UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period endedJune 30,, 2021 2022

OR

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

For the transition period from _______ to _______

Commission file number 000-54730

ITEM 9 LABS CORP.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

96-0665018

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

2727 North 3rd Street, Suite 201 Phoenix, Arizona 85004

(Address of principal executive offices and zip code)

1-833-867-6337

(Registrant'sRegistrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

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 ☑  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 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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,"filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2

 

Large accelerated filer☐Accelerated filer☐
Non-accelerated filer (Do not check if a smaller reporting company)☑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 by Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

As of August 13, 2021,15, 2022, there were 92,209,52196,264,406 shares of the issuer's common stock, $0.0001 par value per share, outstanding.

 
 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain information included in this Quarterly Report on Form 10-Q and other filings of the Registrant under the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as well as information communicated orally or in writing between the dates of such filings, contains or may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements in this Quarterly Report on Form 10-Q, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from expected results. Among these risks, trends and uncertainties are the availability of working capital to fund our operations, the competitive market in which we operate, the efficient and uninterrupted operation of our computer and communications systems, our ability to generate a profit and execute our business plan, the retention of key personnel, our ability to protect and defend our intellectual property, the effects of governmental regulation, and other risks identified in the Registrant's filings with the Securities and Exchange Commission from time to time.

 

In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "could," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Although the Registrant believes that the expectations reflected in the forward-looking statements contained herein are reasonable, the Registrant cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither the Registrant, nor any other person, assumes responsibility for the accuracy and completeness of such statements. The Registrant is under no duty to update any of the forward-looking statements contained herein after the date of this Quarterly Report on Form 10-Q.

 

 
 

 

ITEM 9 LABS CORP.

FORM 10-Q

JUNE 30, 20212022

 

 

INDEX

 

  Page
Part I - Financial Information
   
Item 1.Financial StatementsF-1
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations1625
Item 3.Quantitative and Qualitative Disclosures about Market Risk2131
Item 4.Controls and Procedures2131
   
Part II - Other Information33 
   
Item 1.Legal Proceedings2233
Item 1A.Risk Factors33 
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds2233
Item 3.Defaults Upon Senior Securities33 
Item 4.Mine Safety Disclosures2233
Item 5.Other Information33 
Item 6.Exhibits23
Signatures24
Certifications34 
    
Signatures35
Certifications

 

 
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

INDEXF-1
Condensed Consolidated Balance Sheets as of June 30, 20212022 (Unaudited) and September 30, 20202021F-2
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 20212022 and 2020 (Unaudited)2021F-3

Condensed Consolidated Statements of Cash Flows for the Three and Nine Months Ended June 30, 2021 and 2020 (Unaudited)

F-4
Unaudited Condensed Consolidated Statements of Changes in Stockholders'Stockholders’ Equity for the Three and Nine Months Ended June 30, 20212022 and 2020 (unaudited)2021F-4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2022 and 2021F-5
Notes to Condensed Consolidated Financial Statements (Unaudited)F-6

 

 

 F-1 

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

         
ITEM 9 LABS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
         
   (Unaudited)     
   June 30,   September 30,  
   2021   2020 
ASSETS        
Current Assets:        
Cash and cash equivalents $296,892  $84,677 
Accounts receivable, net of allowance for doubtful accounts of $76,052 and $81,018, respectively  2,055,690   352,598 
Deferred costs  8,495,683   2,147,110 
Prepaid expenses and other current assets  629,138   307,905 
Total current assets  11,477,403   2,892,290 
         
Property and equipment, net  9,413,989   7,208,760 
Right of use asset  156,938   196,756 
Deposits  600,000   1,243,738 
Receivable for sale of Airware assets, net of reserves of $596,430  155,715   160,715 
Notes and interest receivable, net  80,000   80,000 
Other intangible assets, net  126,922,930   7,765,114 
Goodwill  1,116,396   1,116,396 
Total Assets $149,923,371  $20,663,769 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
Current Liabilities:        
Accounts payable $3,534,030  $1,977,207 
Accrued payroll  83,286   197,989 
Accrued interest  1,332,201   780,903 
Accrued expenses  2,707,622   1,808,819 
Deferred revenue  685,349   -   
Notes payable, current portion, net of discounts  838,894   3,193,150 
Operating lease liability - current portion  60,480   60,480 
Convertible notes payable, net of discounts  1,317,821   2,270,000 
Total current liabilities  10,559,683   10,288,548 
         
Operating lease liability, net of current portion  100,518   140,336 
Convertible notes payable, net of current portion and discounts  188,093     
Notes payables, net of current portion and discounts  3,465,106   2,219,636 
         
Total liabilities  14,313,400   12,648,520 
         
Commitments and Contingencies        
         
Stockholders' Equity:        
Common stock, par value $.0001 per share, 2,000,000,000 shares authorized; 104,509,521 and 68,336,113 shares issued and 92,209,521 and 56,036,113 outstanding at June 30, 2021 and September 30, 2020, respectively  10,451   6,834 
Additional paid-in capital  173,877,183   44,426,737 
Accumulated deficit  (24,827,663)  (22,968,322)
Total Item 9 Labs Corp. stockholders' equity  149,059,971   21,465,249 
Treasury stock  (13,450,000)  (13,450,000)
         
Total Stockholders' Equity  135,609,971   8,015,249 
         
Total Liabilities and Stockholders' Equity $149,923,371  $20,663,769 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30,   Se`ptember 30, 
   2022   2021 
   (unaudited)     
ASSETS        
Current Assets:        
Cash and cash equivalents $441,662  $1,454,460 
Accounts receivable, net  591,504   1,448,280 
Inventory  4,130,779   6,391,351 
Prepaid expenses and other current assets  527,655   802,558 
Total current assets  5,691,600   10,096,649 
         
Property and equipment, net  26,307,212   10,877,848 
Right of use asset  1,001,192   156,938 
Construction escrow deposits  8,586,463   17,744,913 
Deposits  86,604   600,000 
Other assets  1,398,720   608,874 
Intangible assets, net  19,222,666   18,659,095 
Goodwill  58,233,386   58,064,816 
Total Assets $120,527,843  $116,809,133 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
Current Liabilities:        
Accounts payable $5,819,455  $3,759,818 
Accrued payroll and payroll taxes  1,846,614   2,678,694 
Accrued interest  2,011,369   1,391,766 
Accrued expenses  1,514,448   1,169,776 
Deferred revenue, current portion  214,994   119,992 
Notes payable, current portion, net of discounts  24,532,509   4,536,002 
Income tax payable  7,948   —   
Operating lease liability, current portion  256,471   56,592 
Convertible notes payable, net of discounts  3,266,179   1,277,394 
Total current liabilities  39,469,987   14,990,034 
         
Deferred revenue, net of current portion  345,855   655,851 
Operating lease liability, net of current portion  756,604   104,406 
Notes payables, net of current portion and discounts  1,448,860   14,957,399 
Total liabilities  42,021,306   30,707,690 
         
Commitments and Contingencies        
         
Stockholders' Equity:        
Common stock, par value $.0001 per share, 2,000,000,000 shares authorized; 108,562,706 and 107,074,417 shares issued and 96,262,706 and 94,774,417 shares outstanding at June 30, 2022 and September 30, 2021, respectively  10,856   10,707 
Additional paid-in capital  138,499,394   133,414,830 
Accumulated deficit  (46,567,663)  (33,874,094)
Treasury stock  (13,450,000)  (13,450,000)
         
Total Item 9 Labs Corp. Stockholders' Equity  78,492,587   86,101,443 
Non-controlling interest  13,950   —   
         
Total Stockholders' Equity  78,506,537   86,101,443 
         
Total Liabilities and Stockholders' Equity $120,527,843  $116,809,133 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 F-2 

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

         
ITEM 9 LABS CORP. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
         
  Three months ended June 30, Nine months ended June 30,
  2021 2020 2021 2020
Revenues, net $6,693,061  $2,207,453  $15,843,256  $5,602,321 
Cost of services  3,802,447   1,188,831   8,531,623   3,508,350 
Gross profit  2,890,614   1,018,622   7,311,633   2,093,971 
                 
Operating expenses                
Professional fees and outside services  442,483   182,610   1,350,196   654,447 
Payroll and employee related expenses  1,592,673   698,477   4,014,819   2,229,493 
Sales and marketing  262,473   37,997   389,819   199,215 
Depreciation and amortization  112,159   138,252   360,601   521,024 
Other operating expenses  728,100   205,250   1,292,154   806,070 
Provision for bad debt  -     -     -     22,460 
Total expenses  3,137,888   1,262,586   7,407,589   4,432,709 
                 
Loss from operations  (247,274)  (243,964)  (95,956)  (2,338,738)
                 
Other income (expense)                
Interest expense  (629,265)  (1,362,347)  (1,806,019)  (2,820,137)
Other income (expense)  42,634   (1,492)  42,634   (1,492)
Total other income (expense), net  (586,631)  (1,363,839)  (1,763,385)  (2,821,629)
                 
Net loss, before income tax provision  (833,905)  (1,607,803)  (1,859,341)  (5,160,367)
                 
Income tax provision (benefit)  -     -     -     -   
                 
Net loss $(833,905) $(1,607,803) $(1,859,341) $(5,160,367)
                 
Less: Net loss attributable to noncontrolling interest $-    $-    $-    $(26,274)
                 
Net loss attributable to Item 9 Labs Corp $(833,905) $(1,607,803) $(1,859,341) $(5,134,093)
                 
Basic and diluted net loss per common share $(0.01) $(0.03) $(0.03) $(0.08)
                 
Basic and diluted weighted average common shares outstanding  92,209,521   61,424,905   72,115,022   61,834,030 

The accompanying notes are an integral part of these condensed consolidated financial statements.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

F-3

     
ITEM 9 LABS CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
     
  Nine Months Ended June 30,
  2021 2020
Operating Activities:        
Net loss $(1,859,341) $(5,160,367)
Adjustments to reconcile net loss to net cash used in operating activities:        
Depreciation  100,535   96,330 
Amortization of intangible assets  260,066   709,740 
Amortization of right of use asset  39,818   60,557 
Amortization of debt discount  565,021   1,273,739 
Common stock issued for services  163,236   132,106 
Stock compensation expense  914,016   75,000 
Provision for bad debt  -     22,460 
Changes in operating assets and liabilities:        
Accounts receivable  (1,703,092)  (191,656)
Deferred costs  (6,348,573)  (1,053,221)
Prepaid expenses and other current assets  (192,292)  (319,927)
Accounts payable  524,088   1,178,434 
Accrued payroll  (114,703)  134,359 
Accrued compensated absences  -     2,193 
Accrued interest  643,068   1,088,462 
Accrued expenses  147,868   1,023,933 
Deferred income  22,844     
Operating lease liability  (39,818)  (42,543)
Net Cash Used in Operating Activities  (6,877,259)  (970,401)
         
Investing Activities:        
Deposit on acquisition  (1,685,368)  -   
Cash paid for acquisition  -     (500,000)
Purchases of property and equipment  (2,263,388)  (82,500)
Cash received from sale of Airware assets  5,000   50,000 
Cash received from note receivable  -     20,000 
Cash acquired in merger  94,596   -   
Capitalized license fees  (2,790)  (426,663)
Net Cash Used in Investing Activities  (3,851,950)  (939,163)
         
Financing Activities:        
Proceeds from the sale of common stock, net of issuance costs  13,298,965   -   
Proceeds from the issuance of debt  1,355,000   4,092,000 
Debt payments  (3,712,541)  (2,192,664)
Net Cash Provided by Financing Activities  10,941,424   1,899,336 
         
Net Increase (Decrease) in Cash  212,215   (10,228)
         
Cash and cash equivalents- Beginning of Period  84,677   574,943 
         
Cash and cash equivalents - End of Period $296,892  $564,715 
         
Supplemental disclosure of cash flow information:        
Interest paid in cash $597,930  $116,000 
Income taxes paid in cash $-    $-   
         
Supplemental disclosure of non-cash investing and financing activities:        
Stock issued (or to be issued) for acquisitions $65,000,000  $3,507,000 
Warrants issued for debt and acquisition $49,648,201  $5,069,734 
Non-cash equity compensation $1,077,252  $-   
Non-cash Treasury Stock $-    $150,216 
Fixed assets purchased with debt $50,914  $-   
Right of use asset $-    $268,359 
Lease liability $-    $268,359 
Debt issued for acquisition $-    $1,000,000 
Amortization of debt discount $565,021  $1,273,739 
Accrued interest transferred to debt $160,590  $300,705 
Beneficial conversion feature $428,802  $-   
         
Net liabilities assumed in acquisition:        
Cash $94,596  $-   
Other current assets $128,941  $-   
Fixed assets, net $41,549  $-   
Other assets - intangibles $10,935  $-   
Accounts payable $1,032,735  $-   
Other current liabilities $3,224,771  $-   
Notes payable $1,186,658  $-   
Other noncurrent liabilities $662,505  $-   
Net liabilities $(5,830,648) $-   

The accompanying notes are an integral part of these condensed consolidated financial statements.

F-4

                 
ITEM 9 LABS CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED JUNE 30, 2021 AND 2020
                 
  Item 9 Labs Corp Equity    
      Additional       Non  
  Common Stock Paid-in Treasury Stock Accumulated Controlling  
  Shares Amount Capital Shares Amount (Deficit) Interest Total
Balance at September 30, 2019  63,643,005  $6,365  $18,148,962   -    $-    $(10,694,939) $(123,942) $7,336,446 
                                 
Treasury stock acquired in settlement agreement  -     -     3,450,000   (2,300,000)  (3,450,000)  -     -     -   
Issuance of shares for services  55,618   6   132,100   -     -     -     -     132,106 
Stock compensation  26,282   3   74,997   -     -     -     -     75,000 
Net loss  -     -     -     -     -     (1,950,190)  (25,138)  (1,975,328)
Balance at December 31, 2019  63,724,905   6,374   21,806,059   (2,300,000)  (3,450,000)  (12,645,129)  (149,080)  5,568,224 
                                 
Stock to be issued for acquisition  3,250,000   325   3,506,675   -     -     -     -     3,507,000 
Noncontrolling interest dissolution from acquisition  -     -     (150,216)  -     -     -     150,216   -   
Warrants issued  -     -     257,094   -     -     -     -     257,094 
Warrants to be issued  -     -     3,336,198   -     -     -     -     3,336,198 
Net loss  -     -     -     -     -     (1,576,100)  (1,136)  (1,577,236)
Balance at March 31, 2020  66,974,905   6,699   28,755,810   (2,300,000)  (3,450,000)  (14,221,229)  -     11,091,280 
                                 
Warrants issued  -     -     1,476,442   -     -     -     -     1,476,442 
Net loss  -     -     -     -     -     (1,607,803)  -     (1,607,803)
Balance at June 30, 2020 $66,974,905  $6,699  $30,232,252  $(2,300,000) $(3,450,000) $(15,829,032) $-    $10,959,919 
                                 
Balance at September 30, 2020  68,336,113  $6,834  $44,426,737   (12,300,000) $(13,450,000) $(22,968,322) $-    $8,015,249 
Stock issued for cash, net  6,813,206   681   5,790,544   -     -     -     -     5,791,225 
Issuance of shares for services  111,765   11   163,225   -     -     -     -     163,236 
Stock compensation  -     -     304,672   -     -     -     -     304,672 
Net loss  -     -     -     -     -     (1,074,456)  -     (1,074,456)
Balance at December 31, 2020  75,261,084   7,526   50,685,178   (12,300,000)  (13,450,000)  (24,042,778)  -     13,199,926 
                                 
Stock issued for cash, net  8,433,437   843   7,167,740   -     -     -     -     7,168,583 
Stock issued for acquisition  19,080,000   1,908   64,998,092   -     -     -     -     65,000,000 
Warrants issued for acquisition  -     -     51,081,066   -     -     -     -     51,081,066 
Stock to be issued for convertible notes - forced conversion  1,335,000   134   (134)  -     -     -     -     -   
Warrants issued with convertible notes  -     -     926,198   -     -     -     -     926,198 
Beneficial conversion - convertible notes  -     -     428,802   -     -     -     -     428,802 
Stock compensation  -     -     304,672   -     -     -     -     304,672 
Net income  -     -     -     -     -     49,020   -     49,020 
Balance at March 31, 2021  104,109,521   10,411   175,591,614   (12,300,000)  (13,450,000)  (23,993,758)  -     138,158,267 
                                 
Stock issued for cash, net  400,000   40   339,960   -     -     -     -     340,000 
Adjustment to acquisition price, warrants  -     -     (2,359,063)  -     -     -     -     (2,359,063)
Stock compensation  -     -     304,672   -     -     -     -     304,672 
Net loss  -     -     -     -     -     (833,905)  -     (833,905)
Balance at June 30, 2021  104,509,521   10,451   173,877,183   (12,300,000)  (13,450,000)  (24,827,663)  -     135,609,971 
  For the three months ended For the three months ended For the nine months ended For the nine months ended
  June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021
Revenues, net $4,931,322  $6,693,061  $17,755,519  $15,843,256 
Cost of revenues  3,341,367   3,802,447   11,089,560   8,531,623 
Gross profit  1,589,955   2,890,614   6,665,959   7,311,633 
                 
Operating expenses                
     Professional fees and outside services  993,452   442,483   2,207,618   1,350,196 
     Payroll and employee related expenses  2,683,722   1,592,673   7,889,672   4,014,819 
     Sales and marketing  207,213   262,473   1,260,551   389,819 
     Depreciation and amortization  439,052   112,159   1,320,664   360,601 
     Other operating expenses  1,114,323   728,100   2,747,158   1,292,154 
     Provision for (recovery of) bad debt  —     —     (5,000)  —   
Total expenses  5,437,762   3,137,888   15,420,663   7,407,589 
                 
Loss from operations  (3,847,807)  (247,274)  (8,754,704)  (95,956)
                 
Other income (expense)                
     Interest expense  (1,625,155)  (629,265)  (3,932,918)  (1,806,019)
     Other income  —     42,634   318   42,634 
Total other income (expense), net  (1,625,155)  (586,631)  (3,932,600)  (1,763,385)
                 
Net loss, before income tax provision (benefit)  (5,472,962)  (833,905)  (12,687,304)  (1,859,341)
                 
Income tax provision (benefit)  4,624   —     7,948   —   
                 
Net loss  (5,477,586)  (833,905)  (12,695,252)  (1,859,341)
Less: Net loss attributable to non-controlling interest  (7,109)  —     (1,683)  —   
                 
Net loss attributable to Item 9 Labs Corp. $(5,470,477) $(833,905) $(12,693,569) $(1,859,341)
                 
Basic net income (loss) per common share $(0.06) $(0.01) $(0.13) $(0.03)
                 
Basic weighted average common shares outstanding  96,162,616   92,209,521   95,446,846   72,115,022 
                 
Diluted net income (loss) per common share  (0.06)  (0.01)  (0.13)  (0.03)
                 
Diluted weighted average common shares outstanding  96,162,616   92,209,521   95,446,846   72,115,022 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-3

ITEM 9 LABS CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

THREE AND NINE MONTHS ENDED JUNE 30, 2022 AND 2021

               
  Item 9 Labs Corp. Equity    
      Additional       Non-  
  Common Stock Paid-in Treasury Stock Accumulated Controlling  
  Shares Amount Capital Shares Amount (Deficit) Interest Total
Balance at September 30, 2020  68,336,113  $6,834  $44,426,737   (12,300,000) $(13,450,000) $(22,968,322) $—    $8,015,249 
                                 
