UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ ] Quarterly Report Pursuant To Section 13 or 15(d) of the Securities
Exchange Act Of 1934
For the quarterly period ended October 31, 2015
[ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act Of 1934
For the transition period from __________ to __________
Commission file number: 000-52825
STRAINWISE, INC
------------------------------------------
(Exact name of registrant as specified in its charter)
Utah 20-8980078
---------------------------- -------------------------------
(State or other jurisdiction of (I.R.S Employer Identification No.)
incorporation or organization)
1350 Independence St., Suite 300
Lakewood, CO 80215
-----------------------------------------
(Address of principal executive offices, including Zip Code)
(303) 736-2442 (Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
section 13 or 15(d) of the Exchange Act during the past 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 [x] No [
]
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting company. See
the definitions of "large accelerated filer," "accelerated filer,"
"non-accelerated filer," and "smaller reporting company" in Rule 12b-2 of the
Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes? [ ] No [x]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 27,147,217 shares of common stock as
of December 1, 2015. STRAINWISE, INC.
INTERIM FINANCIAL STATEMENTS
For the three and nine month periods ended October 31, 2015 and 2014
(UNAUDITED)
2
STRAINWISE, INC.
CONDENSED BALANCE SHEETS
(Unaudited) (Audited)
October 31, January 31,
2015 2015
----------- -----------
ASSETS
Current assets:
Cash $3,536 $674,495
Due from Regulated Entities, net of collection
allowance reserve of $3,155,515
and $2,375,533 at October 31and January 31,
2015, respectively - -
Prepaid expenses and other assets 3,210 9,512
----------- -----------
Total current assets 6,746 684,007
Tenant improvements and office equipment, net of
accumulated amortization and depreciation of
$59,461and $96,574 at
October 31 and January 31, 2015, respectively 79,701 1,647,710
Commercial operating property, net of accumulated
amortization of $18,667 and $5,641 at October 31
and January 31, 2015, respectively 641,333 654,359
Prepaid expenses and other assets 150,000 346,187
Deposit on cultivation equipment 75,000 -
Equity method investment in unconsolidated 25,00 -
Trademark, net of accumulated amortization of
$1,342 and
$793 at October 31 and January 31, 2015,
respectively 9,668 10,217
----------- -----------
Total assets $987,448 $3,342 480
=========== ===========
LIABILITIES AND STOCKHOLERS' EQUITY (DEFICIT)
LIABILITIES
Current liabilities:
Accounts payable $262,175 $156,416
Accrued interest payable 42,466 -
Current portion of tenant allowance note and
mortgage payable 200,380 338,489
----------- -----------
Total current liabilities 505,021 494,405
Note payable for tenant allowances - 1,099,690
Mortgage payable 202,820 356,830
Convertible notes payable 2,000,000 550,000
Deferred rent and interest payable discount 873,524 416,573
----------- -----------
Total liabilities 3,581,365 2,917,998
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, no par value, 100,000,000 shares
authorized,
27,147, 217 issued and outstanding at October
31 and
January 31, 2015, respectively - -
Additional Paid in Capital 2,509,325 2,509,325
Retained (deficit) (5,103,250) (2,084,843)
----------- ------------
Total stockholder's equity (deficit) (2,593,925) 424,482
----------- ------------
Total liabilities and stockholders'
equity (deficit) $987,448 $3,342,480
=========== ============
See accompanying notes.
3
STRAINWISE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended Three Months Ended
October 31, October 31,
2015 2014 2015 2014
----------- ----------- ---------- ----------
Revenues
Lease income from
Regulated Entities $3,480,090 $ 1,978,984 $1,063,125 $1,418,190
Consulting services 2,000 33,000 - 33,000
----------- ----------- ---------- ----------
Total 3,482,090 2,011,984 1,063,125 1,451,190
Operating costs and expenses
Collection reserve for
amounts due from Regulated
Entities 1,412,234 - 19,850 -
Rent and other occupancy 3,119,985 1,561,811 929,665 1,155,531
Compensation 424,743 342,900 154,995 264,300
Professional, legal and
consulting 233,992 167,121 121,508 156,966
Depreciation and amortization 200,623 115,540 48,126 56,059
General and administrative 40,762 23,626 23,626 (5,803)
----------- ----------- ---------- ----------
Total operating costs
and expenses 5,432,339 2,210,998 1,297,382 1627,053
----------- ----------- ---------- ----------
Loss from continuing operations (1,950,249) (199,014) (234,257) (175,863)
Other costs and expenses
Loss on early extinguishment
of debt - (93,000) - -
Loss on cancellation of lease
and related tenant improvment
loan (62,503) - (62,503) -
Interest expense (622,968) (138,928) (207,061) (66,000)
----------- ----------- ---------- ----------
(Loss) from continuing
operations before taxes
on income (2,635,720) (430,942) (503,821) (241,863)
Provision for taxes on income - - -
----------- ----------- ---------- ----------
Loss from continuing
operations, net of tax (2,635,720) (430,942) (503,821) (241,863)
Gain (Loss) from discontinued
operations, net of tax (382,687) 620,803 - 453,474
----------- ----------- ---------- ----------
Net Loss $(3,018,407) $189,861 $(503,821) $274,573
=========== =========== ========== ==========
Basic and fully diluted
loss per common share
Continuing operations $(0.097) $(0.019) $(0.019) $(0.010)
=========== =========== ========== ==========
Discontinued operations $0.014 $0.028 $ - $0.011
=========== =========== ========== ==========
Basic and fully diluted weighted
average number of shares
outstanding 30,630,701 22,563,151 27,147,217 24,421,014
=========== =========== ========== ==========
See accompanying notes.
4
STRAINWISE, INC.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Nine
Months Ended Months Ended
October 31, October 31,
2015 2014
-------------- ------------
Cash flows from operating activities:
Net (loss) $(3,018,407) $189,861
Adjustments to reconcile net loss to net
cash used in operating activities:
Increase in amounts due from affiliates - (1,067,279)
(Increase) decrease in prepaid expenses 196,187 (363,314)
and other assets
Increase in deferred taxes payable - 52,814
Depreciation and amortization 200,074 115,540
Increase in accounts and accrued interest 148,225 344,867
payable
Increase in deferred rent 456,007 203,928
Decrease in trademark 549 -
--------------- -------------
Net cash flow used in operating
activities (2,016,055) (523,583)
Cash flows from investing activities:
Investment in tenant improvements and
office equipment - (2,203,266)
Investment in commercial operating
building - (660,000)
Investment in unconsolidated subsidiary (25,000)
Deposit on equipment (75,000) (255,000)
--------------- --------------
Net cash flow used in investing (100,000) (3,118,266)
activities
Cash flows from financing activities:
Proceeds from common stock subscriptions - 2,517,700
Note payable for tenant improvements 739,729
Proceeds from mortgage - 565,160
Cancellation of lease and tenant
improvement loan 216,537 -
Payments on mortgage (124,585) -
Payments on tenant improvement loan (102,063) -
Proceeds from series of convertible
notes payable 1,450,000 -
Proceeds from convertible note payable,
inclusive - 895,000
of discount of $45,000
Payments on convertible notes payable - (895,000)
--------------- -------------
Net cash flows from financing activities 1,439,526 3,822,589
--------------- --------------
Net cash flows (670,959) 180,740
Cash and equivalent, beginning of period 674,495 100
--------------- -------------
Cash and equivalent, end of period $3,536 $180,840
=============== ==============
Supplemental cash flow disclosures:
Cash paid for interest $580,502 $117,666
=============== ==============
Cash paid for income taxes $ - $ -
=============== ==============
See accompanying notes.
5
STRAINWISE, INC.
Notes to the Unaudited Financial Statements
October 31, 2015
Note 1 - Organization and summary of significant accounting policies:
Following is a summary of our organization and significant accounting policies:
Organization and nature of business - STRAINWISE, INC. (identified in these
footnotes as "we" "us" or the "Company") provides branding marketing,
administrative, accounting, financial and compliance services ("Fulfillment
Services") to entities in the cannabis retail and production industry. The
Company was incorporated in the state of Colorado as a limited liability company
on June 8, 2012, and subsequently converted to a Colorado corporation on January
16, 2014.
