The following discussion of the financial condition and results of operations ofCharlie's Holdings, Inc. should be read in conjunction with the financial statements and the notes to those statements appearing elsewhere in this Quarterly Report on Form 10-Q (this "Report"). Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should read the "Risk Factors" section in this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. As used in this Report, unless otherwise stated or the context otherwise requires, references to the "Company", "we", "us", "our", or similar references meanCharlie's Holdings, Inc. (formerlyTrue Drinks Holdings, Inc. ), its subsidiaries and consolidated variable interest entity on a consolidated basis. References to "Charlie's" and "CCD" refer to Charlie'sChalk Dust, LLC , aCalifornia limited liability company and wholly-owned subsidiary of the Company, and "Don Polly" refers toDon Polly, LLC , aNevada limited liability company that is owned by entities controlled by Brandon andRyan Stump , the Company's former Chief Executive Officer and current Chief Operating Officer, respectively, and a consolidated variable interest ("VIE") for which the Company is the primary beneficiary. Overview Our objective is to become a significant leader in the rapidly growing, global e-cigarette and e-liquid segments of the broader nicotine related products industry. Through Charlie's, we formulate, market and distribute premium, nicotine-based vapor products. Charlie's products are mostly produced domestically through contract manufacturers for sale through select distributors, specialty retailers and third-party online resellers throughoutthe United States , as well as more than 80 countries worldwide. Charlie's primary international markets include theUnited Kingdom ,Italy ,Spain ,Belgium ,Australia ,Sweden andCanada . InJune 2019 , we launched distribution, through Don Polly, of certain premium vapor, tincture and topical wellness products containing hemp-derived cannabidiol ("CBD") and we currently intend to develop and launch additional products containing other synthetic compounds derived from hemp in the future. Operational Plan
Considering industry-specific hurdles, as well as the potential for future regulatory changes, management has targeted opportunities for growth and has adopted the following operational plan.
First, we plan to increase the sales of our hemp-derived products, including topicals, ingestibles and disposable vapor devices. We feel there is a significant upside in the hemp-derived products space, and we have begun to shift our focus in this business to the burgeoning market for products containing compounds synthetically derived from hemp, including Delta-8-Tetrahydrocannabinol ("Delta-8-THC") and other synthetic tetrahydrocannabinol ("Synthetic THC") compounds. These product categories have grown rapidly, as they offer consumers a range of therapeutic benefits across varying potencies and product formats. We have also recently enhanced our focus on our direct-to-consumer business and have allocated additional financial resources to increase e-commerce sales of hemp-derived products. Secondly, we continue to see a significant opportunity for sales growth in international markets for our e-liquid and other vapor products. Presently, approximately 15% of our vapor product sales come from the international market and we are well positioned to increase those sales in the countries that we presently sell, and in additional overseas markets, as we have already built an international distribution platform. Specifically, the Company intends to launch proprietary new disposables, containing synthetically derived nicotine, that have been specially formulated for the European andMiddle East markets. In partnership with our international distributors, Charlie's will sell award wining products in markets where more than 20% of the population consumes nicotine in some format. Most importantly, we feel that tobacco and synthetically derived nicotine vapor products will continue to provide a significant growth opportunity domestically. During the quarter endedMarch 31, 2021 , we launched our synthetic nicotine (not derived from tobacco) Pachamama Disposable product line, which will provide access to additional sales channels and broaden our customer base. These innovative product formats are not currently subject to review by theUnited States Food and Drug Administration ("FDA") and currently represent Charlie's most important, fastest-growing product category. We are continuing with our plan to obtain marketing authorization for certain of our tobacco derived nicotine vapor products through the completion of a Premarket Tobacco Application ("PMTA"), which we submitted inSeptember 2020 . Obtaining a marketing order from the FDA would, in our opinion, help to remediate any perceived health issues related to vaping, and further position the Company as a trusted, industry leader. We feel that a significant amount of our competitors will not have the resources and/or expertise to complete the extensive and costly PMTA process and that once complete, we will be able to benefit from being one of only a select group of companies operating in the flavored vapor products space. - 19 -
