in Kealii Okamalu was $303,451 and $8,528,
respectively. This amount is composed of the third-party portion of the
operating loss of the Quinn River Joint Venture and our loss on equity
investment.
Net Loss Attributable to CLS Holdings USA, Inc.
Our net loss attributable to CLS Holdings USA, Inc. for the nine months ended
February 28, 2023 was $10,263,947 compared to a net loss of $910,141 for the
nine months ended February 28, 2022, an increase of $9,353,806, or 1,028%. The
net loss amount was primarily due to the loss on extinguishment of debt in the
amount of $6,659,359 and interest expense in the amount of $2,024,532.
Liquidity and Capital Resources
The following table summarizes our total current assets, liabilities and working
capital at February 28, 2023 and May 31, 2022:
February 28, May 31,
2023 2022
Current Assets $ 6,139,399 $ 6,883,557
Current Liabilities $ 16,266,491 $ 28,112,190
Working Capital (Deficit) $ (10,127,092 ) $ (21,228,633 )At February 28, 2023, we had a working capital deficit of $10,127,092, an
improvement in our working capital position of $11,101,541 compared to the
working capital deficit of $21,228,633 we had at May 31, 2022. Our working
capital increased primarily due to the restructuring of debenture agreements
whereby (i) the current principal and interest in the aggregate amount of
$11,532,679 was converted to common stock, and (ii) the principal in the
aggregate amount of $3,753,052 was converted to long term liabilities. Our
working capital was negatively impacted by an increase in our accrued potential
tax liability in the amount of $1,552,028 as a result of the calculation of our
tax liability under 280E, which can change based on the deductibility of
applicable expenses and is not necessarily tied to operating income.
We recently completed the first harvest of the Quinn River Joint Venture and
have been selling the products derived from that initial harvest since October
of 2022. Our partner in Kealii Okamalu has not yet contributed its capital
contribution and we have advanced additional amounts to cover this cash need. We
received inventory with a value of $952,125 from the initial crop from the Quinn
River Joint Venture. We believe this source of inventory will continue to
improve our liquidity. We cannot yet estimate when, or if, our partner will make
the required capital contributions. If our partner fails to make the required
capital contributions we will take control and ownership of our partners
interest in Kealii Okamalu (among other remedies) in lieu of the contributions
that should have been made by the partner. Until these issues are resolved, we
may utilize short-term financing through the 2022 Financing Agreement and our
Short-Term Financing Agreement. Although we have been able to secure such
financing so far, there can be no assurance that we will be able to continue to
secure such financing if we continue to need it.
In September 2022, we successfully refinanced all but one of the U.S.
Convertible Debentures and all of the Canaccord Debentures so that 60% of them
were converted into equity and the balance of them mature in equal portions in
December 2023 and December 2024.
Although our revenues are expected to grow as we expand our operations, we only
achieved net income for the first time during our first quarter of fiscal 2022
and we have experienced net losses since such time. Nonetheless, as a result of
the debt restructuring and the competition of the first harvest of the Quinn
River Joint Venture, we believe we will have funds sufficient to sustain our
operations at their current level, or if we require additional cash, we expect
to obtain the necessary funds as described above; however, our prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in the cannabis business. To address these risks, we
must, among other things, seek growth opportunities through investments and
acquisitions in our industry, successfully execute our business strategy and
successfully navigate the COVID-19 business environment in which we currently
operate as well as any changes that may arise in the cannabis regulatory
environment. We cannot assure that we will be successful in addressing such
risks, and the failure to do so could have a material adverse effect on our
business prospects, financial condition and results of operations.
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Cash flows used in operating activities were $1,018,583 during the nine months
ended February 28, 2023, an improvement of $1,538,795 or approximately 60%,
compared to $2,557,348 during the nine months ended February 28, 2022. In
deriving cash flows used in operating activities from the net losses for the
first nine months of fiscal 2023 and the first nine months of fiscal 2022,
certain non-cash items were (deducted from) or added back to the net loss for
each such period. These amounts were $7,794,895 and $(1,539,369) for the nine
months ended February 28, 2023 and 2022, respectively. For the first nine months
of fiscal year 2023, the most significant item deducted from the net loss was
$348,165 related to the gain on settlement of the IGH Settlement Note; compared
to $2,218,574 during the first nine months of fiscal 2022. For the first nine
months of fiscal year 2023, the most significant item added to the net loss was
$6,659,359 related to the loss on extinguishment of debt. There is no comparable
transaction during the first nine months of fiscal 2022.
