TPCO HOLDING CORP. Introduction
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read together with other information, including
our unaudited interim condensed consolidated financial statements and the
related notes to those statements included in Part I, Item 1 of this Quarterly
Report (the "Interim Financial Statements"). Certain information contained in
the discussion and analysis set forth below includes forward-looking statements
that involve risks and uncertainties.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report contains certain information that may constitute
forward-looking information and forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, and under Canadian securities laws
(collectively, "Forward-Looking Statements") which are based upon the Company's
current internal expectations, estimates, projections, assumptions and beliefs.
Such statements can be identified by the use of forward-looking terminology such
as "expect", "likely", "may", "will", "should", "intend", "anticipate",
"potential", "proposed", "estimate" and other similar words, including negative
and grammatical variations thereof, or statements that certain events or
conditions "may" or "will" happen, or by discussions of strategy.
Forward-Looking Statements include estimates, plans, expectations, opinions,
forecasts, projections, targets, guidance, or other statements that are not
statements of fact. Forward-Looking Statements in this Quarterly Report include,
but are not limited to, statements with respect to:
· the performance of the Company's business and operations;
· the Company's expectations regarding revenues, expenses, liquidity and
anticipated cash needs, including the Company's ability to grow revenue
and reach long-term profitability;
· the Company's ability to reduce its operating expenses and cash burn rate,
including the expected cost savings from actions taken to date;
· the Company's ability to complete future strategic alliances and the
expected impact thereof;
· expected future sources of financing;
· the expected future business strategy, competitive strengths, goals,expansion and growth of the Company's business, including operations and
plans, new revenue streams and cultivation and licensing assets;
· the implementation and effectiveness of the Company's distribution
platform, including;
· the expected impact of the Company's agreement to transition its wholesale
distribution to Nabis;
· expectations with respect to future production costs;
· the expected methods to be used by the Company to distribute cannabis;
· the competitive conditions of the industry;
· laws and regulations and any amendments thereto applicable to the business
and the impact thereof;
· the competitive advantages and business strategies of the Company;
· the application for additional licenses and the grant of licenses or
renewals of existing licenses that have been applied for;
· the Company's future product offerings;
· the anticipated future gross margins of the Company's operations;
· the Company's ability to source and operate facilities in the United
States ;
· the Company's ability to source select investment opportunities and
complete future targeted acquisitions, the ability to finance any such
acquisitions, and the expected impact thereof;
· expansion into additional U.S. and international markets;
· expectations of market size and growth in
in which the Company operates or contemplates future operations;
· expectations for regulatory and/or competitive factors related to the
cannabis industry generally; and
· general economic trends.
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Table of Contents
Certain of the Forward-Looking Statements contained herein concerning the
cannabis industry and the general expectations of the Company concerning the
cannabis industry are based on estimates prepared by the Company using data from
publicly available governmental sources as well as from market research and
industry analysis and on assumptions based on data and knowledge of the cannabis
industry, which the Company believes to be reasonable. However, although
generally indicative of relative market positions, market shares and performance
characteristics, such data is inherently imprecise. While the Company is not
aware of any misstatement regarding any industry or government data presented
herein or information presented herein which is based on such data, the cannabis
industry involves risks and uncertainties that are subject to change based on
various factors, which factors are described further below.
Forward-Looking Statements contained in this Quarterly Report reflect
management's current beliefs, expectations and assumptions and are based on
information currently available to management, management's historical
experience, perception of trends and current business conditions, expected
future developments and other factors which management considers appropriate.
With respect to the Forward-Looking Statements contained in this Quarterly
Report, the Company has made assumptions regarding, among other things (i) its
ability to generate cash flows from operations and obtain any necessary
financing on acceptable terms; (ii) general economic, financial market,
regulatory and political conditions in which the Company operates; (iii) the
output from the Company's operations; (iv) consumer interest in the Company's
products; (v) competition; (vi) anticipated and unanticipated costs; (vii)
government regulation of the Company's activities and products and in the areas
of taxation and environmental protection;
(viii) the timely receipt of any required regulatory approvals; (ix) the
Company's ability to obtain qualified staff, equipment and services in a timely
and cost efficient manner; (x) the Company's ability to conduct operations in a
safe, efficient and effective manner; (xi) the Company's ability to meet its
future objectives and priorities; (xii) the Company's access to adequate capital
to fund its future projects and plans; (xiii) the Company's ability to execute
on its future projects and plans as anticipated; (xiv) industry growth rates;
and (xv) currency exchange and interest rates.
Readers are cautioned that the above list of cautionary statements is not
exhaustive. Known and unknown risks, many of which are beyond the control of the
Company, could cause actual results to differ materially from the
Forward-Looking Statements in this Quarterly Report. Such lists include, without
limitation, those discussed under the heading "Risk Factors" in Item 1A of Part
II of this Quarterly Report, in Company's Annual Report on Form 10-K for the
year ended December 31, 2021 filed with the SEC on March 31, 2022 (our "2021
Form 10-K") and in the Company's periodic reports subsequently filed with the
SEC and in the Company's filings on SEDAR at www.sedar.com. The purpose of
Forward-Looking Statements is to provide the reader with a description of
management's expectations, and such Forward-Looking Statements may not be
appropriate for any other purpose. You should not place undue reliance on
Forward- Looking Statements contained in this Quarterly Report. Although the
Company believes that the expectations reflected in such Forward-Looking
Statements are reasonable, it can give no assurance that such expectations will
prove to have been correct. Forward-Looking Statements contained herein are made
as of the date of this Quarterly Report and are based on the beliefs, estimates,
expectations and opinions of management on the date such Forward-Looking
Statements are made. The Company undertakes no obligation to update or revise
any Forward-Looking Statements, whether as a result of new information,
estimates or opinions, future events or results or otherwise or to explain any
material difference between subsequent actual events and such Forward-Looking
Statements, except as required by applicable law. The Forward-Looking Statements
contained in this Quarterly Report are expressly qualified in their entirety by
this cautionary statement.
Results for First nine Months of 2021 Do Not Reflect Complete Period
Our financial results for the nine month period endedSeptember 30, 2021 did not include operating results fromJanuary 1, 2021 toJanuary 15,2021 due to the fact that our qualifying transaction, pursuant to which the Company's business operations began, closed onJanuary 15, 2021 (the "Qualifying Transaction"). Accordingly, our results of operations are not necessarily comparable between the nine months endedSeptember 30, 2022 and the nine months endedSeptember 30, 2021 . Part 1-Business Overview The Company is a consumer-focused cannabis company based inthe United States focused on the recreational and wellness markets. The Company's operations inCalifornia are focused on building winning brands supported by its omni-channel ecosystem. The Company's platform was designed to create one of the most socially responsible and culturally impactful companies inthe United States , producing consistent, well-priced products and culturally relevant brands that are distributed to third-party retailers as well as direct-to-consumer via the Company's delivery service and strategically located storefront retail locations acrossCalifornia . A portfolio of products and brands that appeal to a broad range of user groups, need-states and occasions, offered at many price points, and with various brand value propositions, are produced at thigh caliber of quality through integrated cultivation and manufacturing. The Company believes its delivery and storefront retail outlets will allow it to achieve high gross-margins on many of its products, forge one-on-one relationships between its brands and consumers and collect proprietary consumer data and insights. 34 Table of Contents
The Company's operational footprint spans cultivation, manufacturing, brands, retail and delivery. The management team and directors of the Company bring together deep expertise in cannabis, consumer packaged goods, investing and finance from start-ups to publicly traded companies. The Company aims to leverage the collective industry experience of its management and directors.
As atSeptember 30, 2022 , the Company views its business as having one sales channel - omni-channel retail: brick and mortar retail, e-commerce pick up & delivery, as well as the sale of various branded wholesale products. The Company currently operates twelve omni-channel retail locations and four consumer delivery hubs. The Company made the strategic decision to exit its low margin bulk wholesale business during the third quarter of 2022 to reduce complexity, prioritize higher-margin activities and conserve cash. Ultimately, the Company was successful in disposing of its bulk wholesale business onOctober 31, 2022 . As such, this bulk wholesale business has been presented as discontinued operations commencing in the third quarter of 2022 in our financial statements. All comparative information has been restated to remove the bulk wholesale discontinued operations results. The bulk wholesale business generated revenue from the sale of bulk flower and oil produced in-house. Through a combination of (i) professional leadership (ii) omni-channel operations, (iii) technology and data driven practices, (iv) brand and product expertise, and (v) social justice and equity advocacy, the Company intends to set the example globally as a best-in-class cannabis operation. The Company is actively evaluating cost reductions and business optimization to reduce its
cash burn in the near term.
Beginning in 2022, the Company changed its mergers & acquisitions strategy going forward to be more opportunistic and selective rather than as a core function to achieve rapid growth. Third Quarter Highlights Cost Reduction Initiatives 1)Cultivation Pause
Our operations continue to focus on increasing gross margin and cost reduction in high impact areas of the Company, most notably cultivation.
Inmid-September 2022 , in-house cultivation was paused in response to the availability of lower cost flower that meets our quality specifications for our first party brands. We expect to achieve significant margin enhancement, as well as cost certainty with strategic sourcing relationships in place. We anticipate that the pause of in-house cultivation will reduce annual cash operating expenses by approximately$1.8 million and associated annual payroll by approximately$4 million by eliminating 70 positions or approximately 14% of the workforce for total savings of approximately$5.8 million annually.
2)Delivery Depot Consolidation
In response to proposed changes toCalifornia's cannabis delivery regulations to increase the allowed delivery "case pack value" limit, the Company has acted to optimize its delivery footprint. Under existing regulations, delivery drivers are allowed to carry a maximum of$5,000 worth of product in a vehicle, of which a maximum of$3,000 can be product that was not part of an order made before the driver leaves the delivery depot. The proposed new regulations would double the "case pack value" limit to$10,000 , all of which can be product not part of
a previously made order. As a result of this change, which is expected to come into effect in the fourth quarter of 2022, delivery vehicles will be able to carry significantly more product than currently allowed. This increase is also expected to increase the geographic area that can be covered by a vehicle and allow for a much greater breadth of product to be carried. Consequently, the Company has elected to dispose of select redundant delivery depot locations as many geographic regions can now be more efficiently managed, includingCulver City ,Chula Vista andSacramento operations. These dispositions resulted in$500,000 in gross sale proceeds and are expected to result in additional annual cost savings of$1.8 million .
This consolidation has reduced fixed cost and operational complexity, while retaining sales though store delivery alternatives.
Revenue Growth and Gross Margin Improvement Initiatives
To drive revenue growth and margin improvement in stores, the Company:
1) Focused on increasing new and returning traffic by introducing and
expanding high quality, limited batch Flower brands which include: BLEM,
Teds Budz, Alien Labs , Connected, Fig Farms and Marathon.
2) Focused on increase in our average basket size by introducing and
expanding Ounces and Half Ounces to our Flower assortment.3) Continued to focus on curating a localized assortment that is relevant and
consistently appealing.
4) Rolled out Treez point of sale system in all Coastal and Calma locations.
Caliva locations will be transitioned in the fourth quarter of 2022. Treez
is a leading commerce platform for cannabis retailers.
