6-K
Glass House Brands Inc. (GLASF)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form6-K
REPORT OF FOREIGN PRIVATEISSUER PURSUANT TO RULE 13a-16 OR 15d-16 UNDER THE SECURITIES EXCHANGE ACT OF 1934
| For the month of August, 2022 | Commission File Number: 000-56261 |
|---|
GlassHouse Brands Inc.
(Translation of registrant’s name into English)
3645 Long Beach Blvd.
Long Beach, California 90807
(Address of principal executive office)
Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.
Form 20-F ¨ Form 40-F x
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1): ¨
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): ¨
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.
| Glass House Brands Inc. | |
|---|---|
| Date: August 15, 2022 | /s/ Kyle Kazan |
| By: Kyle Kazan | |
| Title: Chief Executive Officer |
2
EXHIBIT INDEX
3
Exhibit 99.1
GLASSHOUSE BRANDS INC.
UNAUDITEDCONDENSED INTERIM
CONSOLIDATEDFINANCIAL STATEMENTS
ASOF
JUNE30, 2022 AND DECEMBER 31, 2021
ANDFOR THE THREE AND SIX MONTHS ENDED
JUNE30, 2022 AND 2021
GLASS HOUSE BRANDS INC.
Table ofContents
| Condensed Consolidated Balance Sheets | 1 |
|---|---|
| Unaudited Condensed Interim Consolidated Statements of Operations | 2 |
| Unaudited Condensed Interim Consolidated Statements of Changes in Shareholders’ Equity | 3 |
| Unaudited Condensed Interim Consolidated Statements of Cash Flows | 4 – 5 |
| Notes to Unaudited Condensed Interim Consolidated Financial Statements | 6 – 26 |
GLASS HOUSE BRANDS INC.
Condensed Consolidated Balance Sheets
As of June 30,2022 and December 31, 2021
| 2022 | 2021 | |||||
|---|---|---|---|---|---|---|
| Unaudited | ||||||
| ASSETS | ||||||
| Current Assets: | ||||||
| Cash | $ | 14,451,301 | $ | 51,066,831 | ||
| Restricted Cash | 3,000,000 | 3,000,000 | ||||
| Accounts Receivable, Net | 3,652,016 | 2,893,911 | ||||
| Prepaid Expenses and Other Current Assets | 5,326,951 | 5,562,963 | ||||
| Inventory | 12,252,396 | 6,596,302 | ||||
| Notes Receivable | 6,061,255 | - | ||||
| Total Current Assets | 44,743,919 | 69,120,007 | ||||
| Operating Lease Right-of-Use Assets, Net | 3,610,160 | 3,077,730 | ||||
| Investments | 6,869,490 | 7,196,359 | ||||
| Property, Plant and Equipment, Net | 212,647,597 | 195,798,524 | ||||
| Intangible Assets, Net | 24,532,500 | 5,629,833 | ||||
| Goodwill | 10,442,353 | 4,918,823 | ||||
| Deferred Tax Asset | 772,675 | - | ||||
| Other Assets | 3,626,886 | 2,339,993 | ||||
| TOTAL ASSETS | $ | 307,245,580 | $ | 288,081,269 | ||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
| LIABILITIES: | ||||||
| Current Liabilities: | ||||||
| Accounts Payable and Accrued Liabilities | $ | 11,918,025 | $ | 10,215,004 | ||
| Income Taxes Payable | 7,070,182 | 5,038,983 | ||||
| Contingent Shares and Earnout Liabilities | 44,055,752 | 38,428,700 | ||||
| Shares Payable | 2,756,830 | 2,756,830 | ||||
| Current Portion of Operating Lease Liabilities | 561,127 | 269,154 | ||||
| Current Portion of Notes Payable | 9,490,413 | 37,986 | ||||
| Total Current Liabilities | 75,852,329 | 56,746,657 | ||||
| Operating Lease Liabilities, Net of Current Portion | 3,085,332 | 2,865,480 | ||||
| Other Non-Current Liabilities | 1,631,348 | 1,449,045 | ||||
| Deferred Tax Liabilities | - | 1,330,815 | ||||
| Notes Payable, Net of Current Portion | 61,885,504 | 44,817,436 | ||||
| TOTAL LIABILITIES | 142,454,513 | 107,209,433 | ||||
| SHAREHOLDERS' EQUITY: | ||||||
| Multiple Voting Shares (No par<br> value, unlimited shares authorized, 4,754,979 shares issued and outstanding as of June 30, 2022 and December 31, 2021,<br> respectively) | - | - | ||||
| Equity Shares (No par value,<br> unlimited shares authorized, 45,318,773 and 38,563,405 shares issued and outstanding as of June 30, 2022 and<br> December 31, 2021, respectively) | - | - | ||||
| Exchangeable Shares (No par<br> value, unlimited shares authorized, 14,541,193 and 18,256,784 shares issued and outstanding as of June 30, 2022 and<br> December 31, 2021, respectively) | - | - | ||||
| Additional Paid-In Capital | 257,662,914 | 241,896,900 | ||||
| Accumulated Deficit | (94,798,786 | ) | (60,827,290 | ) | ||
| Total Shareholders' Equity Attributable to the Company | 162,864,128 | 181,069,610 | ||||
| Non-Controlling Interest | 1,926,939 | (197,774 | ) | |||
| TOTAL SHAREHOLDERS' EQUITY | 164,791,067 | 180,871,836 | ||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 307,245,580 | $ | 288,081,269 |
The accompanying notes are an integral part of these Unaudited Condensed Interim Consolidated Financial Statements.
- 1 -
GLASS HOUSE BRANDS INC.
Unaudited Condensed Interim Consolidated Statementsof Operations
For theThree and Six Months Ended June 30, 2022 and 2021
| Three Months Ended | Six Months Ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2022 | 2021 | |||||||||
| Revenues, Net | $ | 16,473,247 | $ | 18,674,277 | $ | 30,445,618 | $ | 33,914,558 | ||||
| Cost of Goods Sold | 16,219,430 | 10,079,539 | 27,852,573 | 19,877,824 | ||||||||
| Gross Profit | 253,817 | 8,594,738 | 2,593,045 | 14,036,734 | ||||||||
| Operating Expenses: | ||||||||||||
| General and Administrative | 10,875,317 | 5,886,655 | 20,298,614 | 11,722,386 | ||||||||
| Sales and Marketing | 898,496 | 1,006,747 | 1,764,256 | 1,495,282 | ||||||||
| Professional Fees | 2,670,469 | 1,951,450 | 5,240,975 | 5,304,201 | ||||||||
| Depreciation and Amortization | 2,837,112 | 738,402 | 5,444,606 | 1,462,856 | ||||||||
| Total Operating Expenses | 17,281,394 | 9,583,254 | 32,748,451 | 19,984,725 | ||||||||
| Loss from Operations | (17,027,577 | ) | (988,516 | ) | (30,155,406 | ) | (5,947,991 | ) | ||||
| Other Expense (Income): | ||||||||||||
| Interest Expense | 1,570,779 | 1,171,282 | 2,768,308 | 2,181,710 | ||||||||
| Interest Income | (472 | ) | (16,136 | ) | (472 | ) | (32,222 | ) | ||||
| Loss on Investments | 73,004 | 285,646 | 426,663 | 284,258 | ||||||||
| Loss (Gain) on Change in Fair Value of Derivatives | 53,213 | (154,000 | ) | 53,213 | (825,000 | ) | ||||||
| (Gain) Loss on Change in Fair Value of Contingent Liabilities | (6,314,190 | ) | - | 167,052 | - | |||||||
| Loss on Disposition of Subsidiary | - | - | - | 6,090,339 | ||||||||
| Other Expense (Income), Net | 49,532 | (46,538 | ) | 65,637 | (40,514 | ) | ||||||
| Total Other (Income) Expense, Net | (4,568,134 | ) | 1,240,254 | 3,480,401 | 7,658,571 | |||||||
| Loss from Operations Before Provision for Income Tax Expense | (12,459,443 | ) | (2,228,770 | ) | (33,635,807 | ) | (13,606,562 | ) | ||||
| Provision for Income Tax Expense | 1,732,849 | 2,487,951 | 382,249 | 4,263,952 | ||||||||
| Net Loss | (14,192,292 | ) | (4,716,721 | ) | (34,018,056 | ) | (17,870,514 | ) | ||||
| Net Loss Attributable to Non-Controlling Interest | (23,964 | ) | - | (46,560 | ) | - | ||||||
| Net Loss Attributable to the Company | $ | (14,168,328 | ) | $ | (4,716,721 | ) | $ | (33,971,496 | ) | $ | (17,870,514 | ) |
| Loss Per Share - Basic and Diluted Attributable to the Company | $ | (0.24 | ) | $ | (0.19 | ) | $ | (0.59 | ) | $ | (0.74 | ) |
| Weighted-Average Shares Outstanding - Basic and Diluted | 59,447,659 | 24,262,497 | 58,067,245 | 24,117,056 |
The accompanying notes are an integral part of these Unaudited Condensed Interim Consolidated Financial Statements.
- 2 -
GLASS HOUSE BRANDS INC.
Unaudited Condensed Interim Consolidated Statementsof Changes in Shareholders’ Equity
For theSix Months Ended June 30, 2022 and 2021
| Units | Units | Units | **** | Units | **** | Amount | **** | Units | **** | Amount | **** | **** | **** | **** | **** | **** | **** | **** | **** | **** | **** | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| **** | Multiple Voting | Equity | Exchangeable Voting | **** | Class A Common | **** | Class A <br> Common | **** | Class B Common | **** | Class B <br> Common | **** | Additional Paid- In | **** | Accumulated | **** | TOTAL EQUITY ATTRIBUTABLE TO | **** | Non-Controlling | **** | TOTAL SHAREHOLDERS' | **** | |||||
| **** | Shares | Shares | Shares | **** | Shares | **** | Shares | **** | Shares | **** | Shares | **** | Capital | **** | Deficit | **** | SHAREHOLDERS | **** | Interest | **** | EQUITY | ||||||
| BALANCE AS OF DECEMBER 31, 2020, As Previously Reported | - | - | - | **** | 205,900,164 | **** | **** | 32,295,270 | **** | **** | $ | 42,932,020 | **** | $ | (16,659,478 | ) | $ | 26,274,924 | **** | $ | - | **** | $ | 26,274,924 | **** | ||
| Retroactive Application of Recapitalization<br> (1) | - | - | 23,191,563 | (205,900,164 | ) | ) | (32,295,270 | ) | ) | 2,382 | - | - | - | - | |||||||||||||
| Balance<br> at December 31, 2020, After Effect of Retroactive Application of Recapitalization (1) | - | - | 23,191,563 | - | - | 42,934,402 | (16,659,478 | ) | 26,274,924 | - | 26,274,924 | ||||||||||||||||
| Net Loss | - | - | - | - | - | - | (17,870,514 | ) | (17,870,514 | ) | - | (17,870,514 | ) | ||||||||||||||
| Share-Based<br> Compensation from Options and RSU's | - | - | - | - | - | 2,205,524 | - | 2,205,524 | - | 2,205,524 | |||||||||||||||||
| Share-Based<br> Compensation from Common Shares (1) | - | - | 48,682 | - | - | 225,000 | - | 225,000 | - | 225,000 | |||||||||||||||||
| Issuance<br> for Business Acquisition (1) | - | - | 731,369 | - | - | 3,380,278 | - | 3,380,278 | - | 3,380,278 | |||||||||||||||||
| Issuance<br> for Conversion of Convertible Debt (1) | - | - | 646,096 | - | - | 1,925,000 | - | 1,925,000 | - | 1,925,000 | |||||||||||||||||
| Preferred<br> Shares of Subsidiary Issued for Conversion of Debt (1) | - | - | - | - | - | 31,288,392 | - | 31,288,392 | - | 31,288,392 | |||||||||||||||||
| Derivative<br> Liability Reclassed to Equity Upon Conversion of Debt | - | - | - | - | - | 6,722,000 | - | 6,722,000 | - | 6,722,000 | |||||||||||||||||
| Issuance<br> for Conversion of Preferred Shares (1) | - | - | 2,577,227 | - | - | - | - | - | - | - | |||||||||||||||||
| Issuance<br> for Exercise of Warrants (1) | - | - | 160,149 | - | - | - | - | - | - | - | |||||||||||||||||
| Issuance<br> for Exercise of Options | - | 525,039 | - | - | - | 88,654 | - | 88,654 | - | 88,654 | |||||||||||||||||
| Reclass<br> to Share Payable | - | - | - | - | - | (2,756,830 | ) | - | (2,756,830 | ) | - | (2,756,830 | ) | ||||||||||||||
| Shares<br> issued in Business Combination for Cash | 4,754,979 | 22,335,508 | - | - | - | 116,675,330 | - | 116,675,330 | - | 116,675,330 | |||||||||||||||||
| Distributions<br> to Preferred Shareholders | - | - | - | - | - | (20,033 | ) | - | (20,033 | ) | - | (20,033 | ) | ||||||||||||||
| BALANCE AS OF JUNE 30, 2021 | 4,754,979 | 22,860,547 | 27,355,086 | **** | - | **** | **** | - | **** | **** | $ | 202,667,717 | **** | $ | (34,529,992 | ) | $ | 168,137,725 | **** | $ | - | **** | $ | 168,137,725 | **** | ||
| BALANCE AS OF DECEMBER 31, 2021 | 4,754,979 | 38,563,405 | 18,256,784 | - | - | 241,896,900 | (60,827,290 | ) | 181,069,610 | (197,774 | ) | 180,871,836 | |||||||||||||||
| Net Loss | - | - | - | - | - | - | (33,971,49 | ) | (33,971,496 | ) | (46,560 | ) | (34,018,056 | ) | |||||||||||||
| Share-Based<br> Compensation from Options and RSU's | - | - | - | - | - | 6,173,644 | - | 6,173,644 | - | 6,173,644 | |||||||||||||||||
| Issuance<br> for Business Acquisition | - | 2,311,213 | - | - | - | 9,707,414 | - | 9,707,414 | - | 9,707,414 | |||||||||||||||||
| Fair Value of<br> Incentive Shares Issued in a Business Acquisition | - | - | - | - | - | 188,122 | - | 188,122 | - | 188,122 | |||||||||||||||||
| Issuance<br> for Payment of Liabilities | - | 92,864 | - | - | - | 222,941 | - | 222,941 | - | 222,941 | |||||||||||||||||
| Issuance<br> for Conversion of Exchangeable Shares | - | 3,715,591 | (3,715,591 | ) | - | - | - | - | - | - | - | ||||||||||||||||
| Shares<br> Issued for Exercise of Options | - | 185,242 | - | - | - | 225,694 | - | 225,694 | - | 225,694 | |||||||||||||||||
| Shares<br> Issued for Exercise of Restricted Stock Units | - | 450,458 | - | - | - | - | - | - | - | - | |||||||||||||||||
| Contributions | - | - | - | - | 888,727 | - | 888,727 | 2,171,273 | 3,060,000 | ||||||||||||||||||
| Fair<br> Value of Warrants Issued for Debt | - | - | - | - | - | 89,250 | - | 89,250 | - | 89,250 | |||||||||||||||||
| Distributions<br> to Preferred Shareholders | - | - | - | - | - | (1,729,778 | ) | - | (1,729,778 | ) | - | (1,729,778 | ) | ||||||||||||||
| BALANCE AS OF JUNE 30, 2022 | 4,754,979 | 45,318,773 | 14,541,193 | **** | - | **** | **** | - | **** | **** | $ | 257,662,914 | **** | $ | (94,798,786 | ) | $ | 162,864,128 | **** | $ | 1,926,939 | **** | $ | 164,791,067 | **** |
All values are in US Dollars.
| (1) | Amounts shown have been retroactively restated to give effect to the recapitalization transaction at a rate of 1 to 10.27078 GH Group<br>shares. |
|---|
The accompanying notes are an integral part of these Unaudited Condensed Interim Consolidated Financial Statements.
- 3 -
GLASS HOUSE BRANDS INC.
Unaudited Condensed Interim Consolidated Statementsof Cash Flows
For theSix Months Ended June 30, 2022 and 2021
| 2022 | 2021 | |||||
|---|---|---|---|---|---|---|
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||
| Net Loss | $ | (34,018,056 | ) | $ | (17,870,514 | ) |
| Adjustments to Reconcile Net Loss to<br> Net Cash Used in Operating Activities: | ||||||
| Deferred Tax Recovery | (2,103,489 | ) | (277,247 | ) | ||
| Bad Debt Expense | 384,271 | - | ||||
| Interest Capitalized to Notes Payable | - | 1,426,933 | ||||
| Interest Income Capitalized to Principal Balance | - | (32,085 | ) | |||
| Depreciation and Amortization | 5,444,606 | 1,462,856 | ||||
| Loss on Investments | 426,663 | 284,258 | ||||
| Loss on Disposition of Subsidiary | - | 6,070,902 | ||||
| Non-Cash Operating Lease Costs | (20,605 | ) | 23 | |||
| Accretion of Debt Discount and Loan Origination Fees | 610,338 | 760,226 | ||||
| Loss (Gain) on Change in Fair Value of Derivative Liabilities | 53,213 | (825,000 | ) | |||
| Loss on Change in Fair Value of Contingent Liabilities | 167,052 | - | ||||
| Share-Based Compensation | 6,173,644 | 2,430,524 | ||||
| Changes in Operating Assets and Liabilities: | ||||||
| Accounts Receivable | 572,370 | 2,598,358 | ||||
| Prepaid Expenses and Other Current Assets | 380,630 | (2,022,671 | ) | |||
| Inventory | (3,319,342 | ) | (4,361,105 | ) | ||
| Other Assets | (995,424 | ) | 334,367 | |||
| Accounts Payable and Accrued Liabilities | 775,422 | 3,622,009 | ||||
| Income Taxes Payable | 2,031,198 | 4,057,559 | ||||
| Other Non-Current Liabilities | 182,303 | 397,311 | ||||
| NET CASH USED IN OPERATING ACTIVITIES | (23,255,206 | ) | (1,943,296 | ) | ||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||
| Purchases of Property and Equipment | (20,472,213 | ) | (1,742,031 | ) | ||
| Issuance of Note Receivable | (6,061,255 | ) | - | |||
| Contributions to Equity Method Investments | (99,794 | ) | (472,500 | ) | ||
| Distributions Received from Equity Method Investments | - | 230,229 | ||||
| Cash Paid for Business Acquisition, Net of Cash and Cash Equivalents Acquired | - | (284,028 | ) | |||
| Cash Acquired in a Business Acquisition | 2,316,798 | - | ||||
| NET CASH USED IN INVESTING ACTIVITIES | (24,316,464 | ) | (2,268,330 | ) | ||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||
| Proceeds from the Issuance of Notes Payable, Third Parties and Related Parties | 9,421,000 | 10,512,820 | ||||
| Payments on Notes Payable, Third Parties and Related Parties | (20,776 | ) | (940,395 | ) | ||
| Contributions | 3,060,000 | - | ||||
| Cash Received Upon Exercise of Options | 225,694 | 124,404,318 | ||||
| Distributions to Preferred Shareholders | (1,729,778 | ) | (20,033 | ) | ||
| NET CASH PROVIDED BY FINANCING ACTIVITIES | 10,956,140 | 133,956,710 | ||||
| NET (DECREASE) INCREASE IN CASH, RESTRICTED CASH AND CASH EQUIVALENTS | (36,615,530 | ) | 129,745,084 | |||
| Cash, Restricted Cash and Cash Equivalents, Beginning of Period | 54,066,831 | 4,535,251 | ||||
| CASH, RESTRICTED CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 17,451,301 | $ | 134,280,335 |
The accompanying notes are an integral part of these Unaudited Condensed Interim Consolidated Financial Statements.