The Company was established to provide sophisticated Fulfillment Services to
medical and retail stores, and cultivation facilities in the regulated cannabis
industry throughout the United States. Such Fulfillment Services would only be
provided to stores and facilities located in geographical areas where the
governing state and local ordinances allow for the unfettered provisions of such
services.
The Fulfillment Services that we currently are able to provide are summarized,
as follows:
o Branding, Marketing and Administrative Consulting Services: Customers
may contract with us to use the Strainwise name, logo and affinity
images in their retail store locations. A monthly fee permits our
branding customer to use the Strainwise brand at one specific
location. In addition, we will assist operators in marketing and
managing their businesses, setting up new retail locations and general
business planning and execution at an hourly rate. This includes
services to establish an efficient, predictable production process, as
well as, nutrient recipes for consistent and appealing marijuana
strains.
o Accounting and Financial Services: For a monthly fee, we provide our
customers with a fully implemented general ledger system, with an
industry centric chart of accounts, which enables management to
readily monitor and manage all facets of a marijuana medical
dispensary and cultivation facility. We provide bookkeeping, accounts
payable processing, cash management, general ledger processing,
financial statement preparation, state and municipal sales tax
filings, and state and federal income tax compilation and filings.
o Compliance Services: The rules, regulations and state laws governing
the production, distribution and retail sale of marijuana can be
complex, and compliance may prove cumbersome. Thus, customers may
contract with us to implement a compliance process, based upon the
number and type of licenses and permits for their specific business.
We provide this service on both an hourly rate and stipulated monthly
fee.
o Nutrient Supplier: We presently are a bulk purchaser of nutrients and
other cultivation supplies for the sole purpose of growing marijuana.
As a result, we are able to make bulk purchases with price breaks,
based upon volume. We serve as a sole source nutrient purchasing agent
and distributor with pricing based upon our bulk purchasing power.
o Lending: We will provide loans to individuals and businesses in the
cannabis industry. However, Colorado State law does not allow entities
operating under a cannabis license to pledge the assets or the license
of the cannabis operation for any type of general borrowing activity.
Thus, our lending will be on an unsecured basis, with reliance on a
personal guarantee of the borrower.
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o Lease of Cultivation Facilities and Equipment: We lease cultivation
equipment and facilities on a turn-key basis to customers in the
cannabis industry. We will also enter into a sale-lease-back agreement
with our customers for grow lights, tenant improvements and other
cultivation equipment.
We do NOT grow marijuana plants, produce marijuana infused products, sell
marijuana plants and or sell marijuana infused products of any nature.
Basis of presentation - The unaudited interim financial statements of
Strainwise, Inc. (the "Company") have been prepared in accordance with United
States generally accepted accounting principles ("GAAP") for interim financial
information and the rules and regulations of the U.S. Securities and Exchange
Commission ("SEC"). They do not include all information and footnotes required
by GAAP for complete financial statements. However, except as disclosed herein,
there has been no material changes in the information disclosed in the notes to
the financial statements for the year ended January 31, 2015 included in the
Company's Annual Report on Form 10-K filed with the SEC. The unaudited interim
financial statements should be read in conjunction with those financial
statements and footnotes included in the Form 10-K. In the opinion of
management, all adjustments considered necessary for fair presentation,
consisting solely of normal recurring adjustments, have been made. Operating
results for the three and nine month periods ended October 31, 2015 are not
necessarily indicative of the results that may be expected for the year ending
January 31, 2016.
Share exchange - On August 19, 2014, we entered into an Agreement to Exchange
Securities ("Share Exchange"), pursuant to which we acquired approximately 90%
of the outstanding shares of a privately held Colorado corporation ("Strainwise
Colorado") in exchange for 23,124,184 shares of our common stock.
As part of the Share Exchange, Strainwise Colorado paid $134,700 of our
liabilities and purchased 1,038,000 shares of our common stock for $120,300 from
two of our shareholders. The 1,038,000 shares were returned to treasury and
cancelled. We also agreed to sell our rights to a motion picture, together with
all related domestic and international distribution agreements, and all
pre-production and other rights to the film, to a former officer and director in
consideration for the assumption by one of our shareholders of all of our
liabilities (net of the $134,700 paid by Strainwise Colorado) which were
outstanding immediately prior to the closing of the transaction.
On September 12, 2014 we acquired the remaining outstanding shares of Strainwise
Colorado in exchange for the issuance of 2,517,000 shares of our common stock.
The resulting business combination has been accounted for as a reverse
acquisition and recapitalization, using accounting principles applicable to
reverse acquisitions whereby the financial statements are presented as a
continuation of the Company. Under reverse acquisition accounting, Strainwise
Colorado is treated as the accounting parent (acquirer) and we (parent) are
treated as the accounting Subsidiary (acquiree).
Use of estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Cash and cash equivalents - For purposes of the statement of cash flows, we
consider all cash in banks, money market funds, and certificates of deposit with
a maturity of less than three months to be cash equivalents. Under current
banking regulations, not all marijuana centric entities are afforded normal
7
banking privileges. And thus, because of our perceived association with the
Regulated Entities, we have not been able to maintain a corporate bank account
at any federally or state charted banking institution.
Prepaid expenses and other assets - The Company pays rent in advance of the
rental period. The Company records the carrying amount as of the balance sheet
date of rental payments made in advance of the rental period; such amounts are
charged against earnings within one year. The Company also capitalized any
prepaid expenses related to the reverse merger.
The amount of prepaid expenses and other assets as of October 31 and January 31,
2015 is $153,210 and $355,699, respectively. Current prepaid expenses and other
assets are comprised of the following:
October 31, January 31,
2015 2015
------------ --------------
Current
Prepaid insurance $ 3,210 $ 9,512
Noncurrent
Prepaid rent - 83,308
Security deposits 150,000 262,879
------------ --------------
150,000 346,187
------------ --------------
$ 153,210 $ 355,699
============ ==============
Fair value of financial instruments and derivative financial instruments - The
carrying amounts of cash and current liabilities approximate fair value because
of the short maturity of these items. These fair value estimates are subjective
in nature and involve uncertainties and matters of significant judgment, and,
therefore, cannot be determined with precision. Changes in assumptions could
significantly affect these estimates. We do not hold or issue financial
instruments for trading purposes, nor do we utilize derivative instruments in
the management of our foreign exchange, commodity price or interest rate market
risks.
The FASB Codification clarifies that fair value is an exit price, representing
the amount that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants. It also
requires disclosure about how fair value is determined for assets and
liabilities and establishes a hierarchy for which these assets and liabilities
must be grouped, based on significant levels of inputs as follows:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Quoted prices in active markets for similar assets and liabilities
and inputs that are observable for the asset or liability.
Level 3: Unobservable inputs in which there is little or no market data,
which require the reporting entity to develop its own assumptions.
The determination of where assets and liabilities fall within this hierarchy is
based upon the lowest level of input that is significant to the fair value
measurement.
Commercial Operating Property - On October 26, 2014 we purchased a commercial
property that was previously leased by one of our affiliates, which we have
leased back to the affiliate. The commercial property consists of land and a
building that contains both a retail store and a grow facility. We have
allocated $440,000 and $220,000 of the purchase price to the cost of land and to
8
the cost of the improvements to the building, respectively. The cost of the
improvements to the building will be depreciated on a straight line method over
27.5 years, which we believe is the useful life of this asset.
Tenant improvements and office equipment - Tenant improvements are recorded at
cost, and are amortized over the lesser of the economic life of the asset or the
term of the applicable lease period. We determined that term of the leases
applicable to our tenant improvements are less than the economic life of the
respective assets that comprise our tenant improvements. Office equipment is
recorded at cost and is depreciated under straight line methods over each item's
estimated useful life. We review our tenant improvements and office equipment
for impairment whenever events or changes in circumstances indicate that the
carrying value of such assets may not be recoverable. Maintenance and repairs of
property and equipment are charged to operations. Major improvements are
capitalized. Upon retirement, sale or other disposition of property and
equipment, the cost and accumulated depreciation are eliminated from the
accounts and any gain or loss is included in operations.