Finally, our cash used in operating activities was affected by changes in the
components of working capital. The amounts of the components of working capital
fluctuate for a variety of reasons, including management's expectation of
required inventory levels; the amount of accrued interest, both receivable and
payable; the amount of prepaid expenses; the amount of accrued compensation and
other accrued liabilities; our accounts payable and accounts receivable
balances; and the capitalization of right of use assets and liabilities
associated with operating leases. The overall net change in the components of
working capital resulted in an increase in cash from operating activities in the
amount of $1,1,753,920 during the nine months ended February 28, 2023, compared
to a decrease in cash from operating activities of $99,310 during the first nine
months of fiscal 2022. The more significant changes for the first nine months of
fiscal 2023 were as follows: inventory increased during first nine months of
fiscal 2023 by $931,861, compared to an increase of $1,114,556 during the first
nine months of the prior fiscal year because of increased inventory levels
necessary to support increased sales; tax liability increased by $1,552,028
during the first nine months of fiscal 2023, compared to $793,322 during the
first nine months of the prior year as we accrued potential taxes in connection
with Section 280E of the tax code; accounts receivable increased by $95,718
during the first nine months of fiscal 2023 compared to an increase of $160,067
during the first nine months of prior fiscal year due to an increase in revenue;
and operating lease liability decreased by $244,011 during the first nine months
of fiscal 2023 compared to $213,827 during the first nine months of prior fiscal
year as certain leases were renegotiated resulting in lower monthly
amortization.
Cash flows used by investing activities were $90,449 for the nine months ended
February 28, 2023, a decrease of $2,060,648, or 105%, compared to cash flow
provided by investing activities of $1,970,199 during the nine months ended
February 28, 2022. This decrease was primarily due to payments for our
investment in the Quinn River Joint Venture of $297,149, and payments to acquire
property, plant and equipment of $141,465, all of which occurred in the first
nine months of fiscal 2023. The decrease was partially offset by our receipt of
principal payments received on the IGH Settlement Note in the amount of $348,165
during the nine months ended February 28, 2023, compared to our receipt of
$2,218,574 during the nine months ended February 28, 2022.
Cash flows used by financing activities were $555,015 for the nine months ended
February 28, 2023, an increase of $2,931,485, or 1,239%, compared to cash flow
provided by financing activities of $2,376,470 during the nine months ended
February 28, 2022. This increase was primarily due to proceeds from loans
payable in the amount of $1,717,115. This increase was offset by principal
payments made on loans payable in the amount $1,869,344, principal payments on
convertible notes payable in the amount of $350,000, and principal payments on
our equipment financing lease obligations of $52,786.
Third Party Debt
The table below summarizes the status of our third party debt, excluding our
short term receivables-based debt facilities and reflects whether such debt
remains outstanding, has been repaid, or has been converted into or exchanged
for our common stock:
Original
Name of Note Principal Amount Outstanding Payment Details
Half due on December 31,
2023 and half due onU.S. Convertible Debentures 1 and 2 $ 2,252,229 Outstanding December 31, 2024
Half due December 31, 2023
and half due December 31,
Canaccord Debentures $ 5,253,872 Outstanding 2024
Debentures1,2,3,4,5 and 6* $ 2,500,000 Outstanding Due July 10, 2024
2022 Financing Agreement $ 675,189 Outstanding Due September 2023
* The terms of the 6 Debentures provide for additional payments in the aggregate
amount of not less than $375,000 per year beginning in 2025, for five years.
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U.S. Convertible Debentures 1 and 2
Between October 22, 2018 and November 2, 2018, we entered into six subscription
agreements, pursuant to which we agreed to sell, $5,857,000 in original
principal amount of convertible debentures in minimum denominations of $1,000
each for an aggregate purchase price of $5,857,000.
Under the original terms, the debentures bear interest, payable quarterly, at a
rate of 8% per annum, with capitalization of accrued interest on a quarterly
basis for the first 18 months, by increasing the then-outstanding principal
amount of the debentures. The debentures originally matured on a date that was
three years following their issuance. The debentures were convertible into units
at a conversion price of $3.20 per unit. Each unit consists of (i) one share of
our common stock, par value $0.001 and (ii) one-half of one warrant, with each
warrant exercisable for three years to purchase a share of common stock at an
initial price of $1.10. The warrants also provided that we could force their
exercise at any time after the bid price of our common stock exceeds $2.20 for a
period of 20 consecutive business days. The debentures include a provision for
the capitalization of accrued interest on a quarterly basis for the first 18
months. After capitalizing accrued interest in the aggregate amount of $738,663,
the aggregate principal amount of the debentures increased to $6,595,663.
The debentures have other features, such as mandatory conversion in the event
our common stock trades at a particular price over a specified period of time
and required redemption in the event of a "Change in Control" of the Company.
The debentures are unsecured obligations of the Company and rank pari passu in
right of payment of principal and interest with all other unsecured obligations
of the Company. The warrants have anti-dilution provisions that provide for an
adjustment to the exercise price in the event of a future sale of our common
stock at a lower price, subject to certain exceptions as set forth in the
warrant.