- 4 -
GLASS HOUSE BRANDS INC.
Unaudited Condensed Interim Consolidated Statementsof Cash Flows
For theSix Months Ended June 30, 2022 and 2021
| 2022 | 2021 | |||
|---|---|---|---|---|
| SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION | ||||
| Cash Paid for Interest | $ | 1,935,029 | $ | 174,374 |
| Cash Paid for Taxes | $ | 284,521 | $ | 35,829 |
| NON-CASH INVESTING AND FINANCING ACTIVITIES: | ||||
| Net Assets Acquired From an Acquisition, Excluding Cash Acquired | $ | 29,044,821 | $ | 5,709,615 |
| Proceeds Deposited Into Escrow Account | $ | - | $ | 2,029,932 |
| Purchase of Property and Equipment from Proceeds of Note Payable, Third Parties | $ | 242,868 | $ | 255,757 |
| Conversion of Convertible Debt and Derivative Liability to Equity | $ | - | $ | 39,935,392 |
| Issuance of Equity for Relief of Liabilities | $ | 222,941 | $ | - |
| Recognition of Right-of-Use Assets for Operating Leases | $ | 704,940 | $ | 1,160,730 |
| Fair Value of Warrants Issued with Debt | $ | 89,250 | $ | - |
| Derivative Liability Incurred Upon Issuance of Convertible Debt | $ | - | $ | 182,000 |
| Shares Payable to Vested Option Holders | $ | - | $ | 2,756,830 |
| Contingent Earnout Recorded as a Liability | $ | - | $ | 7,640,334 |
The accompanying notes are an integral part of these Unaudited Condensed Interim Consolidated Financial Statements.
- 5 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**1.**NATUREOF OPERATIONS
Glass House Brands Inc. (the “Company”), formerly known as Mercer Park Brand Acquisition Corp. (“Mercer Park”), was incorporated under the Business Corporations Act (British Columbia) on April 16, 2019. The Company is a vertically integrated cannabis company that operates in the state of California. The Company, through its subsidiaries cultivates, manufactures, and distributes cannabis bulk flower and trim to wholesalers and consumer packaged goods to third-party retail stores in the state of California. The Company also owns and operates retail cannabis stores in the state of California. The Company’s subordinate voting shares (“Subordinate Voting Shares”), restricted voting shares (“Restricted Voting Shares”) and limited voting shares (“Limited Voting Shares”, and collectively with the Subordinate Voting Shares and the Restricted Voting Shares, the “Equity Shares”), and common share purchase warrants are listed on the NEO Exchange Inc., trading under the symbols “GLAS.A.U” and “GLAS.WT.U”, respectively. The Equity Shares and common share purchase warrants also trade on the OTCQX in the United States under the symbols GLASF and GHBWF, respectively. The head office and principal address of the Company is 3645 Long Beach Boulevard, Long Beach, California 90807. The Company’s registered office in Canada is 2200 HSBC Building 885 West Georgia Street, Vancouver, British Columbia, Canada V6C 3E8.
Liquidity
Historically, the Company’s primary source of liquidity has been its operations, capital contributions made by equity investors and debt issuances. The Company is currently meeting its current operational obligations as they become due from its current working capital and from operations. However, the Company has sustained losses since inception and may require additional capital in the future. As of and for the six months ended June 30, 2022, the Company had an accumulated deficit of $94,798,786, a net loss attributable to the Company of $33,791,496 and net cash used in operating activities of $23,255,206. The Company estimates that based on current business operations and working capital, it will continue to meet its obligations as they become due in the short term.
The Company is generating cash from revenues and deploying its capital reserves to acquire and develop assets capable of producing additional revenues and earnings over both the immediate and near term. Capital reserves are primarily being utilized for capital expenditures, facility improvements, product development and marketing.
Liquidity risk is the risk that the Company will not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management of its capital structure. The Company’s approach to managing liquidity is to ensure that it will have sufficient liquidity to settle obligations and liabilities when due. In the event sufficient cash flow is not available from operating activities, the Company may continue to raise equity or debt capital from investors in order to meet liquidity needs. If the Company is not able to secure adequate additional funding, the Company may be forced to make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, or suspend or curtail planned programs. Any of these actions could materially harm the Company’s business, results of operations and future prospects. There can be no assurance that such financing will be available or will be at terms acceptable to the Company.
**2.**SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies and critical estimates applied by the Company in these Unaudited Condensed Interim Consolidated Financial Statements are the same as those applied in the Company’s audited Consolidated Financial Statements and accompanying notes for the years ended December 31, 2021 and 2020, unless disclosed otherwise below. The Company’s audited Consolidated Financial Statements for the years ended December 31, 2021 and 2020, filed on March 22, 2022, can be found on SEDAR at www.sedar.com.
Basis of Preparation
The accompanying Unaudited Condensed Interim Consolidated Financial Statements have been prepared on a going concern basis in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. The Unaudited Condensed Interim Consolidated Financial Statements include the accounts and operations of the Company and those of the Company’s subsidiaries in which the Company has a controlling financial interest, if any, after elimination of intercompany accounts and transactions. Investments in entities in which the Company has significant influence, but less than a controlling financial interest, are accounted for using the equity method. All intercompany transactions and balances have been eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial position of the Company as of June 30, 2022 and December 31, 2021, the consolidated results of operations for the three and six months ended June 30, 2022 and 2021, and changes in shareholders’ equity and cash flows for the six months ended June 30, 2022 and 2021 have been included.
- 6 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**2.**SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The accompanying Unaudited Condensed Interim Consolidated Financial Statements do not include all of the information required for full annual financial statements. Accordingly, certain information, footnotes and disclosures normally included in the annual financial statements, prepared in accordance with GAAP, have been condensed or omitted. The financial data presented herein should be read in conjunction with the Company’s audited Consolidated Financial Statements for the year ended December 31, 2021, and the related notes thereto, and have been prepared using the same accounting policies described therein.
Consolidation of Variable Interest Entities(“VIE”)
ASC 810 requires a variable interest holder to consolidate a VIE if that party has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. To determine whether or not a variable interest the Company holds could potentially be significant to the VIE, the Company considers both qualitative and quantitative factors regarding the nature, size and form of the Company’s involvement with the VIE. The equity method of accounting is applied to entities in which the Company is not the primary beneficiary or the entity is not a VIE and the Company does not have effective control, but can exercise influence over the entity with respect to its operations and major decisions. The Company does not consolidate a VIE in which it is not considered the primary beneficiary. The Company evaluates its relationships with all the VIE’s on an ongoing basis to reassess if it continues to be the primary beneficiary.
Basis of Consolidation
These Unaudited Condensed Interim Consolidated Financial Statements as of June 30, 2022 and for the three and six months ended June 30, 2022 and 2021 and audited Consolidated Financial Statements as of December 31, 2021 include the accounts of the Company, its wholly-owned subsidiaries and entities over which the Company has control as defined in ASC 810 “Consolidation”. Subsidiaries over which the Company has control are fully consolidated from the date control commences until the date control ceases. Control exists when the Company has ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than fifty percent of the outstanding voting securities of another entity. In assessing control, potential voting rights that are currently exercisable are considered.
Non-Controlling Interest
Non-controlling interest represents equity interests owned by parties that are not shareholders of the ultimate parent. The share of net assets attributable to non-controlling interests is presented as a component of equity. Their share of net income or loss is recognized directly in equity. Changes in the parent company’s ownership interest that do not result in a loss of control are accounted for as equity transactions.
Segmented Information
The Company currently operates in one segment, the production and sale of cannabis products, which is how the Company’s Chief Operating Decision Maker manages the business and makes operating decisions. All of the Company’s operations are in the United States of America in the State of California. Intercompany sales and transactions are eliminated in consolidation.
Reclassifications
Certain comparative amounts presented on the statement of cash flows related to non-cash operating lease costs and cash payments on operating lease liabilities have been reclassified to conform with current period presentation. There were no impacts on net loss or cash flows for the periods presented.
Restricted Cash
Restricted cash balances are those which meet the definition of cash and cash equivalents but are not available for use by the Company. As of June 30, 2022 and December 31, 2021, restricted cash was $3.0 million and $3.0 million, respectively, which is held in an escrow account and used as an interest reserve for the senior term loan agreement. See “Note 14 – Notes Payable and Convertible Debentures” for further discussion.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**2.**SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loss per Share
The Company calculates basic loss per share by dividing net loss by the weighted-average number of Equity Shares (including Exchangeable Shares (as defined herein) on an as-exchanged basis) outstanding during the period. Multiple Voting Shares (as defined herein) are excluded in calculating loss per share as they do not participate in profit and loss. Diluted loss per share is the same as basic loss per share as the issuance of shares on the exercise of convertible debentures, warrants and share options are anti-dilutive.
Recently Adopted Accounting Standards
In May 2021, the FASB issued ASU 2021-04, Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), andDerivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40)(“ASU 2021-04”), which amends existing guidance for earnings per share (EPS) in accordance with Topic 260. ASU 2021-04 is effective for the Company beginning January 1, 2022. This update should be applied prospectively on or after the effective date of the amendments. The Company adopted ASU 2021-04 on January 1, 2022. The adoption of the standard did not have a material impact on the Company’s Unaudited Condensed Interim Consolidated Financial Statements.
Recently Issued Accounting Standards
In October 2021, the FASB issued ASU 2021-08, BusinessCombinations (Subtopic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (“ASU 2021-08”), which is intended to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to the recognition of an acquired contract liability and the effect of payment terms on subsequent revenue recognized. ASU 2021-08 is effective for the Company beginning January 1, 2023. This update should be applied prospectively on or after the effective date of the amendments. The Company is currently evaluating the effect of adopting this accounting standard.
On March 31, 2022, the FASB issued ASU 2022-02, “Financial Instruments—Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminates the accounting guidance on troubled debt restructurings for creditors and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. The ASU also updates the requirements related to accounting for credit losses under the current guidance and adds enhanced disclosures for creditors with respect to loan refinancing and restructuring for borrowers experiencing financial difficulty. ASU 2022-02 is effective for the Company beginning January 1, 2023. The Company is currently evaluating the effect of adopting this accounting standard.
**3.**CONCENTRATIONSOF BUSINESS AND CREDIT RISK
The Company maintains cash balances at its physical locations, which are not currently insured, and with various U.S. banks with balances in excess of the Federal Deposit Insurance Corporation limits, respectively. The failure of a bank where the Company has significant deposits could result in a loss of a portion of such cash balances in excess of the insured limit, which could materially and adversely affect the Company’s business, financial condition and results of operations. As of June 30, 2022 and December 31, 2021, the Company has not experienced any losses with regards to its cash balances.
The Company provides credit in the normal course of business to customers located throughout California. The Company performs ongoing credit evaluations of its customers and maintains allowances for doubtful accounts based on factors surrounding the credit risk of specific customers, historical trends, and other information. There was one customer for the three months ended June 30, 2022 and 2021 that comprised 32% and 27%, respectively, of the Company’s revenues. There was one customer for the six months ended June 30, 2022 and 2021 that comprised 32% and 28%, respectively, of the Company’s revenues. As of June 30, 2022, the customer had a balance due to the Company of $1,146,701. As of December 31, 2021, the same customer had a balance due to the Company of $2,403,097.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**4.**INVENTORY
As of June 30, 2022 and December 31, 2021, inventory consists of the following:
| 2022 | 2021 | |||
|---|---|---|---|---|
| Raw Materials | $ | 3,719,414 | $ | 1,325,590 |
| Work-in-Process | 4,515,673 | 2,777,244 | ||
| Finished Goods | 4,017,309 | 2,493,468 | ||
| Total Inventory | $ | 12,252,396 | $ | 6,596,302 |
**5.**NOTESRECEIVABLE
On May 12, 2022, the Company announced it executed definitive agreements (the “Agreements”) to acquire 100% equity interests in two operating retail dispensaries and one retail dispensary slated to open in the third quarter of 2022 in California for approximately $23.4 million, through a combination of approximately $5.7 million in cash and the remainder in Equity Shares. The two operating retail dispensaries are located in Lemoore, California and Morro Bay, California. The third location is currently under construction and located in Turlock, California. As of June 30, 2022, these acquisitions have not closed. Calculation and payment of consideration for the acquisition of Turlock dispensary will occur at the end of its sixth full quarter of operations, at six times its annualized EBITDA in that quarter. The consideration will be paid 80% in stock priced at the 25-day volume-weighted average price (VWAP) of Equity Shares as of that quarter end and 20% in the form of an unsecured, subordinated promissory note bearing interest of 8% annually and maturing after the four-year anniversary of the closing date. As of the date of this report, the transaction has not closed. The Company is currently assessing the impact and accounting of this transaction.
The Company issued senior secured promissory notes (“Notes”) in conjunction with the Agreements. The Notes have an interest rate of 15% per annum with outstanding principal balance and accrued interest to be paid in full in cash 180 days following the closing of the plan of merger of the Natural Healing Center. As of June 30, 2022 and December 31, 2021, the notes receivable balance is $6,061,225 and nil, respectively, and included as Notes Receivable in the Consolidated Balance Sheets.
**6.**INVESTMENTS
The Company has various investments in entities in which it holds a significant but non-controlling interest through voting equity or through representation on the entities’ board of directors or equivalent governing bodies. Accordingly, the Company was deemed to have significant influence resulting in the Company accounting for these investments under the equity method. In May 2022, the Company’s board of directors approved the plan to dispose of its equity method investment in 5042 Venice, LLC. Through the date of this report, no sale of 5042 Venice, LLC has occurred.
As of June 30, 2022, activity related to investments consist of the following:
| LOB<br>Group, <br> Inc. | NRO<br>Management, <br><br>LLC (1) | SoCal<br>Hemp JV, <br><br>LLC | 5042<br>Venice, <br><br>LLC | Lompoc<br>TIC, <br><br>LLC | TOTAL | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair<br>Value as of December 31, 2021 | $ | 2,761,141 | $ | 2,018,949 | $ | - | $ | 2,221,520 | $ | 194,749 | $ | 7,196,359 | ||||
| Additions | - | - | 99,794 | - | - | 99,794 | ||||||||||
| Gain<br>(Loss) on Equity Method Investments | 8,960 | (440,756 | ) | (99,794 | ) | 120,414 | (15,487 | ) | (426,663 | ) | ||||||
| Fair<br>Value as of June 30, 2022 | $ | 2,770,101 | $ | 1,578,193 | $ | - | $ | 2,341,934 | $ | 179,262 | $ | 6,869,490 |
*(1)*See “Note 22 – Subsequent Events” for further information on NRO Management, LLC investment.
During the three and six months ended June 30, 2022, the Company recorded net losses from equity method investments of $73,004 and $426,663, respectively. During the three and six months ended June 30, 2021, the Company recorded net losses from equity method investments of $285,646 and $284,258, respectively. These investments are recorded at the amount of the Company’s initial investment and adjusted for the Company’s share of the investee’s income or loss and dividends paid.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**7.**PROPERTY,PLANT AND EQUIPMENT
As of June 30, 2022 and December 31, 2021, property, plant and equipment consist of the following:
| 2022 | 2021 | |||||
|---|---|---|---|---|---|---|
| Land | $ | 70,888,383 | $ | 70,782,068 | ||
| Buildings | 137,166,590 | 108,024,254 | ||||
| Furniture and Fixtures | 333,356 | 316,395 | ||||
| Leasehold Improvements | 8,834,069 | 8,412,489 | ||||
| Equipment and Software | 7,555,326 | 5,712,519 | ||||
| Construction in Progress | 2,122,346 | 11,867,167 | ||||
| Total Property, Plant and Equipment | 226,900,070 | 205,114,892 | ||||
| Less Accumulated Depreciation and Amortization | (14,252,473 | ) | (9,316,368 | ) | ||
| Property, Plant and Equipment, Net | $ | 212,647,597 | $ | 195,798,524 |
During the three and six months ended June 30, 2022, the Company recorded depreciation expense of $2,579,279 and $5,147,273, respectively. During the three and six months ended June 30, 2021, the Company recorded depreciation expense of $698,902 and $1,371,689, respectively. Additionally, during the three and six months ended June 30, 2022, the Company capitalized interest to property and equipment of $526,497 and $958,563, respectively.
**8.**INTANGIBLEASSETS
As of June 30, 2022 and December 31, 2021, intangible assets consist of the following:
| 2022 | 2021 | |||||
|---|---|---|---|---|---|---|
| Definite Lived Intangible Assets | ||||||
| Customer Relationships | $ | 3,100,000 | $ | - | ||
| Intellectual Property | 7,690,000 | 790,000 | ||||
| Total Definite Lived Intangible Assets | 10,790,000 | 790,000 | ||||
| Less Accumulated Amortization | (506,000 | ) | (208,667 | ) | ||
| Definite Lived Intangible Assets, Net | 10,284,000 | 581,333 | ||||
| Indefinite Lived<br>Intangible Assets <br><br>Dispensary Licenses | 14,248,500 | 5,048,500 | ||||
| Total Indefinite Lived Intangible Assets | 14,248,500 | 5,048,500 | ||||
| Total Intangible Assets, Net | $ | 24,532,500 | $ | 5,629,833 |
In April 2022, as part of the business combination, the Company recorded an intangible asset related to customer relationships. The customer relationships intangible asset has a 5 year life. During the three and six months ended June 30, 2022, the Company recorded amortization expense related to intangible assets of $257,833 and $297,333, respectively. During the three and six months ended June 30, 2021, the Company recorded amortization expense related to intangible assets of $39,500 and $91,167, respectively.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**8.**INTANGIBLEASSETS (Continued)
The following is the future minimum amortization expense to be recognized for the years ended December 31:
| December 31: | ||
|---|---|---|
| 2022 (remaining) | $ | 734,000 |
| 2023 | 1,468,000 | |
| 2024 | 1,455,333 | |
| 2025 | 1,430,000 | |
| 2026 | 1,310,000 | |
| Thereafter | 3,886,667 | |
| Total Future Amortization Expense | $ | 10,284,000 |
**9.**GOODWILL
As of June 30, 2022 and December 31, 2021, goodwill was $10,442,353 and $4,918,823, respectively. See “Note 10 – Business Acquisition” for further information.
Goodwill is assigned to the reporting unit, which is the operating segment level or one level below the operating segment. Goodwill arises when the purchase price for acquired businesses exceeds the fair value of tangible and intangible assets acquired less assumed liabilities. Goodwill is reviewed annually for impairment or more frequently if impairment indicators arise. The goodwill impairment test compares the fair value of a reporting unit with its carrying amount. The amount by which the carrying amount exceeds the reporting unit’s fair value is recognized as a goodwill impairment loss. The Company conducts its annual goodwill impairment assessment as of the last day of the fiscal year. During the six months ended June 30, 2022, management noted no indications of impairment on its goodwill.
**10.**BUSINESSACQUISITION
On April 28, 2022, the Company completed an acquisition of 100% of the equity interests in Plus Products Holding Inc. (“Plus Products”) a leading cannabis edibles company located in California. Pursuant to the terms of the acquisition agreement, the preliminary purchase price is for an aggregate consideration of $31,361,620 and is comprised of the following: (i) 20,005 unsecured convertible debenture notes, of which 8,005 may be issued in the form of alternative convertible debenture notes (see *“Note 14 – Notes Payable and Convertible Debentures”*for further information), (ii) 2,102,578 Common Shares, (iii) 208,635 Common Shares granted pro-rata upon closing to exempt grantees (“Incentive Shares”), (iv) 44,751 RSUs granted pro-rata upon closing which fully vested on May 30, 2022 and settled in the Company’s Common Shares (“Incentive RSUs”) and (v) 1,300,000 RSUs contingent on revenue earnout provisions. In addition, the Company granted 450,000 RSUs (“Retention RSUs”) to certain Plus Products employees (see “Note 16 - Share-based Compensation” for further information) which will vest 33% one year after the grant date and the remaining 67% vest in eight equal quarterly installments following the grant date. The fair value of the Retention RSUs, or $1,890,000, was recognized as a component of equity with expense subsequently recognized over the vesting period.
