Forward Looking Statements





You should read the following discussion of the Company's financial condition
and results of operations together with its audited consolidated financial
statements and notes to such financial statements included elsewhere in this
Form 10-K. The following discussion contains forward-looking statements that
involve risks and uncertainties. The forward-looking statements are not
historical facts, but rather are based on current expectations, estimates,
assumptions and projections about the Company's industry, business and future
financial results. The Company's actual results could differ materially from the
results contemplated by these forward-looking statements due to a number of
factors, including those discussed under "Item 1A. Risk Factors" and other

sections in this 10-K.



Overview



Item 9 Labs produces premium cannabis and cannabis related products in a rapidly
growing market. The Company currently offers over seventy-five (75) active
cannabis strains and more than one hundred fifty (150) differentiated cannabis
vape products as well as premium concentrates and Orion vape technologies. The
Company's product offerings will continue to grow as they develop new products
to meet the needs of the end users. The Company makes its products available to
consumers through licensed dispensaries in Arizona. Item 9 Labs' products are
now carried in more than 60 dispensaries throughout the state of Arizona.



The Company believes its past and future success is dependent upon its ongoing
ability to understand the needs and desires of the consumers, and the Company
develops and offers products that meet those needs.



The Company's objective is to leverage its assets (tangible and intangible) to
fuel the growth of its share of the Arizona cannabis market, as well as expand
the geographical reach of its products into markets outside of Arizona, with the
ultimate goal of providing comfortable cannabis health solutions to a larger
population in a manner that will create value for the Company's shareholders.



In March 2020, the World Health Organization categorized Coronavirus Disease
2019 ("COVID-19") as a pandemic, and the President of the United States declared
the COVID-19 outbreak a national emergency. The extent of the impact of the
COVID-19 outbreak on the Company's operational and financial performance will
depend on certain developments, including the duration and spread of the
outbreak, its impact on its customers and vendors, and the range of governmental
and community reactions to the pandemic, which are uncertain and cannot be

fully
predicted at this time.



In March 2021, the Company closed on the acquisition of OCG, Inc., dba Unity
Rd., a cannabis dispensary franchisor.  The transaction was structured as a
reverse triangular merger, with the effect of OCG, Inc. becoming a wholly owned
subsidiary of the Company. Unity Rd has agreements with more than twenty (20)
entrepreneurial groups to open more than thirty (30) Unity Rd retail dispensary
locations in twelve (12) states. The majority of the locations are in the
licensing process. We currently have one franchisee operating in Boulder,
Colorado. Unity Rd. will assist in providing distribution for Item 9 Labs
products to be sold across the United States and internationally to its
franchisees for public resale, while keeping dispensaries locally owned and
operated. As Unity Rd. dispensaries expand in its market penetration, Item 9
Labs aims to offer its products in those locations by expanding the distribution
footprint of its premium product offerings to new states.



The Company's Arizona cannabis operations have expanded in recent years, with
the addition of a 2nd nearly 10,000 square foot facility in the 4th quarter of
fiscal year 2019, more than doubling the Company's cultivation and processing
space for Arizona. As the Company methodically expanded its operational capacity
by more than 100% in fiscal year 2020, it was also able to significantly
increase efficiencies within the cultivation and processing operations. The
increased efficiencies have been offset in the current period by certain supply
shortages and repair and maintenance delays resulting in longer production

lead
times.




The Arizona expansion has continued in fiscal year 2022 and is expected to
continue thereafter. The Company has tripled production since October 1,
2020, while beginning construction on phase 1 of its construction plan to build
additional cultivation space. Phase 1 plans total over 60,000 square feet
of additional cultivation and processing space, and the planned remaining five
phases would add over 560,000 square feet of cultivation and processing
space. By the conclusion of the master site development, the Company anticipates
a total of more than 640,000 square feet of cultivation and processing
space; there is no assurance the Company can complete these construction
projects as planned.



The Company estimates that phase 1 of its construction plan will be completed
during the third quarter of its fiscal year 2023. The extension of time to
complete phase 1 of its construction plan is primarily due to delays in
obtaining the necessary construction permits and supply chain shortages of
construction materials. Further, given the current level of inflation and the
supply chain shortages, the Company estimates that costs will exceed original
estimates by 25%-30%. The needed permits were obtained subsequent to June 30,
2022. The Company may experience additional construction delays. The Company can
provide no assurance that it will be able to obtain the financing needed to pay
the additional construction costs.