Stock issued for cash, net  6,813,206   681   5,790,544   —     —     —     —     5,791,225 
Issuance of shares for services  111,765   11   163,225   —     —     —     —     163,236 
Stock based compensation  —     —     304,672   —     —     —     —     304,672 
Net loss  —     —     —     —     —     (1,074,456)  —     (1,074,456)
Balance at December 31, 2020  75,261,084   7,526   50,685,178   (12,300,000)  (13,450,000)  (24,042,778)  —     13,199,926 
                                 
Stock issued for cash, net  8,433,437   843   7,167,740   —     —     —     —     7,168,583 
Stock issued for acquisition  19,080,000   1,908   64,998,092   —     —     —     —     65,000,000 
Warrants issued for acquisition  —     —     51,081,066   —     —     —     —     51,081,066 
Stock to be issued for convertible notes  1,335,000   134   (134)  —     —     —     —     —   
Warrants issued with convertible notes  —     —     926,198   —     —     —     —     926,198 
Beneficial conversion features  —     —     428,802   —     —     —     —     428,802 
Stock based compensation  —     —     304,672   —     —     —     —     304,672 
Net income  —     —     —     —     —     49,020   —     49,020 
Balance at March 31, 2021  104,109,521   10,411   175,591,614   (12,300,000)  (13,450,000)  (23,993,758)  —     138,158,267 
                                 
Stock issued for cash, net  400,000   40   339,960   —     —     —     —     340,000 
Adjustment to acquisition price, warrants  —     —     (2,359,063)  —     —     —     —     (2,359,063)
Stock based compensation  —     —     304,672   —     —     —     —     304,672 
Net loss  —     —     —     —     —     (833,905)  —     (833,905)
Balance at June 30, 2021  104,509,521  $10,451  $173,877,183   (12,300,000) $(13,450,000) $(24,827,663) $—    $135,609,971 
                                 
Balance at September 30, 2021  107,074,417  $10,707  $133,414,830   (12,300,000) $(13,450,000.00) $(33,874,094) $—    $86,101,443 
Stock issued for debt inducement  142,365   14   128,348   —     —     —     —     128,362 
Warrants issued with debt  —     —     574,239   —     —     —     —     574,239 
Beneficial conversion feature  —     —     470,047   —     —     —     —     470,047 
Issuance of shares for services  16,666   2   25,830   —     —     —     —     25,832 
Stock based compensation  —     —     507,294   —     —     —     —     507,294 
Stock issued on exercise of options  9,896   1   (1)  —     —     —     —     —   
Net loss  —     —     —     —     —     (3,345,014)  —     (3,345,014)
Balance at December 31, 2021  107,243,344   10,724   135,120,587   (12,300,000)  (13,450,000)  (37,219,108)  —     84,462,203 
                                 
Stock issued for cash, net  278,000   28   288,813   —     —     —     —     288,841 
Stock issued for acquisition  69,892   7   64,993   —     —     —     —     65,000 
Stock issued for licenses  300,000   30   335,970   —     —     —     —     336,000 
Stock issued for debt inducement  25,000   2   24,998   —     —     —     —     25,000 
Beneficial conversion feature  —     —     25,000   —     —     —     —     25,000 
Issuance of shares for services  335,159   34   328,466   —     —     —     —     328,500 
Stock based compensation  —     —     1,091,560   —     —     —     —     1,091,560 
Stock issued on exercise of options  18,033   2   (2)  —     —     —     —     —   
Non-controlling interest  —     —     —     —     —     —     15,633   15,633 
Net income (loss)  —     —     —     —     —     (3,878,078)  5,426   (3,872,652)
Balance at March 31, 2022  108,269,428   10,827   137,280,385   (12,300,000)  (13,450,000)  (41,097,186)  21,059   82,765,085 
                                 
Stock issued for cash, net  263,313   26   254,311   —     —     —     —     254,337 
Issuance of shares for services  29,965   3   30,017   —     —     —     —     30,020 
Stock based compensation  —     —     934,681   —     — ��   —     —     934,681 
Net loss  —     —     —     —     —     (5,470,477)  (7,109)  (5,477,586)
Balance at June 30, 2022  108,562,706   10,856   138,499,394   (12,300,000)  (13,450,000)  (46,567,663)  13,950   78,506,537 

The accompanying notes are an integral part of these condensed consolidated financial statements.

F-4

ITEM 9 LABS CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

  For the nine months ended For the nine months ended
  June 30, 2022 June 30, 2021
Operating Activities:        
Net loss $(12,695,252) $(1,859,341)
Adjustments to reconcile net loss to net cash used in operating activities:        
     Depreciation  217,363   100,535 
     Amortization of intangible assets  1,103,301   260,066 
     Amortization of right of use asset  89,844   39,818 
     Amortization of debt discounts  2,311,783   565,021 
     Common stock issued for services  498,983   163,236 
     Stock based compensation expense  2,533,535   914,016 
     Recovery of bad debt  (5,000)  —   
     Loss on disposal of fixed assets  10,841   —   
Changes in operating assets and liabilities:        
     Accounts receivable  856,776   (1,703,092)
     Inventory  2,276,205   (6,348,573)
     Prepaid expenses and other assets  (339,994)  (192,292)
     Deposits  (86,604)  —   
     Accounts payable  2,107,137   524,088 
     Accrued payroll and payroll taxes  (832,080)  (114,703)
     Income tax payable  7,948   —   
     Accrued interest  542,841   643,068 
     Accrued expenses  (316,760)  147,868 
     Deferred revenue  (214,994)  22,844 
     Operating lease liability  (82,021)  (39,818)
Net Cash Used in Operating Activities  (2,016,148)  (6,877,259)
         
Investing Activities:        
     Deposit on acquisition  —     (1,685,368)
     Cash paid for acquisition  (140,726)  —   
     Purchases of property, equipment and construction in progress  (2,918,584)  (2,263,388)
     Cash received for note receivable  5,000   5,000 
     Cash received from construction escrow accounts  816,227   —   
     Cash acquired in acquisition  6,143   94,596 
     Cash paid to acquisition escrow accounts  (406,932)  —   
     Capitalized license fees  —     (2,790)
     Purchase of license  (1,130,872)  —   
Net Cash Used in Investing Activities  (3,769,744)  (3,851,950)
         
Financing Activities:        
     Proceeds from the sale of common stock  555,911   13,298,965 
     Costs for sale of common stock  (12,733)  —   
     Payment of debt discount  (50,750)  —   
     Proceeds from the issuance of debt  7,282,763   1,355,000 
     Payment of debt  (3,002,097)  (3,712,541)
Net Cash Provided by Financing Activities  4,773,094   10,941,424 
         
Net Increase (Decrease) in Cash  (1,012,798)  212,215 
         
Cash and cash equivalents- Beginning of Period  1,454,460   84,677 
         
Cash and cash equivalents - End of Period $441,662  $296,892 
         
Supplemental disclosure of cash flow information:        
Interest paid in cash $3,855,724  $597,930 
Income taxes paid in cash $—    $—   
         
Supplemental disclosure of non-cash investing and financing activities:        
Stock issued for acquisitions $65,000  $65,000,000 
Stock issued for acquisition of a license $336,000  $—   
Accrued interest transferred to debt $1,762  $160,590 
Warrants issued for debt and acquisition $574,239  $49,648,201 
Stock issued for debt $223,214  $—   
Non-controlling interest $15,633  $—   
Stock issuance costs paid in stock $89,645  $—   
Fixed assets purchased with debt $—    $50,914 
Debt issued for acquisition of a license $200,000  $—   
Debt proceeds used to pay debt discounts $80,000  $—   
Land purchased with escrow funds and deposit $3,000,000  $—   
Stock issued to pay accounts payable and prepay expenses $292,500  $—   
Operating lease right of use asset and liability $934,098  $—   
Beneficial conversion feature on convertible debt $495,047  $428,802 
Construction in progress paid with escrow funds $6,426,063  $—   
Accrued debt discount fees $75,000  $—   
Debt discount amortization capitalized to construction in progress $2,620,476  $—   
Accrued liabilities capitalized in construction in progress $612,158  $—   
Amortized debt discount capitalized in construction in progress $2,620,476  $—   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 F-5 

 

ITEM 9 LABS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 - Description of Business and Summary of Significant Accounting Policies

 

Description of Business

 

Item 9 Labs Corp. ("Item 9 Labs" or, including its subsidiaries, the "Company"), formerly Airware Labs Corp., is a Delaware corporation. The Company was incorporated under the laws of the State of Delaware on June 15, 2010 as Crown Dynamics Corp.

 

ThroughItem 9 Labs is a licensing agreement,holding company, investing in cannabis and cannabis-related businesses. Its subsidiaries currently compete in two different market segments: (1) production of cannabis and cannabis-derived products and technologies through its Item 9 Labs brand (“Cultivation”), which is currently distributed though out the Company grows marijuanaState of Arizona in licensed medical and producesadult-use dispensaries; and (2) sale of medical and adult-use cannabis related products at their facility in Pinal County, Arizona on behalf of a licensed marijuana dispensary in the state of Arizona.franchises under its franchise brand “Unity Rd.” (“Franchising”).

 

In March 2021, the Company closed on the acquisition of OCG, Inc, dba Unity Rd, a dispensary franchisor. The transaction was structured as a reverse triangular merger, with the effect of OCG, Inc. becoming a wholly owned subsidiary of the Company. Unity Rd has agreements with more than fifteen (15)twenty (20) entrepreneurial groups to open more than thirty (30) Unity Rd retail dispensary locations in 7twelve (12) states. The majority of the locations are in the licensing process. We currently have one franchisee operating in Boulder, Colorado. Unity Rd will be the vehicle to bring Item 9 Labs products across the United States and internationally, while keeping dispensaries locally owned and operated, empowering entrepreneurs to confidently and successfully operate their business and contribute to their local communities. As the Unity Rd dispensaries achieve sufficient market penetration, Item 9 Labs aims to offer its products in those locations to expand the distribution footprint of its premium product offerings.

 

In March 2020, the World Health Organization categorized Coronavirus Disease 2019 ("COVID-19") as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The services we provide are currently designated an essential critical infrastructure business under the President's COVID-19 guidance, the continued operation of which is vital for national public health, safety and national economic security. The extent of the impact of the COVID-19 outbreak on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, its impact on our customers and vendors, and the range of governmental and community reactions to the pandemic, which are uncertain and cannot be fully predicted at this time.

 

Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.

Certain prior period balances have been reclassified in the accompanying condensed consolidated financial statements to conform to the current year presentation. These reclassifications had no effect on the prior year's net loss or accumulated deficit.

The accompanying condensed consolidated financial statements of the Company as of June 30, 20212022 have been prepared by us without audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and do not include all of the information and notes necessary for a presentation of financial position and results of operations in accordance with accounting principles generally accepted in the United States of America ("GAAP")US GAAP and should be read in conjunction with our September 30, 20202021 audited financial statements filed with the SEC on our Form 10-K on January 12, 2021.13, 2022. It is management's opinion that all material adjustments (consisting of normal recurring adjustments) have been made, which are necessary for a fair financial statement presentation. We derived the September 30, 20202021 condensed consolidated balance sheet data from audited financial statements, however, we did not include all disclosures required by US GAAP. The results for the interim period ended June 30, 20212022 are not necessarily indicative of the results to be expected for the year ending September 30, 2021.2022.

The condensed consolidated financial statements of the Company include the accounts of the Company, and its wholly-owned subsidiaries and a consolidated variable interest entity (“VIE”). Intercompany balances and transactions have been eliminated.

Item 9 Labs consolidates a VIE in which the Company is deemed to be the primary beneficiary.  An entity is generally a VIE if it meets any of the following criteria: (i) the entity has insufficient equity to finance its activities without additional subordinated financial support from other parties, (ii) the equity investors cannot make significant decisions about the entity’s operations or (iii) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity or receive the expected returns of the entity and substantially all of the entity’s activities involve or are conducted on behalf of the investor with disproportionately few voting rights. The Company makes significant judgments in determining whether an entity is a VIE and, for each reporting period, the Company assesses whether it is the primary beneficiary of the VIE. Effective February 1, 2022, the Company was deemed the primary beneficiary of Elevated Connections, Inc. The equity in Elevated Connections, Inc. held by its stockholder has been presented on the balance sheet and the statement of operations as a non-controlling interest.

Certain prior period balances have been reclassified in the accompanying condensed consolidated financial statements to conform to the current period presentation. These reclassifications had no effect on the prior periods’ net income, net loss or accumulated deficit.

 

 F-6 

 

Accounting Estimates

 

The preparation of financial statements in conformity with US GAAP 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 amounts of revenue and expenses during the reporting period. Actual results could materially differ from those estimates. Significant estimates of the Company include but are not limited to accounting for depreciation and amortization, current and deferred income taxes, deferred costs,inventory, accruals and contingencies, carrying value of goodwill and intangible assets, collectability of notes receivable, the fair value of common stock and the estimated fair value of stock options and warrants, and the estimated fair value of the consideration paid and the fair value of assets purchased and liabilities assumed in the acquisition of OCG, Inc. (See Note 2).warrants. Due to the uncertainties in the formation of accounting estimates, and the significance of these items, it is reasonably possible that these estimates could be materially changed in the near term.

 

Cash and Cash Equivalents

Cash represents cash on hand, demand deposits placed with banks and other financial institutions and all highly liquid instruments purchased with a remaining maturity of three months or less as of the purchase date of such investments. The Company maintains cash on deposit, which, can exceed federally insured limits. The Company has not experienced any losses on such accounts nor believes it is exposed to any significant credit risk on cash.

Accounts ReceivableInventory

 

Accounts receivable are reportedInventory is stated at the amount management expects to collect from outstanding balances. Differences betweenlower of cost or net realizable value with cost being determined on the amount due and the amount management expects to collect are recognizedfirst in the results of operations in the year in which those differences are determined. Accounts receivable are written off when all reasonable collection efforts have been taken. At June 30, 2021 and September 30, 2020, the Company has reserved $76,052 and $81,018, respectively, of specific accounts deemed uncollectible. Accounts receivable are pledged as collateral for debt, bear no interest, and are unsecured.

Deferred Costs

Deferred costs consistfirst out method. Inventory primarily consists of the costs directly related to the production and cultivation of marijuanacannabis crops, cannabis oils, and cannabis concentrate products. Deferred costs areInventory is relieved to cost of servicesrevenues as products are delivered to dispensaries. Deferred costs consistInventory consists primarily of labor, utilities, costs of raw materials, packaging, nutrients and overhead.

Property and Equipment

Property and equipment are recorded at cost. Depreciation is provided for on the straight-line method, over the estimated useful lives of the assets. Maintenance and repairs that neither materially add to the value of the property nor appreciably prolong its life are charged to expense as incurred. Betterments or renewals are capitalized when incurred. Gains and losses on the disposition of property and equipment are recorded in the period incurred. Depreciation expense is not included in cost of revenues. Equipment not yet in service will be depreciated once operations commence.

The estimated useful lives of property and equipment are:

•Cultivation and manufacturing equipment 2-7 years
•Buildings 30 years

Notes and Other Receivables, net

Notes and other receivables are reported at the amount management expects to collect from outstanding balances. Differences between the amount due and the amount management expects to collect are reported in the results of operations in the period in which those differences are determined, with an offsetting entry to a valuation allowance for receivables. Management assesses all receivables individually and in total, considering historical credit losses as well as existing economic conditions to determine the likelihood of future credit losses. The Company stops accruing interest on interest bearing receivables when the receivable is in default. There was a total valuation allowance as of June 30, 2021 and September 30, 2020 of $745,430.

Impairment of Long-Lived Assets

We analyze long-lived assets, including property and equipment and definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. We review the amortization method and estimated period of useful life at least at annually. We record the effects of any revision to operations when the change arises. We recognize impairment when the estimated undiscounted cash flow generated by those assets is less than the carrying amount of such assets. The amount of impairment is the excess of the carrying amount over the fair value of such assets, which is generally calculated using discounted cash flows.

Intangible Assets Subject to Amortization

Intangible assets include trade name, customer relationships, website, a noncompete agreement and intellectual property obtained through a business acquisition. Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods deemed appropriate for the type of intangible asset acquired. Intangible assets with finite lives are amortized over their estimated useful life and reported net of accumulated amortization, separately from goodwill. Amortization is calculated on the straight-line basis using the following estimated useful lives:

•Trade names 10 years
•Customer relationships 2 years
•Noncompete agreement 4 months
•Websites and other intellectual property 5 years

Generally, the Company utilizes the relief from royalty method to value trade name, the with or without method for valuing the customer relationships, and the discounted cash flow method for valuing website and intellectual property.

F-7

Goodwill and Intangible Assets Not Subject to Amortization

Goodwill represents the excess of the purchase price paid for the acquisition of a business over the fair value of the net tangible and intangible assets acquired. Indefinite life intangible assets represent licenses purchased for cultivation, processing and distribution of cannabis. Goodwill and indefinite life intangibles are not subject to amortization and are tested annually for impairment, or more frequently if events or changes in circumstances indicate thatroutinely evaluates the carrying value of goodwill may not be recoverable. The goodwill included in these condensed consolidated financial statements represents the amount of consideration paid above the amount of the individually identifiable assets acquired. In assessing potential impairment, management first considers qualitative factorsinventory for slow moving and potentially obsolete inventory and, when appropriate, will record an adjustment to determine if an impairment of goodwill or indefinite life intangibles existed. Upon the determination of a likely impairment, management assesses thereduce inventory to its estimated net realizable value. There were no inventory reserves recorded goodwill or indefinite life intangibles balance with the fair value of the business or assets acquired.

In addition to the annual impairment test, we are required to regularly assess whether a triggering event has occurred which would require interim testing. We considered the currentat June 30, 2022 and expected future economic and market conditions surrounding the COVID-19 pandemic and its impact on our operations. Currently, we have determined that a triggering event has not occurred that would require an interim impairment test to be performed. However, we refer you to our comment in the first section of this Note 1 as it relates to the impact of COVID-19 and certain economic uncertainties.September 30, 2021.

 

Licenses

 

Cannabis licenses vary in term for each jurisdiction. The Company capitalizes all costs associated with the acquisition of cannabis licenses in the year the license is obtained. Subsequent measurement is determined by the length of the term of the license. The Company acquired licenses during the yearnine months ended SeptemberJune 30, 20202022 that have indefinite useful lives. As such, the license costs will not be amortized, but tested annually for impairment or more frequently if events or changes in circumstances indicate the carrying value may not be recoverable.lives, subject to annual renewals. Costs associated with maintaining licenses (annual fees) are expensed as incurred. The anticipated maintenance fees are not expected to be material to the condensed consolidated financial statements.

Income Taxes

Deferred tax assets and liabilities Licenses are recorded basedincluded on the difference betweenbalance sheet under the financial statement and the tax basis ofheading Intangible assets, and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company calculates a provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In determining the future tax consequences of events that have been recognized in the financial statements or tax returns, judgment and interpretation of statutes are required.

In assessing realizable deferred tax assets, management assesses the likelihood that deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not likely or there is insufficient operating history, a valuation allowance is established. The Company adjusts the valuation allowance in the period management determines it is more likely than not that net deferred tax assets will or will not be realized. After review of the deferred tax asset and valuation allowance in accordance with ASC 740, management determined that it is more likely than not that the Company will not fully realize all of its deferred tax asset and a valuation allowance was recorded at June 30, 20212022 and September 30, 2020.