The purchase price allocations for the business acquisition, as set forth in the table below, reflect various preliminary fair value estimates and analyses that are subject to change within the measurement period as valuations are finalized. The primary areas of the preliminary purchase price allocations that are not yet finalized relate to the fair values of certain tangible assets, the valuation of intangible assets acquired and residual goodwill. The Company expects to continue to obtain information to assist in determining the fair value of the net assets acquired at the acquisition date during the measurement period. Measurement period adjustments that the Company determines to be material will be applied in the period the adjustment is determined to the acquisition in the Company’s consolidated financial statements and, depending on the nature of the adjustments, other periods subsequent to the period of acquisition could be affected. The acquisition noted below was accounted for in accordance with ASC 805, “BusinessCombinations”.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**10.**BUSINESSACQUISITION (Continued)
The preliminary allocation of purchase price of a business acquisition completed during the three and six months ended June 30, 2022 is as follows:
| Total Consideration | |||
|---|---|---|---|
| Convertible Debenture Notes | $ | 16,257,104 | |
| Restricted Stock Units Issued | 188,122 | ||
| Derivative Asset | (251,020 | ) | |
| Contingent Restricted Stock Units | 5,460,000 | ||
| Fair Value of Equity Issued | 9,707,414 | ||
| Total Consideration | $ | 31,361,620 | |
| Net Assets Acquired (Liabilities Assumed) | |||
| Current Assets ^(3)^ | $ | 6,512,915 | |
| Operating Right-of-Use Asset | 294,159 | ||
| Property, Plant and Equipment | 1,281,265 | ||
| Non-Current Assets | 93,662 | ||
| Current Liabilities Assumed | (1,150,540 | ) | |
| Long-Term Liabilities Assumed | (393,371 | ) | |
| Intangible Assets: | |||
| Intellectual Property | 6,900,000 | ||
| Customer Relationship | 3,100,000 | ||
| Dispensary License | 9,200,000 | ||
| Total Intangible Assets | 19,200,000 | ||
| Total Identifiable Net Assets Acquired (Net Liabilities Assumed) | 25,838,090 | ||
| Goodwill ^(1)^ | 5,523,530 | ||
| Total Net Assets Acquired | $ | 31,361,620 | |
| Pro Forma Revenues ^(2)^ | $ | 3,911,580 | |
| Pro Forma Net Loss ^(2)^ | $ | 1,067,848 |
*(1)*Goodwillarising from acquisitions represent expected synergies, future income and growth, and other intangibles that do not qualify for separaterecognition. Generally, goodwill related to dispensaries acquired within a state adds to the footprint of the Company’s dispensarieswithin the state, giving the Company’s customers more access to the Company’s branded stores. Goodwill related to cultivationand wholesale acquisitions provide for lower costs and synergies of the Company’s growing and wholesale distribution methods whichallow for overall lower costs.
*(2)*Ifthe acquisition had been completed on January 1, 2022, the Company estimates it would have recorded increases in revenues and netloss shown in the pro forma amounts noted above.
*(3)*Includedin current assets acquired in the business combination was cash acquired in the amount of approximately $2,300,000, $1,715,000 of accountsreceivable, $145,000 of other current assets and $2,337,000 of inventory, during the three and six months ended June 30, 2022.
**11.**ACCOUNTSPAYABLE AND ACCRUED LIABILITIES
As of June 30, 2022 and December 31, 2021, accounts payable and accrued liabilities consist of the following:
| 2022 | 2021 | |||
|---|---|---|---|---|
| Accounts Payable | $ | 5,107,751 | $ | 4,777,435 |
| Accrued Liabilities | 3,761,902 | 2,418,664 | ||
| Accrued Payroll and Related Liabilities | 1,790,956 | 1,699,253 | ||
| Sales Tax and Cannabis Taxes | 1,257,416 | 1,319,652 | ||
| Total Accounts Payable and Accrued Liabilities | $ | 11,918,025 | $ | 10,215,004 |
The Company offers a customer loyalty rewards program that allows members to earn discounts on future purchases. Unused discounts earned by loyalty rewards program members are included in accrued liabilities and recorded as a sales discount at the time a qualifying purchase is made. The value of points accrued as of June 30, 2022 and December 31, 2021 was $389,000 and $380,000, respectively.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**12.**CONTINGENTSHARES AND EARNOUT LIABILITIES
As of June 30, 2022, activity related to the contingent shares and earnout liabilities consist of the following:
| 2022 | |||
|---|---|---|---|
| Balance at December 31, 2021 | $ | 38,428,700 | |
| Contingent Shares Issued Upon Closing of Business Combinations | 5,460,000 | (iv) | |
| Change in Fair Value of Contingent Liabilities | 167,052 | ||
| Balance at June 30, 2022 | $ | 44,055,752 | (i, ii, iii) |
As of June 30, 2022, the following transactions are related to the contingent shares and earnout liabilities:
| (i) | Contingent Earnout – Business Combination on June 29, 2021 |
|---|
Upon closing of the business combination of Mercer Park and Glass House Brands, Inc. on June 29, 2021 (the “Business Combination”), 1,008,975 Equity Shares issued to the sponsor of Mercer Park were locked up by the Company. These shares are to be released from the lock-up restrictions based upon the amount of cash raised by the Company from certain debt and equity financings through June 2023. During the year ended December 31, 2021, the Company released 392,819 Equity Shares that were originally subject to lock-up restrictions. In accordance with ASC 480 “Distinguishing Liabilities from Equity” (“ASC 480”), management determined the provisions of these earnouts required liability treatment. Accordingly, the remaining 616,156 Equity Shares are subject to a capital-based earnout of permitted debt or equity financings within one year following closing, as further detailed in the Investor Rights Agreement entered into on June 29, 2021 in connection with the completion of the Business Combination (which is available on SEDAR at www.sedar.com). As of June 30, 2022 and December 31, 2021, the value of the contingent earnout was $1,706,752 and $2,372,200, respectively, and included as a component of contingent shares and earnout liabilities in the accompanying Condensed Consolidated Balance Sheets. The decrease in fair value of $1,380,190 and $665,448 were recorded as components of the change in fair value of contingent liabilities during the three and six months ended June 30, 2022, respectively, and is included in the accompanying Unaudited Condensed Interim Consolidated Statements of Operations. During the three and six months ended June 30, 2021, there was no such liability or change in fair value.
Additional earnout payments consisting of up to an additional 6,306,095 Equity Shares are issuable to the previous sponsor of Mercer Park and all holders of record of Equity Shares, the Exchangeable Shares, vested stock options and vested RSU’s as of June 30, 2022 in the event the 20-day VWAP of the Equity Shares reaches $13.00 or $15.00 within two years of closing of the Business Combination. In the event that the permitted debt or equity raised by the Company and Equity Share price targets are not met, as described in the Investor Rights Agreement, the earnout payments will be forfeited. In accordance with ASC 480, management determined the provisions of these earnouts did not require liability treatment. As of June 30, 2022, no Equity Shares were issued in connection with these earnouts.
| (ii) | Contingent Earnout – Camarillo Transaction |
|---|
During the year ended December 31, 2021, the Company purchased certain real property in Camarillo, California (the “Camarillo Transaction”). As a consideration for the option right to purchase certain real property in conjunction with the Camarillo Transaction (the “Option Right”), the Company is obligated to pay a contingent earnout fee of up to $75,000,000, payable in Equity Shares, if certain conditions and financial metrics are met. As of June 30, 2022 and December 31, 2021, the fair value of the contingent earnout was $29,053,000 and $22,571,000, respectively, and included as a component of contingent shares and earnout liabilities in the accompanying Condensed Consolidated Balance Sheets. The increase in fair value of $4,765,000 and $6,482,000 were recorded as components of the change in fair value of contingent liabilities during the three and six months ended June 30, 2022, respectively, and is included in the accompanying Unaudited Condensed Interim Consolidated Statements of Operations. During the three and six months ended June 30, 2021, there was no such liability or change in fair value. The value of the contingent consideration is based upon the potential earn out of the facilities’ adjusted earnings during the earnout period and is measured at fair value using a discounted cash flow model that is based on unobservable inputs.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**12.**CONTINGENTSHARES AND EARNOUT LIABILITIES (Continued)
| (iii) | Contingent Shares – Camarillo Transaction |
|---|
As consideration for the Option Right, the Company issued 6,500,000 Equity Shares closing of the Camarillo Transaction. The Company allocated the fair value of the Option Right to the assets acquired upon its exercise in September 2021. In addition to the Equity Shares issued for the Option Right, the Company is obligated to issue up to 3,500,000 Equity Shares as a contingent payment, which are subject to certain conditions and events following closing. As of June 30, 2022 and December 31, 2021, the fair value of the contingent payment was $9,695,000 and $13,485,500, respectively, and included as a component in contingent shares and earnout liabilities in the accompanying Condensed Consolidated Balance Sheets. The Company recorded decreases in fair value of $7,840,000 and $3,790,500 during the three and six months ended June 30, 2022, respectively, and were included as components of the change in fair value of contingent liabilities in the accompanying Unaudited Interim Condensed Consolidated Statements of Operations. During the three and six months ended June 30, 2021, there was no such liability or change in fair value. The value of the contingent consideration is based upon the value of the Company’s Equity Shares, the probability of future events occurring and other unobservable inputs.
| (iv) | Contingent RSU’s – Plus Products |
|---|
As consideration for the acquisition of Plus Products, see “Note 10 – Business Acquisition” for further details, the Company issued 1,300,000 RSUs contingent on revenue earnout provisions. The Company allocated the fair value of the contingent RSU’s to the net assets acquired upon the transaction in April 2022. As of June 30, 2022 and December 31, 2021, the fair value of the contingent RSU’s was $3,601,000 and nil, respectively, and included as a component in contingent shares and earnout liabilities in the accompanying Condensed Consolidated Balance Sheets. The Company recorded a decrease in fair value of $1,859,000 for during the three and six months ended June 30, 2022, and was included as a component of change in fair value of contingent liabilities in the accompanying Unaudited Interim Condensed Consolidated Statements of Operations. During the three and six months ended June 30, 2021, there was no such liability or change in fair value. The value of the contingent consideration is based upon the value of the Company’s Equity Shares, the probability of future events occurring and other unobservable inputs.
**13.**LEASES
The below are the details of the lease cost and other disclosures regarding the Company’s leases for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended | Six Months Ended | |||||||
|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2022 | 2021 | |||||
| Operating Lease Cost | $ | 265,706 | $ | 128,035 | $ | 456,993 | $ | 314,699 |
| Short-Term Lease Costs | 258,325 | 128,229 | 425,270 | 250,982 | ||||
| Total Lease Expenses | $ | 524,031 | $ | 256,264 | $ | 882,263 | $ | 565,681 |
| Six Months Ended | ||||||||
| --- | --- | --- | --- | --- | --- | --- | ||
| 2022 | 2021 | |||||||
| Cash Paid for Amounts Included in the Measurement of Lease Liabilities: | ||||||||
| Operating Cash Flows from Operating Leases | $ | 477,598 | $ | 314,676 | ||||
| Non-Cash Additions to Right-of-Use Assets and Lease Liabilities: | ||||||||
| Recognition of Right-of-Use Assets for Operating Leases | $ | 704,940 | $ | 1,160,730 | ||||
| Weighted-Average Remaining Lease Term (Years) - Operating Leases | 7.00 | 8.00 | ||||||
| Weighted-Average Discount Rate - Operating Leases | 16.32 | % | 17.00 | % |
Future minimum operating lease payments under non-cancelable operating leases as of June 30, 2022 are as follows:
| December 31: | Third Parties | Related Parties | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|
| 2022 (remaining) | $ | 350,811 | $ | 196,715 | $ | 547,526 | |||
| 2023 | 595,288 | 396,783 | 992,071 | ||||||
| 2024 | 444,088 | 393,597 | 837,685 | ||||||
| 2025 | 425,566 | 320,004 | 745,570 | ||||||
| 2026 | 370,000 | 320,004 | 690,004 | ||||||
| Thereafter | 1,635,833 | 560,007 | 2,195,840 | ||||||
| Total Future Minimum Lease Payments | 3,821,586 | 2,187,110 | 6,008,696 | ||||||
| Less Imputed Interest | (1,573,600 | ) | (788,637 | ) | (2,362,237 | ) | |||
| Total Amount Representing Present Value | 2,247,986 | 1,398,473 | 3,646,459 | ||||||
| Less Current Portion of Operating Lease Liabilities | (385,104 | ) | (176,023 | ) | (561,127 | ) | |||
| Operating Lease Liabilities, Net of Current Portion | $ | 1,862,882 | $ | 1,222,450 | $ | 3,085,332 |
- 14 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**13.**LEASES (Continued)
On September 14, 2021, the Company entered into an agreement to lease out a portion of its real property at approximately $500,000 per month for 36 months. However, lease payments to the Company are abated if certain contingencies are met by the lessee. As of June 30, 2022, such contingencies are expected to be met, and as a result, no rental income was recognized by the Company.
The Company leases certain business facilities from related parties and third parties under non-cancellable operating lease agreements that specify minimum rentals. The operating leases require monthly payments ranging from $800 to $27,000 and expire through July 2032. Certain lease monthly payments may escalate up to 5.0% each year. In such cases, the variability in lease payments is included within the current and noncurrent operating lease liabilities.
**14.**NOTESPAYABLE AND CONVERTIBLE DEBENTURES
As of June 30, 2022 and December 31, 2021, notes payable consist of the following:
| 2022 | 2021 | |||||
|---|---|---|---|---|---|---|
| Term loan payable maturing in November 30, 2026, bearing interest at 10.00 percent per annum | $ | 50,000,000 | $ | 50,000,000 | ||
| Incremental term loan payable maturing in October 31, 2022, bearing interest at 10.00 percent per annum | 10,000,000 | - | ||||
| Convertible Debentures | 16,006,084 | - | ||||
| Other | 560,138 | 238,835 | ||||
| Total Notes Payable | 76,566,222 | 50,238,835 | ||||
| Less Unamortized Debt Issuance Costs, Loan Origination Fees and Premiums | (5,190,305 | ) | (5,383,413 | ) | ||
| Net Amount | 71,375,917 | 44,855,422 | ||||
| Less Current Portion of Notes Payable | (9,490,413 | ) | (37,986 | ) | ||
| Notes Payable, Net of Current Portion | $ | 61,885,504 | $ | 44,817,436 |
Senior Secured Credit Agreement
On December 9, 2021 (“Senior Secure Closing Date”), the Company entered into a senior secured term loan agreement, as amended (the “Credit Agreement”) for total available proceeds of up to $100,000,000 with funds managed by a U.S.-based private credit investment fund and other third-party lenders (together, the “Senior Secured Lender”). Effective December 10, 2021, the Company closed on an initial term loan through the Credit Agreement of $50,000,000. The principal amount under the Credit Agreement will be paid in monthly installments in an aggregate amount equal to 1.25% per annum of the original principal amount, 24 months following the Senior Secure Closing Date, with a maturity date through November 30, 2026. Interest will be paid, beginning December 31, 2021, in monthly installments equal to the floating base rate plus the applicable term margin, or 5.25%. The interest rate will not be less than 10% per annum or exceed 12% per annum. As of June 30, 2022 and December 31, 2021, the interest rate was 10% and 10%, respectively.
Two additional delayed draw term loans may be requested by the Company in an amount equal to the principal amount of $25,000,000 (or such lesser amount as agreed) each. The Company has optional and mandatory prepayments. Mandatory prepayments include any voluntary and involuntary sale or disposition of assets by the Company or any restricted subsidiaries. The outstanding principal amount of the obligation will be repaid by 100% of cash proceeds received from the sale or disposition of assets with certain exemptions as defined in the Credit Agreement. As of the Senior Secure Closing Date, the Company deposited an interest reserve in the amount of $3,000,000 into an escrow account and included as restricted cash in the Condensed Consolidated Balance Sheets as of June 30, 2022 and December 31, 2021. Additionally, the Company’s real properties held in Glass House Farm LLC, Magu Farm LLC and GH Camarillo LLC were pledged as security.
The Credit Agreement contains a financial covenant which require the Company to maintain liquidity in excess of $10,000,000 at all times. As of June 30, 2022 and December 31, 2021, the Company was in compliance with such financial covenant. Additionally, there are certain covenants which will require the Company to maintain a specific minimum debt service coverage ratio which will be measured quarterly beginning with the quarter ending December 31, 2022, as well as achieve completion of phase one project work at the Camarillo facility on or before July 31, 2022. Such covenants were not in effect as of December 31, 2021.
- 15 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**14.**NOTESPAYABLE AND CONVERTIBLE DEBENTURES (Continued)
Amendments to the Senior Secured CreditAgreement
On January 21, 2022, the Company amended and restated the Credit Agreement (the “1st Amendment”) wherein certain events of default were waived.
On May 12, 2022, the Company amended and restated the Credit Agreement (the “2^nd^ Amendment”) wherein certain events of default were waived, and the Company entered into an incremental term loan in the amount of $10,000,000 (“Incremental Term Loan”), for total available proceeds of $110,000,000. The Incremental Term Loan bears interest at a rate of 10% per annum and payable in monthly installments. In addition, a 1% fee of the outstanding principal amount of the Incremental Term Loan is payable in monthly installments beginning August 1, 2022, with a maturity date through October 31, 2022. In connection with the Incremental Term Loan, the Company issued 175,000 warrants to the Senior Secured Lender, with an exercise price of $11.50 per share, to acquire each Equity Share until June 26, 2026. These warrants were fair valued using level 1 inputs as these warrants are openly traded on a stock exchange. Accordingly, the Company recorded an additional debt discount of $89,250 related to the change in terms of the warrants. In addition to receiving the $10,000,000 in Incremental Term Loan, the Company paid $579,000 in direct loan fees, which are recorded as a debt discount.
Convertible Debentures
On April 28, 2022, the Company completed the Plus Products acquisition in which the purchase price was payable in part through an aggregate of 20,005 unsecured convertible debenture notes which consist of 12,003 debenture notes (“Series A Notes”) and 8,002 debenture notes (“Series B Notes”) (collectively “Plus Convertible Notes”). The Plus Convertible Notes accrue interest at 8.00% per annum payable in semi-annual arrears until April 15, 2027 (“Maturity Date”). Interest is payable in cash, by the issuance of in the Company’s Equity Shares or a combination of both at the sole discretion of the Company, based on the 10-day VWAP of the Equity Shares ending 5 trading days prior to the interest payment date with a fixed exchange rate of $1.00 to CAD$1.27.
The Series A Notes are redeemable, at the sole option of the Company, in full or in part on a pro rata basis, and payable in cash, by the issuance of the Company’s Equity Share, or a combination of both, at any time through the Maturity Date based on the higher of (i) the 10-day VWAP of the Equity Shares ending 5 trading days prior to the redemption date, and (ii) $4.08 (“Redemption Right”).