Tenant improvements and office equipment, net of accumulated amortization and
depreciation are comprised of the following:
October 31, January 31,
2015 2015
-------------- -----------
Tenant improvements:
Upgrades of HVAC systems $ - $ 659,586
Upgrades of electrical generators and power
equipment - 468,589
Structural improvements 48,511 468,400
Fire suppression, alarms and surveillance
systems - 59,258
Office equipment:
Computer equipment 41,200 41,200
Office furniture and fixtures 24,450 22,251
Machinery 25,000 25,000
-------------- -----------
139,161 1,744,284
Accumulated amortization and depreciation (59,461) (96,574)
-------------- -----------
$ 79,701 $1,647,710
============== ===========
Tenant improvements are amortized over the term of the lease, and office
equipment is depreciated over its useful lives, which has been deemed by
management to be three years. Amortization and depreciation expense related to
tenant improvements and office equipment for the nine months and three months
ended October 31, 2015 and 2014 was $187,048 and $49,215, and $73,821 and
$22,667, respectively.
Income taxes - The Company accounts for income taxes pursuant to ASC 740. Under
ASC 740 deferred taxes are provided on a liability method whereby deferred tax
assets are recognized for deductible temporary differences and operating loss
carryforwards and deferred tax liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the reported
amounts of assets and liabilities and their tax bases. Deferred tax assets are
reduced by a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.
9
Investment in Unconsolidated Entity
The Company acquired a 50% interest in SentinelStainwise, LLC ("SSL") in June
2015 for $25,000. We account for our investment SSL using the equity method
based on the ownership interest. Accordingly, the investment was recorded at
cost, and adjustments to the carrying amount of the investment to recognize our
share of the earnings or losses of SSL are made in each reporting period. To
date, SSL has not begun operations, and thus at October 31, 2015 there are no
adjustments to the carrying amount. Additionally, in accordance with Accounting
Standard Codification 810-10, Consolidation-Overall, we evaluated the fair value
our investment in SLL and determined that there no adjustment required to the
carrying amount of our original investment
Long-Lived Assets - In accordance with ASC 350, the Company regularly reviews
the carrying value of intangible and other long-lived assets for the existence
of facts or circumstances, both internally and externally, that suggest
impairment. If impairment testing indicates a lack of recoverability, an
impairment loss is recognized by the Company if the carrying amount of a
long-lived asset exceeds its fair value.
Trademarks - Trademarks and other intangible assets are stated at cost and are
amortized using the straight-line method over fifteen years. Accumulated
amortization was $1,342 and $793 at October 31 and January 31, 2015,
respectively, and consisted of the following at October 31, 2015:
Gross
Carrying Accumulated
Amount Amortization Net
------------- ------------ --------------
Trademarks $11,010 $1,342 $ 9,668
============= ============ ==============
Deferred Rent - The Company recognizes rent expense from operating leases on the
straight-line basis. Differences between the expense recognized and actual
payments are recorded as deferred rent.
Revenue recognition - Until June 30, 2015, revenue had been recognized on an
accrual basis as earned under terms of Fulfillment Services contracts ("Master
Service Agreements") that we entered into with two cultivation facilities and
nine retail stores (five of which sell both recreation and medical marijuana to
the public, three of which on sell medical marijuana to the public, and one of
which only sells recreation marijuana to the public) ("Regulated Entities") that
are owned by Shawn Phillips, the former Chief Executive Office and a former
director of the Company. Revenue from Regulated Entities has been recognized as
follows:
o Branding, Marketing and Administrative Services Revenue: Under the
terms of a ten year Master Service Agreement, we allowed the Regulated
Entities to use the Strainwise brand for both retail and marketing
purposes at their respective locations, plus we provided
administrative services to assist the employees of the Regulated
Entity to operate the business of that related location, Also, under
the terms of the Master Service Agreements, we provided administrative
and management services to assist employees of the Regulated Entities
in the operation of the grow facilities. We charged the Regulated
Entities a monthly fee of approximately $4,500 a month for the
branding, marketing and administrative services, and $4,500 to $20,000
for grow facility services; and, since there was no additional
milestone that needed to be met, other than actually providing the
services, in accordance with ASC 605, the revenue was recognized on a
monthly basis in accordance with the terms of the applicable Master
Service Agreement.
10
o Accounting and Financial Services Revenue: Under the terms of a ten
year Master Service Agreement, we provided the Regulated Entities with
a fully implemented general ledger system, coupled with an industry
centric chart of accounts, which enabled their management to readily
monitor and manage all accounting and financial facets of a marijuana
medical dispensary and/or grow facility. Under the terms of the Master
Service Agreement we also provided bookkeeping, accounts payable
processing, cash management, general ledger processing, financial
statement preparation, state and municipal sales tax filings, and
state and federal income tax compilation and filings We provided these
services for a monthly fee of $3,000; and, since there was no
additional milestone that needed to be met, other than actually
providing the above described services, in accordance with ASC 605,
the revenue was recognized on monthly basis in accordance with the
terms of the applicable Master Service Agreement.
o Compliance Services Revenue: Under the terms of a ten year Master
Service Agreement, we provided the Regulated Entities with a
compliance process that included the preparation and filing of state,
city and municipal applications and renewals of licenses in accordance
with the rules, regulations and state laws governing the production,
distribution and retail sale of marijuana. We provided this service to
our Regulated Entities under the terms of Master Service Agreements
for a monthly fee of $2,500 per month; and, since there was no
additional milestone that needed to be met, other than actually
providing the above described services, in accordance with ASC 605,
the revenue was recognized on a monthly basis in accordance with the
terms of the applicable Master Service Agreement.
o Nutrient Sales: Under the terms of a ten year Master Service
Agreement, we served as a sole source nutrient purchasing agent and
distributor for the Regulated Entities, with pricing based upon our
bulk purchasing power. We charged the Regulated Entities for nutrients
supplied to them at the cost of the nutrients, plus a premium of
between thirty to ninety percent. Since there was no additional
milestone that needed to be met, other than actually buying and
delivering the nutrients to the Regulated Entities, in accordance with
ASC 605, the revenue was recognized in the month in which the
nutrients were actually delivered to the Regulated Entities.
o Grow Facilities Revenue: Under the terms of a ten year Master Service
Agreement, we leased grow facilities and equipment for a period equal
to the term of the underlying lease with an independent, third party
lessor in an amount equal to the sum of (i) the monthly lease payment,
(ii) plus the cost of reimbursed operating expenses paid to the lessor
each month, (iii) plus the amount of monthly amortization of tenant
improvements, and (iv) plus a premium of forty percent. Since there
was no additional milestone that needed to be met, other than actually
leasing the facilities and equipment to the respective Regulated
Entity, in accordance with ASC 605, the revenue was recognized in the
month in which the lease payments were made by us to the respective
independent, third party lessor.
Subsequent to June 30, 2015, Shawn Phillips, the owner of and license holder for
all of the Regulated Entities, made the decision, with the concurrence of the
management of the Company, to cancel all of the above referenced Master Service
Agreements. Such cancellation was deemed advisable by Mr. Phillips and
management of the Company in light of the uncertainty of the right of the
Company to supply such Fulfillment Services in Colorado. Such uncertainty was
created by allegations contained in a "Notice of Grounds for Denial of Retail
Marijuana License Application and Notice of Duty to Respond" ("Grounds for
Denial") issued to one of the Regulated Entities on June 11, 2015. Until such
11
time as impact on the method of operations of the Regulated Entities in
conjunction with the Company is resolved, as more fully described in Note 10 -
Contingencies herein, we discontinued providing Fulfillment Services to the
Regulated Entities. We will, however, continue to provide real property to two
cultivation facilities and to one retail store, which also contains a small
cultivation facility, under long term subleases. Revenue from the three leases
to the Regulated Entities are recognized on a straight line basis over the term
of the sublease.
Comprehensive Income (Loss) - Comprehensive income is defined as all changes in
stockholders' equity (deficit), exclusive of transactions with owners, such as
capital investments. Comprehensive income includes net income or loss, changes
in certain assets and liabilities that are reported directly in equity such as
translation adjustments on investments in foreign subsidiaries and unrealized
gains (losses) on available-for-sale securities. Since our inception there have
been no differences between our comprehensive loss and net loss.