--------------------------------------------------------------------------------
Table of Contents Recent Developments Resignation ofBrandon Stump . OnOctober 29, 2021 ,Brandon Stump resigned from his position as: (i) Chief Executive Officer and Chairman of the Board of Directors; and (ii) all positions held for each direct and indirect subsidiary of the Company (each, a "Subsidiary"), including as a member of the Board of Directors of the Company and each Subsidiary. In connection withMr. Stump's resignation, the Company andMr. Stump entered into an agreement regardingMr. Stump's resignation (the "Termination Agreement"), which Termination Agreement is datedOctober 29, 2021 . Pursuant to the Termination Agreement, in consideration forMr. Stump agreeing to terminate his employment agreement with the Company, as amended and restated onFebruary 12, 2020 (the "Employment Agreement"), and agreeing to certain restrictions and covenants, the Company will: (i) continue to payMr. Stump his base salary (as defined in the Employment Agreement), throughApril 22, 2022 ; (ii) payMr. Stump certain bonus compensation owed toMr. Stump in an amount equal to$300,000 , payable in installments of$75,000 on each ofNovember 1, 2021 ,December 1, 2021 ,January 1, 2022 , andFebruary 1, 2022 ; and (iii) continue to make available toMr. Stump certain employee benefits offered by the Company untilApril 22, 2022 . Reverse Stock Split Our Board of Directors approved a reverse stock split of our authorized, issued, and outstanding shares of common stock, par value$0.001 per share (the "Common Stock"), at a ratio of 1-for-100 (the "Reverse Split"). The Reverse Split was effective as ofJune 16, 2021 (the "Effective Date"). All share and per share amounts in this Report have been retroactively adjusted to account for the reverse stock split.March 2021 Private Placement OnMarch 19, 2021 , the Company entered into Securities Purchase Agreements by and between the Company and certain family trusts in which Mr.Brandon Stump , the Company's former Chief Executive Officer and significant shareholder of the Company, and Mr.Ryan Stump , the Company's Chief Operating Officer, are trustees and beneficiaries (the "Purchase Agreements"), for the private placement of an aggregate of 3,517,000 shares of its Common Stock, at a purchase price per share of$0.853 (the "Private Placement"), which Private Placement was consummated onMarch 22, 2021 . The Private Placement resulted in gross proceeds to the Company of approximately$3.0 million . The Private Placement was undertaken pursuant to Rule 506 promulgated under the Securities Act of 1933, as amended, and was consummated in a transaction approved by the Company's independent directors in accordance with Rule 16b-3(d)(1) of the Securities Exchange Act of 1934, as amended.
Red Beard Holdings, LLC Note Payable
OnApril 1, 2020 , the Company, Charlie's and its VIE, Don Polly, issued a secured promissory note (the "Red Beard Note") to one of the Company's largest stockholders,Red Beard Holdings, LLC ("Red Beard") in the principal amount of$750,000 (the "Principal Amount"), requiring a guaranteed minimum interest amount of$75,000 ("Minimum Interest"), which Red Beard Note is secured by all assets of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and Red Beard (the "Red Beard Note Financing"). Red Beard Note was subsequently amended onAugust 27, 2020 ,September 30, 2020 ,October 29, 2020 ,December 1, 2020 , andJanuary 19, 2021 , ultimately increasing Principal Amount to$1,400,000 and Minimum Interest to$150,000 . OnMarch 24, 2021 , the Company and Red Beard entered into a Satisfaction and Release (the "Red Beard Release"), pursuant to which the Company made a payment to Red Beard in the amount of$1.55 million in exchange for an acknowledgment of satisfaction and full release of the Company by Red Beard from liability and obligations arising under the Red Beard Note.
