INTRODUCTION
This Management’s Discussion and Analysis (“MD&A”) should be read together with other information, including the Company’s audited consolidated financial statements and accompanying notes as of and for the years ended December 31, 2022 and 2021 included elsewhere in this Annual Report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.
In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those in this discussion as a result of various factors, including but not limited to those discussed in Part 1, Item 1A, “Risk Factors” in this Annual Report.
The Company is an “emerging growth company,” as defined in Section 2(a) of the Securities, as modified by the JOBS Act, and it may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the independent registered public accounting firm attestation requirements of Section 404 of Sarbanes-Oxley, reduced disclosure obligations regarding executive compensation in its periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.
Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards.
The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non- emerging growth companies but any such election to opt out is irrevocable. The Company has elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, the Company, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. This may make comparison of the Company’s financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accounting standards used.
The Company will remain an emerging growth company until the earlier of (1) the last day of the Company’s fiscal year following the fifth anniversary of the date of the first sale of common equity securities of the Company pursuant to an effective registration statement under the Securities Act, (2) the last day of the fiscal year in which the Company has total annual gross revenue of at least $1.07 billion, (3) the last day of the fiscal year in which the Company is deemed to be a “large accelerated filer,” as defined in Rule 12b-2 under the Exchange Act, and (4) the date on which the Company has, during the previous three year period, issued more than $1.0 billion in nonconvertible debt.
We are a consumer-focused cannabis company based in the United States focused on the recreational and wellness markets. Our operations in California are focused on building winning brands supported by our omni-channel ecosystem. Our platform was designed to create the most socially responsible and culturally impactful cannabis company in the 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 our delivery service and strategically located storefront retail locations across California. A full 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 a high caliber of quality. We believe our delivery and storefront retail outlets will allow us to achieve high gross-margins on many of our products, forge one-on-one relationships between our brands and consumers and collect proprietary consumer data and insights.
As part of our cost reduction initiatives, we recently took the following actions:
While we are focused on the recreational and wellness markets, a small portion (estimated to be less than 1%) of our revenues is derived Medical-Use Cannabis.
Our operational footprint spans production and manufacturing, brands, retail and delivery. Our management team and directors bring together deep expertise in cannabis, consumer packaged goods, investing and finance, from start-ups to publicly traded companies. We aim to leverage the collective industry experience of our management and directors.
Following our exit from the bulk wholesale business, we view our business as having one sales channel: omni-channel retail, comprised of brick and mortar retail, e-commerce pick up & delivery, as well as the sale of various branded wholesale products. As of December 31, 2022, we operate twelve omni-channel retail locations and one stand-alone delivery depot. We operate four store brands, Caliva, Deli by Caliva, Coastal and Calma.
Our continuing operations revenue for the year ended December 31, 2022 was $83,637,407 compared to $79,924,941 in the comparative year ended December 31, 2021 representing growth of 4.6%, respectively.
As we continue to scale and integrate our business, we are incurring operating losses. Our operating losses for the year ended December 31, 2022 totaled $242,938,787, (including an impairment loss of $130,566,825), compared to a loss of $733,885,024 (including an impairment loss of $575,498,897) in the comparative year ended December 31, 2021. We continue to actively evaluate additional cost reductions and business optimization to reduce our cash burn in the near term.
Our financial results for the period ended December 31, 2021 did not include operating results from January 1, 2021 to January 15, 2021 due to the fact that the Qualifying Transaction, pursuant to which our business operations began, closed on January 15, 2021. Accordingly, our results of operations are not necessarily comparable between the year ended December 31, 2022 and the year ended December 31, 2021.
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, we intend to set the example globally as a best-in-class cannabis operation.
Below is a summary of the key components of The Parent Company’s growth strategy:
Factors Affecting Our Performance
The Company’s performance and future success depends on a number of factors. These factors are also subject to a number of inherent risks and challenges, some of which are discussed below.
We have built our brand with a focus on the growing direct to consumer (“DTC”) market. We understand that it is critical to establish trust at all levels of our operations, starting with an executive team and board of directors that believe in “doing business the right way”, focusing on long-term shareholder value and creating trust with our various stakeholders. We strive to prioritize our consumers and our employees (who we refer to as “associates”). We establish trust with our consumers through their experience, which encompasses not only our award-winning products but the consumer’s full buying experience. At The Parent Company, we make information on the products that consumers choose readily available, including the ability to interact with our associates at not only our retail locations, but also curbside as well as through phone and video consultations. The Parent Company’s brand strategy is a “House of Brands” strategy, providing the ability to expand our product lines to meet changing consumer tastes and preferences.
The Company is subject to the local and federal laws in the jurisdictions in which it operates. Outside of the United States, the Company’s products may be subject to tariffs, treaties and various trade agreements as well as laws affecting the importation of consumer goods. The Parent Company holds all required licenses for the production and distribution of its products in the jurisdictions in which it operates and continuously monitors changes in laws, regulations, treaties and agreements. The Company is licensed to cultivate, manufacture, distribute and sell wholesale and retail cannabis and cannabis products. The Company operates in, and/or has ownership interests in businesses operating in, California, pursuant to the California Medicinal and Adult-Use Cannabis Regulation and Safety Act.
Product Innovation and Consumer Trends
The Company’s business is subject to changing consumer trends and preferences, which is dependent, in part, on continued consumer interest in new products. The success of new product offerings depends upon a number of factors, including The Parent Company’s ability to: (i) accurately anticipate customer needs? (ii) develop new products that meet these needs? (iii) successfully commercialize new products? (iv) price products competitively? (v) produce and deliver products in sufficient volumes and on a timely basis? and (vi) differentiate product offerings from those of competitors.