Net income per share of common stock - We have adopted applicable FASB
Codification regarding Earnings per Share, which require presentation of basic
and diluted EPS on the face of the income statement for all entities with
complex capital structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. In the accompanying financial statements, basic
earnings per share of common stock is computed by dividing net income by the
weighted average number of shares of common stock outstanding during the period.
Note 2 - Going concern:
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. Since inception, we have not achieved
profitable operations, and have losses of $1,947,735, net of a $3,155,515
collection reserve for amounts due from the Regulated Entities. Our losses to
date raise substantial doubt about our ability to continue as a going concern.
Our ability to continue as a going concern is dependent upon our achieving a
sustainable level of profitability. The Company intends to continue financing
its future development activities and its working capital needs largely from the
private sale of our securities, with additional funding from other traditional
financing sources, including convertible term notes, until such time that funds
provided by operations are sufficient to fund working capital requirements.
Additionally, the unknown financial consequences that might occur as a result of
the "Notice of Grounds for Denial of Retail Marijuana License Application and
Notice of Duty to Respond" ("Grounds for Denial') issued to one of the Regulated
Entities, as more fully described in Note 11 herein, may make it unlikely that
the Company would be able to attract new capital or financing, or achieve a
sustainable level of profitability. However, the financial statements of the
Company do not include any adjustments relating to the recoverability and
classification of recorded assets, or the amounts and classifications of
liabilities that might be necessary should the Company be unable to continue as
a going concern.
Note 3 - Related Party Transactions and Collection Reserve for Amounts Due From
Regulated Entities:
Substantially all of our revenues to date have been derived from long term
contracts with the Regulated Entities that are majority owned by our former
Chief Executive Officer, who is also the husband of our majority owner and
President. Note that all terms and contracts between the Company and the
Regulated Entities are determined by related parties and these terms can change
at any time. Related party revenue was $4,244,161 and $3,546,501, respectively,
for the nine months ended October 31, 2015 and 2014, and $1,063,125 and
$2,143,760, respectively, for the three months ended October 31, 2015 and 2014.
We had $0.0 accounts receivable from Regulated Entities, net of a collection
allowance reserve in the amount of $3,155,515 and 2,375,533, as of October 31
and January 31, 2015, respectively.
12
On June 30, 2015, Shawn Phillips, the owner of and license holder for all of the
Regulated Entities made the decision, with concurrence of the management of the
Company, to cancel all of the above referenced Master Service Agreements. Such
cancellation was deem advisable by Mr. Phillips and management of the Company in
light of the uncertainty of the right of the Company to supply such Fulfillment
Services in the state of Colorado. Concurrent with the cancellation of the
Master Service Agreements, the Company layed off substantially all of its
employees.
We made an investment in cultivation facilities that we sublease to the
Regulated Entities. Through September 30, 2015, the Company leased to the
Regulated Entities approximately 123,000 square feet of cultivation facilities.
It was estimated that the cultivation facilities had the capacity to provide
enough product to supply approximately 15 to 20 marijuana dispensaries. However,
as a result of the Grounds for Denial described above, one of the cultivation
facilities, the Nome facility, with approximately 38,000 square feet, fully
built-out, was not granted a license to operate, and thus, was never occupied.
Plus, because of the Grounds for Denial, the Regulated Entities have not been
able to obtain licenses to operate any new dispensaries, in addition to the nine
that the Regulated Entities presently operate. As a result, the cultivation
facilities are operating at a loss, and are unable to pay the Company the
amounts owed pursuant to their subleases with the Company. Although the
marijuana dispensaries owned by the Regulated Entities are operating at a
profit, the dispensaries are not able to currently pay all of the amounts billed
to them by the Company, since the profits from the dispensaries are being used
to fund the operating losses of the cultivation facilities.
Therefore, in order to reduce costs, the Nome facility was closed on May 12,
2015, and the employees that had been hired by the Regulated Entities to operate
the facility were terminated. On September 30, 2015, with the consent of the
owner of the Nome property, the Company's lease for this property was
terminated, and the associated tenant improvement loan was cancelled. We wrote
off assets comprised of tenant improvements, security deposits and prepaid lease
amounts in the aggregate of $1,792,910 and wrote off related balances comprised
of a tenant improvement loan, deferred lease payments and accumulated
amortization of leasehold improvements in the aggregate amount of $1,576,374. We
received cash back from the lessor in the amount of $59,558, as the net return
of certain deposits, after $94,475 was retained by the lessor as payment of the
lease for the month in which the lease was cancelled. We recognized a loss on
the cancellation of this lease in the amount of $62,503.
Although the Regulated Entities have been able to pay us approximately
$6,958,475, of the $10,114,020 billed to them through October 31, 2015, there is
no assurance that they will be able to generate enough positive cash flow to
repay the full amount they presently owe to us. Thus, a reserve in the amount of
$3,155,515 and $2,375,533 as of October 31, and January 31, 2015 has been
recorded to recognize the uncertainty of collecting the full amount presently
owed to us from the Regulated Entities.
Note 4 - Operating Leases:
The Company entered into a lease agreement with an affiliate for our corporate
office needs. The lease is for a 31 month period, commenced in January 2014 for
6,176 square feet at an annual rate of $64,848 for the first twelve months,
$67,936 for the subsequent 12 months, and $41,431 for the subsequent 7 months
paid monthly, through October 31, 2016. This lease to the Company is on the same
terms and conditions as is the direct lease between the affiliate and the
independent lessor. Consequently, we believe that the lease terms to the Company
are comparable to lease terms we would receive directly from third party lessors
in our market, because the related party terms mirror the terms of the direct
lease between the independent, third party lessor and the affiliated entity.
13
We entered into a lease agreement on April 1, 2014 to lease from an independent
third party a cultivation facility of approximately 65,000 square feet ("51st
Ave Lease") for a term of five years and nine months. The terms of the 51st Ave
Lease stipulates the payment of $15,000 per month, prorated if necessary, until
such time that the Lessor is able to deliver a Certificate of Occupancy, which
occurred on August 1, 2014. Thereafter, lease payments are scheduled to be
$176,456 per month for the first six months of the lease, and then are scheduled
to be $221,833 per month for the subsequent 24 months, $231,917 per month for
the subsequent 12 months, $242,000 per month for the subsequent 12 months and
$247,041 per month for the final 12 months of the lease. Under the terms of the
51st Ave Lease, we are obligated to reimburse the lessor for operating expenses
applicable to the leased property and we are obligated to pay a security deposit
in the total amount $150,000, two thirds of which has been paid, with the
remaining $50,000 due by December 1, 2014. We have the option to renew the 51st
Ave Lease at the end of the term of the lease at a mutually agreed upon rate per
square foot; there is no option to purchase the property underlying the 51st
Avenue Lease. The Lessor provided all of the tenant improvements that enable the
continuous cultivation of marijuana plants in the facility. We account for this
lease as an operating lease rather than as a capital lease, because the lease
does not transfer ownership to us at the end of the lease, there is no bargain
purchase price for the cultivation facility as a component of the lease, the
terms of the lease are less than 75% of the economic life of the cultivation
facility, and the current present value of the minimum lease payments is less
than 90% of the fair market value of the asset. We subleased this cultivation
facility to a Regulated Entity under the terms of a Master Service Agreement up
until June 30, 2015, at which time the Master Service Agreement with the
Regulated Entity that operates the cultivation facility was terminated. The term
of the Master Service Agreement was for five years and nine months in an amount
equal to the sum of (i) the monthly lease payment, (ii) plus the cost of
reimbursed operating expenses paid to the lessor each month, and (iii) plus the
amount of monthly amortization of tenant improvements, and (iv) a premium of
forty percent. Revenue from the sublease of the 51st Avenue cultivation facility
has been recognized on a monthly basis, as the user is charged for the amount of
the sublease. On October 1, 2015, upon the cancellation of the related Master
Service Agreement, we entered into a sublease with the Regulated Entity that
holds the license to operate the 51st Avenue cultivation facility. The term of
the sublease is for the remainder of the term of the original lease, payable in
the monthly lease amounts of $302,400 from October 1, 2015 through December 31,
2016 (an 18 month period), and then will be increased commensurate with the
increases in the lease amounts payable to the lessor, as deemed appropriate, on
a triple net lease basis.