The Company is generally subject to tax audits for its United States federal and state income tax returns for approximately the last four years, however, earlier years may be subject to audit under certain circumstances. Tax audits by their very nature are often complex and can require several years to complete.2021.

 

Revenue Recognition

 

The Company has adopted ASC Topic 606, "Revenue from Contracts with Customers" ("ASC 606") and all the related amendments.Cultivation revenue

 

The core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASC 606 defines a five-step process to achieve this core principle, and, in doing so, it is possible more judgment and estimates may be required withinincluding identifying the revenue recognition process than previously required under GAAP, includingcontract with the customer, identifying the performance obligations in the contract, determining the transaction price, including estimating the amount of variable consideration to include in the transaction price, and allocating the transaction price to each separate performance obligation.obligation and recognizing revenue when (or as) the performance obligation is satisfied.

 

AllSubstantially all of the Company's revenue is associated with a customer contract that represents an obligation to perform servicesprovide cannabis products that are delivered at a single point in time.  Any costs incurred prior to the period in which the servicesproducts are performeddelivered are recorded to completion are deferredinventory and recognized as cost of servicesrevenues in the period in which the performance obligations areobligation is completed. For the three and nine months ended June 30, 20212022 and 2020, substantially2021, all of the Company's cultivation revenue was generated from performance obligations completed in the state of Arizona.

 

The Company recognizes revenue as servicesonce the products are rendered. Services aredelivered. Revenue is considered completeearned upon successful delivery of the product to the dispensary as the Company has no further performance obligations at this point in time and collection is reasonably assured. Under the performance contract, the Company acted as an agent for the dispensary, did not own the marijuana products, could not exchange the marijuana products, prepared invoices for the dispensary and all employees that were in contact with marijuana products were agents of the dispensary with which we had our contract. Given these facts and circumstances, it was the Company's policy to record the revenue related to the contract net of the amount retained by the dispensary. Per the dispensary contract, the Company was paid 85% of the wholesale market price of the marijuana products for the services rendered for the three months ended December 31, 2019. The contract was amended in December 2019 and beginning in January 2020, the Company was paid 100% of the wholesale market price of the marijuana for the services rendered. The contract called for monthly payments in the amount of $80,000 for the three months ending March 31, 2020. Beginning April 1, 2020, the Company entered into a three-year agreement with another dispensary, which calls for monthly payments of $40,000. Prior to January 1, 2020, the Company recorded revenues at the amount it expected to collect, 85% of the total wholesale sales. Since January 1, 2020, the Company records revenue at the amount it expects to collect, 100% of the wholesale sales.sales revenue. The fees paid for operating under the contract are expensed to cost of revenues.

 

The Company's revenues accounted for under ASC 606 do not require significant estimates or judgments based on the nature of the Company's revenue stream. The sales price is generally fixed at the point of sale and all consideration from the contract is included in the transaction price. The Company's contracts do not include multiple performance obligations, variable consideration, a significant contract, rights of return or warranties.

 

 F-8F-7 

 

Fair Value of Financial InstrumentsFranchising revenue

 

Through OCG, Inc., the Company enters into franchise agreements and consulting agreements. The carrying valuefranchise agreement allows the franchisee to, among other things, establish a franchised outlet under the Company’s Unity Rd. brand. Under the consulting agreements, the Company assists customers with applying for and being awarded a retail cannabis license through the state license application process. The initial franchise fee and the consulting fee are due upon execution of the Company's financial instruments, consistingrelated agreement. These payments are deferred on the condensed consolidated balance sheet and is recognized into revenue on the condensed consolidated statement of cashoperations when (or as) the performance obligations included in the agreements are satisfied. Deferred revenue had a balance of $560,849 and cash equivalents, accounts receivable, accounts payable,$775,843 at June 30, 2022 and accrued expensesSeptember 30, 2021, respectively, and approximates fair value due to their short term to maturity (level 3 inputs).  The Company's receivable resulting fromis included in deferred revenue on the sale of Airware, notes receivablecondensed consolidated balance sheets. Revenue recognized during the three months ended June 30, 2022 and notes payable approximate fair value based on borrowing rates currently available on notes with similar terms2021 that was included in deferred revenue at September 30, 2021 and maturities (level 3 inputs).2020 was $4,998 and $0, respectively. Revenue recognized during the nine months ended June 30, 2022 and 2021 that was included in deferred revenue at September 30, 2021 and 2020 was $214,994 and $0, respectively.

 

Net Loss Per Share

 

Basic net loss per share does not include dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earningsnet loss per share reflects the potential dilution of securities that could share in the earningslosses of an entity. Dilutive securities are not included in the weighted average number of shares when inclusion would be anti-dilutive. The following table summarizes the securities outstanding at June 30, 20212022 and September 30, 2020 there were 44,634,209 and 22,024,419, respectively shares underlying convertible notes payable, warrants and options,2021 that were anti-dilutive, respectively.excluded from the diluted net loss per share calculation for the three and nine months ended June 30, 2022 and 2021 because the effect of including these potential shares was antidilutive due to the Company’s net loss.

 

Stock-Based Compensation

The Company accounts for its stock-based awards in accordance with ASC Subtopic 718-10, "Compensation - Stock Compensation", which requires fair value measurement on the grant date and recognition of compensation expense for all stock-based payment awards made to employees and directors. For stock options, the Company estimates the fair value using a closed option valuation (Black-Scholes) model. The estimated fair value is then expensed over the requisite service period of the award which is generally the vesting period and the related amount is recognized in the condensed consolidated statements of operations. The Company recognizes forfeitures at the time they occur.

  2022 2021
Potentially dilutive common share equivalents        
Options  6,223,462   3,211,709 
Warrants  48,069,687   41,415,000 
Convertible notes  3,510,792   2,707,238 
Potentially dilutive shares outstanding  57,803,941   47,333,947 

Assumptions used to estimate compensation expense are determined as follows:

 

•F-8Expected term is generally determined using the average of the contractual term and vesting period of the award;
•Expected volatility is measured using the historical daily changes in the market price of the Company's common stock over a period consistent with the expected term or since March 20, 2018, if earlier, the day of the merger between BSSD Group LLC ("BSSD") and Airware Labs Corp;
•Risk-free interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards.

Item 9 Labs Corp Incentive Stock Option Plan:

 

On June 21, 2019, our board and shareholders voted to approve the 2019 Equity Incentive Plan (the "2019 Plan"). Pursuant to the 2019 Plan, the maximum aggregate number of Shares available under the Plan through awards is the lesser of: (i) 6,000,000 shares, increased each anniversary date of the adoption of the plan by 2 percent of the then-outstanding shares, or (b) 10,000,000 shares. It is the policy of the Company to issue new shares for options that are exercised.

Warrants, Conversion Options and Debt Discounts

 

The Company bifurcates the value ofanalyzes warrants issued with debt. Thisdebt to determine if the warrants are required to be bifurcated and accounted for at fair value at each reporting period. When bifurcation results inis not required, the establishment ofCompany records a debt discount, based on the relative fair values of the warrants and the debt, with a corresponding charge to equity unless the terms of the warrant require it to be classified as a liability. The warrants and corresponding note discounts are valued using the Black-Scholes valuation model. This model uses estimates of volatility, risk free interest rate and the expected term of the warrants, along with the current market price of the Company's stock, to estimate the value of the outstanding warrants. The Company estimates the expected term using an average of the contractual term and vesting period of the award. The expected volatility is measured using the average historical daily changes in the market price of the Company's common stock over the expected term of the award or, if earlier, since March 20, 2018, the day of the merger between BSSD Group LLC ("BSSD") and Airware Labs Corp, and the risk-free interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards.

 

The Company also analyzes conversion options embedded with debt to determine if the conversion options are required to be bifurcated and accounted for at fair value at each reporting period or to determine if there is a beneficial conversion feature. At June 30, 2022 and September 30, 2021, none of the conversion options embedded in the Company’s debt were required to be bifurcated.

Segment Reporting

The Company defines operating segments as components about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performances. The Company allocates its resources and assesses the performance of its sales activities based on the services performed by its subsidiaries. For the three and nine months ended June 30, 2022 and 2021, the Company has identified two segments: the cultivation, production and sale of cannabis and cannabis derived products and technologies (“Cultivation”) and the sales of Unity Rd. franchises to dispensaries (“Franchising”).

Business Combination

The Company allocates the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. The purchase price allocation process requires management to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets. Direct transaction costs associated with the business combination are expensed as incurred. The allocation of the consideration transferred in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date. The Company includes the results of operations of the business that it has acquired in its consolidated results prospectively from the date of acquisition.

If the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquiree is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss.

F-9

Recently Issued Accounting Pronouncements

 

Pending Adoption

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), which provides guidance on measuring credit losses on financial instruments. The amended guidance replaces current incurred loss impairment methodology of recognizing credit losses when a loss is probable with a methodology that reflects expected credit losses and requires a broader range of reasonable and supportable information to assess credit loss estimates. ASU 2016-13 is effective for usthe Company on October 1, 2023, with early adoption permitted on October 1, 2019. We are assessing the provisions of this amended guidance; however, the adoption of the standard is not expected to have a material effect on our condensed consolidated financial statements.

 

In August 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other optionsOptions (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity'sEntity’s Own Equity (Subtopic 815-40).The amendment is meant to simplify This standard eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for convertible instruments by removing certain separation modelscontracts in subtopic 470-20an entity’s own equity that are currently accounted for convertible instruments. The amendment also changedas derivatives because of specific settlement provisions. In addition, the method used to calculate diluted EPS fornew guidance modifies how particular convertible instruments and for instrumentscertain contracts that may be settled in cash. The amendmentcash or shares impact the diluted EPS computation. For public business entities, it is effective for fiscal years beginning after December 15, 2021, including interim periods forwithin those fiscal years using the fully retrospective or modified retrospective method. Early adoption is permitted but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. We are currently evaluating the impact of adoption of this standard on the Company'sCompany’s condensed consolidated financial statements and relateddisclosures.

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This standard requires contract assets and contract liabilities acquired in a business combination to be recognized in accordance with Topic 606 as if the acquirer had originated the contracts. For public business entities, ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, including interim periods within those years and early adoption is permitted. We are currently evaluating the impact of adoption of this standard on the Company’s condensed consolidated financial statements and disclosures.

 

There have been no other recent accounting pronouncements or changes in accounting pronouncements that have been issued but not yet adopted that are of significance, or potential significance, to us.

Note 2 - Going Concern

The accompanying condensed consolidated financial statements have been prepared assuming the continuation of the Company as a going concern. The Company has not yet established an ongoing source of revenue sufficient to cover its operating costs and has incurred net losses since its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company's planned ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion of the assets in the accompanying condensed consolidated balance sheets is dependent upon continued operations of the Company which in turn is dependent upon the Company's ability to meet its financing requirements, and the success of its future operations. The Company operates in a new, developing industry with a variety of competitors. These factors raise substantial doubt about the Company's ability to continue as a going concern.

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management's plans in regard to these matters are described as follows:

Sales and Marketing. Historically, the Company has generated the majority of its revenues by providing its products to dispensaries throughout the state of Arizona. The Company's revenues have increased significantly since its inception in May 2017. Management will continue its plans to increase revenues in the Arizona market by providing superior products. Additionally, as capital resources become available, the Company plans to expand into additional markets outside of Arizona, with construction of a cultivation and processing facility nearing completion in Nevada. The Company believes that it will reduce the overall costs of revenues and costs of revenues will increase at a lower rate than revenues in future periods, which will lead to increased profit margins.

Financing. To date, the Company has financed its operations primarily with loans from shareholders, private placement financings and sales revenue. Management believes that with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will grow, thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there is no assurance that the Company's overall efforts will be successful.

If the Company is unable to generate additional sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations, and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations are available. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

 F-9F-10 

 

Note 2 -3 – Inventory

Inventory consisted of the following at June 30, 2022 and September 30, 2021.

  June 30, September 30,
  2022 2021
Raw materials and work in process $1,817,094  $4,291,095 
Finished goods  1,596,924   1,052,375 
Packaging and other  716,761   1,047,881 
  $4,130,779  $6,391,351 

Note 4 – Acquisitions

 

Strive Management, LLCOklahoma City dispensary acquisition

 

In February 2020,January 2022, the Company executed an agreementsigned a Co-Management Agreement with a dispensary in Oklahoma for a term of three years. As part of the other membersCo-Management Agreement, the Company purchased substantially all of Strive Management, LLCthe assets of a dispensary, excluding cannabis and cannabis related products and licenses, and assumed the dispensary’s lease. The purchase price was $130,000, payable at $32,500 on the effective date and $32,500 each 30, 60 and 90 days after the effective date. In addition, the Company will pay $1,667 per month for 35 months. Finally, the Company paid the seller $65,000 in the Company’s common stock at a 10% discount to purchase the remaining 80% of Strive Management, LLC ("Strive"), as well as the Nevada licenses its members held in another entity.stock’s 10-day volume weighted average. The Company agreed to pay $500,000 in cash, $1,000,000 in an unsecured note payable, 3,250,000has issued 69,892 shares of the Company's restricted common stock related to the Co-Management Agreement. The accrued purchase price balance is $49,274 at June 30, 2022 and issue 2,000,000 warrants exercisable intois included in accrued expenses on the Company's common stock. The warrants are to be issued upon the earlier of September 30, 2020 or three months following the date on which each provisional certificate becomes a final certificate, which has not yet occurred. The warrants have a three-year term, exercise price of $1.13 and include down round provisions. In order to close the transaction, the Company borrowed $500,000 from Stockbridge Enterprises, a related party (See note 6). Though the Company acquired the remaining portion of Strive, Strive was not considered a business under ASC 805, Business Combinations, as it did not have a substantive process. As such, the Company has recorded the transaction as an asset acquisition. condensed consolidated balance sheet.

As of June 30, 2021 and September 30, 2020, $6,703,981 has been recorded to licenses relating to2022, the transaction.

OCG Inc. (Unity Rd)

On December 13, 2020, the Company and I9 Acquisition Sub Inc. ("Merger Sub"), entered into an Agreement and Plan of Merger (the "Agreement") with OCG Inc., a Colorado corporation ("Target"), pursuant to which the Merger Sub will be merged with and into the Target in a reverse triangular merger with the Target continuing as the surviving entity as a wholly-owned direct subsidiary of the Company ("Merger"). On the terms and subject to the conditions set forth in the Agreement, upon the completion of the Merger, the Target Shareholders became stockholders of the Company through the receipt of an aggregate 19,080,000 restricted shares of the Common Stock of the Company, of which 7,632,000 shares will be held in escrow for 6-18 months ("Merger Consideration"). As the initial merger agreement was agreed upon in February 2020, the Company agreed to fund a line of credit to assist in funding the operations of OCG Inc. during the process. The payments made on behalf of OCG, Inc. were reported as deposits in the amount of $640,000 as of September 30, 2020. As of June 30, 2021, the amount is reported as an internal balance and has been eliminated in consolidation for financial reporting purposes. The Agreement dated December 13, 2020 superseded and replaced all prior agreements between the parties, including that certain merger agreement dated February 27, 2020.  The transaction closed on March 19, 2021, which has currently been determined to be the acquisition date. Per ASC 805, Business Combinations, the measurement period is the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination. The measurement period shall not exceed one year from the acquisition date. As of the date of this filing, the purchase price allocation is underway but not yet completed. Subsequent to the issuance of these financial statements, the Company expects to obtain a third-party valuation of the fair value of the assets acquired, liabilities assumed and consideration paid for use in the purchase price allocation. The estimated consideration paid was recorded based on the market price of Item 9 Labs stock as of March 19, 2021 for the 19,080,000 of restricted common shares issued and the black-scholes model for the 23,560,000 of warrants granted. The assumptions used in the black-scholes model were: grant date stock price of $3.40, term of 1.5 years, 140% volatility and a discount rate of .09% (1 year treasury bond), with a total estimated purchase price of $113,722,003. The valuation and allocation are significant estimates and may be materially modified in future filings as the accountingor accrued for this acquisition progresses and is finalized. Management has retained an independent valuation expert to review the value of the transactionwas as well as the purchase price allocation. Currently the report is not yet available, but it's results may affect the purchase price as well as intangible assets. follows:

Cash $190,000 
Common stock  65,000 
  $255,000 

F-11

The following table summarizes the allocation of the estimated purchase price to the estimated fair values of the assets acquired and the liabilities assumed as of the transaction date:

Tangible assets acquired    
     
Cash $6,143 
Fixed assets  80,287 
Tangible net assets acquired  86,430 
Goodwill  168,570 
     
Consideration paid $255,000 

     
Consideration paid $113,722,003 
     
Tangible assets acquired    
     
Cash  94,596 
Other current assets  128,941 
Fixed assets  41,549 
Other assets  10,935 
     
Total tangible assets $276,021 
     
Assumed liabilities    
     
Accounts payable  1,032,735 
Other current liabilities  3,224,771 
Officer and shareholder loans  1,186,658 
Unearned franchise fee revenue  662,505 
     
Total assumed liabilities  6,106,669 
     
Net liabilities assumed  (5,830,648)
     
Intangible assets (a)(b) $119,552,651 

(a)- The excess purchase price over the tangible assets acquired and liabilities assumed will be allocated to intangible assets and goodwill after completion of the third-party valuation. In accordance with applicable accounting standards, any goodwill will not be amortized but instead will be tested for impairment at least annually or more frequently if certain indicators are present. Goodwill and intangible assets may not be deductible for tax purposes
(b)Any goodwill resulting from the acquisition represents expected synergies from the merger of operations and intangible assets that do not qualify for separate recognition. With the addition of a retail dispensary franchise business, it brings the full vertical to Item 9 Labs Corp (cultivation, processing, distribution and retail), providing a built in premium supply chain to distribute Item 9 Labs products while maintaining a mode of growth which may be less dependent on outside capital for expansion.

Adams County acquisition

On October 6, 2021, the Company entered into an Asset Purchase Agreement with Nebrina Adams County LLC to purchase certain assets, which include licenses, a lease and certain personal property to operate a licensed recreational cannabis dispensary (the “Adams County Acquisition”). The purchase price is $1,651,789 comprised of $1.0 million of cash, a $200,000 note, and 300,000 shares of the Company’s common stock, valued at $1.12 per share. The note has an interest rate of 5% per annum and a term of 18 months and payable in six installments on the last day of each three-month period following the Closing Date. The Adams County Acquisition closed on March 2, 2022. The acquisition is not considered a business combination under ASC 805, Business Combinations, as a substantive process was not acquired. Substantially all of the consideration paid was allocated to the licenses purchased.

As of June 30, 2022, the consideration paid in this asset acquisition was as follows:

Cash $1,000,000 
Debt  200,000 
Common stock  336,000 
Direct costs of acquisition  130,872 
  $1,666,872 

 

The following unaudited pro forma information presentsHerbal Cure pending acquisition

On March 11, 2022, the Company entered into an Asset Purchase Agreement with The Herbal Cure LLC (“Seller”), pursuant to which, the Company is purchasing certain assets from the Seller. The total purchase price for the assets to be acquired is $5,750,000, payable as follows:

(i) Upon mutual execution and delivery of the Asset Purchase Agreement, the Company shall convey to the Seller a down payment in the amount of $250,000;

(ii) At the Closing, the Company shall pay to Seller $3,700,000 in immediately available funds;

(iii) $700,000 shall be financed by the Seller and paid pursuant to the terms and conditions of the Secured Promissory Note (the "Herbal Cure Note"), which interest shall accrue at a rate of 5% per annum, for a term of 18 months commencing on the Closing Date, and payable in even monthly installments until paid in full; and

(iv) the Company shall pay the remainder of the purchase price in shares of its common stock on the Closing Date, in such amount of Shares as is the quotient of $1,100,000 divided by the product of the 10 day volume weighted average price of the shares as of the Closing Date, and 85%.