On July 26, 2019, we entered into amendments to the debentures with four of the
purchasers, pursuant to which we agreed to reduce the conversion price of the
original debentures if, in general, we issue or sell common stock, or warrants
or options exercisable for common stock, or any other securities convertible
into common stock, in a capital raising transaction, at a consideration per
share, or exercise or conversion price per share, as applicable, less than the
conversion price of the original debentures in effect immediately prior to such
issuance. In such case, the conversion price of the original debentures will be
reduced to such issuance price. The amendments also provided that, if a dilutive
issuance occurs, the warrant to be issued upon conversion will be exercisable at
a price equal to 137.5% of the adjusted conversion price at the time of
conversion of the debenture. If a dilutive issuance occurs, the form of warrant
attached to the subscription agreement would be amended to change the Initial
Exercise Price, as defined therein, to be the revised warrant exercise price.
On March 31, 2021, we amended the Canaccord Debentures. This Debenture Amendment
(as hereafter defined) was a dilutive issuance. As a result, the conversion
price of the convertible debentures was automatically reduced from $3.20 per
unit to $1.20 per unit and the form of warrant attached to the subscription
agreement will be amended to reduce the exercise price from $4.40 per share of
common stock to 137.5% of the debenture conversion price (presently $1.65 per
share of common stock).
On April 15, 2021 and April 19, 2021, we amended three of the purchasers'
debentures and subscription agreements in order to (i) reduce the conversion
price of the debentures from $3.20 per unit to $1.20 per unit, and (ii) extend
the maturity date of the debentures by one year to four (4) years from the
execution date of the debentures. The subscription agreements, as amended, also
provide that we will file a registration statement to register for resale all of
the shares of common stock issuable to these three purchasers upon conversion of
the debentures and the exercise of the warrants issuable upon conversion of such
debentures. Each warrant issuable pursuant to the debentures is exercisable for
one share of common stock at a price equal to 137.5% of the conversion price
(presently $1.65 per share) for a period of three years from the earlier of the
date of issuance of the warrant or the effectiveness of a registration statement
registering the warrant shares.
On October 25, 2021, we repaid three of the debentures at maturity, which
comprised $365,991 of principal and $2,065 of interest.
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Effective September 15, 2022, we entered into agreements with the holders of two
of the debentures to make the following changes to these debentures and the
related subscription agreements: (i) to permit the mandatory conversion, in our
discretion, of an aggregate of $3,378,342 in principal amount plus $56,307 in
accrued interest into units at the reduced conversion price of $0.285 per unit;
(ii) to decrease the conversion price of the remaining amount due under these
debentures (following the mandatory conversion) to $0.40 per unit; (iii) to
reduce the mandatory conversion VWAP provision in the debentures from $2.40 to
$0.80; (iv) to provide for a reduced conversion price to holders of these
debentures who elect to covert more than the mandatory conversion amount on or
prior to September 15, 2022; (v) to change the maturity date so that half of the
remaining amounts due of $2,252,229.00 mature on December 31, 2023 and the
remaining amounts due mature on December 31, 2024; (vi) to provide for the
payment of interest accruing between July 1, 2022 and December 31, 2024 so that
one-third of the total scheduled interest is paid on December 31, 2023 and the
balance of the accrued interest is paid on December 31, 2024; and (vii) subject
to the receipt of regulatory approvals, to grant a security interest in certain
of our assets (such as licenses, inventory (including work in process),
equipment (excluding equipment subject to purchase money financing) and contract
rights (excluding investments in entities other than wholly owned subsidiaries))
to the holders of these debentures and to other holders of our debt, now or in
the future, as we may elect. Following execution of the amendments to these two
debentures and the related subscription documents, the Company elected to affect
the mandatory conversion provided for in the amended documents.
Canaccord Debentures
On December 12, 2018, we entered into an agency agreement with two Canadian
agents regarding a private offering of up to $40 million of convertible
debentures of the Company at an issue price of $1,000 per debenture (the
"Canaccord Debentures"). The agents sold the convertible debentures on a
commercially reasonable efforts private placement basis. Each debenture was
convertible into units of the Company at the option of the holder at a
conversion price of $3.20 per unit at any time prior to the close of business on
the last business day immediately preceding the maturity date of the debentures,
being the date that is three (3) years from the closing date of the offering
(the "2018 Convertible Debenture Offering"). Each unit will be comprised of one
share of common stock and a warrant to purchase one-half of a share of common
stock. Each warrant was initially exercisable for one share of common stock at a
price of $4.40 per warrant for a period of 36 months from the closing date.