  31






Item 9 Labs Corp. has continued its expansion plans into other states as well as
the Company acquired (pending regulatory approval) cultivation and processing
licenses in Nye County, Nevada which will be paired with their Nevada facility.
In fiscal 2019, the Company broke ground on their 20,000 square foot cultivation
and processing facility in Nevada. The facility is substantially complete.



On October 6, 2021, the Company entered into an Asset Purchase Agreement ("APA")
to acquire an existing dispensary license and storefront from Nebrina Adams
County LLC, a Colorado limited liability company ("Seller") in Adams County, CO.
The total purchase price was $1,536,000, as to which $1,000,000 was paid to an
escrow account upon conditional approvals of the change of ownership from state
and local licensing authorities concerning the transfer of ownership. At
closing, that amount was released to the Seller along with an 18-month
promissory note in the principal amount of $200,000 and the balance payable in
300,000 shares of Company common stock, valued at $336,000. The Company obtained
financing to consummate this transaction. On March 2, 2022, the Company received
the necessary regulatory approvals and completed this transaction. The existing
dispensary license had never been operational. This dispensary, known as the
Company's North Denver location, began operations on July 11, 2022, making it
the Company's first corporate-owned shop in Colorado under the Company's
cannabis dispensary brand, Unity Rd.



This license acquisition is part of an overarching acquisition strategy that is
intended to accelerate national expansion by creating turnkey investment
opportunities for Unity Rd. franchisees. The Company plans to convert acquired
dispensaries into Unity Rd. shops, operate them internally and sell them to an
existing or future franchise partner. This offers an expedited solution for
entrepreneurs seeking immediate entry into cannabis. The Company is targeting
numerous similar transactions in the next 12 months to gain a deeper market
penetration in select markets. Subsequently and/or concurrently, the Company
plans to introduce the Item 9 Labs suite of products to the same markets through
the acquisition of cultivation and production licenses or through joint ventures
with qualified local, licensed operators.



On March 11, 2022, the Company entered into an Asset Purchase Agreement with The
Herbal Cure LLC, a Colorado limited liability company, pursuant to which the
Company is purchasing certain assets. Effective upon the completion of the sale,
which has not occurred as of the date of this filing, the licenses, contracts
and certain personal property to operate a licensed medicinal and recreational
cannabis dispensary will be delivered to the Company. The total purchase price
is $5,750,000, as to which $250,000 is to be paid upon execution of the Asset
Purchase Agreement, $3,700,000 payable at closing, $700,000 shall be financed by
seller pursuant to a Secured Promissory Note and the remainder of the purchase
prices shall be paid in shares of the Company's common stock on the closing
date. The Secured Promissory Note shall accrue interest at 5% per annum and have
a term of 18 months, commencing on the closing date, payable in even monthly
installments until paid in full. The shares of the Company's common stock to be
issued shall be in such an amount as is the quotient of $1,100,000 divided by
the product of the 10-day volume weighted average price of the shares as of the
closing date and 85%. The Company can provide no assurance that it will be
successful in finalizing this acquisition.