In March 2020, the World Health Organization categorized coronavirus disease 2019 (“COVID-19”) as a pandemic. COVID-19 continues to impact the United States and other countries across the world, and the duration and severity of its effects are currently unknown. While the impacts of COVID-19 have lessened in recent months, the Company continues to implement and evaluate actions to maintain its financial position and support the continuity of its business and operations in the face of this pandemic and other events.
The Company’s priorities during the COVID-19 pandemic and any future pandemic are protecting the health and safety of its employees and its customers, following the recommended actions of government and health authorities. In the future, a resurgence of COVID-19 or a new pandemic in the United States may cause demand for the Company’s products and services if, for example, the pandemic results in a recessionary economic environment or potential new restrictions on business operations or the movement of individuals.
The COVID-19 outbreak in the United States caused business disruption both to the Company and throughout its customer base and supply chain through mandated and voluntary closings of many businesses.
We took the following steps in response to the COVID-19 pandemic:
Currently, our business is largely unaffected by COVID-19, due to the significant decrease in the number of cases that have developed where we have facilities.
Strengthened Management Team
The Company strengthened its leadership team during 2022 with the additions of Esther Song (Chief Marketing Officer), Rozlyn Lipsey (EVP Operations and Wholesale) and Mindi Basha (VP/General Manager Retail).
The Company eliminated its Corporate Development department given the change in focus from a California cannabis market consolidation strategy to focus on cost efficiencies/profitability of its existing assets. Readers should refer to the detailed list cost reduction initiatives in the Business Overview section of this MD&A.
Revenue Growth and Gross Margin Improvement Initiatives
To drive revenue growth and margin improvement in stores, the Company:
The Company developed a plan to consolidate TPCO brands down to five first party brands: Caliva, Cruisers, Mirayo by Santana and Chill and Monogram.
The Company launched “RCVRY”, a premium cannabis product 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. Nordan is currently filming and releasing content across his social channels that follow his road to recovery (RCVRY).
Revised Strategic Agreement with ROC Nation, SC Branding and Affiliates
On December 29, 2022, the Company and certain of its subsidiaries (Caliva, TPCO-US, and NC3), each as entered into the Roc Modification Agreement with Roc Nation. In addition, on December 29, 2022 the Company and certain of its subsidiaries entered into a series of agreements with SC Branding and certain of SC Brandings’ affiliates, including (a) the Termination Agreement, by and between the Company and SC Branding, (b) the Services Agreement, (c) the Brand Transfer Agreement, by and among the Company, Caliva, TPCO-US, and NC3, on the one hand, and SC Branding and Mother Room, on the other hand, and (d) the License Agreement, by and between Mother Room and TPCO-US.
The Roc Modification Agreement supplants the Roc Binding Heads of Terms. The Roc Modification Agreement, among other things, terminated various ongoing Roc Nation service obligations and eliminated future TPCO equity contributions to Roc Nation pursuant to the Binding Heads of Terms. Furthermore, in connection with the Roc Modification Agreement (i) Roc Nation agreed to surrender to the Company 4,865,939 Common Shares, (ii) Roc Nation and the Company agreed to a three-year plan of collaboration with respect to resolving issues of social equity associated with harms created by the prohibition of cannabis and (iii) Roc Nation undertook to introduce various Roc Nation partners and artists to the Company over a three-year period.
Under the SC Branding Agreements, among other things, (A) the parties terminated the Brand Strategy Agreement, (B) the parties cancelled the Company’s obligation to make all future annual payments pursuant to such Brand Strategy Agreement, (C) the parties created a three-year plan of collaboration with respect to resolving issues of social equity associated with harms created by the prohibition of cannabis, (D) the Company and certain of its subsidiaries transferred all rights to the Monogram brand to Mother Room, and (E) Mother Room granted to TPCO-US a license to use the Monogram brand in connection with the legal cannabis businesses in California for an eight-year term, subject to termination under certain conditions. In addition, pursuant to the Brand Transfer Agreement, SC Branding and certain of its affiliates agreed to surrender to the Company 2,255,300 Common Shares.
Closing of Coastal Acquisition
On November 14, 2022, we completed the acquisition of 100% of the equity of Coastal Holding Company, LLC, a California retail dispensary and delivery operator (“Coastal Holding“) by issuing approximately 24,999,999 shares of Coast L Acquisition Corp., a wholly owned subsidiary of TPCO. The shares of Coast L Acquisition Corp. are exchangeable on a one-for-one basis into Common Shares. We also paid an additional $3.75 million upon closing and assumed approximately $1.8 million of debt.
Completion of Acquisition of Calma West HollywoodDuring the three months ended September 30, 2022, we acquired the 15% of the equity of Calma West Hollywood (“Calma”) that we did not own in exchange for 1,762,495 Common Shares.
Through December 31, 2022, we have invested approximately $1,300,000 in three investments being Stanton Brands (dba Josephine & Billie’s), Peakz LLC and Digistrains.
During the first quarter of 2022, we entered into a 50/50 agreement with Peakz NFT, LLC, an entity formed by social equity entrepreneur Jessie Grundy, to develop and launch a collection of cannabis-focused non-fungible token’s (“NFT’s”) referred to as “Digistrains”. The Company invested $150,000 to seed the initiative (the “Initial Capital Contribution”) and expects the Digistrain NFT collection to be launched in the near future. Any distributions from this initiative must first be utilized to repay the Initial Capital Contribution before being shared amongst members of the joint venture.
