See accompanying notes to the unaudited condensed consolidated financial statements
See accompanying notes to the unaudited condensed
consolidated financial statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
NOTE 1 - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Kush Bottles, Inc. (“the Company”)
was incorporated in the state of Nevada on February 26, 2014. The Company provides customizable packaging products, vaporizers,
hydrocarbon gases, solvents, accessories and branding solutions for the cannabis industry. Representative examples of the Company’s
products include pop-top bottles, vaporizer cartridges and accessories, exit/barrier bags, tubes, and other small-sized containers.
The Company’s wholly owned subsidiary Kim International Corporation (KIM), a California corporation, was originally incorporated
as Hy Gro Economics Corporation ("Hy Gro") on December 2, 2010. On October 30, 2012, Hy Gro amended its articles of incorporation
to reflect a name change to KIM International Corporation (KIM). On March 4, 2014, the shareholders of KIM exchanged all 10,000
of their common shares for 32,400,000 shares of common stock of Kush Bottles, Inc. The operations of KIM became the operations
of Kush after the share exchange and accordingly the transaction is accounted for as a recapitalization of KIM whereby the historical
financial statements of KIM are presented as the historical financial statements of the combined entity. KIM was the acquiring
entity in accordance with ASC 805, Business Combinations. The accumulated losses of KIM were carried forward after the completion
of the share exchange. Operations prior to the share exchange were those of KIM.
Acquisition
of CMP Wellness, LLC
On May
1, 2017, the Company entered into an agreement of merger agreement with Lancer West Enterprises, Inc. a California corporation,
Walnut Ventures, a California corporation, Jason Manasse, an individual, and Theodore Nicols, an individual, pursuant to which
each of Lancer West Enterprises, Inc. and Walnut Ventures were merged with and into Merger Sub, with Merger Sub as the surviving
corporation, resulting in the Company’s indirect acquisition of CMP Wellness, LLC, a California limited liability company,
which prior to the merger, was owned 100% by Lancer West Enterprises, Inc. and Walnut Ventures. CMP Wellness, LLC is a distributor
of vaporizers, cartridges and accessories. See Note 2 for a further description of the CMP acquisition.
Acquisition of Summit Innovations, LLC
On May 2, 2018, the Company completed its
acquisition of Summit Innovations, LLC (“Summit”), a leading distributor of hydrocarbon gases to the legal cannabis
industry. Pursuant to the terms of the Agreement and Plan of Merger (the “Merger Agreement”), Summit merged with and
into KCH Energy, LLC (“KCH”), a wholly-owned subsidiary of the Company, with KCH as the surviving entity. See Note
3 for a further description of the Summit acquisition.
Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements and related notes include the activity of the Company and its wholly owned subsidiaries and have been prepared
in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim
financial information. All intercompany balances and transactions have been eliminated. Accordingly, they do not include all of
the information and notes required by generally accepted accounting principles for annual financial statements. In the
opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation
have been included. The Company’s operating results for the three and nine months period ended May 31, 2018 are not necessarily
indicative of the results that may be expected for the fiscal year ended August 31, 2018, or for any other period. These unaudited
condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated
financial statements and accompanying notes for the fiscal year ended August 31, 2017. The condensed consolidated balance sheet
as of August 31, 2017 included herein was derived from the audited financial statements as of that date, but does not include
all disclosures including notes required by GAAP. There have been no changes to the Company’s significant accounting policies
described in its Annual Report on Form 10-K for the fiscal year ended August 31, 2017 that have had a material impact on our condensed
consolidated financial statements and related notes.
Use of Estimates
The preparation of financial statements in
conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amount of revenues and expenses during the reporting period.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
Significant estimates relied upon in preparing these
unaudited condensed consolidated financial statements include revenue recognition, accounts receivable reserves, inventory and
related reserves, valuations and purchase price allocations related to business combinations, expected future cash flows used
to evaluate the recoverability of long-lived assets, estimated fair values of long-lived assets used to record impairment charges
related to intangible assets and goodwill, amortization periods, accrued expenses, stock-based compensation, contingent liabilities
and recoverability of the Company’s net deferred tax assets and any related valuation allowance.
Although the Company regularly assesses these
estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which
they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be
reasonable under the circumstances. Actual results may differ from management’s estimates.
The Company is subject to a number of risks
similar to those of other companies of similar size and having a focus of serving the cannabis industry, including, the development
stage of certain products, competition, limited number of suppliers, integration of acquisitions, substantial indebtedness, government
regulations, protection of proprietary rights, and dependence on key individuals.
Reclassification
Certain classifications have been made to the
prior year financial statements to conform to the current year presentation. The reclassification had no impact on previously reported
net income (loss) or accumulated deficit.
Segments
The Company operates as one operating segment.
Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by
the chief operating decision maker, who is the chief executive officer, in deciding how to allocate resources and assessing performance.
Over the past few years, the Company has completed a number of acquisitions. These acquisitions have allowed the Company to expand
its offerings, presence and reach in the cannabis industry. While the Company has offerings in multiple geographic locations for
its products for the cannabis industry, including as a result of the Company's acquisitions, the Company’s business operates
in one operating segment because the majority of the Company's offerings operate similarly, and the Company’s chief
operating decision maker evaluates the Company’s financial information and resources and assesses the performance of these
resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information
can be found in the unaudited condensed consolidated financial statements.
Accounts Receivable
Trade accounts receivable are carried at their
estimated collectible amounts. Trade credit is generally extended on a short-term basis, thus trade receivables do not bear
interest. Trade accounts receivables are periodically evaluated for collectability based on past credit history and their
current financial condition. The Company’s allowance for doubtful accounts was $132,000 and $25,000 as of May 31, 2018 and
August 31, 2017, respectively.
Inventory
Inventories are stated at the lower of cost
or net realizable value using the first-in first out (FIFO) method. The Company’s inventory consists of finished goods of
$10,059,200 and $3,754,171 as of May 31, 2018 and August 31, 2017, respectively.
Fair Value of Financial Instruments
The fair value of certain of the Company’s
financial instruments, including cash and cash equivalents, receivables, other current assets, accounts payable, accrued compensation
and employee benefits, other accrued liabilities and notes payable, approximate their carrying amounts because of the short-term
maturity of these instruments.