At June 30, 2022, the $250,000 down payment was paid and is included in Other Assets on the condensed consolidated resultsbalance sheet. At June 30, 2022, this acquisition has not yet been finalized. As such, the effects of this acquisition, which is expected to be accounted for under ASC 805, Business Combinations, have not been included in the Company’s condensed consolidated balance sheet or statement of operations as of and for the three and nine months ended June 30, 2022. The Company can provide no assurance that it will be successful in finalizing this acquisition.

Sessions pending acquisition

On May 18, 2022, the Company and its wholly owned subsidiary, OCG Management Ontario, Inc., a corporation formed under the laws of the Province of Ontario (“Purchaser”) solely for the purpose of completing this transaction, entered into a Share Purchase Agreement pursuant to which the Purchaser is purchasing all, but not less than all, of the issued and outstanding shares in the capital of Wild Card Cannabis Incorporated, a corporation formed under the laws of the Province of Ontario free and clear of all Liens from the Shareholders.

The total purchase price for the Shares is Twelve Million Eight Hundred Thousand Dollars ($12,800,000.00 USD) (the "Purchase Price"), as adjusted, plus the Earnout Payment, if any (collectively, the acquisition consummated“Purchase Price”) payable as follows:

(i) The Company has delivered the Exclusivity Deposit in the amount of $156,902 to the Escrow Agent on March 19, 2021 had been consummated4, 2022.

(ii) At the Closing, Purchaser shall pay to Shareholders the Estimated Purchase Price of Twelve Million Eight Hundred Thousand Dollars ($12,800,000.00 USD), as adjusted, in immediately available funds;

(iii) Four Million One Hundred Thousand Dollars ($4,100,000.00), as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on October 1, 2019. Such unaudited pro forma information is based on historical unaudited financial information with respectthe basis of a deemed price per common share equal to the acquisition10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the First Earnout Period (the date that is 12 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the First Earnout Period is greater than or equal to the Target Net Revenue for the First Earnout Period; and does not include operational or other charges which might have been affected

(iv) Four Million One Hundred Thousand Dollars ($4,100,000.00), as adjusted, payable by the Company.delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the Second Earnout Period (the date that is 24 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the Second Earnout Period is greater than or equal to the Target Net Revenue for the Second Earnout Period.

   
  Nine months ended June 30,
  2021 2020
Revenue $15,763,858  $5,728,692 
         
Net loss $(10,242,081) $(11,220,516)
         
Basic and diluted net loss per common share $(0.11) $(0.14)
         
Basic and diluted weighted average common shares outstanding  91,195,022   80,914,030 

At June 30, 2022, the $156,902 Exclusivity Deposit has been paid and is included in Other Assets on the condensed consolidated balance sheet. At June 30, 2022, this acquisition has not yet been finalized. As such, the effects of this acquisition, which is expected to be accounted for under ASC 805, Business Combinations, have not been included in the Company’s condensed consolidated balance sheet or statement of operations as of and for the three and nine months ended June 30, 2022. The Company can provide no assurance that it will be successful in finalizing this acquisition.

 F-10F-12 

 

Note 5 – Variable Interest Entity

In January 2022, the Company signed a Co-Management Agreement with a dispensary in Oklahoma for a term of three years. Under the terms of the Co-Management Agreement, the Company purchased substantially all of the assets of a dispensary, excluding cannabis and cannabis related products and licenses, and assumed the dispensary’s lease (see Note 4). Further, under the Co-Management Agreement, the Company is to operate, staff, and otherwise manage the day-to-day operations of the dispensary. The Company shall also pay all claims, costs and liabilities associated with operating the dispensary.

The terms of the Co-Management Agreement provide the Company with, in its judgment, the ability to manage and make decisions that most significantly affect the operations of Elevated Connections and to absorb losses that could potentially be significant to Elevated Connections. As such, the Company has consolidated Elevated Connections effective February 1, 2022. The purpose of Elevated Connections, as a licensed dispensary, is to hold the cannabis and cannabis related products and licenses of the dispensary.

The assets of the VIE cannot be used to settle obligations of the Company or its wholly owned subsidiaries. However, liabilities recognized as a result of consolidating the VIE does represent additional claims on the Company’s general assets.

The following table presents the carrying values of the assets and liabilities of the entity that is a VIE and consolidated by the Company at June 30, 2022.

  June 30,
Assets 2022
Current assets    
Inventory $27,773 
Total assets $27,773 
     
Liabilities    
Current liabilities    
Income tax payable $7,948 
Total liabilities $7,948 

The following table presents the operations (after intercompany eliminations) of the entity that is a VIE and consolidated by the Company for the three and nine months ended June 30, 2022.

  Three months ended June 30, Nine months ended June 30,
  2022 2022
Revenues, net $40,245  $73,582 
Cost of revenue  21,111   44,128 
Gross profit  19,134   29,454 
Income tax expense  4,624   7,948 
Net income $14,510  $21,506 

F-13

Note 6 – Goodwill and Intangible Assets

Goodwill and identifiable intangible assets, including licenses, consist of the following as of June 30, 2022 and September 30, 2021:

  Gross Carrying Accumulated Accumulated  
  Amount Amortization Impairment Net
June 30, 2022                
Finite lived intangible assets:                
Trade names and trademarks $8,570,848  $1,140,172  $—    $7,430,676 
Customer relationships  290,000   290,000   —     —   
Websites and other intellectual property  2,470,000   1,144,470   955,223   370,307 
Franchise and consulting agreements  3,970,000   919,170   —     3,050,830 
Total finite lived intangible assets  15,300,848   3,493,812   955,223   10,851,813 
Indefinite lived intangible assets:                
Licenses  8,370,853   —     —     8,370,853 
Total intangible assets $23,671,701  $3,493,812  $955,223  $19,222,666 
                 
                 
  Gross Carrying Accumulated Accumulated  
   Amount   Amortization   Impairment   Net 
September 30, 2021                
Finite lived intangible assets:                
Trade names and trademarks $8,570,848  $497,356  $—    $8,073,492 
Customer relationships  290,000   290,000   —     —   
Websites and other intellectual property  2,470,000   946,488   955,223   568,289 
Franchise and consulting agreements  3,970,000   656,667   —     3,313,333 
Total finite lived intangible assets  15,300,848   2,390,511   955,223   11,955,114 
Indefinite lived intangible assets:                
Licenses  6,703,981   —     —     6,703,981 
Total intangible assets $22,004,829  $2,390,511  $955,223  $18,659,095 

    Gross Carrying
  Gross Carrying Amount
  Amount Goodwill
  Goodwill Impairment
Changes in goodwill and indefinite lived intangibles:        
Balance at September 30, 2021 $62,868,420  $4,803,604 
Additional goodwill related to Oklahoma City dispensary acquisition  168,570   —   
Balance at June 30, 2022 $63,036,990  $4,803,604 

As of June 30, 2022, the cultivation and processing licenses from the state of Nevada, included above, have not been transferred to the Company as the transfer is awaiting regulatory approval.

During the three months ended June 30, 2022, the Company has noted indicators of the possible impairment of its goodwill and intangible assets. The Company will analyze these indicators during the fourth quarter of the year ended September 30, 2022 and determine if any impairment has occurred. Given the carrying value of the Company’s goodwill and intangible assets at June 30, 2022, the occurrence of an impairment may be material to the Company’s financial position and results of operations.

F-14

Note 37 - Property and Equipment, Net

 

The following represents a summary of our property and equipment as of June 30, 20212022 and September 30, 2020:2021:

 

PPE    
  June 30, September 30,
  2021 2020
Equipment $507,907  $169,069 
Construction in progress  6,213,234   4,212,208 
Land and building  3,097,539   3,093,780 
   9,818,680   7,475,057 
Accumulated Depreciation  (404,691)  (266,297)
  $9,413,989  $7,208,760 
  June 30, September 30,
  2022 2021
Cultivation and manufacturing equipment $551,045  $506,271 
Computer equipment and software  266,427   266,427 
Leasehold improvements  49,667   —   
Buildings and improvements  2,811,340   2,785,781 
   3,678,479   3,558,479 
Accumulated Depreciation  (696,052)  (479,320)
   2,982,427   3,079,159 
Land  3,455,563   380,584 
Construction on progress  19,869,222   7,418,105 
Property and Equipment, Net $26,307,212  $10,877,848 

 

During the nine months ended June 30, 2022, the Company completed the purchase of 44 acres of land from a related party for $3.0 million plus expenses. The Company hadland-owner is one of the original members of BSSD and a current employee of the Company.

Construction in progress relates to multiple capital projects ongoing during the three and nine months ended June 30, 2021. The fees associated with engineering2022, including the construction of the Nevada facility and plan submittal, material orders, as well as electrical upgrades are reported as constructionthe expansion of the Arizona facility. Construction in progress asalso includes interest and fees on debt that is directly related to the financing of the Company’s capital projects.

Depreciation expense for the three months ended June 30, 2021. Additionally, the Company began implementation of an ERP system, which2022 and 2021 was also reported as construction in progress.

$71,285 and $35,965, respectively. Depreciation expense for the nine months ended June 30, 20212022 and 20202021 was $100,535217,363 and $96,330100,535, respectively.

 

 

Note 4 - Sale of Airware Assets and Investment in Health Defense LLC8 – Debt

 

On May 3, 2018, the Company entered into an intellectual property sales agreement with Health Defense LLC. Pursuant to the terms of the agreement, the Company sold all of the assets related to the former business of the Company, nasal dilator sales.

  Convertible Notes
                   
  Effective  Maturity  Annual Interest   Balance at  Balance at  Conversion
  Date Date  Rate   

June 30, 2022

  

September 30, 2021

  Price
 C-2  3/23/2020  9/23/2020   15%  1,100,000   1,100,000   See C-2 
 C-3  8/15/2011  8/15/2012   8%  20,000   20,000   0.50 
 C-5  3/19/2021  9/19/2021   10%  —     80,000   2.50 
 C-7  9/29/2021  9/29/2022   10%  250,000   250,000   1.67 
 C-8  9/29/2021  9/29/2022   10%  500,000   500,000   1.67 
 C-9  10/1/2021  9/29/2022   10%   750,000   —     1.67 
 C-10   10/29/2021  4/29/2022   15%   750,000   —     1.50 
 C-11  2/21/2022  8/31/2022   24%  250,000   —     1.10 
               3,620,000   1,950,000     
     Less: unamortized discounts  (353,821)  (672,606)     
              $3,266,179  $1,277,394     

  

In consideration for entering into the agreement, the Company was to receive: (i) $300,000 in cash at execution, (ii) $700,000 in cash within one year of execution and (iii) an additional $300,000 by December 31, 2019.

Due to the long-term nature of the final $300,000 payment, the Company recognized a discount of $70,070 using a discount rate of 21.50%. As additional consideration, the Company was given a 10% ownership interest in Health Defense LLC. This ownership was valued at $100,000 and was previously reflected on the consolidated balance sheet as Investment in Health Defense. During 2020, the Company determined the fair value of the investment to be lower than the carrying value. As such, the Company recorded an impairment charge of $100,000 during the year ended September 30, 2020, reducing the carrying amount to $0.

During the year ended September 30, 2019, management determined that the receivable described above should be classified as long-term on the consolidated balance sheet as the payments have not been made as scheduled. Additionally, management has recorded a reserve on the receivable of $596,430 as of June 30, 2021 and September 30, 2020.

Note 5 - Notes Receivable

On May 11, 2018, the Company entered into a Promissory Note Agreement with a borrower in the principal amount of $150,000. This was a one year note with 20% non-compounded annual interest payable at maturity. It is convertible at the discretion of the Company into a unit offering of the borrower at a 15% discount. The note is personally guaranteed by the borrowers. This note is in default and is on non-accrual status. The Company has recorded a reserve of $80,000 on this note at June 30, 2021 and September 30, 2020.

On May 15, 2018, the Company entered into a Promissory Note Agreement with a borrower in the principal amount of $60,000. This was a one year note with 15% non-compounded annual interest payable at maturity. It is convertible at the discretion of the Company into an interest in a strategic partnership of ownership and operations of a certain dispensary license. The note is personally guaranteed by the borrower. This note is in default and is on non-accrual status. At June 30, 2021 and September 30, 2020, the principal and interest has been fully reserved, totaling $69,000.

F-11

Note 6 - Notes Payable

Convertible Notes: 

  Note  Maturity Annual Interest Current Principal Original Discount Net Conversion Shares Issuable Upon
  Date Date Rate Balance Discount Amortization Balance Price Conversion
 C-2  3/23/2020  9/23/2020   12% $1,100,000  $(863,049) $863,049  $1,100,000  $1.00  1,206,730 
 C-3  8/15/2011  8/15/2012   8%  20,000   -     -     20,000   0.50   63,510 
 C-4  4/15/2021  4/15/2023   10%  30,000   -     -     30,000   1.00   30,000 
 C-5  3/19/2021  9/19/2021   10%  167,821   -     -     167,821   2.50   51,998 
 C-6  3/19/2021  3/19/2023   10%  1,355,000   (1,355,000)  188,093   188,093   1.00   1,355,000 
                                     
                          1,505,914       2,707,238 
                                     
                   Less current portion   (1,317,821)        
                                 
                          $188,093         

(C-2) Convertible Viridis NotesNote

 

On March 23, 2020, the Company borrowed proceeds from twoa related parties, Stockbridge Enterprises andparty, Viridis I9 Capital LLC.LLC (“Viridis”), in the amount of $1.1 million. The $2,200,000 borrowingnote is unsecured, had an original termconvertible at the lesser of six months, and accrued interest at a ratea) $1.00 per share or, b) 20% discount to the ten day average closing price of 12% per year.the Company’s common stock, immediately prior to the conversion date. All principal and interest were due on the maturity date. The lender has granted a payment forbearance for the note and all unpaid principal and interest, accrued at the default interest rate of 15% per annum, will be paid at maturity, which has been postponed to a date that has not yet been determined. At December 31, 2020, these notes wereJune 30, 2022 the Viridis note was in default. In February 2021, the Stockbridge note was amended to cure the default (see (n) below). The Viridis note remains in default as of this filing, though the parties are negotiating a long-term arrangement.

F-15

(C-9) Convertible Tysadco Note

On October 1, 2021, the Company entered into a convertible note agreement. Up to fifty percent (50%) of the outstanding and unpaid principal amount is convertible into common stock. The note included warrants to purchase a total of 825,000 shares of the Company’s common stock for $3 per share, with a 4 year term. Further, the Company issued 67,365 shares of common stock, valued at $112,500 as an inducement to the lenders to enter into the note agreements. The debt included a provision forbeneficial conversion feature after consideration of the issuancerelative fair values of 10,000,000the warrants exercisable into the Company'sand shares of common stock. The exercise price on the warrants is $.75 and the warrants have a termdebt, shares of 5 years. The debtcommon stock and warrants were recorded at their relative fair values.values, along with the beneficial conversion feature. The resulting discount of $597,606 and an additional $75,000 discount related to a one-time interest charge of 10% of the original principal amount, is amortized to interest expense over the term of the debt. The one-time interest charge was accrued at June 30, 2022.

(C-10) Convertible Gaines Note

On October 29, 2021, the Company entered into a convertible note agreement. The outstanding and unpaid principal and accrued interest is convertible, in whole, into shares of the Company’s common stock. The notes included warrants to purchase a total of 750,000 shares of the Company’s common stock for $3 per share, with a 2 year term. Further, the Company issued 75,000 shares of common stock, valued at $116,250 as an inducement to the lender to enter into the note agreement. The debt included a beneficial conversion feature after consideration of the relative fair values of the warrants and shares of common stock. The debt, shares of common stock and warrants were recorded at their relative fair values, along with the beneficial conversion feature. The resulting discount of $561,272, which also included debt issuance costs of $44,582, is amortized to interest expense over the term of the debt. This convertible note is currently due on demand and interest is paid monthly.

(C-11) Convertible Goldstein Note

On February 21, 2022, the Company entered into a convertible note agreement. The outstanding and unpaid principal and accrued interest is convertible, in whole, into shares of the Company’s common stock. The Company issued 25,000 shares of common stock, valued at $25,000 as an inducement to the lender to enter into the note agreement. The debt included a beneficial conversion feature after consideration of the relative fair value of the shares of common stock. The debt and shares of common stock were recorded at their relative fair values, along with the beneficial conversion feature. The resulting discount of $50,000 is amortized to interest expense over the term of the debt.

 

(C-3, C-4, C-5) Other Convertible Notes

The Company has various convertible notes outstanding under various provisions. C-5 note was assumed in the OCG, Inc. transaction. It was restructured to be a 6 month convertible note with an initial principal balance of $300,000, with a principal payment due and paid by March 24, 2021, and additional principalfuture minimum payments of $10,000 due monthlythe Company’s convertible debt obligations as wellof June 30, 2022 are as accrued interest at 10%.follows. The note matures September 2021 and may be converted into common stock of the Company at any time before then with an exercise price of $2.50 per share.

(C6) Convertible Notes

The Company and OCG Inc. borrowed $1,355,000 from various investors in March 2021 under a convertible note agreement. The notes bear interest at 10%, calculated semi-annually, payable on the maturity date in which any accrued but unpaid and unconverted interest and unconverted and outstanding principal is due. In addition to the notes being convertible at the option of the noteholders, the notes include automatic conversion features in which the notes will convert to common shares of the Company upon the earlier of the maturity date or when the quoted market price of the Company is $2.00 or above for five consecutive trading days and has 20,000 shares traded in the same five days. The notes also included warrants to purchase 1,355,000 shares of Company stock for $3 per share, with a 3 year term. The debt, and warrants were recorded at their relative fair values. The resultingunamortized discount will be amortized to interest expense over the term of the debt. The beneficial conversion feature was recorded at its intrinsic value, but was limited to the amount of the proceeds allocated to the debt. Subsequent to June 30, 2021, the mandatory conversion feature of the notes was triggered by the market and all shares underlying conversion were issued in place of the notes.through September 2022.