5) Significantly increased exposure and advertising on Weedmaps, e.g., push
messaging, side banners, improved placement on search pages and
programmatic marketing. Weedmaps is a third party platform for users
interested in purchasing cannabis.
6) Held several vendor supported promotions for various brand launches by
Stiizy and Raw Garden
7) Hired street teams to help localize brand awareness and purchased
significant billboard space.
8) Built out a robust product demonstration schedule to develop brand
engagement with customers and increase sell through.
9) Opened the Coastal Concord location during September 2022 .
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Table of Contents
New Product Updates
RCVRY: A premium cannabis product launched in September 2022 at our Calma
location. RCVRY is a brand collaboration featuring Nordan Shat aka "Faze Rain"
from the FaZe Clan (NASDAQ: FAZE) gaming community with a fan base of over 510
million across combined social platforms. Our RCVRY cannabis launch coincided
with Nordan's "public resurfacing" following his accident that left him
temporarily paralyzed two years ago. Nordan is currently filming content that
will be released across his social channels that follow his road to recovery
(RCVRY).
East Coast Expansion
On
Initial brands to be introduced under the terms of the Licensing Agreement include Monogram, Caliva, Mirayo by Santana, Deli, Cruisers and otherTPCO owned brands, in a variety of product form factors including jarred fresh flower, pre-rolls, premium vapes, and infused gummies and chocolates. Some of the products will feature signature strains of cannabis cultivated by Curio in collaboration withThe Parent Company . The Parent Company brands are expected to initially be available at Curio's Far & Dotter dispensaries, with broad wholesale distribution to dispensaries across theState of Maryland to follow. Under the terms the Licensing Agreement, Curio will exclusively manufacture, distribute, market and sell the Company's branded products in theState of Maryland according to the product specifications and quality standards established byThe Parent Company . The Licensing Agreement has an initial term of four years with further renewal terms and anticipates a potential expanded partnership into additional states. Social Equity
OnJuly 1, 2022 , the Company agreed to make a follow-on$200,000 investment in its existing Josephine & Billie's investment. Women-founded and led, Josephine and Billie's is LA's first cannabis speakeasy that gives Women of Color a tailored cannabis experience. We support Josephine and Billie's mission to be inclusive, communal and puts the needs of Women of Color at the forefront.The Parent Company is proud to make this follow-on investment to provide Josephine & Billie's the funds needed to build a sustainable business. The Company plans to reposition itsSocial Equity Ventures to become the centralized owner of all corporate social responsibility activities undertaken with the mission to provide Black and underrepresented minorities with the foundation to succeed in the legal cannabis industry through education, advocacy and access to capital.Social Equity Ventures will be rebranded as "Legacy
Ventures". Subsequent Events Disposal of SISU OnOctober 31, 2022 , the Company finalized the sale of its bulk wholesale business (SISU Extraction LLC ) for$317,000 cash. In addition, the purchaser has agreed to enter into a strategic supply agreement providing the Company the right, but not the obligation, to purchase cannabis oil and flower brokerage services for a period of 24 months on preferred terms. Manufacturing Outsourcing
During
Workforce Reduction We also continue to consolidate operational functions within the organization, which we expect to lead to further cost reductions overall. Including the$4 million payroll savings achieved by pausing cultivation inmid-September 2022 . As of the date of this Quarterly Report, the Company has reduced its workforce by 33% from the beginning of 2022 and expects realize annual payroll savings of approximately$10 million . In summary, to the date of this MD&A, the Company has implemented initiatives that are expected to save a total of approximately$13.6 million of costs: approximately$10 million payroll, approximately$1.8 million from cultivation pause/manufacturing outsourcing and approximately$1.8 million from delivery depot consolidation.
Closing of Coastal Acquisition
OnNovember 14, 2022 , the Company completed the acquisition of 100% of the equity ofCoastal Holding Company, LLC ("Coastal") by issuing 2S,000,000 shares ofCoast L Acquisition Corp. , a who(Iy owned subsidiary of the Company. The shares ofCoast L Acquisition Corp. are exchangeable on a one-for-one basis into shares of the Company. The Company also paid an additional$3.1 million upon closing and assumed approximately$1.9 million of debt. 36 Table of Contents Results of Operations
(Unaudited, in
Three months ended Nine months ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
Sales, net of
discounts $ 19,560,190 $ 18,894,135 $ 63,674,204 $ 55,385,321
Cost of sales 12,942,068 13,893,643 44,316,034 43,774,625
Gross profit 6,618,122 5,000,492 19,358,170 11,610,696
Impairment loss 127,815,307 485,601,121 130,244,837 560,500,228
Operating
expenses 36,838,444 30,936,988 108,036,813 128,763,201
Loss from
operations (158,035,629 ) (511,537,617 ) (218,923,480 ) (677,652,733 )
Other income
(expense)
Interest
expense (1,183,968 ) (1,093,562 ) (3,694,798 ) (3,757,176 )
Gain on debt
forgiveness - - - 3,358,686
Loss on
disposal of
assets - (137,042 ) (317,787 ) (3,656,707 )
Change in fair
value of
investments at
fair value
through profit
loss (388,878 ) (768,030 ) (421,974 ) (418,818 )
Change in fair
value of
contingent
consideration 3,558 38,178,321 642,153 220,997,087
Other income 524,230 1,521,164 1,633,525 4,198,444
(1,045,058 ) 37,700,851 (2,158,881 ) 220,721,516
Loss before
income taxes (159,080,687 ) (473,836,766 ) (221,082,361 ) (456,931,217 )
Income tax
recovery
(expense) 24,460,758 (3,935,160 ) 24,418,531 6,541,380
Loss and
comprehensive
loss from
continuing
operations (134,619,929 ) (477,771,926 ) (196,663,830 ) (450,389,837 )
Loss from
discontinued
operations, net
of income tax (2,327,414 ) (83,578,124 ) (4,302,730 ) (86,074,460 )
Loss from
classification
to discontinued
operations, net
of income tax (11,082,725 ) - (11,082,725 ) -
Net loss $ (148,030,068 ) $ (561,350,050 ) $ (212,049,285 ) $ (536,464,297 )
Loss and
comprehensive
loss
attributable to
shareholders of
the company $ (147,985,084 ) $ (561,350,050 ) $ (211,800,036 ) $ (536,464,297 )
Loss and
comprehensive
loss
attributable to
redeemable
non-controlling
interest (44,984 ) - (249,249 ) -
Net loss $ (148,030,068 ) $ (561,350,050 ) $ (212,049,285 ) $ (536,464,297 )
Per share -
basic and
diluted
Loss per share
from continuing
operations $ (1.30 ) $ (4.85 ) $ (1.94 ) $ (4.80 )
Loss per share
from
discontinued
operations (0.13 ) (0.85 ) (0.15 ) (0.92 )
Loss per share $ (1.43 ) $ (5.70 ) $ (2.09 ) $ (5.72 )
Weighted
average number
of common
shares 103,489,965 98,421,935 101,154,772 93,802,606
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Discontinued Operations - Bulk Wholesale Business
During the third quarter of 2022, the Company made the strategic decision to exit its low margin bulk wholesale business (SISU) during the third quarter of 2022 to reduce complexity, prioritize higher-margin activities and conserve cash. Ultimately, the Company was successful in disposing of its bulk wholesale business onOctober 31, 2022 . The bulk wholesale business generated revenue from the sale of bulk flower and oil produced in-house. As such, the bulk wholesale business has been presented as discontinued operations commencing in the third quarter of 2022 in our financial statements. All comparative information has been restated to remove the bulk wholesale discontinued operations results practically meaning that in our Statement of Operations, we no longer show the revenues and costs of the bulk wholesale business consolidated with our continuing operations but rather the just the net losses incurred from this business below loss from continuing operations (i.e., discontinued operations loss of$2,327,414 and$4,302,730 for the three and nine months endedSeptember 30, 2022 compared to a discontinued operations loss of$83,578,124 and$86,074,460 in the three and nine months endedSeptember 30, 2021 ). Further, the Company recorded a loss from classification to discontinued operations of$11,082,725 in the three and nine months endedSeptember 30, 2022 compared to $nil in the three and nine months endedSeptember 30, 2021 . The Company believes exiting this business will reduce operating losses going forward. Sales Revenue During the third quarter of 2022 the Company focused on optimizing its operations and leveraging the assets it acquired in 2021 to achieve higher gross margins and reduce cash burn. Our results for the nine months endedSeptember 30, 2022 include the various omni-channel retail growth acquisitions we made during 2021 including:Martian Delivery, LLC ("Martian Delivery") (during the third quarter of 2021), Kase'sJourney Inc. ("Kase's Journey") (during the third quarter of 2021), Calma and Coastal (both during the fourth quarter of 2021). The Company considers itself post the exit of the bulk wholesale business to have one sales channel - omni-channel retail (brick and mortar retail, e-commerce pick up & delivery, as well as the sale of various branded wholesale products). The Company directly sells first party and selected third party products into dispensaries acrossCalifornia , leveraging in-house sales teams, as well as the two wholesale distribution centers inSan Jose andCosta Mesa , respectively. As previously announced, the Company has transitioned its wholesale distribution activities to Nabis, a leading cannabis wholesale platform inCalifornia . As ofSeptember 30, 2022 , the Company operated twelve retail locations and four consumer delivery hubs. Subsequent to quarter-end, one delivery hub was closed. We operate four store brands, Caliva, Deli by Caliva, Coastal and Calma. The Company's continuing operations revenue for the three and nine months endedSeptember 30, 2022 was$19,560,190 and$63,674,204 compared to$18,894,135 and$55,385,321 in the comparative three and nine month periods endingSeptember 30, 2021 representing growth of 3.5% and 15%. respectively. The Company achieved omni-channel retail growth as the comparative period did not include the financial results contributed by Coastal and Calma all of which were acquired subsequent toSeptember 30, 2021 . The consolidation of Coastal and Calma in the three and nine months endedSeptember 30, 2022 offset a decrease in same store revenue and average order volume at several retail locations that are presented in the three and nine months endedSeptember 30, 2021 . Gross Profit
Gross Profit reflects our revenue less our cost of sales, which consist of costs primarily consisting of labor, materials, consumable supplies, overhead, amortization of production equipment, shipping, packaging and other expenses.
