CLS Holdings USA, Inc. - Quarter Report: 2017 February (Form 10-Q)

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Total amortization expense charged to operations for the three and nine months ended February 28, 2017 was $108 and $324, respectively,  and $108 and $288 for the three and nine months ended February 29, 2016, respectively.  The domain name is being amortized over a period of 60 months.

 

The Company had accounts payable and accrued liabilities of $569,959 and $431,017 at February 28, 2017 and May 31, 2016, respectively, which consist of legal fees, deferred rent liability and other trade payables.

 

As of February 28, 2017 and May 31, 2016, the Company owed the amount of $112,500 and $250,000, respectively, to Jeffrey Binder, its President and Chief Executive Officer, for accrued salary. For the nine months ended February 28, 2017, unpaid accrued salary in the amount of $250,000  was transferred to a convertible promissory note due to Mr. Binder (see note 11).

 

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The Company has convertible notes payable and notes payable outstanding to Jeffrey Binder, an officer and director, to Frank Koretsky, a director; and to Newcan Investment Partners LLC, an entity affiliated with Frank Koretsky.  See note 11.

 

During the nine months ended February 28, 2017, the Company issued a $150,000 convertible note payable to CLS CO 2016, LLC an entity affiliated with Frank Koretsky, a director of the Company.  See note 11.

During the nine months ended February 28, 2017 the Company incurred $580,000 in notes payable to Newcan Investment Partners LLC,  an entity affiliated with Frank Koretsky, a director of the Company.  See note 11.  During the three months ended February 28, 2017, $460,000 in notes payable was converted to a convertible promissory note.

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The Company’s authorized capital stock consists of 250,000,000 shares of common stock, par value $0.0001 per share and 20,000,000 shares of preferred stock, par value $0.001 per share. The Company had 21,178,176  and 20,350,003 shares (post Reverse Split) of common stock issued and outstanding as of February 28, 2017 and May 31, 2016, respectively.

 

On December 10, 2014, the Company effected a reverse stock split of the Company’s issued and outstanding common stock at a ratio of 1-for-0.625, wherein 0.625 shares of common stock were issued in exchange for each share of the Company’s common stock owned by the Company’s stockholders on December 1, 2014, the record date for the reverse stock split. As a result of the reverse stock split, 11,250,000 shares (post Reverse-Split) of common stock were outstanding as of December 10, 2014. The reverse stock split did not affect the number of authorized shares of the Company’s common stock. All share and per share information contained in the financial statements has been retroactively adjusted to reflect the reverse stock split.

 

The Company recorded imputed interest of $804 and $807 during the nine months ended February 28, 2017 and February 29, 2016 on related party payables due to a director and officer of the Company.

On November 28, 2016 the Company amended the 2016 Convertible Notes which was accounted for as  the extinguishment  and reissuance of the debt.  As a result, the Company recorded a gain on the extinguishment of debt in the amount of $254,114, which was included in additional paid-in  capital at February 28, 2017.

During the three months ended February 28, 2017, Old Main, holder of convertible promissory notes, converted an aggregate of $100,000 of principal, in six transactions, into 828,173 shares of common stock.  As a result of the conversions, the Company charged  the amount $222,574 to additional paid-in capital.  (see Note 11).

 

On August 1, 2015, the Company and Alan Bonsett entered into a five-year employment agreement. Pursuant to the agreement, Mr. Bonsett commenced serving as the Company’s Chief Operating Officer on August 15, 2015. Mr. Bonsett received a one-time signing bonus of 250,000 (post Reverse Split) shares of restricted common stock of the Company, which became fully vested one year from the effective date of the agreement.  The Company valued the shares at $327,500 based on the stock price at August 3, 2015 and is amortizing them over the term of the employment agreement.  During the nine months ended February 29, 2016, the Company recognized $327,500 in share based compensation.

Stock Issued for Services

On August 28, 2015, the Company issued 60,000 shares of common stock, valued at $45,000, to a consultant for services.  Of these shares, 50,000, valued at $37,500, were included in stock payable as of May 31, 2015.  The shares were valued based on the closing market price of the common stock on the grant date.

