NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
November 30, 2016
(Unaudited)
Note 1 – Nature of Business and Significant Accounting Policies
Nature of Business
CLS Holdings USA, Inc. (the “Company”) was originally incorporated as Adelt Design, Inc. (“Adelt”) on March 31, 2011 to manufacture and market carpet binding art. Production and marketing of carpet binding art never commenced.
On November 12, 2014, CLS Labs, Inc. (“CLS Labs”) acquired 10,000,000 shares, or 55.6%, of the outstanding shares of common stock of Adelt from its founder, Larry Adelt. On that date, Jeffrey Binder, the Chairman, President and Chief Executive Officer of CLS Labs, was appointed Chairman, President and Chief Executive Officer of the Company. On November 20, 2014, Adelt adopted amended and restated articles of incorporation, thereby changing its name to CLS Holdings USA, Inc. Effective December 10, 2014, the Company effected a reverse stock split of its issued and outstanding common stock at a ratio of 1-for-0.625 (the “Reverse Split”), wherein 0.625 shares of the Company’s common stock were issued in exchange for each share of common stock issued and outstanding. As a result, 6,250,000 shares of the Company’s common stock were issued to CLS Labs in exchange for the 10,000,000 shares that it owned by virtue of the above-referenced purchase from Larry Adelt.
On April 29, 2015, the Company, CLS Labs and CLS Merger Inc., a Nevada corporation and wholly owned subsidiary of CLS Holdings, entered into an Agreement and Plan of Merger (the “Merger Agreement”) and completed a merger, whereby CLS Merger Inc. merged with and into CLS Labs, with CLS Labs remaining as the surviving entity (the “Merger”). Upon the consummation of the Merger, the shares of the common stock of CLS Holdings owned by CLS Labs were extinguished and the former stockholders of CLS Labs were issued an aggregate of 15,000,000 (post Reverse Split) shares of common stock in CLS Holdings in exchange for their shares of common stock in CLS Labs. As a result of the Merger, the Company acquired the business of CLS Labs and abandoned its previous business.
The Company has a patent pending proprietary method of extracting cannabinoids from cannabis plants and converting the resulting cannabinoid extracts into concentrates such as oils, waxes, edibles and shatter. These concentrates may be ingested in a number of ways, including through vaporization via electronic cigarettes (“e-cigarettes”), and used for a variety of pharmaceutical and other purposes. Internal testing of this extraction method and conversion process has revealed that it produces a cleaner, higher quality product and a significantly higher yield than the cannabinoid extraction processes currently existing in the marketplace. The Company has not commercialized its patent pending proprietary process or otherwise earned any revenues. The Company plans to generate revenues through licensing, fee-for-service and joint venture arrangements related to its patent pending proprietary method of extracting cannabinoids from cannabis plants and converting the resulting cannabinoid extracts into saleable concentrates.
The Company has adopted a fiscal year end of May 31st.
Basis of Presentation
These financial statements and related notes are presented in accordance with accounting principles generally accepted in the United States and are expressed in US dollars.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts of CLS Holdings USA, Inc., and its wholly owned operating subsidiaries, CLS Labs, Inc. and CLS Labs Colorado, Inc. All material intercompany transactions have been eliminated upon consolidation of these entities.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three months or less to be cash equivalents. The Company had cash and cash equivalents of $25,398 and $88,244 as of November 30, 2016 and May 31, 2016, respectively.
Property, Plant and Equipment
Property and equipment is recorded at the lower of cost or estimated net recoverable amount, and is depreciated using the straight-line method over the estimated useful lives. Computer equipment is being depreciated over a three-year period.
Concentrations of Credit Risk
The Company maintains its cash in bank deposit accounts, the balances of which at times may exceed federally insured limits. The Company continually monitors its banking relationships and consequently has not experienced any losses in such accounts.
Advertising and Marketing Costs
Advertising and marketing costs are expensed as incurred. The Company incurred no advertising and marketing costs for the six months ended November 30, 2016 and 2015.
Research and Development
Research and development expenses are charged to operations as incurred. The Company incurred no research and development costs for the six months ended November 30, 2016 and 2015, respectively.
Income Taxes
The Company accounts for income taxes using the asset and liability method, which requires the establishment of deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided to the extent deferred tax assets may not be recoverable after consideration of the future reversal of deferred tax liabilities, tax planning strategies, and projected future taxable income.
Fair Value of Financial Instruments
Pursuant to Accounting Standards Codification (“ASC”) No. 825 - Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheets. The carrying amount of the Company’s cash and cash equivalents, note receivable, notes payable, accounts payable and accrued expenses, none of which is held for trading, approximates their estimated fair values due to the short-term maturities of those financial instruments.
A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly.
Level 3 - Significant unobservable inputs that cannot be corroborated by market data.
Derivative Financial Instruments
Derivatives are recorded on the condensed consolidated balance sheet at fair value. The conversion features of the convertible notes are embedded derivatives and are separately valued and accounted for on the consolidated balance sheet with changes in fair value recognized during the period of change as a separate component of other income/expense. Fair values for exchange-traded securities and derivatives are based on quoted market prices. The pricing model the Company used for determining fair value of its derivatives is the Lattice Model. Valuations derived from this model are subject to ongoing internal and external verification and review. The model uses market-sourced inputs such as interest rates and stock price volatilities. Selection of these inputs involves management’s judgment and may impact net income (see note 11).