The Company's continuing operations gross profit for the three and nine months endedSeptember 30, 2022 was$6,618,122 (33.8%) and$19,358,170 (30.4%) compared with$5,000,492 (26.5%) and$11,610,696 (21%) in the three and nine months endedSeptember 30, 2021 . The improved gross margins represent the results of the various margin enhancing initiatives the Company implemented during 2022 as described in the highlights section of this MD&A. Operating Expenses Three months ended Nine months ended September 30, September 30, September 30, September 30, 2022 2021 2022 2021 General and administrative$ 9,717,296 $ 10,713,535 $ 31,554,670 $ 29,251,275 Allowance for doubtful amounts 722,456 460,358 3,303,791 546,975 Sales and marketing 2,687,884 2,478,499 9,812,259 37,901,914 Salaries and benefits 9,149,250 8,455,719 29,039,258 26,271,625 Share-based compensation 1,061,119 3,612,656 4,764,289 17,450,820 Lease expense 1,940,550 1,035,901 5,807,447 3,165,803 Depreciation and amortization 1,139,282 909,111 2,982,641 2,367,810 Amortization of intangible assets 10,420,607 3,271,209 20,772,458 11,806,979$ 36,838,444 $ 30,936,988 $ 108,036,813 $ 128,763,201 Operating expenses primarily include salaries and benefits, professional fees, rent and facilities expenses, travel-related expenses, advertising and promotion expenses, licenses, fees and taxes, office supplies and pursuit expenses related to outside services, stock-based compensation and other general and administrative expenses. For the three and nine months endedSeptember 30, 2022 , the Company recorded operating expenses of$36,838,444 and$108,036,813 , respectively compared with$30,936,988 and$128,763,201 in the three and nine months endedSeptember 30, 2021 comparative periods. General and administrative costs were$9,717,296 and$31,554,670 in the three and nine months endedSeptember 30, 2022 compared with$11,260,510 and$29,798,250 in the comparative ending in the three and nine months endedSeptember 30, 2021 . The$1,543,214 or 14% decrease in general administrative expenses achieved during the third quarter of 2022 due mainly to lower professional fees and savings from cost reduction initiatives implemented during the year. General and administrative costs for the nine months endedSeptember 30, 2022 were$1,756,420 or 5.9% higher than in the nine-month comparative period due mainly to the cost of the consolidated 2021 year end audit including costs associated with accounting for the Qualifying Transaction incurred during the first quarter of 2022. 38 Table of Contents The allowance for doubtful accounts was$722,456 and$3,303,791 in the three and nine months endedSeptember 30, 2022 compared with$460,358 and$546,975 in the three and nine months endedSeptember 30, 2021 . The increased allowance reflects management's estimates for credit losses on various trade receivables and the Mosaic.Ag matter as described later in this MD&A. Salaries and benefits totaled$9,149,250 and$29,039,258 in the three and nine months endedSeptember 30, 2022 and$8,455,719 and$26,271,625 in the three and nine months endedSeptember 30, 2021 . The increases of$693,531 (8.2%) and$2,767,633 (10.5%) in the three and nine months endedSeptember 30, 2022 is the result of the consolidation of additional head count acquired via the Coastal, Martian, Kase and Calma acquisitions, severances of$409,128 net of restructuring efficiencies. Share based compensation totaled$1,061,119 and$4,764,289 in the three and nine months endedSeptember 30, 2022 compared with$3,612,656 and$17,450,820 in the three and nine months endedSeptember 30, 2021 . Share based compensation is a non-cash expense and fluctuates with the number of restricted stock units ("RSUs") granted in a period and the stock price. The decrease in stock-based compensation expense was primarily attributable to the significant number of RSUs granted in connection with the Qualifying Transaction during 2021, as well as the fact that the market price of our common shares is lower in 2022 than it was in 2021. Lease expense totaled$1,940,550 and$5,807,447 in the three months and nine endedSeptember 30, 2022 and$876,285 and$3,165,803 in the three and nine months endedSeptember 30, 2021 . The increases reflect the numerous acquisitions made during 2021 which are consolidated in the financial results for the three and nine months endedSeptember 30, 2022 whereby the Company increased the number of lease properties and itsCalifornia footprint, as well as the Pullman property sale and lease back arrangement as previously disclosed. Depreciation of property, plant & equipment totaled$1,139,282 and$2,982,641 in the three and nine months endedSeptember 30, 2022 compared with$876,285 and$3,165,803 in the three and nine months endedSeptember 30, 2021 . Depreciation is a non-cash expense and the slight expense increases in the periods represents the higher property, plant & equipment asset base owned by the Company atSeptember 30, 2022 compared toSeptember 30, 2021 due to the various acquisitions made in 2021. Amortization of intangible assets totaled$10,420,607 and$20,772,458 in the three and nine months endedSeptember 30, 2022 compared with$3,271,209 and$11,806,979 . Amortization is a non-cash expense. The increase in amortization expense is due to additional intangible assets acquired as part of the various acquisitions in 2021. Non-Cash Impairment In accordance with Accounting Standard Codification (ASC) Topic 350, the Company is required to assess its goodwill and other indefinite-lived intangible assets for impairment annually or in between tests if events or changes in circumstances indicate the carrying value of its assets may not be recovered. Further, under ASC 360, the Company is required to assess definite lived-intangible assets and long-lived assets whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Impairment charges totaled$127,815,307 and$130,244,837 in the three and nine months endedSeptember 30, 2022 compared with$485,601,121 and$560,500,228 in the three and nine months endedSeptember 30, 2021 . As part of the annual impairment assessment, the Company's future forecasts considered changes in cash flow estimates due to lower cannabis industry growth rate assumptions and cost pressures due to higherU.S. inflation. While the Company remains optimistic that cannabis legalization will occur, our expected future cash flows reflect the current tax and regulatory environment. The issues faced by the Company are not unique to our operations as the entireCalifornia cannabis market has been impacted. The Company continues to focus on activities to create long-term shareholder value and restructure its business to reduce its operating costs. Other Items Interest (expense) Interest expense totaled$1,183,968 and$3,694,798 for the three and nine months endedSeptember 30, 2022 compared with$1,093,562 and$3,757,176 in the three and nine months endedSeptember 30, 2021 . The interest expense is primarily incurred on lease accounting for the Company's right-of-use assets. Discontinued Operations The Company recorded a loss from discontinued operations (its bulk wholesale business) of$2,327,414 and$4,302,730 for the three and nine months endedSeptember 30, 2022 compared to$83,578,124 and$86,074,460 in the three and nine months endedSeptember 30, 2021 . The much larger losses in the comparative period endedSeptember 30, 2021 is primarily due to larger impairment losses recorded in this period. The Company further recorded a loss from classification to discontinued operations, net of income tax of$11,082,725 in the three and nine months endedSeptember 30, 2022 compared with $nil in the three and nine months endedSeptember 30, 2021 .
Net loss and Comprehensive Loss
The Company recorded net losses of$148,030,068 and$212,049,285 in the three and nine months endedSeptember 30, 2022 compared to$561,350,050 and$536,464,297 in the comparative period endedSeptember 30, 2021 . The reduction in losses is due primarily to lower impairment charges in the current periods and to a lesser extent due to higher realized margins and some operating cost efficiencies. 39 Table of Contents
Management's Use of Non-GAAP Measures
This MD&A contains certain financial performance measures, including "EBITDA" and "Adjusted EBITDA," that are not recognized under generally accepted accounting principles inthe United States ("GAAP") and do not have a standardized meaning prescribed by GAAP. As a result, these measures may not be comparable to similar measures presented by other companies. For a reconciliation of these measures to the most directly comparable financial information presented in the Interim Financial Statements in accordance with GAAP, see the section entitled "Reconciliation of Non-GAAP Measures" of this MD&A. We believe EBITDA is a useful measure to assess the performance of the Company as it provides more meaningful operating results by excluding the effects of expenses that are not reflective of our underlying business performance and other one-time or non-recurring expenses. We define "EBITDA" as net income (loss) before (i) depreciation and amortization; (ii) income taxes; and (iii) interest expense and debt amortization. Adjusted EBITDA
We believe Adjusted EBITDA is a useful measure to assess the performance of the
Company as it provides more meaningful operating results by excluding the
effects of expenses that are not reflective of our underlying business
performance and other one-time or non-recurring expenses. We define "Adjusted
EBITDA" as EBITDA adjusted to exclude extraordinary items, non-recurring items
and, other non-cash items, including, but not limited to (i) stock-based
compensation expense, (ii) fair value change in contingent consideration and
investments measured at Fair Value Through Profit and Loss ("FVPL")(iii)
non-recurring legal and professional fees, human-resources, inventory and
collections-related expenses, (iv) intangible and goodwill impairments and loss
on disposal of assets, and (v) transaction costs related to merger and
acquisition activities.
Reconciliation of Non-GAAP Measures
A reconciliation of EBITDA and Adjusted EBITDA to the most directly comparable measure determined under GAAP is set out below.
TPCO Holding Corp. Interim condensed consolidated statements of income and comprehensive income (Unaudited, inUnited States dollars) Three-months ended Nine-months ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Net loss and comprehensive loss from continuing$ (134,619,929 ) $ (477,771,926 ) $ (196,663,830 ) $ (450,389,837 ) Income taxes from continuing operations (24,460,758 ) 3,935,160 (24,418,531 ) (6,541,380 ) Depreciation and amortization from continuing operations 11,559,889 4,180,320 23,755,099 14,174,789 Interest expense from continuing operations 1,183,968 1,093,562 3,694,798 3,757,176 EBITDA (146,336,830 ) (468,562,884 ) (193,632,464 ) (438,999,252 ) Adjustments: Share based compensation expense 1,061,119 3,612,656 4,764,289 17,450,820 Other non-recurring items: Fair value change of contingent consideration (3,558 ) (38,178,321 ) (642,153 ) (220,997,087 ) Change in fair value of investments at fair value through profit or loss 388,878 768,030 421,974 418,818 Loss on disposal of assets - 137,042 317,787 3,656,707 Impairment loss 127,815,307 485,601,121 130,244,837 560,500,228 Other taxes - - - 2,243,441 De-SPAC costs - 500,000 - 4,121,807 Restructuring costs 1,139,128 1,500,000 1,139,128 3,878,782 Sales and marketing expense - - - 30,151,147 Adjusted EBITDA$ (15,935,956 ) $ (14,622,356 ) $ (57,386,602 ) $ (37,574,589 ) The Company's EBITDA loss was$146,336,830 and$193,632,464 for the three and nine months endedSeptember 30, 2022 compared with$468,403,268 and$438,999,252 in the comparative periods endedSeptember 30, 2021 . The lower EBITDA losses are due to primarily lower impairment charges recorded in the three and nine months endedSeptember 30, 2022 compared to the three and nine months endedSeptember 30, 2021 . Adjusted EBITDA
The Company's Adjusted EBITDA loss was$15,935,956 and$57,386,602 for the three and nine months endedSeptember 30, 2022 compared with$14,462,740 and$37,574,589 in the comparative periods endedSeptember 30, 2021 . The increased Adjusted EBITDA losses are due to the increased size of the Company with its numerous acquisitions made during 2021, which are still being integrated. The Company is focused on improving its margins and reducing operating costs.
The Company's management views Adjusted EBITDA as the best measure of its underlying operating performance.
Liquidity and Capital Resources
We manage liquidity risk by reviewing, on an ongoing basis, our sources of liquidity and capital requirements. As atSeptember 30, 2022 ,The Parent Company had cash and cash equivalents of$107,111,075 compared with cash and cash equivalents of$165,310,609 as atDecember 31, 2021 . Cash and cash equivalents are predominately invested in liquid securities issued bythe United States
government.
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In evaluating our capital requirements, including the impact, if any, on our
business from the COVID-19 pandemic, and our ability to fund the execution of
our strategy, we believe we have adequate available liquidity to enable us to
meet our working capital and other operating requirements, fund growth
initiatives and capital expenditures, settle our liabilities and repay scheduled
principal and interest payments on debt for at least the next twelve months.