On May 18, 2022, Item 9 Labs Corp., a Delaware corporation ("Company"), and OCG
Management Ontario, Inc., a corporation formed under the laws of the Province of
Ontario ("Purchaser") and a wholly owned subsidiary of the Company incorporated
solely for the purpose of completing the transaction, entered into a Share
Purchase Agreement (the "Agreement") with Steven Fry, Najla Guthrie, Darryl
Allen, Louis Laskovski, each an individual residing in the Province of Ontario,
and 2628146 Ontario Ltd., a corporation formed under the laws of the Province of
Ontario, and 11949896 Canada Inc., a corporation formed under the federal laws
of Canada (together, the "Shareholders"), pursuant to which Purchaser is
purchasing all (but not less than all) of the issued and outstanding shares in
the capital of Wild Card Cannabis Incorporated, a corporation formed under the
laws of the Province of Ontario, ("Shares") free and clear of all Liens from the
Shareholders. The total purchase price for the Shares is Twelve Million Eight
Hundred Thousand Dollars ($12,800,000 USD) (the "Purchase Price"), as adjusted,
plus the Earnout Payment, if any (collectively, the "Purchase Price") payable as
follows: (i) The Company has delivered the Exclusivity Deposit in the amount of
$156,902 to the Escrow Agent on March 4, 2022; (ii) At the Closing, Purchaser
shall pay to Shareholders the Estimated Purchase Price of Twelve Million Eight
Hundred Thousand Dollars ($12,800,000 USD), as adjusted, in immediately
available funds; (iii) Four Million One Hundred Thousand Dollars ($4,100,000),
as adjusted, payable by the delivery of the Company's common stock, the number
of which will be calculated on the basis of a deemed price per common share
equal to the 10-Day VWAP of the trading price of the Company's common stock on
the stock exchange upon which the Company's common stock is listed, with the
last day of the First Earnout Period (the date that is 12 months following the
Closing Date) as the measurement date less a 15% discount, if actual Net Revenue
is respect of the First Earnout Period is greater than or equal to the Target
Net Revenue for the First Earnout Period; and (iv) Four Million One Hundred
Thousand Dollars ($4,100,000), as adjusted, payable by the delivery of the
Company's common stock, the number of which will be calculated on the basis of a
deemed price per common share equal to the 10-Day VWAP of the trading price of
the Company's common stock on the stock exchange upon which the Company's common
stock is listed, with the last day of the Second Earnout Period (the date that
is 24 months following the Closing Date) as the measurement date less a 15%
discount, if actual Net Revenue is respect of the Second Earnout Period is
greater than or equal to the Target Net Revenue for the Second Earnout Period.



  32




Results of Operations



                                            Year ended September 30,
                                             2022              2021            $ Change         % Change
Revenues, net                           $  21,756,997     $  21,937,227     $    (180,230 )           -1 %
Cost of revenues                           14,445,269        13,324,284         1,120,985              8 %
Gross profit                                7,311,728         8,612,943        (1,301,215 )          -15 %
Operating expenses
Professional fees and outside
services                                    2,982,599         3,241,820          (259,221 )           -8 %
Payroll and employee related expenses      10,279,552         6,649,097         3,630,455             55 %
Sales and marketing                         1,811,981         1,170,982           640,999             55 %
Depreciation and amortization               1,606,851         1,085,847           521,004             48 %
Other operating expenses                    3,755,955         1,828,954         1,927,001            105 %
Loss on assets held for sale                9,535,593                -          9,535,593            N/A
Loss on impairment                            409,431                -            409,431            N/A
Provision for bad debt                         (5,000 )         237,506          (242,506 )          100 %
Total operating expenses                   30,376,962        14,214,206        16,162,756            114 %
Income (loss) from operations             (23,065,234 )      (5,601,263 )     (17,463,971 )          312 %
Other expense, net                         (8,100,598 )      (5,304,509 )      (2,796,089 )           53 %
Net loss, before income tax provision
(benefit)                                 (31,165,832 )     (10,905,772 )     (20,260,060 )          186 %
Income tax provision (benefit)                 13,221                -             13,221              0 %
Net loss                                  (31,179,053 )     (10,905,772 )     (20,273,281 )          186 %
Less: Net loss attributable to
non-controlling interests                     (36,449 )              -            (36,449 )          100 %
Net loss attributable to Item 9 Labs
Corp.                                   $ (31,142,604 )   $ (10,905,772 )   $ (20,236,832 )          186 %




Revenues, net



The decrease in revenue was primarily due to a contraction in the market during
the summer, paired with increased competition as new market entries brought
additional price competition. As the majority of the Company's revenues are
earned in the Arizona market, the market dynamics take a heavy toll on the
Company's consolidated financial statements. Management anticipates revenues to
rebound in the new year as Item 9 Labs branded products have seen more positive
revenue trends at the end of the year and into the new year. Additionally, as
the Company stabilizes its additional revenue sources, such as its retail
dispensaries and franchise operations, management expects additional revenue
from these sources and become less concentrated in its revenues from a single
market.