Revenue Recognition
For revenue from product sales, the Company recognizes revenue using four basic criteria that must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. The Company defers any revenue for which the product has not been delivered or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or no refund will be required.
The Company has not generated revenue to date.
Basic and Diluted Loss Per Share
Basic net earnings per share is based on the weighted average number of shares outstanding during the period, while fully-diluted net earnings per share is based on the weighted average number of shares of common stock and potentially dilutive securities assumed to be outstanding during the period using the treasury stock method. Potentially dilutive securities consist of options and warrants to purchase common stock, and convertible debt. Basic and diluted net loss per share is computed based on the weighted average number of shares of common stock outstanding during the period.
The Company uses the treasury stock method to calculate the impact of outstanding stock options and warrants. Stock options and warrants for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on earnings per common share and, accordingly, are excluded from the calculation.
A net loss causes all outstanding stock options and warrants to be antidilutive. As a result, the basic and dilutive losses per common share are the same for the three and six months ended November 30, 2016 and 2015.
Commitments and Contingencies
Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims brought to such legal counsel’s attention as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.
Recent Accounting Pronouncements
Accounting standards promulgated by the Financial Accounting Standards Board (“FASB”) are subject to change. Changes in such standards may have an impact on the Company’s future financial statements. The following are a summary of recent accounting developments.
In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The update requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by long-term leases. The update also requires certain qualitative and quantitative disclosures about the amount, timing and uncertainty of cash flows arising from leases. Accounting by lessors will remain largely unchanged. This update is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. Adoption will require a modified retrospective approach beginning with the earliest period presented. The Company is currently evaluating the potential impact of the update on its financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), to reduce the complexity of certain aspects of the accounting for employee share-based payment transactions. ASU 2016-09 involves changes in several aspects of the accounting for share-based payment transactions, including the accounting for the income tax consequences of share-based awards. For public companies, ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The update addresses eight specific cash flow issues and is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This update will be effective for reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Early adoption is permitted. The Company is currently evaluating the potential impact of the update on its financial statements.
Management does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying unaudited condensed consolidated financial statements.
Note 2 – Going Concern
As shown in the accompanying financial statements, the Company has incurred net losses from operations resulting in an accumulated deficit of $5,866,414 as of November 30, 2016. Further losses are anticipated in the development of its business raising substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent upon the Company generating profitable operations in the future and/or obtaining the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management intends to finance operating costs over the next twelve months with loans, the proceeds from the sale of securities, and/or revenues from operations. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from this uncertainty.
Note 3 – Prepaid Expenses
Prepaid expenses consisted of the following at November 30, 2016 and May 31, 2016:
|
|
November 30,
|
|
|
November 30,
|
|
|
|
2016
|
|
|
2016
|
|
Prepaid rent
|
|
$
|
16,381
|
|
|
$
|
-
|
|
Prepaid legal fees
|
|
|
6,410
|
|
|
|
6,742
|
|
Total
|
|
$
|
22,791
|
|
|
$
|
6,742
|
|
Note 4 – Construction in Progress
The Company has construction in progress, in the amount of $141,739 and $106,726 at November 30, 2016 and May 31, 2016 on improvements to its leased facility in Colorado. As of November 30, 2016, the Company had yet to start amortizing these improvements.
Note 5 – Security Deposit
The Company had a security deposit in the amount of $50,000 at November 30, 2016 and May 31, 2016. This amount consisted of a deposit to secure office and warehouse space.
Note 6 – Note Receivable
During the year ended May 31, 2015, the Company loaned $500,000 (the “Note”) to Picture Rock Holdings, LLC, a Colorado limited liability company (“PRH”). Pursuant to the Note, as amended by the parties effective June 30, 2015, October 31, 2015, April 11, 2016, and May 31, 2016, PRH will repay the principal due under the Note in twenty (20) equal quarterly installments of Twenty Five Thousand Dollars ($25,000) commencing in the month following the month in which PRH commences generating revenue at the grow facility, which commencement is anticipated to occur in the next four to six months, and continuing until paid in full. Interest will accrue on the unpaid principal balance of the Note at the rate of twelve percent (12%) per annum and will be paid quarterly in arrears commencing after such initial payment and continuing until paid in full. All outstanding principal and any accumulated unpaid interest due under the Note is due and payable on the five-year anniversary of the initial payment thereunder. In the event of default as defined in the agreements relating to the Note, all amounts under the Note shall become at once due and payable. During the year ended May 31, 2015, the Company recorded an impairment related to the note receivable in the amount of $500,000. This receivable is recorded on the balance sheet as of November 30, 2016 and May 31, 2016 in the amount of $0, net of allowance in the amount of $500,000 (see note 10).
Note 7 – Property, Plant and Equipment
Property, plant and equipment consisted of the following at November 30, 2016 and May 31, 2016.
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Computer equipment
|
|
$
|
2,674
|
|
|
$
|
2,674
|
|
Property and equipment, gross
|
|
|
2,674
|
|
|
|
2,674
|
|
Less: accumulated depreciation
|
|
|
(1,338
|
)
|
|
|
(892
|
)
|
Property and equipment, net
|
|
$
|
1,336
|
|
|
$
|
1,782
|
|
Depreciation expense totaled $223 and $446 for the three and six months ended November 30, 2016 and 2015, respectively.