Our objective is to generate sufficient cash to fund our operating requirements
and expansion plans. Since the closing of the Qualifying Transaction on January
15, 2021 , we have incurred net operating losses. However, management is
confident in the Company's ability to grow revenue and reach long- term
profitability. We also expect to have access to public capital markets through
our listing on the NEO Exchange, and continue to review and pursue selected
external financing sources to ensure adequate financial resources. These
potential sources include, but are not limited to (i) obtaining financing from
traditional or non-traditional investment capital organizations; (ii) obtaining
funding from the sale of our common shares or other equity or debt instruments;
and (iii) obtaining debt financing with lending terms that more closely match
our business model and capital needs. There can be no assurance that we will
gain adequate market acceptance for our products or be able to generate
sufficient positive cash flow to achieve our business plans, that additional
capital or other types of financing will be available when needed, or that these
financings will be on terms favorable to the Company or at all.
We expect to continue funding operating losses as we ramp up our operations with
our available cash. Therefore, we are subject to risks including, but not
limited to, our inability to raise additional funds through debt and/or equity
financing to support our continued development, including capital expenditure
requirements, operating requirements and to meet our liabilities and commitments
as they come due.
The Company made the strategic decision to exit its low margin bulk wholesale
business during the third quarter of 2022 to reduce complexity, prioritize
higher-margin activities and conserve cash. As such, this bulk wholesale
business has been presented as discontinued operations commencing in the third
quarter of 2022 in our financial statements including in the statement of cash
flow. During the nine months ended September 30, 2022 , discontinued operations
used cash of $2,565,934 compared with a use of cash of $5,528,420 in the
comparative nine months ended September 30, 2021 . The divestment of the bulk
wholesale business was completed subsequent to September 30, 2022 . The Company
expects this divestment will reduce its operating cash burn rate going forward.
Off-Balance Sheet Arrangements
As of the date hereof the Company does not have any off-balance sheet financing arrangements and has not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets. Contractual Obligations The Company leases real estate used for dispensaries, production plants, and corporate offices. Lease terms for real estate generally range from 1 to 16.5 years. Most leases include options to renew for varying terms at the Company's sole discretion. Lease terms for these assets generally range from 1 to 2 years. Certain leases include escalation clauses or payment of executory costs such as property taxes, utilities, or insurance and maintenance. Rent expense for leases with escalation clauses is accounted for on a straight-line basis over the lease term. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants. The maturity of the contractual undiscounted lease liabilities as ofSeptember 30, 2022 : Operating Lease Finance Lease Remainder of 2022$ 1,441,432 $ 1,147,681 2023 4,826,896 4,625,156 2024 4,552,956 4,763,910 2025 4,518,781 4,906,828 2026 4,370,472 5,054,033 Thereafter 22,192,154 64,884,898
Total undiscounted lease liabilities 41,902,691
85,382,506
Interest on lease liabilities 16,559,013
48,589,146
Total present value of minimum lease payments 25,343,678 36,793,360 Lease liability - current portion
2,423,413 62,783
Lease liability $ 22,920,265 $ 36,730,577
Marketing Agreement ("MA")
The Company has engaged a third-party for strategic and promotional services.
During the three months ended March 31, 2021 and the nine months ended September
30, 2021 , the Company issued 2,376,425 common shares in settlement of the
initial $25,000,000 . As the shares vested immediately, the full amount of the
$25,000,000 has been recognized as an expense in operating expenses during the
nine months ended September 30, 2021 .
The Company is obligated to issue shares to the value of $1,875,000 quarterly
over the second and third year of the contract. During the nine months ended
September 30, 2022 , the Company issued 4,926,165 common shares to settle the
first, second and third quarterly payments.
The Company recognized an expense of $584,181 and $3,311,454 during the three
and nine months ended September 30, 2022 , respectively (three and nine months
ended September 30, 2021 - $1,363,636 and $3,803,030 ) in operating expenses as a
sales and marketing expense. As at September 30, 2022 , the cash-settled
liability is $3,632,574 (December 31, 2021 - $5,166,666 ).
The arrangement can be terminated by the counterparty in certain circumstances,
one of which is any change of control of the Company. In that case, the Company
is required to settle the agreement in a lump sum payment that consists of all
unpaid amounts. As at September 30, 2022 , the amount that the Company would be
liable for if the contract is terminated is $9,375,000 .
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Brand Strategy Agreement ("BSA")
The Company is party to the BSA, whereby the Company receives the services ofShawn C. Carter p/k/aJAY-Z 's related promotion and advertising for the remaining non-cancellable period of 5 years. The Company is committed to settle$21,500,000 in either cash or common shares at the option of the counterparty over the remaining non-cancellable period. The Company is recognizing the cost associated with the arrangement over the same period it is receiving services. During the three and nine months endedSeptember 30, 2022 , the Company recognized an expense of$1,104,167 and$3,312,500 , respectively (three and nine months endedSeptember 30, 2021 -$1,104,167 and$3,079,399 , respectively) in operating expenses related to this arrangement and$2,496,065 accounts payable and accrued liabilities as atSeptember 30, 2022 (December 31, 2021 -$2,183,565 ). During the nine months endedSeptember 30, 2022 , the Company made a cash payment of$3,000,000 (September 30, 2021 - $nil). The agreement can be terminated by the counterparty in certain circumstances, including a change in control of the Company or an involuntary de-listing. In these circumstances, the Company will be obligated to pay damages equal to$18,500,000 less the amount already paid under the arrangement. As atSeptember 30, 2022 , the amount of damages that the Company would be liable for if the contract is terminated was$13,500,000 . Mosaic.Ag OnMay 16, 2021 , the Company entered into a membership interest purchase agreement (the "Membership Interest Purchase Agreement") to obtain leasehold interests of approximately 10 years duration in each of four one-acre parcels of land that are licensed for outdoor cannabis grow (collectively, the "Outdoor Grow Properties "). OnMay 21, 2021 (the "Effective Date"), the Company entered into series of cultivation and supply agreements with each of the leaseholders of theOutdoor Grow Properties and Mosaic.AG, Inc. ("Mosaic.Ag"), pursuant to which Mosaic.Ag agreed to cultivate cannabis on each of theOutdoor Grow Properties on the Company's behalf for a period commencing on the Effective Date of and ending at least three years from the closing of the transactions contemplated by the Membership Interest Purchase Agreement, with options to extend for up to five years (the "Cultivation and Supply Agreements"). Under the terms of the Membership Interest Purchase Agreement, as of the Effective Date, the Company and Mosaic.Ag obtained access to theOutdoor Grow Properties and began to commence cannabis cultivation activities under the Cultivation and Supply Agreements. The purchase price under the Membership Interest Purchase Agreement is$6,000,000 in cash,$2,500,000 in common shares of the Company payable on the closing date (with the number of shares issued based on the volume-weighted average price per common share for the ten consecutive trading days prior to the closing date) and up to 1,309,263 common shares of the Company subject to an earnout based on the production value of cannabis grown on theOutdoor Grow Properties over the twenty-four months following the Effective Date. The closing of the transactions contemplated by the Membership Interest Purchase Agreement are dependent on the satisfaction of various closing conditions, multiple of which were not met by the end of the second quarter of 2022 as required by the Membership Interest Purchase Agreement. Further, Mosaic.Ag was unable to produce sufficient quantities of biomass according to Company quality standards and pursuant to the Cultivation Supply Agreements. For the foregoing reasons,TPCO delivered to Mosaic onJune 30, 2022 , notice of its exercise of its contractual rights to terminate each of the Cultivation and Supply Agreements and the Membership Interest Purchase Agreement effective on such date. Pursuant to the terms of the Membership Interest Purchase Agreement, on the Effective Date, the Company advanced to the seller$5,650,000 secured by a promissory note, which note is now past its maturity date. Pursuant to the terms of the Cultivation and Supply Agreements, the Company made payments for cannabis product in advance based on a projected aggregate yield, with Mosaic owing a refund for any overpayment in the event of the actual yield (as measured at the conclusion of the growing season) being less than the projected yield, which event did transpire, triggering a refund owed to Company of approximately$1,500,000 . There can be no assurance the promissory note and/or the overpayment amount will be repaid in full, or at all. The Company expects to pursue repayment of such debts through appropriate legal actions. Other Legal Matters From time to time in the normal course of business, the Company may be subject to legal matters such as threatened or pending claims or proceedings. We are not currently a party to any material legal proceedings or claims, nor are we aware of any pending or threatened litigation or claims that could have a material adverse effect on our business, operating results, cash flows or financial condition should such litigation or claim be resolved unfavorably. Inflation The Company is not immune to the widespread cost inflation experienced inthe United States and many parts of the world. The Company intends to continue to work to improve its gross margins by partnering with its vendors.
Critical Accounting Policies and Estimates
For a description of our critical accounting policies and estimates, refer to
Part II, Item 7, Critical Accounting Estimates in our 2021 Form 10-K. There have
been no material changes to our critical accounting estimates from the
information provided in our 2021 Form 10-K.