Cost of revenues



Cost of revenues consist primarily of labor, materials, supplies and utilities.
Costs of revenues as a percentage of revenues was 66% for the year ended
September 30, 2022 compared to 61% for the period ended September 30, 2021. The
Company was able to increase operational efficiency throughout fiscal year 2022.
However, the cost of the purchased inventory materials remained high through the
first 3 quarters of the fiscal year, while the pricing pressures with the new
market entrants reduced sales prices. Given the business cycles in product
operations, profit margins are slimmed in a demanding market until the margins
stabilize, which they appear to have done shortly after year end. Management
will remain focused on reducing costs through bulk purchasing, implementing
additional efficiencies in production and making additional investments in
property and equipment. The Company expects costs to reduce as a percentage of
sales as there are indications of such in the new year.



Gross Profit




The decrease in gross profit was due to the decrease in revenue and prices of
purchased inventory materials and other costs remaining high. With the Company's
continued efforts to increase capacity and focus on efficiencies and reducing
costs, management expects gross profit to grow going forward.



  33




Operating Expenses



Professional fees and outside services decreased primarily due to a decrease in
the Company's consulting expenses, such as corporate advisory services,
accounting and finance services and for public relations and equity research.
The increase in payroll expenses was primarily due to 1.) increases in stock
based compensation as a result of the amortization of stock options awarded to
employees during the fiscal year 2022 and prior; 2.) increases in bonuses,
commissions and board compensation during fiscal year 2022; and 3.) an increase
in the average number of employees and pay increases during the year. Sales and
marketing expenses increased due to the continued spending on marketing and
branding initiatives beginning in fiscal year 2021, including spending on
promotional items. The increase in depreciation and amortization is due to the
amortization of intangible assets acquired in the OCG Inc. acquisition during
fiscal year 2021 and the depreciation of assets placed into service during
fiscal year 2022 at our dispensary locations. Other operating expenses increased
primarily due to expanded operations by the Company and the OCG acquisition
during fiscal year 2021. Specifically, facilities expenses increased related to
required security at the dispensary locations and the Nevada facility, increases
in insurance expenses and coverages, increases in travel related expenses due to
travel to new dispensary locations and the Sessions pending acquisition.
Further, rent expense increased due to the required payments on the new leases
in effect during fiscal year 2022. The increase in the loss on assets held for
sale is due to the Nevada facility and related licenses being adjusted to fair
value less costs to sell during fiscal year 2022. The increase in loss on
impairment is due to impairment being recorded on the remaining intangible
assets from the AZ DP Holdings, LLC acquisition that occurred in fiscal year
2019. Finally, the provision for bad debt decreased due to the notes receivable
being fully reserved for at September 30, 2021 and the Company receiving one
payment during the year ended September 30, 2022. Total operating expenses as a
percentage of gross profit increased from 164% to 413% for the years compared.
Management believes this ratio will decrease going forward as the expectation is
that revenues will continue to grow at a higher rate than operating expenses and
there will be a decrease in loss on assets held for sale and impairment in

future years.



Other Expense, net



Other expenses consist primarily of interest expense of $6,414,530 and
$5,295,349 for the years ended September 30, 2022 and 2021, respectively. The
increase in interest expense was primarily the result of an increase in
amortization of debt discounts, and an increase in overall interest expense due
to an increase in stated interest rates and an additional debt entered into
during the year. In addition, during the years ended September 30, 2022 and
2021, the Company recorded a loss on extinguishment of debt in the amount of
$1,686,386 and nil. The increase in fiscal year 2022 was due to accounting for
certain debt modifications and extinguishments.



Adjusted EBITDA



Management uses the non-GAAP measurement of earnings before interest, taxes,
depreciation, amortization, stock-related compensation expense,
acquisition-related costs, and other adjustments, or "Adjusted EBITDA," to
evaluate the Company's performance. Adjusted EBITDA is a non-GAAP measure that
is also frequently used by analysts, investors and other interested parties to
evaluate the market value of companies considered to be in similar businesses.
The Company suggests that Adjusted EBITDA be viewed in conjunction with its
reported financial results or other financial information prepared in accordance
with accounting principles generally accepted in the United States, or "GAAP."