On July 1, 2022, we agreed to make a follow-on $200,000 investment in our existing Josephine & Billie’s investment, bringing our total investment to $700,000. 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 put 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 help build a sustainable business.
We have repositioned our social equity venture fund 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.
Sale and Leaseback of Pullman Property
During the first quarter of 2022, we completed the sale and leaseback of our property on Pullman Avenue in San Jose, California. We received $6,000,000 up front and a $500,000 promissory note receivable over five years. We leased back the space for a ten year term with an option to terminate early after five years and with two five-year options to extend the term at a annual base rent of $552,500.
Subsequent to December 31, 2022, the Company issued 165,217 shares for RSUs and PSUs that were vested.
On January 5, 2023, 7,121,239 Common Shares of the Company were returned to treasury in connection with the revised strategic agreement with ROC Nation, SC Branding and Affiliates.
On February 22, 2023, the Company finalized the sale of Culver City for $350,000 cash.
Proposed Business Combination with Gold Flora, LLC
On February 21, 2023, the Company entered into an agreement to combine with Gold Flora, a leading vertically integrated California cannabis company, in an all-stock merger. Under the terms of the merger agreement, the Company’s shareholders will own approximately 49%, and Gold Flora holders will own approximately 51%, of the outstanding common equity of the combined company on a pro forma basis upon consummation of the business combination.
Upon completion of the transaction, Troy Datcher will be named Chairman of the Board and Laurie Holcomb, the Chief Executive Officer of Gold Flora, will be named Chief Executive Officer of the combined company.
Key Transaction Benefits & Strategic Rationale
Proposed Transaction Summary
The Business Combination will be completed, subject to the Merger Agreement, by way of a court-approved plan of arrangement under the Business Corporations Act (British Columbia), whereby a newly formed British Columbia corporation (“Newco “), created to manage and hold the combined business of The Parent Company and Gold Flora, will, directly and indirectly, acquire all of the issued and outstanding Common Shares and all of the issued and outstanding membership units in the capital of Gold Flora (“Gold Flora Units”). Newco will then domesticate in the United States as a Delaware corporation pursuant to Section 388 of the Delaware General Corporation Law.
Subject to the terms and conditions set forth in the Business Combination Agreement, the Plan of Arrangement and the Plan of Merger, holders of TPCO Common Shares will receive one Newco Share for each TPCO Share held and holders of Gold Flora Units will receive 1.5233 Newco Shares for each Gold Flora Unit held, resulting in the issuance of an aggregate of approximately 312,138,271 New Parent Shares. The Business Combination values Gold Flora at $1.50 per Gold Flora Unit and The Parent Company at $0.9847 per TPCO Share.
Following completion of the Business Combination, current holders of TPCO Common Shares will hold approximately 49% of New Parent and current holders of Gold Flora Units will hold approximately 51% of New Parent.
In connection with the Business Combination, TPCO US Holding LLC, a direct and wholly-owned subsidiary of TPCO, and Gold Flora entered into a working capital facility agreement, pursuant to which the Lender has agreed to advance to Gold Flora in a principal amount of up to $5,000,000, which shall bear interest at a rate of 10% per annum, and shall be secured by certain assets of Gold Flora. The outstanding balance of the loan will become due and payable if the Business Combination Agreement is terminated, subject to certain conditions.
In connection with the Business Combination, Newco will redomicile to the United Stated as a Delaware corporation pursuant to Section 388 of the Delaware General Corporation Law and will operate as Gold Flora Corporation. Newco will remain a reporting issuer in Canada and the United States and, subject to receipt of all requisite stock exchange approvals, it is expected that the Newco Shares will be listed on the NEO Exchange Inc. and on the OTCQX Best Market tier of the electronic over-the-counter marketplace operated by OTC Markets Group Inc.
The Parent Company has entered into voting and support agreements with each of its directors and officers and certain shareholders holding an aggregate of approximately 11% of the issued and outstanding TPCO Common Shares, pursuant to which these parties have agreed, subject to certain rights of withdrawal, to vote in favor of the Business Combination and not to dispose of their TPCO Common Shares.
Gold Flora has entered into voting and support agreements with each manager and the majority holder of its membership interests holding an aggregate of 75.9% of the issued and outstanding Gold Flora Units, pursuant to which these parties have agreed, subject to certain rights of withdrawal, to vote in favor of the Business Combination and not to dispose of their Gold Flora Units.
The Business Combination contains certain customary provisions, including covenants in respect of non-solicitation of alternative business combination proposals for The Parent Company and Gold Flora and a reciprocal termination fee of $4,000,000, payable to either the Company or Gold Flora in certain circumstances. See Item 1. Business-Proposed Business Combination with Gold Flora– Certain Other Terms of the Business Combination Agreement.”
In connection with the Business Combination, the Company anticipates filing a proxy statement and management information circular (the “Circular”) in connection with an annual general and special meeting of holders of TPCO Common Shares (the “Meeting”) expected to be held in the second quarter of this year (unless the U.S. Securities and Exchange Commission elects to review the preliminary Circular, in which case the Meeting is likely to be held in early in the third quarter of this year) to approve the Business Combination.
The Business Combination is expected to close before the end of the third quarter of 2023, following the satisfaction or waiver of closing conditions including, among others, approval by two-thirds of the votes cast by the shareholders of The Parent Company at the Meeting, the approval of the Supreme Court of British Columbia, and the approval of the NEO Exchange.