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Cash Flow
The table below highlights our cash flows for the periods indicated:
(Unaudited, inUnited States dollars) Nine months ended
September 30, 2022 September 30, 2021
Cash provided by (used in)
Operating activities
Net loss from continuing operations $ (196,663,830 ) $ (450,389,837 )
Adjustments for items not involving
cash
Impairment loss 130,244,837 560,500,228
Interest expense 3,694,798 3,739,340
Interest income (75,758 ) (993,639 )
Loss on disposal of assets 317,787 3,656,707
Loss on lease termination (114,458 )
Allowance for accounts receivable and
notes receivable 3,438,664 796,403
Gain on debt forgiveness - (3,358,686 ) Fair value change of investments 421,974
418,818
Depreciation and amortization 23,755,099
14,174,789
Shares issued for long-term strategic contracts -
25,000,000
Share-based compensation expense, net of tax 4,284,916
16,765,238
Non-cash marketing expense 3,311,454
3,803,030
Non-cash operating lease expense 5,402,936
3,029,654
Fair value change of contingent consideration (642,153 ) (220,997,087 ) Deferred income tax recovery (27,771,859 ) (13,714,716 ) Repayment of operating lease liabilities (5,276,778 ) (3,403,629 ) Net changes in non-cash working capital items (2,659,682 )
(39,995,798 )
Net cash used in continued operating activities (58,332,053 ) (100,969,185 ) Net cash used in discontinued operating activities (2,565,934 ) (5,528,420 ) Total operating activities (60,897,987 ) (106,497,605 ) Financing activities Receipt of payments on notes receivable 1,759,318 - Repayment of notes payable (4,680,000 ) -
Repayment of consideration payable (1,150,000 ) (872,021 ) Repayment of finance lease liabilities (3,342,761 ) (3,429,846 ) Proceeds from private placement -
51,635,000
Redemption of Class A restricted voting shares - (264,318,686 ) Proceeds from exercise of options -
12,972
Repurchase of shares - (4,454,571 )
Repayment of line of credit - (1,000,000 )
Total financing activities (7,413,443 ) (222,427,152 )
Investing activities
Net cash paid in the Qualifying
Transaction - (28,143,886 )
Net cash paid in business combinations - (1,402,337 )
Purchases of property and equipment (2,733,218 ) (8,725,860 ) Advances for note receivable - (5,650,000 ) Acquisition of investments (350,000 ) (1,000,000 )
Proceeds from notes receivable -
187,954
Proceeds from sale of property and equipment, net of selling costs 6,253,157 11,068,537 Total investing activities 3,169,939 (33,665,592 ) Net change in cash during the period (65,141,491 )
(362,590,349 )
Cash, restricted cash and restricted cash equivalents Beginning of period$ 174,892,298 $ 582,622,025 End of period$ 109,750,807 $ 220,031,676 Cash 107,111,075 206,677,145 Restricted cash and restricted cash equivalents 2,639,732
13,354,531
Cash, restricted cash and restricted cash equivalents$ 109,750,807 $ 220,031,676 43 Table of Contents Operating Activities Cash used in continued operating activities in the nine months endedSeptember 30, 2022 totaled$58,332,053 as compared to cash used in continued operating activities of$100,854,966 in the comparative nine month period endedSeptember 30, 2021 . In the nine months endedSeptember 30, 2022 , the cash used in operating activities represents an average operating cash burn rate of$6,481,339 per month compared to$11,206,107 per month in the comparative period. The Company is evaluating a number of options to improve operating results including: subleasing excess real estate, combining operations for lower performing locations, closing or disposing of non-core assets, and general and administrative cost reductions. Cash used in discontinued operating activities in the nine months endedSeptember 30, 2022 totaled$2,565,934 compared with cash used in discontinued operating activities of$5,528,420 in the comparative nine month period endedSeptember 30, 2021 . Financing Activities Cash used in financing activities totaled$7,413,443 in the nine months endedSeptember 30, 2022 compared with cash used of$222,427,152 in the comparative nine month period endedSeptember 30, 2021 . In the nine months endedSeptember 30, 2022 , the Company settled$3,342,761 lease liabilities associated with its real estate,$1,150,000 of consideration payable primarily related to its 2021 acquisition of Coastal,$4,680,000 for repayment of notes payable offset associated with Coastal and received$1,759,318 primarily from a legal settlement and the remainder from the sale of non-core assets. The nine months endSeptember 30, 2021 includes a payment of$264,318,686 in connection with the redemption of Class A restricted voting shares on closing the Qualifying Transaction. Investing Activities
Cash provided by investing activities totaled$3,169,939 in the nine months endedSeptember 30, 2022 compared with cash used of$33,665,592 in the comparative nine month period endedSeptember 30, 2021 . In the nine months endedSeptember 30, 2022 , the Company invested$150,000 in its social equity venture investment in Digistrains and$200,000 in Josephine & Billies, received$6,253,157 of proceeds from the sale of property, plant and equipment primarily associated with the sale and leaseback transaction at its Pullman property invested$2,733,218 of property plant and equipment to support its operations. The comparative nine month period endedSeptember 30, 2021 includes$29,546,223 of cash paid for acquisitions as the major use of cash.
Commitments and Contingencies
California Operating Licenses
The Company's primary activity is the cultivation, manufacturing and sale of adult use cannabis pursuant toCalifornia law. However, this activity is not in compliance with the United States Controlled Substances Act (the "CSA"). The Company's assets are potentially subject to seizure or confiscation by governmental agencies and the Company could face criminal and civil penalties for noncompliance with the CSA. Management of the Company
believes the Company is in compliance with all
The Company's operation is sanctioned by the
EffectiveJanuary 1, 2018 , theState of California allowed adult use cannabis sales. Beginning onJanuary 1, 2018 , the State began issuing temporary licenses that expired 120 days after issuance for retail, distribution, manufacturing and cultivation permits. Temporary licenses could be extended in 90- day increments by the State upon submission of an annual license application. All temporary licenses had been granted extensions by the State during 2018. InSeptember 2019 , Senate Bill 1459 (SB 1459) was enacted which enabled state licensing authorities to issue provisional licenses through 2021. A provisional license could be issued if an applicant submitted a completed annual license application to theCalifornia Bureau of Cannabis Control . A completed application for purposes of obtaining a provisional license is not the same as a sufficient application to obtain an annual license. The provisional cannabis license, which is valid for 12 months from the date issued, is said to be in between a temporary license and an annual license and allows a cannabis business to operate as they would under local and state regulations. Licensees issued a provisional license are expected to be diligently working toward completing all annual license requirements in order to maintain a provisional license. The Company obtained its provisional licenses in 2019 and continues to work with the State to obtain annual licensing. The Company's prior licenses obtained from the local jurisdictions it operated in have been continued by such jurisdictions and are necessary to obtain state licensing. The Company has received annual licenses from its local jurisdiction in which it actively operates. Although the Company believes it will continue to receive the necessary licenses from theState of California to conduct its business in a timely fashion, there is no guarantee the Company or its clients will be able to do so and any failure to do so may have a negative effect on the Company's business and results of operations.Social Equity Fund
The Company formed a wholly owned subsidiary to serve as its social equity fund during the during 2021 with a planned$10,000,000 investment and a planned annual contribution of at least 2% of net income from the Company. ThroughSeptember 30, 2022 , the Company has invested approximately$1,300,000 in three investments beingStanton Brands (dba Josephine & Billie's),Peakz LLC and
Digistrains.
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Share Capital and Capital Management
As ofSeptember 30, 2022 , the Company had 104,914,328 common shares and 35,837,500 common share purchase warrants (the "Warrants") issued and outstanding. The Warrants are exercisable at an exercise price of$11.50 and will expire onJanuary 15, 2026 . The Company may accelerate the expiry date of the outstanding Warrants (excluding the Warrants held bySubversive Capital Sponsor LLC in certain circumstances) by providing 30 days' notice, if and only if, the closing price of the Company's common shares equals or exceeds$18.00 per common share (as adjusted for stock splits or combinations, stock dividends, extraordinary dividends, reorganizations and recapitalizations) for any 20 trading days within a 30-trading day period. The Company has an equity incentive plan (the "Equity Incentive Plan") that permits the grant of stock options, RSUs, deferred share units, performance share units and stock appreciation rights to non-employee directors and any employee, officer, consultant, independent contractor or advisor providing services to the Company or any affiliate. As ofSeptember 30, 2022 , a total of 3,694,392 RSUs and 2,448,750 PSUs were outstanding under the Equity Incentive Plan. Prior to closing of the Qualifying Transaction, Caliva maintained theCMG Partners, Inc. 2019 Stock Option and Grant Plan (the "Caliva EIP"), which permitted awards of common stock in Caliva. In connection with the Qualifying Transaction, Caliva and the Company agreed that the Company would maintain the Caliva EIP and that outstanding awards thereunder will entitle the holder to receive Common Shares. There are currently 510,363 options to purchase up to 510,363 Common Shares under the Caliva EIP outstanding. No further awards will be granted under the Caliva EIP. Prior to closing of the Qualifying Transaction, LCV maintained the Amended and Restated 2018 Equity Incentive Plan (the "LCV Equity Plan") which authorized LCV to grant to its employees, directors and consultants stock options and other equity-based awards. In connection with the Qualifying Transaction, LCV and the Company agreed that the Company would maintain the LCV Equity Plan and that outstanding awards thereunder will entitle the holder to receive Common Shares. There are currently 9,206 options to purchase up to 9,206 Common Shares under the LCV Equity Plan outstanding. No further awards will be granted under the LCV Equity Plan.
The Company manages its capital with the following objectives:
· To ensure sufficient financial flexibility to achieve the ongoing business
objectives including of future growth opportunities, and pursuit of
accretive acquisitions; and
· To maximize shareholder return through enhancing the share value.
The Company considers its capital to be total equity. The Company manages
capital through its financial and operational forecasting processes. The Company
reviews its working capital and forecasts its future cash flows based on
operating expenditures, and other investing and financing activities. Selected
information is provided to the Board of Directors of the Company. The Company's
capital management objectives, policies and processes have remained unchanged
during the nine months ended September 30, 2022 and year ended December 31,
2021 . The Company is not subject to any external capital requirements.
Intellectual Property
The Company has a portfolio of industry leading products and brands. As part of
the Company's brand strategy, it strives to protect its proprietary products and
brand elements and its brand as California's premier consumer cannabis product
company. Intellectual property ("IP") protection is pursued both in its ability
to sell products and brands through first "Freedom to Operate" searches and
subsequently, reviewing proprietary and protectable claims, branding,
technology, or design assets. The Company evaluates opportunities for IP
protection from cultivation and strain development, in manufacturing and
processes, and for its portfolio of finished goods. The Company's IP protection
ranges from trademarks to patents to trade secrets and covers anything from
cultivation, genetics, product development, packaging development, claims,
operations, information technology, and branding.
Additionally, the Company partners from time to time with other companies and
pursues further IP protection through licensing and collaboration with those
partners.
The Company seeks to protect its proprietary information, in part, by executing confidentiality agreements with third parties and partners and
non-disclosure and invention assignment agreements with its employees and consultants. These agreements are designed to protect its proprietary information and ensure ownership of technologies that are developed through its relationship with the respective counterparty. The Company cannot guarantee, however, that these agreements will afford it adequate protection of its intellectual property and proprietary information rights. Competitive Conditions As the Company is vertically integrated it competes on multiple fronts, from manufacturing to retail to delivery, and experience competition in each of these areas. From a retail perspective, the Company competes with other licensed retailers and delivery companies in the geographies where retail and delivery services are located. These other retailers range from small local operators to more significant operators with a presence throughout theState of California and other states inthe United States . From a product perspective, the Company competes with other manufactures of brands for shelf space in third-party owned dispensaries throughoutCalifornia . Similar to certain competitors in the retail space, the Company competes with manufacturers ranging in size from small local operators to significant operators with a larger presence. Indirectly, the Company competes with the illicit market, including many illegal dispensaries. 45 Table of Contents
Specialized Knowledge, Skills, Resources & Equipment
Knowledge with respect to cultivating and growing cannabis is important in the cannabis industry and particularly in the medical cannabis industry. The nature of growing cannabis is not substantially different from the nature of growing other agricultural products. Variables such as temperature, humidity, lighting, air flow, watering and feeding cycles are meticulously defined and controlled to produce consistent product and to avoid contamination. The Company grows or procures the primary component of its finished products, namely cannabis. The Company's cultivation operations are dependent on a number of key inputs and their related costs including raw materials and supplies related to its growing operations, as well as electricity, water and other utilities. Staff with suitable horticultural and quality assurance expertise are generally available on the open market. The Company also requires client care staff, which will grow as its business grows. Customer care staff are also generally available on the open market.
Equipment used is specialized but is readily available and not specific to the cultivation of cannabis. Subject to available funding, the Company does not anticipate any difficulty in obtaining equipment.
The Company anticipates an increased demand for skilled manpower, energy resources and equipment in connection with the Company's expected continued growth.