Note 8 – Intangible Assets
Intangible assets consisted of the following at November 30, 2016 and May 31, 2016.
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Domain name
|
|
$
|
2,158
|
|
|
$
|
2,158
|
|
|
|
|
2,158
|
|
|
|
2,158
|
|
Less: accumulated amortization
|
|
|
(612
|
)
|
|
|
(396
|
)
|
Intangible assets, net
|
|
$
|
1,546
|
|
|
$
|
1,762
|
|
Total amortization expense charged to operations for the three and six months ended November 30, 2016 was $108 and $216 and $72 and $108 for the three and six months ended November 30, 2015, respectively. The domain name is being amortized over a period of 60 months.
Note 9 – Accounts Payable and Accrued Liabilities
The Company had accounts payable and accrued liabilities of $568,236 and $431,017 at November 30, 2016 and May 31, 2016, which consist of legal fees, deferred rent liability and other trade payables.
Note 10 – Related Party Transactions
As of November 30, 2016 and May 31, 2016, the Company owed the amount of $75,000 and $250,000, respectively, to Jeffrey Binder, its President and Chief Executive Officer, for accrued salary. In July 2016, unpaid accrued salary in the amount of $250,000 was transferred to a Convertible Promissory Note due to Mr. Binder (see note 11).
As of November 30, 2016 and May 31, 2016, the Company had accrued salary due to Michael Abrams, a former officer of the Company prior to his September 1, 2015 termination, in the amount of $16,250.
As of November 30, 2016 and May 31, 2016, the Company had related party payables in the amount of $17,930 due to officers and directors related to expenses paid on behalf of the Company. The Company imputed interest at the rate of 6% per annum on these liabilities, and recorded imputed interest expense on these liabilities in the amounts of $539 and $539 during the six months ended November 30, 2016 and 2015, respectively. These interest accruals were charged to additional paid-in capital.
As of November 30, 2016, the Company had a related party payable in the amount of $251 due to Alan Bonsett, the Company’s COO, for expenses paid on behalf of the Company.
On April 17, 2015, CLS Labs Colorado, Inc. (“CLS Labs Colorado”), a wholly owned subsidiary of CLS Labs, loaned $500,000 (the “Note”) to Picture Rock Holdings, LLC, a Colorado limited liability company (“PRH”), to be used by PRH in connection with the financing of the building out, equipping, and development of a grow facility by PRH that will be operated by a licensed third-party marijuana grower. Pursuant to the Note, as amended by the parties effective June 30, 2015, October 31, 2015, April 11, 2016, and May 31, 2016, PRH will repay the principal due under the Note in twenty (20) equal quarterly installments of Twenty Five Thousand Dollars ($25,000) commencing in the month following the month in which PRH commences generating revenue at the grow facility, which commencement is anticipated to occur in the next four to six months (the “Payment Date”) and continuing until paid in full. Interest will accrue on the unpaid principal balance of the Note at the rate of twelve percent (12%) per annum and will be paid quarterly in arrears commencing on the Payment Date and continuing until paid in full. All remaining outstanding principal and any accumulated unpaid interest due under the Note will be due and payable on the fifth anniversary of the Payment Date. In the event of default as defined in the agreements related to the Note, all amounts under the Note shall become at once due and payable. During the year ended May 31, 2015, the Company recorded an impairment related to the note receivable in the amount of $500,000. This receivable is recorded on the balance sheet as of November 30, 2016 and May 31, 2016, in the amount of $0, net of a reserve in the amount of $500,000.
On April 17, 2015, prior to Alan Bonsett’s appointment as Chief Operating Officer, the Company, through CLS Labs Colorado, entered into an arrangement with PRH (the “Colorado Arrangement”) to, among other things, (i) license its proprietary technology, methods and processes to PRH in Colorado in exchange for a fee; (ii) sub-lease warehouse and office space in Denver, Colorado to PRH whereby PRH can grow, extract and process cannabis and other plant products in exchange for lease payments totaling an aggregate of $1,067,067 over a seventy-two (72) month term; (iii) build a processing facility and lease such facility, including equipment, to PRH in exchange for a monthly fee; and (iv) loan $500,000 to PRH to be used by PRH in connection with its financing of the building out, equipping, and development of a marijuana grow facility. Mr. Bonsett, as an owner of PRH, will indirectly receive the benefits of the Colorado Arrangement. PRH entered into an arrangement with a third-party grower to grow marijuana at a location that is contiguous to PRH’s leased real property. The grower obtained zoning approval, a certificate of occupancy to begin planting cannabis and operating the grow facility, and a Colorado Retail Marijuana Cultivation Facility License before commencing planting in December 2015, and the grow facility is now fully operational.
Additionally, upon Mr. Bonsett’s employment on August 1, 2015 to serve as the Company’s Chief Operating Officer, he received a one-time signing bonus of 250,000 (post Reverse-Split) shares of restricted common stock of the Company, with a fair value of $327,500, which became fully vested one year from the effective date of the agreement.
Related Party Notes Payable
The Company has convertible notes payable and notes payable outstanding to Jeffrey Binder, an officer and director, and to Frank Koretsky, a director; see note 11.
