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EX-32.2 - EXHIBIT 32.2 - CLS Holdings USA, Inc.ex_181138.htm
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EX-31.2 - EXHIBIT 31.2 - CLS Holdings USA, Inc.ex_181136.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q 

 


 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended February 29, 2020

 

or

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 

 

Commission File Number: 000-55546

 

CLS HOLDINGS USA, INC.

(Exact name of registrant as specified in its charter)

 

Nevada

45-1352286

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

11767 South Dixie Highway, Suite 115, Miami, Florida 33156

(Address of principal executive offices) (Zip Code)

 

(888) 438-9132

Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

N/A

N/A

N/A

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒    No ☐

  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒    No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,  a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated filer ☐

Accelerated filer                   ☐

Non-accelerated filer    ☐

Smaller reporting company  ☒

Emerging growth company ☐

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐    No ☒

 

State the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 126,521,414 shares of $0.0001 par value common stock outstanding as of April 1, 2020. 

 

 

 

 

CLS HOLDINGS USA, INC.

 

FORM 10-Q

Quarterly Period Ended February 29, 2020

 

TABLE OF CONTENTS

 

 

Page

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

3

 

 

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements

4

 

Consolidated Balance Sheets as of February 29, 2020 (Unaudited) and May 31, 2019

4

 

Condensed Consolidated Statements of Operations for the Three and Nine Months ended February 29, 2020 (Unaudited) and February 28, 2019 (Unaudited)

5

 

Consolidated Statements of Stockholders’ Equity for the Three and Nine Months ended February 29, 2020 (Unaudited) and February 28, 2019 (Unaudited)

6

 

Condensed Consolidated Statements of Cash Flows for the Nine Months ended February 29, 2020 (Unaudited) and February 28, 2019 (Unaudited)

7

 

Notes to the Consolidated Financial Statements (Unaudited)

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

39

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

57

Item 4.

Controls and Procedures

57

 

 

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

59

Item 1A.

Risk Factors

59

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

Item 3.

Defaults Upon Senior Securities

59

Item 4.

Mine Safety Disclosures

59

Item 5.

Other Information

59

Item 6.

Exhibits

60

 

 

SIGNATURES

61

 

 

 

 

 

 

EXPLANATORY NOTE

 

Unless otherwise noted, references in this registration statement to “CLS Holdings USA, Inc.,” the “Company,” “we,” “our” or “us” means CLS Holdings USA, Inc. and its subsidiaries.

 

FORWARD-LOOKING STATEMENTS

 

This document contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, the future impact of the COVID-19 virus on our business, the future results of our initiatives to retain our employees and strengthen our relationships with our customers and community during the pandemic, the future effect of our initiatives to retain and expand market share and achieve growth following the pandemic, results of operations during the pandemic, and the effectiveness of our business practices during the pandemic. The continued spread of COVID-19 could have, and in some cases already has had, an adverse impact on our business, operations and financial results, including through disruptions in our processing activities, sales channels, and retail dispensary operations as well as a deterioration of general economic conditions including a possible national or global recession. Due to the speed with which the COVID-19 situation is developing and the uncertainty of its magnitude, outcome and duration, it is not possible to estimate its impact on our business, operations or financial results; however, the impact could be material. These forward-looking statements also relate to anticipated future events, future results of operations, and our future financial performance, and include, without limitation, statements relating to our ability to finance our operations, finance and close our proposed acquisitions, market acceptance of our services and product offerings, and our ability to protect and commercialize our intellectual property. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “will,” “should,” “intends,” “expects,” “plans,” “goals,” “projects,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology.

 

These forward-looking statements are only predictions, are uncertain and involve substantial known and unknown risks, uncertainties and other factors which may cause our (or our industry’s) actual results, levels of activity or performance to be materially different from any expected future results, levels of activity or performance expressed or implied by these forward-looking statements.

 

We cannot guarantee future results, levels of activity or performance. You should not place undue reliance on these forward-looking statements, which speak only as of the date that they were made. These cautionary statements should be considered together with any written or oral forward-looking statements that we may issue in the future. Except as required by applicable law, we do not intend to update any of the forward-looking statements to conform these statements to reflect actual results, later events or circumstances or to reflect the occurrence of unanticipated events.

 

 

AVAILABLE INFORMATION

 

We file certain reports under the Securities Exchange Act of 1934 (the “Exchange Act”). Such filings include annual and quarterly reports. The reports we file with the SEC are available on the SEC’s website (http://www.sec.gov).

 

 

 

 

Item 1. Financial Statements.

CLS HOLDINGS USA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   

February 29,

   

May 31,

 
   

2020

   

2019

 

ASSETS

               

Current assets

               

    Cash and cash equivalents

  $ 3,039,095     $ 10,525,791  

    Accounts Receivable

    157,229       163,571  

    Inventory

    730,330       746,833  

    Prepaid expenses and other current assets

    329,674       390,413  

    Interest receivable - current portion

    399,453       -  

    Notes receivable - current portion

    5,000,000       850,958  

      Total current assets

    9,655,781       12,677,566  
                 

Investment

    -       2,709  

Note receivable

    -       4,299,042  

Interest receivable

    -       178,258  

Property, plant and equipment, net of accumulated depreciation of $745,196 and $546,408

    3,613,937       1,910,301  

Right of use assets, operating leases

    566,049       -  

Intangible assets, net of accumulated amortization of $203,810 and $116,476

    1,437,753       1,525,087  

Goodwill

    25,742,899       25,742,899  

Other assets

    167,455       167,455  
                 

Total assets

  $ 41,183,874     $ 46,503,317  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Current liabilities

               

     Accounts payable and accrued liabilities

  $ 1,071,948     $ 1,517,127  

     Accrued interest

    264,155       474,800  

     Notes payable, net of discount of $0 and $67,384

    -       3,932,616  

     Lease liability - operating leases, current

    443,063       -  

     Contingent liability

    1,000,000       1,000,000  
                 

          Total current liabilities

    2,779,166       6,924,543  
                 

Noncurrent liabilities

               

     Lease liability - operating leases, non-current

    236,851       -  

     Convertible notes payable - Long Term, net of discount of $2,633,799 and $3,819,010

    16,845,337       14,541,220  
                 

Total Liabilities

    19,861,354       21,465,763  
                 

Commitments and contingencies

    -       -  
                 

Stockholder's equity

               

Preferred stock, $0.001 par value; 20,000,000 shares authorized; no shares issued

    -       -  

Common stock, $0.0001 par value; 750,000,000 shares authorized at February 29, 2020 and May 31, 2019; 126,521,414 and 125,839,095 shares issued and outstanding at February 29, 2020 and May 31, 2019, respectively

    12,653       12,585  

   Additional paid-in capital

    71,196,814       70,758,025  

   Common stock subscribed

    211,677       455,095  

   Accumulated deficit

    (50,098,624

)

    (46,188,151

)

      Total stockholder's equity (deficit)

    21,322,520       25,037,554  
                 

Total liabilities and stockholders' equity (deficit)

  $ 41,183,874     $ 46,503,317  

 

See accompanying notes to these financial statements.

 

 

CLS HOLDINGS USA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited) 

 

   

For the Three

   

For the Three

   

For the Nine

   

For the Nine

 
   

Months Ended

   

Months Ended

   

Months Ended

   

Months Ended

 
   

February 29, 2020

   

February 28, 2019

   

February 29, 2020

   

February 28, 2019

 
                                 
                                 

Revenue

  $ 3,224,170     $ 2,372,790     $ 9,139,616     $ 5,529,053  

Cost of goods sold

    1,537,960       1,438,424       4,537,164       3,245,035  

Gross margin

    1,686,210       934,366       4,602,452       2,284,018  
                                 

Selling, general and administrative expenses

    2,213,206       5,102,871       6,533,173       23,472,037  

      Total operating expenses

    2,213,206       5,102,871       6,533,173       23,472,037  
                                 

Operating loss

    (526,996

)

    (4,168,505

)

    (1,930,721

)

    (21,188,019

)

                                 

Other (income) expense:

                               

   Interest expense, net

    725,003       662,961       2,254,752       2,999,630  

   Gain on settlement of liabilities

    -       -       (275,000

)

    -  

      Total other expense

    725,003       662,961       1,979,752       2,999,630  
                                 

Income (Loss) before income taxes

    (1,251,999

)

    (4,831,466

)

    (3,910,473

)

    (24,187,649

)

                                 

Income tax expense

    -       -       -       -  
                                 

Net income (loss)

  $ (1,251,999

)

  $ (4,831,466

)

  $ (3,910,473

)

  $ (24,187,649

)

                                 

Net income (loss) per share - basic

  $ (0.01

)

  $ (0.04

)

  $ (0.03

)

  $ (0.25

)

                                 

Net income (loss) per share - diluted

  $ (0.01

)

  $ (0.04

)

  $ (0.03

)

  $ (0.25

)

                                 

Weighted average shares outstanding - basic

    126,470,865       124,346,650       126,343,206       95,132,835  
                                 

Weighted average shares outstanding - diluted

    126,470,865       124,346,650       126,343,206       95,132,835  

 

See accompanying notes to these financial statements.

 

 

CLS HOLDINGS USA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

 

                   

Additional

                         
   

Common Stock

   

Paid In

   

Stock

   

Accumulated

         
   

Amount

   

Value

   

Capital

   

Payable

   

Deficit

   

Total

 
                                                 

Balance - May 31, 2018

    50,128,972     $ 5,013     $ 17,628,717     $ 307,584     $ (18,569,094

)

  $ (627,780

)

Common stock issued for conversion of debt

    3,697,511       370       1,295,320       -       -       1,295,690  

Common stock issuance with Oasis acquisition

    22,058,823       2,206       15,438,970       -       -       15,441,176  

Common stock issued to consultant

    731,250       73       515,240       (25,313

)

    -       490,000  

Common stock issued to officer

    600,000       60       263,940       (213,320

)

    -       50,680  

Common stock to be issued to officer

    -       -       -       277,833               277,833  

Common stock and warrants issued for cash

    14,375,000       1,438       5,748,562       -       -       5,750,000  

Special Warrants issued for cash

    -       -       9,785,978       -       -       9,785,978  

Cashless exercise of warrant

    129,412       13       (13

)

    -       -       -  

Warrant issued due to penalty

    -       -       941,972       -       -       941,972  

Warrants issued as compensation for offering

    -       -       2,369,830       -       -       2,369,830  

Warrants issued to placement agent

    -       -       1,413,300       -       -       1,413,300  

Units issued as compensation for offering

    559,750       56       557,279       -       -       557,335  

Special warrant issued due to penalty

    -       -       7,142,550       -       -       7,142,550  

Common stock issued for exercise of special warrants

    33,463,838       3,347       (3,347

)

    -       -       -  

Common stock shares issued for settlement

    50,000       5       47,495       -       -       47,500  

Cashless exercise of warrant

    19,551       2       (2

)

    -       -       -  

Foreign currency transaction loss on equity offering

    -       -       403,588       -       -       403,588  

Discount on notes from beneficial conversion feature

    -       -       9,039,096       -       -       9,039,096  

Reclass derivative upon adoption of ASU 2017-11

    -       -       1,265,751       -       -       1,265,751  

Imputed interest

    -       -       807       -       -       807  

Derivative valuation of reset event

    -       -       35,883       -       -       35,883  

Net loss - 9 months ended February 28, 2019

    -       -       -       -       (24,187,649

)

    (24,187,649

)

Balance - February 28, 2019 (unaudited)

    125,814,107     $ 12,583     $ 73,890,916     $ 346,784     $ (42,756,743

)

  $ 31,493,540  
                                                 

Balance - May 31, 2019

    125,839,095     $ 12,585     $ 70,758,025     $ 455,095     $ (46,188,151

)

  $ 25,037,554  

Common stock issued to officers

    550,000       55       390,445       (390,500

)

    -       -  

Conversion of notes payable

    32,319       3       25,854       -       -       25,857  

Vesting of Common stock to be issued to officers

    -       -       -       124,582       -       124,582  

Common stock to be issued to consultants

    -       -       -       45,000       -       45,000  

Common stock issued to consultant

    100,000       10       22,490       (22,500

)

    -       -  

Net loss - 9 months ended February 29, 2020

    -       -       -       -       (3,910,473

)

    (3,910,473

)

Balance - February 29, 2020 (unaudited)

    126,521,414     $ 12,653     $ 71,196,814     $ 211,677     $ (50,098,624

)

  $ 21,322,520  

 

 

CLS HOLDINGS USA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)  

 

   

For the Nine

   

For the Nine

 
   

Months Ended

   

Months Ended

 
   

February 29, 2020

   

February 28, 2019

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net loss

  $ (3,910,473

)

  $ (24,187,649

)

Adjustments to reconcile net loss to net cash used in operating activities:

               

Gain on contingent liabilities

    (275,000

)

    -  

Imputed interest

    -       807  

Stock-based compensation

    124,582       328,513  

Fair value of shares issued to consultants

    45,000       490,000  

Warrants issued to placement agent

    -       3,783,130  

Amortization of debt discounts

    1,249,053       2,481,674  

Warrants and Special Warrants issued due to penalty

    -       8,084,522  

Units issued to placement agent

    -       557,335  

Non-cash offering costs of equity financing

    -       403,588  

Depreciation and amortization expense

    285,073       184,068  

Expense from derivative triggering event

    -       12,659  

Fair value of shares issued in settlement

    -       47,500  

Changes in assets and liabilities:

               

Accounts receivable

    6,342       (259,576

)

Prepaid expenses and other current assets

    (72,742

)

    (608,090

)

Inventory

    16,503       (199,843

)

Interest receivable

    (221,195

)

    (99,618

)

Right of use asset

    1,215,397       -  

Redemption premium in transit

    -       (964,788

)

Accounts payable and accrued expenses

    (166,468

)

    (353,832

)

Accrued compensation

    -       (16,667

)

Accrued interest, related party

    -       5,943  

Deferred rent

    -       1,667  

Accrued interest

    934,117       588,312  

Due to related parties

    -       (50,000

)

Operating lease liability

    (1,101,532

)

    -  

Net cash used in operating activities

    (1,871,343

)

    (9,770,345

)

                 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Payments to purchase property, plant and equipment

    (1,766,185

)

    (735,234

)

Loan made to borrower under note receivable

    (175,000

)

    (5,150,000

)

Proceeds from collection of note receivable

    325,000       -  

Payment for investment in Alternative Solutions, net of cash received of $14,612

    -       (5,982,710

)

Net cash used in investing activities

    (1,616,185

)

    (11,867,944

)

                 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Proceeds from related party notes payable

    -       211,700  

Proceeds from convertible notes payable

    -       18,369,000  

Principal payments on notes payable

    -       (310,000

)

Principal payments on related party notes payable

    -       (211,838

)

Principal payments on convertible notes payable

    -       (37,500

)

Principal payments on notes payable

    (3,999,168

)

    -  

Proceeds from sale of equity

    -       15,535,978  

Net cash (used in) provided by financing activities

    (3,999,168

)

    33,557,340  
                 

Net increase in cash and cash equivalents

    (7,486,696

)

    11,919,051  
                 

Cash and cash equivalents at beginning of period

    10,525,791       52,964  
                 

Cash and cash equivalents at end of period

  $ 3,039,095     $ 11,972,015  
                 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

               

Interest paid

  $ 307,612     $ 8,964  

Income taxes paid

  $ -     $ -  
                 

NON-CASH INVESTING AND FINANCING ACTIVITIES:

               

Related party notes payable reclassified as related party convertible notes payable

  $ -     $ 75,000  

Beneficial conversion feature on convertible notes

  $ -     $ 9,039,096  

Note payable exchanged for common stock

  $ -     $ 1,295,690  

Charge to paid-in capital for par value of shares issued in cashless exercise of warrants

  $ -     $ 3,362  

Reclassify derivative liability to paid-in capital upon adoption of ASU 2017-11

  $ -     $ 1,265,751  

Adoption of lease standard ASU 2016-02

  $ 1,781,446     $ -  

Capitalized interest on convertible debentures

  $ 1,144,762     $ -  

Reclassification of deposit to fixed assets

  $ 136,190     $ -  

Shares issued for conversion of notes payable

  $ 25,857     $ -  

Shares issued for services from stock payable

  $ -     $ 25,313  

 

See accompanying notes to these financial statements. 

 

 

CLS HOLDINGS USA, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

February 29, 2020

(Unaudited)

 

Note 1 – Nature of Business and Significant Accounting Policies

 

Basis of Presentation

 

These financial statements and related notes are presented in accordance with accounting principles generally accepted in the United States and are expressed in US dollars. The Company has adopted a fiscal year end of May 31st.

 

Principals of Consolidation

 

The accompanying consolidated financial statements include the accounts of CLS Holdings USA, Inc., and its wholly owned operating subsidiaries, CLS Nevada, Inc., (“CLS Nevada”), CLS Labs, Inc. (“CLS Labs”), CLS Labs Colorado, Inc. (“CLS Colorado”), CLS Massachusetts, Inc. (“CLS Massachusetts”), and Alternative Solutions, LLC (“Alternative Solutions”). Alternative Solutions is the sole owner of the following three entities (collectively, the “Oasis LLCs”): Serenity Wellness Center, LLC (“Serenity Wellness Center”); Serenity Wellness Products, LLC (“Serenity Wellness Products”); and Serenity Wellness Growers, LLC (“Serenity Wellness Growers”). All material intercompany transactions have been eliminated upon consolidation of these entities.