Valuation of Business Combinations and Acquisition
of Intangible Assets
The Company records intangible assets acquired
in business combinations and acquisitions of intangible assets under the purchase method of accounting. The Company accounts for
acquisitions in accordance with FASB ASC Topic 805,
Business Combinations
. Amounts paid for each acquisition are allocated
to the assets acquired and liabilities assumed based on their fair values at the dates of acquisition. The Company then allocates
the purchase price in excess of the fair value of the net tangible assets acquired to identifiable intangible assets, including
purchased intangibles based on detailed valuations that use information and assumptions provided by management. The Company allocates
any excess purchase price over the fair value of the net tangible and intangible assets acquired to goodwill.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
The Company uses the income approach, the relief
from royalty method (both a market and income method), and the with and without method to determine the fair values of its purchased
intangible assets. The Company uses the probability-weighted expected return method (an income approach) to determine the appropriate
amount of contingent consideration to include in the purchase price for an acquisition. The Company bases its revenue assumptions
on estimates of relevant market sizes, expected market growth rates, expected industry trends and expected product introductions
by competitors. In arriving at the value. The Company bases the discount rate used to arrive at a present value as of the date
of acquisition on the time value of money and cannabis industry investment risk factors. For the intangible assets acquired, the
Company used risk-adjusted discount rates ranging from 19% to 26% to discount its projected cash flows. The Company believes that
the estimated purchased intangible asset amounts so determined represent the fair value at the date of acquisition and do not exceed
the amount a third party would pay for the projects.
The Company also used the income approach (probably
weighted cash flow), as described above, to determine the estimated fair value of certain identifiable intangibles assets including
domain names and tradenames. Domain names represent established relationships with customers, which provides a ready channel for
the sale of additional products and services. Tradenames represent acquired product names that the Company intends to continue
to utilize. The Company used the with and without method to ascertain the fair value of the non-competition agreement.
The company has not completed the valuation
of Summit’s assets acquired and liabilities assumed as of May 31, 2018.
Goodwill and Intangible Assets
Goodwill and intangible assets that have indefinite
useful lives are not amortized but are evaluated for impairment annually or whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. The Company records intangible assets at historical cost. The Company amortizes
its intangible assets that have finite lives using either the straight-line method or based on estimated future cash flows to approximate
the pattern in which the economic benefit of the asset will be utilized. Amortization is recorded over the estimated useful lives
ranging from four to six years. The Company reviews intangible assets subject to amortization quarterly to determine if any adverse
conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life.
Conditions that would indicate impairment and trigger a more frequent impairment assessment include, but are not limited to, a
significant adverse change in legal factors or business climate that could affect the value of an asset, or an adverse action or
assessment by a regulator. If the carrying value of an asset exceeds its undiscounted cash flows, the Company will write-down the
carrying value of the intangible asset to its fair value in the period identified. The Company generally calculates fair value
as the present value of estimated future cash flows to be generated by the asset using a risk-adjusted discount rate. If the estimate
of an intangible asset’s remaining useful life is changed, the Company will amortize the remaining carrying value of the
intangible asset prospectively over the revised remaining useful life.
Consistent with prior years, the Company conducted
its annual impairment test of goodwill during the fourth quarter of fiscal 2018. The estimate of fair value requires significant
judgment. Any loss resulting from an impairment test would be reflected in operating income in the Company’s unaudited condensed
consolidated statements of income. The annual impairment testing process is subjective and requires judgment at many points throughout
the analysis. If these estimates or their related assumptions change in the future, the Company may be required to record impairment
charges for these assets not previously recorded. The Company performed its goodwill impairment test as of June 1, 2018 and goodwill
was not impaired.
Business Combinations
The Company uses its best estimates and assumptions
to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date.
The Company’s estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up
to one year from the acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets
acquired and liabilities assumed, with the corresponding offset to goodwill. In addition, uncertain tax positions and tax-related
valuation allowances are initially established in connection with a business combination as of the acquisition date. The Company
continues to collect information and reevaluates these estimates and assumptions quarterly and records any adjustments to the Company’s
preliminary estimates to goodwill provided that the Company is within the measurement period. Upon the conclusion of the measurement
period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent
adjustments are recorded to the Company’s condensed consolidated statements of operations.
Earnings (Loss) Per Share
The Company computes earnings per share under
Accounting Standards Codification subtopic 260-10, "Earnings per Share" (“ASC 260-10”). Basic net income
(loss) per common share is computed by dividing net loss by the weighted average number of shares of common stock. Diluted
net loss per share is computed using the weighted average number of common and common stock equivalent shares outstanding during
the period.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
Basic earnings per share are computed by dividing
net earnings by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share
are computed by dividing net earnings by the sum of (a) the weighted average number of shares of common stock outstanding during
the period and (b) the potentially dilutive securities outstanding during the period. Stock options are potentially dilutive securities;
and the number of dilutive options is computed using the treasury stock method. The effect of the contingent equity consideration
relating to the acquisitions of CMP and Summit is also factored into the calculation of dilutive securities.
The following table sets forth the calculation
of basic and diluted earnings per share:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
May 31,
|
|
|
May 31,
|
|
|
May 31,
|
|
|
May 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net income
|
|
$
|
(2,165,740
|
)
|
|
$
|
6,119
|
|
|
$
|
(2,991,438
|
)
|
|
$
|
(151,545
|
)
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
64,680,419
|
|
|
|
51,805,930
|
|
|
|
61,995,107
|
|
|
|
50,458,416
|
|
Net effect of dilutive options
|
|
|
-
|
|
|
|
1,528,302
|
|
|
|
-
|
|
|
|
-
|
|
Diluted
|
|
|
64,680,419
|
|
|
|
53,334,232
|
|
|
|
61,995,107
|
|
|
|
50,458,416
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.03
|
)
|
|
$
|
-
|
|
|
$
|
(0.05
|
)
|
|
$
|
-
|
|
Diluted
|
|
$
|
(0.03
|
)
|
|
$
|
-
|
|
|
$
|
(0.05
|
)
|
|
$
|
-
|
|
Potentially dilutive securities consisted of
7,231,042 and 4,695,000 stock options as of May 31, 2018 and 2017, respectively.