Net loss from discontinued operations $ (5,239,379 ) $ (88,705,864 )
Discontinued Operations – Bulk Wholesale Business
The Company was successful in disposing of its bulk wholesale business on October 31, 2022 which will reduce complexity, prioritize higher-margin activities and conserve cash. 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 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 net of tax loss of $5,087,408 for the year ended December 31, 2022 compared to a discontinued operations net of tax loss of $88,705,864 in the year ended December 31, 2021). The Company believes exiting this business will reduce operating losses going forward.
The Company’s sales revenues for the year ended December 31, 2022 was $83,637,407 compared to $79,924,941 in the previous year representing growth of 4.6%.
Our results for the year ended December 31, 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’s Journey Inc. (“Kase’s Journey”) (during the third quarter of 2021), Calma and Coastal (both during the fourth quarter of 2021). The consolidation of these entities in 2022 offset a decrease in same store revenue and average order volume at several retail locations that are presented in our results for the year ended December 31, 2021.
Following our exit from the bulk wholesale business, we view our business as having one sales channel: omni-channel retail comprised of 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 across California, leveraging in-house sales teams, as well as the two wholesale distribution centers in San Jose and Costa Mesa, respectively. As previously announced, the Company has transitioned its wholesale distribution activities to Nabis, a leading cannabis wholesale platform in California.
As of December 31, 2022, we operate twelve omni-channel retail locations and one stand-alone delivery depot. We operate four store brands, Caliva, Deli by Caliva, Coastal and Calma.
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 year ended December 31, 2022 was $26,010,043 (30.4%) compared with $13,018,287 (16.3%) in the year ended December 31, 2021. The significantly improved gross margins represent the results of the various margin enhancing initiatives the Company implemented during 2022 as described in the Business Overview section of this MD&A.
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 year ended December 31, 2022, the Company recorded operating expenses of $138,381,437 compared with $171,404,414 for the year ended December 31, 2021.
General and administrative costs were $42,170,219 in the year ended December 31, 2022 compared with $42,395,204 for the year ended December 31, 2021. The $224,985 or 0.5% decrease in general administrative expenses is due mainly to cost containment efforts offset partially by the full year consolidation of the Company’s 2021 acquisitions (including Coastal and Calma) which increased the size of the Company.
The allowance for doubtful accounts was $3,216,310 in the year ended December 31, 2022 compared with $3,933,081 in the comparative year ended December 31, 2021. The $716,771 decrease in the allowance reflects management’s estimates for credit losses on various trade receivables being comparatively lower in the current year than the prior year which included a larger provision for the Mosaic.Ag matter as described in the Commitments and Contingencies section of this MD&A.
Sales and marketing costs were $12,679,477 in the year ended December 31, 2022 compared with $42,413,733 in the comparative year ended December 31, 2021. The $29,734,256 decrease is mainly attributable to the fact that the 2021 comparative period included $25,000,000 of sales & marketing expense paid in shares to Roc Nation under the marketing agreement that became effective January 19, 2021.
Salaries and benefits totaled $39,441,476 in the year ended December 31, 2022 and $35,119,133 in the year ended December 31, 2021. The increase of $4,322,343 (12.3%) is the result of the consolidation of additional head count acquired via the Coastal Holding, Martian Delivery, Kase’s Journey and Calma acquisitions, and severances expenses incurred for restructuring the business for longer term cost efficiencies.
Share based compensation totaled $6,009,593 in the year ended December 31, 2022 compared with $20,456,297 in the year ended December 31, 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 $8,068,405 in the year ended December 31, 2022 and $4,647,233 in the year ended December 31, 2021. The $3,421,172 increase reflect the numerous acquisitions made during 2021 which are consolidated in the financial results for the year ended December 31, 2022 whereby the Company increased the number of lease properties and its California footprint, as well as the Pullman property sale and lease back arrangement as previously disclosed.
Depreciation of property, plant & equipment totaled $3,953,038 compared with $3,213,376 in the year ended December 31, 2021. Depreciation is a non-cash expense and the $739,662 increase in the expense in the 2022 period represents the higher property, plant & equipment asset base owned by the Company at December 31, 2022 compared to December 31, 2021 due to the various acquisitions made in 2021.
Amortization of intangible assets totaled $22,842,919 compared with $19,226,357 in the year ended December 31, 2021. Amortization is a non-cash expense. The $3,616,562 increase in amortization expense is due to additional intangible assets acquired as part of the various acquisitions in 2021.
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 $130,566,825 in the year ended December 31, 2022 compared with $575,498,897 in the year ended December 31, 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 higher U.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 entire California 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.
(i) Right of use assets – During the year ended December 31, 2022, the Company recorded impairment of $4,307,578 related to properties which are no longer being used by the Company.
(ii) Impairment of long-lived assets – At each reporting period end, the Company considers if there have been any triggers that indicate that its long-lived assets are not recoverable. Based on the softening of the California cannabis market and cost pressures due to higher US inflation during the three months ended September 30, 2022, the Company determined that an impairment test was appropriate.
In the year ended December 31, 2022, the Company record interest income of $845,863 on its cash balances compared with $1,244,606 in the year ended December 31, 2021. The lower interest income is due to lower cash balances during 2022 offset to some extent by higher interest rates.
Interest Expense
In the year ended December 31, 2022, the Company recorded interest expense of $4,928,475 compared with $5,155,217 in the year ended December 31, 2021. The majority of the interest expense relates to interest expense on lease accounting for the Company’s right of use leases.