During the six months ended November 30, 2016 the Company issued a $150,000 convertible note payable to CLS CO 2016, LLC an entity affiliated with Frank Koretsky, a director of the Company, see note 11.
Note 11 – Notes Payable
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Notes payable to Jeffrey Binder, an officer and director of the Company, for advances to fund operations (the “Binder Funding Notes”). The Binder Funding Notes bear interest at a rate of 6%, have no maturity date and are due on demand. During the six months ended November 30, 2016, Mr. Binder advanced a total of $71,000 to the Company under the Binder Funding Notes and the Company repaid Mr. Binder $61,000 under the Binder Funding Notes; during the six months ended November 30, 2016, $12,750 of this amount was transferred out of the Binder Funding Notes and used to fund a new convertible note payable to Mr. Binder (See “Binder Convertible Note 3” below). During the six months ended November 30, 2016, the Company accrued interest in the amount of $72 on the Binder Funding Notes.
|
|
$
|
-
|
|
|
$
|
2,750
|
|
|
|
|
|
|
|
|
|
|
Notes payable to Newcan Investment Partners, LLC, an entity owned by Frank Koretsky, a director of the Company, for advances to fund operations (the “Koretsky Funding Notes”). The Koretsky Funding Notes bear interest at a rate of 6%, have no maturity date and are due on demand. During the six months ended November 30, 2016, Frank Koretsky advanced $140,000 and Newcan Investment Partners, LLC advanced $410,000 to the Company under the Koretsky Funding Notes; during the six months ended November 30, 2016, $210,000 was transferred out of the Koretsky Funding Notes and used to fund a new convertible note payable to Mr. Koretsky (see “Koretsky Convertible Note 3” below). During the six months ended November 30, 2016, the Company accrued interest in the amount of $5,104 on the Koretsky Funding Notes.
|
|
|
410,000
|
|
|
|
70,000
|
|
|
|
|
|
|
|
|
|
|
Total - Notes Payable, Related Parties
|
|
$
|
410,000
|
|
|
$
|
72,750
|
|
13
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Unsecured convertible note issued to Jeffrey Binder, an officer and director of the Company, dated January 12, 2016 and due January 1, 2019 (the “Binder Convertible Note 1”). The Binder Convertible Note 1 was funded with $50,000 of advances Mr. Binder made to the Company under the Binder Funding Notes. This note bears interest at the rate of 6% per annum. No payments are required until January 1, 2017, at which time all accrued interest becomes due and payable. Commencing on April 1, 2017, the first of eight principal payments in the amount of $6,250 will become due; subsequent principal payments will become due on the first day of each July, October, January, and April until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $0.75 converted, with each Unit consisting of one (1) share of common stock and a three-year warrant to purchase (1) share of common stock at a price of $1.00 per share (post Reverse-Split). The Company recognized a discount of $50,000 on the value of the beneficial conversion feature at the time of issuance of this note. During the six months ended November 30, 2016, $12,374 of this discount was charged to operations. During the six months ended November 30, 2016 the Company accrued interest in the amount of $1,504 on this note.
|
|
|
50,000
|
|
|
|
50,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible note issued to Jeffrey Binder, an officer and director of the Company, dated April 8, 2016 and due April 1, 2019 (the “Binder Convertible Note 2”). The Binder Convertible Note 2 was funded with $42,500 of advances Mr. Binder made to the Company under the Binder Funding Notes. This note bears interest at the rate of 6% per annum through February 29, 2016 and 10% per annum thereafter. No payments are required until April 1, 2017, at which time all accrued interest becomes due and payable. Commencing on July 1, 2017, the first of eight principal payments in the amount of $5,313 will become due; subsequent principal payments will become due on the first day of each October, January, April, and July until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share (post Reverse-Split). The Company recognized a discount of $37,840 on the value of the beneficial conversion feature at the time of issuance of this note. During the six months ended November 30, 2016, $9,365 of this discount was charged to operations. During the six months ended November 30, 2016, the Company accrued interest in the amount of $2,131 on this note.
|
|
|
42,500
|
|
|
|
42,500
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible note issued to Jeffrey Binder, an officer and director of the Company, dated July 20, 2016 and due July 1, 2019 (the “Binder Convertible Note 3”). The Binder Convertible Note 3 was funded with the conversion of $250,000 of unpaid accrued salary due to Mr. Binder and $12,750 of advances Mr. Binder made to the Company under the Binder Funding Notes. This note bears interest at the rate of 10% per annum. No payments are required until July 1, 2017, at which time all accrued interest becomes due and payable. Commencing on October 1, 2017, the first of eight principal payments in the amount of $32,844 will become due; subsequent principal payments will become due on the first day of each, January, April, July and October until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share (post Reverse-Split). During the six months ended November 30, 2016, the Company accrued interest in the amount of $9,641 on this note.
|
|
|
262,750
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible note issued to Frank Koretsky, a director of the Company, dated January 12, 2016 and due January 1, 2019 (the “Koretsky Convertible Note 1”). The Koretsky Convertible Note 1 was funded with $895,000 of advances Mr. Koretsky made to the Company under the Koretsky Funding Notes. This note bears interest at the rate of 6% per annum. No payments are required until January 1, 2017, at which time all accrued interest becomes due and payable. Commencing on April 1, 2017, the first of eight principal payments in the amount of $111,875 will become due; subsequent principal payments will become due on the first day of each July, October, January, and April until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $0.75 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.00 per share (post Reverse-Split). The Company recognized a discount of $895,000 on the value of the beneficial conversion feature at the time of issuance of this note. During the six months ended November 30, 2016, $221,489 of this discount was charged to operations. During the three months ended November 30, 2016, the Company accrued interest in the amount of $26,923 on this note.