The Series B Notes are redeemable, at the sole option of the Company, in full or in part on a pro rata basis, and payable in cash, by the issuance of the Company’s Equity Share, or a combination of both, at any time through the Maturity Date based on the lower of (i) the 10-day VWAP of the Equity Shares ending 5 trading days prior to the redemption date, and (ii) $10.00 per Equity Share. In the event the Company’s Equity Shares achieve a closing price of $10.00 per share over any period greater than or equal to 20 consecutive trading days, each holder of the Series B Notes may elect to convert all or a portion into the Company’s Equity Share based on a conversion price of $10.00 per Equity Share. As of June 30, 2022, the Company recorded $11,894,989 and $4,111,095 for the Series A Notes and Series B Notes, respectively. The conversion features of the Series A and Series B Notes were bifurcated from the related notes and classified as derivatives due to the variability of price in accordance with ASC 815, “Derivatives and Hedging”. Accordingly, the fair value of the conversion features for the Series A and Series B Notes were measured at fair value using a discounted cash flow model that is based on unobservable inputs. The Company recorded a change in derivative liability and amortization of approximately $53,000 and $45,000, respectively, as a component of change in fair value of derivatives and interest expense, respectively, in the Unaudited Condensed Interim Consolidated Statements of Operations during the three months ended June 30, 2022.
Scheduled maturities of notes payable for the years ended December 31:
| December 31: | Principal<br><br> Payments | |
|---|---|---|
| 2022 (remaining) | $ | 9,490,413 |
| 2023 | 665,237 | |
| 2024 | 7,542,622 | |
| 2025 | 7,545,148 | |
| 2026 | 7,547,824 | |
| Thereafter | 43,774,978 | |
| Total Future Minimum Principal Payments | $ | 76,566,222 |
- 16 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**15.**SHAREHOLDERS’EQUITY
As of June 30, 2022 and December 31, 2021, the authorized share capital of the Company is comprised of an unlimited number of (i) Subordinate Voting Shares, (ii) Restricted Voting Shares, (iii) Limited Voting Shares, (iv) Multiple Voting Shares and (v) Preferred Shares:
Multiple Voting Shares
The Company is authorized to issue an unlimited number of Multiple Voting Shares without nominal or par value. Holders of Multiple Voting Shares are entitled to receive notice of any meeting of shareholders of the Company, and to attend, vote and speak at such meetings, except those meetings at which only holders of a specific class of shares are entitled to vote separately as a class under the Business Corporations Act (British Columbia). On all matters upon which holders of Multiple Voting Shares are entitled to vote, each Multiple Voting Share are entitles the holder thereof to 50 votes per Multiple Voting Share. Multiple Voting Shares are not entitled to dividends. The Multiple Voting Shares have three (3)-year sunset period that will expire June 29, 2024, upon which they will be automatically redeemed for $0.001 per Multiple Voting Share.
Equity Shares
The holders of each class of Equity Shares are entitled to receive notice of, to attend (if applicable, virtually) and to vote at all meetings of shareholders of the Company, except that they are not able to vote (but are entitled to receive notice of, to attend and to speak) at those meetings at which the holders of a specific class are entitled to vote separately as a class under the Business Corporations Act (British Columbia) and except that holders of Limited Voting Shares are not entitled to vote for the election of directors of the Company. The Subordinate Voting Shares and Restricted Voting Shares carry one vote per share on all matters. The Limited Voting Shares carry one vote per share on all matters except the election of directors, as the holders of Limited Voting Shares do not have any entitlement to vote in respect of the election for directors of the Company.
In the case of liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, or in the event of any other distribution of assets of the Company among its shareholders for the purpose of winding up its affairs, the holders of Equity Shares are entitled, subject to the prior rights of the holders of any shares of the Company ranking in priority to the Equity Shares (including any liquidation preference on any issued and outstanding Multiple Voting Shares and/or Preferred Shares), to participate ratably the Company’s remaining property along with all holders of the other classes of Equity Shares (on a per share basis).
Exchangeable Shares of MPB Acquisition Corp.
Exchangeable shares (the “Exchangeable Shares”) are part of the authorized share capital of MPB Acquisition Corp. (“MPB”), a wholly-owned subsidiary of the Company, which entitle their holders to rights that are comparable to those rights attached to the Equity Shares, except that (i) each Exchangeable Share has 1.1 votes per share until June 29, 2022, after which they will have one vote per share, and (ii) the aggregate voting power of the Exchangeable Shares must not exceed 49.9% of the total voting power of all classes of shares of MPB. Until a holder exchanges their Exchangeable Shares for Equity Shares, the holder of such Exchangeable Shares will not have the right to vote at meetings of the shareholders of the Company, though they will have the right to vote at meetings of the shareholders of MPB, including with respect to altering the rights of holders of any of the Exchangeable Shares, or if MPB decides to take certain actions without fully protecting the holders of any of the Exchangeable Shares, or as otherwise required by law. The Exchangeable Shares are exchangeable at any time, on a one-for-one basis, for Equity Shares at the option of the holder.
The Company treats the Exchangeable Shares as options, each with a value equal to an Equity Share, which represents the holder’s claim on the equity of the Company. In order to comply with certain contractual requirements of the Business Combination, the Company and MPB are required to maintain the economic equivalency of such Exchangeable Shares with the publicly traded Equity Shares of the Company. This means the Exchangeable Shares are required to share the same economic benefits and retain the same proportionate ownership in the assets of the Company as the holders of the Equity Shares. The Company has presented these Exchangeable Shares as a part of shareholders’ equity within these Unaudited Condensed Interim Consolidated Financial Statements due to (i) the fact that they are economically equivalent to the Equity Shares, and (ii) the holders of the Exchangeable Shares are subject to restrictions on transfer under US securities laws but may dispose of the Exchangeable Shares without such restriction by exchanging them for Equity Shares. Changes in these assumptions would affect the presentation of the Exchangeable Shares from shareholders’ equity to non-controlling interests; however, there would be no impact on earnings per share.
- 17 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**15.**SHAREHOLDERS’EQUITY (Continued)
Preferred Shares of GH Group, Inc.
The authorized total number of preferred shares (the “GH Group Preferred Shares”) of GH Group, Inc. (“GH Group”) is 50,000,000. As of June 30, 2022 and December 31, 2021, there was 18,515,491 GH Group Preferred Shares issued and outstanding. Holders of GH Group Preferred Shares are entitled to notice of and to attend any meeting of the shareholders of GH Group but are not entitled to vote. The GH Group Preferred Shares do not carry any voting rights and include a 15% cumulative dividend rate, which is increased by 5% in the year following the first anniversary of the date of issuance. Dividends are payable when and if declared by GH Group’s board of directors. The GH Group Preferred Shares have a conversion option to convert the Preferred Shares into Class A Common Stock of GH Group within 60 days after the issuance by the holder. In the event of a liquidation, voluntary or involuntary, dissolution or winding-up of GH Group, the holders of the GH Group Preferred Shares outstanding are entitled to be paid out of the assets of GH Group available for distribution to it stockholders. GH Group has the right to redeem all or some of the Preferred Shares from a holder for an amount equal to the Liquidation Value and all unpaid accrued and accumulated dividends. In accordance with the provisions above, the Company recorded distributions to the holders of Preferred Shares in the amount of $860,057 and $1,729,778, respectively, for the three and six months ended June 30, 2022. The Company recorded distributions to the holders of Preferred Shares in the amount of $20,333 and $20,333, respectively, for the three and six months ended June 30, 2021.
Non-Controlling Interest
Non-controlling interest represents equity interests owned by parties that are not shareholders of the ultimate parent. The share of net assets attributable to non-controlling interests is presented as a component of equity. Their share of net income or loss is recognized directly in equity. Changes in the parent company’s ownership interest that do not result in a loss of control are accounted for as equity transactions.
The Company recorded a loss attributable to a non-controlling interest during the three and six months ended June 30, 2022 of $23,964 and $46,560, respectively. The Company recorded a loss attributable to a non-controlling interest during the three and six months ended June 30, 2021 of nil and nil, respectively.
Share and Equity Transactions During thePeriod
During the six months ended June 30, 2022, the Company issued 2,311,213 Equity Shares to the sellers of Plus Products valued at $9,707,414, see “Note 10 – BusinessAcquisition” for further information.
During the six months ended June 30, 2022, the Company issued 92,864 Equity Shares to certain debt holders for interest payments valued at $222,941.
During the six months ended June 30, 2022, the Company issued 184,960 Equity Shares to various individuals for the exercise of stock options. In exchange for the exercise of stock options, the Company received $225,694 in cash.
During the six months ended June 30, 2022, the Company issued 450,458 Equity Shares to various individuals for the conversion of Restricted Stock Units.
During the six months ended June 30, 2022, holders of Exchangeable Shares exchanged 3,715,591 Exchangeable Shares for Equity Shares.
During the six months ended June 30, 2022, the Company received $3,060,000 in contributions from controlling and non-controlling interests.
- 18 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**15.**SHAREHOLDERS’EQUITY (Continued)
Variable Interest Entity
On June 30, 2022, the Company transferred tenant improvements with a net book value of $762,095 to 2000 De La Vina LLC (“2000 DLV”), a wholly-owned subsidiary, and simultaneously sold 100% of its interest in 2000 DLV for a cash payment of $3,060,000 upon closing to an entity in which certain executives and board members of the Company are members. As part of the transaction, the Company no longer has an equity interest in the Company, however, the Company remains the manager and retains control of 2000 DLV under the First Amended and Restated Operating Agreement dated May 1, 2022 between the Company and members of 2000 DLV. Accordingly, 2000 DLV became a VIE of the Company.
The below table summarizes information for entities the Company has concluded to be VIE’s as the Company possesses the power to direct activities through various agreements. Through these agreements, the Company can significantly impact the VIE and thus holds a controlling financial interest. This information represents amounts before intercompany eliminations.
As of and for the six months ended June 30, 2022, the aggregate balances of the VIE included in the accompanying consolidated balance sheet and statement of operations are as follows:
| 2022 | ||
|---|---|---|
| Non-Current Assets | $ | 2,414,141 |
| Total Assets | $ | 2,414,141 |
| Non-Current Liabilities | $ | 242,868 |
| Total Liabilities | $ | 242,868 |
| Revenues, Net | $ | 19,500 |
| Net Income Attributable to Non-Controlling Interest | $ | - |
- 19 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**16.**SHARE-BASEDCOMPENSATION
The Company has an equity incentive plan (the “Incentive Plan”) under which the Company may issue various types of equity instruments or instruments that track to equity, more particularly the Equity Shares, to employees, officers, consultants and non-employee directors. The types of equity instruments issuable under the Incentive Plan encompass, among other things, stock options, unrestricted stock bonus, and restricted stock units (together, “Awards”). Share-based compensation expenses are recorded as a component of general and administrative costs. The maximum number of Awards that may be issued under the Incentive Plan is 10% of the fully-diluted Equity Shares of the Company (inclusive of the Exchangeable Shares) as calculated using the treasury method. The Incentive Plan is an “evergreen” plan, meaning that if an Award expires, becomes un-exercisable, or is cancelled, forfeited or otherwise terminated without having been exercised or settled in full, as the case may be, the Equity Shares allocable to the unexercised portion of the Award shall again become available for future grant or sale under the Incentive Plan (unless the Incentive Plan has terminated by its terms), and the number of Awards available for grant will increase as the number of issued and outstanding Equity Shares increases. Granting and vesting of Awards are determined by and recommended to the Board for approval by the Compensation, Nomination and Corporate Governance Committee of the Board of Directors. The exercise price for options (if applicable) will generally not be less than the fair market value of the Award at the time of grant and will generally expire after 5 years.
Stock Options
A reconciliation of the beginning and ending balance of stock options outstanding is as follows:
| Number of Stock<br><br> Options | Weighted-<br><br>Average Exercise<br><br> Price | ||||
|---|---|---|---|---|---|
| Balance as of December 31, 2021 | 2,087,784 | $ | 2.78 | ||
| Exercised | (185,242 | ) | $ | 2.50 | |
| Forfeited | (268,499 | ) | $ | 2.56 | |
| Balance as of June 30, 2022 | 1,634,043 | $ | 2.83 |
The following table summarizes the stock options that remain outstanding as of June 30, 2022:
| Security Issuable | Exercise Price | Expiration Date | Stock Options <br><br>Outstanding | ||
|---|---|---|---|---|---|
| Subordinate Voting Shares | $ | 2.26 | October 2024 | 695,427 | |
| Subordinate Voting Shares | $ | 3.08 | April 2025 | 143,670 | |
| Subordinate Voting Shares | $ | 3.08 | January 2026 | 686,251 | |
| Subordinate Voting Shares | $ | 4.60 | October 2026 | 108,695 | |
| 1,634,043 |
As of June 30, 2022 and December 31, 2021, options vested and exercisable were 1,394,162 and 1,000,717, respectively. For the three months ended June 30, 2022 and 2021, the Company recognized $693,066 and $887,277, respectively, in share-based compensation expense related to these stock options. For the six months ended June 30, 2022 and 2021, the Company recognized $1,190,433 and $2,268,739, respectively, in share-based compensation expense related to these stock options.
As of June 30, 2022 and December 31, 2021, options outstanding have a weighted-average remaining contractual life of 2.8 years and 3.4 years, respectively.
- 20 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**16.**SHARE-BASEDCOMPENSATION (Continued)
Restricted Stock Units
A reconciliation of the beginning and ending balance of restricted stock units outstanding is as follows:
| Number of<br><br> Restricted Stock | |||
|---|---|---|---|
| Balance as of December 31, 2021 | 3,230,948 | ||
| Granted | 1,696,758 | ||
| Converted | (450,458 | ) | |
| Forfeited | (732,408 | ) | |
| Balance as of June 30, 2022 | 3,744,840 |
During the three and six months ended June 30, 2022, the Company recognized $2,798,121 and $4,983,211, respectively, in stock-based compensation related to restricted stock units. During the three and six months ended June 30, 2021, the Company recognized $46,809 in stock-based compensation related to RSU’s. The Company recognizes the exchanged and converted from options as stock-based compensation related to restricted stock units. The fair value of the restricted stock units issued during the three and six months ended June 30, 2022 were determined using the Equity Shares at the time of grant.
Stock Appreciation Right Units of GH Group
During the year ended December 31, 2021, GH Group issued 230,752 stock appreciation rights (“SARs units”) to various employees of GH Group. The SARs units vest 33% one year after the grant date and the remaining 67% vest monthly over two years. Vested and exercised SAR units will receive cash in the amount of the SARs units exercised multiplied by the excess of the fair market value of an Equity Share over the stated strike price of the SAR unit. As the SARs units are cash-settled, the Company recognizes the value of the SAR units as liabilities which are included in accounts payable and accrued liabilities in the Consolidated Balance Sheets. As of June 30, 2022 and December 31, 2021, the Company recorded a liability of nil and $35,442, respectively.
A reconciliation of the beginning and ending balance of SARs units outstanding is as follows:
| Number of Stock<br><br> Appreciation<br><br> Rights Units | |||
|---|---|---|---|
| Balance as of December 31, 2021 | 159,736 | ||
| Forfeited | (33,116 | ) | |
| Balance as of June 30, 2022 | 126,620 |
During the three and six months ended June 30, 2022, the Company recognized $92,472 and $(35,442), respectively, in expense related to the SARs units. During the three and six months ended June 30, 2021, the Company recognized approximately $251,000 in expense related to the SARs units.
Warrants
A reconciliation of the beginning and ending balance of warrants outstanding is as follows:
| Number of<br><br> Warrants | Weighted-<br> Average <br> Exercise Price | |||
|---|---|---|---|---|
| Balance as of December 31, 2021 | 35,418,078 | $ | 11.29 | |
| Granted | 175,000 | $ | 11.50 | |
| Balance as of June 30, 2022 | 35,593,078 | $ | 11.29 |
- 21 -
GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**16.**SHARE-BASEDCOMPENSATION (Continued)
The following table summarizes the warrants that remain outstanding as of June 30, 2022:
| Security Issuable | Exercise Price | Expiration Date | Warrants<br><br> Outstanding | Warrants<br><br> Exercisable | |||
|---|---|---|---|---|---|---|---|
| Subordinate Voting Shares | $ | 11.50 | June 2026 | 30,664,500 | 30,664,500 | ||
| Subordinate Voting Shares | $ | 10.00 | June 2024 | 4,928,578 | 4,928,578 | ||
| 35,593,078 | 35,593,078 |
There were no warrants issued in during the three and six months ended June 30, 2022 that required fair valuing using level 3 inputs.
As of June 30, 2022 and December 31, 2021, warrants outstanding have a weighted-average remaining contractual life of 3.7 years and 4.2 years, respectively.
**17.**LOSSPER SHARE
The following is a reconciliation for the calculation of basic and diluted loss per share for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended | Six Months Ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2022 | 2021 | |||||||||
| Net Loss Attributable to the Company | $ | (14,168,328 | ) | $ | (4,716,721 | ) | $ | (33,971,496 | ) | $ | (17,870,514 | ) |
| Weighted-Average Shares Outstanding - Basic and Diluted | 59,447,659 | 24,262,497 | 58,067,245 | 24,117,056 | ||||||||
| Loss Per Share - Basic and Diluted Attributable to the Company | $ | (0.24 | ) | $ | (0.19 | ) | $ | (0.59 | ) | $ | (0.74 | ) |
Diluted loss per share is the same as basic loss per share as the issuance of shares on the exercise of convertible debentures, warrants, RSU’s and share options are anti-dilutive.
**18.**PROVISIONFOR INCOME TAXES AND DEFERRED INCOME TAXES
Provision for income taxes consists of the following for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended | Six Months Ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2022 | 2021 | |||||||||
| Current: | ||||||||||||
| Federal | $ | 1,226,545 | $ | 2,052,336 | $ | 1,679,458 | $ | 3,451,722 | ||||
| State | 573,436 | 655,065 | 806,280 | 1,089,477 | ||||||||
| Total Current | 1,799,981 | 2,707,401 | 2,485,738 | 4,541,199 | ||||||||
| Deferred: | ||||||||||||
| Federal | 49,420 | (156,682 | ) | (1,486,982 | ) | (201,487 | ) | |||||
| State | (116,552 | ) | (62,768 | ) | (616,507 | ) | (75,760 | ) | ||||
| Total Deferred | (67,132 | ) | (219,450 | ) | (2,103,489 | ) | (277,247 | ) | ||||
| Total Provision for Income Tax (Benefit) Expense | $ | 1,732,849 | $ | 2,487,951 | $ | 382,249 | $ | 4,263,952 |
The Company has used a discrete effective tax rate method to calculate taxes for the fiscal three- and six- month periods ended June 30, 2022 and 2021. We determined that since small changes in estimated ordinary income would result in significant changes in the estimated annual effective tax rate, the historical method would not provide a reliable estimate for the fiscal three- and six-month periods ended June 30, 2022 and 2021.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**18.**PROVISIONFOR INCOME TAXES AND DEFERRED INCOME TAXES (Continued)
As the Company operates in the cannabis industry, it is subject to the limits of IRC Section 280E (“Section 280E”) for U.S. federal income tax purposes under which the Company is only allowed to deduct expenses directly related to the cost of goods sold (“COGS”) of its product. This results in permanent differences between ordinary and necessary business expenses deemed nonallowable under Section 280E, and the Company deducts all operating expenses on its state tax returns.
The Company has determined that the tax impact of its corporate overhead allocation was not more likely than not to be sustained on the merits as required under ASC 740 “Income Taxes” due to the evolving interpretations of Section 280E. As a result, the Company included in the balance of total unrecognized tax benefits as of June 30, 2022 and December 31, 2021, potential benefits of $1,631,348 and $1,449,046, respectively, that if recognized would impact the effective tax rate on income from operations. Unrecognized tax benefits that reduce a net operating loss, similar to tax loss or tax credit carryforwards, are presented as a reduction to deferred income taxes.