We closed the 2018 Convertible Debenture Offering on December 12, 2018, issuing
$12,012,000 million in 8% senior unsecured convertible debentures at the initial
closing. At the closing, we paid the agents: (A)(i) a cash fee of $354,000 for
advisory services provided to us in connection with the offering; (ii) a cash
commission of $720,720, equivalent to 6.0% of the aggregate gross proceeds
received at the closing of the offering; (B)(i) an aggregate of 46,094 units for
advisory services; and (ii) a corporate finance fee equal to 93,844 units, which
is the number of units equal to 2.5% of the aggregate gross proceeds received at
the closing of the offering divided by the conversion price; and (C)(i) an
aggregate of 110,625 advisory warrants; and (ii) 225,225 broker warrants, which
was equal to 6.0% of the gross proceeds received at the closing of the offering
divided by the conversion price. During the year ended May 31, 2020, principal
in the amount of $25,856 was converted into 8,080 shares of common stock. The
debentures include a provision for the capitalization of accrued interest on a
quarterly basis for the first 18 months. Accrued interest in the amount of
$1,514,006 was capitalized, and the principal amount of the debentures is
$13,500,150.
The debentures are unsecured obligations of the Company, rank pari passu in
right of payment of principal and interest and were issued pursuant to the terms
of a debenture indenture, dated December 12, 2018, between the Company and
Odyssey Trust Company as the debenture trustee. The debentures bear interest at
a rate of 8% per annum from the closing date, payable on the last business day
of each calendar quarter.
Beginning on the date that is four (4) months plus one (1) day following the
closing date, we could force the conversion of all of the principal amount of
the then outstanding debentures at the conversion price on not less than 30
days' notice should the daily volume weighted average trading price, or VWAP, of
our common stock be greater than $1.20 per share for the preceding 10
consecutive trading days.
Upon a change of control of the Company, holders of the debentures have the
right to require us to repurchase their debentures at a price equal to 105% of
the principal amount of the debentures then outstanding plus accrued and unpaid
interest thereon. The debentures also contain standard anti-dilution provisions.
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On March 31, 2021, the holders of the Canaccord Debentures approved the
amendment of the indenture related to the Canaccord Debentures (the "Debenture
Amendment") to: (i) extend the maturity date of the Canaccord Debentures from
December 12, 2021 to December 12, 2022; (ii) reduce the conversion price from
$3.20 per unit (as such term is defined in the indenture) to $1.20 per unit;
(iii) reduce the mandatory conversion VWAP threshold from $1.20 to $0.60 per
share; and (iv) amend the definitions of "Warrant" and "Warrant Indenture" (as
such terms are defined in the indenture), to reduce the exercise price of each
warrant to $1.60 per share of our common stock. Simultaneously, we amended the
warrant indenture to make conforming amendments and extend the expiration date
of the warrants to March 31, 2024.
Effective September 15, 2022, we entered into agreements with the holders of the
Canaccord Debentures to restructure the debentures as follows: (i) $7,931,490 in
principal amount of the Canaccord Debentures plus $132,192 in accrued interest
on the Canaccord Debentures were converted into units at the reduced conversion
price of US$0.285 per unit; (ii) to decrease the conversion price of the
remaining Canaccord Debentures (following the mandatory conversion) to $0.40 per
unit; (iii) to reduce the mandatory conversion VWAP provision in the Canaccord
Debentures from $2.40 to $0.80; (iv) to provide for a reduced conversion price
to holders of Canaccord Debentures who elect to covert more than the mandatory
conversion amount of Canaccord Debentures on or prior to the date of the meeting
of debenture holders; (v) to change the maturity date so that half of the
remaining amount due of $5,253,872 matures on December 31, 2023 and the
remaining amounts due mature on December 31, 2024; (vi) to provide for the
payment of interest accruing between July 1, 2022 and December 31, 2024 so that
one-third of the total scheduled interest is paid on December 31, 2023 and the
balance of the accrued interest is paid on December 31, 2024; and (vii) to grant
a security interest in certain of our assets (such as licenses, inventory
(including work in process), equipment (excluding equipment subject to purchase
money financing) and contract rights (excluding investments in entities other
than wholly owned subsidiaries)) to the holders of the Canaccord Debentures and
to other holders of debt of ours now or in the future, as we may elect, provided
that we are able to secure all regulatory approvals required to make such a
grant. Following the meeting, we elected to affect the mandatory conversion
provided for in the amendments to the Canaccord Debentures and received an
additional voluntary conversion of $33,787 in principal and $563 in accrued
interest of the Canaccord Debentures.