 

Nature of Business

 

CLS Holdings USA, Inc. (the “Company”) was originally incorporated as Adelt Design, Inc. (“Adelt”) on March 31, 2011 to manufacture and market carpet binding art. Production and marketing of carpet binding art never commenced.

 

On November 12, 2014, CLS Labs, Inc. (“CLS Labs”) acquired 10,000,000 shares, or 55.6%, of the outstanding shares of common stock of Adelt from its founder, Larry Adelt. On that date, Jeffrey Binder, the Chairman, President and Chief Executive Officer of CLS Labs, was appointed Chairman, President and Chief Executive Officer of the Company. On November 20, 2014, Adelt adopted amended and restated articles of incorporation, thereby changing its name to CLS Holdings USA, Inc. Effective December 10, 2014, the Company effected a reverse stock split of its issued and outstanding common stock at a ratio of 1-for-0.625 (the “Reverse Split”), wherein 0.625 shares of the Company’s common stock were issued in exchange for each share of common stock issued and outstanding. As a result, 6,250,000 shares of the Company’s common stock were issued to CLS Labs in exchange for the 10,000,000 shares that it owned by virtue of the above-referenced purchase from Larry Adelt.

 

On April 29, 2015, the Company, CLS Labs and CLS Merger Inc., a Nevada corporation and wholly owned subsidiary of CLS Holdings  (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) and completed a merger, whereby CLS Merger Inc. merged with and into CLS Labs, with CLS Labs remaining as the surviving entity (the “Merger”). Upon the consummation of the Merger, the shares of the common stock of CLS Holdings owned by CLS Labs were extinguished and the former stockholders of CLS Labs were issued an aggregate of 15,000,000 (post Reverse Split) shares of common stock in CLS Holdings in exchange for their shares of common stock in CLS Labs. As a result of the Merger, the Company acquired the business of CLS Labs and abandoned its previous business.

 

The Company has been issued a U.S. patent with respect to its proprietary method of extracting cannabinoids from cannabis 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 (“e-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. The Company has not commercialized its patented proprietary process or otherwise earned any revenues from it.  The Company plans to generate revenues through licensing, fee-for-service and joint venture arrangements related to its patented proprietary method of extracting cannabinoids from cannabis plants and converting the resulting cannabinoid extracts into saleable concentrates.

 

On December 4, 2017, the Company and Alternative Solutions, entered into a Membership Interest Purchase Agreement (the “Acquisition Agreement”), as amended, for the Company to acquire the Oasis LLCs from Alternative Solutions. Pursuant to the Acquisition Agreement, the Company initially contemplated acquiring all of the membership interests in the Oasis LLCs from Alternative Solutions. Just prior to closing, the parties agreed that the Company 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.  

 

 

Pursuant to the Acquisition Agreement, the Company paid a non-refundable deposit of $250,000 upon signing, which was followed by an additional payment of $1,800,000 paid in February 2018, for an initial 10% of each of the Oasis LLCs.  At that time, the Company applied for regulatory approval to own an interest in the Oasis LLCs, which approval was received. On June 27, 2018, the Company made the payments to indirectly acquire the remaining 90% of the Oasis LLCs, which were equal to cash in the amount of $5,995,543, a $4.0 million promissory note due in December 2019 (the “Oasis Note”), and 22,058,823 shares of its common stock (the “Purchase Price Shares”) (collectively, the “Closing Consideration”). 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 Company used the proceeds of a Canadian private securities offering to fund the cash portion of the Closing Consideration.  The Company then applied for regulatory approval to own the additional 90% in membership interests in the Oasis LLCs, which it received on December 12, 2018. 

 

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 has 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 is 60 days after such date. If CLS Massachusetts exercises the IGH Option, the Company, a wholly-owned subsidiary of the Company and IGH will enter into a merger agreement (the form of which has been agreed to by the parties) (the “IGH Merger Agreement”). At the effective time of the merger contemplated by the IGH Merger Agreement, CLS Massachusetts will pay a purchase price of $47,500,000, subject to reduction as provided in the IGH Merger Agreement, payable as follows: $35 million in cash, $7.5 million in the form of a five-year promissory note, and $5 million in the form of restricted common stock of the Company, plus $2.5 million as consideration for a non-competition agreement with IGH’s President, payable in the form of a five-year promissory note. IGH and certain IGH stockholders holding sufficient aggregate voting power to approve the transactions contemplated by the IGH Merger Agreement have entered into agreements pursuant to which such stockholders have, among other things, agreed to vote in favor of such transactions. On October 31, 2018, as consideration for the IGH Option, the Company 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 is evidenced by a secured promissory note of IGH, which bears interest at the rate of 6% per annum and matures on October 31, 2021. To secure the obligations of IGH to the Company under the loan agreement and the promissory note, the Company and IGH entered into a security agreement dated as of October 31, 2018, pursuant to which IGH granted to the Company a first priority lien on and security interest in all personal property of IGH. If the Company does not exercise the Option on or prior to the date that is 30 days following the end of the option period, the loan amount will be reduced to $2,500,000 as a break-up fee, subject to certain exceptions set forth in the IGH Option Agreement. On August 26, 2019, the parties amended the IGH Option Agreement to, among other things, delay closing until January 2020. By letter agreement dated January 31, 2020, the Company, CLS Massachusetts and IGH extended the IGH Option Agreement to February 4, 2020. On February 4, 2020, CLS Massachusetts exercised the IGH Option. By letter dated February 26, 2020, the Company 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. The Company advised IGH that it was 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 Note.

 

On January 29, 2019, the Company made a line of credit loan to CannAssist, LLC (“CannAssist”), in the principal amount of up to $500,000, subject to the terms and conditions set forth in that certain Loan Agreement, dated as of January 29, 2019 between CannAssist as the Borrower and the Company as the Lender (the “CannAssist Loan Agreement”). Any draws on the line of credit in excess of $150,000 will only be made in the sole discretion of the Company. The loan is evidenced by a secured promissory note of CannAssist (the “CannAssist Note”), which bears interest at the rate of 8% per annum and is personally guaranteed by the two equity owners of CannAssist.  To secure the obligations of CannAssist to the Company under the CannAssist Loan Agreement and the CannAssist Note, the Company and CannAssist entered into a security agreement dated as of January 29, 2019, pursuant to which CannAssist granted to the Company a first priority lien on and security interest in all personal property of CannAssist.

 

On March 11, 2019, the Company, through its wholly-owned subsidiary, CLS Massachusetts, entered into a membership interest purchase agreement (the “CannAssist Purchase Agreement”) with CannAssist, each of the members of CannAssist, and David Noble, as the members’ representative, to acquire an 80% ownership interest in CannAssist. After conducting diligence, the parties decided to terminate the CannAssist Purchase Agreement effective August 26, 2019. 

 

On August 26, 2019, the Company and CannAssist entered into an agreement to amend the CannAssist Note. Pursuant to the amendment, there will be no additional advances under the CannAssist Note beyond the $150,000 advanced on February 4, 2019, and the $175,000 advanced on June 24, 2019. In addition, the CannAssist Note shall become due and payable in full on or before February 28, 2020. See note 15. On December 23, 2019, the Company received payment in full on the CannAssist loan in the amount of $342,567, which is made up of $325,000 of principal and $17,567 of interest. At February 29, 2020, the Company was owed $0 pursuant to the CannAssist Note.

 

 

On January 4, 2018, the Attorney General of the United States issued new written guidance concerning the enforcement of federal laws relating to marijuana. The Attorney General’s memorandum stated that previous DOJ guidance specific to marijuana enforcement, including the memorandum issued by former Deputy Attorney General James Cole on August 29, 2013 (as amended on February 14, 2014, the “Cole Memo”) is unnecessary and is rescinded, effective immediately. The Cole Memo told federal prosecutors that in states that had legalized marijuana, they should use their prosecutorial discretion to focus not on businesses that comply with state regulations, but on illicit enterprises that create harms like selling drugs to children, operating with criminal gangs, and selling across state lines. While the rescission did not change federal law, as the Cole Memo and other DOJ guidance documents were not themselves laws, the rescission removed the DOJ’s formal policy that state-regulated cannabis businesses in compliance with the Cole Memo guidelines should not be a prosecutorial priority. Notably, former Attorney General Sessions’ rescission of the Cole Memo has not affected the status of the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) memorandum issued by the Department of Treasury, which remains in effect. This memorandum outlines Bank Secrecy Act-compliant pathways for financial institutions to service state-sanctioned cannabis businesses, which echoed the enforcement priorities outlined in the Cole Memo. In addition to his rescission of the Cole Memo, Attorney General Sessions issued a one-page memorandum known as the “Sessions Memorandum”. The Sessions Memorandum explains the DOJ’s rationale for rescinding all past DOJ cannabis enforcement guidance, claiming that Obama-era enforcement policies are “unnecessary” due to existing general enforcement guidance adopted in the 1980s, in chapter 9.27.230 of the U.A. Attorneys’ Manual (“USAM”). The USAM enforcement priorities, like those of the Cole Memo, are based on the use of the federal government’s limited resources and include “law enforcement priorities set by the Attorney General,” the “seriousness” of the alleged crimes, the “deterrent effect of criminal prosecution,” and “the cumulative impact of particular crimes on the community.” Although the Sessions Memorandum emphasizes that cannabis is a federally illegal Schedule I controlled substance, it does not otherwise instruct U.S. Attorneys to consider the prosecution of cannabis-related offenses a DOJ priority, and in practice, most U.S. Attorneys have not changed their prosecutorial approach to date. However, due to the lack of specific direction in the Sessions Memorandum as to the priority federal prosecutors should ascribe to such cannabis activities, there can be no assurance that the federal government will not seek to prosecute cases involving cannabis businesses that are otherwise compliant with state law. 

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with maturities of three months or less to be cash equivalents.  The Company had cash and cash equivalents of $3,039,095 and $10,525,791 as of February 29, 2020 and May 31, 2019, respectively.

 

Allowance for Doubtful Accounts

 

The Company generates the majority of its revenues and corresponding accounts receivable from the sale of cannabis, and cannabis related products. The Company evaluates the collectability of its accounts receivable considering a combination of factors. In circumstances where it is aware of a specific customer’s inability to meet its financial obligations to it, the Company records a specific reserve for bad debts against amounts due in order to reduce the net recognized receivable to the amount it reasonably believe will be collected. For all other customers, the Company recognizes reserves for bad debts based on past write-off experience and the length of time the receivables are past due. During the three and nine months ended February 29, 2020 and February 28, 2019, the Company reserved the amount of $0 for uncollectible accounts receivable. 

 

Inventory

 

Inventories are stated at the lower of cost or market. Cost is determined using a perpetual inventory system whereby costs are determined by acquisition costs of individual items included in inventory. Market is determined based on net realizable value. Appropriate consideration is given to obsolescence, excessive levels, deterioration, and other factors in evaluating net realizable values. Our cannabis products consist of prepackaged purchased goods ready for resale, along with produced edibles and extracts developed under our production license. 

 

 

Property, Plant and Equipment

 

Property and equipment is recorded at the lower of cost or estimated net recoverable amount, and is depreciated using the straight-line method over its estimated useful life.  Property acquired in a business combination is recorded at estimated initial fair value. Property, plant, and equipment are depreciated using the straight-line method based on the lesser of the estimated useful lives of the assets or the lease term based upon the following life expectancy:

 

   

Years

 

Office equipment

    3 to 5  

Furniture & fixtures

    3 to 7  

Machinery & equipment

    3 to 10  

Leasehold improvements

 

Term of lease

 

 

Long-Lived Assets

 

The Company reviews its property and equipment and any identifiable intangibles including goodwill for impairment on an annual basis utilizing the guidance set forth in the Statement of Financial Accounting Standards Board ASC 350 “Intangibles – Goodwill and Other” and ASC 360 “Property, Plant, and Equipment”. Based on Step 1 of ASC 350 and ASC 360, there were no impairments to the Company’s long-lived assets as of February 29, 2020. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

 

Comprehensive Income

 

ASC 220-10-15 “Reporting Comprehensive Income,” establishes standards for reporting and displaying of comprehensive income, its components and accumulated balances.  Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners.  Among other disclosures, ASC 220-10-15 requires that all items that are required to be recognized under current accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements.  The Company does not have any items of comprehensive income in any of the periods presented.

 

Concentrations of Credit Risk

 

The Company maintains its cash in bank deposit accounts and other accounts, the balances of which at times may be uninsured or exceed federally insured limits. From time to time, some of the Company’s funds are also held by escrow agents; these funds may not be federally insured. The Company continually monitors its banking relationships and consequently has not experienced any losses in such accounts.

 

Advertising and Marketing Costs

 

All costs associated with advertising and promoting products are expensed as incurred. Total recognized advertising and marketing expenses were $200,927 and $381,082 for the three months ended February 29, 2020 and February 28, 2019, respectively. Total recognized advertising and marketing expenses were $624,946 and $1,134,322 for the nine months ended February 29, 2020 and February 28, 2019, respectively.

 

Research and Development

 

Research and development expenses are charged to operations as incurred. The Company incurred no research and development costs for the three and nine months ended February 29, 2020 and February 28, 2019, respectively.

 

Fair Value of Financial Instruments

 

Pursuant to Accounting Standards Codification (“ASC”) No. 825 - Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheets. The carrying amounts of the Company’s cash and cash equivalents, notes receivable, convertible notes payable, accounts payable and accrued expenses, none of which is held for trading, approximate their estimated fair values due to the short-term maturities of those financial instruments.

 

A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

 

Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly.

 

Level 3 - Significant unobservable inputs that cannot be corroborated by market data.

   

Derivative Financial Instruments

 

Derivatives are recorded on the condensed consolidated balance sheets at fair value. The conversion features of the convertible notes are embedded derivatives and are separately valued and accounted for on the consolidated balance sheets with changes in fair value recognized during each period of change as a separate component of other income/expense. Fair values for exchange-traded securities and derivatives are based on quoted market prices. The pricing model the Company uses for determining the fair value of its derivatives is the Lattice Model. Valuations derived from this model are subject to ongoing internal and external verification and review. The model uses market-sourced inputs such as interest rates and stock price volatilities. Selection of these inputs involves management’s judgment and may impact net income (see note 18). 

 

On June 1, 2018, the Company adopted ASU 2017-11 and accordingly reclassified the fair value of the reset provisions embedded in convertible notes payable and certain warrants with embedded anti-dilutive provisions from liability to equity in the aggregate amount of $1,265,751. 

 

There were no reset provisions triggered, and derivative liabilities were not revalued, during the nine months ended February 29, 2020.

 

During the nine months ended February 28, 2019, a reset event occurred in connection with one of the Company’s convertible notes (see note 15). The following assumptions were used for the valuation of the derivative liability related to the convertible notes that contain a derivative component during the nine months ended February 28, 2019:

 

-     That the quoted market price of the common stock, which increased from $0.6865 as of June 1, 2018 to $0.710 as of June 20, 2018, would fluctuate with the Company’s projected volatility;

 

-     That the conversion price of the YAN II PN Convertible Notes would be equal to $0.40 with a full reset feature, and upon default, 75% of the lowest Variable Weighted Average Price (“VWAP”) in the 15 consecutive trading days ending on the trading day that is immediately prior to the applicable conversion date;

 

-     That the new convertible notes issued during such period with full resets were issued with conversion prices of $0.40, which were not reset as a result of subsequent transactions;

 

-     That an event of default at 24% or 15% interest rate would occur 0% of the time, increasing 1.00% per month to a maximum of 25%, and that instead of a penalty, there would be an alternative conversion price;

 

-     That the projected volatility curve from an annualized analysis for each valuation period would be based on the historical volatility of the Company and the remaining term for each convertible note. The projected volatility was in the range 97.4% to 242.8%.

 

-     That the Company would redeem the convertible notes, projected initially at 0% of the time and increasing monthly by 1.0% to a maximum of 10.0% (from alternative financing);

 

-     That the holder would automatically convert the notes at the maximum of 2 times the conversion price or the stock price if the common stock underlying certain 2017 convertible notes was eligible for sale in compliance with securities laws and the Company was not in default;

 

-     That unless an Event of Default occurred, the holder would sell, per trading day, an amount of common stock up to the greater of (i) $5,000 or (ii) 25% multiplied by the “Aggregate Amount,” as defined in the YA II PN Convertible Notes.

 

Revenue Recognition

 

Revenue is primarily generated through the Company’s subsidiary, Serenity Wellness Center LLC, d/b/a Oasis Cannabis (“Oasis”). Oasis operates a 24-hour cannabis dispensary that recognizes revenue from the sale of medical and recreational cannabis products within the State of Nevada.

 

 

Revenue from the sale of cannabis products is recognized by Oasis at the point of sale, at which time payment is received. Management estimates an allowance for sales returns.