Gain on debt forgiveness
In the year ended December 31, 2022, the Company recorded a gain on debt forgiveness of $Nil compared with $3,358,686 in the year ended December 31, 2021. The gain in 2021 was realized on the forgiveness of Payroll Protection Program (PPP) loans.
In the year ended December 31, 2022, the Company recorded a loss of $5,091,541 on disposal of assets compared with a loss of $2,447,985 in the year ended December 31, 2021. The majority of the current year loss includes a loss of $4,832,891 recognized on the restructuring of the Roc Binding Heads of Terms and Brand Strategy Agreement which resulted in the disposal of the Monogram brand and simultaneous entering into an eight-year license agreement. The majority of the prior year loss on disposal of assets is from the non-THC business.
Credit losses and change in fair value of investments at fair value through profit and loss
In the year ended December 31, 2022, the Company recorded a change in fair value of $947,813 (loss) on its marketable securities compared with $1,250,990 in the comparative year ended December 31, 2021.
Change in fair value of contingent consideration
In year ended December 31, 2022, the Company recorded a loss on the change in the fair value of contingent consideration of $967,726 compared with $229,819,070 gain in the year ended December 31, 2021. The contingent consideration related to acquisitions is fair valued at each reporting period based on the stock amounts committed and gains / losses will be recorded in the statement of operations and comprehensive income (loss).
Other income
In the year ended December 31, 2022, the Company recorded other income of $1,360,724 compared with $3,572,217 in the year ended December 31, 2021. Other income includes items such as legal settlements, sublease income, movements on provisions among other items.
Discontinued Operations
The Company recorded a net of tax loss from discontinued operations (its bulk wholesale business) of $5,087,408 for the year ended December 31, 2022 compared to a net of tax loss $88,705,864 in the year ended December 31, 2021. The much larger losses in the comparative period ended December 31, 2021 is primarily due to larger impairment losses recorded in this period.
Net loss
In the year ended December 31, 2022, the Company recorded a net loss of $242,938,787 compared with a net loss of $587,032,334 in the year ended December 31, 2021. The large variation in net losses recorded is due mainly to non-cash impairment losses of $130,566,825 in the year ended December 31, 2022 ($575,498,897 December 31, 2021).
MANAGEMENT’S USE OF NON-GAAP FINANCIAL MEASURES
This MD&A contains certain financial performance measures, including “EBITDA” and “Adjusted EBITDA,” that are not recognized under 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 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.
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 (“FVTPL”) (iii) non-recurring legal and professional fees, human-resources, inventory and collections-related expenses, (iv) non-recurring tax charges (v) intangible and goodwill impairments and loss on disposal of assets, (vi) transaction costs related to merger and acquisition activities, and (vii) non-cash sales and marketing expenses.
Adjustments:
The Company’s EBITDA loss for the year ended December 31, 2022 was $220,942,755 compared $477,149,687 in the comparative year ended December 31, 2021. The large decrease in EBITDA loss is due mainly to non-cash impairment expenses which are included in the calculation of EBITDA (impairment of $130,566,825 in the year ended December 31, 2022 compared with $575,498,897 for the year ended December 31, 2021).
The Company’s Adjusted EBITDA loss was $71,793,199 for the year ended December 31, 2022 compared with $65,684,544 in the comparative year ended December 31, 2021. The Company’s adjusted EBITDA loss for 2022 calendar year increased over 2021 due to the integration of the numerous acquisitions made in 2021. The Company implemented significant restructuring efforts during 2022 as described earlier in this MD&A with the goal of reducing adjusted EBITDA losses going forward.
We manage liquidity risk by reviewing, on an ongoing basis, our sources of liquidity and capital requirements. As at December 31, 2022, the Company had cash and cash equivalents of $93,697,529 compared with cash and cash equivalents of $165,310,609 as at December 31, 2021. Cash and cash equivalents are predominately invested in liquid securities issued by the United States government.
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 integrate and optimize 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 year ended December 31, 2022, discontinued operations used cash of $5,375,734 compared with a use of cash of $7,430,934 in the comparative year ended December 31, 2021. The divestment of the bulk wholesale business was completed n October 31, 2022. The Company expects this divestment will reduce its operating cash burn rate going forward.
Cash used in continued operating activities in the year ended December 31, 2022 totaled $66,473,163 as compared to cash used in continued operating activities of $120,942,347 in the comparative year ended December 31, 2021. In the year ended December 31, 2022, the cash used in operating activities represents an average operating cash burn rate of $5,539,431 per month compared to $10,078,529 per month in the comparative period. The significant reduction in cash used in operating activities is due to the various restructuring efforts as described earlier in this MD&A and significantly less cash tied up in working capital on our balance sheet due to the cultivation pause and outsourcing of manufacturing. This restructuring allowed for $22,889,489 of cash to be released from working capital in 2022 compared to a use of $43,417,594 of cash for of working capital in 2021.
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 year ended December 31, 2022 totaled $5,375,731 compared with cash used in discontinued operating activities of $7,430,934 in the comparative year ended December 31, 2021.
Cash used in financing activities totaled $6,023,776 in the year ended December 31, 2022 compared with cash used of $225,632,855 in the comparative year ended December 31, 2021. In the year ended December 31, 2022, the Company settled $4,490,443 lease liabilities associated with its real estate, $1,153,333 of consideration payable primarily related to its 2021 entry into a purchase agreement to acquire oastal Holding and related Coastal MSAs. The year end December 31, 2021 includes a payment of $264,318,686 in connection with the redemption of Class A restricted voting shares on closing the Qualifying Transaction which was the reason for the majority of the net cash outflow.