We entered into a lease agreement on April 22, 2014 to lease from an independent
third party a cultivation facility of approximately 38,000 square feet ("Nome
Lease") for a term of seven years. We entered into a modification of the Nome
lease on December 1, 2014, wherein the lease was modified to extend the lease
term through April 30, 2025; and, the lease payments were modified to be $88,616
per month for the five months ending April 30 2015, and then are scheduled to be
$90,207, $91,799, $93,390, $94,981, $73,578, $75,169, $76,761, 78,352, and then
$79,943 per month for the final 12 months of the lease. As more fully described
in Note 8 herein, the modification of the lease included the cancellation of the
$750,000 note payable to the lessor for the financing of tenant improvements,
and the extension of an additional $800,000 to be used by us for future tenant
improvements. The amount of tenant improvement financing provided by the lessor
is to be amortized over the extended term of the modified lease as a component
of the monthly lease payments. Under the terms of the Nome Lease, we are
obligated to reimburse the lessor for operating expenses applicable to the
leased property, and we are obligated to pay a security deposit of $133,679 one
half of which was due and paid upon the execution of the Nome Lease, the final
half was due and payable 30 days after the commencement date. We are responsible
to provide all of the tenant improvements that will enable the continuous
cultivation of marijuana plants at this cultivation facility. We accounted for
this lease as an operating lease rather than as a capital lease, because the
lease does not transfer ownership to us at the end of the lease, there is no
bargain purchase price for the cultivation facility as a component of the lease,
the terms of the lease are less than 75% of the economic life of the cultivation
14
facility, and the current present value of the minimum lease payments is less
than 90% of the fair market value of the asset. The Regulated Entities were not
been able to obtain sufficient licenses from the state of Colorado to allow for
sufficient production levels for the facility to be economically viable. As a
result, the Nome facility was closed on May 12, 2015 and the employees that had
been hired by the Regulated Entities to operate the facility were terminated. On
September 30, 2015, with the consent of the owner of the Nome property, the
Company's lease for this property was terminated and the associated tenant
improvement loan was cancelled. We wrote off assets comprised of tenant
improvements, security deposits and prepaid lease amounts in the aggregate of
$1,792,910 and wrote off related balances comprised of a tenant improvement
loan, deferred lease payments and accumulated amortization of leasehold
improvements in the aggregate amount of $1,576,374. We received cash back from
the lessor in the amount of $59,598, as the net return of certain deposits,
after $94,475 was retained by the lessor as payment of the lease for the month
in which the lease was cancelled. We recognized a loss on the cancellation of
this lease in the amount of $62,503.
We entered into a lease agreement on September 11, 2014 to lease a cultivation
facility of approximately 20,000 square feet ("Bryant St. Lease") for a term of
ten years. During the first 12 months of the lease, lease payments are scheduled
to be $23,984 for the first four months and 24,531 for the next eight months,
and then are scheduled to be $24,647, $25,140, $31,221, $31,845, $32,483,
$33,132, $33,794, $34,470, and $35,160 for the second through the tenth year of
the lease, respectively. We are not required to provide any security deposits or
first and last month's rental amounts. We have an option to purchase the
building for $2,400,000 at any time during the first 36 months of the lease,
provided that we deliver a purchase option notice to the Lessor prior to the end
of the 33rd month of the lease. We are responsible to provide all of the tenant
improvements that will enable the continuous cultivation of marijuana plants
under approximately 370 grow lights. We account for this lease as an operating
lease rather than as a capital lease, because the lease does not transfer
ownership to us at the end of the lease, there is no bargain purchase price for
the cultivation facility as a component of the lease, the terms of the lease are
less than 75% of the economic life of the cultivation facility, and the current
present value of the minimum lease payments is less than 90% of the fair market
value of the asset. We subleased this cultivation facility to a Regulated Entity
under the terms of a Master Services Agreement up until June 30, 2015, at which
time the Master Service Agreement with a Regulated Entity that operates the
cultivation facility was terminated. The term of the Maser Service Agreement was
for a period of 10 years in an amount equal to the sum of (i) the monthly lease
payment, (ii) plus the cost of reimbursed operating expenses paid to the lessor
each month, (iii) plus the amount of monthly amortization of tenant
improvements, and (iv) a premium of forty percent. Revenue from the sublease of
the Bryant Street cultivation facility was recognized on a monthly basis as the
user was charged for the amount of the sublease. On October 1, 2015, upon the
cancellation of the related Master Service Agreement, we entered into a sublease
with a Regulated Entity that holds the license to operate the Bryant Street
cultivation facility. The term of the sublease is for the remainder of the term
of the original lease, payable in the monthly lease amounts of $36,970 from
October 1, 2015 through December 31, 2015, and then $37,710, $43,709, $46,831,
$47,767, $48,723, $49,698, $50,691, $51,705, and $52,740 in each subsequent
calendar year, respectively, on a triple net lease basis.
Future minimum payments for these leases are:
For the twelve Months Ending October 31,
----------------------------------------------------
2016 2017 2018 2019 2020 Thereafter
------------ ---------- ---------- ---------- ----------- ----------
$3,028,482 $3,056,507 $3,239,567 $3,327,749 $1,379,261 $1,572,408
============ ========== =========== ========== =========== ==========
15
Note 5 - Issuance of Shares:
Through a private offering of our common stock at $1 per share, we collected
$2,224,700 from subscribers, as of January 31, 2015, for 2,224,700 shares of our
common stock. Coupled with the 293,000 common shares issued in connection with
the conversion of the convertible note described in Note 7 herein, the issuance
of 198,333 shares of common stock as stock based compensation to employees
described in Note 8 herein, and the Share Exchange described in Note 1 herein,
the total number of shares of common stock issued and outstanding at October 31,
2015 was 27,141,217shares.
Note 6 - Income Taxes:
The Company uses the liability method of accounting for income taxes under which
deferred tax assets and liabilities are recognized for the future tax
consequences of temporary differences between the accounting bases and the tax
bases of the Company's assets and liabilities. The deferred tax assets and
liabilities are computed using enacted tax rates in effect for the year in which
the temporary differences are expected to reverse.
The Company adopted the provisions of ASC 740, "Income Taxes" on October1, 2007.
FASB ASC 740 provides detailed guidance for the financial statement recognition,
measurement and disclosure of uncertain tax positions recognized in the
financial statements. Tax positions must meet a "more-likely-than-not"
recognition threshold at the effective date to be recognized upon the adoption
of FASB ASC 740 and in subsequent periods. The components of the income tax
provision are as follows:
Nine Months Three Months
Ended October 31, Ended October 31,
---------------------------------------------------
2015 2014 2015 2014
------------ ----------- ---------- -----------
Income tax expense
(benefit):
Current:
Federal $(1,139,426) $45,113 $(187,393) $(39,016)
State (139,752) 7,701 (23,327) (10,277)
------------ ----------- ---------- -----------
Deferred income tax expense
(benefit): (1,279,178) (52,814) (210,720) (42,293)
Valuation allowance 1,279,178 - 210,720 42,923
------------ ----------- ---------- -----------
Provision $ - $ - $ - $ -
============ =========== ========== ===========
We have a net operating loss carryforward for financial statement reporting
purposes of $2,014,624 and $76,351 from the year ended January 31, 2015 and
2014, respectively
Note 7 - Notes Payable:
Notes payable consisted of the following:
October 31 2015 January 31, 2015
------------------------------------- -----------------------------------
Long Long
Current Term Total Current Term Total
--------- ---------- ----------- --------- ----------- -----------
Convertible $ $ $ $
notes - $2,000,000 $2,000,000 - 550,000 550,000
Mortgage 200,380 202,820 403,128 170,955 356,830 527,785
Tenant
improvement - - - 167,534 1,099,690 1,267,244
------------ ---------- ----------- --------- ----------- -----------
200,380 $2,202,820 $2,403,128 $338,489 $2,006,520 $2,345,009
============ ========== =========== ========= =========== ===========
16
On March 20, 2014, the Company issued a convertible note in the amount of
$850,000 (the "Note") to an individual. This Note was subsequently amended, and
the unpaid principal balance was converted into common stock, as more fully
described below. The Note had an interest rate of 25%, payable monthly, and was
scheduled to mature on September 21, 2014. The outstanding principal balance of
the Note, plus any accrued but unpaid interest on the Note, was convertible at
any time on or before the maturity date at $1 per common share. The Note was
personally guaranteed by our majority shareholder and by an officer and director
of the Company.