The following table reflects the reconciliation of net loss to Adjusted EBITDA for the years ended September 30, 2022 and 2021:





                                     Year ended September 30,
                                      2022              2021
Net loss                         $ (31,179,053 )   $ (10,905,772 )

Depreciation and amortization 1,606,851 1,220,847 Interest expense

                     6,414,530         5,295,349
Loss on extinguishment of debt       1,686,386                -
Loss on assets held for sale         9,535,593                -
Loss on impairment                     409,431                -
Income tax expense                      13,221                -
Stock-based expense                  3,695,064         2,404,671
Acquisition related costs              537,391           273,432
Adjusted EBITDA                  $  (7,280,586 )   $  (1,711,473 )




  34

Financial Condition, Liquidity and Capital Resources

Liquidity and Capital Resources





The Company's primary need for liquidity is to fund working capital requirements
of its business, capital expenditures, acquisitions, debt service, and for
general corporate purposes. The Company's primary source of liquidity is funds
generated revenues, financing activities and from private placements. The
Company's ability to fund its operations, to make planned capital expenditures,
to make planned acquisitions, to make scheduled debt payments, and to repay or
refinance indebtedness depends on its future operating performance and cash
flows, which are subject to prevailing economic conditions and financial,
business and other factors, some of which are beyond the Company's control.



The accompanying consolidated financial statements have been prepared in
conformity with US GAAP, which contemplates continuation of the Company as a
going concern. The Company has not yet established an ongoing source of revenue
sufficient to cover its operating costs and has incurred net losses since its
inception. These losses, with the associated substantial accumulated deficit,
are a direct result of the Company's planned ramp up period as it is pursuing
market acceptance and geographic expansion. In view of these matters,
realization of a major portion of the assets in the accompanying consolidated
balance sheets is dependent upon continued operations of the Company which in
turn is dependent upon the Company's ability to meet its financing requirements,
and the success of its future operations. The Company operates in a new,
developing industry with a variety of competitors. These factors raise
substantial doubt about the Company's ability to continue as a going concern.

In order to continue as a going concern, the Company will need to generate additional revenue and obtain additional capital to fund its operating losses and service its debt. Management's plans in regard to these matters are described as follows:





Sales and Marketing. Historically, the Company has generated the majority of its
revenues by providing its products to dispensaries throughout the state of
Arizona. The Company's revenues have increased significantly since its inception
in May 2017. Management will continue its plans to increase revenues in the
Arizona market by providing superior products. Additionally, as capital
resources become available, the Company plans to expand into additional markets
outside of Arizona. The Company believes that it will continue reducing the
overall costs of revenues and costs of revenues will increase at a lower rate
than revenues in future periods, which will lead to increased profit margins.



Financing. To date, the Company has financed its operations primarily with loans
from shareholders, private placement financings and sales revenue. Management
believes that with continued production efficiencies, production growth, and
continued marketing efforts, sales revenue will continue to grow, thus enabling
the Company to reverse its negative cash flow from operations and raise
additional capital as needed. However, there is no assurance that the Company's
overall efforts will be successful.



If the Company is unable to generate additional sales growth in the near term
and raise additional capital, there is a risk that the Company could default on
additional obligations, and could be required to discontinue or significantly
reduce the scope of its operations if no other means of financing operations are
available. The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amount and classification of liabilities or any other adjustment that might
be necessary should the Company be unable to continue as a going concern.





As of September 30, 2022, the Company had $85,637 of cash and cash equivalents
and negative working capital of ($37,032,478) (current assets minus current
liabilities), compared with $1,454,460 of cash and cash equivalents and negative
working capital of ($4,893,385) as of September 30, 2021. The decrease of
$32,139,093 in the Company's working capital was primarily due decreases in
accounts receivable, inventory and prepaid expenses and other current assets.
Further, the decrease in the Company's working capital was due to increases in
accounts payable, accrued interest and accrued expenses, and current portions of
debt. The $1,368,823 decrease in cash and cash equivalents was primarily due the
use of cash in operating and investing activities offset by proceeds from the
issuance of debt. The Company is an early-stage growth company. It is generating
cash from sales and is investing its capital reserves in current operations and
new acquisitions that are expected to generate additional earnings in the long
term. The Company expects that its cash on hand and cash flows from operations,
along with private and/or public financing, will be adequate to meet its capital
requirements and operational needs for the next 12 months, although no assurance
can be given that private and/or public financing can be obtained on terms
acceptable to the Company, or at all.