|
|
|
895,000
|
|
|
|
895,000
|
|
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Unsecured convertible note issued to Frank Koretsky, a director of the Company, dated April 8, 2016 and due April 1, 2019 (the “Koretsky Convertible Note 2”). The Koretsky Convertible Note 2 was funded with $380,000 of advances Mr. Koretsky made to the Company under the Koretsky Funding Notes. This note bears interest at the rate of 6% per annum through February 29, 2016 and 10% per annum thereafter. No payments are required until April 1, 2017, at which time all accrued interest becomes due and payable. Commencing on July 1, 2017, the first of eight principal payments in the amount of $47,500 will become due; subsequent principal payments will become due on the first day of each October, January, April, and July until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share (post Reverse-Split). The Company recognized a discount of $338,336 on the value of the beneficial conversion feature at the time of issuance of this note. During the six months ended November 30, 2016, $83,735 of this discount was charged to operations. During the six months ended November 30, 2016, the Company accrued interest in the amount of $19,052 on this note.
|
|
|
380,000
|
|
|
|
380,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible note issued to Frank Koretsky, a director of the Company, dated July 20, 2016 and due July 1, 2019 (the “Koretsky Convertible Note 3”). The Koretsky Convertible Note 3 was funded with $210,000 of advances Mr. Koretsky made to the Company under the Koretsky Funding Notes. This note bears interest at the rate of 10% per annum. No payments are required until July 1, 2017, at which time all accrued interest becomes due and payable. Commencing on October 1, 2017, the first of eight principal payments in the amount of $32,844 will become due; subsequent principal payments will become due on the first day of each, January, April, July and October until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share (post Reverse-Split). During the six months ended November 30, 2016, the Company accrued interest in the amount of $8,550 on this note.
|
|
|
210,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible note issued to CLS CO 2016, LLC an entity affiliated with Frank Koretsky, a director of the Company, dated August 3, 2016 and due August 1, 2018 (the “CLS CO 2016 Note”). This note has a face amount of $150,000 and bears interest at the rate of 15% per annum. All interest accruing on this Note through the first anniversary of this Note shall be added to principal. Commencing on November 1, 2017, the Company shall pay the outstanding principal balance in four (4) equal quarterly installments, together with accrued interest, in arrears, until paid in full. This note and accrued interest under the note may be converted, in whole or in part, into one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share (post Reverse-Split). During the six months ended November 30, 2016, the Company accrued interest in the amount of $7,336 on this note.
|
|
|
150,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Total – Convertible Notes Payable, Related Parties
|
|
$
|
1,990,250
|
|
|
|
1,367,500
|
|
Less: Discount
|
|
|
(787,142
|
)
|
|
|
(1,114,104
|
)
|
Convertible Notes Payable, Related Parties, Net of Discounts
|
|
$
|
1,203,108
|
|
|
|
253,396
|
|
|
|
|
|
|
|
|
|
|
Convertible Notes Payable, Related Parties, Net of Discounts, Current Portion
|
|
$
|
293,594
|
|
|
$
|
22,678
|
|
Convertible Notes Payable, Related Parties, Net of Discounts, Long-term Portion
|
|
|
909,514
|
|
|
|
230,718
|
|
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Convertible promissory note issued to an unaffiliated third party due April 29, 2018 (the “April 2015 Note”). During the twelve months ended May 31, 2015, the lender loaned the Company the amount of $200,000 pursuant to this note. The April 2015 Note bears interest at a rate of 15% per annum. On the first anniversary of this note, the all then accrued interest became due. Thereafter, the Company is required to make eight equal payments of principal together with accrued interest, quarterly in arrears, commencing on July 1, 2016 until paid in full. The note and any accrued unpaid interest is convertible into common stock of the Company. For each dollar converted, the note holder shall receive two shares of common stock and one three-year warrant to purchase 1.33 shares (post Reverse-Split) of common stock at $0.75 per share (post Reverse-Split). The Company recognized a discount of $200,000 on the April 2015 Note related to the value of the beneficial conversion feature at the time of issuance. During the six months ended November 30, 2016 $58,681 of this discount was charged to operations. During the six months ended November 30, 2016, the Company repaid $50,000 in principal and $42,575 in interest and accrued interest in the amount of $13,788, on this note.
