CLS HOLDINGS USA, INC. HISTORY AND OUTLOOK
We were incorporated onMarch 31, 2011 asAdelt Design, Inc. to manufacture and market carpet binding art. Production and marketing of carpet binding art never commenced. OnNovember 20, 2014 , we adopted amended and restated articles of incorporation, thereby changing our name toCLS Holdings USA, Inc. EffectiveDecember 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
CLS Labs was originally incorporated in the state ofNevada onMay 1, 2014 under the nameRJF Labs, Inc. before changing its name toCLS Labs, Inc. onOctober 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 twoColorado 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. OnApril 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 certainColorado 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 aU.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 throughCannabis 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. 37
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OnDecember 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 onFebruary 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 onJune 27, 2018 , we paid the following consideration:$5,995,543 in cash, a$4.0 million promissory note due inDecember 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 inDecember 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 onDecember 12, 2018 . OnOctober 31, 2018 , the Company,CLS Massachusetts, Inc. , aMassachusetts corporation and a wholly-owned subsidiary of the Company ("CLS Massachusetts"), andIn Good Health, Inc. , aMassachusetts 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 andDecember 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. OnOctober 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 ofOctober 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 onOctober 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 ofOctober 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. OnAugust 26, 2019 , the parties amended the IGH Option Agreement to, among other things, delay the closing untilJanuary 2020 . OnSeptember 13, 2018 , we entered into a non-binding letter of intent (the "CannAssist LOI") withCannAssist, LLC ("CannAssist") setting forth the terms and conditions upon which we proposed to acquire an 80% ownership interest in CannAssist. OnJanuary 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 ofJanuary 29, 2019 between CannAssist as the Borrower and the Company as the Lender (the "CannAssist Loan Agreement"). The Loan , which was repaid in full inDecember 2019 , 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. OnMarch 11, 2019 , the Company, through our wholly-owned subsidiary, CLSMassachusetts , entered into a membership interest purchase agreement (the "CannAssist Purchase Agreement") with CannAssist, each of the members of CannAssist, andDavid 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 effectiveAugust 26, 2019 and declare the CannAssist Note due and payable in full not later thanFebruary 28, 2020 . 38
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OnJanuary 4, 2018 , the Attorney General ofthe 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 GeneralJames Cole onAugust 29, 2013 (as amended onFebruary 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 theDepartment 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 instructU.S. Attorneys to consider the prosecution of cannabis-related offenses a DOJ priority, and in practice, mostU.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 endedMay 31, 2019 , and$1,297,090 and$2,673,590 for the three and six months endedNovember 30, 2019 , respectively, resulting in an accumulated deficit of$46,188,151 as ofMay 31, 2019 , which deficit increased to$48,861,741 as ofNovember 30, 2019 . These conditions raise substantial doubt about our ability to continue as a going concern. Results of Operations The table below sets forth our expenses as a percentage of revenue for the applicable periods: Three Months Three Months Ended Ended Six Months Ended Six Months Ended November 30, November 30, November 30, November 30, 2019 2018 2019 2018 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of Goods Sold 52 % 53 % 51 % 57 % Gross Margin 48 % 47 % 49 % 43 % Selling, General, and Administrative Expenses 66 % 151 % 73 % 582 % Interest expense, net 24 % 33 % 26 % 74 % Gain on Settlement of liabilities 0 % 0 % -5 % 0 % 39
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Three Months Ended
Revenue We had revenue of$3,056,431 during the three months endedNovember 30, 2019 , an increase of$1,079,521 , or 55%, compared to revenue of$1,976,910 during the three months endedNovember 30, 2018 . We acquired the Oasis LLCs, which are our only source of revenue, effectiveJuly 1, 2018 , which means that the second quarter of fiscal 2020 is the first quarter that included three months of operations of the Oasis LLCs for both the fiscal 2020 second quarter and the comparable quarter of fiscal 2019. Revenue increased during the second quarter of 2020 because our average sales per day increased from$21,724 during the second quarter of fiscal 2019 to$33,587 during the comparable quarter of fiscal 2020. Our cannabis dispensary accounted for$2,312,362 , or 76%, of our revenue for the three months endedNovember 30, 2019 , an increase of$629,096 , or 37%, compared to$1,683,266 during the three months endedNovember 30, 2018 . Our cannabis production accounted for$744,069 , or 24%, of our revenue for the three months endedNovember 30, 2019 , an increase of$450,425 , or 153%, compared to$293,644 for the three months endedNovember 30, 2018 . Cost of goods sold Our cost of goods sold for the three months endedNovember 30, 2019 was$1,587,632 , an increase of$540,965 , or 52%, compared to cost of goods sold of$1,046,667 for the three months endedNovember 30, 2018 . The increase in cost of goods sold for the three months endedNovember 30, 2019 was due primarily to our increase in sales during the second quarter of fiscal 2020. Cost of goods sold was 52% of sales during the second quarter of fiscal 2020 compared to 53% during the second quarter of fiscal 2019. This improvement in gross margin during the second 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 second quarter of fiscal 2020 primarily consisted of$1,404,161 of product cost,$105,975 of state and local taxes, and$26,177 of supplies and materials.