Additionally, the approximately 640,000 shares
of Common Stock held back by the Company for a period of 15 months for potential post-closing working capital and/or indemnification
claims relating to, among other things, breaches of representations, warranties and covenants contained in the Summit Merger Agreement
and the potential earn-out consideration of up to an additional 1,280,000 shares of common stock, in the aggregate, based on the
performance of the Summit business during a one-year period following the closing were not included in earnings per share because
it is not certain that the shares will be issued.
Revenue Recognition
It is the Company’s policy that revenues
from product sales is recognized in accordance with ASC 605 "Revenue Recognition". Four basic criteria must be
met before revenue can be recognized; (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling
price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are
based on management’s judgments regarding fixed nature in selling prices of the products delivered and the collectability
of those amounts. The Company has not implemented any specific rebate programs. Provisions for discounts to customers, estimated
returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. During the three-month
period ended May 31, 2018 and 2017, the Company had no provisions for sales discounts of $140,018 and $40,806, respectively. The
Company has not established a formal customer incentive program, but considers and accommodates discounts to certain customers
on a case by case basis, including by way of example, for volume shipping or for certain new customers with orders over a specific
discretionary dollar threshold. The Company classifies the reimbursement by customers of shipping and handling costs as revenue
and the associated cost as cost of revenue.
As of May 31, 2018 and 2017, the Company had
a refund allowance of nil, respectively. Consistent with ASC 605-15-25-1, the Company considers factors such as historical return
of products, estimated remaining shelf life, price changes from competitors, and introductions of competing products in establishing
a refund allowance. The Company recognizes revenues when and title to products transfers to the customer (which generally occurs
at the time shipment is made), the sales price is fixed or determinable, and collectability is reasonably assured. The
Company defers any revenue for which the product was not delivered or is subject to refund until such time that the Company and
the customer jointly determine that the product has been delivered or no refund will be required.
Warranty Costs
The Company has not had any historical warranty
related expenditures and so does not record a reserve for warranty costs.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
Fair Value of Financial Instruments
The Company adopted ASC 820 which defines
fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value
hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under
this standard certain assets and liabilities must be measured at fair value, and disclosures are required for items measured at
fair value.
The Company currently does not have non-financial
assets or non-financial liabilities that are required to be measured at fair value on a recurring basis. The Company’s financial
assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels are as follows:
Level 1 - Inputs are unadjusted quoted prices
in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. The fair
value of the Company’s cash is based on quoted prices and therefore classified as Level 1.
Level 2 - Inputs include quoted prices for
similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that
are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves,
etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market
corroborated inputs).
Level 3 - Unobservable inputs that reflect
management’s assumptions about the assumptions that market participants would use in pricing the asset or liability.
Application of Valuation Hierarchy
Financial instrument’s categorization
within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following
is a description of the valuation methodology used to measure fair value, as well as the general classification of such instruments
pursuant to the valuation hierarchy.
The Company has a contingent consideration
liability of $2,150,000 which consists of contingent cash consideration of $1,650,000 resulting from the acquisition of CMP and
$500,000 resulting from the acquisition of Summit. The contingent consideration liability is calculated based on the weighted average
probability of meeting certain milestones. This liability is remeasured at each reporting period. The Company had no other financial
assets or liabilities that are measured at fair value on a recurring basis as of May 31, 2018.
The following table summarizes, for assets or liabilities
measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy:
|
|
|
|
|
Fair Value Measurement at Reporting Date Using
|
|
Description
|
|
May 31, 2018
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level
3)
|
|
Contingent consideration liability
|
|
$
|
2,150,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,150,000
|
|
The Company classifies its contingent consideration
liability within Level 3 as the valuation inputs are based on quoted market prices and market observable data. During the nine
months ended May 31, 2018, a payment of $170,000 was made towards this liability, an increase of $500,000 resulted from the Summit
acquisition, resulting in a net liability of $2,150,000. During the three months ended May 31, 2018, the Company did not recognize
any change in the fair value of its contingent consideration liability of $2,150,000.
Recently Issued Accounting Pronouncements
On December 22, 2017 the Securities and Exchange
Commission (“SEC”) staff issued Staff Accounting Bulletin 118 (SAB 118), which provides guidance on accounting
for the tax effects of the Tax Cuts and Jobs Act (the TCJA). SAB 118 provides a measurement period that should not extend
beyond one year from the enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118,
a company must reflect the income tax effects of those aspects of the TCJA for which the accounting under ASC 740 is complete.
To the extent that a company’s accounting for certain income tax effects of the TCJA is incomplete but for which they
are able to determine a reasonable estimate, it must record a provisional amount in the financial statements. Provisional
treatment is proper in light of anticipated additional guidance from various taxing authorities, the SEC, the FASB, and even the
Joint Committee on Taxation. If a company cannot determine a provisional amount to be included in the financial statements,
it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment
of the TCJA. The Company is still in the process of estimating the tax impact and is expected to apply this guidance at year
end.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
In September 2017, the Financial Accounting Standards Board
“FASB” issued Accounting Standards Update (ASU) No. 2017-13,
“Revenue Recognition (Topic 605), Revenue from
Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the
Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments.”
The amendments in ASU No. 2017-13 amends the early adoption date option for certain companies related to the adoption of ASU
No. 2014-09 and ASU No. 2016-02. The Company may still adopt using the public company adoption guidance in the related ASUs, as
amended. The effective date is the same as the effective date and transition requirements for the amendments for ASU 2014-09 and
ASU 2016-02.
In March 2017, the FASB issued ASU 2017-08,
“Receivables
– Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities”
.
This update shortens the amortization period of a callable security that is held at a premium to the earliest call date of that
security instead of the contractual life of the security. Although the Company does not currently hold any callable securities
at a premium, it may do so in the future. Unless such securities are purchased by the Company, the Company does not believe that
ASU 2017-08 will have an impact its consolidated financial statements effective beginning January 1, 2019.
In January 2017, the FASB issued Accounting
Standards Update No. 2017-04,
Simplifying the Test for Goodwill Impairment
("ASU 2017-04"). ASU 2017-04 simplifies
the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test, which requires a hypothetical purchase
price allocation. ASU 2017-04 is effective for annual or interim goodwill impairment tests in fiscal years beginning after December
15, 2019 and should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests
performed on testing dates after January 1, 2017. The Company does not anticipate the adoption of ASU 2017-04 will have a material
impact on its consolidated financial statements.