Year ended  
June 30, Amount
 2023  $3,620,000 
     3,620,000 
 Less: unamortized discount   (353,821)
    $3,266,179 

 

Non-convertible notes:

  Note  Maturity Annual Interest Current Principal Original Discount Net  
  Date Date Rate Balance Discount Amortization Balance Secured by
 f  5/1/2020  11/1/2023   10% $1,386,370   (612,760)  203,774   $977,384  2nd DOT AZ property
 g  5/1/2020  4/1/2024   10%  1,564,849   (731,228)  237,593   1,071,214  1st DOT NV property
 h  5/1/2020  5/1/2023   15%  283,666   (151,212)  53,005   185,459  N/A
 i  2/14/2020  10/14/2022   2%  366,033   (155,040)  104,582   315,575  Secured by licenses
 m  12/20/2020  12/20/2021   9%  39,740   -     -     39,740  2 vehicles in AZ
 n  2/1/2021  2/5/2022   10%  880,590   -     -     880,590  N/A
 o  3/19/2021  4/1/2024   10%  233,427   -     -     233,427  N/A
 p  3/19/2021  4/1/2024   10%  58,003   -     -     58,003  N/A
 q  3/19/2021  4/1/2024   10%  542,608   -     -     542,608  N/A
                               
                           4,304,000   
                               
                   Less current portion   (838,894)  
                               
                   Long-term debt  $3,465,106   
F-16

 

(e) Aeneas Venture Partners 3, LLC Note

  Notes Payable
             
  Effective Maturity Annual Interest Balance at Balance at  
  Date Date 

Rate

 

June 30, 2022

 

September 30, 2021

 Secured by
 f  5/1/2020 11/1/2023  10%  1,386,370   1,386,370  2nd DOT AZ property
 h  5/1/2020 5/1/2023  15%  283,666   283,666  N/A
 i  2/14/2020 10/14/2022  2%  —     312,500  Secured by licenses
 l  8/18/2021 1/25/2023  36%  1,713,707   2,162,590  Future revenues
 n  12/20/2020 12/20/2021  9%  —     13,148  Secured by vehicles
 o  3/19/2021 4/1/2024  10%  670,932   816,582  N/A
 p  2/1/2021 6/30/2022  15%  270,590   520,590  N/A
 q  8/6/2021 2/6/2023  16%  13,500,000   13,500,000  1st AZ property and other personal property
 r  8/6/2021 2/6/2023  16%  5,500,000   5,500,000  1st NV property and other personal property
 s  9/30/2021 12/31/2021  18%  500,000   500,000  Restricted common stock
 t  3/19/2021 7/19/2022  18%  250,000   500,000  N/A
 u  2/22/2022 2/28/2023  36%  547,806   —    Future revenues
 v  2/22/2022 2/28/2023  36%  176,453   —    Future revenues
 w  3/4/2022 On demand  15%  3,652,000   —     
 x  3/10/2022 5/10/2022  20%  250,000   —    N/A
 y  3/2/2022 8/1/2023  5%  166,667   —    N/A
             28,868,191   25,495,446   
     Less: unamortized discounts (2,886,822)  (6,002,045)  
            $25,981,369  $19,493,401   

 

On August 28, 2019, Item 9 Properties, LLC, a Nevada limited liability company, and BSSD Group, LLC, an Arizona limited liability company, each wholly owned subsidiaries of Item 9 Labs Corp. collectively, entered into a Loan Agreement of up to $2.5 million (the "Loan Agreement") with Aeneas Venture Partners 3, LLC, an Arizona limited liability company (the "Lender"). The Loan is secured by a first priority interest in the Company's real property located in Coolidge, Arizona, including improvements and personal property thereon (the "Property") and includes an unconditional guarantee by Item 9 Labs Corp. The 5-acre property has 20,000 square feet of buildings, housing the cultivation and processing operations. On March 23, 2020, the Company paid $2,000,000 on the note and reached a settlement to bring the note current. The settlement calls for monthly interest payments of $22,000 and the remaining principal balance of the note is due on March 1, 2021. The note was paid in full on March 1, 2021.

 

(f) Viridis AZ

 

On September 13, 2018, the Company entered into a Loan and Revenue Participation Agreement with Viridis Group I9 Capital LLC ("Viridis"), a related party, in which Viridis agreed to loan the Company up to $2.7$1.2 million for the expansion of the Company's Arizona and Nevada properties.property. In exchange for the loan, Viridis was to be repaid in the form of waterfall revenue participation schedules. Viridis was to receive 5% of the Company's gross revenues from the Arizona operations until the loan was repaid, 2% until repaid 200% of the amount loaned, and 1% of gross revenues in perpetuity or until a change in control. The loan was originally collateralized with a Deed of Trust on the Company's 5-acre parcel in Coolidge, AZ and its two 10,000 square foot buildings. In August 2019, Viridis agreed to subordinate its first priority Deed of Trust and move into a 2ndposition. At that time, the loan was amended to include 6% annualized interest.

 

On May 1, 2020, under a troubled debt restructuring, the Company renegotiated the $1,200,000 note payable. As part of the restructuring, the Company issued 1,555,556 warrants exercisable into the Company's common stock. The warrants have an exercise price on the warrants isof $1.00 and they have a term of 5 years. Accrued interest in the amount of $186,370 was added to the principal balance of the note, making the total principal $1,386,370. Interest only payments of $11,553 shall be paid monthly until November 1, 2020 at which time monthly principal and interest payments of $28,144 are required for 36 months, with a balloon payment of $693,185all outstanding principal and interest due upon the note's maturity. The note also entitles Viridis to a gross revenue participation of the Arizona Operations equal to 1% of the gross sales (up to $20,000 monthly) upon the maturity of the note and for the subsequent 5 year period. The debt and warrants were recorded at their relative fair values. The resulting discount will beis amortized to interest expense over the term of the debt. The lender has granted a payment forbearance for the note and all unpaid principal and interest, during this timeaccrued at the default interest rate of 12% per annum, will be added to the balloon payment at maturity.

 

In August 2021, the Viridis AZ and Viridis NV debt was modified to subordinate these notes to the Pelorus Notes (see (q) and (r)). As of the date of these condensed consolidated financial statements, the terms of this modification have not been finalized. Based on the expected modification terms, this modification was accounted for as an extinguishment of the debt during the year ended September 30, 2021.

 F-12F-17 

 

(g) Viridis NV

On September 13, 2018, the Company borrowed $1,500,000 from Viridis Group I9 Capital LLC, a related party. The proceeds were utilized to acquire a 20% ownership in Strive Management, LLC and is collateralized with a Deed of Trust on the Company's approximately 5 acre property and construction in progress. In exchange for the loan, Viridis was to be repaid in the form of waterfall revenue participation schedules. Viridis was to receive 5% of the Company's gross revenues from the Nevada operations until the loan is repaid, 2% until repaid 200% of the amount loaned, and 1% of gross revenues in perpetuity or until a change in control. Payments on the loan was to commence 90 days after the Nevada operation begins earning revenue.

On May 1, 2020, under a troubled debt restructuring, the Company renegotiated the $1,500,000 note payable. As part of the restructuring, the Company issued 1,944,444 warrants exercisable into the Company's common stock. The exercise price on the warrants is $1.00 and they have a term of 5 years. Accrued interest in the amount of $64,849 was added to the principal balance of the note, making the total principal $1,564,849. Interest only payments of $13,040 shall be paid monthly until 3 months following the commencement date of the Nevada Operations at which time monthly principal and interest payments of $33,962 will be required for 36 months, with a balloon payment of $761,007 due upon the note's maturity. The note also entitles Viridis to a gross revenue participation of the Nevada Operations equal to 1% of the gross sales (up to $20,000 monthly) upon the maturity of the note and for the subsequent 5 year period. The debt and warrants were recorded at their relative fair values. The resulting discount will be amortized to interest expense over the term of the debt. The lender has granted a payment forbearance for the note and all unpaid principal and interest during this time will be added to the balloon payment at maturity.

(h) Viridis (unsecured)

 

The Company's subsidiary, BSSD Group, LLC borrowed $269,000 from Viridis, a related party, in December 2019. This note borebears annualized interest at 15%. On May 1, 2020, under a troubled debt restructuring, the Company renegotiated the $269,000 note payable. Accrued interest in the amount of $14,666 was added to the principal balance of the note, making the total principal $283,666. As part of the restructuring, the Company issued 400,000 warrants exercisable into the Company's common stock. The warrants have an exercise price of $.05 and a term of 5 years. Payments of principal and interest in the amount of $9,833 are due monthly, untilwith a balloon payment of all outstanding principal and interest is due upon the note's maturity on May 1, 2023.maturity. The debt and warrants were recorded at their relative fair values. The resulting discount will beis amortized to interest expense over the term of the debt. The lender has granted a payment forbearance for the note and all unpaid principal and interest, during this timeaccrued at the default interest rate of 18% per annum, will be added to the balloon payment at maturity.

 

(i) Strive Note  (l) Upwise Capital

 

In connection with the license acquisition described in Note 2, the Company entered into a note payable with the sellers in February 2020. The $1,000,000 note has a term of two years starting September 30, 2020 and bears interest at 2% per year. A principal payment in the amount of $500,000 was due on the earlier of October 10, 2020 or three months following the date on which each provisional certificate becomes a final certificate. The remaining balance is to be paid in quarterly installments of $62,500 plus accrued interest. Due to the low stated interest rate on the note, management imputed additional interest on the note.

(j) CBR 1

In June 2020, the Company executed on a short-term financing arrangement. The net proceeds of $873,000 were utilized to further expand the production capabilities of our operations in Arizona. Thirty payments of $40,500 were due weekly and the arrangement matured and was paid in full in January 2021. The loan was secured by future revenues of our operations in Arizona.

(k) CBR 2

In September 2020,August 2021, the Company executed on a short-term financing arrangement. The proceeds of $490,000$2.5 million are being utilized to further expand the production capabilities of ourthe operations in Arizona. Five paymentsArizona and to complete the Nevada facility. Payments of $11,250$64,762 are due weekly through October 14, 2020until $3.264 million is repaid. This results in an effective interest rate of approximately 36%.

On January 26, 2022, the Company executed a second short-term financing arrangement. The proceeds of $2.5 million were used to repay the first short-term financing arrangement, discussed above, in the amount of approximately $1.839 million, and twenty-five paymentsthe remainder of $24,750the proceeds was used for working capital purposes. Payments of $66,468 are then due weekly until $3.35 million has been repaid. This results in an effective interest rate of 36%. The repayment of the first short-term financing was accounted for as an extinguishment. As such, all previously unamortized discount in the amount of $46,588 and imputed interest in the amount of $483,840 was capitalized to construction in progress during January 2022. Fees paid for the second short-term financing arrangement matures in April 2021. The loan is secured by future revenuesthe amount of our operations in Arizona. The note was paid in full April 2021.$91,000 have been recorded as a discount and will be amortized to interest expense over the term of the arrangement. See Note 14.

 

(l) Stockbridge Note(o) OCG Officers Debt

 

TheAs part of the OCG transaction in March 2021, the Company entered into an additional noteassumed the debt that OCG, Inc. owed to its officers. Principal and interest payments are due monthly with Stockbridge Enterprises, a related party, in February 2020. The $500,000 borrowing had a termballoon payment of 60 days and bore interest at 6% per year. Allall outstanding principal and interest were due on the maturity date of April 2020. The note included a provision for the issuance of 500,000 warrants exercisable into the Company's common stock. The warrants have an exercise price of $.05 and a term of 5 years. In February 2021, this note was amended to cure the default (see (n) below).at maturity.

 

(m) Automotive Debt

In December 2020, the Company's subsidiary, BSSD Group purchased vehicles for use in operations. The dealership financed the vehicles. The initial principal balance of the note was $50,914.

(n)(p) Stockbridge Amended Debt

 

In February 2021, the Company and Stockbridge Enterprises, a related party, under a trouble debt restructuring, agreed to restructure and settle theits outstanding notes. The total outstanding balance of $1,660,590, including accrued interest, willwere to be repaid under a new promissory note, calling for a down payment of $300,000 (paid at time of signing), $120,000 monthly payments for 11 months with the remaining balance of $40,590 paidpayable on February 1, 2022. The note bearsThis agreement was amended to extend the maturity date to March 31, 2022 and starting with the October 1, 2021 payment, the loan payments are interest only at 10%. The restructured notes removedan interest rate of 15% per annum until January 25, 2022. Principal payments in the conversion features included in oneamount of $50,000 are due on January 25, 2022, February 15, 2022 and March 15, 2022, with a final payment of the notes that was restructured.

(o, p, q) OCG Officers Debt

remaining principal and accrued interest due on March 31, 2022. Upon closing of an equity raise of at least $750,000, the Company will repay the outstanding balance plus any accrued interest immediately. As part of the OCG transaction in March 2021,amendment, the Company assumedissued 164,744 warrants to purchase the officerCompany’s common stock. The warrants have a two-year period and an exercise price of $1.00. The resulting discount of $58,352 was fully amortized to interest expense during the six months ended March 31, 2022.

Effective March 31, 2022, the debt of OCG, Inc. The debt is held in OCG, Inc., bearswas amended to extend the maturity date to June 30, 2022, interest at 10% and is amortized over a 3 year term. Interest only payments are due monthly for 6 months, then halfon April 1, May 1 and June 1, 2022. Principal payments in the amount of the principal balance will be amortized over the remaining 30 months, with principal$50,000 are due on April 15, May 15 and accrued interest paid monthly, withJune 15, 2022 and a final balloon payment of all outstanding principal and interest in the amount of $223,972 is due on June 30, 2022. This note is currently due on demand and interest is paid monthly.

(s) Viridis $500,000

On September 30, 2021, the Company borrowed $500,000 from Viridis Group I9 Capital LLC, a related party. The proceeds of the debt were used to make a payment on the outstanding unpaid payroll tax liability. The debt is collateralized by restricted common stock in the amount of twice the balance of the debt. It is anticipated that the note will include warrants to purchase a total of 500,000 shares of the Company’s common stock for $0.60 per share, with a five-year term. As of the date of these condensed consolidated financial statements, the terms of these warrants have not been finalized. The debt and anticipated warrants were recorded at maturity.their relative fair values. The resulting discount is amortized to interest expense over the term of the debt. The lender has granted a payment forbearance for the note and all unpaid principal and interest, accrued at the default interest rate of 18% per annum beginning January 1, 2022, will be paid at maturity, which has been postponed to a date that has not yet been determined.

 

 F-13F-18 

 

(t) Chessler note

Prior to the acquisition, OCG entered into a settlement agreement with its former landlord, which included a note agreement for $500,000. During March 2022, this note agreement was modified to extend the maturity date to July 19, 2022 and add an interest rate of 18% per annum. The modified note also calls for principal payments of $75,000 on the effective date of the note, $75,000 on April 10, 2022, $100,000 on May 22, 2022 and $250,000 at maturity, plus accrued and unpaid interest. The principal balance of this note plus accrued and unpaid interest was paid subsequent to June 30, 2022.

(u) Lendspark

In February 2022, the Company executed on a short-term financing arrangement for proceeds of $750,000. Payments of $20,400 are due weekly until approximately $1.02 million is repaid. This results in an effective interest rate of approximately 36%. Fees in the amount of $48,765 have been recorded as a discount and are being amortized to interest expense over the term of the arrangement. See Note 14.

(v) Upwise Capital 2

In February 2022, the Company executed on a third short-term financing arrangement with Upwise Capital for proceeds of $250,000. Payments of $6,746 are due weekly until $340,000 is repaid. This results in an effective interest rate of approximately 36%. Fees in the amount of $16,255 have been recorded as a discount and are being amortized to interest expense over the term of the arrangement. See Note 14.

(w) Viridis working capital loans

During the nine months ended June 30, 2022, the Company received several short-term working capital loans from Viridis, a related party, in the amount of $3,702,000. The terms of these short term loans are still being determined, however, an interest rate of 15% has been estimated.

(x) Non-convertible Gaines Note

On March 10, 2022, the Company entered into a short-term promissory note for $250,000. The short-term promissory note is due and payable in monthly payments of interest only, with all principal and any accrued and unpaid interest due at maturity. This convertible note is currently due on demand and interest is paid monthly.

(y) Nebrina Adams County Note

Effective with the close of the Adams County acquisition (see Note 4), the Company entered into a note for $200,000 with the seller as part of the purchase price. The note is payable in six installments on the last day of each three-month period following the Closing Date.

The future minimum payments of the Company’s notes payable obligations as of March 31, 2022 are as follows. The unamortized discount will be amortized through November 2023.

Year ended  
June 30, Amount
 2023  $27,563,901 
 2024   1,862,175 
 2025   —   
     29,426,076 
 Less: unamortized discount   (2,886,822)
 Less: imputed interest   (557,885)
     25,981,369 
 Less: current portion   (24,532,509)
    $1,448,860 

F-19

A summary of interest expense for the three and nine months ended June 30, 2022 and 2021 is as follows.

         
  

Three months ended

June 30,

 

Nine months ended

June 30, 2022

  2022 2021 2022 2021
Amortization of debt discounts $1,440,535  $316,320  $4,932,259  $564,622 
Stated interest paid or accrued  1,508,210   301,933   4,073,665   1,217,726 
Finance charges and other interest  22,021   11,012   25,016   23,671 
   2,970,766   629,265   9,030,940   1,806,019 
Less: interest capitalized to construction in progress  (1,345,611)  —     (5,098,022)  —   
  $1,625,155  $629,265  $3,932,918  $1,806,019 

Note 79 - Concentrations

 

For the three and nine months ended June 30, 20212022 and 2020,2021, substantially all of the Company's revenue was generated from a single customer. Given the agreement with the license holder, although the Company’s products are distributed to numerous dispensaries throughout Arizona, all sales are made through the license holder. The Company's wholly owned subsidiary provides servicescannabis products to this customer under a three-year Cultivation Management Services Agreement that commenced on April 1, 2020. Provisions of the agreement require 30-day written notice to terminate except for the following circumstances, in which case the agreement is cancellable with no notice: (i) uncured default; (ii) gross negligence, intentional, or willful misconduct by either party; (iii) federal or state enforcement action against either party; (iv) any change or revocation of state or local law that has the effect of prohibiting the legal operation of the Cultivation Facility; (v) the dispensary license renewal is not approved; (vi) the dispensary fails to maintain its dispensary license in good standing with the regulators resulting in the revocation of the dispensary license. One of our license holder’s customers that the Company’s products are distributed to accounts for 33% of our cultivation revenue for the nine months ended June 30, 2022. Should our products no longer be distributed to this customer of our license holder, it would have a material adverse effect on our operations.

 

 

Note 810 - Commitments and Contingencies

 

The production and possession of marijuanacannabis is prohibited on a national level by the United States of America,Controlled Substances Act, though the state of Arizona allows these activities to be performed at licensed facilities such as BSSD. If the federal government decides to enforcechange its policy on the enforcement of the Controlled Substances Act, it couldwould have a material adverse effect on our business. However, the Company does not currently believe the federal prohibition of these activities will negatively impact the business. As such, the Company has not elected to record a related accrual contingency.

 

On April 20, 2018, the Company entered into an agreement for the purchase of approximately 44 acres of land from an affiliate of a founding member of BSSD. The purchase price of the property is $3,000,000, payable as follows; (i) $200,000 deposited with escrow agent as an initial earnest money deposit, (ii) on or before February 1, 2019, the Company will deposit an additional $800,000 into escrow as additional earnest money deposit and (iii) the balance of the purchase price shall be paid via a promissory note. The earnest money amounts are non-refundable. The Company has negotiated an amendment to this agreement that will spread the $800,000 payment over the course of 4 months. As of the date of these financial statements, $600,000 has been deposited in escrow which has been classified as a long-term asset on the condensed consolidated balance sheet as of June 30, 2021 and September 30, 2020.

The Company entered into a 60 month lease with VGI Citadel LLC, a related party, to rent office space for its corporate headquarters which began on September 1,in June 2019. The monthly lease payments totalwere $6,478 monthly for the first twelve months and include all utilities and an estimated amount for common area maintenance and real estate taxes. The monthly lease rate increasespayments increase to $6,653, $6,828, $7,003, and $7,178 for years two through five, respectively. Rent expense for the three months ended June 30, 2022 and 2021 on this lease was $20,782 and $20,617, respectively. Rent expense for the nine months ended June 30, 2022 and 2021 on this lease was $64,939 and $61,454, respectively. Interest was imputed using a discount rate of 20%. The lease does not include renewal options.