Selling, general and administrative expenses
Selling, general and administrative expenses, or SG&A, decreased by$955,383 , or approximately 32%, to$2,021,653 during the three months endedNovember 30, 2019 , compared to$2,977,036 for the three months endedNovember 30, 2018 . The decrease in SG&A expenses for the three months endedNovember 30, 2019 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$931,920 to an aggregate of$596,456 from$1,528,376 during the second 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$708,638 ; investor relations costs decreased by$260,339 ; and non-cash compensation decreased by$105,070 . These reductions were partially offset by an increase in payroll and related costs by$74,857 and an increase in depreciation and amortization by$26,058 . The decrease in legal fees was primarily due to the reduction in acquisition and financing activity that occurred during the second quarter of fiscal 2020 compared to the second quarter of fiscal 2019. The decrease in SG&A expense during the second quarter of fiscal 2020 was partially offset by an increase in costs associated with operating the Oasis LLCs during the three months endedNovember 30, 2019 by an aggregate of$169,622 , or approximately 14%, compared to$1,255,589 during the three months endedNovember 30, 2018 . This increase in operating costs is primarily due to an increase in the number of people employed by the Oasis LLCs from 74 to 79 to handle the increase in sales. The major components of the increase in the operating costs associated with the Oasis LLCs during the three months endedNovember 30, 2019 compared to the comparable quarter of fiscal 2019 were as follows: payroll and related costs increased by$204,378 ; lease, facilities and office costs increased by$32,229 ; and sales, marketing, and advertising increased by$28,196 . Interest expense Interest expense for the three months endedNovember 30, 2019 was$729,120 , an increase of$76,670 , or 12%, compared to$652,450 for the three months endedNovember 30, 2018 . This increase was primarily due to an increase in interest accrued on convertible notes, which increased by$275,414 to$404,705 , compared to$129,291 in the comparable period of the prior year. The increase in interest expense is due to the addition of convertible debt during the three months endedNovember 30, 2018 in the amount of$5,857,000 . The increase in interest expense during the three months endedNovember 30, 2019 , was partially offset by an increase in interest income during the same period in the amount of$56,619 due to higher cash balances maintained during the period. 40
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The increase in net interest expense during the three months endedNovember 30, 2019 was also partially offset by the decrease in the amortization of the discount on our convertible debentures, which decreased by$140,136 to$405,692 , compared to$545,828 in the comparable period of the prior year. During the comparable period of the prior year, amortization of the discount on our convertible debentures in the amount of$303,818 was recorded in connection with the conversion of a portion of the YA II PN note. Net loss
For the reasons above, we incurred a net loss for the three months ended
Six Months Ended
Revenue We had revenue of$5,915,446 during the six months endedNovember 30, 2019 , an increase of$2,759,183 , or 87%, compared to revenue of$3,156,293 during the six months endedNovember 30, 2018 . We acquired the Oasis LLCs, which are our only source of revenue, effectiveJuly 1, 2018 , which means that the first half of fiscal 2020 included six months of operations of the Oasis LLCs but the comparable quarter of fiscal 2019 included only five months of operations of the Oasis LLCs. This is one of the reasons for the increase in revenues for the first half of fiscal 2020. Revenue also increased during the first half of fiscal 2020 because our average sales per day increased from$20,629 during the first half of fiscal 2019 to$32,325 during the comparable half of fiscal 2020. Our cannabis dispensary accounted for$4,398,262 , or 85%, of our revenue for the six months endedNovember 30, 2019 , an increase of$1,938,289 , or 79%, compared to$2,459,973 during the six months endedNovember 30, 2018 ; our cannabis production accounted for$1,517,184 , or 15%, of our revenue for the six months endedNovember 30, 2019 , an increase of$820,894 , or 118%, compared to$696,290 for the six months endedNovember 30, 2018 . Cost of goods sold Our cost of goods sold for the six months endedNovember 30, 2019 was$2,999,204 , an increase of$1,192,593 , or 66%, compared to cost of goods sold of$1,806,611 for the six months endedNovember 30, 2018 . The increase in cost of goods sold for the six months endedNovember 30, 2019 was due primarily to our increase in sales during the first half of fiscal 2020. Cost of goods sold was 51% of sales during the first half of fiscal 2020 compared to 57% during the first half of fiscal 2019. This improvement in gross margin during the first half 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 half of fiscal 2020 primarily consisted of$2,632,682 of product cost,$213,930 of state and local taxes, and$49,425 of supplies and materials.
Selling, general and administrative expenses
Selling, general and administrative expenses, or SG&A, decreased by$14,049,199 , or approximately 76%, to$4,319,967 during the six months endedNovember 30, 2019 , compared to$18,369,166 for the six months endedNovember 30, 2018 . The decrease in SG&A expenses for the six months endedNovember 30, 2019 was primarily due to the absence of approximately$12,947,556 in one-time financing and acquisition (and financing) costs attributable to the acquisition of the Oasis LLCs, which were incurred during the six months endedNovember 30, 2018 . No such comparable expenses were incurred during the first half of fiscal 2020. The major components of these one-time cash and non-cash financing and acquisition costs incurred during the first half 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 toStar 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 toU.S. dollars in the amount of$403,588 . 41
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SG&A also decreased by an aggregate of$1,728,288 during the first half 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 an$1,485,960 from$3,214,248 during the first half of fiscal 2019. The major components of these changes compared to fiscal 2019 are as follows: legal fees decreased by$1,487,298 ; investor relations costs decreased by$363,986 ; non-cash compensation decreased by$154,486 ; and facilities, office, and general costs increased by$104,178 . These reductions were partially offset by an increase in payroll and related costs by$111,917 and an increase in depreciation and amortization by$57,464 . The decrease in legal fees was primarily due to the reduction in acquisition and financing activity that occurred during the first half of fiscal 2020 compared to the first half of fiscal 2019. The decreases in SG&A expense during the first half of fiscal 2020 described above were partially offset by an increase in costs associated with operating the Oasis LLCs during the six months endedNovember 30, 2019 by an aggregate of$819,730 , or approximately 41%, compared to$2,014,291 during the six months endedNovember 30, 2018 . This increase in operating costs is primarily due to the timing of our acquisition of the Oasis LLCs, which occurred onJune 27, 2018 . As a result, we incurred these costs for six months during fiscal 2020 compared to approximately five months during fiscal 2019. The major components of the increase in the operating costs associated with the Oasis LLCs during the six months endedNovember 30, 2019 were as follows: payroll and related costs increased by$524,061 ; lease, facilities and office costs increased by$138,686 ; bad debt increased by$102,615 ; professional fees increased by$67,623 ; and sales, marketing, and advertising increased by$34,765 .
Gain on settlement of liabilities
During the six months endedNovember 30, 2019 , 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 six months endedNovember 30, 2019 was$1,529,749 , a decrease of$806,920 , or 35%, compared to$2,336,669 for the six months endedNovember 30, 2018 . This decrease was primarily due to a decrease in the amortization of the discount on convertible notes, which decreased by$1,290,346 to$853,983 , compared to$2,144,329 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 theDarling Capital note to common stock. There were no comparable transactions during the six months endedNovember 30, 2019 . During the six months endedNovember 30, 2019 , interest expense also decreased due to an increase in interest income in the amount of$163,446 as a result of higher cash balances maintained during the period. The decrease in net interest expense during the six months endedNovember 30, 2019 was partially offset by an increase in accrued interest on our outstanding notes payable and convertible debentures, which was$839,212 during the first half of fiscal 2020, an increase of$627,964 , compared to$211,248 during the first half of fiscal 2019. This increase was due an increase in our outstanding debt as a result of our successful fundraising efforts during fiscal 2019. Net loss For the reasons above, we incurred a net loss for the six months endedNovember 30, 2019 of$2,658,474 , which was a decrease of$16,697,709 , or approximately 86%, compared to a net loss of$19,356,183 during the six months endedNovember 30, 2018 . 42
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Liquidity and Capital Resources
The following table summarizes our total current assets, liabilities and working
capital at
November 30, May 31,
2019 2019
Current Assets $ 8,409,129 $ 12,677,566
Current Liabilities $ 4,378,459 $ 6,924,543
Working Capital (Deficit) $ 4,023,670 $ 5,753,023
At November 30, 2019 , we had working capital of $4,023,670 , a decrease of
$1,729,353 from working capital of $5,753,023 at May 31, 2019 . Our working
capital at November 30, 2019 , included $4,937,013 of cash. The decrease in
working capital was primarily the result of our acquisition of equipment and
leasehold improvements in the amount of $1,240,636 in connection with the
buildout of our cannabis processing facility in Nevada . We are presently
expanding the Oasis and City Trees businesses in Nevada and are considering
other potential acquisitions, including our previously announced potential
acquisition of IGH in Massachusetts . Our working capital needs will likely
continue to increase, 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 $1,208,112 during the six months
ended November 30, 2019 , a decrease of $4,549,215 , or 79%, compared to
$5,757,327 during the six months ended November 30, 2018 . In deriving cash
flows used in operating activities from the net loss for fiscal 2020, there were
$874,382 of non-cash items that were added back to the net loss for fiscal 2020
compared to $14,451,228 during the six months ended November 30, 2018 .