Cannabis Industry Regulation OnFebruary 8, 2018 , the Canadian Securities Administrators revised their previously released Staff Notice 51-352 -Issuers withU.S. Marijuana-Related Activities ("Staff Notice 51-352"), which provides specific disclosure expectations for issuers that currently have, or are in the process of developing, cannabis-related activities inthe United States as permitted within a particular state's regulatory framework. All issuers withU.S. cannabis-related activities are expected to clearly and prominently disclose certain prescribed information in prospectus filings and other required disclosure documents. As a result of the Company's existing operations inCalifornia , the Company is providing the following disclosure pursuant to Staff Notice 51-352. The Company derives a substantial portion of its revenues from state legalized: (i) cannabis, and products containing cannabis, used by someone 21 or older that is not a medical cannabis patient (where use may include inhalation, consumption, or application) ("Adult-Use Cannabis") and (ii) to a lesser extent, cannabis and products containing cannabis used by medical cannabis patients in accordance with applicable state law, but for which no drug approval has been granted by theUnited States Food and Drug Administration (where use may include inhalation, consumption, or application) ("Medical-Use Cannabis") ((i) and (ii) collectively "Regulated Cannabis"). The Regulated Cannabis industry is illegal underU.S. Federal Law.The Parent Company is directly involved (through its licensed subsidiaries) in both the Adult-Use Cannabis and Medical-Use Cannabis industry in theState of California which has legalized and regulated such industries.The United States federal government regulates certain drugs through the Controlled Substances Act (21 U.S.C. §§ 801-971) (the "CSA") and through the Food, Drug & Cosmetic Act (21 U.S.C. §§ 301-392) (the "FDCA"). The CSA schedules controlled substances, including "marihuana" (defined as all parts of the plant cannabis sativa L. containing more than 0.3 percent THC), based on their approved medical use and potential for abuse. Marihuana (also referred to as cannabis) and THC ("except for tetrahydrocannabinols in hemp") are each classified as Schedule I controlled substances (21 U.S.C. § 812(c)). The Drug Enforcement Administration ("DEA "), an agency of theU.S. Department of Justice (the "DOJ") defines Schedule I drugs, substances or chemicals as "drugs with no currently accepted medical use and a high potential for abuse."The United States Food and Drug Administration (the "FDA"), which implements and enforces the FDCA, regulates, among other things, drugs used for the diagnosis or treatment of diseases. The FDA has not approved cannabis as a safe and effective treatment for any medical condition, and regularly issues cease-and-desist letters to manufacturers of CBD products making health claims to consumers in contravention of the FDCA. The FDA has approved drugs containing THC and CBD, individual cannabinoids in the plant cannabis sativa L., for a narrow segment of medical conditions. State laws that permit and regulate the cultivation, production, distribution, sale and use of Medical-Use Cannabis or Adult-Use Cannabis are in direct conflict with the CSA, which makes cannabis and THC distribution and possession federally illegal. Although certain states and territories of theU.S. authorize Medical- Use Cannabis or Adult-Use Cannabis production and distribution by licensed or registered entities, underU.S. federal law, the possession, cultivation, and/or transfer of cannabis and THC is illegal and any such acts are criminal acts under any and all circumstances under the CSA. Additionally, any cultivation, manufacture, possession, distribution and/or sale of cannabis accessories, in states without laws expressly permitting such activity, are also federally illegal activity under the CSA. Although the Company's activities are believed to be compliant with applicableCalifornia state and local law, strict compliance with state and local laws with respect to cannabis does not absolve the Company of liability underUnited States federal law, nor does it provide a defense to any federal proceeding which may be brought against the Company.
However, in
As ofSeptember 30, 2022 , 38 U.S. states, and theDistrict of Columbia and the territories ofGuam ,Puerto Rico , theU.S. Virgin Islands , and theNorthern Mariana Islands have legalized the cultivation and sale of Medical-Use Cannabis, with at least six of the remaining states expected to pass such legalization measures within the next 12 months. In 19 U.S. states, the sale and possession of both Medical-Use Cannabis and Adult-Use Cannabis has been legalized, though due to the time period between a state's legalization of commercial cannabis activities and the completion of its regulatory framework and marketplace launch, the purchase of Adult-Use Cannabis is currently possible in 13 states, with the remainder of the currently-legal states to commence sales activities in 2023. TheDistrict of Columbia has legalized Adult-Use Cannabis but has not yet permitted the commercial sale of Adult Use Cannabis, however, Adult-Use sales are expected to commence in 2023. 46 Table of Contents Eleven states have also enacted low-THC / high-CBD only laws for medical cannabis patients. The sale and possession of both Medical-Use Cannabis and Adult-Use Cannabis is legal in theState of California , subject to applicable licensing requirements and compliance with applicable conditions. Included in the numbers above are ballot initiatives to legalize Adult-Use Cannabis which passed inNovember 2020 , withArizona commencing Adult-Use sales inJanuary 2021 , andNew Jersey andMontana commencing Adult-Use sales in 2022 andMississippi enacting Medical-Use cannabis legislation inJanuary 2022 , following a successful ballot initiative and subsequent invalidation on technical grounds by theMississippi State Supreme Court . Under PresidentBarack Obama , theU.S. administration attempted to address the inconsistencies between federal and state regulation of cannabis in a memorandum which then-Deputy Attorney GeneralJames Cole sent to allUnited States Attorneys onAugust 29, 2013 (the "2013 Cole Memorandum") outlining certain priorities for theDOJ relating to the prosecution of cannabis offenses. The 2013 Cole Memorandum noted that in jurisdictions that have enacted laws legalizing or decriminalizing Regulated Cannabis in some form and that have also implemented strong and effective regulatory and enforcement systems to control the cultivation, processing, distribution, sale and possession of Regulated Cannabis, conduct in compliance with those laws and regulations is less likely to be a priority at the federal level. TheDOJ did not provide (and has not provided since) specific guidelines for what regulatory and enforcement systems would be deemed sufficient under the 2013 Cole Memorandum. In light of limited investigative and prosecutorial resources, the 2013 Cole Memorandum concluded that theDOJ should be focused on addressing only the most significant threats related to cannabis, a non-exhaustive list of which was enumerated therein. OnJanuary 4, 2018 ,U.S. Attorney GeneralJeff Sessions formally issued a new memorandum (the "Sessions Memorandum"), which rescinded all "previous nationwide guidance specific to marijuana enforcement," including the 2013 Cole Memorandum. The Sessions Memorandum stated, in part, that current law reflects "Congress' determination that Cannabis is a dangerous drug and Cannabis activity is a serious crime", andMr. Sessions directed allU.S. Attorneys to enforce the laws enacted byCongress by following well-established principles when pursuing prosecutions related to cannabis activities. There can be no assurance that the federal government will not enforce federal laws relating to cannabis in the future. As a result of the Sessions Memorandum, federal prosecutors are now free to utilize their prosecutorial discretion to decide whether to prosecute cannabis activities despite the existence of State-level laws that may be inconsistent with federal prohibitions. No direction was given to federal prosecutors in the Sessions Memorandum as to the priority they should ascribe to such cannabis activities, and resultantly it is uncertain how activeU.S. federal prosecutors will be in relation to such activities. The Company believes it is still unclear what prosecutorial effects will be created by the rescission of the 2013 Cole Memorandum. The Company believes that the sheer size of the Regulated Cannabis industry, in addition to participation by state and local governments and investors, suggests that a large- scale enforcement operation would more than likely create unwanted political backlash for theDOJ and the Biden administration in certain states that heavily favor decriminalization and/or legalization. Regardless, cannabis and THC remain Schedule I controlled substances at the federal level, and neither the 2013 Cole Memorandum nor its rescission has altered that fact. The federal government ofthe United States has always reserved the right to enforce federal law in regard to the manufacture, distribution, sale and disbursement of Medical-Use Cannabis or Adult-Use Cannabis, even if state law permits such cultivation, manufacture, distribution, sale and disbursement. The Company believes, from a purely legal perspective, that the criminal risk today remains similar to the risk onJanuary 3, 2018 . It remains unclear whether the risk of enforcement has been altered. Additionally, underUnited States federal law, it is a violation of federal money laundering statutes for financial institutions to take any proceeds from the sale of Regulated Cannabis or any other Schedule I controlled substance. Canadian banks are likewise hesitant to deal with cannabis companies, due to the uncertain legal and regulatory framework of the industry. Banks and other financial institutions, particularly those that are federally chartered inthe United States , could be prosecuted and possibly convicted of money laundering for providing services to Regulated Cannabis businesses. WhileCongress is considering legislation that may address these issues, there can be no assurance that such legislation passes.