In January 2017, the FASB issued Accounting
Standards Update No. 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business
(ASU
2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and
activities is a business. This guidance will be effective for the Company in the first fiscal quarter of 2018 on a prospective
basis, and early adoption is permitted. The Company does not expect the standard to have a material impact on its consolidated
financial statements. The Company adopted this standard on March 1, 2018 and the adoption did not have a material on its consolidated
financial statements.
In August, 2016, the FASB issued Accounting
Standards Update No. 2016-15,
Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues
Task Force)
(“ASU 2016-15”). The amendments in ASU 2016-15 address eight specific cash flow issues and apply to
all entities that are required to present a statement of cash flows under ASC Topic 230,
Statement of Cash Flows
. The
amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim
periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. The Company has not
yet completed the analysis of how adopting this guidance will affect its consolidated financial statements.
In May 2014, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts
with Customers (Topic 606)” (“ASU 2014-09”), and subsequently issued modifications or clarifications in ASU No.
2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” ASU 2016-08, “Revenue
from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU
No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing,”
and ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients.”
The revenue recognition principle in ASU 2014-09 and the related guidance is that an entity should recognize revenue to depict
the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in exchange for those goods or services. ASU 2014-09 prescribes a five-step process for evaluating contracts and determining revenue
recognition. In addition, new and enhanced disclosures are required. Companies may adopt the new standard either using the full
retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach.
The Company has not yet determined whether the impact that this new guidance will be material to its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation-Stock
Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. The amendments in this update change existing
guidance related to accounting for employee share-based payments affecting the income tax consequences of awards, classification
of awards as equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual reporting
periods beginning after December 15, 2016, including interim periods within those annual periods, with early adoption permitted.
The Company adopted this standard on September 1, 2017 and the adoption did not have a material on its consolidated financial statements.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
In February 2016, the FASB issued ASU 2016-02,
Leases
(Topic 842)
. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset
and a lease liability on the consolidated balance sheet for all leases with terms longer than 12 months. Leases will be classified
as either finance or operating, with classification affecting the pattern of expense recognition in the consolidated income statement.
ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods,
with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases
existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with
certain practical expedients available. The Company is currently evaluating the potential impact of the adoption of this standard.
In January 2016, the FASB issued ASU 2016-01,
Recognition
and Measurement of Financial Assets and Financial Liabilities
. The amendments in this update revise the accounting related
to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for
financial liabilities measured at fair value. The amendments are effective for annual reporting periods after December 15, 2017,
including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the potential
impact of the adoption of this standard.
Other Accounting standards that have been issued
or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated
financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact
on or are unrelated to its financial condition, results of operations, cash flows or disclosures.
NOTE
2 – ACQUISITION OF CMP WELLNESS, LLC
On May
1, 2017 (“Merger Date”), the Company and KBCMP, Inc., a Delaware corporation and newly formed wholly-owned subsidiary
of the Company (“Merger Sub”), entered into an Agreement of Merger (the “Merger Agreement”) with Lancer
West Enterprises, Inc. a California corporation and Walnut Ventures, a California corporation, pursuant to which each of Lancer
West Enterprises, Inc. and Walnut Ventures were merged with and into Merger Sub, with Merger Sub as the surviving corporation,
resulting in the Company’s indirect acquisition of CMP Wellness, LLC (“CMP”), a California limited liability
company, which prior to the merger, was owned 100% by Lancer West Enterprises, Inc. and Walnut Ventures. Membership interest in
CMP was the sole and only asset of Lancer West Enterprises, Inc. and Walnut Ventures. As a result, CMP became a wholly-owned subsidiary
of the Company. CMP is a distributor of vaporizers, cartridges and accessories.
The Company’s Directors believed
the acquisition of CMP and the product offerings of CMP leveraged the Company’s existing product development program and
provided the Company with the possibility of generating near term revenue and operating cash flow, as well as establishing a commercial
platform whereby other cannabis industry-support products may be accessed in the future. Going forward, the existing product offering
and other product licensing opportunities, will be the basis of the Company's long-term product portfolio.
The acquisition
consideration consisted of a cash payment of $1,500,000, unsecured promissory notes in the aggregate principal amount of approximately
$770,820, having a one-year maturity, and an aggregate of 7,800,000 restricted shares of the Company’s common stock (equal
to 12% of the Company’s common stock outstanding as of May 31, 2018). During the one-year period following the closing, the
two sellers of CMP may become entitled to receive up to an additional $1,905,000 in cash, in the aggregate, and 4,740,960 shares
of common stock of the Company, in the aggregate, based on the gross profit generated by CMP product line for the period from May
1, 2017 to April 30, 2018. Per the terms of the Merger Agreement, post-closing adjustments to CMP’s working capital is directly
offset to the unsecured promissory notes payable. Management has estimated that the post-closing working capital adjustments amounted
to $104,032, which management estimates will result in a decrease of the unsecured promissory notes payable from $770,820 to $666,788.
In accordance with ASC 805, management has evaluated the estimated fair value of the contingent consideration based a probability-weighted
assessment of the occurrence of CMP reaching certain gross profit earnout targets. The Company initially recorded a contingent
liability for the contingent cash consideration of $1,735,375 and recorded contingent equity consideration of $10,763,760. Based
on information obtained during the fourth fiscal quarter, the Company revised its estimate of the contingent cash consideration
from $1,735,375 to $1,905,000, and its estimate of the contingent equity consideration from $10,763,760 to $11,852,400.
A
payment of $85,000 was made towards this liability during the year ended August 31, 2017, resulting in a net liability of $1,820,000.
During the six months ended February, a payment of $170,000 was made towards this liability, resulting in a net liability of $1,650,000.
During the three months ended May 31, 2018, the Company did not recognize any change in the fair value of its contingent consideration
liability of $1,650,000.
CMP’s
assets acquired and liabilities assumed are recorded at their acquisition-date fair values.
As part of the purchase
price allocation, all intangible assets that were a part of the acquisition were identified and valued. It was determined that
only non-competition agreements and trade name had separately identifiable values. Trade name represents the CMP product names
that the Company intends to continue to use. The deferred income tax liability relates to the tax effect of acquired identifiable
intangible assets as such amounts are not deductible for tax purposes. For the acquisition discussed above, goodwill represents
the excess of the purchase price over the net identifiable tangible and intangible assets acquired. The Company determined that
the acquisition of CMP resulted in the recognition of goodwill primarily because of synergies unique to the Company and the strength
of its acquired workforce.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
The results of operations of CMP were consolidated
beginning on the date of the merger.