Cash used in investing activities totaled $3,638,101 in the year ended December 31, 2022 compared with cash used of $53,322,649 in the comparative year ended December 31, 2021. In the year ended December 31, 2022, the Company invested $150,000 in its social equity venture investment in Digistrains and $200,000 in Josephine & Billies, received $6,401,402 of proceeds from the sale of property, plant and equipment primarily associated with the sale and leaseback transaction at its Pullman property, and invested $3,322,873 in property plant and equipment to support its operations and paid cash of $8,430,000 to acquire the non-controlling interests ($3,750,000 for Coastal and $4,680,000 for Varda). The comparative year ended December 31, 2021 includes $48,756,753 of cash paid for acquisitions as the major use of cash.
The Company leases real estate used for dispensaries, production plants, and corporate offices. Lease terms for real estate generally range from 1 to 14.75 years. Most leases include options to renew for varying terms at the Company’s sole discretion. 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.
Total undiscounted lease liabilities 44,022,494 84,234,825
The Company had engaged a third-party for strategic and promotional services. During the year ended December 31, 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 was recognized as an expense in operating expenses during the year ended December 31, 2021.
The Company was obligated to issue shares to the value of $1,875,000 quarterly over the second and third year of the contract. During year ended December 31, 2022, the Company issued 7,355,453 Common Shares to settle the first year of quarterly payments. These Common Shares are restricted under applicable US securities laws.
The Company recognized an expense of $3,718,402 during the year ended December 31, 2022 (December 31, 2021 – $5,166,666) in operating expenses as a sales and marketing expense. As of December 31, 2022, the cash-settled liability is $nil (December 31, 2021 – $5,166,666).
Brand Strategy Agreement (“BSA”)
The Company was party to the BSA, whereby the Company received the services of Shawn C. Carter p/k/a JAY-Z‘s related promotion and advertising for the remaining non-cancellable period of 5 years. The Company was 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 was recognizing the cost associated with the arrangement over the same period it was receiving services.
During the year ended December 31, 2022, the Company recognized an expense of $4,416,667 (December 31, 2021 – $4,183,565) in operating expenses related to this arrangement and $nil in accounts payable and accrued liabilities as of December 31, 2022 (December 31, 2021 – $2,183,565). During the year ended December 31, 2022, the Company made a cash payment of $3,000,000 (December 31, 2021 – $nil).
On December 29, 2022, the Company entered into modification agreements (the “Modification Agreements”) to restructure the relationship between the Company and the counterparties to each of the MA and BSA. As part of the restructured arrangements, the Company is no longer obligated to issue additional shares or cash related to the long-term strategic contracts, and the counterparties agreed to return 7,121,239 Common Shares of the Company to treasury. In addition, ownership of the brand “Monogram” was transferred to an entity designated by one of the counterparties. The Company was provided with an exclusive and royalty-free eight-year license to commercialize Monogram in California. The Company recognized a loss on disposal of assets of $4,832,891 related to the Modification Agreements which is included in loss on disposal of assets in the consolidated statement of operations and comprehensive loss.
California operating licenses
The Company’s primary activity is engaging in state-legal commercial cannabis business, including the cultivation, manufacture, distribution, and sale of cannabis and cannabis products pursuant to California law. However, this activity is not in compliance with the United States Controlled Substances Act, or the CSA. The Company’s assets are potentially subject to seizure or confiscation by Federal governmental agencies, and the Company could face criminal and civil penalties for noncompliance with the CSA, although such events would be without relevant precedent. Management of the Company believes the Company is in compliance with all California and local jurisdiction laws and monitor the regulatory environment on an ongoing basis along with counsel to ensure the continued compliance with all applicable laws and licensing agreements.
The Company’s operation is sanctioned by the State of California and local jurisdictions. There have been no instances of federal interference with those who adhere to State of California and local laws and regulations regarding commercial cannabis activities. Due to the uncertainty surrounding the Company’s noncompliance with the CSA, the potential liability from any noncompliance cannot be reasonably estimated and the Company may be subject to regulatory fines, penalties or restrictions in the future.
Effective January 1, 2018, the State of California allowed for adult use cannabis sales. Beginning on January 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.
In September 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 the 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 of California 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 each local jurisdiction in which it actively operates. Although the Company believes it will continue to receive the necessary licenses from the State and applicable local jurisdictions to conduct its business in a timely fashion, there is no guarantee its clients will be able to do so and any failure of its clients receive necessary licenses may have a negative effect on the Company’s business and results of operations.
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. The Company is 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.
On May 17, 2021, the Company announced that it had entered into a series of arrangements to obtain the rights to four acres of land that is licensed for outdoor grow from a consortium of experienced cannabis farms affiliated with Mosaic.Ag, In addition, in connection with each of the four acres of land, the Company entered into a cultivation and supply agreement with Mosaic.Ag to cultivate cannabis on its behalf for a period of at least three years, with options to extend each of the four agreements up to five years.