 

In February 2022, the Company assumed a lease to rent approximately 3,100 square feet of retail space in Oklahoma City, Oklahoma as part of the Oklahoma City acquisition disclosed in Note 4. The lease calls for base rent payments of $21 per square foot ($5,483), plus a prorated share of taxes, insurance and common area maintenance expenses, per month and increasing each year by 3% through the end of the lease term on February 28, 2029. The lease may be extended for two additional 5 year periods. Rent expense for the three and nine months ended June 30, 2022 on this lease was $22,129 and $36,406, respectively. There was no rent expense on this lease during the three and nine months ended June 30, 2021. Interest was imputed using a discount rate of 18%.

In March 2022, the Company assumed a lease to rent approximately 2,650 square feet of retail space in Adams County, Colorado as part of the Adams County acquisition disclosed in Note 4. The lease calls for base rent payments of $15,450, plus a prorated share of operating costs of the building, per month and escalate each year to $15,913 in the final year which ends on February 1, 2024. The lease may be extended for one additional 3 year period. Rent expense for the three and nine months ended June 30, 2022 on this lease was $52,822 and $68,870, respectively. There was no rent expense on this lease during the three and nine months ended June 30, 2021. Interest was imputed using a discount rate of 18%.

In September 2021, the Company signed a seven-year lease to rent approximately 3,000 square feet of retail space in Biddeford, Maine. The lease calls for base rent payments of $6,604, plus taxes and operating expenses, per month for the first year and escalate each year to $7,886 per month in year seven. The lease may be extended for two terms of 5 years each. The commencement of this lease is contingent upon the issuance and receipt of a license and city approval. The agreement will terminate if the contingency is not met. At June 30, 2022, the contingency has not been met, however, control over the use of the leased premises has been received by the Company. As such, the Company has recorded the right of use asset and liability to the condensed consolidated balance sheet. Rent expense for the three and nine months ended June 30, 2022 on this lease was $21,781 and $48,197, respectively. There was no rent expense on this lease during the three and nine months ended June 30, 2021. Interest was imputed using a discount rate of 18%.

F-20

The future lease payments are as follows.

Year ended  
June 30, Amount
 2023  $420,720 
 2024   359,998 
 2025   158,342 
 2026   163,093 
 2027   167,985 
 Thereafter   266,399 
     1,536,537 
 Less: imputed interest   (523,462)
     1,013,075 
 Less: current portion:   (256,471)
    $756,604 

In October 2021, the Company entered into a commercial lease agreement to rent 12,000 square feet located in Denver, Colorado. The lease has a term of five years with escalating monthly base rent beginning at $6,354 and escalating each year to $7,295 in year five. Commencement of the lease is contingent upon the Company receiving an approved retail license within 120 days from October 22, 2021. The agreement will terminate if the contingency is not met. As of June 30, 20212022, the contingency has not been met and the Company is currently considering its options in regards to this agreement. The future minimum rental payments under this lease have not been included in the Company’s right of use asset and liability at June 30, 2022 or the future lease payments schedule above.

As of June 30, 2022 and September 30, 2020,2021, the Company has accrued unpaid payroll taxes of approximately $2,100,000and $1,700,000, respectively, which includes estimated penalties and interest of approximately $1,350,000 and $2,400,000, respectively, and is included in accrued expensespayroll and payroll taxes in the accompanying condensed consolidated balance sheets. The Company is making monthly payments of $94,278, beginning March 1, 2022, to pay this liability. Further, during the three months ended June 30, 2022, the Company received approximately $294,000 of Employee Retention Credits ("ERCs") that were used to reduce the unpaid payroll taxes liability. The ERCs were recorded to payroll and employee related expenses on the condensed consolidated statement of operations.

There are no material pending legal proceedings in which the Company or any of its subsidiaries is a party or in which any director, officer or affiliate of the Company, any owner of record or beneficially of more than 5% of any class of its voting securities, or security holder is a party adverse to us or has a material interest adverse to the Company.

 

 

Note 911 - Related Party Transactions

 

As discussed in Note 8,7, the Company has entered into an agreement as of April 20, 2018 forcompleted the purchase of land.44 acres of land from a related party for $3.0 million plus expenses. The land-owner is one of the original members of BSSD and a current employee of the Company.

 

As discussed in Note 6, BSSD Group, LLC, a wholly owned subsidiary of the Company entered into a loan agreement with Viridis.

As discussed in Note 6, the Company has notes payable to Viridis I9 Capital LLC and Stockbridge Enterprises with varying terms as of June 30, 2021.

As discussed in Note 8, the Company has entered into various loan agreements with Viridis or its related entities. Two members of Viridis serve on the Company’s board of directors and one of these members also serves as the Company’s Chief Executive Officer.

As discussed in Note 8, the Company has a loan agreement with Stockbridge Enterprises. Stockbridge Enterprises holds more than 5% of the Company’s common stock.

F-21

As discussed in Note 10, the Company has a lease agreement with VGI Capital LLC. A memberTwo members of VGI Capital was elected toLLC serve on the Company'sCompany’s board of directors on December 21, 2018 and is currentlyone of these members also serves as the Company's CEO.Company’s Chief Executive Officer.

 

During the three months ended June 30, 2022 and 2021, the Company purchased cultivation supplies from a related party in the amount of $0 and $13,868, respectively. During the nine months ended June 30, 2022 and 2021, the Company purchased cultivation supplies from a related party in the amount of $31,708 and $39,397, respectively. This related party is owned by the parent of a stockholder that holds more than 5% of the Company’s common stock.

Included in our accounts payable at June 30, 20212022 and September 30, 20202021 is approximately $80,000231,000, and $90,000138,000, respectively in amounts due to related parties.

F-14

Note 1012 - Stockholders' Equity

 

Common StockUnit Offering

 

InPrior to the three months ended June 30, 2022, the Company began offering up to 28,000,000 units of the Company for $1.40 per Unit on a “best-efforts/no minimum” basis pursuant to Regulation A of Section 3(6) of the Securities Act of 1933, as amended, for Tier 2 offerings. Each Unit is comprised of one share of common stock and one-half of one warrant to purchase a share of common stock. Only whole warrants are exercisable. Each whole warrant entitles the holder to purchase one share of common stock for $2.00 per share, subject to certain adjustments, from the date of issuance until the second anniversary of the date of issuance and is redeemable by the Company under certain conditions. Effective May 4, 2022, the Company repriced the offering to $1.12 per Unit and the exercise price of the warrant was reduced to $1.75 per share. The Company has incurred approximately $922,000 in fees related to this offering. These fees are included in Other assets on the condensed consolidated balance sheet at June 30, 2022 and will be netted against the proceeds received in the offering.

Warrants

The following table summarizes the Company’s warrant activity for the nine months ended June 30, 2020, in the normal course of business, the Company issued 55,618 shares of restricted common stock, valued at $132,106 as consideration for various contracts, including venue sponsorships, marketing, and investor relations.2022:

 

  Common Shares Issuable Upon Exercise of Weighted Average Weighted Average Contractual Aggregate
  Warrants Exercise Price Term in Years Intrinsic Value
Balance of warrants at September 30, 2021  46,095,000   2.08  3.9  14,243,000 
                 
Warrants granted  1,974,687   2.68   2.8   —   
Exercised  —     —     —     —   
Forfeited/Cancelled  —     —     —     —   
                 
Balance of warrants at June 30, 2022  48,069,687  $2.10  $3.7  $1,375,000 

As discussed in Note 2,

(1)The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of the Company’s common stock as of June 30, 2022, for those awards that have an exercise price currently below the closing price as of June 30, 2022. Awards with an exercise price above the closing prices as of June 30, 2022 are considered to have no intrinsic value.

The following range of assumptions were used to estimate the fair value of warrants issued during the nine months ended June 30, 2020,2022, using the Company agreed to issue 3,250,000 shares of restricted common stock, valued at $3,507,000Black-Scholes option-pricing model, excluding the 234,943 whole warrants issued as part of an asset acquisition. The stock has been reserved, though certain criteria must be met for the issuance to occur.Company’s unit offering.

Nine months ended

June 30, 2022
Expected stock price volatility92% - 130%
Risk-free interest rate0.10% - 0.30%
Expected term (years)1.0 - 2.0
Expected dividend yield0%
Black-scholes value$0.34 - $0.89

 

In

F-22

Stock Options

On June 21, 2019, the Company’s shareholders voted to approve the 2019 Equity Incentive Plan (the “2019 Plan”). Pursuant to the 2019 Plan, the maximum aggregate number of Shares available under the Plan through awards is the lesser of: (i) 6,000,000 shares, increased each anniversary date of the adoption of the plan by 2 percent of the then-outstanding shares, or (b) 10,000,000 shares. The maximum contractual term of the award is 10 years. The vesting period for options outstanding at June 30, 2022 ranges from vesting immediately to three years.

The following table summarizes the Company’s stock option activity for the nine months ended June 30, 2020, the Company issued 26,282 shares of restricted common stock to employees, valued at $75,000.2022:

 

  Common Shares Issuable Upon Exercise of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term in Years Aggregate Intrinsic Value (1)
Balance of Options at September 30, 2021  5,217,315  1.23   8.9   2,633,375 
                 
Options granted  1,161,582   1.55   6.7   15,800 
Exercised  (41,104)  0.87   8.3   19,730 
Forfeited/Cancelled  (114,331)  0.94   —     —   
                 
Balance of Options at June 30, 2022  6,223,462  $1.29   7.9  $67,175 
                 
Exercisable at June 30, 2022  2,456,774  $1.33   7.3  $33,588 
Unvested at June 30, 2022  3,766,688  $1.27         

In

 Number of Options Weighted Average Grant Date Fair Value
Unvested at June 30, 2022 3,766,688  $1.21 
Granted during the nine months ended June 30, 2022 1,161,582  $1.37 
Vested during the nine months ended June 30, 2022 358,004  $1.49 
Forfeited during the nine months ended June 30, 2022 114,331  $1.91 

(1)The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of the Company’s common stock as of June 30, 2022, for those awards that have an exercise price currently below the closing price as of June 30, 2022. Awards with an exercise price above the closing prices as of June 30, 2022 are considered to have no intrinsic value.

The following range of assumptions were used to estimate the fair value of stock options granted during the nine months ended June 30, 2021, in2022, using the normal course of business,Black-Scholes option-pricing model.

Nine months ended
June 30, 2022
Expected stock price volatility126% - 176%
Risk-free interest rate.7% - 2.6%
Expected term (years)2.8 - 6.5
Expected dividend yield0%
Black-scholes value$0.68 - $3.01

During the three months ended June 30, 2022 and 2021, the Company issued recognized compensation expense of $111,765934,681 shares of restricted common stock to vendors, valued atand $163,236304,672.

, respectively. During the nine months ended June 30, 2022 and 2021, the Company raised $13,299,808 via private placement. The Company issued 15,646,643 shares with a selling price for its restricted common stockrecognized compensation expense of $0.852,533,535. and $914,016, respectively. At June 30, 2022, there was $2,299,311 of total unrecognized compensation cost. This unrecognized cost is expected to be recognized over the weighted average vesting period of 1 year. 

 

In March 2021, the Company issued 19,080,000 shares of restricted common stock for the OCG, Inc. acquisition. See Note 2.

F-23

 

Warrants

As of June 30, 2021, there are 41,415,000 warrants for purchase of the Company's common stock outstanding. Warrants outstanding as of June 30, 2021 are as follows:

  Common Shares Issuable Upon Exercise Exercise Price Grant Date Expiration
Warrants issued by predecessor  100,000  $1.00  7/28/2016  7/28/2021 
Warrants issued in connection with debt financing  500,000  $0.05  2/14/2020  2/14/2025 
Warrants issued in connection with acquisition  2,000,000  $1.13  2/14/2020  2/14/2023 
Warrants issued in connection with debt financing  10,000,000  $0.75  3/28/2020  3/29/2025 
Warrants issued in connection with debt financing  3,500,000  $1.00  5/1/2020  5/2/2025 
Warrants issued in connection with debt financing  400,000  $0.05  5/1/2020  5/2/2025 
Warrants issued in connection with acquisition  23,560,000  $3.00  3/19/2021  6/30/2024 
Warrants issued in connection with debt financing  1,355,000  $3.00  3/16/2021  6/30/2024 
Balance of Warrants at June 30, 2021  41,415,000           

Stock Options

As of June 30, 2021, there are 3,211,709 stock options outstanding, 287,491 of those options are exercisable with a weighted average exercise price of $5.34. The 2,924,218 unvested options have a weighted average exercise price of $0.87.

Note 11 - Going Concern13 – Segment Information

 

The accompanying condensed consolidated financial statements have been prepared in conformity with GAAP, which contemplate continuationCompany has identified two segments: the cultivation, production and sale of cannabis products (Cultivation) and the sales of Unity Rd. franchises to dispensaries (Franchising). The following tables presents segment information for the three and nine months ended June 30, 2022 and 2021. The Company acquired the Franchising segment at the closing of the Company as a going concern. The Company has not yet established an ongoing sourceacquisition of revenue sufficient to cover its operating costs and has incurred net losses since its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company's planned ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion of the assets in the accompanying condensed consolidated balance sheets is dependent upon continued operations of the Company which in turn is dependent upon the Company's ability to meet its financing requirements, and the success of its future operations. The Company operates in a new, developing industry with a variety of competitors. These factors raise substantial doubt about the Company's ability to continue as a going concern. As a result, the Company's independent registered public accounting firm included an emphasis-of-matter paragraph with respect to the consolidated financial statements for the year ended September 30, 2020, expressing uncertainty regarding the Company's assumption that it will continue as a going concern.OCG, Inc. effective March 19, 2021.

 

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management's plans in regard to these matters are described as follows:

Sales and Marketing. Historically, the Company has generated the majority of its revenues by providing its products to dispensaries throughout the state of Arizona. The Company's revenues have increased significantly since its inception in May 2017. Management will continue its plans to increase revenues in the Arizona market by providing superior products. Additionally, as capital resources become available, the Company plans to expand into additional markets outside of Arizona, with construction of a cultivation and processing facility underway in Nevada.

Financing. To date, the Company has financed its operations primarily with loans from shareholders, private placement financings and sales revenue. Management believes that with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will grow significantly, thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there is no assurance that the Company's overall efforts will be successful.

If the Company is unable to generate significant sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations, and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations are available. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

  Cultivation Franchising Corporate Total
Nine months ended June 30, 2022      
Revenues from external customers $17,360,844  $280,529  $114,146  $17,755,519 
Operating income (loss)  3,993,350   (2,705,153)  (10,042,901)  (8,754,704)
Interest expense  460,524   79,993   3,392,401   3,932,918 
Depreciation and amortization  90,362   901,675   328,627   1,320,664 
Additions to property, equipment and construction in progress  25,623   —     15,631,945   15,657,568 
                 
Three months ended June 30, 2022                
Revenues from external customers $4,861,737  $22,031  $47,554  $4,931,322 
Operating income (loss)  983,533   (1,001,768)  (3,829,572)  (3,847,807)
Interest expense  303,462   36,777   1,284,916   1,625,155 
Depreciation and amortization  27,830   300,150   111,072   439,052 
                 
At June 30, 2022                
Property, equipment and construction in progress, net $421,757  $20,899  $25,864,556  $26,307,212 
Total assets (after intercompany eliminations)  5,102,841   68,217,019   47,207,983   120,527,843 
                 
Three and nine months ended June 30, 2021                
Revenues from external customers $6,585,396  $78,418  $29,247  $6,693,061 
Operating income (loss)  2,315,224   (484,351)  (2,078,147)  (247,274)
Interest expense  123,286   112,419   393,560   629,265 
Depreciation and amortization  16,530   5,633   89,996   112,159 
                 
At June 30, 2021                
Property, equipment and construction in progress, net $1,526,319  $34,990  $7,852,680  $9,413,989 
Total assets (after intercompany eliminations)  12,313,816   118,976,427   18,633,128   149,923,371 

 

Note 1214 - Subsequent Events

 

Subsequent to June 30, 20212022 the 100,000 warrants set to expirefollowing events have occurred.

The Company’s North Denver dispensary location began operations on July 28, 202111, 2022, making it the Company’s first corporate-owned shop in Colorado under the Company’s cannabis dispensary brand, Unity Rd.

The Company has sold 1,700 units under its offering pursuant to Regulation A of Section 3(6) of the Securities Act of 1933, as amended, for Tier 2 offerings for total proceeds of $1,904 subsequent to June 30, 2022.  

The Company received short-term loans in the aggregate amount of $1,370,000 from Viridis, a related party. The terms of these short-term loans are being determined as of the date of the filing.

On July 20, 2022, the Company entered into short-term financing arrangement with Capybara Capital. The proceeds of $0.5 million were exercised usingused for working capital purposes. Payments of $18,889 are due weekly until $0.68 million has been repaid. This results in an effective interest rate of 36%.

On July 22, 2022, the cashless provision.Company entered into a short-term financing arrangement with Upwise Capital. The proceeds of $1.954 million were used to repay the second short-term financing arrangement (see (l) in Note 8 above) and the Upwise Capital 2 financing arrangement (see (v) in Note 8 above). Payments of $55,552 are due weekly until $2.598 million has been repaid. This results in an effective interest rate of 33%.

On July 22, 2022, the Company entered into a short-term financing arrangement with Lendspark. The proceeds of $0.65 million were used to repay the previous Lendspark short-term financing (see (u) in Note 8 above) in the amount of $0.591 million, and the remainder of the proceeds, approximately $0.05 million was used for working capital purposes. Payments of $17,680 are due weekly until $0.884 million has been repaid. This results in an effective interest rate of 36%. 

 F-15F-24 

 

 

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended September 30, 20202021 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company's Annual Report on Form 10-K for the year ended September 30, 2020,2021, filed with the Securities and Exchange Commission (the "SEC") on January 12, 2021.13, 2022.

 

Forward-Looking Statements

 

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the securities Exchange Act of 1934, as amended, (the "Exchange Act"), which are subject to the "safe harbor" created by those sections. The words "anticipated," "believes," "estimates," "expects," "intends," "may," "plans," "projects," "will," "should," "could," "predicts," potential,"potential," continue,"continue," "would," and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this quarterly report on Form 10-Q. You should carefully consider these risks and uncertainties described and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

 

Overview

 

Item 9 Labs produces premium cannabis and cannabis related products in a rapidly growing market. WeThe Company currently offeroffers over seventy-five (75) active cannabis strains and more than 300one hundred fifty (150) differentiated cannabis vape products that we group in the following categories: flower; concentrates; distillatesas well as premium concentrates and hardware. OurOrion vape technologies. The Company’s product offerings will continue to grow as wethey develop new products to meet the needs of the end users. We make ourThe Company makes its products available to consumers through licensed dispensaries in Arizona. Item 9 Labs'Labs’ products are now carried in more than 80 dispensaries throughout the state of Arizona.

The Company believes its past and future success is dependent upon its ongoing ability to understand the needs and desires of the consumers, and the Company develops and offers products that meet those needs.

The Company’s objective is to leverage its assets (tangible and intangible) to fuel the growth of its share of the Arizona cannabis market, as well as expand the geographical reach of its products into markets outside of Arizona, with the ultimate goal of providing comfortable cannabis health solutions to a larger population in a manner that will create value for the Company’s shareholders.