Acquisition-related transaction costs are not included
as a component of consideration transferred, but are accounted for as an expense in the period in which the costs are incurred.
Any excess of the acquisition consideration over the fair value of tangible and intangible assets acquired and liabilities assumed
is allocated to goodwill.
The amount of contingent consideration was recorded at its estimated fair value as of the
acquisition date. The subsequent accounting for contingent consideration depends on whether the contingent consideration is classified
as a liability or equity. The portion of contingent consideration classified as equity is not remeasured in subsequent accounting
periods. However, contingent consideration classified as a liability is remeasured to its fair value at the end of each reporting
period and the change in fair value is reflected in income or expense during that period. Any changes within the measurement period
resulting from facts and circumstances that existed as of the acquisition date may result in retrospective adjustments to the provisional
amounts recorded at the acquisition date.
The equity consideration received by CMP members
was calculated based on the negotiated price per share of common stock of the Company of $2.50, which approximated the quoted market
price on the acquisition date. The contingent equity consideration (number of common shares) was also calculated based on the negotiated
price per share of common stock of the Company of $2.50, which approximated the quoted market price. The total preliminary acquisition
consideration used in preparing the consolidated financial statements is as follows:
Acquisition Consideration:
|
|
May 1, 2017
(As initially
reported)
|
|
|
Measurement
Period
Adjustments (1)
|
|
|
August 31,
2017
(As adjusted)
|
|
Cash
|
|
$
|
1,500,000
|
|
|
$
|
—
|
|
|
$
|
1,500,000
|
|
Fair value of common shares issued to CMP members
|
|
|
19,500,000
|
|
|
|
—
|
|
|
|
19,500,000
|
|
Promissory notes
|
|
|
660,216
|
|
|
|
6,572
|
|
|
|
666,788
|
|
Estimated fair value contingent cash consideration
|
|
|
1,735,375
|
|
|
|
169,625
|
|
|
|
1,905,000
|
|
Estimated fair value contingent equity consideration
|
|
|
10,763,760
|
|
|
|
1,088,640
|
|
|
|
11,852,400
|
|
Total estimated acquisition consideration
|
|
$
|
34,159,351
|
|
|
$
|
1,264,837
|
|
|
$
|
35,424,188
|
|
|
(1)
|
As of August 31, 2017, the Company revised its estimate of the contingent cash consideration from $1,735,375 to $1,905,000, and the Company revised its estimate of the contingent equity consideration from $10,763,760 to $11,852,400, to reflect the increased probability of the sellers of CMP reaching the maximum earnouts available. An additional post-closing adjustment of $6,572 was recorded, which resulted in an increase of the promissory notes from $660,216 to $666,788. The balance of the note payable at May 31, 2018 reflects principal payments of $583,440 made to the sellers of CMP. The balance of the contingent cash consideration $1,650,000 as of May 31, 2018, reflects a decrease of $255,000 due to cash payments made to the sellers of CMP.
|
NOTE 3 - ACQUISITION OF SUMMIT INNOVATIONS,
LLC
On May 2, 2018, the Company completed its acquisition
of Summit, a leading distributor of hydrocarbon gases to the legal cannabis industry. Pursuant to the terms of the Merger Agreement
with Summit, Summit merged with and into KCH, a wholly-owned subsidiary of the Company, with KCH as the surviving entity.
The acquisition
was accounted for using the acquisition method of accounting in accordance with ASC 805, Business Combinations.
The
consideration paid to the Members of Summit at the closing included the Cash Consideration, consisting of an aggregate of $1.4
million in cash, net of cash received and the Share Consideration, consisting of an aggregate of 1,280,000 shares common stock.
$500,000 of the Cash Consideration and approximately 640,000 shares of common stock from the Share Consideration were held back
by the Company for a period of 15 months for potential post-closing working capital and/or indemnification claims relating to,
among other things, breaches of representations, warranties and covenants contained in the Merger Agreement. The Members may become
entitled to receive earn-out consideration of up to an additional 1,280,000 shares of common stock, in the aggregate, based on
the net revenue performance of the Summit business during a one-year period following the closing.
The Company estimated the probability of the
contingent consideration at 100% and recorded the earn-out consideration of the additional 1,280,000 shares of common stock in
stockholders’ equity.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
The preliminary total purchase price (based
on the $5.59 May 2, 2018 closing price)
was as follows:
|
|
Shares
|
|
|
Dollars
|
|
Company stock
|
|
|
640,000
|
|
|
$
|
3,577,600
|
|
Company stock held back
|
|
|
640,000
|
|
|
|
3,577,600
|
|
Contingent company stock consideration
|
|
|
1,280,000
|
|
|
|
7,155,200
|
|
Cash, net of cash received
|
|
|
-
|
|
|
|
945,218
|
|
Cash held back
|
|
|
-
|
|
|
|
500,000
|
|
Total purchase price
|
|
|
2,560,000
|
|
|
$
|
15,755,618
|
|
The following table summarizes the allocation
of the preliminary purchase price to the assets acquired and liabilities assumed:
Accounts receivable
|
|
$
|
470,670
|
|
Prepaid expense and other current assets
|
|
|
86,626
|
|
Inventory
|
|
|
237,000
|
|
Property and equipment, net
|
|
|
648,770
|
|
Goodwill
|
|
|
17,033,935
|
|
Accounts payable
|
|
|
(1,376,531
|
)
|
Accrued expenses
|
|
|
(358,035
|
)
|
Notes payable
|
|
|
(986,816
|
)
|
Total purchase price
|
|
$
|
15,755,618
|
|
The following unaudited pro forma financial
data assumes the acquisition had occurred at September 1, 2016. Pro forma results have been prepared by adjusting the Company’s
historical results to include Summit's results of operations. The unaudited pro forma results presented do not necessarily reflect
the results of operations that would have resulted had the acquisition been completed at September 1, 2016, nor do they indicate
the results of operations in future periods. Additionally, the unaudited pro forma results do not include the impact of possible
business model changes, nor do they consider any potential impacts of current market conditions or revenues, reduction of expenses,
asset dispositions, or other factors. The impact of these items could alter the following pro forma results ($ in thousands):
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
|
|
Three Months Ended
|
|
|
Three Months Ended
|
|
|
|
May 31, 2018
|
|
|
May 31, 2017
|
|
|
|
Unaudited
|
|
|
Unaudited
|
|
Total revenues
|
|
$
|
13,860,746
|
|
|
$
|
4,735,295
|
|
Net income (loss)
|
|
$
|
(2,778,867
|
)
|
|
$
|
(83
|
)
|
Loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.04
|
)
|
|
$
|
(0.00
|
)
|
Diluted
|
|
$
|
(0.04
|
)
|
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
Nine Months Ended
|
|
|
|
May 31, 2018
|
|
|
May 31, 2017
|
|
|
|
Unaudited
|
|
|
Unaudited
|
|
Total revenues
|
|
$
|
35,249,655
|
|
|
$
|
10,177,631
|
|
Net income (loss)
|
|
$
|
(4,285,427
|
)
|
|
$
|
(157,747
|
)
|
Loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.07
|
)
|
|
$
|
(0.00
|
)
|
Diluted
|
|
$
|
(0.07
|
)
|
|
$
|
(0.00
|
)
|
NOTE 4 - CONCENTRATIONS OF RISK
Supplier Concentrations
The Company purchases inventory from various
suppliers and manufacturers. For the nine months ended May 31, 2018 and 2017, two vendors, Transpring And Shenzhen Buddy Technology
Co. Ltd.,
accounted for approximately 14% and 22%, respectively, of total inventory
purchases.