On October 16, 2014, the terms of the Note were amended ("Amendment") wherein
the holder of the Note elected to convert $200,000 of the principal of the Note
into 293,000 of our common shares of stock at a price of $.6825 per share. As a
component of the Amendment, we in turn elected to prepay the remaining principal
balance of the Note, after the scheduled payment of the principal and accrued
interest due the holder on October 24, 2014, and to pay a prepayment penalty of
$11,250. The difference of $93,000 in the premium of the per-share price of
$0.6825 per share per the Amendment and the $1 per share per the Note, plus the
amount of the prepayment penalty was charged to the loss on the early
extinguishment of debt and interest expense, respectively.
On January 31, 2015, the Company entered into three convertible notes totaling
up to $2,500,000, of which $2,000,000 had been received by the Company at
October 31, 2015. The convertible notes are being funded by the noteholders in
varying amounts from approximately $250,000 to $550,000 per month. The
convertible notes are unsecured, have an interest rate of 25%, with the interest
is payable monthly. The principal amount of the convertible notes are due
twenty-four months from the date of the funding. At any time prior to the due
date of the convertible notes, the unpaid principal amount of the convertible
note, plus any accrued but unpaid interest, may be converted into common stock
of the Company at a per-share price of $1 per share. The convertible loans are
personally guaranteed by Shawn Phillips, a former officer of the Company and
affiliate, and Erin Phillips, the majority shareholder of the Company.
On October 26, 2014 the company entered into a mortgage payable for the purpose
of purchasing a commercial operating property that contains a cultivation
facility and retail store, which we lease to one of the Regulated Entities. The
amount of the mortgage is $595,000, has a three year term, and has no stated
rate of interest. In accordance with ASC 835-30, we imputed an interest rate for
the mortgage payable of 21.36%. The mortgage is payable in varying amounts from
$11,000 to $36,000 per month, which includes interest at a stated amount of
$6,000 per month, with a balloon payment of $126,000 due in the thirty-sixth
month of the term. We account for the mortgage on a straight line basis with an
imputed monthly payment of principal and interests in the amount of $22,301 per
month. The difference between the imputed monthly payment amount and actual
payment amounts is recorded as an increase or decrease to deferred interest
expense, at the time a monthly payment is made.
17
The amount of principal and interest payments on the notes for the five year
period ending October 31, 2020 are, as follows:
October 31,
-------------------------------------------------
2016 2017 2018 2019 2020
---------- ---------- ------- ------- -------
Convertible notes - interest
only $509,589 $127,397 $ - $ - $ -
Convertible notes - principal - 2,000,000 - - -
Mortgage 200,380 202,820 - - -
---------- ---------- ------- ------- -------
$709,969 $2,330,217 $ - $ - $ -
========== ========== ======= ======= =======
Note 8 - Stock-Based Compensation:
The Company issued 198,333 shares of common stock as compensation to employees
during the year ended January 31, 2015, and recognized $198,333 of expense. The
shares were fully vested upon issuance and were valued at $1.00 per share, the
value on the grant date of January 31, 2015.
Note 9 - New accounting Pronouncements:
The Financial Accounting Standards Board ("FASB") periodically issues new
accounting standards in a continuing effort to improve standards of financial
accounting and reporting. The Company has reviewed the recently issued
pronouncements and concluded that there are no new accounting standards are
applicable to the Company. The Company elected to adopt ASU 2014-10, Development
Stage Entities: Elimination of Certain Financial Reporting Requirements,
Including an Amendment to Variable Interest Entities Guidance in Topic 810,
Consolidation. The adoption of this ASU allows the Company to remove the
inception to date information and all references to development stage. We do not
expect the adoption of recently issued accounting pronouncements to have a
significant impact on our results of operations, financial position or cash
flow.
Note 10 - Investment in Unconsolidated Subsidiary:
Effective June 12, 2015, we purchased a 50% interest in SentinelStainwise, LLC
("SSL"), which was recorded at our cost of $25,000 using the equity method of
accounting. SSL is 50% owned by Sentinel, Inc. and the Company. It was formed
for the purpose of providing consulting services to NAtive American entities
that are considering participating in the marijuana industry. In accordance with
Accounting Standard Codification 810-10, Consolidation - Overall, we remeasured
our held equity interest at the acquisition-date fair value and recognized no
gain or loss for the period on our investment in SSL.
Fair value of 50% interest 25,000
Investment under equity method -
------------
Total purchase price to be allocated $25,000
============
SSL has not begun operations, and since there is little or no market data for
SSL, our investment has been deemed a level 3 investment for valuation purposes.
Thus, we used unobservable inputs to determine the fair market value of our
investment in SSL, and it is our belief that the fair market value of our
investment in SSL is $25,000, which is the amount of our original investment.
18
Note 11 - Contingencies:
In April 2015, the Company advised the lessor of one of our operating leases
that we had elected to abandon the lease and would not be occupying the
premises. The leased premises were originally intended to be subleased to the
Regulated Entities for use as a cultivation facility. We elected to abandon the
lease, because of our belief that the lessor was not acting in good faith, and
had breached major terms of the lease agreement. The lessor filed a lawsuit
against the Company seeking possession of the leased premises and alleging
breach of the lease; but, the lessor has not quantified the amount of any
claimed damages resulting from the alleged breach of the lease agreement. The
Company stipulated to the lessor's demand for possession of the leased property,
but is vigorously defending the remaining claims in this action. At this time,
we cannot estimate the amount of damages, if any, and accordingly, we have not
recorded any corresponding liability.
In anticipation of fully implementing the Company's business plan, management of
the Company met with representatives of the Colorado Marijuana Enforcement
Division (the "MED") in August 2014 and presented the structure of the Company
and its business plan for providing services to the Regulated Entities.
Subsequent to the meeting, over 60 license applications for the cultivation and
sale of marijuana were approved and licenses were granted to Shawn Phillips,
while he was also serving as the Company's Chief Executive Officer, and while
his wife, Erin Phillips, maintained her position an officer and the principal
shareholder of the Company.
Up until June 30, 2015, the Company provided Fulfillment Services to the
Regulated Entities. Effective June 30, 2015, the owner of and license holder for
all of the Regulated Entities made the decision, with the concurrence of the
management of the Company, to cancel all of the above referenced Master Service
Agreements. The termination of the Agreements was considered advisable since, in
June 2015, the Colorado State Licensing Authority issued a Grounds for Denial to
one of the Regulated Entities owned by Mr. Phillips. The Grounds for Denial was
based upon the belief of the Colorado Marijuana Enforcement Division (the "MED")
that the Company and persons other than Mr. Phillips have a direct or indirect
ownership or financial interest in the cultivation facility and dispensary owned
by Mr. Phillips and should have been included on the application.
As a result of the denial of Mr. Phillips' application, all applications for the
renewal of existing licenses owned by the Regulated Entities, have been placed
in a "Administrative Continuation" status, pending the resolution of the license
application. Administrative Continuation status enables a licensee to continue
to operate, but the licensee operates without an actual current license.
Mr. Phillips is attempting to work with the MED in order to resolve this
situation. However, if a resolution of the denial of his application is not
reached, Mr. Phillips has advised the Company that it is his intention to appeal
the denial of his application.
If Mr. Phillips is not able to reach a mutually acceptable resolution with
respect to his application, or if he is not successful in appealing the denial,
the allegations of the MED could possibly affect all of the licenses under which
the Regulated Entities operate and possibly result in the cancellation of all of
the licenses held by the Regulated Entities. Although the ultimate outcome of
this matter cannot be determined at this time, a failure to reach an acceptable
resolution might negatively impact the ability of the Company to continue
operating as a going concern.