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On July 22, 2015, pursuant to a consulting agreement, the Company agreed to issue 5,000 shares of common stock, valued at $5,750, to a consulting firm in exchange for investor relations consulting services.  On August 17, 2015, the consulting agreement was amended, whereby the Company agreed to issue 5,000 additional shares of common stock, valued at $6,650.  On August 26, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $12,700.  On October 9, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $11,700.  On December 15, 2015, the Company extended the consulting agreement and agreed to issue the consultant an additional 10,000 shares of common stock, valued at $8,000.  All shares were valued based on the closing market price of the common stock on the grant date.  During the year ended May 31, 2016, the Company issued 40,000 shares to this consultant, valued at $32,750.  

 

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CLS Labs and Jeffrey Binder entered into a five-year employment agreement effective October 1, 2014. Under the agreement, Mr. Binder serves as CLS Labs’ Chairman, President and Chief Executive Officer and is entitled to receive an annual salary of $150,000. Under the agreement, Mr. Binder is also entitled to receive a performance bonus equal to 2% of CLS Labs’ annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of CLS Labs’ common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million.  On April 28, 2015, CLS Labs and the Company entered into an addendum to Mr. Binder’s employment agreement whereby Mr. Binder agreed that following the merger of CLS Labs and a subsidiary of the Company, in addition to his obligations to CLS Labs, he would serve the Company and its subsidiaries in such roles as the Company may request.  In exchange, the Company agreed to assume the obligations of CLS Labs to grant Mr. Binder annual stock options, as referenced above.  Mr. Binder continues to receive an annual salary of $150,000 from CLS Labs for serving as its Chairman, President and Chief Executive Officer.  My Binder has deferred all of the salary payable to him under his employment agreement through February 28, 2017.  On July 20, 2016 and March 31, 2017, the Company issued Mr. Binder convertible notes in exchange for $250,000 and $112,500, respectively, in deferred salary, among other amounts owed to Mr. Binder by the Company.  As of February 28, 2017 and May 31, 2016, the Company had accrued compensation due to Mr. Binder in the amount of $112,500 and $250,000.

 

Effective August 1, 2015, the Company and Alan Bonsett entered into a five-year employment agreement. Pursuant to the agreement, Mr. Bonsett commenced serving as the Company’s Chief Operating Officer on August 15, 2015. Under the agreement, Mr. Bonsett is entitled to receive an annual salary of $150,000. Further, he is entitled to receive a performance bonus equal to 2% of the Company’s annual EBITDA, up to a maximum annual cash compensation of $1 million (including his base salary), and annual stock options, exercisable at the fair market value of the Company’s common stock on the date of grant, in an amount equal to 2% of its annual EBITDA up to $42.5 million and 4% of its annual EBITDA in excess of $42.5 million. Additionally, Mr. Bonsett received a one-time signing bonus of 250,000 (post Reverse-Split) shares of restricted common stock of the Company, valued at $327,500, which became fully vested one year from the effective date of the agreement. Mr. Bonsett, as an owner of PRH, will indirectly receive the benefits of the Colorado Arrangement, as discussed in Note 10. The business to be operated by PRH pursuant to the Colorado Arrangement has not yet produced revenues.

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On March 27, 2017, the Company entered into Amendment #3 to the Convertible  Promissory Notes issued on March 18, April 22 and May 27, 2016 (the “Third Amendment”) to further amend the 2016 Convertible Notes in certain respects. In the Third Amendment, the Company agreed to (i) prepay all amounts due under the 10% Notes on or before April 1, 2017, which amount was agreed to be $372,669.95 (the “Settlement Amount”), and (ii) to increase the outstanding amount due under the 8% Note as of March 18, 2017 by 5%.  In exchange for doing so, Old Main agreed to extend the maturity of the 8% Note until July 1, 2017 and to suspend conversions under the 8% Note until July 1, 2017. If we fail to pay the Settlement Amount on or before April 1, 2017, Old Main has the right to declare the Third Amendment null and void.