Customer Concentrations
During the nine months ended May 31, 2018 there
was no customer which represented over 10% of the Company’s revenues there were no such customers for the same period ended
May 31, 2017. As of May 31, 2018, there were two customers who represented 8% of accounts receivable. As of May 31, 2017, there
was one customer that accounted for over 10% of accounts receivable.
NOTE 5 - RELATED-PARTY TRANSACTIONS
The Company leases its California and Colorado
facilities from related parties. During the nine months ended May 31, 2018 and 2017, the Company made rent payments
of
$161,100 and $152,100, respectively, to these related parties.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
NOTE 6 - PROPERTY AND EQUIPMENT
The major classes of fixed assets consist of
the following as of May 31, 2018 and August 31, 2017:
|
|
May 31,
|
|
|
August 31,
|
|
|
|
2018
|
|
|
2017
|
|
Machinery and equipment
|
|
$
|
1,422,523
|
|
|
$
|
886,608
|
|
Vehicles
|
|
|
378,543
|
|
|
|
144,845
|
|
Office Equipment
|
|
|
219,123
|
|
|
|
118,387
|
|
Leasehold improvements
|
|
|
800,120
|
|
|
|
71,545
|
|
Gas Tanks - Summit
|
|
|
593,974
|
|
|
|
-
|
|
|
|
|
3,414,283
|
|
|
|
1,221,385
|
|
Accumulated Depreciation
|
|
|
(635,487
|
)
|
|
|
(289,622
|
)
|
|
|
$
|
2,778,796
|
|
|
$
|
931,763
|
|
Depreciation expense was $113,258 and $ 51,297
for the three months ended May 31, 2018 and 2017, respectively. Of the $113,258 of depreciation expense, $70,885 is included in
depreciation and amortization expense and $42,373 is included in cost of goods sold on the consolidated statements of operations.
Depreciation expense was $227,496 and $124,393
for the nine months ended May 31, 2018 and 2017, respectively. Of the $227,496 of depreciation expense, $102,385 is included in
depreciation and amortization expense and $125,111 is included in cost of goods sold on the consolidated statements of operations.
NOTE 7 - INTANGIBLE ASSETS AND GOODWILL
Intangible assets consist of the following
as of May 31, 2018 and August 31, 2017:
|
|
|
|
|
|
|
As of May 31, 2018
|
|
|
As of August 31, 2017
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
|
|
|
Useful
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Accumulated
|
|
Acquisition
|
|
Description
|
|
Life
|
|
|
Value
|
|
|
Amortization
|
|
|
Value
|
|
|
Amortization
|
|
Roll-Uh-Bowl
|
|
Domain name
|
|
|
5 years
|
|
|
$
|
598,605
|
|
|
$
|
(136,910
|
)
|
|
$
|
589,284
|
|
|
$
|
(47,886
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMP Wellness, LLC
|
|
Trade name
|
|
|
6 years
|
|
|
|
2,600,000
|
|
|
|
(469,444
|
)
|
|
|
2,600,000
|
|
|
|
(144,444
|
)
|
|
|
Non-compete agreement
|
|
|
4 years
|
|
|
|
800,000
|
|
|
|
(216,667
|
)
|
|
|
800,000
|
|
|
|
(66,667
|
)
|
|
|
|
|
|
|
|
|
$
|
3,998,605
|
|
|
$
|
(823,022
|
)
|
|
$
|
3,989,284
|
|
|
$
|
(258,997
|
)
|
The activity in the goodwill balance for the nine months ended May
31, 2018 was as follows:
Balance - August 31, 2017
|
|
$
|
34,247,344
|
|
Summit acquisition (Note 2)
|
|
|
17,033,935
|
|
Balance - May 31, 2018
|
|
$
|
51,281,279
|
|
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
NOTE 8 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities
consist of the following as of May 31, 2018 and August 31, 2017:
|
|
May 31,
|
|
|
August 31,
|
|
|
|
2018
|
|
|
2017
|
|
Customer deposits
|
|
$
|
750,950
|
|
|
$
|
319,492
|
|
Accrued compensation
|
|
|
388,342
|
|
|
|
245,975
|
|
Income tax payable
|
|
|
1,774
|
|
|
|
219,082
|
|
Credit card liabilities
|
|
|
198,709
|
|
|
|
142,157
|
|
Deferred revenue
|
|
|
476,384
|
|
|
|
-
|
|
Deferred rent
|
|
|
25,301
|
|
|
|
25,881
|
|
Sales tax payable
|
|
|
364,601
|
|
|
|
17,182
|
|
Other accrued expenses
|
|
|
288,734
|
|
|
|
23,417
|
|
|
|
$
|
2,494,794
|
|
|
$
|
993,186
|
|
NOTE 9 - NOTES PAYABLE
Notes payable – current portion consists
of unsecured promissory notes relating to the CMP acquisition with a principal balance of $83,348 and vehicle loans with an aggregate
principal balance of $62,065 for the sum of $145,413, as described below.