 

The Company also recognizes revenue from Serenity Wellness Products LLC and Serenity Wellness Growers LLC, d/b/a City Trees (“City Trees”). City Trees recognizes revenue from the sale of the following cannabis products and services to licensed dispensaries within the State of Nevada:

 

 

Premium organic medical cannabis sold wholesale to licensed retailers

 

 

Recreational marijuana cannabis products sold wholesale to licensed distributors and retailers

 

 

Extraction products such as oils and waxes derived from in-house cannabis production

 

 

Processing and extraction services for licensed medical cannabis cultivators in Nevada

 

 

High quality cannabis strains in the form of vegetative cuttings for sale to licensed medical cannabis cultivators in Nevada

 

Effective June 1, 2018, the Company adopted ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identifying the contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to each performance obligation in the contract; and (5) recognizing revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the performance of the service has been rendered to a customer or delivery has occurred; (3) the amount of fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured.

 

There was no impact on the Company’s financial statements as a result of adopting Topic 606 for the three and nine months ended February 29, 2020 and February 28, 2019.

 

Disaggregation of Revenue

 

The following table represents a disaggregation of revenue for the three and nine months ended February 29, 2020 and February 28, 2019:

 

   

For the Nine

   

For the Nine

   

For the Three

   

For the Three

 
   

Months Ended

   

Months Ended

   

Months Ended

   

Months Ended

 
   

February 29, 2020

   

February 28, 2019

   

February 29, 2020

   

February 28, 2019

 

Cannabis Dispensary

    7,035,268       3,574,662       2,637,006       1,114,689  

Cannabis Production

    2,104,348       1,954,391       587,164       1,258,101  
      9,139,616       5,529,053       3,224,170       2,372,790  

 

Basic and Diluted Earnings or Loss Per Share

 

Basic net earnings per share is based on the weighted average number of shares outstanding during the period, while fully diluted net earnings per share is based on the weighted average number of shares of common stock and potentially dilutive securities assumed to be outstanding during the period using the treasury stock method. Potentially dilutive securities consist of options and warrants to purchase common stock, and convertible debt. Basic and diluted net loss per share are computed based on the weighted average number of shares of common stock outstanding during the period.  At February 29, 2020 and February 28, 2019, the Company excluded from the calculation of fully diluted shares outstanding the following shares because the result would have been anti-dilutive: At February 29, 2020, a total of 87,577,583 shares (54,835,145 issuable upon the exercise of warrants; 7,676,974 issuable upon the exercise of unit warrants; 24,678,796 issuable upon the conversion of convertible notes payable and accrued interest; and 386,668 in stock payable; at February 28, 2019, a total of 89,455,637 shares (57,062,190 issuable upon the exercise of warrants; 7,676,974 issuable upon the exercise of unit warrants; 24,556,389 issuable upon the conversion of convertible notes payable and accrued interest; and 160,084 in stock payable).

  

 

The Company uses the treasury stock method to calculate the impact of outstanding stock options and warrants. Stock options and warrants for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on earnings per common share and, accordingly, are excluded from the calculation.

 

A net loss causes all outstanding stock options and warrants to be anti-dilutive. As a result, the basic and dilutive losses per common share are the same for the three and nine months ended February 29, 2020 and February 28, 2019. 

 

Income Taxes

 

The Company accounts for income taxes under the asset and liability method in accordance with ASC 740.  The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The components of the deferred tax assets and liabilities are classified as current and non-current based on their characteristics.  A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.

 

Section 280E of the Internal Revenue Code, as amended, prohibits businesses from deducting certain expenses associated with trafficking controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act). The IRS has invoked Section 280E in tax audits against various cannabis businesses in the U.S. that are permitted under applicable state laws. Although the IRS has issued a clarification allowing the deduction of certain expenses, the bulk of operating costs and general administrative costs are generally not permitted to be deducted. The Company is in the process of evaluating the impact and application of Section 280E on its business. The Company believes that its net operating loss carryforwards will be sufficient to offset any potential income tax liability associated with Section 280E as of February 29, 2020.

 

Commitments and Contingencies

 

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur.  The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment.  In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims brought to such legal counsel’s attention as well as the perceived merits of the amount of relief sought or expected to be sought therein.

 

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements.  If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.

 

Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.

 

Recent Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Codification (“ASC”) No. 2016-02, Leases (Topic 842): Accounting for Leases. This update requires that lessees recognize right-of-use assets and lease liabilities that are measured at the present value of the future lease payments at the lease commencement date. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee will largely remain unchanged and shall continue to depend on its classification as a finance or operating lease. The Company has performed a comprehensive review in order to determine what changes were required to support the adoption of this new standard. The Company adopted the ASU and related amendments on June 1, 2019 and has elected certain practical expedients permitted under the transition guidance. The Company has elected the optional transition method that allows for a cumulative-effect adjustment in the period of adoption and will not restate prior periods. Under the new guidance, the majority of the Company’s leases continue to be classified as operating. During the first quarter of fiscal 2020, the Company completed its implementation of its processes and policies to support the new lease accounting and reporting requirements. This resulted in an initial increase in both its total assets and total liabilities in the amount of $1,781,446.

 

 

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 the Company on January 1, 2020. The amendments in this ASU will be applied on a prospective basis. The adoption of this ASU is not expected to have a material impact on our consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The update addresses eight specific cash flow issues and is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This update is effective for reporting periods beginning after December 15, 2017, including interim periods within the reporting period. Adoption of ASU 2016-15 did not have a material effect on our financial statements.

 

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 the Company 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.

 

Effective June 1, 2018, the Company adopted ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from the commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the performance of a service has been rendered to a customer or delivery has occurred; (3) the amount of the fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured. There was no impact on the Company’s financial statements as a result of adopting ASC 606.

 

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.

 

Those 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.

 

 

On June 1, 2018, the Company adopted ASU 2017-11 and accordingly reclassified the fair value of the reset provisions embedded in convertible notes payable and certain warrants with embedded anti-dilutive provisions from liability to equity in the aggregate amount of $1,265,751.

 

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 the Company’s consolidated financial position, results of operations or cash flows. 

 

Note 2 – Going Concern

 

As shown in the accompanying financial statements, the Company has incurred net losses from operations resulting in an accumulated deficit of $50,098,624 as of February 29, 2020. The Company’s auditors stated in their opinion on the Company’s financial statements for the year ended May 31, 2019 that there was substantial doubt about the Company’s ability to continue as a going concern, and that further losses were anticipated in the development of the Company’s business raising substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent upon the Company generating profitable operations in the future and/or obtaining the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from this uncertainty.

 

Note 3 – Acquisition of Alternative Solutions

 

On June 27, 2018, the Company closed on the purchase of all of the membership interests in Alternative Solutions and its three operating subsidiaries (collectively, the “Oasis LLCs”) from the members of such entities (other than Alternative Solutions).  The Oasis LLCs operate a fully integrated cannabis business in Las Vegas, Nevada, including a grow; extraction, conversion and processing facility; and a retail dispensary.  The closing occurred pursuant to a Membership Interest Purchase Agreement (the “Acquisition Agreement”) entered into between the Company and Alternative Solutions on December 4, 2017, as amended.  Pursuant to the Acquisition Agreement, the Company initially contemplated acquiring all of the membership interests in the Oasis LLCs from Alternative Solutions. Just prior to closing, the parties agreed that the Company 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.  The revised structure of the transaction is referenced in the Oasis Note, which modified the Acquisition Agreement.

 

Pursuant to the Acquisition Agreement, the Company paid a non-refundable deposit of $250,000 upon signing, which was followed by an additional payment of $1,800,000 paid in February 2018, for an initial 10% of each of the Oasis LLCs.  At that time, the Company applied for regulatory approval to own an interest in the Oasis LLCs, which approval was received. On June 27, 2018, the Company made the payments to indirectly acquire the remaining 90% of the Oasis LLCs, which were equal to cash in the amount of $5,995,543, a $4.0 million promissory note due in December 2019 (see note 15), (the “Oasis Note”), and 22,058,823 shares of its common stock (see note 17), (the “Purchase Price Shares”) (collectively, the “Closing Consideration”). 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 Company used the proceeds of a Canadian private securities offering to fund the cash portion of the Closing Consideration (see note 17).  The Company then applied for regulatory approval to own the additional 90% in membership interests in the Oasis LLCs, which it received on December 12, 2018. On August 14, 2019, the Company made a prepayment in the amount of $2,500,000, which, along with certain legal fees and other costs in the aggregate amount of $138,784, was applied to the amount due under the $4.0 million promissory note. The Company repaid the balance due under the Oasis Note on December 31, 2019.

 

The number of Purchase Price Shares was equal to 80% of the offering price of the Company’s common stock in its last equity offering, which price was $0.34 per share.  The Oasis Note is secured by a first priority security interest over the membership interests in Alternative Solutions and the Oasis LLCs, as well as by the assets of the Oasis LLCs.  The Company also delivered a confession of judgment to a representative of the sellers that will become effective, in general, if the Company defaults under the Oasis Note.

 

A claim was made that Oasis owed certain amounts to a consultant at the acquisition date; Oasis disputed this claim.   This claim was accrued on the Company’s balance sheet as of May 31, 2019, and was resolved during the nine months ended February 29, 2020 (see note 16).

 

 

The sellers are also entitled to a $1,000,000 payment from the Company on May 30, 2020 if the Oasis LLCs have maintained an average revenue of $20,000 per day during the 2019 calendar year. The fair value of this contingent consideration was $678,111 at the acquisition date as determined by the Company’s outside valuation consultants. At May 31, 2019, the Company increased the value of this contingent consideration to $1,000,000 and charged the amount of $321,889 to operations during the year ended May 31, 2019. This amount is recorded as a contingent liability on the Company’s balance sheet at February 29, 2020 and May 31, 2019.

 

The acquisition date estimated fair value of the consideration transferred totaled $27,975,650, which consisted of the following:

 

Initial purchase price

  $ 2,050,000  

Cash paid in connection with transaction

    5,995,543  

Note payable

    3,810,820  

Contingent consideration

    678,111  

Common stock

    15,441,176  

Total purchase price

  $ 27,975,650  
         

Net tangible assets

  $ 595,151  

Intangible assets

    1,637,600  

Goodwill

    25,742,899  

Total purchase price

  $ 27,975,650  

 

The above estimated fair value of the intangible assets is based on a preliminary purchase price allocation prepared by a third party valuation expert.  During the preliminary purchase price allocation period, which may be up to one year from the business combination date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill.  After the preliminary purchase price allocation period, the Company may record adjustments to assets acquired or liabilities assumed subsequent to the purchase price allocation period in its operating results in the period in which the adjustments were determined. 

 

Pro forma results

 

The following table sets forth the unaudited pro forma results of the Company as if the acquisition of the Oasis LLCs was effective on June 1, 2018.

 

   

Three months ended

February 28,

 
   

2019

 
   

(unaudited)

 

Revenues

  $ 2,372,790  

Net loss

  $ (12,850,356

)

Basic net income per share

  $ (0.10

)

Diluted net income per share

  $ (0.10

)

Weighted average shares - basic

    124,346,650  

Weighted average shares - diluted

    124,346,650  

 

   

Nine Months ended

February 28,

 
   

2019

 
   

(unaudited)

 

Revenues

  $ 6,299,932  

Net loss

  $ (24,402,155

)

Basic net income per share

  $ (0.26

)

Diluted net income per share

  $ (0.26

)

Weighted average shares - basic

    95,132,835  

Weighted average shares - diluted

    95,132,835  

 

 

These combined results are not necessarily indicative of the results that may have been achieved had the companies always been combined.

 

Note 4 – Joint Venture and Options Transaction

 

In Good Health

 

On October 31, 2018, the Company, CLS Massachusetts, and IGH, which converted to a for-profit corporation on November 6, 2018 (the “Conversion”), entered into the IGH Option Agreement. Under the terms of the IGH Option Agreement, CLS Massachusetts has 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 is 60 days after such date (the “Option Period”). If CLS Massachusetts exercises the IGH Option, the Company, a wholly-owned subsidiary of the Company and IGH will enter into the IGH Merger Agreement (the form of which has been agreed to by the parties). At the effective time of the merger contemplated by the IGH Merger Agreement, CLS Massachusetts will pay a purchase price of $47,500,000, subject to reduction as provided in the IGH Merger Agreement, payable as follows: $35 million in cash, $7.5 million in the form of a five-year promissory note, and $5 million in the form of restricted common stock of the Company, plus $2.5 million as consideration for a non-competition agreement with IGH’s President, payable in the form of a five-year promissory note.

 

IGH and certain IGH stockholders holding sufficient aggregate voting power to approve the transactions contemplated by the IGH Merger Agreement have entered into agreements pursuant to which such stockholders have, among other things, agreed to vote in favor of such transactions.

 

On October 31, 2018, as consideration for the IGH Option, the Company made a loan to IGH (the “IGH Loan”), in the principal amount of $5,000,000 (the “IGH Loan Amount”), 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 “IGH Loan Agreement”) (see note 8). The IGH Loan is evidenced by a secured promissory note of IGH (the “IGH Note”), which bears interest at the rate of 6% per annum and matures on October 31, 2021. The Company recorded interest income in the amount of $74,795 and $225,205 on the IGH Loan during the three and nine months ended February 29, 2020, respectively.

 

To secure the obligations of IGH to the Company under the IGH Loan Agreement and the IGH Note, the Company and IGH entered into a Security Agreement dated as of October 31, 2018 (the “IGH Security Agreement”), pursuant to which IGH granted to the Company a first priority lien on and security interest in all personal property of IGH.

 

If the Company does not exercise the IGH Option on or prior to the date that is 30 days following the end of the Option Period, the IGH Loan Amount will be reduced to $2,500,000 as a break-up fee (the “Break-Up Fee”), except in the event of a Purchase Exception (as defined in the IGH Option Agreement), in which case the Break-Up Fee will not apply and there will be no reduction to the Loan Amount.

 

On August 26, 2019, the parties amended the IGH Option to, among other things, extend the Option Period and delay closing until January 2020.

 

By letter agreement dated January 31, 2020, the Company, CLS Massachusetts and IGH extended the IGH Option Agreement to February 4, 2020. On February 4, 2020, CLS Massachusetts exercised the IGH Option.

 

By letter dated February 26, 2020, the Company 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. The Company advised IGH that it was 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 Note.

 

On March 3, 2020, the Company filed a claim for declaratory relief, among other things, requesting the court declare that CLS Massachusetts had validly exercised the IGH Option and instruct IGH to comply with its diligence requests and ultimately execute a merger agreement with CLS and CLS Massachusetts. The dispute regarding whether CLS Massachusetts properly exercised the IGH Option arose after CLS Massachusetts delivered a notice of exercise to IGH and IGH subsequently asserted that CLS Massachusetts’ exercise was invalid. CLS and CLS Massachusetts intend to pursue this suit vigorously and believe that their claims are meritorious, however, there can be no assurance as to the ultimate outcome of this matter.

 

 

CannAssist

 

On January 29, 2019, the Company made a line of credit loan to CannAssist in the principal amount of up to $500,000, subject to the terms and conditions set forth in the CannAssist Loan Agreement. Any draws on the line of credit in excess of $150,000 will only be made in the sole discretion of the Company. The loan is evidenced by the CannAssist Note, which bears interest at the rate of 8% per annum and is personally guaranteed by the two equity owners of CannAssist. On June 24, 2019, the Company advanced the sum of $175,000 to CannAssist, increasing the balance due to the Company under the CannAssist Note to $325,000. The Company recorded interest income in the amount of $1,638 and $12,536 on the loan during the three and nine months ended February 29, 2020, respectively.

 

To secure the obligations of CannAssist to the Company under the CannAssist Loan Agreement and the CannAssist Note, the Company and CannAssist entered into a security agreement dated as of January 29, 2019, pursuant to which CannAssist granted to the Company a first priority lien on and security interest in all personal property of CannAssist.

 

On March 11, 2019, the Company, through its wholly-owned subsidiary, CLS Massachusetts, entered into the CannAssist Purchase Agreement with CannAssist, each of the members of CannAssist, and David Noble, as the members’ representative.

  

On August 26, 2019, the Company and CannAssist amended the CannAssist Note. Pursuant to the amendment, there will be no additional advances under the CannAssist Note beyond the $150,000 advanced on February 4, 2019, and the $175,000 advanced on June 24, 2019. In addition, the CannAssist Note shall become due and payable in full on or before February 28, 2020. Finally, the Company and CannAssist terminated the CannAssist Purchase Agreement.

 

On December 23, 2019, the Company received payment in full on the CannAssist loan in the amount of $342,567, which comprises $325,000 of principal and $17,567 of interest.

 

Note 5 – Accounts Receivable

 

Accounts receivable was $157,229 and $163,571 at February 29, 2020 and May 31, 2019, respectively. No allowance for doubtful accounts was necessary during the three and nine months ended February 29, 2020 and 2019.

 

Note 6 – Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following:

 

   

February 29,

2020

   

May 31,

2019

 

Deposits

  $ 75,303       211,493  

Prepaid expenses

    254,371       178,920  

Total

  $ 329,674     $ 390,413  

 

During the nine months ended February 29, 2020, the Company charged the amount of $101,512 as a reserve against a receivable from a payment card company in connection with the processing of its payment card sales. Also, during the nine months ended February 29, 2020, the Company applied deposits in the amount of $136,190 to the acquisition of fixed assets. See note 9.