Small Business Administration Loan Programs
OnApril 30, 2020 , Charlie's, a wholly owned subsidiary of the Company, received approval to enter into aU.S. Small Business Administration ("SBA") Promissory Note (the " Charlie's PPP Loan") withTBK Bank, SSB (the "SBA Lender"), pursuant to the Paycheck Protection Program ("PPP") of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") as administered by the SBA (the "PPP Loan Agreement"). - 20 -
--------------------------------------------------------------------------------
Table of Contents
The Charlie's PPP Loan provides for working capital to CCD in the amount of$650,761 . The Charlie's PPP Loan was set to mature onApril 30, 2022 and accrued interest at a rate of 1.00% per annum. Payments of principal and interest were deferred for six months from the date of the Charlie's PPP Loan, or untilNovember 30, 2020 . Interest, however, continued to accrue during that time. OnApril 14, 2020 , Don Polly also obtained a loan pursuant to the PPP enacted under the CARES Act (the "Polly PPP Loan" and together with the Charlie's PPP Loan, the "PPP Loans") fromCommunity Banks of Colorado , a division ofNBH Bank (the "Polly Lender"). The Polly PPP Loan obtained by Don Polly provided for working capital to Don Polly in the amount of$215,600 . The Polly PPP Loan was set to mature onApril 14, 2022 and accrued interest at a rate of 1.00% per annum. Payments of principal and interest were deferred for six months from the date of the Polly PPP Loan, or untilNovember 14, 2020 . Interest continued to accrue during that time. The aforementioned PPP Loans were made under the PPP enacted byCongress under the CARES Act. The CARES Act (including the guidance issued bySBA and U.S. Department of the Treasury ) provides that all or a portion of the PPP Loans may be forgiven upon request from the respective borrower to the SBA Lender or the Polly Lender, as the case may be, subject to requirements in the PPP Loans and under the CARES Act. OnFebruary 19, 2021 Don Polly received notice from the Polly Lender, that the Polly PPP Loan was fully repaid, and its promissory note was cancelled as a result of the loan forgiveness process set forth by theU.S. Small Business Administration . There is no further action required on the part of Don Polly to satisfy this liability. OnMarch 17, 2021 , Don Polly obtained a second draw PPP loan ("Polly PPP Loan 2") under the CARES Act fromPolly Lender . The Polly PPP Loan 2 obtained by Don Polly provides general working capital in the amount of$184,200 . The Polly PPP Loan 2 will mature onMarch 17, 2026 and will accrue interest at a rate of 1.00% per annum. Payments of principal and interest will be deferred, however interest will continue to accrue during this time. OnApril 28, 2021 , Charlie's received notice from SBA Lender that the Charlie's PPP Loan was fully repaid, and its promissory note was cancelled as a result of the loan forgiveness process set forth by theU.S. Small Business Administration . There is no further action required on the part of Charlie's to satisfy this liability. OnJune 24, 2020 , SBA authorized (under Section 7(b) of the Small Business Act, as amended) an Economic Injury Disaster Loan ("EID Loan") to Don Polly in the amount of$150,000 . Installment payments, including principal and interest of$731 monthly will begin twelve months from date of the EID Loan. The balance of principal and interest will be payable thirty years from the date of the EID Loan and interest will accrue at the rate of 3.75% per annum. PMTA During the quarter endedSeptember 30, 2020 , theFDA's Center for Tobacco Products informed us that our PMTA has received a valid submission tracking number, passed theFDA's filing review phase, and recently entered the substantive review phase. To date, Charlie's has invested over$4.4 million for our initial PMTA submission. We engaged a team of more than 200 professionals, including doctors, scientists, biostatisticians, data analysts, and numerous contract research organizations to create our comprehensive PMTA submission. During the quarter endedSeptember 30, 2021 , the FDA began issuing Marketing Denial Orders ("MDO") for electronic nicotine delivery system ("ENDS") products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. As ofSeptember 30, 2021 , the Company had not received an MDO for any of its submissions. This news highlights our progress toward achieving full regulatory compliance and our goal of providing customers with a trusted product portfolio. Impact of COVID-19 The outbreak of a novel strain of coronavirus ("COVID-19", or, "Coronavirus") has had and continues to have a negative impact on the global economy and the markets in which we operate. Beginning inMarch 2020 , the Company transitioned nearly all employees to a remote working environment for their safety and to protect the integrity of Company operations. We have updated certain sales, accounting and administrative processes, and corresponding information technology platforms, in an effort to help facilitate the virtual work environment in which we now operate. During the nine months endedSeptember 30, 2021 , we engaged in periodic, informal testing of our business operations, and we do not believe that our financial position, work efficiency and overall operational integrity have been materially affected. However, we recognize that a certain degree of employee enthusiasm, teamwork, creativity, and support is normally generated by being present at a physical location, and we believe that prolonged remote working may have a negative impact over time on our business, and on employee productivity. OurDenver, CO office andHuntington Beach, CA warehouse locations have fully returned to on premise status, while our corporate headquarters inCosta Mesa, CA remains remote for many employees. We will continue to monitor the COVID-19 situation in all regions we operate and will maintain strict adherence to local health guidelines and mandates. We may have to take further actions that we determine are in the best interests of our employees or as required by federal, state, or local authorities. - 21 -