The Company’s evaluation of tax positions was performed for those tax years which remain open to for audit. The Company may from time to time, be assessed interest or penalties by the taxing authorities, although any such assessments historically have been minimal and immaterial to the Company’s financial results. In the event the Company is assessed for interest and/or penalties, such amounts will be classified as income tax expense in the financial statements.
As of June 30, 2022, the Company’s federal tax returns since 2018 and state tax returns since 2017 are still subject to adjustment upon audit. No tax returns are currently being examined by any taxing authorities. While it is reasonably possible that certain portions of the unrecognized tax benefit may change from a lapse in applicable statute of limitations, it is not possible to reasonably estimate the effect of any amount of such a change to previously recorded uncertain tax positions in the next 12 months.
**19.**COMMITMENTSAND CONTINGENCIES
Contingencies
The Company’s operations are subject to a variety of local and state regulations. Failure to comply with one or more of these regulations could result in fines, restrictions on its operations, or revocation, cancellation, non-renewal or other losses of permits, licensed and entitlements that could result in the Company ceasing operations. While management of the Company believes that the Company is in compliance with applicable local and state statues, regulations, and ordinances as of June 30, 2022 and December 31, 2021, cannabis laws and regulations continue to evolve and are subject to differing interpretations. As a result, the Company may be subject to regulatory fines, penalties or restrictions in the future.
Royalty
Effective as of May 9, 2019, Sweet & Salty, Inc., a California corporation (“Lender”) and GH Brands LLC, a California limited liability company and subsidiary of the Company (“GH Brands”) entered into a License and Services Agreement, pursuant to which Lender granted to GH Brands an exclusive, transferable, sublicensable, right and license to use, exploit and incorporate the name, nicknames, initials, signature, voice, image, likeness, and photographic or graphic representations of likeness, statements and biography of the artist Annabella Avery Thorne, professionally known as Bella Thorne, for all purposes relating to or in connection with the development, quality control, cultivation, extraction, manufacture, production, branding, testing, advertising, marketing, promotion, commercialization, packaging, distribution, exploitation and/or sale of the products of GH Brands and its affiliates. The term of the License and Service Agreement is 3 years and was extended through November 2022. Royalty fees for Bella Thorne branded boxes are 10% for the 1^st^ year and 12% for years 2 to 5. Royalty fees for flower products and accessories are 6% for the 1^st^ year, 7% for the 2^nd^ year and 8% for years 3 to 5. Minimum guarantee fees are recoupable against royalties for an initial term of $1,000,000 ($50,000 initial payment, $200,000 for the 1^st^ year, $375,000 for the 2^nd^ year and $375,000 for the 3^rd^ year). The agreement provides an option to renew for a 2-year term with a guaranteed minimum fee of $1,500,000 ($750,000 for the 4^th^ year, $750,000 for the 5^th^ year). During the three and six months ended June 30, 2022, the Company recognized expenses related to these royalties in the amount of $93,750 and $187,500, respectively. During the three and six months ended June 30, 2021, the Company recognized expenses related to these royalties in the amount of $93,750 and $187,500, respectively. As of June 30, 2022 and December 31, 2021, the Company has approximately $375,000 and $328,000, respectively, due under this royalty agreement which are included in accounts payable and accrued liabilities in the consolidated balance sheets.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**19.**COMMITMENTSAND CONTINGENCIES (Continued)
Claims and Litigation
From time to time, the Company may be involved in litigation relating to claims arising out of operations in the normal course of business. As of June 30, 2022 and December 31, 2021, there were no pending or threatening lawsuits that could be reasonably assessed to have resulted in a probable loss to the Company in an amount that can be reasonably estimated. As such, no accrual has been made in the Consolidated Financial Statements relating to claims and litigations. As of June 30, 2022 and December 31, 2021, there were also no proceedings in which any of the Company’s directors, officers or affiliates were an adverse party to the Company or had a material interest adverse to the Company’s interest.
Element 7 Transaction
Element 7 Acquisition and Litigation Effective February 23, 2021, GH Group entered into a Merger and Exchange Agreement (the “E7 Merger Agreement”) with Element 7 CA, LLC (“E7”) whereby GH Group had the right, subject to satisfactory completion of due diligence and other conditions, to obtain all of the membership or equity interests held by E7 in seventeen holding companies that hold the rights to in-process state and local cannabis retail licenses or license applications, some of which are partially owned. In addition, GH Group entered into a License Development and Consulting Agreement (the “E7 License Agreement”, and together with the E7 Merger Agreement, the “E7 Agreements”) with E7 to provide certain retail consulting services to develop and obtain up to thirty-four cannabis retail licenses in exchange for the payment of certain fees set forth in the E7 License Agreement. In November 2021, GH Group terminated the E7 Agreements based on a breach of contractual terms, and as of December 31, 2021, GH Group had converted certain pre-closing financing payment and consulting fees into notes receivable in the amount of $2,274,167. As of June 30, 2022 and December 31, 2021, the notes receivable was fully reserved by the Company. As of December 31, 2021, the Company had received membership or equity interests in one entity out of seventeen entities that were contractually committed to be transferred under the E7 Merger Agreement.
On November 4, 2021, GH Group filed a lawsuit in the Superior Court for the County of Los Angeles, Central District (Case No. 21STCV40401) against E7 and its principals and owners Josh Black and Robert “Bobby” DiVito (together, “Element 7”) for a variety of claims, including fraud and breach of contract and demanded performance under the E7 Agreements.
The court proceeding was subsequently withdrawn by the Company without prejudice, and on March 13, 2022, GH Group entered into an agreement with American Patriot Brands, Inc. (“APB”) to jointly file suit against Element 7 to enforce the transfer of contractually committed licenses (the “Joint Litigation Agreement”). GH Group and APB jointly refiled a complaint against Element 7 in the County of Los Angeles, Central District (Case No. 22STCV09323) (the “Element 7 Proceeding”). If either GH Group or APB is successful in the Element 7 Proceeding, the Company expects to have a path to achieve transfer of the existing licenses at issue.
Under the terms of the Joint Litigation Agreement, GH Group will pay all legal fees for GH Group and APB’s joint litigation against Element 7. GH Group will have the option to purchase any license or licensed entity interests recovered by APB from Element 7 that were included in the E7 Merger Agreement, that have either a state or local permit and a valid lease, or a have a local permit that is without a real property site but is in a competitive license jurisdiction, in each case at a valuation of $750,000 per license or licensed entity, paid in Equity Shares at the 10-day volume weighted average price calculated as of the date of such purchase. In addition, under the Joint Litigation Agreement, GH Group also has the right of first refusal to purchase any other licenses or licensed entity outside of the foregoing groups, and the right to terminate the Joint Litigation Agreement at any time.
**20.**RELATEDPARTY TRANSACTIONS
Leases
Neo Street Partners LLC, a company partially owned by an executive and board member of the Company, entered into a five-year lease with a subsidiary of the Company. The lease, which commenced in October 2018, provides for an initial annual base rent payment of $213,049 increasing to $243,491 for years two to five. Rent expense for the three and six months ended June 30, 2022 were $60,873 and $121,746, respectively. Rent expense for the three and six months ended June 30, 2021 were $60,873 and $121,746, respectively.
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GLASS HOUSE BRANDS INC.
Notes to Unaudited Condensed Interim Consolidated Financial Statements
(AmountsExpressed in United States Dollars Unless Otherwise Stated)
**20.**RELATEDPARTY TRANSACTIONS (Continued)
3645 Long Beach LLC, a company partially owned by an executive and board member of the Company, entered into a five-year lease with a subsidiary of the Company. The lease, which commenced in December 2019, provides for an initial annual base rent payment of $64,477 increasing to $69,352 for year two and increasing five percent per annum thereafter. Rent expense for the three and six months ended June 30, 2022 were $18,205 and $36,699, respectively. Rent expense for the three and six months ended June 30, 2021 were $17,338 and $34,676, respectively.
Isla Vista GHG LLC, a company partially owned by executives and board members of the Company, entered into a ten-year lease with a subsidiary of the Company. The lease, which commences on the first calendar day after the Company publicly announces the opening of the retail location at the leased property (“Commencement Date”), provides for an initial monthly rent of $5,000 starting April 19, 2022 until the Commencement Date. Effective on the Commencement Date, the initial annual base rent payment will be $144,000 and increasing three percent per annum thereafter. Rent expense for the three and six months ended June 30, 2022 were $12,000 and $12,000, respectively. There was no rent expense recorded for the three and six months ended June 30, 2021.
Consulting Agreement
Beach Front Property Management Inc, a company that is majority-owned by an executive and board member of the Company, entered into a consulting agreement with the Company dated September 28, 2020. The monthly consulting fee is $10,860 for M&A advisory and assistance and real estate acquisition and financing services. The agreement may be terminated by either party for any/or no reason without penalty upon seven days written notice. Consulting fees for the three and six months ended June 30, 2022 were $32,580 and $65,160, respectively. Consulting fees for the three and six months ended June 30, 2021 were $32,580 and $65,160, respectively.
**21.**REVENUES,NET
Revenues are disaggregated as follows for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended | Six Months Ended | |||||||
|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2022 | 2021 | |||||
| Retail | $ | 4,839,307 | $ | 6,393,757 | $ | 9,697,540 | $ | 11,376,642 |
| Wholesale | 11,633,940 | 12,280,520 | 20,748,078 | 22,537,916 | ||||
| Revenues, Net | $ | 16,473,247 | $ | 18,674,277 | $ | 30,445,618 | $ | 33,914,558 |
**22.**SUBSEQUENTEVENTS
On April 25, 2022, the Company announced it had entered into a binding Letter of Intent ("LOI") to acquire the remaining equity and property ownership interests of N.R.O Management, LLC and The Pottery, a retail dispensary located in Los Angeles. The Company currently owns 50% of the equity and property ownership interests. Under the terms of the LOI, the Company will acquire all of the equity interests for 500,000 Equity Shares set at a fixed price of $6 per share. The shares will have a one-year lock-up period from the closing date. In addition, the Company, or its designee has committed to acquire all of the remaining undivided ownership interests in the underlying real property for $3,005,000, in cash.
On July 28, 2022, the Company acquired the remaining equity interest of N.R.O. Management LLC and The Pottery under the terms described above. The Company elected not to acquire the remaining undivided ownership interest of the underlying real property.
In July 2022, the Company began a private placement financing to raise up to $25,000,000 of Series B Preferred Stock with a par value of $0.00001. For each share sold, the purchaser will receive one warrant with an exercise price of $5.00. Through the date of this report, the Company has raised approximately $3,900,000 under this private placement financing. As part of this transaction, the Company will redeem and exchange on a one-for-one basis the Series A Preferred Stock for Series B Preferred Stock. The warrants the Series A Preferred Stock held will also be redeemed and exchanged for the same warrants the Series B Preferred Stock holders receive on a two-for-one basis.
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Exhibit 99.2
GLASS HOUSE BRANDS INC.
MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND UNAUDITED RESULTS OF OPERATIONS
FORTHE THREE AND SIX MONTHS ENDED
JUNE30, 2022 AND 2021
| Introduction |
|---|
This management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as of August 15, 2022 and should be read together with Glass House Brands Inc.’s (the “Company”) Unaudited Condensed Interim Consolidated Financial Statements (the “Financial Statements”) and accompanying notes, as of June 30, 2022 and December 31, 2021 and for the three and six months ended June 30, 2022 and 2021, and the audited Consolidated Financial Statements and the accompanying notes for the years ended December 31, 2021 and 2020. The financial results discussed herein have been prepared in accordance with U.S. GAAP (“GAAP”) and, unless otherwise noted, are expressed in United States dollars. Additional information relating to the Company can be found on SEDAR at www.sedar.com.
| Overview |
|---|
The Company, formerly known as Mercer Park Brand Acquisition Corp. (“Mercer Park”), was incorporated under the Business Corporations Act (British Columbia) on April 16, 2019. The Company is a vertically integrated cannabis company that operates in the state of California. The Company through its subsidiaries, cultivates, manufactures, and distributes cannabis bulk flower and trim to wholesalers and consumer packaged goods to third-party retail stores in the state of California. The Company also owns and operates retail cannabis stores in the state of California. The Company’s subordinate voting shares (“Subordinate Voting Shares”), restricted voting shares (“Restricted Voting Shares”) and limited voting shares (“Limited Voting Shares”, and, collectively with the Subordinate Voting Shares and the Restricted Voting Shares, the “Equity Shares”), and common share purchase warrants are listed on the NEO Exchange Inc., trading under the symbols “GLAS.A.U” and “GLAS.WT.U”, respectively. The Equity Shares and common share purchase warrants also trade on the OTCQX in the United States under the symbols GLASF and GHBWF, respectively. The head office and principal address of the Company is 3645 Long Beach Boulevard, Long Beach, California 90807. The Company’s registered office in Canada is 2200 HSBC Building 885 West Georgia Street, Vancouver, British Columbia, Canada V6C 3E8.
Major Business Lines andGeographies
The Company views its financial results under one business line – the creation of extensible wholesale and consumer packaged goods (“CPG”) and brands through cannabis cultivation, production, and sales. The Company currently generates all of its revenue in the state of California.
While many cannabis businesses prioritize brand building and customer acquisition before securing a reliable product flow, the Company believes that in a consumer-focused CPG space, consistent delivery of high-quality product at an attractive price point is a first principle and a prerequisite for any other activity.
Cannabis Cultivation, Productionand Sales
The Company operates multiple greenhouse cultivation facilities located in Carpinteria and Camarillo, California, and its manufacturing production facilities are located in Lompoc and Adelanto, California. During the year ended December 31, 2021, the Company completed its previously announced acquisition of an approximately 5.5 million square feet greenhouse facility (“Camarillo Facility”) located in Camarillo, California (the “Camarillo Asset Acquisition”). Phase I of the Camarillo Facility is now licensed and operational. The Company completed the first harvest in June 2022, four weeks earlier than expected. In April 2022, the Company completed the acquisition of Plus Products Holdings Inc., a leading edibles brand in California.
The Company generates revenue by selling its products in bulk at wholesale and at retail to its own and third-party dispensaries in California, including raw cannabis, cannabis oil, and cannabis consumer goods. The Company’s “Farmacy” branded dispensaries are currently located in Santa Barbara, Santa Ana and Berkeley, California.
Market Update and Objectives
The state of California represents the largest single market for cannabis in the U.S., with an adult population of over 31 million. The California market is highly fragmented, with over 8,500 cultivation licenses in operation, over 1,000 distribution licenses over 800 operational dispensaries and greater than 1,000 brands. With this backdrop, the Company looks to use scale in cultivation and distribution (at wholesale and through its own dispensaries and third-party retailers) to achieve economies of scale that will allow the Company to outperform competitors and build superior brand awareness and loyalty.
SELECTED FIANCIAL INFORMATION
Results of Operations(Unaudited)
The following are the results of our operations (unaudited) for the three months ended June 30, 2022 compared to the three months ended June 30, 2021:
| Three Months Ended | ||||||
|---|---|---|---|---|---|---|
| June 30,<br> <br><br>2022 | June<br> 30, <br><br>2021 | |||||
| Unaudited | Unaudited | |||||
| Revenues, Net | $ | 16,473,247 | $ | 18,674,277 | ||
| Cost of Goods Sold | 16,219,430 | 10,079,539 | ||||
| Gross Profit | 253,817 | 8,594,738 | ||||
| Operating Expenses: | ||||||
| General and Administrative | 10,875,317 | 5,886,655 | ||||
| Sales and Marketing | 898,496 | 1,006,747 | ||||
| Professional Fees | 2,670,469 | 1,951,450 | ||||
| Depreciation and Amortization | 2,837,112 | 738,402 | ||||
| Total Operating Expenses | 17,281,394 | 9,583,254 | ||||
| Loss from Operations | (17,027,577 | ) | (988,516 | ) | ||
| Other Expense (Income): | ||||||
| Interest Expense | 1,570,779 | 1,171,282 | ||||
| Interest Income | (472 | ) | (16,136 | ) | ||
| Loss on Investments | 73,004 | 285,646 | ||||
| Loss (Gain) on Change in Fair Value of Derivatives | 53,213 | (154,000 | ) | |||
| (Gain) on Change in Fair Value of Contingent Liabilities | (6,314,190 | ) | - | |||
| Other Expense (Income), Net | 49,532 | (46,538 | ) | |||
| Total Other (Income) Expense, Net | (4,568,134 | ) | 1,240,254 | |||
| Loss from Operations Before Provision for Income Tax Expense | (12,459,443 | ) | (2,228,770 | ) | ||
| Provision for Income Tax Expense | 1,732,849 | 2,487,951 | ||||
| Net Loss | (14,192,292 | ) | (4,716,721 | ) | ||
| Net Loss Attributable to Non-Controlling Interest | (23,964 | ) | - | |||
| Net Loss Attributable to the Company | $ | (14,168,328 | ) | $ | (4,716,721 | ) |
| Loss Per Share - Basic and Diluted Attributable to the Company | $ | (0.24 | ) | $ | (0.19 | ) |
| Weighted-Average Shares Outstanding - Basic and Diluted | 59,447,659 | 24,262,497 |
Revenue
Revenue for the three months ended June 30, 2022 was $16.5 million, which represents a decrease of $2.2 million, or 12%, from $18.7 million for the three months ended June 30, 2021. The decrease in revenue was primarily due to decreases in the Company’s cannabis retail operations and wholesale biomass by $1.6 million and $0.6 million, or 24% and 5%, respectively, for the three months ended June 30, 2022 as compared to the three months ended June 30, 2021. The decrease in cannabis retail operation revenues was primarily attributable to the Company’s modification to the reward and loyalty programs which resulted in a one-time favorable adjustment to revenue of $1.3 million during the quarter ended June 30, 2021, compared to the current period. The decrease in wholesale biomass revenues was driven by lower pricing during the quarter ended June 30, 2022, compared to the same period in the prior year.
Cost of Goods Sold and GrossProfit
Cost of goods sold for the three months ended June 30, 2022 was $16.2 million, an increase of $6.1 million, or 61%, compared with $10.1 million for the three months ended June 30, 2021. Gross profit for the three months ended June 30, 2022 was $0.3 million, representing a gross margin of 2%, compared with a gross profit of $8.6 million, representing a gross margin of 46% for the three months ended June 30, 2021. The increase in cost of goods sold was primarily attributable to the Camarillo facility which completed phase one project work during the three months ended June 30, 2022. Cost of goods sold for the Camarillo facility during the second quarter of 2022 was $7.1 million, compared to nil in the same period in the prior year. The decrease in gross margin is primarily due increased product, labor and overhead costs associated with the Company’s cultivation expansion compared to the same period in the prior year.
Total Operating Expenses
Total operating expenses for the three months ended June 30, 2022 was $17.3 million, an increase of $7.7 million, or 80%, compared to total operating expenses of $9.6 million for the three months ended June 30, 2021. The increase in total operating expenses was attributable to the factors described below.
General and administrative expenses for the three months ended June 30, 2022 and 2021 were $10.9 million and $5.9 million, respectively, an increase of $5.0 million, or 85%. The increase in general and administrative expenses is primarily attributed to the Company’s operational expansion initiatives including increased salaries and stock-based compensation expense of $4.0 million and start-up expenses for the Camarillo Facility of $0.8 million.
Sales and marketing expenses for the three months ended June 30, 2022 and 2021 were $0.9 million and $1.0 million, respectively, a decrease of $0.1 million, or 11%. The Company’s sales and marketing expense is primarily driven by public relations, digital media expenses, promotions and trade shows, promotions, and digital media expenses which was $0.4 million and $0.5 million for the three months ended June 30, 2022 and 2021, respectively. Sales and marketing expenses include trade marketing, point of sale marketing for our wholesale CPG business product lines and promotions in various media outlets.