|
|
|
150,000
|
|
|
|
200,000
|
|
|
|
|
|
|
|
|
|
|
Convertible Promissory Notes payable to Old Main Capital, LLC (“Old Main”) dated March 18, 2016, April 22, 2016 and May 27, 2016
as amended on October 6, 2016 and November 28, 2016, for the purchase of up to $333,333 in 10% Original Issue Discount Convertible Promissory Notes (the “10% Notes”). These notes originally bore interest at the rate of 10% per annum, which increased to 15% effective August 1, 2016. Initially, Old Main could, at its option, convert all or a portion of the notes and accrued but unpaid interest into shares of common stock at a conversion price of $0.80 per share (post Reverse-Split) (the “Fixed Conversion Price”). The Fixed Conversion Price is subject to adjustment if, at any time while this note is outstanding, the Company should issue any equity security with an effective price per share that is lower than the Fixed Conversion Price (the “Base Conversion Price”), other than certain exempt issuances. In such an instance, the Fixed Conversion Price will be lowered to match the Base Conversion Price. Originally, at the earlier of October 18, 2016 or two trading days after the registration statement related to the Company’s equity line was declared effective, the Company must begin to redeem 1/24th of the face amount of the notes and any accrued but unpaid interest on a bi-weekly basis. Such amortization payments could be made, at the Company’s option, in cash or, subject to certain conditions, in common stock pursuant to a conversion rate equal to the lower of (a) $0.80 or (b) 75% of the lowest daily volume weighted average price of the common stock in the twenty consecutive trading days immediately prior to the conversion date. The Company recognized a discount of $330,188 on the 10% Notes related to the value of the original issue discount and embedded derivative at time of issuance.
On October 6, 2016 the 10% Notes were amended to increase the interest rate to 15% (effective August 1, 2016) and subsequently amended November 28, 2016 to convert the 10% Notes from installment notes to “balloon” notes, with all principal and accrued interest due on September 18, 2017. In exchange for amending the terms of the 10% Notes, the Company increased the outstanding principal balance by 10% to $366,666. In addition the Fixed Conversion Price was changed to a variable conversion price equal to the lesser of the prior Fixed Conversion Price or 75% of the lowest VWAP in the fifteen trading days ending on the trading day immediately prior to the conversion date. This November 28, 2016 amendment required an extinguishment analysis of the 10% Notes resulting in the gain on extinguishment of debt in the amount of $172,618 during the six months ended November 30, 2016. The gain on extinguishment of debt was included in additional paid in capital during the six months ended November 30, 2016. The 10% Notes were revalued as of the November 28, 2016 amendment and the Company recognized a discount of $366,666 on the value of the embedded derivative. During the six months ended November 30, 2016, $4,208 of this discount was charged to operations in addition to the amortization of $314,230 in note discounts prior to the November 28, 2016 amendment. During the six months ended November 30, 2016, the Company accrued interest in the amount of $22,310 on the 10% Notes.
|
|
|
366,666
|
|
|
|
333,332
|
|
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2016
|
|
|
2016
|
|
Convertible promissory note payable to Old Main dated March 18, 2016 and mended on October 6, 2016 and November 28, 2016, and bearing interest at a rate of 8% (the “8% Note”). The 8% Note was issued for Old Main’s commitment to enter into an equity line transaction with the Company and prepare all of the related transaction documents. Originally, Old Main could, at its option, convert all or a portion of the note and accrued but unpaid interest into shares of common stock at a conversion price of $1.07 per share (post Reverse-Split) (the “8% Fixed Conversion Price”). The 8% Fixed Conversion Price is subject to adjustment if, at any time while this note is outstanding, the Company should issue any equity security with an effective price per share that is lower than the 8% Fixed Conversion Price (the “8% Base Conversion Price”), other than certain exempt issuances. In such an instance, the 8% Fixed Conversion Price will be lowered to match the 8% Base Conversion Price. Originally, at the earlier of February 3, 2017 or the effectiveness of the registration statement related to the Company’s equity line, the Company must begin to redeem 1/6th of the face amount of the note and any accrued but unpaid interest on a monthly basis. Such amortization payment could be made, at its option, in cash or, subject to certain conditions, in common stock pursuant to a conversion rate equal to the lower of (a) $1.07 (post Reverse-Split) or (b) 75% of the lowest daily volume weighted average price of the common stock in the twenty consecutive trading days ending on the trading day that is immediately prior to the applicable conversion date. The Company recognized a discount of $172,108 on the value of the embedded derivative at the time of issuance.
On November 28, 2016 the 8% Note was amended converting the note from an installment note to a “balloon” note, with all principal and accrued interest due March 18, 2017. In addition the Fixed Conversion Price was changed to variable conversion price equal to the lesser of the prior Fixed Conversion Price or 75% of the lowest VWAP in the fifteen trading days ending on the trading day immediately prior to the conversion date. The November 28, 2016 amendment required an extinguishment analysis of the 8% Note resulting in the gain on extinguishment of debt in the amount of $81,496 for the six months ended November 30, 2016. The gain on extinguishment of debt was included in additional paid in capital during the six months ended November 30, 2016. The 8% Note was revalued as of the November 28, 2016 amendment and the Company recognized a discount of $169,476 on the value of the embedded derivative. During the six months ended November 30, 2016, $7,201 of this discount was charged to operations in addition to amortization of $143,589 in note discounts prior to the November 28, 2016 amendment. During the six months ended November 30, 2016, the Company accrued interest in the amount of $8,022 on the 8% Note.