--------------------------------------------------------------------------------
Table of Contents Risks and Uncertainties The Company operates in an environment that is subject to rapid changes and developments in laws and regulations that could have a significant impact on the Company's ability to sell its products. Federal, state, and local governmental bodies acrossthe United States have indicated that flavored e-cigarette liquid, vaporization products and certain other consumption accessories may become subject to new laws and regulations at the federal, state and local levels. Beginning inSeptember 2019 , certain states temporarily banned the sale of flavored e-cigarettes, and onJanuary 2, 2020 , the FDA issued an enforcement policy effectively banning the sale of flavored cartridge-based e-cigarettes marketed primarily by large manufacturers without prior authorization from the FDA. The application of any new laws or regulations that may be adopted in the future, at a federal, state, or local level, directly or indirectly implicating flavored e-cigarette liquid and products used for the vaporization of nicotine could significantly limit the Company's ability to sell such products, result in additional compliance expenses, and/or require the Company to change its labeling and/or methods of distribution. Any ban of the sale of flavored e-cigarettes directly limits the markets in which the Company may sell its products. In the event the prevalence of such bans and/or changes in laws and regulations increase acrossthe United States , or internationally, the Company's business, results of operations and financial condition could be adversely impacted. In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products. Our PMTA applications were submitted inSeptember 2020 on a timely basis, which if approved, will allow the Company to continue to sell its products inthe United States . At this date, Charlie's PMTA remains among the select minority of applications submitted to the FDA that has not received an MDO or Refuse-to-File designation. However, it is possible that the FDA will request additional information or that the Company will need to amend its PMTA at some point in the future. The Company may also require additional financing in the future to support potential PMTA related expenses and general working capital. There is no assurance that regulatory approval to sell our products will be granted or that we can raise the additional financing required, and if not, this could have a significant impact on our sales. OnMarch 11, 2020 , theWorld Health Organization designated the ongoing and evolving COVID-19 outbreak as a pandemic. The outbreak has caused substantial disruption in international andU.S. economies and markets as it continues to evolve. The outbreak is having a temporary adverse impact on our industry as well as our business, with regards to certain supply chain disruptions and sales volume. While the disruption from COVID-19 is currently expected to be temporary, there is uncertainty around the duration. Basis of Presentation The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles inthe United States ("U.S. GAAP") have been omitted pursuant to suchSEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented in this Report not misleading. Amounts related to disclosure ofDecember 31, 2020 balances within the interim condensed consolidated financial statements were derived from audited financial statements and notes thereto included in the Company's Form 10-K for the year endedDecember 31, 2020 , filed with theSEC onApril 5, 2021 . The operating results of Don Polly are also included.
Current Operating Trends and Financial Highlights
Management currently considers the following events, trends and uncertainties to be important in understanding the Company's results of operations and financial condition for the most recent calendar quarter and full year: Regarding results from operations for the quarter endedSeptember 30, 2021 , we generated revenue of approximately$5,219,000 , as compared to revenue of$3,894,000 for the three months endedSeptember 30, 2020 . This$1,325,000 increase in revenue was due primarily to a$1,168,000 increase in sales of our nicotine-based vapor products, as well as a$157,000 increase in sales of our hemp-derived wellness products. We generated net income for the three months endedSeptember 30, 2021 of approximately$3,107,000 , as compared to net loss of approximately$6,824,000 for the three months endedSeptember 30, 2020 . The net income for the three months endedSeptember 30, 2021 includes non-cash stock-based compensation expense of approximately$39,000 and a non-cash gain in fair value of derivative liabilities of$2,729,000 . - 22 -
--------------------------------------------------------------------------------
Table of Contents
Regarding results from operations for the nine months endedSeptember 30, 2021 , we generated revenue of approximately$15,013,000 , as compared to revenue of$12,462,000 for the nine months endedSeptember 30, 2020 . This increase in revenue was due primarily to a$2,551,000 increase in sales of our nicotine-based vapor products, while sales of our hemp-derived products remained relatively unchanged. We generated net income for the nine months endedSeptember 30, 2021 of approximately$2,734,000 , as compared to net loss of approximately$11,384,000 for the nine months endedSeptember 30, 2020 . The net income for the nine months endedSeptember 30, 2021 includes non-cash stock-based compensation expense of approximately$563,000 and a non-cash gain in fair value of derivative liabilities of$1,901,000 .