 

On March 31, 2017, the Company issued convertible promissory notes to Newcan Investment Partners LLC, an entity owned by Frank Koretsky, a director of the company, in the amount of $120,000, and to Jeffrey Binder, an officer and director of the Company, in the amount of $159,500 (the “Notes”), to finalize the terms of repayment with respect to certain loans made to the Company by Newcan Investment Partners LLC and Mr. Binder between January 1, 2017 and February 27, 2017, and certain compensation payable to Mr. Binder as of February 28, 2017. The Notes, which otherwise contain identical terms, are unsecured and bear interest at the rate of 10% per annum. No payments are required until April 1, 2018, at which time all accrued interest becomes due and payable. Principal will be paid in eight equal quarterly installments, together with interest accrued thereon, beginning on July 1, 2018. The Notes may be prepaid by the Company with no penalty at any time upon thirty days written notice.

The holder of each Note may, at any time prior to payment or prepayment in full, convert all principal and accrued interest thereunder, in whole or in part, into securities of the Company. For each $0.25  converted, the holder will receive one share of the Company’s common stock and a five-year warrant to purchase one share of the Company’s common stock at a price of $0.25  per share.

We evaluated subsequent events after the balance sheet date through the date the financial statements were issued. We did not identify any additional material events or transactions occurring during this subsequent event reporting period that required further recognition or disclosure in these financial statements.

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Professional fees decreased $243,951, or approximately 71%, to $99,867 during the three months ended February 28, 2017 compared to $343,818 for the three months ended February 29, 2016.  This decrease was due primarily in the reduction of legal and investor relations  fees for the three months ended February 28, 2017 compared to the prior period. We expect professional fees to increase in future periods as our business grows.

 

 

Interest expense for the three months ended February 28, 2017 was $381,149, an increase of $274,550 compared to $106,599 for the three months ended February 29, 2016.  Interest expense increased primarily due to an increase in amortization of the discount on convertible debt, which was $308,606  during the current period compared to $81,116 for the prior year.

 

During the three months ended February 28, 2017, Old Main, a holder of convertible promissory notes, converted an aggregate of $100,000 in principal, in six transactions, into 828,173 shares of commons stock. As a result, we revalued  the derivative liability related to these convertible notes and at February 28, 2017.  This revaluation resulted in a gain of $244,848, which we included in results of operations for the three months ended February 28, 2017.

 

For the reasons above, we had a net loss for the three months ended February 28, 2017 of $380,372, which is a decrease of $476,368, or approximately 56%, compared to a net loss of $856,740 during the three months ended February 29, 2016.

Results of Operations for the Nine Months Ended February 28, 2017 and February 29, 2016

The Company had no revenues during the nine months periods ended February 28, 2017 and February 29, 2016.

General and administrative expenses decreased $435,655, or approximately 47%, to $482,071 during the nine months ended February 28, 2017, compared to $917,726 for the nine months ended February 29, 2016.  General and administrative expenses consisted primarily of general office expenses, travel costs, rent expense, compensation costs, bank charges and payroll expenses. The decrease was primarily due to the reduction in noncash compensation, travel and advertising expenses.  We expect general and administrative expenses to increase in future periods as we implement our business plan and commence operations.

Professional fees  decreased $164,322, or approximately 21%, to $603,098 during the nine months ended February 28, 2017 compared to $767,420 for the nine months ended February 29, 2016.  This decrease was due primarily to the reduction of legal and investor relations  fees for the nine months ended February 28, 2017 compared to the prior period. We expect professional fees to increase in future periods as our business grows.

 

 

Interest expense for the nine months ended February 28,  2017 was $1,395,511, an increase of $1,218,047 compared to $177,464 for the nine months ended February 29, 2016.  Interest expense increased primarily due to an increase in amortization of the discount on convertible debt, which was $1,197,998 during the current period compared to $114,489 for the prior year.

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On November 28, 2016  we entered into an amendment with Old Main regarding the 10% Notes.  In exchange for amending the terms of the 10% Notes we agreed to increase the outstanding principal balance by 10%, resulting in a loss on the modification of 10% Notes of $33,334, which we included in results of operation for the nine months ended February 28, 2017.

 

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On March 27, 2017, we entered into Amendment #3 to the Convertible  Promissory Notes issued on March 18, April 22 and May 27, 2016 (the “Third Amendment”) to further amend the Agreements, as amended by the First Amendment and Second Amendment, in certain respects.  In the Third Amendment, we agreed, among other things, to prepay all amounts due under the 10% Notes on or before April 1, 2017, which amount was agreed to be $372,669.95 (the “Settlement Amount”).  If we fail to pay the Settlement Amount on or before April 1, 2017, Old Main has the right to declare the Third Amendment null and void.