Despite these laws, theU.S. Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN") issued a memorandum onFebruary 14, 2014 (the "FinCEN Memorandum") outlining the pathways for financial institutions to bank state-sanctioned Regulated Cannabis businesses in compliance with federal enforcement priorities. The FinCEN Memorandum echoed the enforcement priorities of the 2013 Cole Memorandum and stated that in some circumstances, it is possible for banks to provide services to cannabis-related businesses without risking prosecution for violation of federal money laundering laws. Under these guidelines, financial institutions must submit a Suspicious Activity Report ("SAR") in connection with all cannabis-related banking activities by any client of such financial institution, in accordance with federal money laundering laws. These cannabis-related SARs are divided into three categories-cannabis limited, cannabis priority, and cannabis terminated-based on the financial institution's belief that the business in question follows state law, is operating outside of compliance with state law, or where the banking relationship has been terminated, respectively. On the same day that the FinCEN Memorandum was published, theDOJ issued a memorandum (the "2014 Cole Memorandum") directing prosecutors to apply the enforcement priorities of the 2013 Cole Memorandum in determining whether to charge individuals or institutions with crimes related to financial transactions involving the proceeds of cannabis-related conduct. The 2014 Cole Memorandum has been rescinded as ofJanuary 4, 2018 , along with the 2013 Cole Memorandum, removing guidance that enforcement of applicable financial crimes against state-compliant actors was not aDOJ priority. However, former Attorney General Sessions' rescission of the 2013 Cole Memorandum and the 2014 Cole Memorandum has not affected the status of the FinCEN Memorandum, nor has theDepartment of the Treasury given any indication that it intends to rescind the FinCEN Memorandum itself. Though it was originally intended for the 2014 Cole Memorandum and the FinCEN Memorandum to work in tandem, the FinCEN Memorandum is a standalone document which explicitly lists the eight enforcement priorities originally cited in the 2013 Cole Memorandum. As such, the FinCEN Memorandum remains intact, indicating that theDepartment of the Treasury and FinCEN intend to continue abiding by its guidance. However, FinCEN issued further guidance onDecember 3, 2019 , in which it acknowledged that the Agricultural Improvement Act of 2018 (the "Farm Bill") removed hemp as a Schedule I controlled substance and authorized theUnited States Department of Agriculture ("USDA") to issue regulations governing, among other things, domestic hemp production. The guidance states that because hemp is no longer a controlled substance under federal law, banks are not required to file SARs on these businesses solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations. The guidance further notes that for hemp-related customers, banks are expected to follow standard SAR procedures, and file a SAR if indicia of suspicious activity warrants. FinCEN noted in itsDecember 2019 guidance that the 2014 SAR reporting structure for cannabis remains in place even with the passage of the Farm Bill and this additional guidance related to hemp. FinCEN confirmed this point in guidance issued onJune 29, 2020 , and clarified that, if proceeds from cannabis-related activities are kept separate, a SAR filing is only required for the cannabis-related part of a business that engages in both cannabis and hemp activity. 47 Table of Contents Although the 2013 Cole Memorandum has been rescinded, one legislative safeguard for the Medical-Use Cannabis industry has historically remained in place:Congress adopted a so-called "rider" provision to the fiscal years 2015, 2016, 2017, and 2018, 2019 and 2020 and 2021. Consolidated Appropriations Acts (currently referred to as the "Rohrabacher/Blumenauer Amendment") to prevent the federal government from using congressionally appropriated funds to enforce federal cannabis laws against regulated Medical-Use Cannabis actors operating in compliance with state and local law. OnMarch 15, 2022 , the Rohrabacher/Blumenauer Amendment was renewed through the signing of the fiscal year 2022 omnibus bill, which extended the protections of the Amendment throughSeptember 30, 2022 . The Rohrabacher/Blumenauer Amendment may or may not be included in a subsequent omnibus appropriations package or a continuing budget resolution. Should the Rohrabacher/Blumenauer Amendment not be renewed upon expiration in subsequent spending bills, there can be no assurance that the federal government will not seek to prosecute cases involving medical cannabis businesses that are otherwise compliant with State law. Such potential proceedings could involve significant restrictions being imposed upon the Company. TheUnited States Congress has passed appropriations bills each of the last four years that have not appropriated funds for prosecution of cannabis offenses of individuals who are in compliance with state medical cannabis laws. American courts have construed these appropriations bills to prevent theU.S. federal government from prosecuting individuals when those individuals comply with state law relating to approved medical uses. However, because this conduct continues to violateU.S. federal law, American courts have observed that shouldCongress at any time choose to appropriate funds to fully prosecute the CSA, any individual or business-even those that have fully complied with state law-could be prosecuted for violations ofU.S. federal law. And ifCongress restores funding, the government will have the authority to prosecute individuals for violations of the law that took place before received funding under the CSA's five-year statute of limitations. In recent years, certain temporary federal legislative enactments that protect the Medical-Use Cannabis and industry have also been in effect. For instance, cannabis businesses that are in strict compliance with state law receive a measure of protection from federal prosecution by operation of a temporary appropriations measures that has been enacted into law as an amendment (or "rider") to federal spending bills passed byCongress and signed by Presidents Obama, Trump and Biden. First adopted in the Appropriations Act of 2015,Congress has included in successive budgets since a "rider" that prohibits theDOJ from expending any funds to enforce any law that interferes with a state's implementation of its own medical cannabis laws. The rider, discussed above, is known as the "Rohrbacher-Blumenauer" Amendment, and now known colloquially as the "Joyce-Amendment" after its most recent sponsors. The rider was renewed onMarch 15, 2022 through the signing of the FY 2022 omnibus spending bill, which extended the protections of the Amendment throughSeptember 30, 2022 . Despite the legal, regulatory, and political obstacles the Regulated Cannabis industry currently faces, the industry has continued to grow. Under certain circumstances, the federal government may repeal the federal prohibition on cannabis and thereby leave the states to decide for themselves whether to permit Regulated Cannabis cultivation, production and sale, just as states are free today to decide policies governing the distribution of alcohol or tobacco. Until that happens, the Company faces the risk of federal enforcement and other risks associated with the Company's business. However, as noted previously, inOctober 2022 President Biden directed theDepartment of Justice and Department of Health & Human Services to conduct a review of the scheduling status of cannabis. It is anticipated that cannabis may be rescheduled or descheduled entirely within the next 12-24 months.
To the knowledge of management of the Company, there have not been any
statements or guidance made by federal authorities or prosecutors regarding the
risk of enforcement action in
The Company's objective is to capitalize on the opportunities presented as a result of the changing regulatory environment governing the cannabis industry inthe United States . Accordingly, there are a number of significant risks associated with the business of the Company. Unless and until theUnited States Congress amends the CSA with respect to Medical-Use Cannabis or Adult-Use Cannabis, there is a risk that federal authorities may enforce current federal law, and the business of the Company may be deemed to be producing, cultivating, extracting, or dispensing "marihuana" or aiding or abetting or otherwise engaging in a conspiracy to commit such acts in violation ofU.S. federal law. The Company has received and continues to receive legal input, in verbal and written form (including opinions when required), regarding (a) compliance with applicable state and local regulatory frameworks and (b) potential exposure and implications arising fromU.S. federal law in certain respects. The 2013 Cole Memorandum and the Rohrabacher/Blumenauer Amendment gave Medical-Use Cannabis operators and investors in states with legal regimes greater certainty regarding federal enforcement as to establish Regulated Cannabis businesses in those states. While the Sessions Memorandum has introduced some uncertainty regarding federal enforcement, the Regulated Cannabis industry continues to experience growth in legal Medical-Use Cannabis and Adult-Use Cannabis markets acrossthe United States .U.S. Attorney GeneralJeff Sessions resigned onNovember 7, 2018 . Nonetheless, there is no guarantee that state laws legalizing and regulating the sale and use of cannabis will not be repealed or overturned, even under aBiden Administration's DOJ or that local governmental authorities will not limit the applicability of state laws within their respective jurisdictions. Unless and until theUnited States Congress amends the CSA with respect to cannabis and THC (and as to the timing or scope of any such potential amendments there can be no assurance), there is a risk that federal authorities may enforce currentU.S. federal law. Despite the expanding market for Regulated Cannabis, traditional sources of financing, including bank lending or private equity capital, are lacking which can be attributable to the fact that cannabis remains a Schedule I substance under the CSA. These traditional sources of financing are expected to remain scarce unless and until the federal government legalizes cannabis cultivation and sales.
Exposure to
The Company operates inthe United States through various subsidiaries and other entities pursuant to arrangements with third-parties on arm's length terms as more specifically described herein. As of the date hereof, a majority of the Company's business was directly derived fromU.S. cannabis-related activities. As such, a majority of the Company's balance sheet and operating statement for periods following closing of the Qualifying Transaction will reflects exposure toU.S. cannabis related activities. 48 Table of Contents
California Regulatory Landscape
In 1996,California was the first state to legalize Medical-Use Cannabis through Proposition 215, the Compassionate Use Act of 1996. This legislation legalized the use, possession and cultivation of cannabis by patients with a physician recommendation for treatment of cancer, anorexia, AIDS, chronic pain, spasticity, glaucoma, arthritis, migraine, or any other illness for which cannabis provides relief.
In 2003, Senate Bill 420 was signed into law establishing not-for-profit medical cannabis collectives and dispensaries, and an optional identification card system for Medical-Use Cannabis patients.
InSeptember 2015 , theCalifornia legislature passed three bills collectively known as the Medical Cannabis Regulation and Safety Act (" MCRSA"). The MCRSA established a licensing and regulatory framework for Medical-Use Cannabis businesses inCalifornia . The system created multiple license types for dispensaries, infused products manufacturers, cultivation facilities, testing laboratories, transportation companies, and distributors. Edible infused product manufacturers would require either volatile solvent or non-volatile solvent manufacturing licenses depending on their specific extraction methodology. Multiple agencies would oversee different aspects of the program and businesses would require a state license and local approval to operate. However, inNovember 2016 , voters inCalifornia passed Proposition 64, the Adult Use of Marijuana Act ("AUMA"), creating an Adult-Use Cannabis program for adults 21 years of age or older. InJune 2017 , theCalifornia State Legislature passed Senate Bill No. 94, known as Medicinal and Adult-Use Cannabis Regulation and Safety Act ("MAUCRSA"), which amalgamated MCRSA and AUMA and provided for a set of regulations to govern a medical and adult-use licensing regime for cannabis businesses in theState of California . The four agencies that regulate cannabis at the state level are theBureau of Cannabis Control ("BCC"), CalCannabis at theCalifornia Department of Food and Agriculture ("CalCannabis"), and theManufactured Cannabis Safety Branch California Department of Public Health ("MCSB"), andCalifornia Department of Tax andFee Administration . MAUCRSA went into effect onJanuary 1, 2018 . MAUCRSA was then amended and restated inJuly 2021 through the annual budget trailer bill process to, among other things, consolidate the three state licensing agencies-BCC, CalCannabis and MCSB-into a single licensing authority known as theDepartment of Cannabis Control ("DCC"). Subsequent to the agency consolidation, the newly formed DCC consolidated the three separate sets of BCC, CalCannabis, and MCSB regulations into a single set of state regulations, which regulations went into effect as ofSeptember 27, 2021 .
To legally operate a Medical-Use Cannabis or Adult-Use Cannabis business inCalifornia , the operator must generally have both a local and state license. This requires license holders to operate in cities with cannabis licensing programs. Therefore, counties and cities inCalifornia are allowed to determine the number of licenses they will issue to cannabis operators, or can choose to outright ban the siting of cannabis operations in their jurisdictions.
California Licensing Requirements
A storefront retailer license with an "M-designation" permits (i) the purchase of cannabis goods that are "For Medical Use Only" from licensed distributors (ii) the sale of such medicinal cannabis goods to medicinal cannabis patients age 18 years of age or older inCalifornia who possesses a physician's recommendation. Only certified physicians may provide medicinal cannabis recommendations. A storefront retailer license with an "A-designation" permits the sale of cannabis and cannabis products to any individual age 21 years of age or older regardless of whether they possess a physician's recommendation. A storefront retailer license with both the M- and A- designations is permitted to do all of the above described in this paragraph. Where the local jurisdiction permits, a state storefront retailer license allows the retailer to engage in delivery of cannabis goods to retail customers. A non-storefront license permits the same delivery activity, but does not permit the licensee to operate a retail storefront. A distribution license permits the license holder to engage in the procurement, storage, required regulatory and compliance testing, sale to certain licensed entities within theState of California , and transport of cannabis and cannabis products between licensees.
An adult-use or medicinal cultivation license permits cannabis cultivation which means any activity involving the planting, growing, harvesting, drying, curing, grading or trimming of cannabis. Such licenses further permit the production of a limited number of "non-manufactured cannabis products" and the sales of cannabis to certain licensed entities within theState of California for resale or manufacturing purposes.
An adult-use or medical manufacturing license permits the manufacturing of "manufactured cannabis products". Manufacturing includes the compounding, blending, extracting, post-processing refinement, infusion, packaging or repackaging, labeling or relabeling, remediation or other preparation of a cannabis product in theState of California , only cannabis that is grown in the state by a licensed operator can be sold in the state.California neither mandates or prohibits integration, and the state allows licensees to make wholesale purchase of cannabis from, or a distribution of cannabis and cannabis product to, another licensed entity within the state. Holders of cannabis licenses inCalifornia are subject to a detailed regulatory scheme encompassing security, staffing, transport, sales, manufacturing standards, testing, inspections, inventory, advertising and marketing, product packaging and labeling, white labeling, records and reporting, and more. As with all jurisdictions, the full regulations, as promulgated by each applicable state agency, should be consulted for further information about any particular operational area. 49 Table of Contents
California Reporting Requirements
TheState of California uses METRC as the state's track-and-trace system used to track commercial cannabis activity and movement across the distribution chain for all state-issued licensees. The system allows for other third-party system integration via application programming interface. Only licensees have access to METRC.