Note 12 - Discontinued Operations
As more fully described in Note 11 - Contingencies above, we discontinued
providing Fulfillment Services to the Regulated Entities on June 30, 2015. The
19
summarized discontinued operating results for the nine and three months ended
October 31, 2015 and 2014, respectively, are, as follows:
Nine Months Ended October 31, Three Months Ended October 31,
------------------------------ ----------------------------
2015 2014 2015 2014
-------------- -------------- ------------ --------------
Revenues $ 764,071 $ 1,567,514 $ - $ 725,570
Expenses (1,146,758) (946,711) - (209,134)
-------------- -------------- ------------ --------------
$ (382,687) $ 620,803 $ - $ 516,436
============== ============== ============ ==============
There were no components of major assets and liabilities associated with the
discontinued operations at October 31, 2015 and 2014.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As discussed in more detail below, the organization and operations of the
Company were substantially modified beginning in June 2015, resulting in a
combined net savings to the Company and the Regulated Entities of approximately
$1,416,000 per year.
On August 19, 2014, the Company acquired approximately 90% of the outstanding
shares of Strainwise, Inc., a Colorado corporation, in exchange for 23,124,184
shares of the Company's common stock. Strainwise was organized in Colorado on
June 8, 2012 as a limited liability company, and converted to a Colorado
corporation on January 16, 2014. On September 12, 2014 the Company acquired the
remaining outstanding shares of Strainwise Colorado in exchange for 2,517,700
shares of the Company's common stock.
Although, from a legal standpoint, the Company acquired Strainwise on August 19,
2014, for financial reporting purposes the acquisition of Strainwise constituted
a recapitalization, and the acquisition was accounted for similar to a reverse
merger, whereby Strainwise was deemed to have acquired the Company.
In connection with the acquisition of Strainwise, the Company sold its rights to
a motion picture, together with all related domestic and international
distribution agreements, and all pre-production and other rights to the film, to
a former officer and director of the Company in consideration for the assumption
by a shareholder of the Company of all liabilities of the Company (including the
Company's outstanding liabilities as of June 30, 2014) which were outstanding
immediately prior to the closing of the transaction.
In anticipation of fully implementing the Company's business plan, management of
the Company met with representatives of the Colorado Marijuana Enforcement
Division (the "MED") in August 2014 and presented the structure of the Company
and its business plan for providing services to the retail marijuana outlets and
marijuana cultivation facilities (the "Regulated Entities") owned by Shawn
Phillips, a former officer and director. Subsequent to the meeting, over 60
license applications for the cultivation and sale of marijuana were approved and
licenses were granted to Mr. Phillips, while he was also serving as the
Company's Chief Executive Officer, and while his wife, Erin Phillips, maintained
her position an officer and the principal shareholder of the Company.
Mr. Phillips, is the sole owner of Rocky Mountain Farmacy, Inc. ("RMF"), one of
the Regulated Entities, which operates The Retreat and The Shelter marijuana
dispensaries. In November 2014, Mr. Phillips submitted an application to the MED
for a retail license for RMF to permit the 51st Avenue cultivation facility to
supply recreational marijuana. On June 11, 2015, the State Licensing Authority
20
issued a "Notice of Grounds for Denial of Retail Marijuana License Application
and Notice of Duty to Respond" ("Grounds for Denial").The Grounds for Denial
were based upon the belief of the MED that the Company and persons other than
Mr. Phillips have a direct or indirect ownership or financial interest in RMF,
and such should have been included on the application.
As a result of the denial of Mr. Phillips' application, all applications for the
renewal of existing licenses owned by the Regulated Entities, have been placed
in a "Continuation" status, pending the resolution of the license application.
Continuation status enables a licensee to continue to operate, but the licensee
operates without an actual current license.
Mr. Phillips is attempting to work with the MED in order to resolve this
situation. However, if a resolution of the denial of his application is not
reached, Mr. Phillips has advised the Company that it is his intention to appeal
the denial of his application.
If Mr. Phillips is not able to reach a mutually acceptable resolution with
respect to his application, or if he is not successful in appealing the denial,
the allegations of the MED could possibly affect all of the licenses under which
the Regulated Entities operate, and possibly result in the cancellation of all
of the licenses held by the Regulated Entities. Although the ultimate outcome of
this matter cannot be determined at this time, a failure to reach an acceptable
resolution might negatively impact the ability of the Company to continue
operating as a going concern.
Prior to June 30, 2015, the Company provided the following services to the
Regulated Entities pursuant to separate Master Service Agreements:
o Branding, Marketing and Administrative Consulting Services
o Accounting and Financial Services
o Compliance Services
o Nutrient Supplier
Subsequent to June 30, 2015, Shawn Phillips, the owner of and license holder for
all of the Regulated Entities made the decision, with concurrence of the
management of the Company, to cancel all of the above referenced Master Service
Agreements. The cancellation was deem advisable by Mr. Phillips and management
of the Company in light of the uncertainty of the right of the Company to supply
such Fulfillment Services in Colorado. The uncertainty was created by
allegations contained in the Grounds for Denial issued to one of the Regulated
Entities on June 11, 2015. As a result of the cancellation of the Master Service
Agreements, the Company terminated approximately 80% of its employees. Until
such time as impact on the method of operations of the Regulated Entities is
resolved, we will discontinued providing Fulfillment Services to the Regulated
Entities. We will, however, continue to provide real property to two cultivation
facilities and to one retail store, which also contains a small cultivation
facility, under long term subleases. Revenue from the three subleases to the
Regulated Entities will be recognized on a straight line basis over the term of
the sublease.
As of December 1, 2015 the Company was not providing the services listed above
to any person or entity.
Through September 30, 2015, the Company leased to the Regulated Entities
approximately 123,000 square feet of cultivation facilities. It was estimated
that the cultivation facilities had the capacity to provide enough product to
supply approximately 15 to 20 marijuana dispensaries. However, as a result of
the Grounds for Denial described above, one of the cultivation facilities, the
Nome facility, with approximately 38,000 square feet, fully built-out, was not
granted a license to operate, and thus, was never occupied. Plus, because of the
21
Grounds for Denial, the Regulated Entities have only been able to obtain
licenses to operate any new dispensaries in addition to the nine that the
Regulated Entities presently operate. As a result, the cultivation facilities
are operating at a loss and are unable to pay the Company the amounts owed
pursuant to their subleases with the Company. Although the marijuana
dispensaries owned by the Regulated Entities are operating at a profit, the
dispensaries are not able to currently pay all of the amounts billed to them by
the Company, since the profits from the dispensaries are being used to fund the
operating losses of the cultivation facilities.
Therefore, in order to reduce costs, the Nome facility was closed on May 12,
2015 and the employees that had been hired by the Regulated Entities to operate
the facility were terminated. On September 30, 2015, with the consent of the
owner of the Nome property, the Company's lease for this property was terminated
and the associated tenant improvement loan was cancelled. We wrote off assets
comprised of tenant improvements, security deposits and prepaid lease amounts in
the aggregate of $1,792,910 and wrote off related balances comprised of a tenant
improvement loan, deferred lease payments and accumulated amortization of
leasehold improvements in the aggregate amount of $1,576,373. We received cash
back from the lessor in the amount of $59,598, as the net return of certain
deposits, after $94,475 was retained by the lessor as payment of the lease for
the month in which the lease was cancelled. We recognized a loss on the
cancellation of this lease in the amount of $62,507.
Management estimates that the termination of the Nome lease will save the
Company, approximately $1,200,000 annually.
Because of the impact on the Regulated Entities from the regulatory factors
described below, we substantially revised the organization and operations of the
Company, beginning in June 2015. During the month of May 2015, the Regulated
Entities terminated approximately 55% of their employees, at an estimated annual
saving in payroll costs of $2,116,000; and, we subsequently terminated
approximately 80% of our employees at an estimated annual savings in payroll
costs of $700,000, We also cancelled all of our Master Service Agreements with
the Regulated Entities on June 30, 2015, Substantially all of the employees
Strainwise terminated were subsequently retained by the Regulated Entities. As a
result of these changes to the employee base, the combined net savings to the
Company and the Regulated Entities is approximately an estimated $1,416,000.
The Regulated Entities have paid the Company approximately $6,958,475 of the
$10,114,020 billed to them between January 16, 2014 and October 31, 2015,
including $4,244,161billed during the nine months ended October 31, 2015.