Significant items were as follows: gain on contingent liabilities of $275,000
during the six months ended November 30, 2019 , compared to no such comparable
gain during the six months ended November 30, 2018 ; amortization of debt
discounts in the amount of $853,983 during the six months ended November 30,
2019 in connection with discounts on the U.S. and Canaccord convertible
debentures, compared to $2,144,328 during the six months ended November 30, 2018
in connection with the discounts on the Darling Capital , Efrat Investments, YA
II PN and Lasky notes; stock-based compensation of $93,902 during the six months
ended November 30, 2019 , compared to $230,888 during the six months ended
November 30, 2018 ; and the fair value of shares issued to consultants of $30,000
during the six months ended November 30, 2019 , compared to $490,000 during the
six months ended November 30, 2018 . The Company also incurred approximately
$11,400,000 of non-cash financing charges during the first half of fiscal 2019
and had no comparable activity during the first half 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 $575,980 during the six months ended November 30, 2019 , compared to a
decrease in cash from operating activities in the amount of $852,372 during the
first half of fiscal 2019. The more significant changes in the components of
working capital that increased the amount of cash from operating activities
during the six months ended November 30, 2019 were as follows: accrued interest
increased cash by $838,662 , which related primarily to the increased principal
outstanding on the convertible debentures of $19,088,351 at November 30, 2019
compared to $6,857,000 at November 30, 2018 . In addition, right of use asset,
net of operating lease liability, increased cash from operating activities by
$131,816 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 from operating activities during the six months ended
November 30, 2019 were as follows: accounts payable and accrued expenses
decreased cash by $293,872 , 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 $163,446 due to interest accruals on the
CannAssist and IGH notes receivable, which were not yet outstanding during the
first half of the year ended November 30, 2018 .
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Cash flows used in investing activities were$1,741,882 for the six months endedNovember 30, 2019 , a decrease of$9,275,923 , or 84%, compared to$11,017,805 during the six months endedNovember 30, 2018 . During the six months endedNovember 30, 2019 , we made cash payments in the amount of$1,240,636 to purchase equipment and build out our leased facilities inNevada pursuant to our expansion plan. We also made a loan in the amount of$175,000 to CannAssist. During the six months endedNovember 30, 2018 , we made a net cash payment in the amount of$5,982,710 in connection with the acquisition of Alternative Solutions. Cash flows used in financing activities were$2,638,784 for the six months endedNovember 30, 2019 , an increase of$24,233,000 , or 112%, compared to cash provided by financing activities of$21,594,216 during the six months endedNovember 30, 2018 . During the six months endedNovember 30, 2019 , we made a cash prepayment in the amount of$2,638,784 on the Oasis Note. During the six months endedNovember 30, 2018 , we received cash in the amount of$21,892,908 from the sale of equity toNavy Capital and convertible debentures to investors in the Canaccord Special Warrant Offering. Third Party Debt
The table below summarizes the status of our third party debt and reflects whether such debt remains outstanding, has been repaid, or has been converted into or exchanged for our Common Stock:
Original Outstanding
Name of Note Principal Amount or Repaid Payment Details
FirstFire Note $ 363,000 Repaid Repaid
Darling Capital
Note $ 550,000 Repaid Converted into 1,808,000 shares
Efrat
Investments
Note $ 55,000 Repaid Converted into 183,040 shares
Todd Blatt $ 210,000 Repaid Repaid
AJG Group $ 100,000 Repaid Repaid
YA II PN Note $ 750,000 Repaid Repaid
$250,000 plus interest converted into
$ 250,000 Repaid 700,616 shares of Common Stock.
$250,000 plus interest converted into
$ 250,000 Repaid 640,068 shares of Common Stock.
Oasis Note $ 4,000,000 Outstanding Repaid
2018 U.S.
Convertible
Debentures $ 5,857,000 Outstanding Due October 26-31, 2021
Due December 2021. Principal and
2018 interest in the aggregate amount of
Convertible $25,803 converted into 32,321 shares of
Debentures $ 12,012,000 Outstanding Common Stock.
Darling Capital Note
On February 5, 2018 , we entered into a securities purchase agreement with
Darling, whereby Darling agreed to purchase an 8% convertible promissory note in
the aggregate principal amount of $550,000 (the "Darling Note") from us due,
subject to the terms therein, eighteen (18) months from the date of issuance,
for a purchase price of $500,000 .
Darling could, at its option, convert all or a portion of the Darling Note and
accrued but unpaid interest into shares of Common Stock at a conversion price of
$0.3125 per share. On the closing date, we also issued Darling a three-year
Common Stock purchase warrant to purchase 400,000 shares of our Common Stock at
an initial exercise price of $0.75 per share.
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On
Efrat Investments Note OnFebruary 16, 2018 , we entered into a securities purchase agreement with Efrat, whereby Efrat agreed to purchase an 8% convertible promissory note in the aggregate principal amount of$55,000 (the "Efrat Note") from us due, subject to the terms therein, eighteen (18) months from the date of issuance, for a purchase price of$50,000 . Efrat could, at its option, convert all or a portion of the Efrat Note and accrued but unpaid interest into shares of Common Stock at a conversion price of$0.3125 per share. On the closing date, we also issued Efrat a three-year Common Stock purchase warrant to purchase 40,000 shares of our Common Stock at an initial exercise price of$0.75 per share.