Professional fees for the three months ended June 30, 2022 and 2021 were $2.7 million and $2.0 million, respectively, an increase of $0.7 million, or 37%. The increase in professional fees is primarily attributable to an increase in legal fees of $0.9 million driven by start-up activities associated with cannabis retail applicants located in Santa Barbara and Santa Ynez, California, and other acquisition-related fees. This was partially offset by decreased consulting fees and accounting services of $0.3 million during the second quarter of 2022 as compared to the same period in the prior year.
Depreciation and amortization for the three months ended June 30, 2022 and 2021 were $2.8 million and $0.7 million, respectively, an increase of $2.1 million, or 284%. The increase is attributed to the growth of the Company’s operations through the acquisition of the Camarillo Facility in the third quarter of 2021 which resulted in an increase of depreciation and amortization during the three months ended June 30, 2022 as compared to the same period in the prior year.
Total Other Expense
Total other (income) expense for the three months ended June 30, 2022 and 2021 was $(4.6) million and $1.2 million, respectively, a favorable variance of $5.8 million. The variance was primarily due to $6.3 million favorable change in fair value of contingent liabilities due to the decrease in the Company’s share price for the quarter ended June 30, 2022, when compared to the same period in the prior year. See “Note 12 – Contingent Shares and Earnout Liabilities” in the Financial Statements for further information on the contingent shares and earnout liabilities.
Provision for Income Taxes
The provision for income tax expense for the three months ended June 30, 2022 and 2021 was $1.7 million and $2.5 million, respectively, a favorable change of $0.8 million, or 30%. The favorable change in provision for income taxes was directly impacted by the Company’s decrease in gross profit for the current period.
The following are the results of our operations for the six months ended June 30, 2022 compared to six months ended June 30, 2021:
| Six<br> Months Ended | ||||||
|---|---|---|---|---|---|---|
| June 30, | June 30, | |||||
| 2022 | 2021 | |||||
| Unaudited | Unaudited | |||||
| Revenues, Net | $ | 30,445,618 | $ | 33,914,558 | ||
| Cost of<br> Goods Sold | 27,852,573 | 19,877,824 | ||||
| Gross Profit | 2,593,045 | 14,036,734 | ||||
| Operating Expenses: | ||||||
| General<br> and Administrative | 20,298,614 | 11,722,386 | ||||
| Sales<br> and Marketing | 1,764,256 | 1,495,282 | ||||
| Professional<br> Fees | 5,240,975 | 5,304,201 | ||||
| Depreciation<br> and Amortization | 5,444,606 | 1,462,856 | ||||
| Total<br> Operating Expenses | 32,748,451 | 19,984,725 | ||||
| Loss from<br> Operations | (30,155,406 | ) | (5,947,991 | ) | ||
| Other Expense (Income): | ||||||
| Interest<br> Expense | 2,768,308 | 2,181,710 | ||||
| Interest<br> Income | (472 | ) | (32,222 | ) | ||
| Loss<br> on Investments | 426,663 | 284,258 | ||||
| Loss<br> (Gain) on Change in Fair Value of Derivatives | 53,213 | (825,000 | ) | |||
| Loss<br> on Change in Fair Value of Contingent Liabilities | 167,052 | - | ||||
| Loss<br> on Disposition of Subsidiary | - | 6,090,339 | ||||
| Other<br> Expense (Income), Net | 65,637 | (40,514 | ) | |||
| Total<br> Other Expense, Net | 3,480,401 | 7,658,571 | ||||
| Loss from Operations Before<br> Provision for Income Tax Expense | (33,635,807 | ) | (13,606,562 | ) | ||
| Provision<br> for Income Tax Expense | 382,249 | 4,263,952 | ||||
| Net Loss | (34,018,056 | ) | (17,870,514 | ) | ||
| Net Loss<br> Attributable to Non-Controlling Interest | (46,560 | ) | - | |||
| Net<br> Loss Attributable to the Company | $ | (33,971,496 | ) | $ | (17,870,514 | ) |
| Loss<br> Per Share - Basic and Diluted Attributable to the Company | $ | (0.59 | ) | $ | (0.74 | ) |
| Weighted-Average<br> Shares Outstanding - Basic and Diluted | 58,067,245 | 24,117,056 |
Revenue
Revenue for the six months ended June 30, 2022 was $30.4 million, which represents a decrease of $3.5 million or 10% from $33.9 million for the six months ended June 30, 2021. The decrease in revenue was primarily due to decreases in the Company’s wholesale biomass and cannabis retail operations by $1.8 million and $1.7 million, or 8% and 15%, respectively, for the six months ended June 30, 2022 as compared to the same period in the prior year. The decrease in wholesale biomass revenues was driven by lower pricing during the six months ended June 30, 2022, compared to the same period in the prior year. The decrease in cannabis retail operation revenues was primarily attributable to the Company’s modification to the reward and loyalty programs which resulted in a one-time favorable adjustment to revenue of $1.3 million during the six months ended June 30, 2021, compared to the current period.
Cost of Goods Sold and GrossProfit
Cost of goods sold for the six months ended June 30, 2022 was $27.9 million, an increase of $8.0 million, or 40%, compared with $19.9 million for the six months ended June 30, 2021. Gross profit for the six months ended June 30, 2022 was $2.6 million, representing a gross margin of 9%, compared with a gross profit of $14.0 million, representing a gross margin of 41% for the six months ended June 30, 2021. The increase in cost of goods sold was primarily attributable to costs associated with the Company’s cultivation expansion coupled with increased cultivation tax and labor expense of $5.7 million during the six months ended June 30, 2022 as compared to the same prior year period. The decrease in gross margin is primarily due a gross loss of the Camarillo Facility of $4.9 million during the six months ended June 30, 2022 as compared to nil for the same period in the prior year.
Total Operating Expenses
Total operating expenses for the six months ended June 30, 2022 was $32.7 million, an increase of $12.8 million, or 64%, compared to total operating expense of $20.0 million for the six months ended June 30, 2021. The increase in total operating expenses was attributable to the factors described below.
General and administrative expenses for the six months ended June 30, 2022 and June 30, 2021 were $20.3 million and $11.7 million, respectively, an increase of $8.6 million, or 73%. The increase in general and administrative expenses is primarily attributed to the Company’s initiatives of operational expansion for corporate, cultivation and retail operations. The Company’s initiatives resulted in increases in salaries and wages and stock-based compensation of $6.4 million as well as increases to general operational accounts during the six months ended June 30, 2022 as compared to the same period in the prior year.
Sales and marketing expenses for the six months ended June 30, 2022 and June 30, 2021 were $1.8 million and $1.5 million, respectively, an increase of $0.3 million, or 18%. The increase in sales and marketing expenses is primarily attributed to the increase in the Company’s efforts related to digital media, marketing research and promotions of $0.1 million. Sales and marketing expenses include trade marketing, point of sale marketing for our CPG product lines and promotions in various media outlets.
Professional fees for the six months ended June 30, 2022 and June 30, 2021 were $5.2 million and $5.3 million, respectively, a decrease of $0.1 million, or 1%. The Company recognized increased legal fees of $1.1 million during the six month ended June 30, 2022 as compared to the same period in the prior year which was driven by start-up activities associated with cannabis retail applicants located in Santa Barbara and Santa Ynez, California, and other acquisition-related fees. The increase in legal fees was partially offset by a decrease in accounting services and consulting fees of $1.2 million during the six months ended June 30, 2022 as compared to the same period in the prior year as a result of the preparation for the merger with Mercer Park during the six months ended June 30, 2021.
Depreciation and amortization for the six months ended June 30, 2022 and June 30, 2021 was $5.4 million and $1.5 million, respectively, an increase of $4.0 million, or 272%. The increase is attributed to the growth of the Company’s operations through the acquisition of the Camarillo Facility in the third quarter of 2021 which resulted in an increase of depreciation and amortization during the six months ended June 30, 2022 as compared to the same period in the prior year
Total Other Expense, Net
Total other expense for the six months ended June 30, 2022 and June 30, 2021 was $3.5 million and $7.7 million, respectively, a favorable variance of $4.2 million, or 55%. The variance was primarily due to a loss in disposition of subsidiary of $6.1 million recognized during the six months ended June 30, 2021, as compared to nil recognized during the six months ended June 30, 2022. During the six months ended June 30, 2021, the Company deconsolidated Field Investment Co, LLC a subsidiary and its subsidiaries Field Taste Matters, Inc., ATES Enterprises, LLC, and Zero One Seven Management, LLC for de minimis consideration to an unrelated party. The favorable variance was partially offset by a loss on change in fair value of derivatives of $0.9 million and an increase in interest expense of $0.6 million during the six months ended June 30, 2022 as compared to the same period in the prior year. See “Note 12 – Contingent Shares and Earnout Liabilities” in the Financial Statements for further information on the contingent shares and earnout liabilities.
Provision for Income Taxes
The provision for income tax expense for the six months ended June 30, 2022 and June 30, 2021 was $0.4 million and $4.3 million, respectively, a favorable change of $3.9 million, or 91%. The favorable change in provision for income taxes was due to the Company’s decreased revenue and higher loss from operations compared to the same period in the prior year.
Non-GAAP Financial Measures
In addition to providing financial measurements based on GAAP, the Company provides additional financial metrics that are not defined under, prepared in accordance with or a standardized financial measure under GAAP and may not be comparable to similar financial measures disclosed by other issuers. Management uses such non-GAAP financial measures, in addition to GAAP financial measures, to understand and compare operating results across accounting periods, for financial and operational decision-making, for planning and forecasting purposes and to evaluate the Company’s financial performance. These non-GAAP financial measures (collectively, the “non-GAAP financialmeasures”) are:
| EBITDA | Net Loss (GAAP) adjusted for interest and financing costs, income taxes, depreciation, and amortization. |
|---|---|
| Adjusted EBITDA | EBITDA (Non-GAAP) adjusted for share-based compensation, stock appreciation rights expense, loss (income) on equity method investments, change in fair value of derivative liabilities, change in fair value of contingent liabilities, acquisition-related professional fees, non-operational start-up costs and loss on disposition of subsidiary. Non-operational start-up costs are set-up costs to prepare a location for its intended use. Start-up costs are expensed as incurred and are not indicative of ongoing operations. |
Management believes that these non-GAAP financial measures assess the Company’s ongoing business in a manner that allows for meaningful comparisons and analysis of trends in the business, as they facilitate comparing financial results across accounting periods and to those of peer companies. Management also believes that these non-GAAP financial measures enable investors to evaluate the Company’s operating results and future prospects in the same manner as management. These non-GAAP financial measures may also exclude certain material non-cash items, expenses and gains and other adjustments that may be unusual in nature, infrequent or that the Company believes are not reflective of the Company’s ongoing operating results and performance.
As there are no standardized methods of calculating these non-GAAP financial measures, the Company’s methods may differ from those used by others, and accordingly, the use of these measures may not be directly comparable to similarly titled measures used by others in the cannabis industry or otherwise. Accordingly, these non-GAAP financial measures are intended to provide additional information and are not intended to represent and should not be considered as alternatives to net income, operating income or any other performance measures derived in accordance with GAAP as measures of operating performance or operating cash flows or as measures of liquidity. Such non-GAAP financial measures should only be considered in conjunction with the GAAP financial measures presented herein.
These supplemental non-GAAP financial measures are presented because management has evaluated the financial results both including and excluding the adjusted items and believe that the supplemental non-GAAP financial measures presented provide additional perspective and insights when analyzing the core operating performance of the business. In addition, the Company believes investors use both GAAP and non-GAAP measures to assess management’s past and future decisions associated with its priorities and allocation of capital, as well as to analyze how the business operates in, or responds to, swings in economic cycles or to other events that impact the cannabis industry.
These non-GAAP financial measures have important limitations as analytical tools and should not be considered in isolation or as a substitute for any standardized measure under GAAP. For example, certain of these non-GAAP financial measures:
| · | exclude certain tax payments that may reduce cash available to the Company; |
|---|---|
| · | do not reflect any cash capital expenditure requirements for the assets being depreciated and amortized<br>that may have to be replaced in the future; |
| --- | --- |
| · | do not reflect changes in, or cash requirements for, working capital needs; and |
| --- | --- |
| · | do not reflect the interest expense, or the cash requirements necessary to service interest or principal<br>payments on debt. |
| --- | --- |
Other companies in the cannabis industry may calculate these measures differently than the Company does, limiting their usefulness as comparative measures.
Adjusted EBITDA (non-GAAP)(Unaudited)
The following table provides a reconciliation of the Company’s net loss to Adjusted EBITDA (non-GAAP) for the three months ended June 30, 2022 compared to three months ended June 30, 2021:
| Three Months Ended | ||||||
|---|---|---|---|---|---|---|
| June 30, | June 30, | |||||
| 2022 | 2021 | |||||
| Unaudited | Unaudited | |||||
| Net Loss (GAAP) | $ | (14,192,292 | ) | $ | (4,716,721 | ) |
| Depreciation and Amortization | 2,837,112 | 738,402 | ||||
| Interest Expense | 1,570,779 | 1,171,282 | ||||
| Income Tax Expense | 1,732,849 | 2,487,951 | ||||
| EBITDA (non-GAAP) | (8,051,552 | ) | (319,086 | ) | ||
| Adjustments: | ||||||
| Share-Based Compensation | 3,491,187 | 824,062 | ||||
| Stock Appreciation Rights Expense | 92,472 | 251,491 | ||||
| Loss on Equity Method Investments | 73,004 | 285,646 | ||||
| Change in Fair Value of Derivative Liabilities | 53,213 | (154,000 | ) | |||
| Change in Fair Value of Contingent Liabilities | (6,314,190 | ) | - | |||
| Acquisition Related Professional Fees | 791,581 | 1,287,694 | ||||
| Non-Operational Start-up Costs | 98,706 | - | ||||
| Adjusted EBITDA (non-GAAP) | $ | (9,765,579 | ) | $ | 2,175,807 |
Adjusted EBITDA, a non-GAAP financial measure was $(9.8) million for the three months ended June 30, 2022 compared to $2.2 million for the three months ended June 30, 2021. The unfavorable change in adjusted EBITDA of $12.0 million is primarily due to lower gross profit coupled with higher operating expenses after adjustments.
The following table provides a reconciliation of the Company’s net loss to Adjusted EBITDA (non-GAAP) for the six months ended June 30, 2022 compared to six months ended June 30, 2021:
| Six Months Ended | ||||||
|---|---|---|---|---|---|---|
| June 30, | June 30, | |||||
| 2022 | 2021 | |||||
| Unaudited | Unaudited | |||||
| Net Loss (GAAP) | $ | (34,018,056 | ) | $ | (17,870,514 | ) |
| Depreciation and Amortization | 5,444,606 | 1,462,856 | ||||
| Interest Expense | 2,768,308 | 2,181,710 | ||||
| Income Tax Expense | 382,249 | 4,263,952 | ||||
| EBITDA (non-GAAP) | (25,422,893 | ) | (9,961,996 | ) | ||
| Adjustments: | ||||||
| Share-Based Compensation | 6,173,644 | 2,430,524 | ||||
| Stock Appreciation Rights Expense | (35,442 | ) | 251,491 | |||
| Loss on Equity Method Investments | 426,663 | 284,258 | ||||
| Change in Fair Value of Derivative Liabilities | 53,213 | (825,000 | ) | |||
| Change in Fair Value of Contingent Liabilities | 167,052 | - | ||||
| Acquisition Related Professional Fees | 1,326,233 | 4,474,145 | ||||
| Non-Operational Start-up Costs | 991,647 | - | ||||
| Loss on Disposition of Subsidiary | - | 6,090,339 | ||||
| Adjusted EBITDA (non-GAAP) | $ | (16,319,883 | ) | $ | 2,743,761 |
Adjusted EBITDA, a non-GAAP financial measure was $(16.3) million for the six months ended June 30, 2022 compared to $2.7 million for the six months ended June 30, 2021. The unfavorable change in adjusted EBITDA of $19.0 million is primarily due to lower gross profit coupled with higher operating expenses after adjustments.
Selected Quarterly Information
A summary of selected information for each of the quarters presented is as follows:
| Revenues | Net Loss Before <br> Non-Controlling<br> Interest | Loss Per Share -<br><br> Basic and Diluted<br><br> Attributable to the <br><br>Company | ||||||
|---|---|---|---|---|---|---|---|---|
| Unaudited | Unaudited | |||||||
| June 30, 2022 | $ | 16,473,247 | $ | (14,192,292 | ) | $ | (0.24 | ) |
| March 31, 2022 | $ | 13,972,371 | $ | (19,825,764 | ) | $ | (0.35 | ) |
| December 31, 2021 | $ | 18,360,442 | $ | (18,766,598 | ) | $ | (0.33 | ) |
| September 30, 2021 | $ | 17,171,852 | $ | (7,728,476 | ) | $ | (0.15 | ) |
| June 30, 2021 | $ | 18,674,277 | $ | (4,716,721 | ) | $ | (0.19 | ) |
| March 31, 2021 | $ | 15,240,281 | $ | (13,153,793 | ) | $ | (0.55 | ) |
| December 31, 2020 | $ | 16,939,792 | $ | (4,059,249 | ) | $ | (0.18 | ) |
| September 30, 2020 | $ | 13,307,759 | $ | (3,804,960 | ) | $ | (0.16 | ) |
Revenues for the quarter ended June 30, 2022 was $16.5 million, which represents an increase of $2.5 million, of 18% from $14.0 million for the quarter ended March 31, 2022. The increase in revenue was primarily due to the operations of the Camarillo Facility which had revenues of $2.2 million as compared to nil during the quarter ended March 31, 2022. The Company completed phase one project work of the Camarillo Facility during the quarter ended June 30, 2022. Revenues for the quarter ended March 31, 2022 was $14.0 million, which represents a decrease of $4.4 million or 24% from $18.4 million for the quarter ended December 31, 2021. The decrease in revenues during the three months ended March 31, 2022 was driven by decreased wholesale biomass pricing. Revenue for the quarter ended December 31, 2021 was $18.4 million, which represents an increase of $1.2 million or 7% from $17.2 million for the quarter ended September 30, 2021. The increase in revenue was primarily due to the increase in quantity of wholesale biomass sold offset by continued decline in pricing. Revenue growth from the quarter ended September 30, 2020 through the quarter ended December 31, 2020 was primarily driven by an increase in cannabis production from the Company’s second greenhouse cultivation facility located in Carpinteria, California, which commenced operations during the first quarter of 2020 and expanded operational canopy from approximately 113,000 square feet to over 390,000 square feet by December 31, 2020.
Net loss for the quarter ended June 30, 2022 was $14.2 million, which represents a decrease of $5.6 million, or 28% from $19.8 million net loss for the quarter ended March 31, 2022. The decrease in net loss was primarily due to a gain on change in fair value of contingent liabilities as a result of the unfavorable change in Company stock price as of June 30, 2022 as compared to March 31, 2022. Net loss for the quarter ended March 31, 2022 was $19.8 million, which represents an increase of $1.1 million or 6% from a net loss of $18.8 million for the quarter ended December 31, 2021. The difference in net loss was due to a decrease in gross profit for the quarter ended March 31, 2022, coupled with increased operating expenses, including an increase in general and administrative expenses as well as depreciation and amortization. The Company was building out the Camarillo Facility acquired during the fourth quarter of 2021, which resulted in a $2.6 million net loss recognized for the quarter ended March 31, 2022. Net loss for the quarter ended December 31, 2021 was $18.8 million, which represents an increase of $11.1 million, or 143% from a net loss of $7.7 million for the quarter ended September 30, 2021. The difference in net loss was primarily due to an increase in total operating expenses for the quarter ended December 31, 2021 of $7.4 million of which $4.9 million is related to non-operational start-up costs and non-operational notes receivable bad debt reserve coupled with net loss related to the Camarillo Facility of $2.6 million for the quarter ended December 31, 2021. Net loss increased $9.5 million, or 202%, from a net loss of $4.7 million for the quarter ended June 30, 2021, to a net loss of $14.2 million for the quarter ended June 30, 2022. The increase in net loss was primarily due to a decrease in gross profit and increased operating expenses.