 

Note 7 – Inventory

 

Inventory, consisting of material, overhead, labor, and manufacturing overhead, is stated at the lower of cost (first-in, first-out) or market, and consists of the following:

 

   

February 29,

   

May 31,

 
   

2020

   

2019

 

Raw materials

  $ 186,351     $ 323,635  

Finished goods

    543,979       423,198  

Total

  $ 730,330     $ 746,833  

 

 

Raw materials consist of cannabis plants and the materials that are used in our production process prior to being tested and packaged for consumption.  Finished goods consist of pre-packaged materials previously purchased from other licensed cultivators and the Company’s manufactured edibles and extracts.

  

Note 8 – Notes Receivable

 

PRH Note Receivable

 

During the year ended May 31, 2015, the Company loaned $500,000 pursuant to a promissory note (the “PRH Note”) to Picture Rock Holdings, LLC, a Colorado limited liability company (“PRH”).  Pursuant to the PRH Note, as amended by the parties effective June 30, 2015, October 31, 2015, April 11, 2016, and May 31, 2016, PRH was expected to repay the principal due under the PRH Note in twenty (20) equal quarterly installments of Twenty Five Thousand Dollars ($25,000) commencing in the month following the month in which PRH commenced generating revenue at the grow facility, which commencement was originally anticipated to occur in the first quarter of 2017, and continuing until paid in full.  The Company suspended its plans to operate in Colorado due to regulatory delays and has not yet determined when it will pursue them again.  Interest will accrue on the unpaid principal balance of the PRH Note at the rate of twelve percent (12%) per annum and will be paid quarterly in arrears commencing after such initial payment and continuing until paid in full.  All outstanding principal and any accumulated unpaid interest due under the PRH Note is due and payable on the five-year anniversary of the initial payment thereunder.  In the event of default as defined in the agreements underlying the PRH Note, all amounts under the PRH Note shall be due and payable at once.  During the year ended May 31, 2015, the Company recorded an impairment related to the note receivable in the amount of $500,000. 

 

During the year ended May 31, 2018, the Company received a payment of $50,000 on the PRH Note.  As a result, the Company has reduced the impairment of the PRH Note by $50,000 to reflect this payment.  The receivable is recorded on the balance sheet as of February 29, 2020 in the amount of $0, net of allowance in the amount of $450,000. 

 

IGH Note Receivable

 

On October 31, 2018, in connection with an option to purchase transaction (see note 4), the Company loaned $5,000,000 pursuant to the IGH Note to IGH; on November 6, 2018, IGH converted to a for-profit corporation. The IGH Note bears interest at the rate of 6% per annum. On March 1, 2020 (the “Initial Payment Date”), all accrued interest shall be added to the outstanding principal due hereunder and such amount shall be payable in eight equal quarterly installments, commencing on the Initial Payment Date, together with interest accruing after the Initial Payment Date. The IGH Note shall mature and all outstanding principal, accrued interest and any other amounts due hereunder, shall become due and payable in full on the third anniversary of the IGH Note. The IGH Note was issued in connection with a loan agreement and security agreement between the Company and IGH, and the IGH Option Agreement between the Company and IGH, among others, in both cases dated as of October 31, 2018 and the other IGH Loan Documents, and is secured by the collateral described in the IGH Loan Documents and by such other collateral as may in the future be granted to the Company to secure the IGH Note. During the three and nine months ended February 29, 2020, the Company recorded interest income in the amount of $74,795 and $225,205 in connection with the IGH Note, respectively.

 

By letter dated February 26, 2020, the Company 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.  The Company advised IGH that it was 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 Note.  As a result, at February 29, 2020, principal in the amount of $5,000,000 and interest receivable in the amount of $399,453  due under the IGH Note were classified as current assets on the Company’s balance sheet.

 

CannAssist Note Receivable

 

On January 29, 2019, the Company made a line of credit loan to CannAssist pursuant to the CannAssist Note, in the principal amount of up to $500,000.  The loan bears interest at the rate of 8% per annum and is personally guaranteed by the two equity owners of CannAssist. Payments on the loan were to commence on July 1, 2019 and the CannAssist Note was to mature on December 1, 2019. On August 26, 2019, the Company and CannAssist amended the CannAssist Note. Pursuant to the amendment, among other things, the CannAssist Note shall become due and payable in full on or before February 28, 2020. During the three and nine months ended February 29, 2020, the Company recorded interest income in the amount of $1,638 and $12,536 on the CannAssist Note, respectively. On December 23, 2019, the Company received payment in full on the CannAssist loan in the amount of $342,567, which comprises $325,000 of principal and $17,567 of interest. At February 29, 2020, the principal amount of $0 and interest receivable in the amount of $0 due under the CannAssist Note were classified as current assets on the Company’s balance sheet.

 

 

Note 9 – Property, Plant and Equipment

 

Property, plant and equipment consisted of the following at February 29, 2020 and May 31, 2019.

 

   

February 29

2020

   

May 31,

2019

 

Office equipment

    73,810       53,152  

Furniture and fixtures

    144,019       140,701  

Machinery & Equipment

    1,241,060       969,196  

Leasehold improvements

  $ 2,900,244     $ 1,293,660  

Less: accumulated depreciation

    (745,196

)

    (546,408

)

Property, plant, and equipment, net

  $ 3,613,937     $ 1,910,301  

 

During the nine months ended February 29, 2020 and February 28, 2019, the Company made payments in the amount of $1,766,185 and $735,234, respectively, for property, plant, and equipment. In addition, during the nine months ended February 28, 2019, the Company acquired plant, property, and equipment in the amount of $933,142 with the acquisition of Alternative Solutions. See note 3. Also, during the nine months ended February 29, 2020, the Company applied $136,190 of deposits to the acquisition of fixed assets. See note 6.

 

Depreciation of property, plant, and equipment was $87,025 and $45,045 for the three months ended February 29, 2020 and February 28, 2019 respectively. Depreciation of property, plant, and equipment was $198,788 and $121,212 for the nine months ended February 29, 2020 and February 28, 2019, respectively.

 

Note 10 – Right to Use Assets and Liabilities – Operating Leases

 

The Company has operating leases for offices and warehouses. The Company’s leases have remaining lease terms of 1 year to 4 years, some of which include options to extend.

 

The Company’s lease expense for the three and nine months ended February 29, 2020 was entirely comprised of operating leases and amounted to $109,236 and $305,019, respectively. The Company’s right of use (“ROU”) asset amortization for the three and nine months ended February 29, 2020 was $92,285 and $267,863, respectively. The difference between the lease expense and the associated ROU asset amortization consists of interest. 

 

Right to use assets – operating leases are summarized below:

 

   

February 29,

2020

 

Amount at inception of leases

  $ 1,781,446  

Amount amortized

    (1,215,397

)

Balance – February 29, 2020

  $ 566,049  

 

Operating lease liabilities are summarized below:

 

Amount at inception of leases

  $ 1,781,446  

Amount amortized

    (1,101,532

)

Balance – February 29, 2020

  $ 679,914  

 

   

February 29,

2020

 

Warehouses and offices 

  $ 679,914  

Lease liability

  $ 679,914  

Less: current portion

    (443,063

)

Lease liability, non-current

  $ 236,851  

 

 

Maturity analysis under these lease agreements is as follows:

 

Twelve months ended February 28, 2021

  $ 443,063  

Twelve months ended February 28, 2022

    147,767  

Twelve months ended February 28, 2023

    122,128  

Twelve months ended February 29, 2024

    43,677  

Twelve months ended February 28, 2025

    -  

Thereafter

    -  

Total

  $ 756,635  

Less: Present value discount

    (76,721

)

Lease liability

  $ 679,914  

 

Note 11 – Intangible Assets

 

Intangible assets consisted of the following at February 29, 2020 and May 31, 2019:

 

           

Accumulated

         

February 29, 2020

 

Gross

   

Amortization

   

Net

 

Intellectual Property

  $ 319,600     $ (53,267

)

  $ 266,333  

License & Customer Relations

    990,000       (82,500

)

    907,500  

Tradenames - Trademarks

    301,000       (50,167

)

    250,833  

Non-compete Agreements

    27,000       (14,622

)

    12,378  

Domain Names 

    3,963       (3,254

)

    709  

Total

  $ 1,641,563     $ (203,810

)

  $ 1,437,753  

 

           

Accumulated

         

May 31, 2019

 

Gross

   

Amortization

   

Net

 

Intellectual Property

  $ 319,600     $ (29,297

)

  $ 290,303  

License & Customer Relations

    990,000       (45,375

)

    944,625  

Tradenames - Trademarks

    301,000       (27,592

)

    273,408  

Non-compete Agreements

    27,000       (12,378

)

    14,622  

Domain names

    3,963       (1,834

)

    2,129  

Total

  $ 1,641,563     $ (116,476

)

  $ 1,525,087  

 

Total amortization expense charged to operations for the three months ended February 29, 2020 and February 28, 2019 was $28,030 and $31,403, respectively.  Total amortization expense charged to operations for the nine months ended February 29, 2020 and February 28, 2019 was $86,334 and $83,796, respectively.  

 

Amount to be amortized during the twelve months ended February 28, 

       

2021

  $ 164,156  

2022

    164,073  

2023

    163,760  

2024

    163,760  

2025

    162,638  

Thereafter

    619,366  
    $ 1,437,753  

 

Note 12 – Goodwill

 

The Company recorded goodwill in the amount of $25,742,899 in connection with the acquisition of Alternative Solutions on June 27, 2018 (see note 3). Goodwill is tested for impairment on an annual basis utilizing the two-step process set forth in ASC 350 and ASC 360. The first step of this process compares the book value of the Company with its fair value. If the fair value exceeds its carrying amount (including recorded goodwill), no goodwill impairment has occurred. Since the fair value of the Company based upon the market price of the Company’s common stock exceeded the carrying value (including goodwill) at February 29, 2020 and May 31, 2019, no indication of goodwill impairment existed.

 

 

Note 13 – Other Assets

 

Other assets consisted of the following at February 29, 2020 and May 31, 2019:

 

   

February 29,

   

May 31,

 
   

2020

   

2019

 

Security deposits

    167,455       167,455  
    $ 167,455     $ 167,455  

 

Note 14 – Accounts Payable and Accrued Liabilities

 

Accrued accounts payable and accrued liabilities consisted of the following at February 29, 2020 and May 31, 2019:

 

   

February 29,

2020

   

May 31,

2019

 

Trade accounts payable

  $ 569,846     $ 510,210  

Accrued payroll and payroll taxes

    193,902       230,119  

Accrued liabilities

    308,200       625,399  

Deferred rent liability 

    -       151,399  

Total

  $ 1,071,948     $ 1,517,127  

 

Note 15 – Notes Payable and Convertible Notes Payable

 

Notes Payable

 

   

February 29, 

2020

   

May 31,

2019

 
                 

The Company issued a secured note payable to Serenity Wellness Enterprises, LLC, as nominee (“Oasis Note”) dated June 27, 2018 in the principal amount of $4,000,000 and bearing interest at a rate of 6% per annum pursuant to the Membership Interest Purchase Agreement with Alternative Solutions.  The note is due on December 4, 2019, but may be prepaid at any time without penalty.   The Oasis Note is secured by all of the membership interests in Alternative Solutions and the Oasis LLCs and by the assets of the Oasis LLCs. 

 

The Company recognized an original issue discount of $189,180 on the Oasis Note.  During the three and nine months ended February 29, 2020, $3,541 and $67,384, respectively, of this discount was charged to operations.  On August 14, 2019, the Company made a prepayment in the amount of $2,500,000, which was applied to the amount due under the Oasis Note; in addition, principal due under the Oasis note was further reduced by $133,389 for legal fees and $5,395 for other costs incurred by the Company in connection with a settlement agreement (see note 16). During the three and nine months ended February 29, 2020, the Company accrued interest in the amount of $7,047 and $82,037, respectively, on the Oasis Note. On December 31, 2019, the Company repaid the remaining amount of the note, $1,671,296, which comprised $1,363,925 of principal and $370,370 of interest.

    -       4,000,000  
                 

Total – Notes Payable

  $ -     $ 4,000,000  

Less: Discount

    -       (67,384

)

Notes Payable, Net of Discounts

  $ -     $ 3,932,616  

Current portion

  $ -     $ 3,932,616  

Long term portion

  $ -     $ -  

 

 

Related Party Convertible Demand Notes Payable

 

On May 31, 2017, the Company entered into an Omnibus Loan Amendment Agreement (the “Omnibus Loan Amendment”) with Jeffrey I. Binder, Frank Koretsky, Newcan Investment Partners LLC and CLS CO 2016, LLC (collectively, the “Insiders”).  Pursuant to the Omnibus Loan Amendment, the Company agreed with the Insiders to amend certain terms of loans the Insiders made to the Company for working capital purposes, which loans were initially demand loans, and, except for loans made in 2017, were later memorialized as convertible loans (the “Insider Loans”), in exchange for the agreement of the Insiders to convert all Insider Loans where funds were advanced prior to January 1, 2017, which totaled $2,537,750, plus $166,490 of accrued interest thereon, into an aggregate of 10,816,960 shares of the Company’s common stock at $0.25 per share, and forego the issuance of warrants to purchase the Company’s common stock upon conversion.  This resulted in the issuance of an additional 7,609,910 shares compared to the original number of shares issuable upon conversion of the Insider Loans prior to the Omnibus Loan Amendment. The Company valued the shares at $0.125, which was the market price of the Company’s stock at the conversion date, and charged the amount of $951,239 to loss on modification of debt during the year ended May 31, 2017. The Company entered into the Omnibus Loan Amendment in order to ease the debt burden on the Company and prevent it from defaulting on the Insider Loans.

 

Pursuant to the Omnibus Loan Amendment, the following amendments were made to the Insider Loans: (a) the Company reduced the conversion price on the Insider Loans from between $0.75 and $1.07 per share of common stock to $0.25 per share of common stock, in those cases where the conversion price was greater than $0.25, which reduced conversion price exceeded the closing price of the common stock during the three months prior to the Omnibus Loan Amendment; (b) the Company deleted the requirement to issue warrants to purchase the Company’s common stock upon conversion of the Insider Loans; (c) the Company amended one Insider Loan to permit conversion of only the portion of the Insider Loan related to services that were provided to it prior to January 1, 2017; and (d) the Company amended the terms of the Insider Loans where funds were advanced on or after January 1, 2017, which Insider Loans were not converted into the Company’s common stock, to provide for, where not already the case, a 10% interest rate per annum, a $0.25 conversion price per share of common stock, and the deletion of the requirement that the Company issue warrants to purchase its common stock upon conversion of such Insider Loans.

 

On January 10, 2018, effective December 1, 2017, the Company entered into an Omnibus Amendment to Convertible Notes (the “Second Omnibus Loan Agreement”) with Jeffrey I. Binder, an officer and director of the Company, and Newcan Investment Partners LLC, an entity owned by Frank Koretsky, a director of the Company. The Second Omnibus Loan Agreement provides that the conversion price of all outstanding convertible promissory notes issued to either Mr. Binder or Newcan Investment Partners, LLC as of the date of the Agreement would be increased from $0.25 to $0.3125 per share of common stock.  The remaining terms of such notes remain unchanged. There were no balances outstanding under the Insider Loans at February 29, 2020 or May 31, 2019.

 

 

Convertible Notes Payable 

 

   

February 29,

2020

   

May 31,

2019

 
                 

Convertible debenture in the principal amount of $4,000,000 (the “U.S. Convertible Debenture 1”) dated October 31, 2018, which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 1. The U.S. Convertible Debenture 1 matures on a date that is three years following issuance. The U.S. Convertible Debenture 1 is convertible into units (the “Convertible Debenture Units”) at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. On July 26, 2019, U.S. Convertible Debenture 1 was amended such that, should the Company issue or sell common stock or equity securities convertible into common stock at a price less than the conversion price of the U.S. Convertible Debenture 1, the conversion price of Convertible Debenture 1 will be reduced to such issuance price, and the exercise price of the warrant issuable in connection with Convertible Debenture 1 will be exercisable at a price equal to 137.5% of the adjusted conversion price at the time of conversion. The U.S. Convertible Debenture 1 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 1 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $3,254,896 on the U.S. Convertible Debenture 1. During the three and nine months ended February 29, 2020, $271,241 and $813,724, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $86,485 and $260,416, respectively, on the U.S. Convertible Debenture 1. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $88,017 and $257,896, respectively, from accrued interest to principal of the U.S. Convertible Debenture 1.

    4,993,202       4,135,306  

 

 

 

   

February 29,

2020

   

May 31,

2019

 

Convertible debenture in the principal amount of $1,000,000 (the “U.S. Convertible Debenture 2”) dated October 31, 2018, which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 2. The U.S. Convertible Debenture 2 matures on a date that is three years following issuance. The U.S. Convertible Debenture 2 is convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. On July 26, 2019, U.S. Convertible Debenture 1 was amended such that, should the Company issue or sell common stock or equity securities convertible into common stock at a price less than the conversion price of the U.S. Convertible Debenture 2, the conversion price of Convertible Debenture 2 will be reduced to such issuance price, and the exercise price of the warrant issuable in connection with Convertible Debenture 2 will be exercisable at a price equal to 137.5% of the adjusted conversion price at the time of conversion. The U.S. Convertible Debenture 2 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 2 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $813,724 on the U.S. Convertible Debenture 2. During the three and nine months ended February 29, 2020, $67,810 and $203,431, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $22,058 and $65,104, respectively, on the U.S. Convertible Debenture 2. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $22,004 and $64,474, respectively, from accrued interest to principal of the U.S. Convertible Debenture 2.

