| Description of Business and Summary of Significant Accounting Policies | Note 1 – Description
of Business and Summary of Significant Accounting Policies Description
of Business Item 9 Labs Corp.
(“Item 9 Labs” or 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. Through a licensing
agreement, the Company grows medical marijuana and produces cannabis related products at their facility in Pinal County, Arizona
on behalf of a licensed marijuana dispensary in the state of Arizona. On September 12,
2018, the Company executed a $1,500,000 promissory note (see Note 6) which was used to make a capital contribution into Strive
Management, LLC, a Nevada limited liability company (“Strive Management”). In exchange for the contribution, the Company
received a 20% membership interest in Strive Management. The remaining interests were held by three individuals one of which was
the Company’s former Chief Executive Officer. Through a management agreement with Strive Wellness of Nevada, LLC, a related
party (the Company’s former CEO is a member of this LLC), Strive Management will facilitate the cultivation and processing
of marijuana in Nevada. Strive Wellness of Nevada, LLC has been allocated cultivation and processing licenses from the state of
Nevada. The Company acquired the remaining membership interests in Strive Management in February 2020 as well as the licenses
owned by Strive Wellness of Nevada, LLC. As of December 31, 2020, the licenses have not been transferred to the Company, as the
transfer is awaiting regulatory approval. See Note 2. 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 Item
9 Labs consolidates all variable interest entities (“VIEs”) in which the Company is deemed to be the primary beneficiary
and all other entities in which it has a controlling voting interest. 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 periodically makes judgments in determining whether
its investees are VIEs and, for each reporting period, the Company assesses whether it is the primary beneficiary of any of its
VIEs. As of December 31, 2019, the Company was deemed the primary beneficiary of Strive Management because the entity had insufficient
equity to finance its activities without additional subordinated support. The interests in Strive Management held by non-controlling
members was presented on the statement of operations and statement of stockholders’ equity as non-controlling interest for
the three months ended December 31, 2019. See Note 2. The condensed consolidated
financial statements include the accounts of the Company, its wholly-owned subsidiaries and variable interest entities in which
the Company is the primary beneficiary. Intercompany balances and transactions have been eliminated. Certain balances
have been reclassified in the accompanying 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
unaudited condensed consolidated financial statements of the Company as of December 31, 2020 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 the information and notes necessary for a presentation of financial position and results of operations in accordance
with GAAP and should be read in conjunction with our September 30, 2020 audited financial statements filed with the SEC on our
Form 10-K on January 12, 2021. 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, 2020
condensed balance sheet data from audited financial statements, however, we did not include all disclosures required by GAAP.
The results for the interim period ended December 31, 2020 are not necessarily indicative of the results to be expected for the
year ending September 30, 2021. Accounting Estimates The preparation
of financial statements in conformity with Accounting Principles Generally Accepted in the United States of America (“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,
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. 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 and Restricted Cash 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. Restricted cash represents funds held by a bank pending resolution of a dispute with a
former officer of the Company. The dispute was resolved during the year ended September 30, 2020 and the cash is no longer restricted. Accounts Receivable Accounts receivable
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 expensed in the results of operations in the year in which those differences are determined,
with an offsetting entry to a valuation allowance for accounts receivable. The Company’s policy is to evaluate the collectability
of accounts receivable on an ongoing basis, record an allowance for specific accounts deemed uncollectible, and evaluate the remaining
balance for a general allowance for doubtful accounts. Historical write-offs and current macro and microeconomic conditions are
considered when evaluating the need for an allowance. Accounts receivable are written off when all reasonable collection efforts
have been taken. At December 31, 2020 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
consist of the costs directly related to the production and cultivation of marijuana crops, cannabis oils, and cannabis concentrate
products. Deferred costs are relieved to cost of services as products are delivered to dispensaries. Deferred costs consist 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 December 31, 2020 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 each balance sheet date. 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 (settlement agreement)
· 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. 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 that 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 factors
to determine if an impairment of goodwill or indefinite life intangibles existed. Upon the determination of a likely impairment,
management assesses the 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 current 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. 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 year ended September 30, 2020 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. 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 are recorded based on the difference between the financial statement and the tax basis of 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 December 31, 2020 and September 30, 2020. The Company did