The purchase price for Mosaic.Ag under the arrangements was $6,000,000 in cash, $2,500,000 in Common Shares when the transaction closed, and up to 1,309,263 Common Shares subject to earnouts. The upfront payment of $5,650,000, net of a holdback amount of $350,000, was (and continues to be) secured by a promissory note. The closing of the transaction was dependent on the satisfaction of various closing conditions, which were not met by the second quarter of 2022, as required by the Membership Interest Purchase Agreement. Futher, Mosiac.Ag was unable to produce sufficient quantities of biomass according to Company quality standards and pursuant to the cultivation supply agreements, leading to an overpayment under those agreements and a refund due to the Company of approximately $1,490,000 in cash. The Company noticed termination of the arrangements on June 30, 2022, and requested that Mosaic.Ag present an acceptable restructure to the arrangements and/or a payback plan for the owed refund and for the upfront payment under the promissory note. Mosaic.Ag has contested certain of the Company’s positions and has claimed an inability to pay the owed cash amounts. For the foregoing reasons, the Company filed a lawsuit against Mosaic.Ag and related individuals on December 16, 2022, in the Superior Court of California, County of Santa Clara, alleging breach of contract and asking for declaratory relief. Defendants have not yet responded to the complaint.
The Company formed SEV in 2021 as its social equity investment vehicle. The Company intends to fund SEV with $10,000,000 and contribute 2% of its net income to allow SEV to make further social equity investments. During the year ended December 31, 2022, SEV made two social equity investments totaling $350,000 (December 31, 2021 – SEV made two social equity investments totaling $1,000,000).
In March 2020, the World Health Organization categorized COVID-19 as a pandemic. COVID19 continues to impact the U.S. and other countries across the world. While the impacts of COVID-19 have lessened in recent months, the outbreak of COVID-19 severely impacted global economic activity and caused significant volatility and negative pressure in financial markets. The Company continues to implement and evaluate actions to maintain its financial position and support the continuity of its business and operations in the face of COVID-19, potential future pandemics and other events.
The Company’s priorities during the COVID-19 pandemic continue to be protecting the health and safety of its employees and its customers, following the recommended actions of government and health authorities. In the future, COVID-19 or future pandemics may cause reduced demand for the Company’s products and services if, for example, the pandemic results in a recessionary economic environment or potential new restrictions on business operations or the movement of individuals.
The COVID-19 outbreak in the United States caused business disruption both to the Company and throughout its customer base and supply chain through mandated and voluntary closings of many businesses. It is unclear the extent to which this disruption negatively impacted the Company’s operating results. The Company has taken, important steps to protect its employees, customers and business operations since the beginning of the pandemic.
The Company has incurred incremental costs to implement proactive measures to prevent the spread of COVID-19. Additionally, the Company closely monitors its supply chain and third-party product availability in light of the pandemic. To date, the business has not experienced negative consequences due to interruptions in its supply chain. However, the Company continues to undertake preemptive measures to ensure alternate supply sources as needed.
The Company is not immune to the widespread cost inflation experienced in the United States and many parts of the world. The Company intends to continue to work to improve its gross margins despite cost inflation through market pricing, greater cost efficiencies, advantageous vendor partnerships, and other measures.
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.
As of December 31, 2022, the Company had 107,516,333 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 on January 15, 2026. The Company may accelerate the expiry date of the outstanding Warrants (excluding the Warrants held by Subversive Capital Sponsor LLC in certain circumstances) by providing 30 days’ notice, if and only if, the closing price of the 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 (“PSUs”) 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 of December 31, 2022, a total of 3,093,992 RSUs and 2,325,000 PSUs were outstanding under the Equity Incentive Plan.
Prior to closing of the Qualifying Transaction, Caliva maintained the CMG 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. As of December 31, 2022, there were 367,179 options to purchase up to 367,179 Common Shares under the Caliva EIP outstanding with a weighted average exercise price of $7.20 per share. 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. At December 31, 2022, there were 9,206 options to purchase up to 9,206 Common Shares under the LCV Equity Plan outstanding with a weighted average exercise price of $26.74 per share. No further awards will be granted under the LCV Equity Plan.
The Company manages its capital with the following objectives:
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 Company Board. The Company’s capital management objectives, policies and processes have remained unchanged during the year ended December 31, 2022 and year ended December 31, 2021. The Company is not subject to any external capital requirements.
The preparation of consolidated financial statements in conformity with GAAP requires the Company’s management to make judgments, estimates and assumptions about future events that affect the amounts reported in the consolidated financial statements. Although these estimates are based on management’s best knowledge of the amount, event or actions, actual results may differ from those estimates. Estimates and judgments are continuously evaluated and are based on management’s experience and other factors, including expectations of future events that management considers to be reasonable.
See Note 3: Significant Accounting Policies to the consolidated financial statements included in this Annual Report on Form 10-K for further information.
Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected.
The Company assesses all variable interests in entities and uses judgment when determining if the Company is the primary beneficiary. Other qualitative factors that are considered include decision-making responsibilities, the VIE capital structure, risk and rewards sharing, contractual agreements with the VIE, voting rights and the level of involvement of other parties. .
In determining the fair value of net identifiable assets acquired in a business combination, including any acquisition-related contingent consideration, estimates including market based and appraisal values are used. One of the most significant areas of judgment and estimation relates to the determination of the fair value of these assets and liabilities, including the fair value of contingent consideration, if applicable. If any intangible assets are identified, depending on the type of intangible asset and the complexity of determining its fair value, an independent external valuation expert may develop the fair value, using appropriate valuation techniques, which are generally based on a forecast of the total expected future net cash flows. These valuations are linked closely to the assumptions made by management regarding the future performance of the assets concerned and any changes in the discount rate applied. In addition, management applies judgment in determining the amount, if any, that leases acquired in a business combination are off-market resulting in an adjustment to the right-of-use assets. In particular, management’s judgment is used in determining the premium over basic market rents that would be applied by a lessor where the leased premise is being used for cannabis-related businesses. Finally, determining whether amounts should be included as part of consideration requires judgment.