If, at the time of exercise of any warrant in accordance with the warrant
indenture, there is no effective registration statement under the Securities Act
covering the resale by the holder of a portion of the shares of common stock to
be issued upon exercise of the warrant, or the prospectus contained therein is
not available for the resale of the shares of common stock by the holder under
the Securities Act by reason of a blackout or suspension of use thereof, then
the warrants may be exercised, in part for that portion of the shares of common
stock not registered for resale by the holder under an effective registration
statement or in whole in the case of the prospectus not being available for the
resale of such shares of common stock, at such time by means of a "cashless
exercise" in which the holder shall be entitled to receive a number of shares of
common stock equal to the quotient obtained by dividing [(A-B) (X)] by (A),
where: A = the last volume weighted average price, or VWAP, for the trading day
immediately preceding the time of delivery of the exercise form giving rise to
the applicable "cashless exercise"; B = the exercise price of the warrant; and X
= the number of shares of common stock that would be issuable upon exercise of
the warrant in accordance with the terms of such warrant if such exercise were
by means of a cash exercise rather than a cashless exercise.
Pursuant to the agency agreement, we granted the agents an option to increase
the offering by an additional $6 million in principal amount of debentures,
which option was not exercised by the agents prior to the closing date of the
offering.
Pursuant to the agency agreement and the subscription agreements signed by
investors in the offering, we granted certain registration rights to the holders
of the debentures pursuant to which we agreed to prepare and file a registration
statement with the SEC to register the resale by the original purchasers of the
debentures of the shares of common stock issuable upon conversion of the
debentures or exercise of the warrants.
Debentures 1,2,3,4,5 and 6
During November 2021, we commenced an offering of a maximum of $5,500,000 of
2021 Debentures and warrants to purchase shares of our common stock at an
exercise price of $1.65 per share in an aggregate amount equal to one-half of
the aggregate purchase price for the 2021 Debentures The proceeds of the
November 2021 Debenture Offering were used to fund our investment in the Quinn
River Joint Venture.
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On March 9, 2022, we conducted the final closing of the November 2021 Debenture
Offering. Between December 1, 2021 and January 4, 2022, we completed multiple
closings of the November 2021 Debenture Offering in which we sold an aggregate
of $2,500,000 in 6 debentures and issued an aggregate of 757,576 Debenture
Warrants to the investors. Debenture Number 1 was in the principal amount of
$250,000; Debenture Number 2 was in the principal amount of $250,000; Debenture
Number 3 was in the principal amount of $500,000; Debenture Number 4 was in the
principal amount of $500,000; Debenture Number 5 was in the principal amount of
$500,000; and Debenture Number 6 was in the principal amount of $500,000. The 6
Debentures bear interest at the rate of 15% per annum calculated on the basis of
a 360-day year and mature with 50% due on dates ranging from May 31 to July 4
2023 and the remaining 50% due all on July 10, 2024. Commencing in 2025, and for
a period of 5 years thereafter, all note holders of the 6 Debentures shall
receive, on an annual basis, cash payments equal to the greater of (i) 15% of
the principal amount of the notes they purchased, or (ii) such purchaser's pro
rata portion of 5% of the distributions we receive for the prior fiscal year
pursuant to the terms of the Quinn River Joint Venture Agreement. This will
result in additional payments in the aggregate amount of not less than $375,000
per year beginning in 2025, for five years, to the 6 Debenture holders.
Leaflink Financing Agreement
We maintain an accounts receivable financing agreement (the "Short Term
Financing Agreement") with LeafLink Financial whereby we can sell certain of our
accounts receivable for a discount of 3%. In April 2022, the discount rate
decreased to 2.5% Loans under the facility cannot exceed an aggregate of
$1,500,000 and are payable within 30 days.
2022 Financing Agreement CBR
Effective September 30, 2022, we entered into a Business Loan and Security
Agreement with CBR Capital LLC to borrow $900,000. The loan is repayable in 48
weekly installments in the amount of $13,312.50 for weeks 1-8 and $29,287.50 for
weeks 9-48. CBR Capital LLC has stated that it is aware of the Canaccord
Debentures and the U.S. Convertible Debentures and has agreed to subordinate the
CBR security interest to these debenture holders. During the nine months ended
February 28, 2023, the Company received cash proceeds in the amount of $873,000
from the loan agreement and made payments in the amount of $457,950.
2022 Financing Agreement TVT
Effective October 21, 2022, we entered into an Agreement for the Purchase and
Sale of Future Receipts with TVT Business Funding LLC to borrow $200,000. The
loan is prepayable in future receipts until the amount of $284,000 has been
repaid. During the nine months ended February 28, 2023, the Company received
cash proceeds in the amount of $194,000 from the loan agreement and made
payments in the amount of $106,500.
Sales of Equity
The Canaccord Special Warrant Offering
On June 20, 2018, we executed an agency agreement with Canaccord Genuity Corp.
and closed on a private offering of our Special Warrants for aggregate gross
proceeds of CD$13,037,859 (USD$9,785,978). In connection therewith, we also
entered into a Special Warrant Indenture and a Warrant Indenture with Odyssey
Trust Company, as special warrant agent and warrant agent.