On
The YA II PN, Ltd. Notes OnMay 11, 2018 , we entered into a securities purchase agreement with YA II, pursuant to which we agreed to sell to YA II, in two closings, (i) convertible debentures in the aggregate principal amount of$1,250,000 , plus accrued interest, which may be converted into shares of our Common Stock, at the discretion of either YA II or us in accordance with the terms of the debentures, and (ii) five-year warrants to purchase an aggregate of 3,125,000 shares of our Common Stock at$0.60 per share of Common Stock. At the first closing, which occurred onMay 14, 2018 , we issued a$750,000 debenture to YA II and warrants to purchase 1,875,000 shares of our Common Stock. At the second closing, which occurred onJuly 20, 2018 , we issued a$500,000 debenture to YA II and warrants to purchase 1,250,000 additional shares of our Common Stock. The debentures bear interest at the rate of 8% per annum. If an event of default occurs and for so long as such event of default remains uncured, the interest rate on the debentures shall immediately become 15% per annum and shall remain at such increased interest rate until the applicable event of default is cured. Commencing onDecember 1, 2018 and on the first day of each month thereafter throughJuly 1, 2019 , subject to certain exceptions, we shall pay to YA II one-eighth of the principal amount of the debentures, plus accrued and outstanding interest (the "Installment Amount"), plus 20% of the of the Installment Amount for Installment Amounts due within 180 days following the date of execution of the purchase agreement, and 25% of the Installment Amount for Installment Amounts due thereafter in cash or by converting such Installment Amount into shares of our Common Stock. if we have met the applicable conditions for such a conversion and as long as the conversion does not exceed certain maximum amounts. Each Installment Amount will be deferred to the maturity date if the daily dollar volume-weighted average price of our Common Stock equals or exceeds$0.40 per share for each of the 10 consecutive days preceding the fifth trading day prior to the respective installment date. Pursuant to the terms of the debentures, YA II may elect to convert any portion of the principal and accrued interest under the debentures into our Common Stock at a fixed conversion price of$0.40 per share. The fixed conversion price may change if certain dilutive events or issuances occur. In addition, we may, at our sole discretion, make an Installment Payment using our Common Stock if certain conditions have been met. In such case, the applicable conversion price would be equal to 75% of the VWAP of our Common Stock during the fifteen consecutive trading days immediately preceding such conversion. During the three months endedAugust 31, 2018 , a reset event occurred. As a result, the conversion price of the first YA II PN Note, in the principal amount of$750,000 , was reduced to$0.34 per share of Common Stock. During the year endedMay 31, 2019 , YA II 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. OnJanuary 8, 2019 , YA II converted$256,027 , of which$250,000 was principal and$6,027 was accrued interest, into 640,068 shares of Common Stock.
On
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Table of ContentsBlatt Note OnFebruary 7, 2018 , we issued a note payable toTodd Blatt in the amount of$210,000 . This note accrued interest at a rate of 6% per annum and was due onFebruary 7, 2019 . This note along with$5,627 of accrued interest was paid onJuly 20, 2018 . AJG Group Note OnFebruary 7, 2018 , we issued a note payable toAJG Group in the amount of$200,000 . This note accrued interest at a rate of 6% per annum and was due onFebruary 7, 2019 . We made a principal payment in the amount of$100,000 on this note onMarch 30, 2018 ; we then made an additional principal payment of$100,000 , together with accrued interest in the amount of$3,337 , onJuly 9, 2018 .Oasis Note OnJune 27, 2018 , we closed on the purchase of the remaining 90% of the membership interests of Alternative Solutions and the Oasis LLCs. The closing occurred pursuant to the Acquisition Agreement datedDecember 4, 2017 , as amended. On such date, we 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 inDecember 2019 (the "Oasis Note"), and 22,058,823 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 in liabilities. The Oasis Note bears interest at the rate of 6% per annum. The principal amount of the Oasis Note was reduced inAugust 2019 , in accordance with the terms of the Acquisition Agreement, as a result of the settlement of the dispute between the former owners of Alternative Solutions and 4Front Advisors, a consultant to Alternative Solutions. The terms of the settlement with 4Front Advisors are confidential. The Oasis Note was secured by all of the membership interests in Alternative Solutions and the Oasis LLCs and by the assets of the Oasis LLCs. We repaid the Oasis Note in full inDecember 2019 .
2018 U.S. Convertible Debenture Offering
BetweenOctober 25, 2018 andNovember 2, 2018 , we entered into six subscription agreements, pursuant to which we agreed to sell, for an aggregate purchase price of$5,857,000 ,$5,857,000 in original principal amount of convertible debentures in minimum denominations of$1,000 each. The debentures bear interest, payable quarterly, at a rate of 8% per annum, with interest during the first eighteen (18) months following their issuance, being payable by increasing the then-outstanding principal amount of the debentures. The debentures mature on a date that is three years following their issuance. The debentures are convertible into units at a conversion price of$0.80 per unit. Each unit consists of (i) one share of our Common Stock, par value$.001 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 debentures have other features, such as mandatory conversion in the event our Common Stock trades at a particular price over a specified period of time and required redemption in the event of a "Change in Control" of the Company. The debentures are unsecured obligations of the Company and rank pari passu in right of payment of principal and interest with all other unsecured obligations of the Company.Navy Capital and its affiliates purchased$5,000,000 in principal amount of debentures, with the remaining$857,000 in principal amount being purchased by several unaffiliated purchasers. The debentures include a provision for the capitalization of accrued interest on a quarterly basis; atNovember 30, 2019 , accrued interest in the aggregate amount of$448,051 has been capitalized, and the aggregate principal amount of the debentures is$6,305,051 . If the debentures are converted, the warrants that would be issued are exercisable from time to time, in whole or in part for three years. The warrants have anti-dilution provisions that provide for an adjustment to the exercise price in the event of a future sale of our Common Stock at a lower price, subject to certain exceptions as set forth in the warrant. The warrants also provide that we can force their exercise at any time after the bid price of our Common Stock exceeds$2.20 for a period of 20 consecutive business days. OnJuly 26, 2019 , we entered into amendments to these convertible debentures with four of the purchasers, pursuant to which we agreed to adjust the conversion price of the original debentures if, in general, we issue or sell common stock, or warrants or options exercisable for common stock, or any other securities convertible into common stock, in a capital raising transaction, at a consideration per share, or exercise or conversion price per share, as applicable, less than the conversion price of the original debentures in effect immediately prior to such issuance (a "Dilutive Issuance"). In such case, the conversion price of the original debentures will be reduced to such issuance price (the "Adjusted Conversion Price"). The amendments also provides that, if a Dilutive Issuance occurs, the warrant to be issued upon conversion will be exercisable at a price equal to 137.5% of the Adjusted Conversion Price at the time of conversion of the debenture (the "Revised Warrant Exercise Price"). If a Dilutive Issuance occurs, the form of warrant attached to the subscription agreement shall be amended to change the Initial Exercise Price, as defined therein, to be the Revised Warrant Exercise Price. 46