    1,098,301       1,033,827  
                 

Convertible debenture in the principal amount of $100,000 (the “U.S. Convertible Debenture 3”) dated October 24, 2018, which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 3. The U.S. Convertible Debenture 3 matures on a date that is three years following issuance. The U.S. Convertible Debenture 3 is convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. On July 26, 2019, U.S. Convertible Debenture 3 was amended such that, should the Company issue or sell common stock or equity securities convertible into common stock at a price less than the conversion price of the U.S. Convertible Debenture 3, the conversion price of Convertible Debenture 3 will be reduced to such issuance price, and the exercise price of the warrant issuable in connection with Convertible Debenture 3 will be exercisable at a price equal to 137.5% of the adjusted conversion price at the time of conversion. The U.S. Convertible Debenture 3 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 3 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $75,415 on the U.S. Convertible Debenture 3. During the three and nine months ended February 29, 2020, $6,285 and $18,854, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $2,209 and $6520, respectively, on the U.S. Convertible Debenture 3. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $2,204 and $6,457, respectively, from accrued interest to principal of the U.S. Convertible Debenture 3.

    109,998       103,541  

 

 

   

February 29,

2020

   

May 31,

2019

 

Convertible debenture in the principal amount of $532,000 (the “U.S. Convertible Debenture 4”) dated October 25, 2018, which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 4. The U.S. Convertible Debenture 4 matures on a date that is three years following issuance. The U.S. Convertible Debenture 4 is convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. On July 26, 2019, U.S. Convertible Debenture 4 was amended such that, should the Company issue or sell common stock or equity securities convertible into common stock at a price less than the conversion price of the U.S. Convertible Debenture 4, the conversion price of Convertible Debenture 4 will be reduced to such issuance price, and the exercise price of the warrant issuable in connection with Convertible Debenture 4 will be exercisable at a price equal to 137.5% of the adjusted conversion price at the time of conversion. The U.S. Convertible Debenture 4 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 4 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $416,653 on the U.S. Convertible Debenture 4. During the three and nine months ended February 29, 2020, $34,721 and $104,163, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $15,781 and $38,711, respectively, on the U.S. Convertible Debenture 4. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $11,722 and $34,345, respectively, from accrued interest to principal of the U.S. Convertible Debenture 4.

    585,926       550,719  
                 

Convertible debenture in the principal amount of $150,000 (the “U.S. Convertible Debenture 5”) dated October 26, 2018,  which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 5. The U.S. Convertible Debenture 5 matures on a date that is three years following issuance. The U.S. Convertible Debenture 5 is convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. The U.S. Convertible Debenture 5 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 5 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $120,100 on the U.S. Convertible Debenture 5. During the three and nine months ended February 29, 2020, $10,008 and $30,025, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $3,312 and $9,776, respectively, on the U.S. Convertible Debenture 5. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $3,304 and $9,682, respectively, from accrued interest to principal of the U.S. Convertible Debenture 5.

    164,926       155,244  

 

 

   

February 29,

2020

   

May 31,

2019

 

Convertible debenture payable in the principal amount of $75,000 (the “U.S. Convertible Debenture 6”) dated October 26, 2018, which bears interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the U.S. Convertible Debenture 6. The U.S. Convertible Debenture 6 matures on a date that is three years following issuance. The U.S. Convertible Debenture 6 is convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. The U.S. Convertible Debenture 6 has other features, such as mandatory conversion in the event the 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 U.S. Convertible Debenture 6 is an unsecured obligation of the Company and ranks pari passu in right of payment of principal and interest with all other unsecured obligations of the Company. The Company recorded a discount in the amount of $60,049 on the U.S. Convertible Debenture 6. During the three and nine months ended February 29, 2020, $5,004 and $15,012, respectively, of this discount was charged to operations. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $1,656 and $4,888, respectively, on the U.S. Convertible Debenture 6. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $1,652 and $4,841, respectively, from accrued interest to principal of the U.S. Convertible Debenture 6.

    82,463       77,622  
                 

Convertible debentures payable in the aggregate principal amount of $12,012,000 (the “Canaccord Debentures”) dated December 12, 2018, which bear interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen months following issuance being payable by increasing the then-outstanding principal amount of the Canaccord Debentures. The Canaccord Debentures mature on a date that is three years following issuance. The Canaccord Debentures are convertible into Convertible Debenture Units at a conversion price of $0.80 per Convertible Debenture Unit. Each Convertible Debenture Unit consists of (i) one share of the Company’s common stock, and (ii) one-half of one warrant, with each warrant exercisable for three years to purchase a share of common stock at a price of $1.10. The value of the warrants will be recorded when the issuance becomes probable. The Canaccord Debentures have other features, such as mandatory conversion in the event the 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 Canaccord 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. During the three months ended November 30, 2019, in two separate transactions, principal in the aggregate amount of $25,857 was converted into an aggregate of 32,321 shares of the Company’s common stock, and warrants to purchase 16,160 shares of common stock. There were no gains or losses recorded on these conversions because they were done in accordance with the terms of the original agreement. No discount was recorded for the fair value of the warrants issued. Because the market price of the Company’s common stock was less than the conversion price on the date of issuance of the Canaccord Debentures, a discount was not recorded on the Canaccord Debentures. During the three and nine months ended February 29, 2020, the Company accrued interest in the amounts of $262,527 and $774,604, respectively, on the Canaccord Debentures. Also, during the three and nine months ended February 29, 2020, the Company transferred the amounts of $261,881, and $767,066, respectively, from accrued interest to principal of the Canaccord Debentures.

    13,054,182       12,303,971  

 

 

 

   

February 29,

2020

   

May 31,

2019

 

Total - Convertible Notes Payable

  $ 19,479,136     $ 18,360,230  

Less: Discount

    (2,633,799

)

    (3,819,010

)

Convertible Notes Payable, Net of Discounts

  $ 16,845,337     $ 14,541,220  
                 

Total - Convertible Notes Payable, Net of Discounts, Current Portion

  $ -     $ -  

Total - Convertible Notes Payable, Net of Discounts, Long-term Portion

  $ 16,845,337     $ 14,541,220  

 

   

February 29,

2020

   

February 28,

2019

 

Discounts on notes payable amortized to interest expense – 3 months ended February 29, 2020 and February 28, 2018, respectively 

  $ 398,611     $ 732,027  

  

Discounts on notes payable amortized to interest expense – 9 months ended February 29, 2020 and February 28, 2018, respectively

  $ 1,249,053     $ 2,481,674  

 

Aggregate maturities of notes payable and convertible notes payable as of February 29, 2020 are as follows:

 

For the twelve months ended February 29,

 

2021 

  $ -  

2022

    19,479,136  

2023

    -  

2024

    -  

2025

    -  

Thereafter

    -  

Total

  $ 19,479,136  

 

Beneficial Conversion Features

 

Certain of the Company’s convertible notes contained conversion features that create derivative liabilities. The pricing model the Company uses for determining fair value of its derivatives is the Lattice Model. Valuations derived from this model are subject to ongoing internal and external verification and review. The model uses market-sourced inputs such as interest rates and stock price volatilities. Selection of these inputs involves management’s judgment and may impact net income.  The derivative components of the notes were valued at issuance, at conversion, at restructure, and at each period end. 

 

On June 1, 2018, the Company adopted ASU 2017-11 and accordingly reclassified the fair value of the reset provisions embedded in convertible notes payable and certain warrants with embedded anti-dilutive provisions from liability to equity in the aggregate amount of $1,265,751. See note 1.

 

Certain of the Company’s other convertible notes payable contain beneficial conversion features that are not derivatives, but which require valuation in order to determine the discount to the related convertible note payable. The value of these conversion features is calculated using the intrinsic value method, whereby the amount of the discount is calculated as the difference between the conversion price and the market price of the underlying common stock at the date of issuance multiplied by the number of shares issuable.

 

Note 16 – Contingent Liability

 

The terms of the Company’s acquisition of Alternative Solutions, include a payment of $1,000,000 contingent upon the Oasis LLCs achieving certain revenue targets. (see note 3). The fair value of this contingent consideration at the time of the Acquisition Agreement was $678,111 as determined by the Company’s outside valuation consultants. Management has reviewed the value of the contingent consideration, and has concluded that, due to the increased revenue of Alternative Solutions, the fair value of this contingent liability was $1,000,000 at February 29, 2020 and May 31, 2019. The Company recorded a charge to operations in the amount of $321,889 during the year ended May 31, 2019.

 

 

Note 17 – Stockholders’ Equity

 

The Company’s authorized capital stock consists of 750,000,000 shares of common stock, par value $0.0001, at February 29, 2020 and May 31, 2019, and 20,000,000 shares of preferred stock, par value $0.001 per share. The Company had 126,521,414 and 125,839,095 shares of common stock issued and outstanding as of February 29, 2020 and May 31, 2019, respectively.

 

Nine months ended February 29, 2020

 

Common Stock and Warrants Issued upon Conversion of Notes Payable:

 

On July 8, 2019, the Company issued 16,644 shares of common stock and three-year warrants to acquire 8,322 shares of common stock at a price of $1.10 per share to Canaccord Genuity Corp., as nominee, in connection with the conversion of a portion of the Canaccord Debentures in the principal amount of $13,315. No gain or loss was recorded on this transaction because the conversion was made pursuant to the terms of the original agreement.

 

On July 19, 2019, the Company issued 15,677 shares of common stock and three-year warrants to acquire 7,838 shares of common stock at a price of $1.10 per share to Canaccord Genuity Corp., as nominee, in connection with the conversion of a portion of the Canaccord Debentures in the principal in the amount of $12,542. No gain or loss was recorded on this transaction because the conversion was made pursuant to the terms of the original agreement.

 

Common Stock Issued and To Be Issued to Officers and Service Providers:

 

On July 22, 2019, the Company issued 500,000 shares of common stock to Ben Sillitoe, Chief Executive Officer of CLS Nevada, in connection with his employment agreement. The fair value of these shares in the amount of $355,000 had been charged to operations as the shares vested. At issuance, this amount was transferred from common stock subscribed; $50 was charged to common stock, and $354,950 was charged to additional paid-in capital.

 

On July 22, 2019, the Company issued 50,000 shares of common stock to Don Decatur, Chief Operating Officer of CLS Nevada, in connection with his employment agreement. The fair value of these shares in the amount of $35,500 had been charged to operations as the shares vested. At issuance, this amount was transferred from common stock subscribed; $5 was charged to common stock, and $35,495 was charged to additional paid-in capital.

 

During the nine months ended February 29, 2020, the Company charged an aggregate of $124,582 to common stock subscribed representing the accrual over the vesting period of 791,668 shares of restricted common stock issuable to officers.

 

The Company also charged $45,000 to common stock subscribed representing the fair value of 200,000 shares of common stock to be issued to a service provider. During the nine months ended February 29, 2020, the Company issued 100,000 of these shares of common stock. At issuance, $22,500 was transferred from common stock subscribed; $10 was charged to common stock, and $22,490 was charged to additional paid-in capital.

 

Nine months ended February 28, 2019

 

Stock Issued upon Conversion of Notes Payable:

 

During the nine months ended February 28, 2019, Darling Capital, holder of a convertible promissory note, converted a total of $565,000, which consisted of $550,000 of principal and $15,000 of accrued interest, into 1,808,000 shares of common stock. 

 

During the nine months ended February 28, 2019, Efrat Investments, holder of a convertible promissory note, converted a total of $57,200, which consisted of $55,000 of principal and $2,200 of accrued interest, into 183,040 shares of common stock. 

 

During the nine months ended February 28, 2019, David Lamadrid, holder of a convertible promissory note, converted a total of $32,497, which consisted of $31,250 of principal and $1,247 of accrued interest, into 103,989 shares of common stock. 

 

 

During the nine months ended February 28, 2019, Jay Lasky, holder of a convertible promissory note, converted a total of $26,185, which consisted of $25,000 of principal and $1,185 of accrued interest, into 65,462 shares of common stock.

 

During the nine months ended February 28, 2019, Newcan, holder of a convertible promissory note, converted a total of $78,534, which consisted of $75,000 of principal and $3,534 of accrued interest, into 196,336 shares of common stock.

 

During the nine months ended February 28, 2019, YA II PN, holder of a convertible promissory note, converted a total of $280,247, which consisted of $250,000 of principal and $30,247 of accrued interest, into 700,616 shares of common stock.

 

During the nine months ended February 28, 2019, YA II PN, holder of a convertible promissory note, converted a total of $256,027 which consisted of $250,000 of principal and $6,027 of accrued interest, into 640,068 shares of common stock.

 

Stock Issued and To Be Issued to Officers and Service Providers:

 

On July 24, 2018, the Company awarded Star Associates, LLC, a limited liability company owned by Andrew Glashow, a director of the Company, a cash payment in the amount of $250,000 and 700,000 shares of the Company’s restricted common stock in recognition of Mr. Glashow’s efforts, through Star Associates, in successfully assisting the Company in negotiating and obtaining the financing necessary to acquire Alternative Solutions.  The shares were valued at $490,000 and were charged to operations during the nine months ended February 28, 2019.

 

On June 24, 2018, pursuant to the terms of a severance agreement between the Company and David Lamadrid, the Company issued 600,000 shares of restricted common stock to Mr. Lamadrid. These shares were valued at $264,000, $213,320 of which was previously expensed and the remaining $50,680 of which was charged to operations during the nine months ended February 28, 2019. 

 

On September 11, 2018, the Company issued 31,250 shares of common stock with a fair value of $25,310 in exchange for legal services previously rendered to the Company. These shares were accrued on February 8, 2018, and were issued from stock payable.

 

Stock Issued for Acquisition:

 

On June 27, 2018, the Company issued 22,058,823 shares of its common stock pursuant to the terms of the Alternative Solutions, LLC Acquisition Agreement.  These shares were valued at $15,441,176.  (See note 3).

 

Special Warrants Issued in Offering:

 

On June 20, 2018, the Company executed an Agency Agreement with Canaccord Genuity Corp. and closed on a private offering of its special warrants for aggregate gross proceeds of C$13,037,859 (USD$9,785,978). Pursuant to the offering, the Company issued 28,973,020 special warrants at a price of C$0.45 (USA$0.34) per special warrant.  Each special warrant was automatically exercisable, for no additional consideration, into units of the Company on the earlier of: (i) the date that was five business days following the date on which the Company obtained a receipt from the applicable securities regulatory authorities in each of the jurisdictions in Canada in which the special warrants were sold for a final prospectus qualifying the distribution of the units, which was intended to be no later than November 30, 2018, and (ii) the date that was four months and one day after the completion of the Company's acquisition of all of the membership interests in Alternative Solutions, LLC, known as Oasis Cannabis.

 

In connection with the offering, the Company paid Canaccord Genuity Corp. a cash commission equal to C$1,043,028 (USD$799,053), a corporate finance fee equal to 1,448,651 special warrants, and 2,317,842 compensation broker warrants valued at $1,495,373. Each compensation broker warrant entitles the holder thereof to acquire one unit at a price of C$0.45 per unit for a period of 36 months from the date that the Company's common stock is listed on a recognized Canadian stock exchange, subject to adjustment in certain events. The 1,448,651 special warrants that were issued were valued at $1,413,300 and were charged to operations during the nine months ended February 28, 2019.

 

Upon exercise of the special warrants, each unit was to consist of one share of the Company's common stock and one warrant to purchase one share of common stock.  Each warrant was to be exercisable at a price of C$0.65 for three years after the Company's common stock was listed on a recognized Canadian stock exchange, subject to adjustment in certain events. 

 

 

Because the Company did not receive a receipt from the applicable Canadian securities authorities for the qualifying prospectus by August 20, 2018, the unexercised special warrants were adjusted to entitle the holders to receive 1.1 units instead of one unit of the Company. This resulted in the planned issuance of an additional 3,042,167 units. This penalty was valued at $7,142,550 and was charged to operations during the nine months ended February 28, 2019.

 

On November 30, 2018, all of the special warrants were automatically converted into 33,465,110 shares of common stock and warrants to purchase 33,465,110 shares of common stock for CD$0.65 per share.

 

Stock Issued in Navy Capital Offering:

 

On July 31, 2018, the Company entered into a Subscription Agreement with Navy Capital Green International, Ltd, (the “Navy Capital Offering”) for 7,500,000 units at a price of $0.40 per unit, or an aggregate amount of $3,000,000.  The units collectively represent (i) 7,500,000 shares of common stock, and (ii) three-year warrants to purchase an aggregate of 7,500,000 shares of common stock at an exercise price of $0.60 per share of common stock. 

 

In connection with the Navy Capital Offering, between August 8, 2018 and August 10, 2018, the Company entered into five subscription agreements for a total of 6,875,000 units at a price of $0.40 per unit, or an aggregate purchase price of $2,750,000.  The units collectively represent (i) 6,875,000 shares of common stock, and (ii) three-year warrants to purchase an aggregate of 6,875,000 shares of common stock at an exercise price of $0.60 per share of common stock.

 

Stock Issued to Officers:

 

Effective August 1, 2018, the Company granted 25,000 shares of restricted common stock to its Chief Financial Officer.  These shares vested four months after issuance.  The shares were valued at $17,500, and were amortized over the vesting period.  On April 1, 2019, these shares were issued. As of February 29, 2020, $17,500 had been charged to operations.  