Pursuant to the offering, we issued 7,243,014 special warrants at a price of
CD$1.80 (USD$1.36) per Special Warrant. Each Special Warrant was automatically
exercised, for no additional consideration, into Units on November 30, 2018.
Each Unit consisted of one Unit Share and one warrant to purchase one share of
common stock. Each warrant was to be exercisable at a price of CD$2.60 for three
years after our common stock was listed on a recognized Canadian stock exchange,
subject to adjustment in certain events. The warrants expired on January 7,
2022. Because we did not receive a receipt from the applicable Canadian
securities authorities for the qualifying prospectus by August 20, 2018, each
Special Warrant entitled the holder to receive 1.1 Units (instead of one (1)
Unit); provided, however, that any fractional entitlement to penalty units was
rounded down to the nearest whole penalty unit.
In connection with the Special Warrant Offering, we paid a cash commission and
other fees equal to CD$1,413,267 (USD$1,060,773), a corporate finance fee equal
to 362,163 Special Warrants with a fair value of USD$1,413,300, and 579,461
Broker Warrants. Each Broker Warrant entitles the holder thereof to acquire one
unit at a price of CD$1.80 per unit for a period of 36 months from the date that
our common stock is listed on a recognized Canadian stock exchange, subject to
adjustment in certain events. Our common stock commenced trading on the Canadian
Stock Exchange on January 7, 2019. During the year ended May 31, 2020, we also
issued investors 760,542 Special Warrants with a fair value of $7,142,550 as a
penalty for failure to timely effect a Canadian prospectus with regard to the
securities underlying the Special Warrants.
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The Navy Capital Investors
Effective July 31, 2018, we entered into a subscription agreement with Navy
Capital Green International, Ltd., a British Virgin Islands limited company
("Navy Capital"), pursuant to which we agreed to sell to Navy Capital, for a
purchase price of $3,000,000, 1,875,000 units ($1.60 per unit), representing (i)
1,875,000 shares of our common stock, and (ii) three-year warrants to purchase
an aggregate of 1,875,000 shares of our common stock (the "Navy Warrant Shares")
at an exercise price of $2.40 per share of common stock (the "Navy Capital
Offering"). We valued the warrants using the Black-Scholes valuation model, and
allocated gross proceeds in the amount of $1,913,992 to the common stock and
$1,086,008 to the warrants. The closing occurred on August 6, 2018. In the
subscription agreement, we also agreed to file, on or before November 1, 2018, a
registration statement with the SEC registering the shares of common stock and
Navy Warrant Shares issued to Navy Capital. If we failed to file the
registration statement on or before that date, we were required to issue to Navy
Capital an additional number of units equal to ten percent (10%) of the units
originally subscribed for by Navy Capital (which would include additional
warrants at the original exercise price). On August 29, 2019, we filed a
registration statement with the SEC which included the shares of common stock
and Navy Warrant Shares issued to Navy Capital. The warrant was exercisable from
time to time, in whole or in part for three years. The warrant had anti-dilution
provisions that provided for an adjustment to the exercise price in the event of
a future issuance or sale of common stock at a lower price, subject to certain
exceptions as set forth in the warrant. The warrant also provided that it is
callable at any time after the bid price of our common stock exceeds 120% of the
exercise price of the warrant for a period of 20 consecutive business days. This
warrant expired on July 31, 2021.
Between August 8, 2018 and August 10, 2018, we entered into five subscription
agreements, pursuant to which we sold, for an aggregate purchase price of
$2,750,000, 1,718,750 units ($1.60 per unit), representing (i) 1,718,750 shares
of our common stock, and (ii) three-year warrants to purchase an aggregate of
1,718,750 shares of our common stock at an exercise price of $2.40 per share of
common stock. We valued the warrants using the Black-Scholes valuation model,
and allocated gross proceeds in the amount of $1,670,650 to the common stock and
$1,079,350 to the warrants. These warrants expired on August 7, 2021. The
balance of the terms set forth in the subscription agreements are the same as
the terms in the Navy Capital subscription agreement summarized above.
Oasis Cannabis Transaction
On December 4, 2017, we entered into the Acquisition Agreement, with Alternative
Solutions for us to acquire all of the outstanding equity interests in
Alternative Solutions and the Oasis LLCs. Pursuant to the Acquisition Agreement,
we paid a non-refundable deposit of $250,000 upon signing, which was followed by
an additional payment of $1,800,000 approximately 45 days thereafter and were to
receive, upon receipt of applicable regulatory approvals, an initial 10% of each
of the Oasis LLCs. Regulatory approvals were received and the 10% membership
interests were transferred to us.