California Storage and Security
To ensure the safety and security of cannabis business premises and to maintain adequate controls against the diversion, theft, and loss of cannabis or cannabis products,California's retail cannabis businesses are generally required to
do the following:
· limit access to storefront retail premises to medical cannabis patients at
least 18 years and older, and adults 21 and over maintain a fully
operational security alarm system;
· contract for professionally-certified security guard services;
· maintain a video surveillance system that records continuously 24 hours a
day;
· ensure that the facility's outdoor premises have sufficient lighting;
· not dispense from its premises outside of permissible hours of operation;
· limit the daily amount of cannabis goods dispensed to individual customers
to prevent diversion;
· store cannabis and cannabis product only in areas per the premises diagram
submitted to and approved by the
process;
· store all cannabis and cannabis products in a secured, locked room or a
vault; report to local law enforcement and the DCC within 24 hours after
discovering the theft, diversion, or loss of cannabis; and
· ensure the safe transport of cannabis and cannabis products between
licensed facilities, maintain a delivery manifest and QR-code scannable
State license in any vehicle transporting cannabis and cannabis products.
Only vehicles registered with the DCC that meet DCC distribution
requirements are to be used to transport cannabis and cannabis products.
California Home Delivery Requirements
California law allows certain licensed retailers to deliver cannabis to adult customers at any private address within the state, including within those jurisdictions that have land use and zoning ordinances prohibiting the establishment of commercial cannabis businesses. At least 25 local jurisdictions where cannabis sales are banned sued the state, seeking to overturn the rule allowing home deliveries statewide. As of the date hereof, the suit was dismissed on procedural grounds, and the state regulation stands. To the knowledge of management, there have been no significant enforcement efforts mounted by local governments. TheState of California requires the satisfaction of various regulatory compliance obligations in order to operate a cannabis delivery service. The cannabis license that permits the operation of a storefront dispensary in theState of California (also referred to as a retail license) currently permits that entity to also establish a delivery operation. If an entity does not wish to set up and operate a storefront dispensary location at which it can sell products to customers in person,California has established a separate license which allows for a retail delivery operation (also referred to as a non-storefront retail license).California regulations regarding the delivery of cannabis products include the following requirements:
· All deliveries of cannabis goods must be performed by a delivery employee
(at least 21 years of age) who is directly employed by a licensed
retailer.
· All deliveries of cannabis goods must be made in person to a physical
address that is not on publicly-owned land or to a building leased by a
public agency.
· Prior to providing cannabis goods to a delivery customer, a delivery
employee must confirm the identity and age of the delivery customer (as is
required if such customer was purchasing the product in the physical
retail store) and ensure that all cannabis goods sold comply with the
regulatory requirements.
· A licensed cannabis entity is permitted to contract with a service that
provides a technology platform to facilitate the sale and delivery ofcannabis goods, in accordance with all of the following: (1) the licensed
cannabis entity does not allow for delivery of cannabis goods by the
technology platform service provider; (2) the licensed entity does notshare in the profits of the sale of cannabis goods with the technology
platform service provider, or otherwise provide for a percentage or
portion of the cannabis goods sales to the technology platform service
provider; (3) the licensed cannabis entity does not advertise or market
cannabis goods in conjunction with the technology platform service
provider, outside of the technology platform, and ensures that the
technology platform service provider does not use the licensed cannabis
entity's license number or legal business name on any advertisement or
marketing that primarily promotes the services of the technology platform;
and (4) provides various disclosures to customers about the source of the
delivered cannabis goods.
In March 2022 , the state of California issued notable new regulations pertaining
to cannabis delivery. First, the state increased the total value of cannabis
goods delivery employees can carry in their vehicle from $5,000 to $10,000 .
Second, for purposes of this limit, the state removed any distinction between
"ordered" and "unordered" product. These changes will afford cannabis delivery
operators considerably more flexibility, allowing them to carry a broader array
of products and serve a larger geographic area. These regulations are proposed
to take effect in November 2022 .
California Cannabis Cultivation Tax
As ofJuly 1st, 2022 ,California has eliminated its cannabis cultivation tax. Prior to this, cannabis cultivated inCalifornia was subject to a$161 /pound tax. In practice, this tax amounted to 30% or more of the wholesale price of cannabis. The elimination of the cannabis cultivation tax may make legal cannabis more competitive withCalifornia's robust illicit cannabis market.
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Laws Applicable to Financial Services for Regulated Cannabis Industry
All banks are subject to federal law, whether the bank is a national bank or state-chartered bank. At a minimum, most banks maintain federal deposit insurance which requires adherence to federal law. Violation of federal law could subject a bank to loss of its charter. Financial transactions involving proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes, unlicensed money transmitter statutes and the Currency and Foreign Transactions Reporting Act of 1970 (31 U.S.C. § 5311 et seq) (commonly known as the "Bank Secrecy Act"). For example, under the Bank Secrecy Act, banks must report to the federal government any suspected illegal activity, which would include any transaction associated with a Regulated Cannabis-related business. These reports must be filed even though the business is operating in compliance with applicable state and local laws. Therefore, financial institutions that conduct transactions with money generated by Regulated Cannabis-related conduct could face criminal liability under the Bank Secrecy Act for, among other things, failing to identify or report financial transactions that involve the proceeds of cannabis-related violations of the CSA. FinCEN issued guidance inFebruary 2014 which clarifies how financial institutions can provide services to cannabis-related businesses consistent with their obligations under the Bank Secrecy Act. Concurrently with the FinCEN guidance, theDOJ issued supplemental guidance directing federal prosecutors to consider the federal enforcement priorities enumerated in the 2013 Cole Memorandum with respect to federal money laundering, unlicensed money transmitter and Bank Secrecy Act offenses based on cannabis-related violations of the CSA. The FinCEN guidance sets forth extensive requirements for financial institutions to meet if they want to offer bank accounts to cannabis-related businesses, including close monitoring of businesses to determine that they meet all of the requirements established by theDOJ , including those enumerated in the 2013 Cole Memorandum. This is a level of scrutiny that is far beyond what is expected of any normal banking relationship. Under the 2019 FinCEN guidance discussed above, banks are not required to file SARs on businesses solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations. However, the 2014 guidance remains in place with respect to Regulated Cannabis businesses. FinCEN confirmed this point in guidance issued onJune 29, 2020 , and clarified that, if proceeds from cannabis-related activities are kept separate, a SAR filing is only required for the cannabis- related part of a business that engages in both cannabis and
hemp activity. As a result, many banks are hesitant to offer any banking services to Regulated Cannabis-related businesses, including opening bank accounts. While the Company currently has bank accounts, its inability to maintain these accounts or the lack of access to bank accounts or other banking services in the future, would make it difficult for the Company to operate its business, increase its operating costs, and pose additional operational, logistical and security challenges. Furthermore, it remains unclear what impact the rescission of the 2013 Cole Memorandum and 2014 Cole Memorandum will have, but federal prosecutors may increase enforcement activities against institutions or individuals that are conducting financial transactions related to cannabis activities. Ongoing Compliance Overview
The Company is subject to the general licensing and regulatory framework inCalifornia set out under the heading "United States Regulatory Environment -California ". The Company has developed a compliance program designed to achieve its strategic business goals while protecting the organization and operations. The Company's compliance program integrates external regulations with internal rules and procedures to effectively lay out expectations for employee duties and behaviors; this aligns the goals of its employees with those of the Company and helps the Company's operations run smoothly. The Company focuses on upholding policies and procedures that ensure the organization and its employees comply with applicable laws and regulations. Employee Training The Company is in the process of training employees, and in completing development of and instituting a robust online training center for employees, in connection with its compliance program's objectives, relevant policies and procedures, and the basic components of the compliance program. Such training includes additional specialized training for various policies and procedures that are applicable to specific job functions and/or departments where needed to properly perform their jobs. Training is tracked, attested to, and documented.
Inventory and Security Policies
Maintaining security and inventory control is important to the Company and it has adopted a number of policies, procedures, and practices in these areas:
Security: The Company has taken extensive security measures including implementing professionally vetted policies, procedures, and systems to provide comprehensive protection, not only for its physical plant and inventory, but also for its employees, customers, and the surrounding public. Every licensed facility has strict access controls, thorough video surveillance coverage, and burglar alarms linked directly to local police departments. These controls are supported by professionally certified on-site security personnel in certain instances. Inventory: The Company maintains inventory control and reporting systems that document the present location, amount, and a description of all cannabis and cannabis products at all facilities. The traceability of cannabis goods is maintained using theCalifornia's "Track-and-Trace" system, METRC, and the Company's integrated enterprise resource planning system ("ERP"). The Company conducts regular continuous cycle counts in addition to both quarterly and annual manual inventory reconciliations, in accordance with regulations and
best practices. Operational Compliance
Internal audits are conducted quarterly in the normal course. These audits allow
us to identify and monitor the Company's strengths and weaknesses, highlighting
continuous opportunities for improvement. These internal audits also provide us
an opportunity to reinforce best practices and to institute changes in areas
that are identified as opportunities for improvement. The information discovered
and obtained during these internal audits is used to improve the compliance
programs, when necessary, by revising policies, strengthening training, and
establishing better reporting processes. The focus of the Company's internal
compliance audit is to ensure it is compliant with both state and local laws and
regulations and internal policies and procedures. Internal audits may be delayed
or completed remotely by video from time to time as a result of COVID-19
precautions.
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Big Data Analysis
The Company has invested in a highly scalable data architecture and platform
built using leading technologies and tools. By extracting data from its ERP
software and the California METRC track and trace system and subsequently
organizing it in its data warehouse, the Company has enabled critical data and
insights for its compliance efforts. The Company's data warehouse secures and
stores all data and transactions at frequent intervals, allowing extensive
access and analysis to information that is current. The Company has the ability
to understand precise movement of inventory or dollars, past or present,
required for review or due diligence as related to compliance requirements or
inquiries. The Company is using this data infrastructure proactively to track,
monitor and reconcile inventory levels and for ongoing reconciliation withMETRC. Ongoing Compliance The Company prides itself on a robust internal compliance program encompassing both the compliance measures described above as well as monitoring compliance withU.S. state law on an ongoing basis. Key to those compliance efforts is the employment of individuals dedicated to monitoringCalifornia law for changes and updates to statutes and regulations, both at the state level and the local level, that impact business operations. Currently, the Company employs five individuals whose job function includes some aspect of compliance. Further, the Company employs a government relations employee whose primary job function is to monitor the changing landscape of state and local law while employing an external consultant and two external law firms that assist in the monitoring, notification, and interpretation of any changes. Additionally, the Company currently implements and maintains standard operating procedures ("SOPs") that are designed for monitoring compliance withCalifornia law on an ongoing basis. These SOPs include regular review of current and anticipated statutes, regulations, and ordinances and the training of employees to maintain compliance withCalifornia law. In addition to the internal compliance team and the consultants and law firms described above, the Company also engages local regulatory compliance counsel and consultants in the jurisdictions in which it operates. Such counsel regularly provides legal advice to the Company regarding compliance with state and local laws and regulation and the Company's legal and compliance exposures underUnited States federal law.
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