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Table of Contents
2018 Convertible Debenture Offering
OnDecember 12, 2018 , we entered into an agency agreement with two Canadian agents regarding a private offering of up to$40 million of convertible debentures of the Company at an issue price of$1,000 per debenture. The agents sold the convertible debentures on a commercially reasonable efforts private placement basis. Each debenture is convertible into units of the Company at the option of the holder at a conversion price of$0.80 per unit at any time prior to the close of business on the last business day immediately preceding the maturity date of the debentures, being the date that is three (3) years from the closing date of the offering (the "2018 Convertible Debenture Offering"). Each unit will be comprised of one share of Common Stock and a warrant to purchase one-half of a share of Common Stock. Each warrant will be exercisable for one share of Common Stock at a price of$1.10 per warrant for a period of 36 months from the closing date. We closed the 2018 Convertible Debenture Offering onDecember 12, 2018 , issuing$12,012,000 million in 8% senior unsecured convertible debentures at the initial closing. At the closing, we paid the agents: (A)(i) a cash fee of$354,000 for advisory services provided to us in connection with the offering; (ii) a cash commission of$720,720 , equivalent to 6.0% of the aggregate gross proceeds received at the closing of the offering; (B)(i) an aggregate of 184,375 units for advisory services; and (ii) a corporate finance fee equal to 375,375 units, which is the number of units equal to 2.5% of the aggregate gross proceeds received at the closing of the offering divided by the conversion price; and (C)(i) an aggregate of 442,500 advisory warrants; and (ii) 900,900 broker warrants, which was equal to 6.0% of the gross proceeds received at the closing of the offering divided by the conversion price. The debentures include a provision for the capitalization of accrued interest on a quarterly basis; atNovember 30, 2019 , accrued interest in the amount of$797,420 had been capitalized. During the six months endedNovember 30, 2019 , principal in the amount of$25,856 was converted into 32,319 shares of common stock, and the principal amount of the debenture is$12,809,420 . The debentures are unsecured obligations of the Company, rank pari passu in right of payment of principal and interest and were issued pursuant to the terms of a debenture indenture, datedDecember 12, 2018 , between the Company andOdyssey Trust Company as the debenture trustee. The debentures bear interest at a rate of 8% per annum from the closing date, payable on the last business day of each calendar quarter. For a period of 18 months from the closing date, any interest payable shall automatically accrue and be capitalized to the principal amount of the debentures and shall thereafter be deemed to be part of the principal amount of the convertible debentures. Beginning on the date that is four (4) months plus one (1) day following the closing date, we may force the conversion of all of the principal amount of the then outstanding debentures at the conversion price on not less than 30 days' notice should the daily volume weighted average trading price of our Common Stock be greater than$1.20 per share for the preceding 10 consecutive trading days. Upon a change of control of the Company, holders of the debentures have the right to require us to repurchase their debentures at a price equal to 105% of the principal amount of the debentures then outstanding plus accrued and unpaid interest thereon. The debentures also contain standard anti-dilution provisions. If, at the time of exercise of any warrant in accordance with the warrant indenture, there is no effective registration statement under theU.S. Securities Act of 1933, as amended (the "U.S. Securities Act") covering the resale by the holder of a portion of the shares of Common Stock to be issued upon exercise of the warrant, or the prospectus contained therein is not available for the resale of the shares of Common Stock by the holder under theU.S. Securities Act by reason of a blackout or suspension of use thereof, then the warrants may be exercised, in part for that portion of the shares of Common Stock not registered for resale by the holder under an effective registration statement or in whole in the case of the prospectus not being available for the resale of such shares of Common Stock, at such time by means of a "cashless exercise" in which the holder shall be entitled to receive a number of shares of Common Stock equal to the quotient obtained by dividing [(A-B) (X)] by (A), where: A = the last volume weighted average price ("VWAP") for the trading day immediately preceding the time of delivery of the exercise form giving rise to the applicable "cashless exercise"; B = the exercise price of the warrant; and X = the number of shares of Common Stock that would be issuable upon exercise of the warrant in accordance with the terms of such warrant if such exercise were by means of a cash exercise rather than a cashless exercise. Pursuant to the agency agreement, we granted the agents an option to increase the offering by an additional$6 million in principal amount of debentures, which option was not exercised by the agents prior to the closing date of the offering. Pursuant to the agency agreement and the subscription agreements signed by investors in the offering, we granted certain registration rights to the holders of the debentures pursuant to which we agreed to prepare and file a registration statement with theSEC to register the resale by the original purchasers of the debentures of the shares of Common Stock issuable upon conversion of the debentures or exercise of the warrants. 47
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Table of Contents Related Party DebtDavid Lamadrid Note OnFebruary 26, 2018 , we entered into a securities purchase agreement withMr. Lamadrid , our former President and Chief Financial Officer, wherebyMr. Lamadrid agreed to purchase an 8% convertible promissory note in the aggregate principal amount of$31,250 (the "Lamadrid Note") from us due, subject to the terms therein, eighteen (18) months from the date of issuance.Mr. Lamadrid could, at his option, convert all or a portion of the Lamadrid Note and accrued but unpaid interest into shares of Common Stock at a conversion price of$0.3125 per share. On the closing date, we also issuedMr. Lamadrid a three-year Common Stock purchase warrant to purchase 25,000 shares of our Common Stock at an initial exercise price of$0.75 per share. OnAugust 21, 2018 , we received a conversion notice fromMr. Lamadrid notifying us that he had converted$31,250 in principal and$1,247 of accrued interest into 103,989 shares of our Common Stock. Koretsky and Affiliate Notes BetweenAugust 11, 2015 andMay 31, 2017 , we borrowed an aggregate of$1,657,000 fromFrank Koretsky , a director of the Company, and$150,000 from CLS CO 2016, LLC and$465,000 from Newcan, two entities that are affiliated withMr. Koretsky . These loans were unsecured, accrued interest between 6% and 15% per year, were due either on demand or within three years after the date of the applicable note, and, in some cases, were convertible into shares of our Common Stock and warrants at rates between$0.25 and 1.07 per share. Effective onMay 31, 2017 , we entered into the Omnibus Loan Amendment Agreement, whereby the portion of these loans that was advanced prior toDecember 31, 2017 was converted into our Common Stock, together with accrued interest on these loans. As a result of these conversions,Mr. Koretsky , CLS CO 2016, LLC and Newcan converted an aggregate of$1,485,000 ,$150,000 , and$460,000 in principal, and$130,069 , 49,247 and$7,747 in accrued interest, into an aggregate of 6,460,276, 636,988 and 1,870,988 shares of Common Stock at$0.25 per share. Pursuant to the Omnibus Loan Amendment Agreement, the conversion rate on all of the loans made byMr. Koretsky , CLS CO 2016, LLC and Newcan was reduced, if applicable, to$0.25 per share andMr. Koretsky and his affiliates gave up the right to receive