 

On July 31, 2018, the Company granted the Chief Executive Officer of CLS Nevada, Inc. a one-time signing bonus of 500,000 shares of restricted common stock, which fully vested one year from the effective date of his employment agreement.  These shares were valued at $355,000 and were amortized over the vesting period.  As of February 29, 2020, $355,000 had been charged to operations. The shares were issued on July 22, 2019.

 

On July 31, 2018, the Company granted the Chief Operating Officer of CLS Nevada, Inc. a one-time signing bonus of 50,000 shares of restricted common stock, which fully vested one year from the effective date of his employment agreement.  These shares were valued at $35,500 and were amortized over the vesting period. As of February 28, 2020, $35,500 had been charged to operations. The shares were issued on July 22, 2019.

 

Stock Issued upon Cashless Exercise of Warrants:

 

On August 14, 2018, the Company issued 129,412 shares of common stock for the cashless exercise of 350,000 warrants at an exercise price of $0.75 per share.

 

On September 6, 2018, the Company issued 13,684 shares of common stock upon the cashless exercise of 40,000 warrants at an exercise price of $0.75 per share.

 

On November 14, 2018, the Company issued 5,867 shares of common stock upon the cashless exercise of 25,000 warrants at an exercise price of $0.75 per share.

 

Additional Paid-in Capital

 

Nine months ended February 29, 2020

 

No activity other than changes to additional paid-in capital related to the issuance of common stock disclosed above.

 

Nine months ended February 28, 2019

 

During the nine months ended February 28, 2019, the Company recorded discounts on two convertible notes payable relating to beneficial conversion features in the aggregate amount of $362,500 on the YA II PN Note 2, and $58,594 on the Newcan Convertible Note 8. Also, during the nine months ended February 28, 2019, a reset event occurred with regard to the YAII PN Note.

 

 

During the nine months ended February 28, 2019, the Company recorded an original issue discount on the Serenity Wellness Note in the amount of $81,961.

 

On June 1, 2018, the Company adopted ASU 2017-11 and accordingly reclassified the fair value of the reset provisions embedded in the previously issued convertible notes payable and certain warrants with embedded anti-dilutive provisions from liability to additional paid-in capital in the aggregate amount of $1,265,751. On June 20, 2018, a reset event occurred in connection with the YA II PN Note (see note 13), and the Company charged the change in fair value of the conversion feature in the amount of $35,833 to additional paid-in capital. This was considered a material modification of the note, and the Company created a new discount to this note in the amount of $750,000, which was charged to additional paid-in capital.

 

During the nine months ended February 28, 2019, the Company recorded discounts on six convertible debentures relating to beneficial conversion features as follows: a discount of $3,254,863 was recorded on the U.S. Convertible Debenture 1; a discount of $813,696 was recorded on the U.S. Convertible Debenture 2; a discount of $75,395 was recorded on the U.S. Convertible Debenture 3; a discount of $416,627 was recorded on the U.S. Convertible Debenture 4; a discount of $120,078 was recorded on the U.S. Convertible Debenture 5; and a discount of $60,030 was recorded on the U.S. Convertible Debenture 6.

 

Warrants

 

On June 27, 2018, the Company incurred a penalty in connection with the WestPark Offering due to the late filing of the registration statement that included the resale of the securities that were sold in such offering.  As a result of the penalty, the Company issued three-year common stock warrants to purchase an aggregate of 1,368,250 shares of the Company’s common stock at an exercise price of $0.50 per share.   In addition, the Company reduced the exercise price of the common stock purchase warrants previously issued to the investors in the WestPark Offering from $0.75 per share to $0.50 per share.  The fair value of the penalty was $941,972; this amount was charged to operations during the nine months ended February 28, 2019.

 

On July 20, 2018, in connection with the Company’s sale of a convertible debenture, the Company issued to YA II PN, Ltd. a five-year common stock purchase warrant to purchase 1,250,000 shares of the Company’s common stock at an initial exercise price of $0.60 per share. 

 

On August 6, 2018, the Company issued three-year common stock purchase warrants to purchase an aggregate of 7,500,000 shares of the Company’s common stock at an exercise price of $0.60 per share, to investors in the Navy Capital Offering.

 

On August 8, 2018, the Company issued three-year common stock purchase warrants to purchase an aggregate of 6,875,000 shares of the Company’s common stock at an exercise price of $0.60 per share, to investors in the Navy Capital Offering.

 

The following table summarizes the significant terms of warrants outstanding at February 29, 2020. This table does not include the unit warrants. See Unit Warrants section below.

 

 

Range of 

exercise

Prices

   

 

Number of 

warrants

Outstanding

   

 

Weighted 

average

remaining

contractual

life (years)

   

Weighted 

average

exercise

price of

outstanding 

Warrants

   

 

Number of

warrants 

Exercisable

   

Weighted

average

exercise

price of

exercisable 

Warrants

 
$ 0.49       33,465,110       1.75     $ 0.49       33,465,110     $ 0.49  
  0.50       2,736,500       1.98       0.50       2,736,500       0.50  
  0.60       17,500,000       1.75       0.60       17,500,000       0.60  
  0.75       837,500       0.98       0.75       837,500       0.75  
  1.10       296,035       1.82       1.10       296,035       1.10  
          54,835,145       1.75     $ 0.53       54,835,145     $ 0.53  

 

 

Transactions involving warrants are summarized as follows. This table does not include the special warrants or unit warrants. See Special Warrants and Unit Warrants sections below.

 

   

Number of

Shares

   

Weighted

Average

Exercise

Price

 

Warrants outstanding at May 31, 2018

    4,497,750     $ 0.61  

Granted

    50,738,235     $ 0.53  

Exercised

    (415,000

)

  $ 0.75  

Cancelled / Expired

    -     $ -  
                 

Warrants outstanding at May 31, 2019

    54,820,985     $ 0.53  

Granted

    16,160     $ 1.10  

Exercised

    -     $ -  

Cancelled / Expired

    -     $ -  

Warrants outstanding at February 29, 2020

    54,835,145     $ 0.53  

 

Unit Warrants

 

On June 20, 2018, in connection with the special warrant offering, the Company issued Canaccord Genuity Corp. 2,317,842 three-year broker warrants at an exercise price of C$0.45 per unit as compensation.  Each warrant entitles the holder to purchase one unit, which consists of one share of common stock and a warrant to purchase one share of common stock, for C$0.65 per share. These warrants were valued at $1,495,373, and this amount was charged to operations during the nine months ended February 28, 2019.

 

On December 12, 2018, in connection with the issuance of the Canaccord Debentures, the Company issued Canaccord Genuity Corp., as compensation, 1,074,720 three-year agent and advisory warrants. Each warrant entitles the holder to purchase a unit for $0.80, which unit consists of one share of common stock and a warrant to purchase one-half share of common stock at an exercise price of $1.10 per share. The Company, in connection with the issuance of the Canaccord Debentures, also issued to National Bank Financial Inc., as compensation, 268,680 three-year agent and advisory warrants. Each warrant entitles the holder to purchase a unit for $0.80, which unit consists of one share of common stock and a warrant to purchase one-half share of common stock at an exercise price of $1.10 per share. The aggregate value of these warrants was $874,457, which was charged to operations during the year ended May 31, 2019.

 

Special Warrants

 

On June 20, 2018, the Company sold 28,973,019 special warrants for net proceeds of US$9,785,978.   Each special warrant was automatically exercisable, for no additional consideration, into units of the Company on the earlier of: (i) the date that was five business days following the date on which the Company obtained a receipt from the applicable securities regulatory authorities in each of the jurisdictions in Canada in which the special warrants were sold for a final prospectus qualifying the distribution of the units, which was intended to be no later than November 30, 2018, and (ii) the date that was four months and one day after the completion of the Company's acquisition of all of the membership interests in Alternative Solutions, known as Oasis Cannabis, which was June 28, 2018.

 

All of the special warrants were automatically exercised for units on November 30, 2018. Each unit consists of one share of the Company’s common stock and one three-year warrant to purchase one share of common stock at a price of C$0.65.

 

Note 18 – Gain on Settlement of Liabilities

 

On August 14, 2019, the Company made a payment to 4Front Advisors to settle its dispute with Alternative Solutions and its former owners and the Oasis Note was reduced in accordance with its terms.  In addition, the amount of $275,000, which the Company had accrued with respect to this dispute, was extinguished resulting in a gain of $275,000.

 

 

Note 19 – Fair Value of Financial Instruments

 

The Company has issued convertible notes containing beneficial conversion features.  One of the features is a ratchet reset provision which, in general, reduces the conversion price should the Company issue equity with an effective price per share that is lower than the stated conversion price in the note. The Company accounts for the fair value of the conversion feature in accordance with ASC 815- Accounting for Derivatives and Hedging and Emerging Issues Task Force (“EITF”) 07-05- Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF 07-05”). The Company carries the embedded derivative on its balance sheet at fair value and accounts for any unrealized change in fair value as a component of its results of operations. The Company also has a contingent liability in connection with the acquisition of Alternative Solutions, (see note 16).

 

The following summarizes the Company’s financial liabilities that are recorded at fair value on a recurring basis at February 29, 2020 and May 31, 2019:

 

   

February 29, 2020

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities

                               

Derivative liabilities 

  $ -     $ -     $ -     $ -  

 

   

May 31, 2019

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities

                               

Derivative liabilities

  $ -     $ -     $ -     $ -  

 

Note 20 – Related Party Transactions

 

On July 22, 2019, the Company issued 500,000 shares of common stock to Ben Sillitoe, Chief Executive Officer of CLS Nevada, in connection with his employment agreement.

 

On July 22, 2019, the Company issued 50,000 shares of common stock to Don Decatur, Chief Operating Officer of CLS Nevada, in connection with his employment agreement.

 

As of May 31 2019 and 2018, the Company had accrued salary due to Michael Abrams, a former officer of the Company prior to his September 1, 2015 termination, in the amount of $16,250.

 

Note 21 – Commitments and Contingencies

 

Leased Facility

 

In connection with the Company’s planned Colorado operations, on April 17, 2015, pursuant to an Industrial Lease Agreement (the “Lease”), CLS Labs Colorado leased 14,392 square feet of warehouse and office space (the “Leased Real Property”) in a building in Denver, Colorado where certain intended activities, including growing, extraction, conversion, assembly and packaging of cannabis and other plant materials, are permitted by and in compliance with state, city and local laws, rules, ordinances and regulations. The Lease had an initial term of seventy-two (72) months and provided CLS Labs Colorado with two options to extend the term of the lease by up to an aggregate of ten (10) additional years.  In August 2017, as a result of the Company’s decision to suspend its proposed operations in Colorado, CLS Labs Colorado asked its landlord to be relieved from its obligations under the Lease, but the parties have not yet reached an agreement on how to proceed.

 

In August 2017, the Company’s Colorado subsidiary received a demand letter from its Colorado landlord requesting the forfeiture of the $50,000 security deposit, $10,000 in expenses, $15,699 in remaining rent due under the lease agreement and $30,000 to buy out the remaining amounts due under the lease.  These expenses, which are a liability of the Company’s Colorado subsidiary, have been accrued on the balance sheet as of February 29, 2020.

 

Contingent Liability

 

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, the Company made a payment to this company to settle this dispute and the Oasis Note was reduced accordingly.

 

 

Employment Agreements

 

CLS Labs and Jeffrey Binder entered into a five-year employment agreement effective October 1, 2014. Under the agreement, Mr. Binder serves as CLS Labs’ Chairman and Chief Executive Officer and is entitled to receive an annual salary of $150,000. Under the agreement, Mr. Binder is also entitled to receive a performance bonus equal to 2% of CLS Labs’ annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of CLS Labs’ common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million.  On April 28, 2015, CLS Labs and the Company entered into an addendum to Mr. Binder’s employment agreement whereby Mr. Binder agreed that following the merger of CLS Labs and a subsidiary of the Company, in addition to his obligations to CLS Labs, he would serve the Company and its subsidiaries in such roles as the Company may request.  In exchange, the Company agreed to assume the obligations of CLS Labs to grant Mr. Binder annual stock options, as referenced above.  On July 20, 2016, March 31, 2017, August 23, 2017, October 9, 2017, January 5, 2018 and April 6, 2018, the Company issued Mr. Binder convertible notes in exchange for $250,000, $112,500, $62,500, $39,521, $37,500 and $37,500 respectively, in deferred salary, among other amounts owed to Mr. Binder by the Company.  On October 14, 2019 but effective October 1, 2019, CLS Labs, Inc., the Company, and Jeffrey Binder entered into an amendment to Mr. Binder’s employment agreement to provide that the Company would assume all obligations of CLS Labs under the employment agreement.  The amendment also extends the term of Mr. Binder’s employment agreement by three years instead of relying on the automatic one-year renewal provision in the employment agreement, and increases Mr. Binder’s annual base salary to $200,000.  Additionally, the amendment provides for certain change of control provisions, including a payment of up to three years base salary and bonuses up to a maximum of $1,000,000, if Mr. Binder resigns or is terminated in connection with a change in control of the Company.  In connection with the amendment, the parties also amended and restated that certain Confidentiality, Non-Compete and Property Rights Agreement entered into by and between RJF Labs, Inc. (now CLS Labs), and Mr. Binder effective as of July 16, 2014.

 

Effective August 1, 2015, the Company and Alan Bonsett entered into a five-year employment agreement. Pursuant to the agreement, Mr. Bonsett commenced serving as the Company’s Chief Operating Officer on August 15, 2015. Under the agreement, Mr. Bonsett was entitled to receive an annual salary of $150,000. Further, he was entitled to receive a performance bonus equal to 2% of the Company’s annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of the Company’s common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million. Additionally, Mr. Bonsett received a one-time signing bonus of 250,000 (post Reverse-Split) shares of restricted common stock of the Company, valued at $327,500, which became fully vested one year from the effective date of the agreement. Mr. Bonsett, as an owner of Picture Rock Holdings, LLC (“PRH”), was expected to indirectly receive the benefits of the Colorado operations discussed above. Mr. Bonsett agreed to defer his salary effective July 1, 2017. No additional amounts are due to Mr. Bonsett as of February 28, 2020. On October 1, 2017, the Company and Mr. Bonsett, the Company’s Chief Operating Officer, mutually agreed to end his employment with the Company.  Mr. Bonsett may provide consulting services to the Company in the future on an as needed basis.

  

Effective November 30, 2017, the Company and Mr. Lamadrid entered into a one-year employment agreement. Pursuant to the agreement, Mr. Lamadrid commenced serving as the Company’s President and Chief Financial Officer on December 1, 2017. Under the agreement, Mr. Lamadrid was entitled to receive an annual salary of $175,000. Further, he was entitled to receive a performance bonus equal to 2% of the Company’s annual EBITDA, and annual restricted stock awards of the Company’s common stock in an amount equal to 3% of its annual EBITDA. Additionally, Mr. Lamadrid was entitled to a one-time signing bonus of 500,000 shares of restricted common stock of the Company, which were to become fully vested one year from the effective date of the agreement. On July 24, 2018, the Company and Mr. Lamadrid mutually agreed to terminate the employment agreement. Mr. Lamadrid resigned as President and Chief Financial Officer effective as of July 13, 2018. In connection with a severance agreement between the Company and Mr. Lamadrid, the Company paid certain amounts and issued 600,000 shares of common stock to Mr. Lamadrid, and the parties further agreed that neither party would have any further obligations under the employment agreement or otherwise after such date. 

 

On July 31, 2018, the Company and Mr. Sillitoe entered into a one-year employment agreement. Pursuant to the agreement, Mr. Sillitoe commenced serving as the Chief Executive Officer of CLS Nevada, Inc. effective July 1, 2018. Under the agreement, Mr. Sillitoe is entitled to receive an annual salary of $150,000. Further, he is entitled to receive a performance bonus equal to 2% of the annual EBITDA of CLS Nevada, Inc., and annual restricted stock awards of the Company’s common stock in an amount equal to 3% of the annual EBITDA of CLS Nevada, Inc. Additionally, Mr. Sillitoe received a one-time signing bonus of 500,000 shares of restricted common stock, which became fully vested one year from the effective date of his employment agreement. On July 31, 2019, CLS Nevada, Inc. and Mr. Sillitoe amended Mr. Sillitoe’s employment agreement to effect the original intention of the parties that the performance bonus would be based on the results of Alternative Solutions and not CLS Nevada, Inc.

 

 

The Company and Mr. Decatur entered into a one-year employment agreement effective July 31, 2018.  Pursuant to the agreement, Mr. Decatur commenced serving as the Chief Operating Officer of CLS Nevada, Inc. on July 1, 2018.  Under the agreement, Mr. Decatur is entitled to receive an annual salary of $150,000.  Further, he is entitled to receive a performance bonus equal to 2% of the annual EBITDA of CLS Nevada, Inc., and annual restricted stock awards of the Company’ common stock in an amount equal to 3% of the annual EBITDA of CLS Nevada, Inc.  Additionally, Mr. Decatur received to a one-time signing bonus of 50,000 shares of restricted common stock, which became fully vested one year from the effective date of his employment agreement. On May 14, 2019, CLS Nevada and Mr. Decatur entered into an amendment to his employment agreement to extend the term of Mr. Decatur's employment agreement by two years instead of relying on the automatic one-year renewal provision in the employment agreement. On July 31, 2019, CLS Nevada, Inc. and Mr. Decatur amended Mr. Decatur’s employment agreement to effect the original intention of the parties that the performance bonus would be based on the results of Alternative Solutions and not CLS Nevada, Inc. On December 16, 2019, Mr. Decatur resigned from his position as Chief Operating Officer of CLS Nevada, Inc., effective immediately, for personal reasons.