 

During the three months ended February 28, 2017, Old Main converted an aggregate of $100,000 in principal of the 10% Notes, in six transactions, into 828,173 share of common stock.

 

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On March 27, 2017, we entered into the Third Amendment, which, among other things, increased the outstanding amount due under the 8% Note as of March 18, 2017 by 5%.  In exchange for doing so, Old Main agreed to extend the maturity of the 8% Note until July 1, 2017 and to suspend conversions under the 8% Note until July 1, 2017.  If we fail to pay the Settlement Amount on or before April 1, 2017, Old Main has the right to declare the Third Amendment null and void.

 

On April 18, 2016, we also entered into an equity line agreement with Old Main whereby we may issue and sell to Old Main, at our option from time to time, up to $4,000,000 of our common stock at a purchase price equal to 80% of the lowest VWAP of the common stock during a five day “Valuation Period.”

On October 6, 2016, we entered into an amendment of the Equity Purchase Agreement to amend the new Commitment Period, which is 24 months from the date of this amendment.  Second, the Equity Purchase Agreement was amended to prohibit us from delivering a subsequent Put Notice from the beginning of any “Valuation Period” until the fourth Trading Day immediately following the closing associated with the prior Put Notice.  Third, the beneficial ownership limitation was amended to increase the Beneficial Ownership Limitation to 9.99% and to remove the ability of the Investor to increase or decrease the Beneficial Ownership Limitation.

 

During July 2016, we issued convertible promissory notes in favor of Mr. Koretsky and Mr. Binder.  These notes represent deferred salary of $250,000 due to Mr. Binder and prior advances in the amount of $12,750 from Mr. Binder, and $210,000 in advances from Mr. Koretsky, being reclassified as convertible notes payable. These notes are unsecured and bear interest at the rate of 10% per annum. No payments are required until July 1, 2017, at which time all accrued interest becomes due and payable. Principal will be paid in eight equal quarterly installments, together with accrued interest, beginning on October 1, 2017. At the note holder’s election, at any time prior to payment or prepayment of the loans in full, all principal and accrued interest under the loans may be converted, in whole or in part, into our securities. Upon such an election, the holder will receive one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share.

On August 3, 2016, we borrowed $150,000 from CLS CO 2016, an entity affiliated with Mr. Koretsky.   This note is unsecured and bears interest at the rate of 15% per annum. All interest accruing during the first year will be added to principal.  Commencing on November 1, 2017, principal will be payable in four equal quarterly installments, together with accrued interest.  At the note holder’s election, at any time prior to payment or prepayment of the loan in full, all principal and accrued interest under the loan may be converted, in whole or in part, into our securities. Upon such an election, the holder will receive one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share.

 

On January 10, 2017, the Company issued convertible promissory notes to Newcan Investment Partners LLC, an entity owned solely by Frank Koretsky, who is a director of the Company, in the amount of $410,000 and $50,000 and bear interest at the rate of 10% per annum thereafter. No payments are required until January 2, 2018, at which time all accrued interest becomes due and payable. Commencing on April 1, 2018, principal will be payable in eight equal quarterly installments, together with accrued interest. At the note holder’s election, at any time prior to payment or prepayment of the loan in full, all principal and accrued interest under the loan may be converted, in whole or in part, into our securities. Upon such an election, the holder will receive one “Unit” for each $1.07 converted, with each Unit consisting of one (1) share of common stock and a five-year warrant to purchase (1) share of common stock at a price of $1.07 per share.

On March 31, 2017, we issued convertible promissory notes to Newcan Investment Partners LLC, an entity owned by Frank Koretsky, a director of the company, in the amount of $120,000 (the “Koretsky Note”), and to Jeffrey Binder, an officer and director of the Company, in the amount of $159,500 (the “Binder Note” and, together with the Koretsky Note, the “Notes”), to finalize the terms of repayment with respect to certain loans made to the Company by Newcan Investment Partners LLC and Mr. Binder between January 1, 2017 and February 27, 2017, and certain compensation payable to Mr. Binder as of February 28, 2017. The Notes, which otherwise contain identical terms, are unsecured and bear interest at the rate of 10% per annum. No payments are required until April 1, 2018, at which time all accrued interest becomes due and payable. Principal will be paid in eight equal quarterly installments, together with interest accrued thereon, beginning on July 1, 2018. The Notes may be prepaid by the Company with no penalty at any time upon thirty days written notice.