On June 27, 2018, we closed on the purchase of the remaining 90% of the
membership interests in Alternative Solutions and the Oasis LLCs from the owners
thereof (excluding Alternative Solutions). The closing consideration was as
follows: $5,995,543 in cash, a $4.0 million promissory note due in December
2019, known as the Oasis Note, and $6,000,000 in shares of our common stock. The
cash payment of $5,995,543 was less than the $6,200,000 payment originally
contemplated because the Company assumed an additional $204,457 of liabilities.
The number of shares to be issued was computed as follows: $6,000,000 divided by
the lower of $1.00 or the conversion price to receive one share of our common
stock in our first equity offering of a certain minimum size that commenced in
2018, multiplied by 80%. This price was determined to be $0.272 per share. The
Oasis Note was secured by a first priority security interest over our membership
interests in Alternative Solutions and the Oasis LLCs, and by the assets of each
of the Oasis LLCs and Alternative Solutions. We also delivered a confession of
judgment to a representative of the former owners of Alternative Solutions and
the Oasis LLCs (other than Alternative Solutions) that would generally become
effective upon an event of default under the Oasis Note or failure to pay
certain other amounts when due. We repaid the Oasis Note in full in December
2019.
At the time of closing of the Acquisition Agreement, Alternative Solutions owed
certain amounts to a consultant known as 4Front Advisors, which amount was in
dispute. In August 2019, we made a payment to this company to settle this
dispute and the Oasis Note was reduced accordingly.
The former owners of Alternative Solutions and the Oasis LLCs (other than
Alternative Solutions) became entitled to a $1,000,000 payment from us because
the Oasis LLC maintained an average revenue of $20,000 per day during the 2019
calendar year. We made a payment in the amount of $850,000 to the sellers on May
27, 2020. We deposited the balance due to sellers of $150,000 with an escrow
agent to hold pending the outcome of a tax audit. During the year ended May 31,
2020, the State of Nevada notified the Oasis LLCs that it would be conducting a
tax audit for periods both before and after the closing of the sale to CLS. In
February 2021, we finalized the tax audit, used approximately $43,000 of the
escrowed amount to reimburse ourselves for the portion of the tax liability
properly payable by the sellers, and returned approximately $107,000 of the
escrowed amount to the sellers.
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We received final regulatory approval to own the membership interests in the
Oasis LLCs on December 12, 2018. We received final regulatory approval to own
our interest in the Oasis LLCs through Alternative Solutions under the revised
structure of the transaction on April 26, 2022.
Consulting Agreements
We periodically use the services of outside investor relations consultants.
During the year ended May 31, 2016, pursuant to a consulting agreement, we
agreed to issue 2,500 shares of common stock per month, valued at $11,600 per
month, to a consultant in exchange for investor relations consulting services.
The consulting agreement was terminated during the first month of its term. The
parties are in discussions regarding whether any shares of our common stock have
been earned and it is uncertain whether any shares will be issued. As of
February 28, 2023, we included 5,000 shares of common stock, valued at $23,200
in stock payable on the accompanying balance sheets. The shares were valued
based on the closing market price on the grant date.
On December 29, 2015, pursuant to a consulting agreement, we agreed to issue
6,250 shares of common stock per month, valued at $21,250, to a consultant in
exchange for investor relations consulting services. The consulting agreement
was terminated during the first month of its term. The parties are in
discussions regarding whether any shares of our common stock have been earned
and it is uncertain whether any shares will be issued. As of February 28, 2023,
we had 12,500 shares of common stock, valued at $42,500 included in stock
payable on the accompanying balance sheet. The shares were valued based on the
closing market price on the grant date.
Going Concern
Our financial statements were prepared using accounting principles generally
accepted in the United States of America applicable to a going concern, which
contemplate the realization of assets and liquidation of liabilities in the
normal course of business. With the exception of the first quarter of fiscal
2022, we have incurred losses from operations since inception, and have an
accumulated deficit of $105,343,764 as of February 28, 2023, compared to
$95,079,817 as of May 31, 2022. We had a working capital deficit of $10,127,092
as of February 28, 2023, compared to a working capital deficit of $21,228,633 as
of May 31, 2022. The report of our independent auditors for the year ended May
31, 2022 contained a going concern qualification.
Our ability to continue as a going concern must be considered in light of the
problems, expenses, and complications frequently encountered by early-stage
companies.