 

On March 1, 2019, the Company and Mr. Glashow entered into a two-year employment agreement and Mr. Glashow commenced serving as the Company’s President and Chief Operating Officer. Under the agreement, Mr. Glashow is entitled to receive an annual salary of $175,000. Further, he is entitled to receive a performance bonus equal to 1% of the Company’s annual EBITDA, and annual restricted stock awards in an amount equal to 1% of the Company’s annual EBITDA. Additionally, Mr. Glashow is entitled to a one-time signing bonus of 500,000 shares of the Company’s restricted common stock, half of which shall vest on March 1, 2020, and half of which shall vest on March 1, 2021. Effective March 1, 2019, and in connection with the employment agreement, Mr. Glashow and the Company entered into a Confidentiality, Non-Compete and Proprietary Rights Agreement. Pursuant thereto, Mr. Glashow agreed (i) not to compete with us during the term of his employment and for a period of one year thereafter, (ii) not to release or disclose our confidential information, and (iii) to assign the rights to all work product to us, among other terms. On October 14, 2019, but effective October 1, 2019, the Company and Mr. Glashow entered into an amendment to his employment agreement to extend the term by one year instead of relying on the automatic one-year renewal provision in the employment agreement, and to increase Mr. Glashow’s annual base salary to $200,000. The amendment also provides that in addition to his base salary, Mr. Glashow is entitled to receive, on an annual basis, a performance-based bonus equal to two percent (2%) of the Company’s annual EBITDA up to a maximum annual cash compensation of $1 million including base salary, and annual stock options, exercisable at the fair market value of the Company’s common stock on the effective date of grant, in an amount equal to 2% of the Company’s EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million. Additionally, the amendment provides for certain change of control provisions, including a payment of up to three years base salary and bonuses up to a maximum of $1,000,000, if Mr. Glashow resigns or is terminated in connection with a change in control of the Company.

 

On May 2, 2019, the Company and Gregg Carlson entered into a one-year employment agreement. Pursuant to the employment agreement, Mr. Carlson commenced serving as the Company’s Chief financial Officer on May 1, 2019 and will continue his employment with us pursuant to the terms of his one-year employment agreement with Alternative Solutions effective April 8, 2019. Mr. Carlson receives an annual salary of $110,000, and received a one-time signing bonus of 50,000 shares of restricted common stock of the Company, which shall become fully vested one year from the effective date of his employment agreement assuming Mr. Carlson remains employed by the Company on such date.

  

At February 29, 2020 and 2019, the Company had accrued salary due to Michael Abrams, a former officer of the Company, prior to his September 1, 2015 termination, in the amount of $16,250. 

 

Note 22 – Subsequent Events

 

On March 3, 2020, the Company filed a claim for declaratory relief, among other things, requesting the court declare that CLS Massachusetts had validly exercised the IGH Option and instruct IGH to comply with its diligence requests and ultimately execute a merger agreement with CLS and CLS Massachusetts. The dispute regarding whether CLS Massachusetts properly exercised the IGH Option arose after CLS Massachusetts delivered a notice of exercise to IGH and IGH subsequently asserted that CLS Massachusetts’ exercise was invalid. CLS and CLS Massachusetts intend to pursue this suit vigorously and believe that their claims are meritorious, however, there can be no assurance as to the ultimate outcome of this matter.

 

 

In December 2019, a novel strain of coronavirus (“COVID-19") emerged in Wuhan, China. Since then, it has spread to the United States and infections have been reported around the world. On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. In response to the outbreak, federal and state authorities in the United States have introduced various recommendations and measures to try to limit the pandemic, including travel restrictions, border closures, nonessential business closures, quarantines, self-isolations, shelters-in-place and social distancing. The COVID-19 outbreak and the response of governmental authorities to try to limit it are having a significant impact on the private sector and individuals, including unprecedented business, employment and economic disruptions. On March 20, 2020, Nevada Governor Sisolak ordered all cannabis dispensaries to close their retail operations but permitted them to shift to a delivery-only model to serve their communities. As a result, the Company closed its retail operations for two days as it changed its business model, onboarded new staff, trained them on new software and communicated with its customer base. Within six days, the Company was achieving 50% of February 2020 sales despite having reduced its operating hours from 24 hours a day to a 14 hour a day delivery model. The Company’s wholesale business has also been adversely affected. Additional State mandates that impact the Company’s business could occur. The continued spread of COVID-19 could have a continuing adverse impact on the Company’s business, operations and financial results, including through disruptions in processing activities, sales channels, payments by wholesale customers and retail dispensary operations, as well as a deterioration of general economic conditions including a possible national or global recession. Due to the speed with which the COVID-19 pandemic is developing and the uncertainty of its magnitude, outcome and duration, it is not possible to estimate its impact on the Company’s business, operations or financial results; however, the impact could be material.

 

 

 

 

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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. These concentrates may be ingested in a number of ways, including through vaporization via electronic cigarettes (“e-cigarettes”), and used for a variety of pharmaceutical and other purposes. Testing in conjunction with two Colorado growers 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.

 

On April 17, 2015, CLS Labs took its first step toward commercializing its proprietary methods and processes by entering into the Colorado Arrangement through its wholly owned subsidiary, CLS Labs Colorado, with certain Colorado entities, including PRH. 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 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. We plan to generate revenues through licensing, fee-for-service and joint venture arrangements related to our proprietary method of extracting cannabinoids from cannabis plants and converting the resulting cannabinoid extracts into saleable concentrates.

 

We intend to monetize our extraction and conversion method and generate revenues through (i) the licensing of our patented proprietary methods and processes to others, (ii) the processing of cannabis for others, and (iii) the purchase of cannabis 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 can establish a position as one of the premier cannabinoid extraction and processing companies in the industry. Assuming we do so, we then intend to explore the creation of our own brand of concentrates for consumer use, which we would sell wholesale to cannabis dispensaries. We believe that we can create 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.

 

 

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. We received final regulatory approval to own the membership interests in the Oasis LLCs on December 12, 2018.

 

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 has 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 is 60 days after such date. If CLS Massachusetts exercises the IGH Option, the Company, a wholly-owned subsidiary of the Company and IGH will enter into a merger agreement (the form of which has been agreed to by the parties) (the “IGH Merger Agreement”). At the effective time of the merger contemplated by the IGH Merger Agreement, CLS Massachusetts will pay a purchase price of $47,500,000, subject to reduction as provided in the IGH Merger Agreement, payable as follows: $35 million in cash, $7.5 million in the form of a five-year promissory note, and $5 million in the form of restricted Common Stock of the Company, plus $2.5 million as consideration for a non-competition agreement with IGH’s President, payable in the form of a five-year promissory note. IGH and certain IGH stockholders holding sufficient aggregate voting power to approve the transactions contemplated by the IGH Merger Agreement have entered into agreements pursuant to which such stockholders have, among other things, agreed to vote in favor of such transactions. 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 is evidenced by a secured promissory note of IGH, which bears interest at the rate of 6% per annum and matures on October 31, 2021. To secure the obligations of IGH to us under the loan agreement and the promissory note, the Company and IGH entered into a security agreement dated as of October 31, 2018, pursuant to which IGH granted to us a first priority lien on and security interest in all personal property of IGH. If we do not exercise the Option on or prior to the date that is 30 days following the end of the option period, the loan amount will be reduced to $2,500,000 as a break-up fee, subject to certain exceptions set forth in the IGH Option Agreement. On August 26, 2019, the parties amended the IGH Option Agreement to, among other things, delay the closing until January 2020. By letter agreement dated January 31, 2020, the parties extended the IGH Option Agreement to February 4, 2020. On February 4, 2020, CLS Massachusetts exercised the IGH Option.

 

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 further 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 March 3, 2020, we filed a claim for declaratory relief, among other things, requesting the court declare that CLS Massachusetts had validly exercised the IGH Option and instruct IGH to comply with its diligence requests and ultimately execute a merger agreement with us. The dispute regarding whether CLS Massachusetts properly exercised the IGH Option arose after CLS Massachusetts delivered a notice of exercise to IGH and IGH subsequently asserted that CLS Massachusetts’ exercise was invalid. CLS and CLS Massachusetts intend to pursue this suit vigorously and believe that their claims are meritorious, however, there can be no assurance as to the ultimate outcome of this matter.

 

On September 13, 2018, we entered into a non-binding letter of intent (the “CannAssist LOI”) with CannAssist, LLC (“CannAssist”) setting forth the terms and conditions upon which we proposed to acquire an 80% ownership interest in CannAssist. On January 29, 2019, we made a line of credit loan to CannAssist, in the principal amount of up to $500,000, subject to the terms and conditions set forth in that certain Loan Agreement, dated as of January 29, 2019 between CannAssist as the Borrower and the Company as the Lender (the “CannAssist Loan Agreement”). The Loan was evidenced by a secured promissory note of CannAssist (the “CannAssist Note”), which bore interest at the rate of 8% per annum and was personally guaranteed by the two equity owners of CannAssist. CannAssist had drawn down $325,000 on the CannAssist Note. On March 11, 2019, the Company, through our wholly-owned subsidiary, CLS Massachusetts, entered into a membership interest purchase agreement (the “CannAssist Purchase Agreement”) with CannAssist, each of the members of CannAssist, and David Noble, as the members’ representative. Mr. Noble currently serves as the President of IGH, an entity that we hold an option to acquire. After conducting diligence regarding the cost of the planned buildout of the CannAssist facility, the parties jointly decided to terminate the CannAssist Purchase Agreement effective August 26, 2019 and declared the CannAssist Note due and payable in full not later than February 28, 2020. On December 23, 2019, we received payment in full on the CannAssist Note in the amount of $342,567, which comprised $325,000 of principal and $17,567 of interest.

 

 

On January 4, 2018, the Attorney General of the United States issued new written guidance concerning the enforcement of federal laws relating to marijuana. The Attorney General’s memorandum stated that previous DOJ guidance specific to marijuana enforcement, including the memorandum issued by former Deputy Attorney General James Cole on August 29, 2013 (as amended on February 14, 2014, the “Cole Memo”) is unnecessary and is rescinded, effective immediately. The Cole Memo told federal prosecutors that in states that had legalized marijuana, they should use their prosecutorial discretion to focus not on businesses that comply with state regulations, but on illicit enterprises that create harms like selling drugs to children, operating with criminal gangs, and selling across state lines. Although the rescission did not change federal law, as the Cole Memo and other DOJ guidance documents were not themselves laws, the rescission removed the DOJ’s formal policy that state-regulated cannabis businesses in compliance with the Cole Memo guidelines should not be a prosecutorial priority. Notably, former Attorney General Sessions’ rescission of the Cole Memo has not affected the status of the FinCen memorandum issued by the Department of Treasury, which remains in effect. This memorandum outlines Bank Secrecy Act-compliant pathways for financial institutions to service state-sanctioned cannabis business, which echoed the enforcement priorities outlined in the Cole Memo. In addition to his rescission of the Cole Memo, former Attorney General Sessions issued a one-page memorandum known as the “Sessions Memorandum.” The Sessions Memorandum explains the DOJ’s rationale for rescinding all past DPJ cannabis enforcement guidance, claiming that Obama-era enforcement policies are “unnecessary” due to existing general enforcement guidance adopted in the 1980s. Although the Sessions Memorandum emphasizes that cannabis is a federally illegal Schedule I controlled substance, it does not otherwise instruct U.S. Attorneys to consider the prosecution of cannabis-related offenses a DOJ priority, and in practice, most U.S. Attorneys have not changed their prosecutorial approach to date. However, due to the lack of specific direction in the Sessions Memorandum as to the priority federal prosecutors should ascribe to such cannabis activities, there can be no assurance that the federal government will not seek to prosecute cases involving cannabis businesses that are otherwise compliant with state law.

 

We incurred a net loss of $27,619,057 for the year ended May 31, 2019, and $1,251,999 and $3,910,473 for the three and nine months ended February 29, 2020 respectively, resulting in an accumulated deficit of $46,188,151 as of May 31, 2019, which deficit increased to $50,098,624 as of February 29, 2020.  These conditions raise substantial doubt about our ability to continue as a going concern.

 

Recent Developments – COVID-19

 

In December 2019, an outbreak of a novel strain of coronavirus, COVID-19, was identified in Wuhan, China. Since then, COVID-19 has spread across the globe, including the U.S., in which we and our subsidiaries operate, and has subsequently been recognized as a pandemic by the World Health Organization. Much of the global efforts to contain or slow the spread of COVID-19, including in the U.S., have been unsuccessful to date. The COVID-19 outbreak has severely restricted the level of economic activity around the world. In response to the COVID-19 outbreak, the federal and state governments of the U.S., including Nevada where we operate, have taken preventative or protective actions, such as imposing restrictions on travel and business operations and advising or requiring individuals to limit or forego their time outside of their homes. Temporary closures of businesses have been ordered and numerous other businesses have temporarily closed voluntarily. In particular, on March 20, 2020, Nevada Governor Sisolak ordered all cannabis dispensaries to close their retail operations but permitted them to shift to a delivery-only model to serve their communities. The global pandemic of COVID-19 continues to rapidly evolve and the ultimate duration and impact of the COVID-19 outbreak is highly uncertain and subject to change.

 

As mentioned above, on March 20, 2020, we were required to close our Nevada dispensary and shift to a delivery-only model. As a result, we closed our retail operations for two days as we transitioned our business model to a delivery-only model, onboarded new staff, trained them on new software and communicated with our customer base. Within six days, we were achieving 50% of February sales despite having reduced our operating hours from 24 hours a day to a 14 hour a day delivery model. Although we furloughed 20 dispensary employees, as a result of the dedication of our loyal staff, we were able to quickly train a large number of our dispensary employees for new roles in our delivery-only model. While this was occurring, approximately 20% of the Nevada dispensaries closed their doors completely unable to transition to a delivery-only model. Although we are still acclimating to the delivery-only model, at present, we are experiencing larger average orders, which helps a customer minimize the impact of the delivery fee. Because our customer base has historically been approximately 80% local, we have the opportunity to continue to serve our customer base even with the almost complete elimination of the tourist and convention business in Las Vegas. Our challenge now will be to retain our local customer base until such time as the tourist and convention business resumes.

 

 

Our manufacturing facility continues to operate, but primarily for the purposes of manufacturing City Trees products to be sold at our dispensary. The wholesale business has declined substantially as the sales staff has been unable to make sales calls and most dispensaries have curtailed purchasing products from third parties, electing instead only to offer their own products for sale at their dispensaries. As a result, we have furloughed two employees who worked at our manufacturing facility. Although we have not faced shortages of extraction material to date, we are currently being impacted by the limited availability of certain materials, such as the supply of masks, gowns and other protective equipment, due to the global shortage of such protective equipment and materials

 

It is impossible for us to predict whether there will be additional government-mandated closures that could affect our business, how long the existing closures will remain in place, and how these measures will impact our operations. Although cannabis dispensaries in Nevada have been designated as “essential, this designation could change and it is possible that we might be prohibited even from operating our manufacturing facilities or from delivering products to our customers due to health and safety concerns for our employees. Even if our production facilities and delivery operations remain open, mandatory or voluntary self-quarantines and travel restrictions may limit our employees’ ability to get to our facilities or to customers’ homes, and this, together with the uncertainty produced by the rapidly evolving nature of the COVID-19 outbreak, may result in a suspension of or decline in production or retail sales. These types of restrictions could also impact the abilities of customers in Nevada to continue to have access to our products. Quarantines, shelter-in-place and similar government orders, or the perception that such orders, shutdowns or other restrictions on the conduct of business operations could occur, could impact personnel at third-party grow and manufacturing facilities in Nevada and elsewhere. Additionally, delays in shipping as a result of COVID-19 may impact our ability to obtain materials in a timely manner. Finally, due to the almost complete elimination of the tourist and convention business in Las Vegas, dispensaries who relied heavily on such customers are now competing with us for local customers. Some of these competitors have greater financial resources than we do and could offer aggressively low prices to lure in local customers. Collectively, we expect the effects of the COVID-19 outbreak will adversely affect our fourth quarter results of operations and, if the effects continue unabated, our financial results longer term. At this time, neither the duration nor scope of the disruption can be predicted, therefore, the ultimate impact to our business cannot be reasonably estimated but such impact could be material.