The Company applies judgment in determining whether a contract contains a lease and whether a lease is classified as an operating lease or a finance lease. The Company determines the lease term as the non-cancellable term of the lease, which may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. The lease term is used in determining classification between operating lease and finance lease, calculating the lease liability and determining the incremental borrowing rate.
The Company has several lease contracts that include extension and termination options. The Company applies judgment in evaluating whether it is reasonably certain to exercise the option to renew or terminate the lease. That is, it considers all relevant factors that create an economic incentive for it to exercise either the renewal or termination. After the commencement date of the lease, the Company reassesses the lease term if there is a significant event or change in circumstances that is within its control and affects its ability to exercise or not to exercise the option to renew or to terminate (e.g., construction of significant leasehold improvements or significant customization to the leased asset).
The Company also applies judgment in allocating the consideration in a contract between lease and non-lease components. It considers whether the Company can benefit from the right-of-use asset either on its own or together with other resources and whether the asset is highly dependent on or highly interrelated with another right-of-use asset.
The Company is required to discount lease payments using the rate implicit in the lease if that rate is readily available. If that rate cannot be readily determined, the lessee is required to use its incremental borrowing rate. The Company generally uses the incremental borrowing rate when initially recording real estate leases. Information from the lessor regarding the fair value of underlying assets and initial direct costs incurred by the lessor related to the leased assets is not available. The Company determines the incremental borrowing rate as the interest rate the Company would pay to borrow over a similar term the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
In determining the fair value of stock-based payments, the Company makes assumptions, such as the expected life of the award, the volatility of the Company’s stock price, the risk-free interest rate, and the rate of forfeitures.
Goodwill is tested for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of goodwill may have been impaired. In order to determine that the value of goodwill may have been impaired, the Company performs a qualitative assessment to determine whether it is more-likely-than-not that the reporting unit’s fair value is less than its carrying value, indicating the potential for goodwill impairment. A number of factors, including historical results, business plans, forecasts and market data are used to determine the fair value of the reporting unit. Changes in the conditions for these judgments and estimates can significantly affect the assessed value of goodwill.
Depreciation and amortization of property and equipment, right-of-use assets and intangible assets are dependent upon estimates of useful lives, which are determined through the exercise of judgment. The assessment of any impairment of these assets is dependent upon estimates of recoverable amounts that consider factors such as economic and market conditions and the useful lives of assets. The Company uses judgment in: (i) assessing whether there are impairment triggers affecting long-lived assets, (ii) determining the asset groups and (iii) determining the recoverable amount and if necessary, estimating the fair value.
The Company uses valuation techniques to determine the fair value of financial instruments (where active market quotes are not available) and non- financial assets. This involves developing estimates and assumptions consistent with how market participants would price the instrument. The Company bases its assumptions on observable data as far as possible, but this is not always available. In that case, the Company uses the best information available. Estimated fair values may vary from the actual prices that would be achieved in an arm’s length transaction at the reporting date.
Deferred tax assets and uncertain tax positions
The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the respective tax bases of its assets and liabilities. The Company measures deferred tax assets and liabilities using current enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse. The Company routinely evaluates the likelihood of realizing the benefit of its deferred tax assets and may record a valuation allowance if, based on all available evidence, it determines that some portion of the tax benefit will not be realized.
In evaluating the ability to recover deferred tax assets within the jurisdiction from which they arise, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of operations. In projecting future taxable income, the Company considers historical results and incorporates assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. The Company’s assumptions regarding future taxable income are consistent with the plans and estimates that are used to manage its underlying businesses. In evaluating the objective evidence that historical results provide, the Company considers three years of cumulative operating income/(loss). The income tax expense, deferred tax assets and liabilities and liabilities for unrecognized tax benefits reflect the Company’s best assessment of estimated current and future taxes to be paid. Deferred tax asset valuation allowances and liabilities for unrecognized tax benefits require significant judgment regarding applicable statutes and their related interpretation, the status of various income tax audits and the Company’s particular facts and circumstances. Although the Company believes that the judgments and estimates discussed herein are reasonable, actual results, including forecasted COVID-19 business recovery, could differ, and the Company may be exposed to losses or gains that could be material. To the extent the Company prevails in matters for which a liability has been established or is required to pay amounts in excess of the established liability, the effective income tax rate in a given financial statement period could be materially affected.
Accounting standards issued but not yet effective
In September 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This guidance was subsequently amended by ASU 2018-19, Codification Improvements, ASU 2019- 04, Codification Improvements, ASU 2019-05, Targeted Transition Relief, ASU 2019-10, Effective Dates, and ASU 2019-11, Codification Improvements. These ASUs are effective for Smaller Reporting Companies for fiscal years beginning after December 15, 2022, including interim periods therein. The Company is currently evaluating the effect of adopting this ASU.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805) – Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (“ASU 2021-08”). The amendments in this update require contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with Topic 606, Revenue from Contracts with Customers, as if it had originated the contracts. Under the current business combinations guidance, such assets and liabilities are recognized by the acquirer at fair value on the acquisition date. These ASUs are effective for Smaller Reporting Companies for fiscal years beginning after December 15, 2023, including interim periods therein. This ASU is currently not expected to have a material impact on the consolidated financial statements.
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