Liquidity and Capital Resources
Overview
Historically, the Company’s primary source of liquidity has been its operations, capital contributions made by equity investors and debt issuances. The Company is currently meeting its current operational obligations as they become due from its current working capital and from operations. However, the Company has sustained losses since inception and may require additional capital in the future. As of and for the six months ended June 30, 2022, the Company had an accumulated deficit of $94,798,786, a net loss attributable to the Company of $33,791,496 and net cash used in operating activities of $23,255,206. The Company estimates that based on current business operations and working capital, it will continue to meet its obligations as they become due in the short term.
The Company is generating cash from revenues and deploying its capital reserves to acquire and develop assets capable of producing additional revenues and earnings over both the immediate and near term. Capital reserves are primarily being utilized for capital expenditures, facility improvements, product development and marketing.
Liquidity risk is the risk that the Company will not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management of its capital structure. The Company’s approach to managing liquidity is to ensure that it will have sufficient liquidity to settle obligations and liabilities when due. In the event sufficient cash flow is not available from operating activities, the Company may continue to raise equity or debt capital from investors in order to meet liquidity needs. If the Company is not able to secure adequate additional funding, the Company may be forced to make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, or suspend or curtail planned programs. Any of these actions could materially harm the Company’s business, results of operations and future prospects. There can be no assurance that such financing will be available or will be at terms acceptable to the Company.
Credit Agreement with SeniorSecured Lender
On December 9, 2021, the Company entered into a senior secured term loan agreement, as amended (the “Credit Agreement”), for total available proceeds of up to $100,000,000 with funds managed by a U.S.-based private credit investment fund and other third-party lenders (together, the “Senior Secured Lender”). Effective December 10, 2021, the Company closed on an initial term loan through the Credit Agreement of $50,000,000. The initial term loan has a variable interest rate currently set at 10% per annum, and in no event shall be more than 12% per annum. The principal amount of the initial term loan has been, and is anticipated to be used for ongoing operations, capital expenditures and other corporate purposes. See “Note 14 – Notes Payable and Convertible Debentures” in the Unaudited Condensed Interim Financial Statements for further information.
On May 12, 2022, the Company amended and restated the Credit Agreement (the “2^nd^ Amendment”) wherein certain events of default were waived, and the Company entered into an incremental term loan in the amount of $10,000,000 (“Incremental Term Loan”), for total available proceeds of $110,000,000. The Incremental Term Loan bears interest at a rate of 10% per annum and payable in monthly installments. In addition, a 1% fee of the outstanding principal amount of the Incremental Term Loan is payable in monthly installments beginning August 1, 2022, with a maturity date through October 31, 2022. In connection with the Incremental Term Loan, the Company issued 175,000 warrants to the Senior Secured Lender, with an exercise price of $11.50 per share, to acquire each Equity Share until June 26, 2026. These warrants were fair valued using level 1 inputs as these warrants are openly traded on a stock exchange. The principal amount of the initial term loan has been, and is anticipated to be, used for ongoing operations, capital expenditures and other corporate purposes.
Financial Condition
Cash Flows
The following table summarizes the Company’s Consolidated Statements of Cash Flows from the Financial Statements for the six months ended June 30, 2022 and 2021:
| Six Months Ended | ||||||
|---|---|---|---|---|---|---|
| June 30, | June 30, | |||||
| 2022 | 2021 | |||||
| Unaudited | Unaudited | |||||
| Net Cash Used in Operating Activities | $ | (23,255,206 | ) | $ | (1,943,296 | ) |
| Net Cash Used in Investing Activities | (24,316,464 | ) | (2,268,330 | ) | ||
| Net Cash Provided by Financing Activities | 10,956,140 | 133,956,710 | ||||
| Net (Decrease) Increase in Cash, Restricted Cash and Cash Equivalents | (36,615,530 | ) | 129,745,084 | |||
| Cash, Restricted Cash and Cash Equivalents, Beginning of Period | 54,066,831 | 4,535,251 | ||||
| Cash, Restricted Cash and Cash Equivalents, End of Period | $ | 17,451,301 | $ | 134,280,335 |
Cash Flow from OperatingActivities
Net cash used in operating activities was $23.3 million for the six months ended June 30, 2022, an increase of $21.4 million, or 1,097%, compared to $1.9 million for the six months ended June 30, 2021. The increase in cash used in operating activities was primarily due to an increase in net loss and adjustments to reconcile net loss to net cash used in operating activities of $16.3 million coupled with an increase in changes in operating assets and liabilities of $5.0 million for the six months ended June 30, 2022 as compared to the same period in the prior year.
Cash Flow from Investing Activities
Net cash used in investing activities was $24.3 million for the six months ended June 30, 2022, an increase of $22.0 million, or 972%, compared to $2.3 million for the six months ended June 30, 2021. This was primarily driven by the increase in purchases of property and equipment of $18.7 million for the six months ended June 30, 2022, compared to the prior period. During the six months ended June 30, 2022, the Company was in process of constructing the Camarillo Facility for its intended operational use. Additionally, the Company issued senior secured promissory notes totaling $6.1 million for the purchase of 100% equity interests in operating retail dispensaries during the six months ended June 30, 2022. See “Note 5 – Notes Receivable” in the Unaudited Condensed Interim Financial Statements for further information.
Cash Flow from FinancingActivities
Net cash provided in financing activities was $11.0 million for the six months ended June 30, 2022, a decrease of $123.0 million, or 92%, compared to $134.0 million for the six months ended June 30, 2021. This was driven by cash proceeds received from the issuance of equity during the six months ended June 30, 2021 of $124.4 million, compared to $0.2 million for the six months ended June 30, 2022.
As discussed in the “Liquidity and Capital Resources” section above, the Company’s primary source of liquidity has been capital contributions and debt capital made available from investors. In the event sufficient cash flow is not available from operating activities, the Company may continue to raise equity capital from investors in order to meet liquidity needs. Other than the senior secured term loan agreement discussed above, the Company does not have any committed sources of financing.
Contractual Obligations
The Company has contractual obligations to make future payments, including debt agreements and lease agreements from third parties.
The following table summarizes such obligations as of June 30, 2022:
| 2022 | 2023 | 2024-2025 | After 2025 | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|---|
| (remaining) | ||||||||||
| Notes Payable from Third Parties | $ | 9,490,413 | $ | 665,237 | $ | 15,087,770 | $ | 51,322,802 | $ | 76,566,222 |
| Lease Obligations | 547,526 | 992,071 | 1,583,255 | 2,885,844 | 6,008,696 | |||||
| Total Contractual Obligations | $ | 10,037,939 | $ | 1,657,308 | $ | 16,671,025 | $ | 54,208,646 | $ | 82,574,918 |
Off-Balance Sheet Arrangements
As of the date of this MD&A, the Company does not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the results of operations or financial condition of the Company including, without limitation, such considerations as liquidity and capital resources that have not previously been discussed.
Transactions with RelatedParties During the Six Months Ended June 30, 2022
Related parties are defined as management and members of the Company and/or members of their immediate family and/or other companies and/or entities in which a board member or senior officer is a principal owner or senior executive. Other than disclosed elsewhere in the financial statements, related party transactions and balances are as follows:
Leases
Neo Street Partners LLC, a company partially owned by an executive and board member of the Company, entered into a five-year lease with a subsidiary of the Company. The lease, which commenced in October 2018, provides for an initial annual base rent payment of $213,049 increasing to $243,491 for years two to five. Rent expense for the three and six months ended June 30, 2022 were $60,873 and $121,746, respectively. Rent expense for the three and six months ended June 30, 2021 were $60,873 and $121,746, respectively.
3645 Long Beach LLC, a company partially owned by an executive and board member of the Company, entered into a five-year lease with a subsidiary of the Company. The lease, which commenced in December 2019, provides for an initial annual base rent payment of $64,477 increasing to $69,352 for year two and increasing five percent per annum thereafter. Rent expense for the three and six months ended June 30, 2022 were $18,205 and $36,699, respectively. Rent expense for the three and six months ended June 30, 2021 were $17,338 and $34,676, respectively.
Isla Vista GHG LLC, a company partially owned by executives and board members of the Company, entered into a ten-year lease with a subsidiary of the Company. The lease, which commences on the first calendar day after the Company publicly announces the opening of the retail location at the leased property (“Commencement Date”), provides for an initial monthly rent of $5,000 starting April 19, 2022 until the Commencement Date. Effective on the Commencement Date, the initial annual base rent payment will be $144,000 and increasing three percent per annum thereafter. Rent expense for the three and six months ended June 30, 2022 were $12,000 and $12,000, respectively. There was no rent expense recorded for the three and six months ended June 30, 2021.
Consulting Agreement
Beach Front Property Management Inc, a company that is majority-owned by an executive and board member of the Company, entered into a consulting agreement with the Company dated September 28, 2020. The monthly consulting fee is $10,860 for M&A advisory and assistance and real estate acquisition and financing services. The agreement may be terminated by either party for any/or no reason without penalty upon seven days written notice. Consulting fees for the three and six months ended June 30, 2022 were $32,580 and $65,160, respectively. Consulting fees for the three and six months ended June 30, 2021 were $32,580 and $65,160, respectively.
Critical Accounting Estimates
Use of Estimates
The preparation of the Financial Statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the Financial Statements and the reported amounts of total net revenue and expenses during the reporting period. The Company regularly evaluates significant estimates and assumptions related to the consolidation or non-consolidation of variable interest entities, estimated useful lives, depreciation of property and equipment, amortization of intangible assets, inventory valuation, share-based compensation, business combinations, goodwill impairment, long-lived asset impairment, purchased asset valuations, fair value of financial instruments, compound financial instruments, derivative liabilities, deferred income tax asset valuation allowances, incremental borrowing rates, lease terms applicable to lease contracts and going concern. These estimates and assumptions are based on current facts, historical experience and various other factors that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results the Company experiences may differ materially and adversely from these estimates. To the extent there are material differences between the estimates and actual results, the Company’s future results of operations will be affected.
Estimated Useful Lives and Depreciationof Property and Equipment
Depreciation of property and equipment is dependent upon estimates of useful lives which are determined through the exercise of judgment. The assessment of any impairment of these assets is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful lives of assets.
Estimated Useful Lives and Amortizationof Intangible Assets
Amortization of intangible assets is dependent upon estimates of useful lives and residual values which are determined through the exercise of judgment. Intangible assets that have indefinite useful lives are not subject to amortization and are tested annually for impairment, or more frequently if events or changes in circumstances indicate that they might be impaired. The assessment of any impairment of these assets is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions.
Impairment of Long-Lived Assets
For purposes of the impairment test, long-lived assets such as property, plant and equipment and definite-lived intangible assets are grouped with other assets and liabilities at the lowest level for which identifiable independent cash flows are available (“asset group”). The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order to determine if assets have been impaired, the impairment test is a two-step approach wherein the recoverability test is performed first to determine whether the long-lived asset is recoverable. The recoverability test (Step 1) compares the carrying amount of the asset to the sum of its future undiscounted cash flows using entity-specific assumptions generated through the asset’s use and eventual disposition. If the carrying amount of the asset is less than the cash flows, the asset is recoverable and an impairment is not recorded. If the carrying amount of the asset is greater than the cash flows, the asset is not recoverable and an impairment loss calculation (Step 2) is required. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying value of the asset group. Fair value can be determined using a market approach, income approach or cost approach. The cash flow projection and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies, at the date of evaluation. The reversal of impairment losses is prohibited.
Leased Assets
In accordance with ASC 842 “Leases” (“ASC 842”), the Company determines if an arrangement is a lease at inception. The Company elected the package of practical expedients provided by ASC 842, which forgoes reassessment of the following upon adoption of the new standard: (1) whether contracts contain leases for any expired or existing contracts, (2) the lease classification for any expired or existing leases, and (3) initial direct costs for any existing or expired leases. In addition, the Company elected an accounting policy to exclude from the balance sheet the right-of-use assets and lease liabilities related to short-term leases, which are those leases with a lease term of twelve months or less that do not include an option to purchase the underlying asset that the Company is reasonably certain to exercise.
The Company applies judgment in determining whether a contract contains a lease and if a lease is classified as an operating lease or a finance lease. The Company applies judgement in determining the lease term as the non-cancellable term of the lease, which may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. All relevant factors that create an economic incentive for it to exercise either the renewal or termination are considered. The Company reassesses the lease term if there is a significant event or change in circumstances that is within its control and affects its ability to exercise or not to exercise the option to renew or to terminate. In adoption of ASC 842, the Company applied the practical expedient test or approach which applies hindsight in determining the lease term and assessing impairment of right-of-use assets by using its actual knowledge or current expectation as of the effective date. The Company also applies judgment in allocating the consideration in a contract between lease and non-lease components. It considers whether the Company can benefit from the right-of-use asset either on its own or together with other resources and whether the asset is highly dependent on or highly interrelated with another right-of-use asset. Lessees are required to record a right-of -use asset and a lease liability for all leases with a term greater than twelve months. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected remaining lease term. The incremental borrowing rate is determined using estimates which are based on the information available at commencement date and determines the present value of lease payments if the implicit rate is unavailable.
Income Taxes
Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the Condensed Consolidated Balance Sheets of the Financial Statements. Effects of enacted tax law changes on deferred tax assets and liabilities are reflected as adjustments to tax expense in the period in which the law is enacted. Deferred tax assets may be reduced by a valuation allowance if it is deemed more likely than not that some or all of the deferred tax assets will not be realized.
The Company follows accounting guidance issued by the Financial Accounting Standards Board (“FASB”) related to the application of accounting for uncertainty in income taxes. Under this guidance, the Company assesses the likelihood of the financial statement effect of a tax position that should be recognized when it is more likely than not that the position will be sustained upon examination by a taxing authority based on the technical merits of the tax position, circumstances, and information available as of the reporting date.
Convertible Instruments
The Company evaluates and accounts for conversion options embedded in its convertible instruments in accordance with ASC 815, “Accounting for Derivative Instrumentsand Hedging Activities”. Professional standards generally provide three criteria that, if met, require companies to bifurcate conversion options from their host instruments and account for them as free-standing derivative financial instruments. These three criteria include circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument”.
During the year ended December 31, 2021, the Company early adopted ASU 2020-06, “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivativesand Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in anEntity’s Own Equity”, which simplifies the accounting for convertible instruments by eliminating the requirement to separate embedded conversion features from the host contract when the conversion features are not required to be accounted for as derivatives under ASC 815, Derivatives and Hedging, or that do not result in substantial premiums accounted for as paid-in capital. By removing the separation model, a convertible debt instrument will be reported as a single liability instrument with no separate accounting for embedded conversion features. This standard also removes certain settlement conditions that are required for contracts to qualify for equity classification and simplifies the diluted earnings per share calculations by requiring that an entity use the if-converted method and that the effect of potential share settlement be included in diluted earnings per share calculations. The Company also records, when necessary, deemed dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. ASC 815-40 provides that generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be classified as an asset or a liability.
Derivative Liabilities
The Company evaluates its agreements to determine if such instruments have derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the Unaudited Condensed Interim Consolidated Statements of Operations. In calculating the fair value of derivative liabilities, the Company uses a valuation model when Level 1 inputs are not available to estimate fair value at each reporting date. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the Condensed Consolidated Balance Sheets as current or non-current based on whether net-cash settlement of the derivative instrument could be required within twelve months of the Balance Sheets dates.
Business Combinations
Business combinations are accounted for using the acquisition method. The consideration transferred in a business combination is measured at fair value at the date of acquisition. Acquisition related transaction costs are expensed as incurred and included in the Unaudited Condensed Consolidated Statements of Operations of the Financial Statements. Identifiable assets and liabilities, including intangible assets, of acquired businesses are recorded at their fair value at the date of acquisition. When the Company acquires control of a business, any previously held equity interest is also remeasured to fair value. The excess of the purchase consideration and any previously held equity interest over the fair value of identifiable net assets acquired is goodwill. If the fair value of identifiable net assets acquired exceeds the purchase consideration and any previously held equity interest, the difference is recognized in the Unaudited Condensed Interim Consolidated Statements of Operations of the Financial Statements immediately as a gain on acquisition.
Contingent consideration is measured at its acquisition-date fair value and included as part of the consideration transferred in a business combination. The Company allocates the total cost of the acquisition to the underlying net assets based on their respective estimated fair values. As part of this allocation process, the Company identifies and attributes values and estimated lives to the intangible assets acquired. These determinations involve significant estimates and assumptions regarding multiple, highly subjective variables, including those with respect to future cash flows, discount rates, asset lives, and the use of different valuation models, and therefore require considerable judgment. The Company’s estimates and assumptions are based, in part, on the availability of listed market prices or other transparent market data. These determinations affect the amount of amortization expense recognized in future periods. The Company bases its fair value estimates on assumptions it believes to be reasonable but are inherently uncertain. Contingent consideration that is classified as equity is not remeasured at subsequent reporting dates and its subsequent settlement is accounted for within equity. Contingent consideration that is classified as an asset or a liability is remeasured at subsequent reporting dates in accordance with ASC 450, “Contingencies”, as appropriate, with the corresponding gain or loss being recognized in earnings in accordance with ASC 805, “Business Combinations”.
Consolidation of VariableInterest Entities (“VIE”)
ASC 810 requires a variable interest holder to consolidate a VIE if that party has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. To determine whether or not a variable interest the Company holds could potentially be significant to the VIE, the Company considers both qualitative and quantitative factors regarding the nature, size and form of the Company’s involvement with the VIE. The equity method of accounting is applied to entities in which the Company is not the primary beneficiary or the entity is not a VIE and the Company does not have effective control, but can exercise influence over the entity with respect to its operations and major decisions. The Company does not consolidate a VIE in which it is not considered the primary beneficiary. The Company evaluates its relationships with all the VIE’s on an ongoing basis to reassess if it continues to be the primary beneficiary.
Share-Based Compensation
The Company has an equity incentive plan (the “Incentive Plan”) under which the Company may issue various types of equity instruments or instruments that track to equity, more particularly the Equity Shares, to employees, officers, consultants and non-employee directors. The types of equity instruments issuable under the Incentive Plan encompass, among other things, stock options, unrestricted stock bonus and restricted stock units (together, “Awards”). See “Note 16 – Share-Based Compensation” in the Unaudited Condensed Interim Financial Statements for further information.
The Company accounts for its share-based awards in accordance with ASC 718, “Compensation – Stock Compensation”, which requires fair value measurement on the grant date and recognition of compensation expense for all share-based payment awards made to employees and directors, including restricted share awards. For stock options, the Company estimates the fair value using a closed option valuation (Black-Scholes) model. When there are market-related vesting conditions to the vesting term of the share-based compensation, the Company uses a valuation model to estimate the probability of the market-related vesting conditions being met and will record the expense. The fair value of restricted share awards is based upon the quoted market price of the common shares on the date of grant. The fair value is then expensed over the requisite service periods of the awards, net of estimated forfeitures, which is generally the performance period, and the related amount is recognized in the Unaudited Condensed Interim Consolidated Statements of Operations of the Financial Statements.