As partial consideration for the acquisition
of CMP, the Company issued the sellers unsecured promissory notes totaling $770,820. Management has estimated that the post-closing
working capital adjustments amounted to $104,032, which resulted in a decrease of the unsecured promissory notes payable from
$770,820 to $666,788. The promissory notes matured on May 1, 2018 (however, this note payable remains outstanding as of July 9,
2018) and bear interest at an annual rate of 1.15%. The notes and accrued and unpaid interest are payable in quarterly installments
beginning August 1, 2017. As of May 31, 2018, management has accrued for $0 of interest expense on the promissory notes, which
is included in accrued expenses and other current liabilities. The principal balance of $83,348 is recognized in the current portion
of notes payable in the consolidated balance sheet as of May 31, 2018. Principal payments of $583,441 were made during the nine
months ended May 31, 2018.
Automobile Contracts Payable
The Company has entered into purchase contracts
for its vehicles. The loans are secured by the vehicles and bear interest at an average interest rate of approximately 6%
per annum. Future principal payments on these automobile contracts payable is summarized in the table below:
|
|
|
Principal
|
|
May 31, 2018
|
|
|
Due
|
|
|
2018
|
|
|
$
|
62,247
|
|
|
2019
|
|
|
|
59,351
|
|
|
2020
|
|
|
|
52,730
|
|
|
2021
|
|
|
|
46,812
|
|
|
2022
|
|
|
|
30,906
|
|
|
|
|
|
$
|
252,045
|
|
NOTE 10 - LOAN AGREEMENT
On November 16, 2017, the Company and KIM
as borrowers, and all of the Company’s other subsidiaries, as credit parties, entered into a Loan and Security Agreement
(the “Loan Agreement”) with Gerber Finance Inc., as lender (“Gerber”), effective as of November 6, 2017.
The Loan Agreement provides a secured revolving credit facility (the “Revolving Line”) in an aggregate principal amount
of up to $2.0 million at any time outstanding (subsequently increased to $4.0 million), of which $2,433,907
including
accrued interest was outstanding on May 31, 2018. Under the original terms of the Loan Agreement, the principal amount of loans,
plus the face amount of any outstanding letters of credit, at any time outstanding cannot exceed up to 85% of the Company’s
eligible receivables minus reserves. Under the terms of the Loan Agreement, the Company may also request letters of credit from
Gerber. The proceeds of the loans under the Loan Agreement will be used for working capital and general corporate purposes. The
Revolving Line has a maturity date of November 6, 2019. Borrowings under the Revolving Line accrues interest at a rate based on
the prime rate as customarily defined, plus a margin of 3.0%. On March 8, 2018, the Company and KIM entered into an amendment
to the Loan Agreement with Gerber. Pursuant to this amendment, the aggregate principal amount of the Revolving Line at any time
outstanding was increased to $4.0 million and the principal amount of loans, plus the face amount of any outstanding letters of
credit, at any time outstanding cannot exceed the lesser of (i) 40% of the value of certain inventory and (ii) 50% of certain
accounts receivable.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
NOTE 11 - STOCKHOLDERS' EQUITY
Preferred Stock
The authorized preferred stock is 10,000,000
shares with a par value of $0.001. As of May 31, 2018, and August 31, 2017, the Company has no shares of preferred stock issued
or outstanding.
Common Stock
The authorized common stock is 265,000,000
shares with a par value of $0.001. As of May 31, 2018, and August 31, 2017, 66,389,529 and 58,607,066 shares were issued and outstanding,
respectively.
During the nine months ended May 31, 2018,
the Company sold 5,877,415 shares of its common stock to investors in exchange for cash of $16,404,723.
During the nine months ended May 31, 2018,
the Company received $30,000 from an investor but the shares were not issued as of May 31, 2018.
Share-based Compensation
The Company recorded stock compensation expense
of $495,897 and $259,418 for the three month periods ended May 31, 2018 and 2017, respectively, in connection with the issuance
of shares of common stock and options to purchase common stock.
The Company recorded stock compensation expense
of $1,904,568 and $522,226 for the nine month periods ended May 31, 2018 and 2017, respectively, in connection with the issuance
of shares of common stock and options to purchase common stock.
During the nine month period ended May 31,
2018, the Company issued 368,624 shares of common stock to consultants in exchange for $1,794,828 of services, of which $485,899
was service rendered and $1,308,929 of prepaid services.
During the nine month period ended May 31,
2018, the Company entered into a separation agreement dated as of January 12, 2018 with one employee. The Company issued 100,000
restricted common shares as part of the separation agreement to this employee, which valued at $667,000 and was recorded as share-based
compensation during the nine months ended May 31, 2018.
Stock Options
The Company’s 2016 Stock Incentive Plan
(the Plan) was adopted on February 9, 2016. The Plan permits the grant of share options and shares to its employees and directors
for up to 5,000,000 shares of common stock. The Company believes that such awards better align the interests of its employees with
those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of the Company's
stock at the date of grant; those option awards generally vest based on three years of continuous service and have 10-year contractual
terms.
The Company estimates the fair value of share-based
compensation utilizing the Black-Scholes option pricing model, which is dependent upon several variables such as the expected option
term, expected volatility of the Company’s stock price over the expected option term, expected risk-free interest rate over
the expected option term, expected dividend yield rate over the expected option term, and an estimate of expected forfeiture rates.