 

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We currently have two employees, Jeffrey Binder, who serves as our Chairman, President and Chief Executive Officer; and Alan Bonsett, who serves as our Chief Operating Officer.   In an effort to assist us conserve cash, Mr. Binder converted all accrued salary due to him through February 28, 2017 into a convertible promissory note and a promissory note.  Mr. Binder has deferred all of his salary to date for the fiscal year ending May 31, 2017.

We do not currently have the capital necessary to meet our liquidity needs, fund our capital requirements or implement our business plan. We intend to fund our cash flow and capital requirements during the next year from the proceeds of the Equity Line, the sale of our debt and equity securities, by obtaining additional loans and with cash generated through operations in connection with the Colorado Arrangement. There can be no assurance that we will be able to meet our needs, however, as we have not yet received any commitments for the purchase of our equity securities or for additional loans.  Further, we do not yet know when our processing facility in Colorado will become operational, and accordingly, when we will commence receiving revenues under the Licensing Agreement and Equipment lease from PRH.  We have been advised that the solutions to be used in our proprietary conversion process are not included in Colorado’s list of designated solutions that may be used for cannabis extraction.  We have advised the state that the solutions will be used in the conversion, not the extraction, process.  The matter has been referred to the Colorado attorney general’s office for consideration.  We cannot complete the construction of our processing facility until this matter is resolved.  Based on our internal review, similar requirements relating to either extraction or processing do not exist in other relevant states.  Assuming this issue is resolved favorably to us, we would anticipate completion of our Colorado processing facility and the commencement of operations by PRH within six months after such resolution, and we would anticipate the receipt of revenues from PRH between 30 and 90 days after it commences operations.  As a result of these uncertainties, there can be no assurance that PRH will ever generate sufficient cash to repay the $500,000 loan from CLS Labs Colorado or to meet PRH’s obligations under the Licensing Agreement or Equipment Lease. We anticipate that we will incur operating losses during the next twelve months. 

 

Going concern

 

Our financial statements were prepared using accounting principles generally accepted in the United States of America applicable to a going concern, which contemplate the realization of assets and liquidation of liabilities in the normal course of business. We have incurred continuous losses from operations since inception, have an accumulated deficit of $6,246,786 and had a working capital deficit of $2,157,226 at February 28, 2017. In addition, we do not currently have the cash resources to meet our operating commitments during the next twelve months. Our ability to continue as a going concern must be considered in light of the problems, expenses, and complications frequently encountered by developmental stage companies.

Our ability to continue as a going concern is dependent on our ability to generate sufficient cash from operations to meet our cash needs, to borrow capital and to sell equity to support the opening of processing facilities and to finance ongoing operations. There can be no assurance, however, that we will be successful in our efforts to raise additional debt or equity capital and/or that cash generated by our future operations will be adequate to meet our needs. These factors, among others, indicate that we may be unable to continue as a going concern for a reasonable period of time.

Off-Balance Sheet Arrangements

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

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Critical Accounting Estimates

Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:

·	Estimates and assumptions used in valuation of derivative liability: Management utilizes a lattice model to estimate the fair value of derivative liabilities. The model includes subjective assumptions that can materially affect the fair value estimates.

 

Recently Issued Accounting Standards 

 

Accounting standards promulgated by the Financial Accounting Standards Board (“FASB”) are subject to change. Changes in such standards may have an impact on our future financial statements. The following are a summary of recent accounting developments.

In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The update requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by long-term leases. The update also requires certain qualitative and quantitative disclosures about the amount, timing and uncertainty of cash flows arising from leases. Accounting by lessors will remain largely unchanged. This update is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. Adoption will require a modified retrospective approach beginning with the earliest period presented. We are currently evaluating the potential impact of the update on our financial statements.

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