warrants upon conversion. Thus, each ofMr. Koretsky , CLS CO 2016, LLC and Newcan received 4,560,849, 488,159 and 1,433,841 shares of Common Stock in excess of what they would have received had they converted their loans into Common Stock prior to the effective date of the Omnibus Loan Amendment Agreement. BetweenJune 1, 2017 andMay 31, 2018 , we borrowed an aggregate of$145,000 fromNewcan Investment Partners, LLC , an entity that is affiliated withMr. Koretsky . These loans were unsecured, accrued interest at 10% per year, were due either on demand or within three years after the date of the applicable note, and were convertible into shares of our Common Stock and warrants at$0.25 per share. OnJanuary 10, 2018 , effectiveDecember 1, 2017 , we entered into the Second Omnibus Loan Agreement with Newcan andMr. Binder . The Second Omnibus Loan Agreement provides that the conversion price of all outstanding convertible promissory notes issued to Newcan 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. Following the Second Omnibus Loan Agreement, onMarch 12, 2018 , Newcan converted all of its outstanding convertible loans, which totaled$956,658 in principal and$98,098 in accrued interest, into a total of 3,375,220 shares of our Common Stock. OnAugust 6, 2018 , we issued a convertible promissory note to Newcan, an entity owned byFrank Koretsky , a director of the Company, in the amount of$75,000 (the "Newcan Convertible Note 8"), to finalize the terms of repayment with respect to a certain loan made to the Company by Newcan onMay 4, 2018 , which was converted into 196,336 shares of Common Stock onOctober 23, 2018 . 48
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Table of Contents Binder Notes BetweenJune 1, 2015 andMay 31, 2017 , we borrowed an aggregate of$251,800 fromJeffrey Binder , a director and officer of the Company. These loans were unsecured, accrued interest between 6% and 10% per year, were due either on demand or within three years after the date of the applicable note, and, in some cases, were convertible into shares of our Common Stock and warrants at rates between$.25 and 1.07 per share. Effective onMay 31, 2017 , we entered into the Omnibus Loan Amendment Agreement, whereby the portion of these loans that was advanced prior toMay 31, 2017 was converted into our Common Stock, together with accrued interest on these loans. As a result of these conversions,Mr. Binder converted an aggregate of$442,750 in principal and$19,427 in accrued interest, into an aggregate of 1,848,708 shares of Common Stock at$.25 per share. Pursuant to the Omnibus Loan Amendment Agreement, the conversion rate on all of the loans made byMr. Binder was reduced, if applicable, to$.25 per share andMr. Binder gave up the right to receive warrants upon conversion. Thus,Mr. Binder received 1,127,061 shares of Common Stock in excess of what he would have received had he converted his loans into Common Stock prior to the effective date of the Omnibus Loan Amendment Agreement. BetweenJune 1, 2017 andMarch 31, 2018 , we borrowed an aggregate of$204,881 fromMr. Binder . These loans were unsecured, accrued interest at 10% per year, were due either on demand or within three years after the date of the applicable note, and were convertible into shares of our Common Stock and warrants at$0.25 per share. OnJanuary 10, 2018 , effectiveDecember 1, 2017 , we entered into the Second Omnibus Loan Agreement with Newcan andMr. Binder . The Second Omnibus Loan Agreement provides that the conversion price of all outstanding convertible promissory notes issued toMr. Binder 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. Following the Second Omnibus Loan Agreement, onMarch 12, 2018 ,Mr. Binder converted all of his outstanding convertible loans, which totaled$464,698 in principal and$43,058 in accrued interest, into a total of 1,624,819 shares of our Common Stock. OnApril 6, 2018 , we issued Binder Convertible Note 9, in the amount of$37,500 , toMr. Binder with respect to certain compensation payable toMr. Binder as ofFebruary 28, 2018 , which was repaid in full onAugust 7, 2018 .
Omnibus Loan Amendment Agreements
OnMay 31, 2017 , we entered into an Omnibus Loan Amendment Agreement (the "Omnibus Loan Amendment") withJeffrey Binder ,Frank Koretsky ,Newcan Investment Partners LLC and CLS CO 2016, LLC (collectively, the "Insiders"). Pursuant to the Omnibus Loan Amendment, we agreed with the Insiders to amend certain terms of loans the Insiders made to us for working capital purposes, which loans were initially demand loans, and, except for certain 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 toJanuary 1, 2017 , which total$2,537,750 , plus$166,490 of accrued interest thereon, into an aggregate of 10,816,960 shares of our Common Stock, and forego the issuance of warrants to purchase our 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 Agreement. We valued the shares at$0.125 , which was the market price of our stock at the conversion date, and charged the amount of$951,239 to loss on modification of debt during the twelve months endedMay 31, 2017 . We entered into the Omnibus Loan Amendment in order to ease the debt burden on us and prevent us from defaulting on the Insider Loans. Pursuant to the Omnibus Loan Amendment, the following amendments were made to the Insider Loans: (a) we 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 exceeds the closing price of the Common Stock during the last three months; (b) we deleted the requirement to issue warrants to purchase our Common Stock upon conversion of the Insider Loans; (c) we amended one Insider Loan to permit conversion of only the portion of the Insider Loan related to services that were provided to us prior toJanuary 1, 2017 ; and (d) we amended the terms of the Insider Loans where funds were advanced on or afterJanuary 1, 2017 , which Insider Loans were not converted into our 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 we issue warrants to purchase our Common Stock upon conversion of such Insider Loans. OnJanuary 10, 2018 , effectiveDecember 1, 2017 , we entered into the Second Omnibus Loan Agreement withJeffrey I. Binder , an officer and director of the Company, and Newcan, an entity owned byFrank Koretsky , a director of the Company. The Second Omnibus Loan Agreement provides that the conversion price of all outstanding convertible promissory notes issued to eitherMr. Binder or Newcan as of the date of such agreement would be increased from$0.25 to$0.3125 per share of Common Stock. The remaining terms of such notes remain unchanged. 49
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Table of Contents Sales of Equity
The Canaccord Special Warrant Offering
OnJune 20, 2018 , we executed an agency agreement withCanaccord Genuity Corp. and closed on a private offering of our Special Warrants for aggregate gross proceeds of CD$13,037,859 (USD$9,785,978 ). In connection therewith, we also entered into a Special Warrant Indenture and a Warrant Indenture withOdyssey Trust Company , as special warrant agent and warrant agent. Pursuant to the offering, we issued 28,973,014 special warrants at a price of CD$0.45 (USD$0.34 ) per Special Warrant. Each Special Warrant was automatically exercised, for no additional consideration, into Units onNovember 30, 2018 . Each Unit consisted of one Unit Share and one Warrant to purchase one share of Common Stock. Each Warrant was to be exercisable at a price of CD$0.65 for three years after our Common Stock was listed on a recognizedCanadian stock exchange , subject to adjustment in certain events. Because we did not receive a receipt from the applicable Canadian securities authorities for the qualifying prospectus byAugust 20, 2018 , each Special Warrant entitled the holder to receive 1.1 Units (instead of one (1) Unit); provided, however, that any fractional entitlement to Penalty Units was rounded down to the nearest whole Penalty Unit. All Special Warrants were automatically exercised onNovember 30, 2018 . In connection with the Special Warrant Offering, we paid a cash commission and other fees equal to CD$1,413,267 (USD$1,060,773 ), a corporate finance fee equal to 1,448,651 Special Warrants with a fair value ofUSD$1,413,300 , and 2,317,842 Broker Warrants. Each Broker Warrant entitles the holder