Our ability to continue as a going concern is dependent on our ability to
generate sufficient cash from operations to meet our cash needs and finance our
ongoing operations. There can be no assurance that cash generated by our future
operations will be adequate to meet our needs.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably
likely to have, a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
Critical Accounting Estimates
Management uses various estimates and assumptions in preparing our financial
statements in accordance with generally accepted accounting principles. These
estimates and assumptions affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities, and the reported revenues
and expenses. Accounting estimates that are the most important to the
presentation of our results of operations and financial condition, and which
require the greatest use of judgment by management, are designated as our
critical accounting estimates. We have the following critical accounting
estimates:
? Estimates and assumptions regarding the deductibility of expenses for
purposes of Section 280E of the Internal Revenue Code: Management evaluates
the expenses of its manufacturing and retail operations and makes certain
judgments regarding the deductibility of various expenses under Section 280E
of the Internal Revenue Code based on its interpretation of this regulation
and its subjective assumptions about the categorization of these expenses.
? Estimates and assumptions used in the valuation of derivative liabilities:
Management utilizes a lattice model to estimate the fair value of derivative
liabilities. The model includes subjective assumptions that can materially
affect the fair value estimates.
? Estimates and assumptions used in the valuation of intangible assets. In
order to value our intangible assets, management prepares multi-year
projections of revenue, costs of goods sold, gross margin, operating
expenses, taxes and after tax margins relating to the operations associated
with the intangible assets being valued. These projections are based on the
estimates of management at the time they are prepared and include subjective
assumptions regarding industry growth and other matters.
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Recently Issued Accounting Standards
Accounting standards promulgated by the Financial Accounting Standards Board
(the "FASB") are subject to change. Changes in such standards may have an impact
on our future financial statements. The following are a summary of recent
accounting developments.
In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for
Goodwill Impairment, which simplifies the subsequent measurement of goodwill by
eliminating Step 2 from the goodwill impairment test. In computing the implied
fair value of goodwill under Step 2, current U.S. GAAP requires the performance
of procedures to determine the fair value at the impairment testing date of
assets and liabilities (including unrecognized assets and liabilities) following
the procedure that would be required in determining the fair value of assets
acquired and liabilities assumed in a business combination. Instead, the
amendments under this ASU require the goodwill impairment test to be performed
by comparing the fair value of a reporting unit with its carrying amount. An
impairment charge should be recognized for the amount by which the carrying
amount exceeds the reporting unit's fair value; however, the loss recognized
should not exceed the total amount of goodwill allocated to that reporting unit.
The ASU became effective for us on January 1, 2020. The amendments in this ASU
were applied on a prospective basis. During the year ended May 31, 2020, the
Company recorded an impairment of goodwill in the amount of $25,185,003 pursuant
to ASU No. 2017-04.
In May 2017, the FASB issued ASU No. 2017-09, Stock Compensation - Scope of
Modification Accounting, which provides guidance on which changes to the terms
or conditions of a share-based payment award require an entity to apply
modification accounting. The ASU requires that an entity account for the effects
of a modification unless the fair value (or calculated value or intrinsic value,
if used), vesting conditions and classification (as equity or liability) of the
modified award are all the same as for the original award immediately before the
modification. The ASU became effective for us on January 1, 2018 and is applied
to an award modified on or after the adoption date. Adoption of ASU 2017-09 did
not have a material effect on the Company's financial statements.
In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260),
Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging
(Topic 815). The amendments in Part I of this update change the classification
analysis of certain equity-linked financial instruments (or embedded features)
with down round features. When determining whether certain financial instruments
should be classified as liabilities or equity instruments, a down round feature
no longer precludes equity classification when assessing whether the instrument
is indexed to an entity's own stock. The amendments also clarify existing
disclosure requirements for equity-classified instruments. As a result, a
freestanding equity-linked financial instrument (or embedded conversion option)
no longer would be accounted for as a derivative liability at fair value as a
result of the existence of a down round feature. For freestanding equity
classified financial instruments, the amendments require entities that present
earnings per share (EPS) in accordance with Topic 260 to recognize the effect of
the down round feature when it is triggered. That effect is treated as a
dividend and as a reduction of income available to common shareholders in basic
EPS. Convertible instruments with embedded conversion options that have down
round features are now subject to the specialized guidance for contingent
beneficial conversion features (in Subtopic 470-20, Debt-Debt with Conversion
and Other Options), including related EPS guidance (in Topic 260). The
amendments in Part II of this update recharacterize the indefinite deferral of
certain provisions of Topic 480 that now are presented as pending content in the
Codification, to a scope exception.
These amendments do not have an accounting effect. For public business entities,
the amendments in Part I of this update are effective for fiscal years, and
interim periods within those fiscal years, beginning after December 15, 2018.
Early adoption is permitted for all entities, including adoption in an interim
period. If an entity early adopts the amendments in an interim period, any
adjustments should be reflected as of the beginning of the fiscal year that
includes that interim period.
There are various other updates recently issued, most of which represented
technical corrections to the accounting literature or application to specific
industries and are not expected to a have a material impact on our consolidated
financial position, results of operations or cash flows.
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