  35




Cash Flows



The following table summarizes the sources and uses of cash for each of the
periods presented:



                                       Year ended September 30,
                                         2022             2021           $ Change        % Change
Net cash used in operating
activities                          $ (2,254,362 )   $ (5,989,581 )   $  3,634,070             -61 %
Net cash used in investing
activities                            (5,160,472 )     (3,917,969 )     (1,242,503 )            32 %
Net cash provided by financing
activities                             6,046,011       11,277,333       (5,130,173 )           -45 %
Net increase (decrease) in cash
and cash equivalents                $ (1,368,823 )   $  1,369,783     $ (2,738,606 )          -200 %




Operating Activities



During the year ended September 30, 2022, operating activities used $2,254,362
of cash and cash equivalents, primarily resulting from a net loss of $31,179,053
offset by net cash provided by operating assets and liabilities of $7,862,117,
comprised of decreases in accounts receivable of $862,010 and inventory of
$3,942,762 and net increases in accounts payable and accrued expenses of
$3,508,996. The net loss was further offset by non-cash operating expenses of
$21,062,574, primarily comprised of depreciation and amortization of fixed and
intangible assets and the right of use asset in the amount of $1922,200,
amortization of debt discounts in the amount of $3,808,059, loss on
extinguishment of debt of $1,686,386, stock-based compensation totaling
$3,695,064 and losses on assets held for sale and on impairment in the amounts
of $9,535,593 and $409,431, respectively.



During the year ended September 30, 2021, operating activities used $5,989,581
of cash and cash equivalents, primarily resulting from a net loss of $10,905,772
and net cash used by operating assets and liabilities of $2,877,911, comprised
of increases in accounts receivable of $1,085,400 and inventory of $4,244,241,
offset by increases in accounts payable and accrued expenses of $2,397,416.
These uses of cash were further offset by non-cash operating expenses of
$7,794,102, primarily comprised of depreciation and amortization of fixed and
intangible assets and the right of use asset in the amount of $1,260,665,
amortization of debt discounts in the amount of $3,891,260, stock-based
compensation totaling $2,404,671 and the provision for bad debt in the amount of
$237,506.



Investing Activities



During the year ended September 30, 2022, investing activities used $5,160,472
of cash and cash equivalents, consisting primarily of the purchase of licenses
of $1,130,872, deposits on acquisitions of $406,932 and purchases of property,
equipment and construction in process of $4,327,468. These uses of cash were
offset by cash received from the construction escrow accounts of $837,717.



During the year ended September 30, 2021, investing activities used $3,917,969
of cash and cash equivalents, consisting primarily of deposits on acquisitions
of $1,775,348 and purchases of property, equipment and construction in process
of $2,242,217.



Financing Activities



During the year ended September 30, 2022, financing activities provided
$6,046,011 of cash and cash equivalents, which includes cash proceeds from the
sale of common stock of $657,815 and cash proceeds from the issuance of debt of
$9,415,919. These proceeds were offset by payments on existing debt of
$3,903,280.



During the year ended September 30, 2021, financing activities provided
$11,277,333 of cash and cash equivalents, which includes cash proceeds from the
sale of common stock of $13,299,808 and cash proceeds from the issuance of debt
of $2,580,000. These proceeds were offset by payments on existing debt of
$4,583,469.

Off-Balance Sheet Arrangements

The Company is not currently a party to, or otherwise involved with, any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.





  36




Critical Accounting Policies



The preparation of financial statements and related disclosures in conformity
with U.S. Generally Accepted Accounting Principles ("GAAP") and the Company's
discussion and analysis of its financial condition and operating results require
the Company's management to make judgments, assumptions and estimates that
affect the amounts reported in its consolidated financial statements and
accompanying notes. Note 1, "Description of Business and Summary of Significant
Accounting Policies," of the Notes to Consolidated Financial Statements included
in this Form 10-K, describes the significant accounting policies and methods
used in the preparation of the Company's consolidated financial statements.
Management bases its estimates on historical experience and on various other
assumptions it believes to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities. Actual results may differ from these estimates, and such
differences may be material.