thereof to acquire one unit at a price of CD$0.45 per unit for a period of 36 months from the date that our Common Stock is listed on a recognizedCanadian stock exchange , subject to adjustment in certain events. Our Common Stock commenced trading on theCanadian Stock Exchange onJanuary 7, 2019 . During the six months endedNovember 30, 2018 , we also issued investors 3,042,167 Special Warrants with a fair value of$7,142,550 as a penalty for failure to timely effect a Canadian prospectus with regard to the securities underlying the Special Warrants.The Navy Capital Investors EffectiveJuly 31, 2018 , we entered into a subscription agreement withNavy Capital Green International, Ltd. , aBritish Virgin Islands limited company ("Navy Capital "), pursuant to which we agreed to sell toNavy Capital , for a purchase price of$3,000,000 , 7,500,000 Units ($0.40 per unit), representing (i) 7,500,000 shares of our Common Stock, and (ii) three-year warrants to purchase an aggregate of 7,500,000 shares of our Common Stock (the "Navy Warrant Shares") at an exercise price of$0.60 per share of Common Stock. We valued the warrants using the Black-Scholes valuation model, and allocated gross proceeds in the amount of$1,913,992 to the common stock and$1,086,008 to the warrants. The closing occurred onAugust 6, 2018 . In the subscription agreement, we also agreed to file, on or beforeNovember 1, 2018 , a registration statement with theSEC registering the shares of Common Stock and Navy Warrant Shares issued toNavy Capital . If we fail to file the registration statement on or before that date, we must issue toNavy Capital an additional number of units equal to ten percent (10%) of the units originally subscribed for byNavy Capital (which will include additional warrants at the original exercise price). The warrant is exercisable from time to time, in whole or in part for three years. The warrant has anti-dilution provisions that provide for an adjustment to the exercise price in the event of a future sale of Common Stock at a lower price, subject to certain exceptions as set forth in the warrant. The warrant also provides that it is callable at any time after the bid price of our Common Stock exceeds 120% of the exercise price of the warrant for a period of 20 consecutive business days. BetweenAugust 8, 2018 andAugust 10, 2018 , we entered into five subscription agreements, pursuant to which we sold, for an aggregate purchase price of$2,750,000 , 6,875,000 Units ($0.40 per unit), representing (i) 6,875,000 shares of our Common Stock, and (ii) three-year warrants to purchase an aggregate of 6,875,000 shares of our Common Stock at an exercise price of$0.60 per share of Common Stock. We valued the warrants using the Black-Scholes valuation model, and allocated gross proceeds in the amount of$1,670,650 to the common stock and$1,079,350 to the warrants. The balance of the terms set forth in the subscription agreements are the same as the terms in theNavy Capital subscription agreement summarized above. The Company valued warrants using the Black-Scholes valuation model utilizing the following variables: November 30, November 30, 2019 2018 Volatility 134.8 to 144.7 % 231.1-232.2 % Dividends $ 0 $ 0 Risk-free interest rates 1.86% to 1.87 % 2.65% to 2.67 % Term (years) 3 3 50
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Table of Contents Liquidity and Capital Needs During fiscal 2020, we will likely require additional capital to cover our projected corporate level cash flow deficits, the implementation of our business plan, including the expansion of ourNevada operation, and the development of other revenue sources, including the closing of the IGH Option Agreement. During the next twelve months we expect to expand ourNevada processing facility to utilize our patented technology. Phase 2 of our expansion plan, the substantial expansion of our grow facility inNevada , is on hold as we monitor and evaluate wholesale marijuana prices, supply, and demand. We hold an option to purchase IGH for a purchase price that includes$35 million in cash, which we plan to fund with the proceeds of future equity sales, warrant exercise proceeds and/or loans. Although we believe we will be successful in raising the capital required to close this acquisition, we have not entered into any definitive agreements with respect to such fundraising and there can be no assurances that we will be able to raise the necessary funds. We may also pursue additional acquisitions in the next twelve months but we have not entered into any definitive agreements with respect to either additional acquisitions or the capital necessary to finance them. Although our revenues are expected to grow as we expand our operations, our revenues only recently exceeded our Oasis and City Trees operating costs and we do not yet exceed our Oasis and City Trees operating costs and corporate overhead. Although we believe we have funds sufficient to sustain our operations at their current level, if we require additional cash, we expect to obtain the necessary funds as described above; however, our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of operations. To address these risks, we must, among other things, seek growth opportunities through additional debt and/or equity investments and acquisitions in our industry, successfully execute our business strategy, including our planned expansion and acquisitions, and successfully navigate any changes that may arise in the cannabis regulatory environment. We cannot assure that we will be successful in addressing such risks, and the failure to do so could have a material adverse effect on our business prospects, financial condition and results of operations. Oasis Cannabis Transaction OnDecember 4, 2017 , we entered into the Acquisition Agreement, with Alternative Solutions for us to acquire all of the outstanding equity interests in Alternative Solutions and the Oasis LLCs. Pursuant to the Acquisition Agreement, we paid a non-refundable deposit of$250,000 upon signing, which was followed by an additional payment of$1,800,000 approximately 45 days thereafter and were to receive, upon receipt of applicable regulatory approvals, an initial 10% of each of the Oasis LLCs. Regulatory approvals were received and the 10% membership interests were transferred to us. OnJune 27, 2018 , we closed on the purchase of the remaining 90% of the membership interests in Alternative Solutions and the Oasis LLCs from the owners thereof (excluding Alternative Solutions). The closing consideration was as follows:$5,995,543 in cash, a$4.0 million promissory note due inDecember 2019 , known as the Oasis Note, and$6,000,000 in shares of our Common Stock. The cash payment of$5,995,543 was less than the$6,200,000 payment originally contemplated because the Company assumed an additional$204,457 of liabilities. The number of shares to be issued was computed as follows:$6,000,000 divided by the lower of$1.00 or the conversion price to receive one share of our Common Stock in our first equity offering of a certain minimum size that commenced in 2018, multiplied by 80%. This price was determined to be$0.272 per share. The Oasis Note was secured by a first priority security interest over our membership interests in Alternative Solutions and the Oasis LLCs, and by the assets of each of the Oasis LLCs and Alternative Solutions. We also delivered a confession of judgment to a representative of the former owners of Alternative Solutions and the Oasis LLCs (other than Alternative Solutions) that will generally become effective in the event of any event of default under the Oasis Note or failure to pay certain other amounts when due. We repaid the Oasis Note in full inDecember 2019 . At the time of closing of the Acquisition Agreement, Alternative Solutions owed certain amounts to a consultant known as 4Front Advisors, which amount was in dispute. InAugust 2019 , we made a payment to this company to settle this dispute and the Oasis Note was reduced accordingly. InMay 2020 , the former owners of Alternative Solutions and the Oasis LLCs (other than Alternative Solutions) will also be entitled to a$1,000,000 payment from us if the existing dispensary operated by anOasis LLC has maintained an average revenue of$20,000 per day during the 2019 calendar year.