In March 2020, the World Health Organization categorized Coronavirus Disease 2019 ("COVID-19"(“COVID-19”) as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The services we provide are currently designated an essential critical infrastructure business under the President's COVID-19 guidance, the continued operation of which is vital for national public health, safety and national economic security. The extent of the impact of the COVID-19 outbreak on ourthe Company’s operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, its impact on ourits customers and vendors, and the range of governmental and community reactions to the pandemic, which are uncertain and cannot be fully predicted at this time. As of the date of this filing,

In March 2021, the Company has not experienced any material negative impact fromclosed on the pandemic, though it is unknown what will occur going forward.

We believe our past and future success is dependent upon our ongoing ability to understand the needs and desiresacquisition of the consumers, and we develop and offer products that meet those needs.

Our objective is to leverage our assets (tangible and intangible) to fuel the growth of our share of the Arizona cannabis market, as well as expand the geographical reach of our products into markets outside of Arizona, with the ultimate goal of providing comfortable cannabis solutions to a larger population in a manner that will create value for our shareholders.

On December 13, 2020, the Company and I9 Acquisition Sub Inc. ("Merger Sub"), entered into an Agreement and Plan of Merger (the "Agreement") with OCG, Inc., dba Unity Rd., a Colorado corporation ("Target"), pursuant to which the Merger Sub will be merged with and into the Target incannabis dispensary franchisor. The transaction was structured as a reverse triangular merger, with the Target continuing as the surviving entity aseffect of OCG, Inc. becoming a wholly-owned directwholly owned subsidiary of the Company ("Merger"). OCG Inc. ownsCompany. Unity Rd has agreements with more than twenty (20) entrepreneurial groups to open more than thirty (30) Unity Rd retail dispensary locations in twelve (12) states. The majority of the dispensary franchise concept, Unity Rd.locations are in the licensing process. We currently have one franchisee operating in Boulder, Colorado. Unity Rd. will be the retail vertical of the Company, will be supplied with premiumassist in providing distribution for Item 9 Labs products and gives the Company a less capital intensive method of expanding into other markets. The transaction closed on March 19, 2021.

Unity Rd willto be the vehicle to bring Item 9 Labs productssold across the United States and internationally to its franchisees for public resale, while keeping dispensaries locally owned and operated, empowering entrepreneurs to confidently and successfully operate their business and contribute to their local communities.operated. As the Unity RdRd. dispensaries achieve sufficientexpand in its market penetration, Item 9 Labs aims to offer its products in those locations to expandby expanding the distribution footprint of its premium product offerings. In June 2021, the first Unity Rd franchise location opened in Boulder, Colorado.offerings to new states.

Our

25

The Company’s Arizona cannabis operations saw significant expansion as well, bothhave expanded in our physical and geographic footprint. Our physical footprint expandedrecent years, with the addition of a 2nd2nd nearly 10,000 square foot facility in the 4th4th quarter of fiscal year 2019, more than doubling ourthe Company’s cultivation and processing space for Arizona. As the Company methodically expanded ourits operational capacity by more than 100% in fiscal year 2020, we wereit was also able to significantly increase efficiencies within the cultivation and processing operations. The increased efficiencies have been offset in the current period by certain supply shortages and repair and maintenance delays resulting in longer production lead times.

The Arizona expansion will continuehas continued in fiscal year 2021. We have2022 and is expected to continue thereafter. The Company has tripled production since October 1, 2020, and we continue driving towards doubling production in the second half of the year, while beginning construction on phase 1 of ourits construction plan to build additional cultivation space. Phase 1 plans total over 60,000 square feet of additional cultivation and processing space, and the planned remaining five phases willwould add over 600,000560,000 square feet of cultivation and processing space. By the conclusion of the master site development, the Company anticipates a total of more than 640,000 square feet of cultivation and processing space; there is no assurance the Company can complete these construction projects as planned. 

The Company estimates that phase 1 of its construction plan will be completed during the third quarter of its fiscal year 2023. The extension of time to complete phase 1 of its construction plan is primarily due to delays in obtaining the necessary construction permits and supply chain shortages of construction materials. Further, given the current level of inflation and the supply chain shortages, the Company estimates that costs will exceed original estimates by 25%-30%. The needed permits were obtained subsequent to June 30, 2022. The Company may experience additional construction delays. The Company can provide no assurance that it will be able to obtain the financing needed to pay the additional construction costs.

Item 9 Labs Corp. has continued its expansion plans into other states during fiscal year 2020 as well as the Company acquired (pending regulatory approval) cultivation and processing licenses in Nye County, Nevada which will be paired with ourtheir Nevada facility. In fiscal 2019, wethe Company broke ground on ourtheir 20,000 square foot cultivation and processing facility in Nevada. The facility is now approximately 65%98% complete. With financing plansConstruction recommenced, after a pause due to Covid-19, in process, we anticipate recommencing construction in the coming months as we aimAugust 2021. The Company aims to commence operations in Nevada in the fourth quarter ofearly fiscal year 2023. 

On October 6, 2021, the Company entered into an Asset Purchase Agreement (“APA”) to acquire an existing dispensary license and storefront from Nebrina Adams County LLC, a Colorado limited liability company (“Seller”) in Adams County, CO. The total purchase price was $1,536,000, as to which $1,000,000 was paid to an escrow account upon conditional approvals of the change of ownership from state and local licensing authorities concerning the transfer of ownership. At closing, that amount was released to the Seller along with an 18-month promissory note in the principal amount of $200,000 and the balance payable in 300,000 shares of Company common stock, valued at $336,000. The Company obtained financing to consummate this transaction. On March 2, 2022, the Company received the necessary regulatory approvals and completed this transaction. The existing dispensary license had never been operational. This dispensary, known as the Company’s North Denver location, began operations on July 11, 2022, making it the Company’s first corporate-owned shop in Colorado under the Company’s cannabis dispensary brand, Unity Rd.

This license acquisition is part of an overarching acquisition strategy that is intended to accelerate national expansion by creating turnkey investment opportunities for Unity Rd. franchisees. The Company plans to convert acquired dispensaries into Unity Rd. shops, operate them internally and sell them to an existing or first quarterfuture franchise partner. This offers an expedited solution for entrepreneurs seeking immediate entry into cannabis. The Company is targeting numerous similar transactions in the next 12 months to gain a deeper market penetration in select markets. Subsequently and/or concurrently, the Company plans to introduce the Item 9 Labs suite of fiscal yearproducts to the same markets through the acquisition of cultivation and production licenses or through joint ventures with qualified local, licensed operators.

On March 11, 2022, the Company entered into an Asset Purchase Agreement with The Herbal Cure LLC, a Colorado limited liability company, pursuant to which the Company is purchasing certain assets. Effective upon the completion of the sale, which has not occurred as of the date of this filing, the licenses, contracts and certain personal property to operate a licensed medicinal and recreational cannabis dispensary will be delivered to the Company. The total purchase price is $5,750,000, as to which $250,000 is to be paid upon execution of the Asset Purchase Agreement, $3,700,000 payable at closing, $700,000 shall be financed by seller pursuant to a Secured Promissory Note and the remainder of the purchase prices shall be paid in shares of the Company’s common stock on the closing date. The Secured Promissory Note shall accrue interest at 5% per annum and have a term of 18 months, commencing on the closing date, payable in even monthly installments until paid in full. The shares of the Company’s common stock to be issued shall be in such an amount as is the quotient of $1,100,000 divided by the product of the 10-day volume weighted average price of the shares as of the closing date and 85%. The Company can provide no assurance that it will be successful in finalizing this acquisition.

On May 18, 2022, the Company and its wholly owned subsidiary, OCG Management Ontario, Inc., a corporation formed under the laws of the Province of Ontario (“Purchaser”) solely for the purpose of completing this transaction, entered into a Share Purchase Agreement pursuant to which the Purchaser is purchasing all, but not less than all, of the issued and outstanding shares in the capital of Wild Card Cannabis Incorporated, a corporation formed under the laws of the Province of Ontario free and clear of all Liens from the Shareholders. The Company can provide no assurance that it will be successful in finalizing this acquisition.

The total purchase price for the Shares is Twelve Million Eight Hundred Thousand Dollars ($12,800,000.00 USD) (the "Purchase Price"), as adjusted, plus the Earnout Payment, if any (collectively, the “Purchase Price”) payable as follows:

(i) The Company has delivered the Exclusivity Deposit in the amount of $156,902 to the Escrow Agent on March 4, 2022.

 

(ii) At the Closing, Purchaser shall pay to Shareholders the Estimated Purchase Price of Twelve Million Eight Hundred Thousand Dollars ($12,800,000.00 USD), as adjusted, in immediately available funds;

(iii) Four Million One Hundred Thousand Dollars ($4,100,000.00), as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the First Earnout Period (the date that is 12 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the First Earnout Period is greater than or equal to the Target Net Revenue for the First Earnout Period; and

(iv) Four Million One Hundred Thousand Dollars ($4,100,000.00), as adjusted, payable by the delivery of the Company’s common stock, the number of which will be calculated on the basis of a deemed price per common share equal to the 10-Day VWAP of the trading price of the Company’s common stock on the stock exchange upon which the Company’s common stock is listed, with the last day of the Second Earnout Period (the date that is 24 months following the Closing Date) as the measurement date less a 15% discount, if actual Net Revenue is respect of the Second Earnout Period is greater than or equal to the Target Net Revenue for the Second Earnout Period.

 1626 

 

Results of Operations

  Nine months ended June 30,    
  2022 2021 $ Change % Change
Revenues, net $17,755,519  $15,843,256  $1,912,263   12%
Cost of revenues  11,089,560   8,531,623   2,557,937   30%
Gross profit  6,665,959   7,311,633   (645,674)  -9%
Operating expenses                
Professional fees and outside services  2,207,618   1,350,196   857,422   64%
Payroll and employee related expenses  7,889,672   4,014,819   3,874,853   97%
Sales and marketing  1,260,551   389,819   870,732   223%
Depreciation and amortization  1,320,664   360,601   960,063   266%
Other operating expenses  2,747,158   1,292,154   1,455,004   113%
Provision for bad debt  (5,000)  —     (5,000)  100%
Total operating expenses  15,420,663   7,407,589   8,013,074   108%
Income (loss) from operations  (8,754,704)  (95,956)  (8,658,748)  9024%
Other expense, net  (3,932,600)  (1,763,385)  (2,169,215)  123%
Net loss, before income tax provision (benefit)  (12,687,304)  (1,859,341)  (10,827,963)  582%
Income tax provision (benefit)  7,948   —     7,948   0%
Net loss  (12,695,252)  (1,859,341)  (10,835,911)  583%
Less: Net loss attributable to non-controlling interests  (1,683)  —     (1,683)  100%
Net loss attributable to Item 9 Labs Corp. $(12,693,569) $(1,859,341) $(10,834,228)  583%

 

 Three Months Ended June 30, Nine Months Ended June 30, Three months ended June 30,    
 2021 2020 2021 2020 2022 2021 $ Change % Change
Revenues, net $6,693,061  $2,207,453  $15,843,256  $5,602,321  $4,931,322  $6,693,061  $(1,761,739)  -26%
Cost of services  3,802,447   1,188,831   8,531,623   3,508,350 
Cost of revenues  3,341,367   3,802,447   (461,080)  -12%
Gross profit  2,890,614   1,018,622   7,311,633   2,093,971   1,589,955   2,890,614   (1,300,659)  -45%
                
Operating expenses  3,137,888   1,262,586   7,407,589   4,432,709                 
                
Professional fees and outside services  993,452   442,483   550,969   125%
Payroll and employee related expenses  2,683,722   1,592,673   1,091,049   69%
Sales and marketing  207,213   262,473   (55,260)  -21%
Other operating expenses  1,114,323   728,100   386,223   53%
Total operating expenses  5,437,762   3,137,888   2,299,874   73%
Income (loss) from operations  (247,274)  (243,964)  (95,956)  (2,338,738)  (3,847,807)  (247,274)  (3,600,533)  1456%
                
Other income (expense), net  (586,631)  (1,363,839)  (1,763,385)  (2,821,629)
                
Other expense, net  (1,625,155)  (586,631)  (1,038,524)  177%
Net income (loss), before income tax provision (benefit)  (5,472,962)  (833,905)  (4,639,057)  556%
Income tax provision (benefit)  4,624   —     4,624   0%
Net income (loss) $(833,905) $(1,607,803) $(1,859,341) $(5,160,367)  (5,477,586)  (833,905)  (4,643,681)  557%
Less: Net loss attributable to non-controlling interests  (7,109)  —     (7,109)  100%
Net loss attributable to Item 9 Labs Corp. $(5,470,477) $(833,905) $(4,636,572)  556%

 

Revenues

 

Total revenuesThe increase in revenue for the nine months ended June 30, 2022 was primarily due to a change in certain processes and procedures in the Company’s lab during the year ended September 30, 2021. That is, during fiscal year 2021, the Company purchased equipment to automate certain manual processes. The purchase of this equipment made certain processes, such as the filling of cartridges, more efficient, which allowed for increased output. In order to support this increased output, the Company purchases certain inventory materials from third party vendors that it had previously produced itself. Further, during fiscal year 2021, the Company added and reorganized post-production space to more efficiently package its products for sale. These improvements for the nine months ended June 30, 2022 were offset by the following events during the quarter ended June 30, 2022. 

The decrease in revenue for the three months ended June 30, 20212022 was primarily due to effects of additional competition entering the Company’s market that were $6,693,061 compared tonot as significant during the revenue forsame three month period of the periodprior year. This additional competition resulted in a decrease in units sold and a decrease in unit sales prices. Further, during the three months ended June 30, 2020 of $2,207,453, an increase of $4,485,608 or 203%.2022, the Company experienced supply chain issues that caused a decrease in new orders for the Company’s products and delays in fulfilling existing orders.

 

Total

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Cost of Revenues

Cost of revenues consist primarily of labor, materials, supplies and utilities. Cost of revenues as a percentage of revenues was 68% and 62% for the three and nine months ended June 30, 2022 compared to 57% and 54% for the three and nine months ended June 30, 2021. The Company was able to increase operational efficiency throughout fiscal year 2021. However, the cost of the purchased inventory materials discussed above and increases in other costs, such as product testing, primarily negated these efficiency gains. Further, cost of revenues as a percentage of revenues decreased due to the reduction in unit sales prices during the quarter. Management will remain focused on reducing costs through bulk purchasing, implementing additional efficiencies in production and making additional investments in property and equipment. The Company believes that it will reduce the overall cost of revenues and cost of revenues will increase at a lower rate than revenues in future periods, which will lead to increased profit margins. 

Gross Profit

The decrease in gross profit as a percentage of revenue for the nine months ended June 30, 2021 were $15,843,2562022 was due to increases in revenue offset by price reduction as competition rises and by increases in purchased inventory materials and other costs. Further, the decrease in gross profit as a percentage of revenue of the three months ended June 30, 2022 also decreased due to the decrease in the number of units sold as a result of the increased competition and the supply chain issues experienced. With the Company’s continued efforts to increase capacity and focus on efficiencies and reducing costs, management expects gross profit to increase going forward.

Operating Expenses

Professional fees and outside services increased for the nine months ended June 30, 2022 compared to the revenue for the periodnine months ended June 30, 20202021 primarily due to the amortization of $5,602,321, an increaseprepaid consulting agreements that were entered into subsequent to June 30, 2021 and additional expenses incurred for corporate advisory services, and investor and public relations services. Further, the Company incurred significant legal expenses during the three and nine months ended June 30, 2022 related to entering into the Share Purchase Agreement for the purchase of $10,240,935 or 183%.all of the issued and outstanding shares of Wild Card Cannabis, Incorporated, a corporation formed under the laws of the Province of Ontario, Canada.

 

The increase isin payroll expenses was primarily due to management's focusthe amortization of increasing productionstock-based compensation expense for stock options granted subsequent to June 30, 2021. Further, payroll expenses increased due to an increase in employee headcount during fiscal year 2021 and the nine months ended June 30, 2022, as a result of increased hiring of employees. The increase was offset by approximately $294,000 of Employee Retention Credits ("ERCs") received by the market demand remains to be higher than our production capacity.Company.

 

Costs of Services

Costs of services consist primarily of labor, materials, supplies, utilities,Sales and overhead. Costs of services as a percentage of revenues was 57%marketing expenses increased due to increased spending on promotional items and marketing and branding initiatives during the nine months ended June 30, 2022. The decrease in sales and marketing expenses decreased slightly for the three months ended June 30, 20212022 compared to 54%June 30, 2021 as a result of the decrease in promotional items during the quarter.

The increase in depreciation and amortization is due primarily to the scheduled amortization of intangible assets acquired in the OCG Inc. acquisition in March 2021.

Other operating expenses increased primarily due to increases in insurance expenses, facility expenses, such as rent expense, travel related expenses, and additional IT support for the three months ended June 30, 2020. Costs of servicesincrease in employees.

Total operating expenses as a percentage of revenues was 54%gross profit increased from 109% and 101% for the three and nine months ended June 30, 2021, comparedrespectively, to 63% for the nine months ended June 30, 2020.

As the initial ramp up costs were significant in fiscal year 2020, the Company has been able to increase efficiencies in production. Management believes these costs will continue to increase at a lower rate than revenue growth,342% and production in future periods, which will lead to higher profit margins than these historical figures illustrate. Given the sixteen to seventeen-week grow cycle, efficiencies are not immediately realized in costs. The upcoming expansion is expected to increase profit margins as well as the Company will reduce its outsourced purchases.

Gross Profit

Gross profit for the three months ended June 30, 2021 was $2,890,614 (43%) compared to $1,018,622 (46%) for the three months ended June 30, 2020. Gross profit for the nine months ended June 30, 2021 was $7,311,633 (46%) compared to $2,093,971 (37%) for the nine months ended June 30, 2020. The decrease in profit margin in the current quarter is due to the maturation of the Arizona cannabis market, which saw downward pressure on pricing. The increase in gross profit for the nine month period is due to the Company operating more efficiently during its production expansion. The Company has been able to lower costs since first half of fiscal year 2020 and expects to see gross profit margins continue to increase in future periods.

Operating Expenses

Total operating expenses for the three months ended June 30, 2021 were $3,137,888 compared to $1,262,586 for the three months ended June 30, 2020, an increase of $1,875,302 or 149%. Total operating expenses for the nine months ended June 30, 2021 were $7,407,589 compared to $4,432,709 for the nine months ended June 30, 2020, an increase of $2,974,880 or 67%. Operating expenses as a percentage of revenue decreased to 47% and 47% from 57% and 79%231% for the three and nine months endingended June 30, 2021 and 2020,2022, respectively. The increase in the current quarter and nine month period operating expenses is largely attributable to the acquisition of OCG Inc., its subsidiaries and its brand, Unity Rd. Management believes this ratio will decrease for the Cultivation segment going forward as the expectation is that revenues will grow at a higher rate than operating expenses. The decrease inexpenses, however, management believes that operating expenses will outpace revenues for the Franchising and Corporate segments as a percentagethe Franchising and Corporate segments continue to perform on growth initiatives.

During the three months ended June 30, 2022, the Company has noted indicators of revenuesthe possible impairment of its goodwill and intangible assets. The Company will analyze these indicators during the fourth quarter of the year ended September 30, 2022 and determine if any impairment has occurred. Given the carrying value of the Company’s goodwill and intangible assets at June 30, 2022, the occurrence of an impairment may be material to the Company’s financial position and results of operations.