|
|
|
200,000
|
|
|
|
200,000
|
|
|
|
|
|
|
|
|
|
|
Total - Convertible Notes Payable
|
|
$
|
716,666
|
|
|
$
|
733,332
|
|
Less: Discount
|
|
|
(573,785
|
)
|
|
|
(587,910
|
)
|
Convertible Notes Payable, Net of Discounts
|
|
$
|
142,881
|
|
|
$
|
145,422
|
|
|
|
|
|
|
|
|
|
|
Total - Convertible Notes Payable, Net of Discounts, Current Portion
|
|
$
|
92,881
|
|
|
$
|
72,525
|
|
Total - Convertible Notes Payable, Net of Discounts, Long-term Portion
|
|
$
|
50,000
|
|
|
$
|
43,312
|
|
|
|
|
|
|
|
|
|
|
Discounts on notes payable amortized to interest expense:
|
|
$
|
889,392
|
|
|
$
|
286,317
|
|
Beneficial Conversion Features
The 10% Notes and the 8% Note (collectively, the “2016 Convertible Notes”) contain conversion features that create derivative liabilities. The pricing model the Company used for determining fair value of its derivatives is the Lattice Model. Valuations derived from this model are subject to ongoing internal and external verification and review. The model uses market-sourced inputs such as interest rates and stock price volatilities. Selection of these inputs involves management’s judgment and may impact net income. The derivative component of the 2016 Convertible Notes was valued at November 28, 2016, the date of the second amendment to the 2016 Convertible Notes, and at period end. The following assumptions and key inputs were used for the valuation of the derivative liability related to the 2016 Convertible Notes at November 28, 2016 and November 30, 2016:
|
|
|
Assumption
|
|
|
Expected dividends:
|
|
|
0
|
%
|
Expected volatility:
|
|
|
93
|
%
|
Expected term (years):
|
0.80 years
|
|
Risk free interest rate:
|
|
|
0.60-0.62
|
|
Stock price
|
|
$
|
0.55-0.59
|
|
Note 12 – Stockholders’ Equity
The Company’s authorized capital stock consists of 250,000,000 shares of common stock, par value $0.0001 per share and 20,000,000 shares of preferred stock, par value $0.001 per share. The Company had 20,350,003 and 20,350,003 shares (post Reverse Split) of common stock issued and outstanding as of November 30, 2016 and May 31, 2016, respectively.
On December 10, 2014, the Company effected a reverse stock split of the Company’s issued and outstanding common stock at a ratio of 1-for-0.625, wherein 0.625 shares of common stock were issued in exchange for each share of the Company’s common stock owned by the Company’s stockholders on December 1, 2014, the record date for the reverse stock split. As a result of the reverse stock split, 11,250,000 shares (post Reverse-Split) of common stock were outstanding as of December 10, 2014. The reverse stock split did not affect the number of authorized shares of the Company’s common stock. All share and per share information contained in the financial statements has been retroactively adjusted to reflect the reverse stock split.
The Company recorded imputed interest of $539 and $539 during the six months ended November 30, 2016 and 2015 on related party payables due to a director and officer of the Company.
On November 28, 2016 the Company amended the 2016 Convertible Notes which qualified for the extinguishment analysis and reissuance of the debt. As a result the Company recorded a gain on the extinguishment of debt in the amount of $254,114, which was included in additional paid in capital at November 30, 2016.
On August 1, 2015, the Company and Alan Bonsett entered into a five-year employment agreement. Pursuant to the agreement, Mr. Bonsett commenced serving as the Company’s Chief Operating Officer on August 15, 2015. Mr. Bonsett received a one-time signing bonus of 250,000 (post Reverse Split) shares of restricted common stock of the Company, which became fully vested one year from the effective date of the agreement. The Company valued the shares at $327,500 based on the stock price at August 3, 2015 and is amortizing them over the term of the employment agreement. During the six months ended November 30 2015
,
the Company recognized $109,167 in share based compensation.
No shares of common stock were issued during the six months ended November 30, 2016.
Stock Issued for Services
On August 28, 2015, the Company issued 60,000 shares of common stock, valued at $45,000, to a consultant for services. Of these shares, 50,000, valued at $37,500, were included in stock payable as of May 31, 2015. The shares were valued based on the closing market price on the grant date.
On July 22, 2015, pursuant to a consulting agreement, the Company agreed to issue 5,000 shares of common stock, valued at $5,750, to a consulting firm in exchange for investor relations consulting services. On August 17, 2015, the consulting agreement was amended, whereby the Company agreed to issue 5,000 additional shares of common stock, valued at $6,650. On August 26, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $12,700. On October 9, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $11,700. On December 15, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $8,000. All shares were valued based on the closing market price on the grant date. During the year ended May 31, 2016, the Company issued 40,000 shares to this consultant, valued at $32,750.
As of November 30, 2016, the Company had 70,000 shares of common stock payable valued at $65,700 due to two third party consultants included in stock payable on the accompanying balance sheets. The parties are in discussions regarding whether any shares of the Company’s common stock have been earned and it is uncertain whether any shares will be issued.
Note 13 – Fair Value of Financial Instruments
In March 2016, the Company entered into convertible note agreements containing beneficial conversion features with Old Main. One of the features is a ratchet reset provision which, in general, reduces the conversion price should the Company issue equity with an effective price per share that is lower than the stated conversion price in the note agreement (see note 11). The Company accounts for the fair value of the conversion feature in accordance with ASC 815- Accounting for Derivatives and Hedging and Emerging Issues Task Force (“EITF”) 07-05- Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF 07-05”). The Company carries the embedded derivative on its balance sheet at fair value and accounts for any unrealized change in fair value as a component of its results of operations.