The transfer of 90% of the membership interests in Alternative Solutions and the
Oasis LLCs to us was approved by the
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Table of Contents Consulting Agreements We periodically use the services of outside investor relations consultants. During the year endedMay 31, 2016 , pursuant to a consulting agreement, we agreed to issue 10,000 shares of Common Stock per month, valued at$11,600 per month, to a consultant in exchange for investor relations consulting services. The consulting agreement was terminated during the first month of its term. The parties are in discussions regarding whether any shares of our Common Stock have been earned and it is uncertain whether any shares will be issued. As ofNovember 30, 2018 , we have included 20,000 shares of Common Stock, valued at$23,200 in stock payable on the accompanying balance sheets. The shares were valued based on the closing market price on the grant date. OnDecember 29, 2015 , pursuant to a consulting agreement, we agreed to issue 25,000 shares of Common Stock per month, valued at$21,250 , to a consultant in exchange for investor relations consulting services. The consulting agreement was terminated during the first month of its term. The parties are in discussions regarding whether any shares of our Common Stock have been earned and it is uncertain whether any shares will be issued. As ofNovember 30, 2018 , we had 50,000 shares of Common Stock, valued at$42,500 included in stock payable on the accompanying balance sheet. The shares were valued based on the closing market price on the grant date. OnJuly 24, 2018 , we issued 700,000 shares of Common Stock with a fair value of$490,000 toStar Associates for services in connection with the Oasis acquisition.Star Associates is controlled byAndrew Glashow , a director (and current officer) of the Company. OnSeptember 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 onFebruary 8, 2018 , and were issued from stock payable. OnAugust 16, 2019 , we amended a consulting agreement whereby we agreed to issue up to 200,000 shares of common stock with a fair value of$45,000 plus pay certain amounts in exchange for the consultant's development for us of a corporate finance and investor relations campaign, which services will be provided over a six month period. The amount of$22,500 and$30,000 was charged to operations during the three and six months endedNovember 30, 2019 , respectively, in connection with this agreement. Going Concern Our financial statements were prepared using accounting principles generally accepted inthe United States of America applicable to a going concern, which contemplate the realization of assets and liquidation of liabilities in the normal course of business. We have incurred continuous losses from operations since inception, and had an accumulated deficit of$48,846,625 and working capital of$4,023,670 atNovember 30, 2019 . The report of our independent auditors for the year endedMay 31, 2019 , contained a going concern qualification. Our ability to continue as a going concern must be considered in light of the problems, expenses, and complications frequently encountered by early stage companies. Our ability to continue as a going concern is dependent on our ability to generate sufficient cash from operations to meet our cash needs, to borrow capital and to sell equity to support our plans to acquire operating businesses, open processing facilities and finance ongoing operations. We began generating revenue from operations with the acquisition of Alternative Solutions onJune 27, 2018 . Alternative Solutions is now profitable and management intends to finance corporate level and expansion costs over the next twelve months with revenues from its operations, and if necessary, loans and/or the proceeds from the sale of securities. There can be no assurance, however, that we will be successful in our efforts to raise additional debt or equity capital and/or that cash generated by our future operations will be adequate to meet our needs. These factors, among others, indicate that we may be unable to continue as a going concern for a reasonable period of time.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably
likely to have, a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
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Table of Contents Critical Accounting Estimates Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:
? Estimates and assumptions used in the valuation of derivative liabilities:
Management utilizes a lattice model to estimate the fair value of derivative
liabilities. The model includes subjective assumptions that can materially
affect the fair value estimates.
Recently Issued Accounting Standards
Accounting standards promulgated by theFinancial Accounting Standards Board (the "FASB") are subject to change. Changes in such standards may have an impact on our future financial statements. The following are a summary of recent accounting developments. InFebruary 2016 , the FASB issued Accounting Standards Update ("ASU") 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 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. We have performed a comprehensive review in order to determine what changes were required to support the adoption of this new standard. We adopted the ASU and related amendments onJune 1, 2019 and expect to elect certain practical expedients permitted under the transition guidance. We 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 our leases will continue to be classified as operating. During the first quarter of fiscal 2020, we completed our implementation of our processes and policies to support the new lease accounting and reporting requirements. This resulted in an initial increase in both our total assets and total liabilities in the amount of$1,781,446 . The adoption of this ASU is not expected to have a significant impact on our consolidated statements of operations or cash flows on an ongoing basis. InAugust 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 afterDecember 15, 2017 , including interim periods within the reporting period. Adoption of ASU 2016-15 did not have a material effect on our financial statements. InJanuary 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, currentU.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 becomes effective for us onJanuary 1, 2020 . The amendments in this ASU will be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed. InMay 2017 , the FASB issued ASU No. 2017-09, Stock Compensation - Scope of Modification Accounting, which provides guidance on which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU requires that an entity account for the effects of a modification unless the fair value (or calculated value or intrinsic value, if used), vesting conditions and classification (as equity or liability) of the modified award are all the same as for the original award immediately before the modification. The ASU became effective for us onJanuary 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. 53
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Table of Contents
InJuly 2017 , the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments in Part I of this update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity's own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt-Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. These amendments do not have an accounting effect. For public business entities, the amendments in Part I of this update are effective for fiscal years, and interim periods within those fiscal years, beginning afterDecember 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. EffectiveJune 1, 2018 , we adopted Accounting Standards Codification ("ASC") 606 - Revenue from Contracts with Customers. Under ASC 606, we recognize 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 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 our financial statements as a result of adopting ASC 606. OnJune 1, 2018 , we 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 our consolidated financial position, results of operations or cash flows.
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