Other Expense, net 

Other expenses consist primarily of interest expense of $1,625,155 and $3,932,918 for the three and nine months ended June 30, 2022, respectively, and $629,265 and $1,806,019 for the three and nine months ended June 30, 2021, respectively. The increase in interest expense was dueprimarily the result of the continued interest and amortization of debt discounts for debt outstanding at June 30, 2021 and the additional interest and amortization of debt discounts for debt incurred subsequent to June 30, 2021. This increase in interest expense was offset by debt and amortization of debt discounts that were capitalized to construction in progress related to the Company's focus on increasing revenue, reducing expenses and performing more efficiently.Company’s capital projects.

 

Interest ExpenseAdjusted EBITDA

 

TotalManagement uses the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, stock-related compensation expense, acquisition-related costs, and other adjustments, or “Adjusted EBITDA,” to evaluate the Company’s performance.  Adjusted EBITDA is a non-GAAP measure that is also frequently used by analysts, investors and other interested parties to evaluate the market value of companies considered to be in similar businesses. The Company suggests that Adjusted EBITDA be viewed in conjunction with its reported financial results or other financial information prepared in accordance with accounting principles generally accepted in the United States, or “US GAAP.” 

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The following table reflects the reconciliation of net income (loss) to Adjusted EBITDA for the three and nine months ended June 30, 2021 was $629,2652022 and $1,806,019, respectively, compared to $1,362,347 and $2,820,137, respectively, for the three and nine months ended June 30, 2020, a decrease of $733,082 and $1,014,118 for the three and nine months respectively. Included in interest expense is non-cash amortization of debt discounts. Amortization of discounts totaled $292,662 and $565,021, respectively, for the three and nine months ended June 30, 2021 compared with $926,803 and 1,273,739 for the three and nine months ended June 30, 2020, respectively.2021:

 

17
  Three months ended June 30, Nine months ended June 30,
  2022 2021 2022 2021
Net loss $(5,477,586) $(833,905) $(12,695,252) $(1,859,341)
Depreciation and amortization  439,052   112,159   1,320,664   360,601 
Interest expense  1,625,155   629,265   3,932,918   1,806,019 
Income tax expense  4,624   —     7,948   —   
Stock-based expense  1,161,739   304,672   3,032,518   1,077,252 
Acquisition related costs  479,904   5,804   499,904   272,541 
Adjusted EBITDA $(1,767,112) $217,995  $(3,901,300) $1,657,072 

 

The approximately $5.6 million change from prior year is due to the addition of the franchise business, as well as significant investments in human capital and infrastructure to prepare for anticipated growth. 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity and Capital Resources

 

OurThe Company’s primary need for liquidity is to fund working capital requirements of ourits business, capital expenditures, acquisitions, debt service, and for general corporate purposes. OurThe Company’s primary source of liquidity is funds generated byfrom revenues, financing activities and from private placements. OurThe Company’s ability to fund ourits operations, to make planned capital expenditures, to make planned acquisitions, to make scheduled debt payments, and to repay or refinance indebtedness depends on ourits future operating performance and cash flows, which are subject to prevailing economic conditions and financial, business and other factors, some of which are beyond ourthe Company’s control.

 

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted inassuming the United States, which contemplate continuation of the Company as a going concern. The Company has not yet established an ongoing source of revenue sufficient to cover its operating costs and has incurred net losses since its inception. These losses, with the associated substantial accumulated deficit, are a direct result of the Company's planned ramp up period as it is pursuing market acceptance and geographic expansion. In view of these matters, realization of a major portion of the assets in the accompanying condensed consolidated balance sheets is dependent upon continued operations of the Company which in turn is dependent upon the Company's ability to meet its financing requirements, and the success of its future operations. The Company operates in a new, developing industry with a variety of competitors. These factors raise substantial doubt about the Company's ability to continue as a going concern. As a result, the Company's independent registered public accounting firm included an emphasis-of-matter paragraph with respect to the consolidated financial statements for the year ended September 30, 2020, expressing uncertainty regarding the Company's assumption that it will continue as a going concern.

 

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management's plans in regard to these matters are described as follows:

 

Sales and Marketing.Marketing. Historically, the Company has generated the majority of its revenues by providing its products to dispensaries throughout the state of Arizona. The Company's revenues have increased significantly since its inception in May 2017 and continue to grow as of the date of these condensed consolidated financial statements.2017. Management will continue its plans to increase revenues in the Arizona market by providing top qualitysuperior products. Additionally, as capital resources become available, the Company willplans to expand into additional markets outside of Arizona, with construction of a cultivation and processing facility underwaynearing completion in Nevada. The Company believes that it will continue reducing the overall cost of revenues and cost of revenues will increase at a lower rate than revenues in future periods, which will lead to increased profit margins.

 

Financing.Financing. To date, the Company has financed its operations primarily with loans from shareholders, private placement financings and sales revenue. Management believes that with continued production efficiencies, production growth, and continued marketing efforts, sales revenue will continue to grow, significantly, thus enabling the Company to reverse its negative cash flow from operations and raise additional capital as needed. However, there is no assurance that the Company's overall efforts will be successful.

 

If the Company is unable to generate significantadditional sales growth in the near term and raise additional capital, there is a risk that the Company could default on additional obligations and could be required to discontinue or significantly reduce the scope of its operations if no other means of financing operations are available. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

29

As of June 30, 2021,2022, the Company had $296,892$441,662 of cash and cash equivalents and negative working capital of $917,720($33,778,387) (current assets minus current liabilities), compared with $84,677$1,454,460 of cash and ($7,396,258) ofcash equivalents and negative working capital of ($4,893,385) as of September 30, 2020.2021. The increasedecrease of $8,313,978$28,885,002 in ourthe Company’s working capital is primarily due to increases in the amount of the Company’s debt maturing within the next 12 months. The decrease is also due to decreases in the Company’s cash, accounts receivable, inventory and $212,215prepaid balances and increases in the Company’s accounts payable and other operating liabilities and the current portion of operating lease liabilities. The $1,012,798 decrease in cash and cash equivalents was primarily due to the salenet cash used in operating activities, purchases of property, equipment and construction in progress related to the Company's restricted common stock as well as investingCompany’s capital projects, and the cash proceedsCompany’s acquisition of a dispensary license in inventory to be able to increase sales and profitability.Colorado. The Company is an early-stage growth company. It is generating cash from sales and is investing its capital reserves in current operations plant expansion and enhancement, and new acquisitions that willare expected to generate additional earnings in the long term. The Company expects that its cash on hand and cash flows from operations, along with private and/or public financing, will be adequate to meet its capital requirements and operational needs for the next 12 months, although no assurance can be given that private and/or public financing can be obtained on terms acceptable to the Company, or at all.

 

Cash Flows

 

The following table summarizes the sources and uses of cash for each of the periods presented:

 

 Nine Months Ended June 30, Nine months ended June 30,    
 2021 2020 2022 2021 $ Change % Change
Net cash used in operating activities $(6,877,259) $(970,401) $(2,016,148) $(6,877,259) $4,861,111   -71%
Net cash used in investing activities  (3,851,950)  (939,163)  (3,769,744)  (3,851,950)  82,206   -2%
Net cash provided by financing activities  10,941,424   1,899,336   4,773,094   10,941,424   (6,168,330)  -56%
Net increase (decrease) in cash and cash equivalents $212,215  $(10,228) $(1,012,798) $212,215  $(1,225,013)  -577%

 

18

Operating Activities

 

During the nine months ended June 30, 2022, operating activities used $2,016,148 of cash and cash equivalents, primarily resulting from a net loss of $12,695,252 which was offset by net cash provided by operating assets and liabilities of $3,918,454. There was significant non-cash activity that contributed to the net loss totaling $6,760,650 including depreciation and amortization of $1,410,508, amortization of debt discount of $2,311,783, and stock-based compensation of $3,032,518.

During the nine months ended June 30, 2021, operating activities used $6,877,259 of cash, primarily resulting from a net loss of $1,859,341which was extended by net cash used in operating assets and liabilities of $7,060,610. There was significant non-cash activity that contributed to the net loss totaling $2,042,692 including depreciation and amortization of $400,419, amortization of debt discount of $565,021, and stock based compensation of $1,077,252. With the increase in revenues, the Company's receivables increased $1,703,092, deferred costs increased $6,348,573 and prepaid expenses increased $192,292, offset by an increase in current liabilities of $1,183,347.

Investing Activities

 

During the nine months ended June 30, 2020, operating2022, investing activities used $970,401$3,769,744 of cash and cash equivalents, consisting primarily resulting fromof $2,918,584 in purchases of property, equipment and construction in progress, the purchase of a net lossdispensary license in the amount of $5,160,367 which was$1,130,872, cash payments for acquisitions of $140,726 and cash paid to acquisition escrow accounts of $406,932, offset by net$816,227 of cash provided by operating assets and liabilities of $1,820,034. There was significant non-cash activity that contributed toreceived from the net loss totaling $2,369,932 including depreciation and amortization of $2,140,366, provision for bad debt of $22,460, and compensation paid in the form of stock of $207,106.escrow deposit accounts.

 

Investing Activities

During the nine months ended June 30, 2021, investing activities used $3,851,950 of cash, consisting primarily of $2,263,388 in purchase of property and equipment and $1,685,368 of deposits paid on an acquisition.

Financing Activities

 

During the nine months ended June 30, 2020, investing2022, financing activities used $939,239provided $4,773,094, consisting of cash, consisting primarily$7,282,763 in proceeds from the issuance of $500,000debt, $555,911 in purchasesproceeds from the issuance of cannabis licensesstock and $426,663offset by $3,002,097 of capitalized legal fees related to trademarks and licenses.debt payments made.

 

Financing Activities

During the nine months ended June 30, 2021, financing activities provided $10,941,424, consisting of $13,298,965 in proceeds from the issuance of stock and proceeds from the issuance of convertible debt of $1,355,000 and offset by $3,712,541 in debt payments made.

During the nine months ended June 30, 2020, financing activities provided $1,899,336, consisting of $4,092,000 in proceeds from the issuance of debt offset by $2,192,664, in debt payments made.

 

Given that our cash needs are strongly driven by our growth requirements, we also intend to maintain a cash reserve for other risk contingencies that may arise.

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We intend to meet our cash requirements for the next 12 months through the use of the cash we have on hand and through business operations, future equity financing, debt financing, or other sources, which may result in further dilution in the equity ownership of our shares. We currentlyhave filed an offering document on Form 1-A with the Securities and Exchange Commission in order to sell units comprising of one share of common stock and one-half of one warrant. We are also in discussions with various potential capital partners to provide additional debt capital for accretive acquisitions. We do not have any other arrangements in place to complete any private placement financings of debt and equity and thereequity. There is no assurance that we will be successful in completing the offering on Form 1-A, or in finding a capital partner to provide additional debt capital or any other such financings on terms that will be acceptable to us.

 

Off-Balance Sheet Arrangements

 

We are not currently a party to, or otherwise involved with, any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

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Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of our condensed consolidated financial statements requires us to make estimates and judgements that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. SignificantCritical accounting policies and estimates in these condensed consolidated financial statements include but are not limitedthose related to accounting for depreciationrevenue recognition, valuation of options, warrants and amortization, current and deferred income taxes, deferred costs, accruals and contingencies,debt discounts, carrying value of goodwill and intangible assets collectability of notes receivable, the fair value of common stocksubject to amortization, infinite life intangible assets and the estimated fair value of stock optionsgoodwill, stock-based compensation, and warrants and the estimated fair value of the consideration paid and the fair value of assets purchased and liabilities assumed in the acquisition of OCG, Inc.income taxes. We base our estimates on historical experience, our observance of trends in particular areas, and information or valuations and various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying value of assets and liabilities that may not be readily apparent from other sources. Actual amounts could differ significantly from amounts previously estimated. For a discussion of our critical accounting policies, refer to Part I, item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended September 30, 2020.2021. Management believes that there have been no material changes in our critical accounting policies during the three months ended June 30, 2021.2022.

 

Recently Issued Accounting Pronouncements

 

See Note 1 to our condensed consolidated financial statements, included in Part I, Item 1, Financial Information for this quarterly report on Form 10-Q.

Seasonality

We do not expect our sales to be impacted by seasonal demands for our products and services. Also, due to the fact we use indoor grow space, seasonality should not have any impact on our cultivation operations.

Inflation

We do not believe that inflation had a material impact on us for the three and nine months ended June 30, 2021 or 2020, though the increase in prices in building materials will impact the costs of our construction projects, though the Company believes the increase in costs will not impact the overall return on investment significantly.

 

Contractual Obligations

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

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ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

ITEM 4.CONTROLS AND PROCEDURES

 


Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by our company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management carried out an evaluation under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act"). Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were not effective as of June 30, 2021.2022.

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Identified Material Weaknesses

A material weakness in our internal control over financial reporting is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.

Management identified the following material weaknesses during its assessment of internal controls over financial reporting, which are primarily due to the size of the Company and available resources:

·lack of properly controlled segregation of duties
·lack of risk assessment procedures on internal control to detect financial reporting risks in a timely manner; and
·lack of documentation on policies and procedures that are critical to the accomplishment of financial reporting objectives.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting subsequent to the fiscal year ended September 30, 2020,2021, which were identified in connection with our management's evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations of the Effectiveness of Disclosure Controls and Internal Controls

 

 Our management, including our Principal Executive Officer and Principal Financial Officer, does not expect that our disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

 

The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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PART II - OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

From time to time, the Company may become subject to various legal proceedings that are incidental to the ordinary conduct of its business. Although the Company cannot accurately predict the amount of any liability that may ultimately arise with respect to any of these matters, it makes provision for potential liabilities when it deems them probable and reasonably estimable. These provisions are based on current information and legal advice and may be adjusted from time to time according to developments.

 

 

ITEM 1A.RISK FACTORS

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Unless otherwise indicated, all of the following sales or issuances of Company securities were conducted under the exemption from registration as provided under Section 4(2) of the Securities Act of 1933 (and also qualified for exemption under 4(5), formerly 4(6) of the Securities Act of 1933, except as noted below). All of the shares issued were issued in transactions not involving a public offering, are considered to be restricted stock as defined in Rule 144 promulgated under the Securities Act of 1933 and stock certificates issued with respect thereto bear legends to that effect. 

 

 1.Quarterly Issuances:

The Company issued 400,00029,965 shares for services during the three months ended June 30, 2021 for $340,000. The proceeds of the issuance are being used to expand the production capacity.2022.

 

 2.Subsequent Issuances:

 

Subsequent to June 30, 2021, the Company issued 265,558 shares.2022, there have been no issuances of unregistered equity securities.

 

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

 

The Company has a convertible note payable to a related party outstanding with an original principal balance of $1,100,000 which is in default as of the date of this filing. The Company and lender are negotiating a long-term arrangement to cure the default.None.  

 

 

ITEM 4.MINE SAFETY DISCLOSURES

 

N/A.

 

 

ITEM 5.OTHER INFORMATION

N/AA.

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ITEM 6.EXHIBITS

 

The exhibits required to be filed herewith by Item 601 of Regulation S-K, as described in the following index of exhibits, are attached hereto unless otherwise indicated as being incorporated by reference, as follows:

 

Exhibit
NumberDescription of Exhibit
3.01aArticles of Incorporation dated June 15, 2010Filed with the SEC on May 12, 2011 as part of our Registration Statement on Form S-1/A.
3.013.01bbCertificate of Amendment to Articles of Incorporation dated October 22, 2012Filed with the SEC on November 13, 2012 as part of our Current Report on Form 8-K
3.013.01ccCertificate of Amendment to Articles of Incorporation dated March 15, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
3.013.01ddCertificate of Amendment to Articles of Incorporation dated March 19, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
3.013.01eeCertificate of Amendment to Articles of Incorporation dated April 3, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
3.013.01ffCertificate of Amendment to Articles of Incorporation dated October  9, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
3.02BylawsFiled with the SEC on May 12, 2011 as part of our Registration Statement on Form S-1/A.
4.12019 Equity Incentive PlanFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
10.03Share Exchange Agreement between Crown Dynamics Corp. and Airware Dated March 20, 2012Filed with the SEC on March 26, 2012 as part of our current report on Form 8-K.
10.04Agreement and Plan of Exchange   between Item 9 Labs Corp. fka Airware and  BSSD Group, LLC dated March 20, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
10.05Purchase Agreement between Sidewinder Dairy, Inc. and the Company  dated April 20, 2018Filed with the SEC on August 16, 2019 as an exhibit to our Form 10-Q
10.6Asset Purchase Agreement between Item 9 Labs Corp. and AZ DP Consulting, LLC dated November 26, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
10.7Loan and Revenue Participation Agreement between Item 9 Labs Corp. and Viridis Group I9 Capital LLC dated September 13, 2018Filed with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
10.8Severance Agreement between Airware Labs Corp and Jeffrey Rassas, effective July 16, 2013Filed with the SEC on July 19, 2013 as part of our Current Report on Form 8-K.
10.910.11EmploymentAgreement and Plan of Merger between Item 9 Labs Corp, I9 Acquisition Sub, Inc., and OCG Inc.Filed with the SEC on December 14, 2020 as part of our Current Report on Form 8-K.
10.12AZ Construction Loan and Security Agreement with Sara Gullickson dated November 26, 2018Pelorus Fund REIT LLCFiled with the SEC on August 31, 2021 as part of our Current Report on Form 8-K.
10.13NV Construction Loan and Security Agreement with Pelorus Fund REIT LLCFiled with the SEC on August 31, 2021 as part of our Current Report on Form 8-K.
14.1Code of EthicsFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
10.1131.01Agreement and PlanCertification of Merger between Item 9 Labs Corp, I9 Acquisition Sub, Inc., and OCG Inc.Principal Executive Officer Pursuant to Rule 13a-14Filed with the SEC on December 14, 2020 as part of our Current Report on Form 8-K.herewith.
14.131.02CodeCertification of EthicsPrincipal Financial Officer Pursuant to Rule 13a-14Filed herewith.
32.01CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley ActFiled herewith.
32.02CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley ActFiled herewith.
99.1Audit Committee CharterFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
31.0199.2Certification of Principal Executive Officer Pursuant to Rule 13a-14Filed herewith.
31.02Certification of Principal Financial Officer Pursuant to Rule 13a-14Filed herewith.
32.01CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley ActFiled herewith.
32.02CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley ActFiled herewith.
99.1AuditCompensation Committee CharterFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
99.299.3CompensationNominations and Governance Committee CharterFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
99.3Nominations and Governance Committee CharterFiled with the SEC on June 27, 2019 as an exhibit to our Registration Statement on Form 10-12G
101.INS*Inline XBRL Instance DocumentFiled herewith.
101.SCH*Inline XBRL Taxonomy Extension Schema DocumentFiled herewith.
101.CAL*Inline XBRL Taxonomy Extension Calculation Linkbase DocumentFiled herewith.
101.LAB*Inline XBRL Taxonomy Extension Labels Linkbase DocumentFiled herewith.
101.PRE*101.PRE*Inline XBRL Taxonomy Extension Presentation Linkbase DocumentFiled herewith.
101.DEF*101.DEF*Inline XBRL Taxonomy Extension Definition Linkbase DocumentFiled herewith.
104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

  

 

*Pursuant to Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 Item 9 Labs Corp.
  
 Date: August 16, 202115, 2022By:/s/ Andrew Bowden 
 

Name:

Title:

Andrew Bowden

Chief Executive Officer

(Principal Executive Officer)

 

 Date: August 16, 202115, 2022By:/s/ Robert Mikkelsen 
 

Name:

Title:

Robert Mikkelsen

Chief Financial Officer

(Principal Financial Officer)

 

 

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