Management believes the Company's critical accounting policies and estimates are
those related to revenue recognition, valuation of warrants and debt discounts,
carrying value of intangible assets subject to amortization, infinite life
intangible assets and goodwill, stock-based compensation, business combinations
and income taxes. Management considers these policies critical because they are
both important to the portrayal of the Company's financial condition and
operating results, and they require management to make judgments and estimates
about inherently uncertain matters. The Company's management has reviewed these
critical accounting policies and related disclosures with the Audit Committee of
the Company's Board of Directors.



Revenue Recognition

The Company's revenue is primarily associated with a customer contract that represents an obligation to provide cannabis products that are delivered at a single point in time. Any costs incurred prior to the period in which the products are delivered are recorded to inventory and recognized as cost of revenues in the period in which the performance obligations are completed.





Stock-Based Compensation

The Company calculates the cost of awards of equity instruments based on the grant date fair value of the awards using the Black-Scholes-Merton option pricing valuation model, which incorporates various assumptions including volatility, expected term and risk-free interest rates.





The expected term of the options is the estimated period of time until exercise
and was determined using the SEC's safe harbor rules, using an average of
vesting and contractual terms, as the Company did not have sufficient historical
experience of similar awards. Expected stock price volatility is based on
historical volatility of the Company's stock since March 20, 2018, the day of
the merger between BSSD Group LLC and Airware Labs Corp. The risk-free interest
rate is based on the implied yield available on United States Treasury
zero-coupon issues with an equivalent remaining term. The estimated fair value
of stock-based compensation awards is amortized on a straight-line basis over
the relevant vesting period and forfeitures at the time the occur.

Impairment of Goodwill and Other Intangible Assets





In accordance with ASC Topic 350, Intangibles - Goodwill and Other, the Company
performs goodwill and indefinite life intangible asset impairment testing at
least annually during the fourth quarter, unless indicators of impairment exist
in interim periods. The Company's test of goodwill impairment included assessing
qualitative factors and the use of judgment in evaluating economic conditions,
industry and market conditions, cost factors, and entity-specific events, as
well as overall financial performance. The impairment test for goodwill compares
the estimated fair value of a reporting unit with goodwill to its carrying
value. If the carrying amount of a reporting unit's goodwill exceeds the fair
value of its goodwill, the Company recognizes an impairment loss equal to the
excess, not to exceed the total amount of recorded goodwill.



The Company also review the recoverability of its net intangible assets with
finite lives when an indicator of impairment exists. Based on the Company's
qualitative analysis of impairment indicators and estimated undiscounted future
cash flows expected to result from the use of these net intangibles with finite
lives, if needed, the Company determines if it will recover their carrying
values as of the test date. If not recoverable, the Company records an
impairment charge.



The Company performed its most recent goodwill impairment analysis in the third
quarter of 2022, utilizing an income approach with no impairment recorded. The
Company believes that the discounted cash flow method best captures the
significant value-creating activities it is undertaking. The primary assumptions
in its income approach included estimating cash flows and projections. The
Company determined that the fair value of its goodwill exceeded our carrying
value, and consequently, no impairment was deemed to have occurred. However, a
prolonged period of declining gross margins or a significant decrease in its
anticipated revenue growth could result in the write-off of a portion or all of
its goodwill and other intangible assets in future periods.



  37




Business Combinations



The Company accounts for acquisitions in accordance with ASC Topic 805, Business
Combinations. In purchase accounting, consideration paid, identifiable assets
acquired and liabilities assumed are recognized at their estimated fair values
at the acquisition date, and any remaining purchase price is recorded as
goodwill. In determining the fair values of the consideration paid, assets
acquired and liabilities assumed, the Company makes significant estimates and
assumptions, particularly with respect to equity paid in the acquisition, and
long-lived tangible and intangible assets. Critical estimates used in valuing
tangible and intangible assets include, but are not limited to, future expected
cash flows, discount rates, market prices and asset lives. Critical assumptions
used in valuing the equity paid includes, but is not limited to, the stock price
of the Company's stock on the date of acquisition and assumptions used in
valuing the warrants paid, such as the stock price volatility, risk free
interest rate and expected term. The Company's consolidated financial statements
include the results of operations of the acquired company from the date of

the
acquisition.