However, there is no assurance that the Regulated Entities will be able to
generate enough cash to pay the $3,155,515 presently owed to the Company at
October 31, 2015, and as a result, the receivable from the Regulated Entities at
October 31, 2015 ($3,155,515) has been reserved in the amount of $ 3,155,515 and
charged to expense.
As a result of terminating substantially all of the Company's employees in
connection with the cancellation of all of the Master Service Agreements in June
2015 with the Regulated Entities and the cancellation of the Nome lease
described above, the operating expenses of the Company have been substantially
reduced. As of December 1, 2015, the Company's operating expenses, excluding
payments required for its operating leases, were approximately $150,500 per
month, the primary components of which are interest expense, compensation for
Erin Phillips, the Company's President and compensation for the Company's
employees and consultants.
22
Leases/Subleasing
As of December 1, 2015, we were leasing two properties in the Denver
Metropolitan area, which we sublease to the Regulated Entities for their
marijuana cultivation and growing operations. The subleases with the Regulated
Entities expire on the same date (generally between December 2019 and December
2023) as our leases with the owners of these properties. We charge the Regulated
Entities in an amount that approximates a premium of from 36% to 50% of the
amount we pay the lessors of these properties.
None of the persons leasing these facilities to us are affiliated with us in any
way. We believe the terms of our subleases are comparable to those which we
could have obtained from unrelated third parties.
The future minimum amounts we are required to pay under the terms of these
leases (which we refer to as our "Operating Leases") are shown below.
Lease Payments Due During the Twelve Months Ending October
31,
----------------------------------------------------------------
2016 2017 2018 2019 2020 Thereafter
---- ---- ---- ---- ---- ----------
51st $2,661,996 $2,742,665 $2,863,333 $2,944,333 $988,167 $ -
Bryant 295,750 313,842 375,900 383,416 391,094 1,572,408
----------------------------------------------------------------
$2,958,746 $3,056,507 $3,239,567 $3,327,749 $1,379,261 $1,572,408
========== ========== ========== ========== ========== ==========
(1) Amounts are based upon terms of lease amended on December 1, 2014. See Note
4 to the financial statements included as part of this report.
Liquidity and Capital Resources
Between March 15, 2014 and August 19, 2014, the Company sold 2,224,700 units, at
a price of $1.00 per unit, to a group of private investors. Each unit consisted
of one share of the Company's common stock and one warrant. Every two warrants
entitle the holder to purchase one share of the Company's common stock at a
price of $5.00 per share at any time prior to January 31, 2019. When the Company
acquired the remaining shares of Strainwise, the Company exchanged its warrants
for the outstanding Strainwise warrants. The warrants issued by the Company had
the same terms as the Strainwise warrants.
On March 20, 2014 the Company borrowed $850,000 from an unrelated third party.
The loan bears interest at 25% per year, payable monthly, and matured on
September 21, 2014. On October 16, 2014, the terms of the loan were amended such
that $200,000 of the loan was converted into 293,000 shares of the Company's
common stock and the Company agreed to pay the remaining balance of the loan
($325,000), plus accrued interest and a prepayment penalty of $11,250, prior to
October 29, 2014. The $850,000 loan was used (i) to secure approximately
$217,800 of deposits for the future rental and/or purchase of cultivation
facilities to lease to growers in the industry, (ii) to acquire approximately
$175,000 of cultivation equipment (iii) to make approximately $63,500 of tenant
improvements to cultivation facilities under lease, (iv) to pay approximately
$373,000 of principal and interest to the note holder, and (v) to pay other
miscellaneous expenses
In October 2014 the Company purchased a 5,000 square foot commercial building
for $660,000. The building, which is located at 5110 Race Street in Denver,
Colorado, houses a medical and recreational marijuana dispensary and a small
cultivation facility which are owned by Shawn Phillips. The retail dispensary
(known as "The Sanctuary") and cultivation facility are leased to one of the
Regulated Entities. The purchase price was paid with cash of $60,000 and a loan
of $600,000, which is payable in varying amounts from $11,000 to $36,000 per
month, with a final payment of $126,000 due on August 1, 2017.
23
As of December 1, 2015, three unrelated third parties collectively loaned the
Company $2,000,000. The loans bear interest at 25% per year, are unsecured, and
are due and payable on January 31, 2017. Interest-only payments are due each
month, and at the option of the lenders, the loans can be converted into shares
of the Company's common stock at the rate of $1.00 per share. The loan proceeds
were used to pay general and administrative expenses.
Any of the following are an event of default which would cause all amounts due
the lenders to become immediately due and payable:
o the Company fails to make any interest payment when due; or
o the Company breaches any representation, warranty or covenant or
defaults in the timely performance of any other obligation in its
agreements with the lenders.
The future minimum payments under the terms of the Company's material
contractual obligations are shown below.
For the Twelve Months Ending October 31,
------------------------------------------------------------
2016 2017 2018 2019 2020 Thereafter
---- ---- ---- ---- ----- ----------
Corporate office $ 69,736 $ - $ - $ - $ - $ -
Operating leases 2,958,746 3,056,507 3,239,567 3,327,749 1,379,261 1,572,408
Mortgage (1) 232,000 300,000 - - -
Convertible loans:
Interest 509,589 127,397 - - - -
Principal - 2,000,000 - - - -
--------- --------- --------- --------- --------- ----------
$3,770,071$ 5,483,905 $3,239,567 $3,327,749 $1,379,261 $1,572,408
(1) Includes principal and interest payments.
The Company plans to fund its operations and contractual requirements through
fees received for subleasing facilities to the Regulated Entities and through
management and consulting services provided to independent third parties.
The Company may need to raise enough capital to fund its operations until it is
able to earn a profit. The Company does not know what the terms of any future
capital raising may be but any future sales of the Company's equity securities
will dilute the ownership of existing stockholders and could be at prices below
the market price of the Company's common stock. The inability of the Company to
obtain the capital which it requires may result in the failure of the Company.
The Company does not have any commitments from any person to provide the Company
with capital.
As previously disclosed, as a result of the termination of substantially all of
the Company's employees in connection with the cancellation of the Master
Service Agreements in June 2015 and the cancelation of the Nome lease, the
operating expenses of the Company haven been substantially reduced.
During May 2015, the Regulated Entities terminated approximately 55% of their
employees, and the Company subsequently terminated approximately 80% of its
employees. Substantially all the employees the Company terminated were
subsequently hired by the Regulated Entities. As a result of these changes, the
combined net savings to the Company and the Regulated Entities is approximately
$1,416,000 per year.
24
Trends
The factors that will most significantly affect the Company's future operating
results, liquidity and capital resources will be:
o The ability of the Company to find new sources of revenue; o
Government regulation of the marijuana industry;
o Revision of Federal banking regulations for the marijuana industry;
o Legalization of recreational marijuana in more states; and
o The outcome of Shawn Phillips' appeal of the decision of the State
Licensing Authority
Other than the foregoing, the Company does not know of any trends, events or
uncertainties that have had, or are reasonably expected to have, a material
impact on:
o revenues or expenses;
o any material increase or decrease in liquidity; or
o expected sources and uses of cash.
Critical Accounting Policies and New Accounting Pronouncements
See Notes 1 and 9 to the financial statements included as part of this report
for a description of our critical accounting policies and the potential impact
of the adoption of any new accounting pronouncements.
Item 4. Controls and Procedures.
(a) The Company maintains a system of controls and procedures designed to ensure
that information required to be disclosed in reports filed or submitted under
the Securities Exchange Act of 1934, as amended ("1934 Act"), is recorded,
processed, summarized and reported, within time periods specified in the SEC's
rules and forms and to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the 1934 Act, is
accumulated and communicated to the Company's management, including its
Principal Executive and Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. As of October 31, 2015, the Company's
Principal Executive and Financial Officer evaluated the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, the Principal Executive and Financial Officer concluded that
the Company's disclosure controls and procedures were effective.
(b) Changes in Internal Controls. There were no changes in the Company's
internal control over financial reporting during the quarter ended October 31,
2015, that materially affected, or are reasonably likely to materially affect,
its internal control over financial reporting.
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PART II
Item 6. Exhibits
Exhibits
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
26
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.
STRAINWISE, INC.
December 21 , 2015 By: /s/ Erin Phillips
------------------------------------
Erin Phillips, President, Chief Financial
and Accounting Officer
27