The Company believes this valuation methodology is appropriate for estimating the fair value of stock options granted to employees
and directors which are subject to ASC Topic 718 requirements. These amounts are estimates and thus may not be reflective of actual
future results, nor amounts ultimately realized by recipients of these grants. The Company recognizes compensation on a straight-line
basis over the requisite service period for each award. The following table summarizes the assumptions the Company utilized to
record compensation expense for stock options granted during the nine months ended May 31, 2018 and 2017:
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
|
|
May 31,
|
|
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February 28,
|
|
|
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2018
|
|
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2017
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Expected term (years)
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|
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1-4
|
|
|
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1-4
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|
Expected volatility
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|
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60
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%
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|
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60
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%
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Weighted-average volatility
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|
|
60
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%
|
|
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60
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%
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Risk-free interest rate
|
|
|
0.67%-2.81
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%
|
|
|
0.85%-1.57
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%
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Dividend yield
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|
|
0
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%
|
|
|
0
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%
|
Expected forfeiture rate
|
|
|
33
|
%
|
|
|
33
|
%
|
The expected life is computed using the simplified
method, which is the average of the vesting term and the contractual term. The expected volatility is based on management's analysis
of historical volatility for comparable companies. The risk-free interest rate is based on the U.S. Treasury yields with terms
equivalent to the expected term of the related option at the time of the grant. While the Company believes these estimates are
reasonable, the compensation expense recorded would increase if the expected life was increased, a higher expected volatility was
used, or if the expected dividend yield increased.
During the nine months ended May 31, 2018 and
2017, the Company issued 4,096,000 and 2,940,000 stock options, respectively, pursuant to the Company’s 2016 Stock Incentive
Plan. A summary of the Company’s stock option activity during the nine month period ended May 31, 2018 is presented below:
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|
|
|
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Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
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Average
|
|
|
|
|
|
|
|
|
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Average
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Remaining
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Aggregate
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|
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No. of
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|
|
Exercise
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|
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Contractual
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|
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Intrinsic
|
|
|
|
Options
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|
|
Price
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|
|
Term
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|
|
Value
|
|
Balance Outstanding, August 31, 2017
|
|
|
5,275,500
|
|
|
$
|
1.73
|
|
|
|
8.0 years
|
|
|
$
|
917,610
|
|
Granted
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|
|
4,098,500
|
|
|
$
|
4.42
|
|
|
|
9.7 years
|
|
|
|
-
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|
Exercised
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|
|
834,459
|
|
|
$
|
0.56
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
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|
|
1,579,375
|
|
|
$
|
2.60
|
|
|
|
-
|
|
|
|
-
|
|
Balance Outstanding, May 31, 2018
|
|
|
6,960,166
|
|
|
$
|
3.25
|
|
|
|
8.7 years
|
|
|
|
23,250,945
|
|
Exercisable, May 31, 2018
|
|
|
2,135,549
|
|
|
$
|
1.74
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|
|
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7.5 years
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|
|
|
16,093,825
|
|
The weighted-average grant-date fair value
of options granted during the nine months ended May 31, 2018 and 2017, was $4.42 and $0.96, respectively. The weighted-average
grant-date fair value of options forfeited during the nine months ended May 31, 2018 was $2.61.
During the nine months ended May 31, 2018,
the Company issued 796,425 shares of common stock pursuant to exercises of stock options and received cash of $245,791.
As of May 31, 2018, there was $14,500,580 of
total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost
is expected to be recognized over a weighted-average period of 8.7 years. The total fair value of shares vested during the nine
month period May 31, 2018 is $939,420. This amount is included in stock compensation expense on the consolidated statements
of operations.
NOTE 12- COMMITMENTS AND CONTINGENCIES
Lease
The Company’s corporate head-quarters
and primary distribution center is located in Santa Ana, California. In July 2017, the Company entered into a facility lease in
Garden Grove, California. The Garden Grove facility lease expires on August 1, 2022 and requires escalating monthly payments that
range between $24,480 and $28,379. As part of the acquisition of CMP on May 1, 2017, the Company assumed the lease for CMP’s
facility located in Lawndale, California. The lease expires in January 2019, and requires escalating monthly payments that range
between $4,031 and $4,143. On April 1, 2016, the Company entered into a sublease agreement for a facility located in Woodinville,
Washington. The lease commenced on July 15, 2016 and expires on January 31, 2020, and requires escalating monthly payments that
range between $14,985 and $16,022. Effective April 10, 2015, the Company assumed the facility lease in Denver, Colorado, which
is the headquarters of operations for its wholly-owned subsidiary, Dank. On September 1, 2016, the Colorado facility lease was
amended to include additional office space. The lease runs through March 31, 2020 and requires escalating monthly payments, ranging
between $4,800 and $7,300. During the nine months ended May 31, 2018 and 2017, the Company recognized $601,938 and $288,789, respectively,
of rental expense, related to its office, retail and warehouse space. The increase is the result of the addition of the CMP Wellness
facility as well as expenses related to the Company’s new headquarters in Garden Grove, CA.
KUSH BOTTLES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
Additionally, Summit has several short-term
operating leases in several states, which expire at various dates during 2018.
Other Commitments
In the ordinary course of business, the Company
may enter into contractual purchase obligations and other agreements that are legally binding and specify certain minimum payment
terms. The Company had no such agreements as of May 31, 2018.
Litigation
The Company may be subject to legal proceedings
and claims which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur,
the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position,
results of operations or liquidity. The Company had no pending legal proceedings or claims as of May 31, 2018.
NOTE 13 - SUBSEQUENT EVENTS
On June 7, 2018, the Company entered into a
securities purchase agreement (the “Purchase Agreement”) with certain accredited investors (the “Purchasers”)
pursuant to which the Company agreed to issue and sell an aggregate of 7,500,000 shares of its common stock and warrants to purchase
3,750,000 shares of common stock in a registered direct offering (the “Offering”). The securities were offered by the
Company pursuant to its shelf registration statement on Form S-3 (File No. 333-221910). Subject to certain ownership limitations,
the warrants are immediately exercisable at an exercise price equal to $5.28 per share of common stock. The warrants are exercisable
for five years from the date of issuance. The combined per share purchase price for a share of common stock and half of a warrant
was $4.80.
The Company completed the Offering on June 12, 2018 for aggregate
gross proceeds of $36.0 million and net proceeds, after deducting the placement agent fees and other estimated offering expenses,
of approximately $32.9 million. A.G.P./Alliance Global Partners (the “Placement Agent”) acted as the placement agent
for the Offering. The Company agreed to pay the Placement Agent an aggregate cash fee equal to 7% of the aggregate gross proceeds
raised in the Offering. The Company also agreed to reimburse the Placement Agent for up to $120,000 of certain of its expenses
with respect to the Offering and to pay the Placement Agent a non-accountable expense allowance equal to 1% of the aggregate gross
proceeds raised in the Offering.