The fair value models require the input of certain assumptions that require the Company’s judgment, including the expected term and the expected share price volatility of the underlying share. The assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, but these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change resulting in the use of different assumptions, share-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the actual forfeiture rate is materially different from management’s estimates, the share-based compensation expense could be significantly different from what the Company has recorded in the current period.
Financial Instruments
Fair Value
The Company applies fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the Financial Statements on a recurring basis. The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities that are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.
Impairment
The Company assesses all information available, including on a forward-looking basis the expected credit loss associated with its assets carried at amortized cost. The impairment methodology applied depends on whether there has been a significant increase in credit risk. To assess whether there is a significant increase in credit risk, the Company compares the risk of a default occurring on the asset at the reporting date with the risk of default at the date of initial recognition based on available information, and forward-looking information that is reasonable and supportive. For accounts receivable only, the Company applies the simplified approach as permitted by ASU 2016-13, “Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The simplified approach to the recognition of expected losses does not require the Company to track the changes in credit risk. Rather, the Company recognizes a loss allowance based on lifetime expected credit losses at each reporting date from the date of the trade receivable.
Expected credit losses are measured as the difference in the present value of the contractual cash flows that are due to the Company under the contract, and the cash flows that the Company expects to receive. The Company assesses all information available, including past due status, credit ratings, the existence of third-party insurance, and forward-looking macro-economic factors in the measurement of the expected credit losses associated with its assets carried at amortized cost. The Company measures expected credit loss by considering the risk of default over the contract period and incorporates forward-looking information into its measurement.
Changes in Accounting PoliciesIncluding Adoption
In May 2021, the FASB issued ASU 2021-04, Modifications andExtinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’sOwn Equity (Subtopic 815-40)(“ASU 2021-04”), which amends existing guidance for earnings per share (EPS) in accordance with Topic 260. ASU 2021-04 is effective for the Company beginning January 1, 2022. This update should be applied prospectively on or after the effective date of the amendments. The Company adopted ASU 2021-04 on January 1, 2022. The adoption of the standard did not have a material impact on the Company’s Unaudited Condensed Interim Consolidated Financial Statements.
Recently Issued Accounting Standards
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Subtopic 805), Accounting for Contract Assets and Contract Liabilities fromContracts with Customers (“ASU 2021-08”), which is intended to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to the recognition of an acquired contract liability and the effect of payment terms on subsequent revenue recognized. ASU 2021-08 is effective for the Company beginning January 1, 2023. This update should be applied prospectively on or after the effective date of the amendments. The Company is currently evaluating the effect of adopting this accounting standard.
On March 31, 2022, the FASB issued ASU 2022-02, “FinancialInstruments—Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminates the accounting guidance on troubled debt restructurings for creditors and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. The ASU also updates the requirements related to accounting for credit losses under the current guidance and adds enhanced disclosures for creditors with respect to loan refinancing and restructuring for borrowers experiencing financial difficulty. ASU 2022-02 is effective for the Company beginning January 1, 2023. The Company is currently evaluating the effect of adopting this accounting standard.
Financial Instruments and OtherInstruments
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, accounts receivables, investments, notes receivable, trade payables, accrued liabilities, operating lease liabilities, derivatives, notes payable, acquisition consideration of assets and liabilities. All assets and liabilities for which fair value is measured or disclosed in the Financial Statements are categorized within the fair value hierarchy. This is described, as follows, based on the lowest level input that is significant to the fair value measurement as a whole:
Level 1 – inputs are quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2 – inputs are observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in markets that are not active, or other inputs that are observable directly or indirectly.
Level 3 – inputs are unobservable inputs for the asset or liability that reflect the reporting entity’s own assumptions and are not based on observable market data.
There have been no transfers between fair value levels during the years.
Other Risks and Uncertainties
Credit Risk
Credit risk is the risk of a potential loss to the Company if a customer or third party to a financial instrument fails to meet its contractual obligations. The maximum credit exposure as of June 30, 2022 and December 31, 2021 is the carrying values of cash and cash equivalents, accounts receivable, due from related party. The Company does not have significant credit risk with respect to its customers. All cash and cash equivalents are placed with major U.S. financial institutions. The Company provides credit to its customers in the normal course of business and has established credit evaluation and monitoring processes to mitigate credit risk but has limited risk as the majority of its sales are transacted with cash.
Liquidity Risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations associated with financial liabilities. The Company manages liquidity risk through the management of its capital structure. The Company’s approach to managing liquidity risk is to ensure that it will have sufficient liquidity to settle obligations and liabilities when due. As of June 30, 2022 and December 31, 2021, cash generated from ongoing operations was not sufficient to fund operations and growth strategy as discussed above in “Liquidity and Capital Resources”. The Company has therefore depended on financing from sale of our equity and from debt financing to fund our operations. Overall, management does not expect the net cash contribution from our operations and investments to be positive in the near term, and the Company therefore expect to rely on financing from equity or debt.
Regulatory Risk
Regulatory risk pertains to the risk that the Company’s business objectives are contingent, in part, upon the compliance of regulatory requirements. Due to the nature of the industry, the Company recognizes that regulatory requirements are more stringent and punitive in nature. Any delays in obtaining, or failure to obtain regulatory approvals can significantly delay operational and product development and can have a material adverse effect on the Company’s business, results of operation, and financial condition. The Company is cognizant of the advent of regulatory changes occurring in the cannabis industry on the city, state, and national levels. Although regulatory outlook on the cannabis industry has been moving in a positive trend, the Company is aware of the effect that unforeseen regulatory changes could have on the goals and operations of the business as a whole.
Interest Rate Risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Cash and cash equivalents bear interest at market rates. The Company’s financial liabilities have fixed rates of interest and therefore expose the Company to a limited interest rate fair value risk.
Price Risk
Price risk is the risk of variability in fair value due to movements in equity or market prices. The Company’s investments are susceptible to price risk arising from uncertainties about their future outlook, future values and the impact of market conditions. The fair value of investments in privately-held entities are based on a market approach, which uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Tax Risk
Tax risk is the risk of changes in the tax environment that would have a material adverse effect on the Company’s business, results of operations, and financial condition. Currently, state licensed marijuana businesses are assessed a comparatively high effective federal tax rate due to Internal Revenue Code Section 280E, which bars businesses from deducting all expenses except their cost of goods sold when calculating federal tax liability. Any increase in tax levies resulting from additional tax measures may have a further adverse effect on the operations of the Company, while any decrease in such tax levies will be beneficial to future operations.
For a detailed description of risk factors associated with the Company and its operations, please see the “Risk Factors” section of the Company’s annual information form for the year ended December 31, 2021, available on SEDAR at www.sedar.com.
Shareholders’ Equity
As of June 30, 2022 and December 31, 2021, the authorized share capital of the Company is comprised of an unlimited number of (i) Subordinate Voting Shares, (ii) Restricted Voting Shares, (iii) Limited Voting Shares, (iv) Multiple Voting Shares and (v) Preferred Shares:
Multiple Voting Shares
The Company is authorized to issue an unlimited number of Multiple Voting Shares without nominal or par value. Holders of Multiple Voting Shares are entitled to receive notice of any meeting of shareholders of the Company, and to attend, vote and speak at such meetings, except those meetings at which only holders of a specific class of shares are entitled to vote separately as a class under the Business Corporations Act (British Columbia). On all matters upon which holders of Multiple Voting Shares are entitled to vote, each Multiple Voting Share entitles the holder thereof to 50 votes per Multiple Voting Share. Multiple Voting Shares are not entitled to dividends. The Multiple Voting Shares have three (3)-year sunset period that will expire June 29, 2024, upon which they will be automatically redeemed for $0.001 per Multiple Voting Share.
Equity Shares
The holders of each class of Equity Shares are entitled to receive notice of, to attend (if applicable, virtually) and to vote at all meetings of shareholders of the Company, except that they are not able to vote (but are entitled to receive notice of, to attend and to speak) at those meetings at which the holders of a specific class are entitled to vote separately as a class under the Business Corporations Act (British Columbia) and except that holders of Limited Voting Shares are not entitled to vote for the election of directors of the Company. The Subordinate Voting Shares and Restricted Voting Shares carry one vote per share on all matters. The Limited Voting Shares carry one vote per share on all matters except the election of directors, as the holders of Limited Voting Shares do not have any entitlement to vote in respect of the election for directors of the Company.
In the case of liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, or in the event of any other distribution of assets of the Company among its shareholders for the purpose of winding up its affairs, the holders of Equity Shares are entitled, subject to the prior rights of the holders of any shares of the Company ranking in priority to the Equity Shares (including any liquidation preference on any issued and outstanding Multiple Voting Shares and/or Preferred Shares), to participate ratably the Company’s remaining property along with all holders of the other classes of Equity Shares (on a per share basis).
Exchangeable Shares of MPB Acquisition Corp.
Exchangeable shares (the “Exchangeable Shares”) are part of the authorized share capital of MPB Acquisition Corp. (“MPB”), a wholly-owned subsidiary of the Company, which entitle their holders to rights that are comparable to those rights attached to the Equity Shares, except that (i) each Exchangeable Share has 1.1 votes per share until June 29, 2022, after which they will have one vote per share, and (ii) the aggregate voting power of the Exchangeable Shares must not exceed 49.9% of the total voting power of all classes of shares of MPB. Until a holder exchanges their Exchangeable Shares for Equity Shares, the holder of such Exchangeable Shares will not have the right to vote at meetings of the shareholders of the Company, though they will have the right to vote at meetings of the shareholders of MPB, including with respect to altering the rights of holders of any of the Exchangeable Shares, or if MPB decides to take certain actions without fully protecting the holders of any of the Exchangeable Shares, or as otherwise required by law. The Exchangeable Shares are exchangeable at any time, on a one-for-one basis, for Equity Shares at the option of the holder.
The Company treats the Exchangeable Shares as options, each with a value equal to an Equity Share, which represents the holder’s claim on the equity of the Company. In order to comply with certain contractual requirements of the Business Combination, the Company and MPB are required to maintain the economic equivalency of such Exchangeable Shares with the publicly traded Equity Shares of the Company. This means the Exchangeable Shares are required to share the same economic benefits and retain the same proportionate ownership in the assets of the Company as the holders of the Equity Shares. The Company has presented these Exchangeable Shares as a part of shareholders’ equity within these Unaudited Condensed Interim Consolidated Financial Statements due to (i) the fact that they are economically equivalent to the Equity Shares, and (ii) the holders of the Exchangeable Shares are subject to restrictions on transfer under US securities laws but may dispose of the Exchangeable Shares without such restriction by exchanging them for Equity Shares. Changes in these assumptions would affect the presentation of the Exchangeable Shares from shareholders’ equity to non-controlling interests; however, there would be no impact on earnings per share.
Preferred Shares of GH Group, Inc.
The authorized total number of preferred shares (the “GH Group Preferred Shares”) of GH Group, Inc. (“GH Group”) is 50,000,000. As of June 30, 2022 and December 31, 2021, there was 18,515,491 GH Group Preferred Shares issued and outstanding. Holders of GH Group Preferred Shares are entitled to notice of and to attend any meeting of the shareholders of GH Group but are not entitled to vote. The GH Group Preferred Shares do not carry any voting rights and include a 15% cumulative dividend rate, which is increased by 5% in the year following the first anniversary of the date of issuance. Dividends are payable when and if declared by GH Group’s board of directors. The GH Group Preferred Shares have a conversion option to convert the Preferred Shares into Class A Common Stock of GH Group within 60 days after the issuance by the holder. In the event of a liquidation, voluntary or involuntary, dissolution or winding-up of GH Group, the holders of the GH Group Preferred Shares outstanding are entitled to be paid out of the assets of GH Group available for distribution to it stockholders. GH Group has the right to redeem all or some of the Preferred Shares from a holder for an amount equal to the Liquidation Value and all unpaid accrued and accumulated dividends.
Shares Outstanding
As of June 30, 2022, the Company had 4,754,979 Multiple Voting Shares and 45,318,773 Equity Shares issued and outstanding. There are 14,541,193 Exchangeable Shares issued and outstanding in the capital of MPB Acquisition Corp. In addition, the Company had an aggregate of 35,593,078 warrants, 1,634,043 stock options and 3,744,840 RSUs outstanding as of June 30, 2022.
The following table summarizes the Equity Shares that were issued and outstanding as of June 30, 2022:
| Equity Shares | Issued and<br><br> Outstanding | |
|---|---|---|
| Subordinate Voting Shares | 23,702,898 | |
| Restricted Voting Shares | 20,281,755 | |
| Limited Voting Shares | 1,334,120 | |
| 45,318,773 |
Cautionary Note Regarding Forward-LookingInformation
This MD&A contains certain forward-looking information and forward-looking statements, as defined in applicable securities laws (collectively referred to herein as “forward-looking statements”). These statements relate to future events or the Company’s future performance. All statements other than statements of historical fact are forward-looking statements. Often, but not always, forward-looking statements can be identified by the use of words such as “plans”, “expects”, “is expected”, “budget”, “scheduled”, “estimates”, “continues”, “forecasts”, “projects”, “predicts”, “intends”, “anticipates” or “believes”, or variations of, or the negatives of, such words and phrases, or statements that certain actions, events or results “may”, “could”, “would”, “should”, “might” or “will” be taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from those anticipated in such forward-looking statements. Forward looking statements include, but are not limited to: statements concerning the completion of, and matters relating to, the various proposed transactions discussed by the Company herein and the expected timing related thereto; the expected operations, financial results and condition of the Company; general economic trends; expectations of market size and growth in the United States and the States the Company operates; cannabis cultivation, production and extraction capacity estimates and projections; additional funding requirements; the Company’s future objectives and strategies to achieve those objectives; the Company’s estimated cash flow and capitalization and adequacy thereof; and other statements with respect to management’s beliefs, plans, estimates and intentions, and similar statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts.
Inherent in forward-looking statements are risks, uncertainties, and other factors beyond the Company’s ability to predict or control. Factors that could cause such differences include, but are not limited to: cannabis is a controlled substance under applicable legislation; the enforcement of cannabis laws could change; differing regulatory requirements across State jurisdictions may hinder economies of scale; legal, regulatory or other political change; the unpredictable nature of the cannabis industry; regulatory scrutiny; the impact of regulatory scrutiny on the ability to raise capital; anti-money laundering laws and regulations; any reclassification of cannabis or changes in U.S. controlled substances and regulations; restrictions on the availability of favorable locations; enforceability of contracts; general regulatory and licensing risks; California regulatory regime and transfer and grant of licenses; limitations on ownership of licenses; regulatory action from the Food and Drug Administration; competition; ability to attract and retain customers; unfavorable publicity or consumer perception; results of future clinical research and/or controversy surrounding vaporizers and vaporizer products; limited market data and difficulty to forecast; constraints on marketing products; execution of the Company’s business strategy; reliance on management; ability to establish and maintain effective internal control over financial reporting; competition from synthetic production and technological advances; fraudulent or illegal activity by employees, contractors and consultants; product liability and recalls; risks related to product development and identifying markets for sale; dependence on suppliers, manufacturers, and contractors; reliance on inputs; reliance on equipment and skilled labor; service providers; litigation and any unexpected outcomes thereof; intellectual property risks; information technology systems, cyber-attacks, security, and privacy breaches; bonding and insurance coverage; transportation; energy costs; risks inherent in an agricultural business; management of growth; risks of leverage; future acquisitions or dispositions; difficulty attracting and retaining personnel; and past performance not being indicative of future results.
Readers are cautioned that the factors outlined herein are not an exhaustive list of the factors or assumptions that may affect the forward-looking statements, and that the assumptions underlying such statements may prove to be incorrect. Actual results and developments are likely to differ, and may differ materially, from those expressed or implied by the forward-looking statements contained in this MD&A. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the Company’s actual results, performance, or achievements to be materially different from any of its future results, performance or achievements expressed or implied by forward-looking statements. All forward-looking statements herein are qualified by this cautionary statement. The forward-looking statements in this MD&A speak only as of the date of this MD&A or as of the date specified in such statement. Accordingly, readers should not place undue reliance on forward-looking statements. The Company undertakes no obligation to update publicly or otherwise revise any forward-looking statements whether because of new information or future events or otherwise, except as may be required by law. If the Company does update one or more forward-looking statements, no inference should be drawn that it will make additional updates with respect to those or other forward-looking statements, unless required by law.
Disclosure Controls and InternalControl over Financial Reporting
In accordance with National Instrument 52-109 – Certification of Disclosure in Issuers’ Annual and Interim Filings (“NI 52-109”), management is responsible for establishing and maintaining adequate Disclosure Controls and Procedures (“DCP”) and Internal Control Over Financial Reporting (“ICFR”).
Disclosure Controls and Procedures
In accordance with NI 52-109, management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) of the Company, have evaluated the effectiveness of the Company’s DCP. Based on the evaluation of the Company’s DCP as of June 30, 2022, the Company’s CEO and CFO concluded that, as a result of the material weaknesses in our ICFR described below, the Company’s DCP were not effective as of such date.
Internal Control Over FinancialReporting
ICFR is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with applicable U.S. GAAP. Internal control over financial reporting should include those policies and procedures that establish the following:
• maintenance of records in reasonable detail, that accurately and fairly reflect the transactions and dispositions of our assets;
• reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable GAAP
• receipts and expenditures are only being made in accordance with authorizations of management and the board of directors of the Company; and
• reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial instruments.
A material weakness is a deficiency, or combination of control deficiencies, in ICFR, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis.
As of June 30, 2022, we have material weaknesses in our ICFR relating to use of estimates and assumptions that affect the reported amounts of certain assets and liabilities at the dates of the Financial Statements and the reported amount of total expenses during the reporting period. The Company did not appropriately review the accounting treatment of forfeitures for share-based compensation, capitalization of interest for certain construction in progress as well as deferred income tax asset valuation allowances. As a result, the Company corrected the recorded amounts related to share-based compensation expense, interest expense and construction in progress assets as well as a deferred income tax accounts as of and for the six months ended June 30, 2022. No other material errors were identified in the Financial Statements as a result of the material weaknesses. These material weaknesses create a reasonable possibility that material misstatements in interim or annual financial statements would not be prevented or detected on a timely basis.
Remediationof Material Weakness in ICFR
Management, with oversight from the audit committee, will implement remediation measures related to the material weaknesses identified. The Company will implement a plan, which includes providing more comprehensive and timely review of accounting treatment as it relates to use of estimates. Management believes these measures, and others that may be implemented, will remediate the material weaknesses in ICFR described above. We will continue to monitor and evaluate the effectiveness of our ICFR over financial reporting on an ongoing basis and are committed to taking further action and implementing additional improvements as necessary and as funds allow.
No assurance can be provided at this time that the actions and remediation efforts will effectively remediate the material weakness described above or prevent the incidence of other material weaknesses in the Company’s ICFR in the future. Management, including the CEO and CFO, does not expect that disclosure controls and procedures or ICFR will prevent all errors, even as the remediation measures are implemented and further improved to address the material weakness. A control system is subject to inherent limitations and even those systems determined to be effective can provide only reasonable, but not absolute, assurance that control objectives will be met with respect to financial statement preparation and presentation.
Limitations of Controls andProcedures
Our management, including the CEO and CFO, believes that any DCP or ICFR, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, they cannot provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been prevented or detected. These inherent limitations include the realities that judgements in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by unauthorized override of the control. The design of any control system also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Additional Information
Additional information relating to the Company, including the Company’s annual information form for the year ended December 31, 2021, is available on SEDAR at www.sedar.com.