The following summarizes the Company’s derivative financial liabilities that are recorded at fair value on a recurring basis at November 30, 2016 and May 31, 2016.
|
November 30, 2016
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
534,877
|
|
|
$
|
534,877
|
|
|
May 31, 2016
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
418,537
|
|
|
$
|
418,537
|
|
The estimated fair values of the Company’s derivative liabilities are as follows:
|
|
Derivative
|
|
|
|
Liability
|
|
Liabilities Measured at Fair Value
|
|
|
|
|
|
|
|
Balance as of May 31, 2016
|
|
$
|
418,537
|
|
|
|
|
|
|
Issuances
|
|
|
518,720
|
|
|
|
|
|
|
Extinguishment of debt
|
|
|
(254,114
|
)
|
|
|
|
|
|
Revaluation gain
|
|
|
(148,266
|
)
|
|
|
|
|
|
Balance as of November 30, 2016
|
|
$
|
534,877
|
|
Note 14 – Commitment and Contingencies
The Company, through CLS Labs Colorado, leases 42,392 square feet of warehouse and office space (the “Leased Space”) in a building located on 1.92 acres in Denver Colorado. CLS Labs Colorado subleases the Leased Space to Picture Rock Holdings, LLC as part of an arrangement whereby Picture Rock Holdings, LLC and its affiliate will conduct certain intended activities, including growing, extraction, conversion, assembly and packaging of cannabis and other plant materials, as permitted by and in compliance with state, city and local laws, rules, ordinances and regulations. Total expense for the lease was $89,354 and $118,536 for the six months ended November 30, 2016 and 2015.
Employment Agreements
CLS Labs and Jeffrey Binder entered into a five-year employment agreement effective October 1, 2014. Under the agreement, Mr. Binder serves as CLS Labs’ Chairman, President and Chief Executive Officer and is entitled to receive an annual salary of $150,000. Under the agreement, Mr. Binder is also entitled to receive a performance bonus equal to 2% of CLS Labs’ annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of CLS Labs’ common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million. On April 28, 2015, CLS Labs and the Company entered into an addendum to Mr. Binder’s employment agreement whereby Mr. Binder agreed that following the merger of CLS Labs and a subsidiary of the Company, in addition to his obligations to CLS Labs, he would serve the Company and its subsidiaries in such roles as the Company may request. In exchange, the Company agreed to assume the obligations of CLS Labs to grant Mr. Binder annual stock options, as referenced above. Mr. Binder continues to receive an annual salary of $150,000 from CLS Labs for serving as its Chairman, President and Chief Executive Officer. My Binder deferred all of the salary payable to him under his employment agreement through May 31, 2016. On July 20, 2016, the Company issued Mr. Binder a convertible note in exchange for $250,000 in deferred salary, among other amounts owed to Mr. Binder by the Company. As of November 30, 2016 and May 31, 2016, the Company had accrued compensation due to Mr. Binder in the amount of $75,000 and $250,000.
Effective August 1, 2015, the Company and Alan Bonsett entered into a five-year employment agreement. Pursuant to the agreement, Mr. Bonsett commenced serving as the Company’s Chief Operating Officer on August 15, 2015. Under the agreement, Mr. Bonsett is entitled to receive an annual salary of $150,000. Further, he is entitled to receive a performance bonus equal to 2% of the Company’s annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of the Company’s common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million. Additionally, Mr. Bonsett received a one-time signing bonus of 250,000 (post Reverse-Split) shares of restricted common stock of the Company, valued at $327,500, which became fully vested one year from the effective date of the agreement. Mr. Bonsett, as an owner of PRH, will indirectly receive the benefits of the Colorado Arrangement, as discussed in Note 10. The business to be operated by PRH pursuant to the Colorado Arrangement has not yet produced revenues.
At November 30, 2016 and May 31, 2016, the Company had accrued salary due to Michael Abrams, a former officer of the Company, prior to his September 1, 2015 termination, in the amount of $16,250 in accrued compensation on the accompanying consolidated balance sheets.
Note 15 – Subsequent Events
On January 10, 2017, the Company issued convertible promissory notes to Newcan Investment Partners LLC, an entity owned solely by Frank Koretsky, who is a director of the Company, in the amount of $410,000 and $50,000 (the “Koretsky Notes”), to finalize the terms of repayment with respect to certain loans made to the Company by Newcan Investment Partners LLC between September 6, 2016 and December 15, 2016. The Notes, which otherwise contain identical terms, are unsecured and bear interest at the rate of 10% per annum thereafter. No payments are required until January 2, 2018, at which time all accrued interest becomes due and payable. Principal will be payable in eight equal quarterly installments, together with interest accrued thereon, beginning on April 1, 2018. The Notes may be prepaid by the Company with no penalty at any time upon thirty days written notice.
The holder of each of the Koretsky Notes may, at any time prior to payment or prepayment in full, convert all principal and accrued interest thereunder, in whole or in part, into securities of the Company. For each $1.07 converted, the holder will receive one share of the Company’s common stock and a five-year warrant to purchase one share of the Company’s common stock at a price of $1.07 per share.
We evaluated subsequent events after the balance sheet date through the date the financial statements were issued. We did not identify any additional material events or transactions occurring during this subsequent event reporting period that required further recognition or disclosure in these financial statements.