The Company expenses all acquisition-related costs as incurred in selling, general and administrative expenses in the consolidated statements of operations.





Income Taxes



The Company uses significant judgment in determining the provision for income
taxes, deferred tax assets and liabilities, and any valuation allowance recorded
against net deferred tax assets. In preparing its financial statements, the
Company is required to estimate income taxes in each of the jurisdictions in
which it operates. This process involves estimating the actual current tax
liability together with assessing temporary differences resulting from differing
treatment of items, such as depreciation and amortization of property and
equipment, benefits of net operating loss tax carryforwards. These differences
result in deferred tax assets, which include tax loss carryforwards, and
liabilities. The Company then assesses the likelihood that deferred tax assets
will be recovered from future taxable income, and to the extent that recovery is
not likely or there is insufficient operating history, it establishes a
valuation allowance. In evaluating its ability to recover its deferred tax
assets within the jurisdiction from which they arise, the Company considers all
available positive and negative evidence, including scheduled reversals of
deferred tax liabilities, projected future taxable income, tax-planning
strategies, and results of recent operations. In projecting future taxable
income, the Company begins with historical results and incorporate assumptions
about the amount of future state and federal pretax operating income adjusted
for items that do not have tax consequences. The assumptions about future
taxable income require significant judgment and are consistent with the plans
and estimates the Company is using to manage the underlying business. To the
extent the Company establishes or changes a valuation allowance in a period, it
includes an adjustment within the tax provision of its statements of operations.



Deferred tax assets reflect current statutory income tax rates in effect for the
period in which the deferred tax assets are expected to be realized. As changes
in tax laws or statutory tax rates are enacted, deferred tax assets and
liabilities are adjusted through the provision of income taxes.



The calculation of the Company's tax liabilities involves dealing with
uncertainties in the application of complex tax laws and regulations in a
multitude of jurisdictions across its global operations. A tax benefit from an
uncertain tax position may be recognized when it is more likely than not that
the position will be sustained upon examination, including resolutions of any
related appeals or litigation processes, on the basis of the technical merits.
The Company (1) records unrecognized tax benefits as liabilities in accordance
with ASC 740 and (2) adjusts these liabilities when their judgment changes as a
result of the evaluation of new information not previously available. Because of
the complexity of some of these uncertainties, the ultimate resolution may
result in a payment that is materially different from its current estimate of
the unrecognized tax benefit liabilities. These differences will be reflected as
increases or decreases to income tax expense in the period in which new
information is available.

Warrants, Common Stock and Debt Discounts





The Company bifurcates the value of warrants and common stock issued with debt.
This bifurcation results in the establishment of a debt discount, based on the
relative fair values of the warrants, common stock and debt, with a
corresponding charge to equity unless the terms of the warrant require it to be
classified as a liability. The warrants are initially valued using the
Black-Scholes valuation model. This model uses estimates of volatility, risk
free interest rate and the expected term of the warrants, along with the current
market price of the Company's stock, to estimate the value of the outstanding
warrants. The Company estimates the expected term using an average of the
contractual term and vesting period of the award. The expected volatility is
measured using the average historical daily changes in the market price of the
Company's common stock over the expected term of the award and the risk-free
interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury
bonds with a remaining maturity equal to the expected term of the awards. The
establishment of a debt discount on convertible debt recorded at the relative
fair values may result in a beneficial conversion feature based on an effective
conversion price. This beneficial conversion feature is recorded as an
additional debt discount. The total debt discount is limited by the total
proceeds received and is amortized over the term of the debt.



  38

Recent Accounting Pronouncements

See Note 1 to the Company's financial statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.





Seasonality



The Company does not expect its sales to be impacted by seasonal demands for its
products and services. Also, due to the fact the Company uses indoor grow space,
seasonality should not have any impact on its cultivation operations.

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