 

Results of Operations

 

The table below sets forth our expenses as a percentage of revenue for the applicable periods: 

 

   

Three Months Ended

February 29,

2020

   

Three Months Ended

February 28,

2019

   

Nine Months Ended

February 29,

2020

   

Nine Months Ended

February 28,

2019

 
                                 

Revenue

    100.0

%

    100.0

%

    100.0

%

    100.0

%

Cost of Goods Sold

    48

%

    61

%

    50

%

    59

%

Gross Margin

    52

%

    39

%

    50

%

    41

%

Selling, General, and Administrative Expenses

    69

%

    215

%

    71

%

    425

%

Interest expense, net

    22

%

    28

%

    25

%

    54

%

Gain on Settlement of liabilities

    0

%

    0

%

    -3

%

    0

%

 

The table below sets forth certain statistical and financial highlights for the applicable periods:

 

   

Three Months Ended

February 29,

2020

   

Three Months Ended

February 28,

2019

   

Nine Months Ended

February 29,

2020

   

Nine Months Ended

February 28,

2019

 
                                 

Number of Customers Served (Dispensary)

    73,133       32,267       187,468       81,239  

Revenue

    3,224,170       2,372,790       9,139,616       5,529,053  

Gross Profit

    1,686,210       934,366       4,602,452       2,284,018  

Net Loss

    (1,251,999 )     (4,831,466 )     (3,910,473 )     (24,187,649 )

 

 

Three Months Ended February 29, 2020 and February 28, 2019

 

Revenue

 

We had revenue of $3,224,170 during the three months ended February 29, 2020, an increase of $851,380, or 36%, compared to revenue of $2,372,790 during the three months ended February 28, 2019. Our cannabis dispensary accounted for $2,637,006, or 82%, of our revenue for the three months ended February 29, 2020, an increase of $1,522,317, or 137%, compared to $1,114,689 during the three months ended February 28, 2019. This increase in dispensary revenue occurred because our average sales per day increased from $12,385 during the third quarter of fiscal 2019 to $28,978 during the comparable quarter of fiscal 2020. Our cannabis production accounted for $587,164, or 18%, of our revenue for the three months ended February 29, 2020, a decrease of $670,937, or 53%, compared to $1,258,101 for the three months ended February 28, 2019. The decrease in our production revenue occurred because we were delayed in making changes to our wholesale product mix dictated by market demand during construction of our state-of-the-art manufacturing facility. Such changes have now been implemented.

  

Cost of goods sold

 

Our cost of goods sold for the three months ended February 29, 2020 was $1,537,960, an increase of $99,536, or 7%, compared to cost of goods sold of $1,438,424 for the three months ended February 28, 2019. The increase in cost of goods sold for the three months ended February 29, 2020 was due primarily to our increase in sales during the third quarter of fiscal 2020. Cost of goods sold was 48% of sales during the third quarter of fiscal 2020 compared to 61% during the third quarter of fiscal 2019. This improvement in gross margin during the third quarter of fiscal 2020 was primarily due to a decrease in the cost of purchasing product as a result of the implementation of new processes, the retention of additional skilled employees and an improvement in inventory purchasing. Cost of goods sold during the third quarter of fiscal 2020 primarily consisted of $1,325,811 of product cost, $84,898 of state and local fees and taxes, and $73,023 of supplies and materials.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses, or SG&A, decreased by $2,889,665, or approximately 57%, to $2,213,206 during the three months ended February 29, 2020, compared to $5,102,871 for the three months ended February 28, 2019. The decrease in SG&A expenses for the three months ended February 29, 2020 was primarily due to the ongoing implementation of aspects of our business plan (other than the Oasis LLCs) and changes in our general corporate overhead. These costs decreased by $500,214 to an aggregate of $576,834 from $1,077,048 during the third quarter of fiscal 2019. The major components of these changes compared to the comparable quarter of fiscal 2019 are as follows: professional fees decreased by $373,539; investor relations costs decreased by $255,657; and travel related costs decreased by $34,824. These reductions were partially offset by an increase in corporate payroll and related costs by $81,972 and an increase in depreciation and amortization by $28,870. The decrease in legal fees was primarily due to the reduction in acquisition and financing activity that occurred during the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019.

 

The decrease in SG&A expense during the third quarter of fiscal 2020 was also partially offset by an increase in costs associated with operating the Oasis LLCs during the three months ended February 29, 2020 by an aggregate of $483,513, or approximately 40%, compared to $1,207,257 during the three months ended February 28, 2019. This increase in operating costs is primarily due to an increase in the number of people employed by the Oasis LLCs to handle the increase in sales and increases in pay rates. The major components of the increase in the operating costs associated with the Oasis LLCs during the three months ended February 29, 2020 compared to the comparable quarter of fiscal 2019 were as follows:  payroll and related costs increased by $303,659; and lease, facilities and office costs increased by $49,481.

 

Interest expense

 

Interest expense for the three months ended February 29, 2020 was $725,003, an increase of $62,042, or 9%, compared to $662,961 for the three months ended February 28, 2019.  This increase was primarily due to an increase in amortization of discounts on convertible notes, which increased by $61,264 to $398,611, compared to $337,347 in the comparable period of the prior year. This occurred due to the addition of convertible debt during the three months ended February 28, 2019 in the amount of $5,857,000. The increase in interest expense during the three months ended February 29, 2020, was partially offset by an increase in interest income during the same period in the amount of $1,473 due to higher cash balances maintained during the period.

 

 

The increase in net interest expense during the three months ended February 29, 2020 was also due to the increase in convertible notes payable due to the quarterly capitalization of interest on such notes.

 

Net loss

 

For the reasons above, we incurred a net loss for the three months ended February 29, 2020 of $1,251,999, which was a decrease of $3,579,467, or approximately 74%, compared to a net loss of $4,831,466 during the three months ended February 28, 2019.

 

Nine Months Ended February 29, 2020 and February 28, 2019

 

Revenue

 

We had revenue of $9,139,616 during the nine months ended February 29, 2020, an increase of $3,610,563, or 65%, compared to revenue of $5,529,053 during the nine months ended February 28, 2019. We acquired the Oasis LLCs, which are our only source of revenue, effective July 1, 2018, which means that fiscal 2020 included nine months of operations of the Oasis LLCs but the comparable period during fiscal 2019 included only eight months of operations of the Oasis LLCs. This is one of the reasons for the increase in revenues for the first nine months of fiscal 2020. Our cannabis dispensary accounted for $7,035,268, or 77%, of our revenue for the nine months ended February 29, 2020, an increase of $3,460,606, or 97%, compared to $3,574,662 during the nine months ended February 28, 2019. Dispensary revenue also increased during the first nine months of fiscal 2020 because our average sales per day increased from $14,711 during the first nine months of fiscal 2019 to $25,676 during the comparable nine months of fiscal 2020. Our cannabis production accounted for $2,104,348, or 23%, of our revenue for the nine months ended February 28, 2019, an increase of $149,957, or 8%, compared to $1,954,391 for the nine months ended February 28, 2019.

 

Cost of goods sold

 

Our cost of goods sold for the nine months ended February 29, 2020 was $4,537,164, an increase of $1,292,129, or 40%, compared to cost of goods sold of $3,245,035 for the nine months ended February 28, 2019. The increase in cost of goods sold for the nine months ended February 29, 2020 was due primarily to our increase in sales during the first nine months of fiscal 2020. Cost of goods sold was 50% of sales during the first nine months of fiscal 2020 compared to 59% during the first nine months of fiscal 2019. This improvement in gross margin during the first nine months of fiscal 2020 was primarily due to a decrease in the cost of purchasing product as a result of the implementation of new processes, the retention of additional skilled employees and an improvement in inventory purchasing. Cost of goods sold during the first nine months of fiscal 2020 primarily consisted of $3,958,493 of product cost, $298,808 of state and local fees and taxes, and $119,448 of supplies and materials.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses, or SG&A, decreased by $16,938,864, or approximately 72%, to $4,319,967 during the nine months ended February 29, 2020, compared to $23,472,037 for the nine months ended February 28, 2019. The decrease in SG&A expenses for the nine months ended February 29, 2020 was primarily due to the absence of approximately $12,947,556 in one-time financing and acquisition costs attributable to the acquisition of the Oasis LLCs, which were incurred during the nine months ended February 28, 2019. No such comparable expenses were incurred during the first nine months of fiscal 2020.

 

The major components of these one-time cash and non-cash financing and acquisition costs incurred during the first nine months of fiscal 2019 were as follows: the  fair value of additional warrants and special warrants issued due to our failure to meet certain registration statement filing deadlines in connection with the Westpark equity offering and the Canaccord special warrants offering in the amount of $8,084,522; the fair value of the special warrants and compensation broker warrants issued to Canaccord in connection with our sale of the special warrants in the amount of $2,908,673; broker and agent fees and commissions in the amount of $1,060,773; the fair value of 700,000 shares of common stock issued to Star Associates, which is affiliated with one of our directors, for services in connection with the Oasis transaction, of $490,000; and a foreign exchange loss on conversion of the Canaccord funds from Canadian to U.S. dollars in the amount of $403,588. 

 

 

SG&A also decreased by an aggregate of $2,228,502 during the first nine months of fiscal 2020 as a result of the ongoing implementation of other aspects of our business plan and changes in our general corporate overhead, to $2,062,794 from $4,291,296 during the first nine months of fiscal 2019. The major components of these changes compared to the first nine months of fiscal 2019 are as follows: legal fees decreased by $1,860,837; investor relations costs decreased by $619,643; non-cash compensation decreased by $108,806; and travel costs increased by $30,901. These reductions were partially offset by an increase in corporate payroll and related costs by $193,889 and an increase in depreciation and amortization by $86,334. The decrease in legal fees was primarily due to the reduction in acquisition and financing activity that occurred during the first nine months of fiscal 2020 compared to the first nine months of fiscal 2019.

 

The decrease in SG&A expense during the first nine months of fiscal 2020 described above was partially offset by an increase in costs associated with operating the Oasis LLCs during the nine months ended February 29, 2020 by an aggregate of $1,248,831, or approximately 39%, compared to $3,221,548 during the nine months ended February 28, 2019. This increase in operating costs was primarily due to the timing of our acquisition of the Oasis LLCs, which occurred on June 27, 2018. As a result, we incurred these costs for nine months during fiscal 2020 compared to approximately eight months during fiscal 2019. The increase was also due to an increase in operating costs during the first nine months of fiscal 2020 compared to the comparable period in fiscal 2019. The major components of the increase in the operating costs associated with the Oasis LLCs during the nine months ended February 29, 2020 were as follows: payroll and related costs increased by $827,720; lease, facilities and office costs increased by $188,167; professional fees increased by $110,681; sales, marketing, and advertising increased by $110,267; and bad debt increased by $108,374.

 

Gain on settlement of liabilities

 

During the nine months ended February 29, 2020, we made a prepayment on the Oasis Note in connection with the settlement of a dispute between the former owners of Alternative Solutions and a consultant, and the amount of $275,000, which we had accrued with respect to this dispute, was extinguished.

 

Interest expense

 

Interest expense for the nine months ended February 29, 2020 was $2,254,752, a decrease of $744,878, or 25%, compared to $2,999,630 for the nine months ended February 28, 2019.  This decrease was primarily due to a decrease in the amortization of the discount on convertible notes, which decreased by $1,229,083 to $1,252,594, compared to $2,481,677 in the comparable period of the prior year. During the comparable period of the prior year, a reset event occurred with respect to the YA II PN note. As a result, the conversion price of this note was reduced to $0.34 per share of common stock. This was considered a material modification of the note, resulting in the amortization of the discount on this note in the amount of $699,628 being recorded. In addition, amortization in the amount of $509,573 was recorded in connection with the conversion of the Darling Capital note to common stock. There were no comparable transactions during the nine months ended February 29, 2020. During the nine months ended February 29, 2020, interest expense also decreased due to an increase in interest income in the amount of $140,261 as a result of higher cash balances maintained during the period.

 

The decrease in net interest expense during the nine months ended February 29, 2020 was partially offset by an increase in accrued interest on our outstanding notes payable and convertible debentures, which was $1,242,037 during the first nine months of fiscal 2020, an increase of $631,213, compared to $610,824 during the first nine months of fiscal 2019. This increase was due to an increase in our outstanding debt as a result of our successful fundraising efforts during fiscal 2019 and the capitalization of interest on our outstanding convertible debentures.

 

Net loss

 

For the reasons above, we incurred a net loss for the nine months ended February 29, 2020 of $3,910,473, which was a decrease of $20,277,176, or approximately 84%, compared to a net loss of $24,187,649 during the nine months ended February 28, 2019.

 

Liquidity and Capital Resources

 

The following table summarizes our total current assets, liabilities and working capital at February 29, 2020 compared to May 31, 2019.

 

   

February 29,

2020

   

May 31,

2019

 

Current Assets

  $ 9,655,781     $ 12,677,566  

Current Liabilities

  $ 2,779,166     $ 6,924,543  

Working Capital

  $ 6,876,615     $ 5,753,023  

 

 

At February 29, 2020, we had working capital of $6,876,615, an increase of $1,123,592 from working capital of $5,753,023 at May 31, 2019. The increase in working capital was primarily the result of all $5,399,453 due under the IGH Note being reclassified as a current asset as a result of IGH’s default and our acceleration of the full amount due under the IGH Note. Our working capital at February 29, 2020, included $3,039,095 of cash compared to $10,525,791 of cash at May 31, 2019. The decrease in cash was primarily the result of our repayment of the $4 million Oasis Note and our expenditures of cash to purchase equipment and leasehold improvements in the amount of $1,385,317 in connection with the buildout of our cannabis processing facility in Nevada. It is uncertain whether we will close on our previously announced potential acquisition of IGH in Massachusetts. On March 3, 2020, we filed a claim for declaratory relief, among other things, requesting the court declare that CLS Massachusetts had validly exercised the IGH Option and instruct IGH to comply with its diligence requests and ultimately execute a merger agreement with CLS and CLS Massachusetts. The dispute regarding whether CLS Massachusetts properly exercised the IGH Option arose after CLS Massachusetts delivered a notice of exercise to IGH and IGH subsequently asserted that CLS Massachusetts’ exercise was invalid. CLS and CLS Massachusetts intend to pursue this suit vigorously and believe that their claims are meritorious, however, there can be no assurance as to the ultimate outcome of this matter. Regardless of whether we acquire IGH, our working capital needs will likely continue to increase, particularly if the disruption to our operations caused by the COVID-19 pandemic continue, and if we require additional funds to meet them, we will seek additional debt or equity financing. We have operated at a loss since inception.

 

Cash flows used in operating activities were $1,871,343 during the nine months ended February 29, 2020, a decrease of $7,899,002, or 81%, compared to $9,770,345 during the nine months ended February 28, 2019.  In deriving cash flows used in operating activities from the net loss for the first nine months of fiscal 2020, there were $1,428,708 of non-cash items that were added back to the net loss for fiscal 2020 compared to $16,373,796 during the nine months ended February 28, 2019.  Significant items were as follows: gain on contingent liabilities of $275,000 during the nine months ended February 29, 2020, compared to no such comparable gain during the nine months ended February 28, 2019; amortization of debt discounts in the amount of $1,249,053 during the nine months ended February 29, 2020 in connection with discounts on the U.S. and Canaccord convertible debentures, compared to $2,481,674 during the nine months ended February 28, 2018 in connection with the discounts on the Darling Capital, Efrat Investments, YA II PN, and Lasky notes; stock-based compensation of $124,582 during the nine months ended February 28, 2020 compared to $328,513 during the nine months ended February 28, 2019; and the fair value of shares issued to consultants of $45,000 during the nine months ended February 29, 2020, compared to $490,000 during the nine months ended February 28, 2019. We also incurred approximately $11,400,000 of non-cash financing charges during the first nine months of fiscal 2019 and had no comparable activity during the first nine months of fiscal 2020. These charges consisted of a financing penalty in the amount of $8,084,522 associated with our issuance of warrants and special warrants, $2,908,673 related to the value of warrants and units issued to placement agents, and non-cash offering costs of $403,588.

 

Finally, our cash used in operating activities was affected by changes in the components of working capital. The overall net change in the components of working capital resulted in an increase in cash from operating activities in the amount of $610,42 during the nine months ended February 29, 2020, compared to a decrease in cash from operating activities in the amount of $1,956,492 during the first nine months of fiscal 2019.  The more significant changes in the components of working capital that increased the amount of cash used in operating activities during the nine months ended February 29, 2020 were as follows: accrued interest increased cash by $934,117, which related primarily to the increased principal outstanding on the convertible debentures of $19,479,137 at February 29, 2020 compared to $18,750,227 at February 28, 2019. In addition, the right of use asset, net of operating lease liability, increased cash used in operating activities by $113,865 due to lease payments made and recorded in accordance with ASU 2016-02. The more significant changes in the components of working capital that decreased the amount of cash used in operating activities during the nine months ended February 29, 2020 were as follows: accounts payable and accrued expenses decreased cash by $166,468, primarily due to the elimination of deferred rent in the amount of $151,399 in connection with the implementation of ASU 2016-02; and interest receivable decreased cash by $221,195 due to interest accruals on the CannAssist and IGH notes receivable, which were not yet outstanding during the nine months ended February 28, 2019.

 

Cash flows used in investing activities were $1,616,185 for the nine months ended February 29, 2020, a decrease of $10,251,759, or 86%, compared to $11,867,944 during the nine months ended February 28, 2019.  During the nine months ended February 29, 2020, we made cash payments to purchase equipment and build out our leased facilities, which included $1,385,317 to build out our facilities in Nevada pursuant to our expansion plan. We also made a second advance of $175,000 on our loan to CannAssist and received a principal payment from CannAssist of $325,000, which together with an interest payment, repaid this loan in full. During the nine months ended February 28, 2019, we made a net cash payment in the amount of $5,982,710 in connection with the acquisition of Alternative Solutions and made loans to IGH and CannAssist in the amounts of $5,000,000 and $150,000, respectively.

 

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