not recognize any assets or liabilities relative to uncertain tax positions at December 31, 2020 and September 30, 2020. Interest
or penalties, if any, will be recognized in income tax expense. Since there are no significant unrecognized tax benefits as a
result of tax positions taken, there are no accrued penalties or interest. Tax positions are positions taken in a previously filed
tax return or positions expected to be taken in a future tax return that are reflected in measuring current or deferred income
tax assets and liabilities reported in the financial statements. The Company reflects
tax benefits, only if it is more likely than not that the Company will be able to sustain the tax return position, based on its
technical merits. If a tax benefit meets this criterion, it is measured and recognized based on the largest amount of benefit
that is cumulatively greater than 50% likely to be realized. Management does not believe that there are any uncertain tax positions
at December 31, 2020 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. Revenue
Recognition On
October 1, 2017, the Company adopted ASC Topic 606, “Revenue from Contracts with Customers” (“ASC 606”)
and all the related amendments. 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 within the revenue recognition process than previously required under GAAP, including identifying performance
obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating
the transaction price to each separate performance obligation. All
of the Company’s revenue is associated with a customer contract that represents an obligation to perform services that are
delivered at a single point in time. Any costs incurred prior to the period in which the services are performed to completion
are deferred and recognized as cost of revenues in the period in which the performance obligations are completed. For the three
months ended December 31, 2020 and 2019, substantially all of the Company’s revenue was generated from performance obligations
completed in the state of Arizona. The
Company recognizes revenue as services are rendered. Services are considered complete 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 dispensary 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. 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. Fair
Value of Financial Instruments The carrying value
of the Company’s financial instruments, consisting of cash and cash equivalents, accounts receivable, accounts payable,
and accrued expenses approximate fair value due to their short term to maturity (level 3 inputs). The Company’s receivable
resulting from the sale of Airware, notes receivable and notes payable approximate fair value based on borrowing rates currently
available on notes with similar terms and maturities (level 3 inputs). ASC Topic 820,
Fair Value Measurements, defines fair value as the price that would be received in the sale of an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies a fair value
hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring
fair value. The standard describes three levels of inputs that may be used to measure fair value as follows: Level 1: Quoted
prices in active markets for identical assets or liabilities; Level 2: Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of
the assets or liabilities; and Level 3: Valuation
is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions
reflect our own estimates and assumptions that market participants would use in pricing the asset or liability. Net
Loss Per Share Basic 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 earnings per share reflects the potential dilution of securities that
could share in the earnings of an entity. Dilutive securities are not included in the weighted average number of shares when inclusion
would be anti-dilutive. At December 31, 2020 and September 30, 2020 there were 22,238,678 and 22,024,419, respectively shares
underlying convertible notes payable, warrants and options, that were anti-dilutive, respectively. Stock-Based Compensation
The
award of an option to buy the Company’s common stock is a long-term element of compensation since on the date of the award,
the exercise price, or purchase price, of the shares subject to the option is the same as the price of those shares on the open
market. The recipient of a stock option will only realize its value if the market price of the shares increases over the life
of the option, the award gives the executive an incentive to remain with the Company and aligns his interests with those of our
stockholders. The Company accounts
for its stock-based awards in accordance with ASC Subtopic 718-10, “Compensation – Stock Compensation”, The Black-Scholes
option-pricing model requires the input of certain assumptions that require the Company’s judgment, including the expected
term and the expected stock price volatility of the underlying stock. The assumptions used in calculating the fair value of stock-based
compensation represent management’s best estimates, but these estimates involve inherent uncertainties and the application
of judgment. As a result, if factors change resulting in the use of different assumptions, stock-based compensation expense could
be materially different in the future. Assumptions used
to estimate compensation expense are determined as follows:
· Expected
term is generally determined using the average of the contractual term and vesting period
of the award;
· Expected
volatility is measured using the average of historical daily changes in the market price
of the Company’s common stock since March 20, 2018, the day of the merger between
BSSD Group LLC 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
and Debt Discounts The Company bifurcates
the value of warrants issued with debt. This bifurcation results in the establishment of 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 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. Recently Issued
Accounting Pronouncements Pending Adoption In June 2016, the
FASB issued ASU 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 us 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 options (Subtopic 470-20) and Derivatives and
Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40). 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. |