A review of the three-month period ended
For the three months ended September 30, Change 2021 2020 Amount Percentage
($ in thousands) Revenues: Product revenue, net$ 5,219 $ 3,894 $ 1,325 34.0 % Total revenues 5,219 3,894 1,325 34.0 % Operating costs and expenses: Cost of goods sold - product revenue 2,310 1,666 644 38.7 % General and administrative 2,084 2,073 11 0.5 % Sales and marketing 442 335 107 31.9 % Research and development 5 741 (736 ) -99.3 % Total operating costs and expenses 4,841 4,815 26 0.5 % Income (loss) from operations 378 (921 ) 1,299 -141.0 % Other income (expense): Interest expense (2 ) (29 ) 27 -93.1 % Change in fair value of derivative liabilities 2,729 (5,874 ) 8,603 -146.5 % Other income 2 - 2 100 % Total other income (loss) 2,729 (5,903 ) 8,632 -146.2 % Net income (loss)$ 3,107 $ (6,824 ) $ 9,931 -145.5 %
Results of Operations for the Three Months Ended
Revenue Revenue for the three months endedSeptember 30, 2021 increased approximately$1,325,000 or 34%, to approximately$5,219,000 , as compared to approximately$3,894,000 for same period in 2020 due to a$1,168,000 increase in sales of our nicotine-based vapor products and a$157,000 increase in sales of our hemp-derived wellness products. The increase in our nicotine-based vapor product sales is directly related to the launch of our Pachamama Disposable product line, which is not currently subject to FDA review and currently represents Charlie's most important, fastest-growing product category. Pachamama Disposables became Charlie's first-ever entrant into the rapidly expanding, disposable e-cigarette market and offer users a variety of premium flavors containing synthetic nicotine (not derived from tobacco) in a compact, discrete format. However, ongoing uncertainty surrounding theFDA's recent issuance of MDO's and Refuse-to-File designations, as well as the addition of vapor products to the Prevent All Cigarette Trafficking Act ("PACT Act") (See Regulatory and Market Risks) continue to affect buying patterns in the domestic vapor products market as customers reduce inventories of non-PMTA submitted products and adjust their business models to suit recent changes in regulation. Lingering effects of COVID-19 as well as shifting consumer preferences in our channels have both continued to affect sales of our CBD wellness products. As a result, during the quarter endedMarch 31, 2021 , we began to streamline our existing hemp-derived wellness product offering and pursue the developing market for products containing synthetically derived cannabinoids, including Delta-8-THC and other Synthetic THC compounds. We view this market segment as having higher growth potential, as well as better alignment with our existing sales channels. - 23 -
--------------------------------------------------------------------------------
Table of Contents Cost of Revenue Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs increased approximately$644,000 , or 38.7%, to approximately$2,310,000 , or 44.3% of revenue, for the three months endedSeptember 30, 2021 , as compared to approximately$1,666,000 , or 42.8% of revenue, for the same period in 2020. This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pachamama Disposable product line, which carries a lower margin per unit relative to our other vapor products. Cost of revenue was partially offset by a lower than expected provision for inventory obsolescence across both business lines.
General and Administrative Expenses
For the three months endedSeptember 30, 2021 , total general and administrative expense increased approximately$11,000 to$2,084,000 as compared to approximately$2,073,000 for the same period in 2020. Notably, this change is primarily comprised of increases of approximately$175,000 in the provision for bad debt,$124,000 in professional fees as well as$109,000 in other general and administrative expenses. The increase in provision for bad debt was primarily related to the increase in sales and accounts receivable balance during the period. The increase in professional fees was the result of several internal projects, most of which focused on the creation of a solution "network" necessary to effectively meet the requirements of both the Consolidated Appropriations Act of 2021 and the PACT Act. These increases were offset by reductions in non-cash stock-based compensation and salaries and benefits costs of approximately$342,000 and$55,000 , respectively. The reduction in non-cash, stock-based compensation is primarily due to the conclusion of the vesting period for shares of Common Stock awarded to several employees in conjunction with Share Exchange inApril 2019 (as defined in Note 3 of Item 1, Part 1 of this Report). Sales and Marketing Expense For the three months endedSeptember 30, 2021 , total sales and marketing expense increased approximately$107,000 , or 31.9%, to approximately$442,000 as compared to approximately$335,000 for the same period in 2020, which was primarily due to a return to normalized trade-show activity during the quarter. Sales commissions increased marginally due to revenue growth across our businesses, however the increase was mitigated by a restructuring of our sales team and compensation program at the beginning of 2021.
Research and Development Expense
For the three months endedSeptember 30, 2021 , total research and development costs decreased approximately$736,000 , or 99.3%, to approximately$5,000 as compared to approximately$741,000 for the same period in 2020, which was primarily due to reduced costs associated with our PMTA registrations. Income from Operations We had operating income of approximately$378,000 for the three months endedSeptember 30, 2021 , due primarily to an increase in sales across both Charlie's and Don Polly. We also incurred certain non-cash, general and administrative expenses during the period including a$39,000 expense related to stock-based compensation. Net income is determined by adjusting income from operations by the following items:
? Change in Fair Value of Derivative Liabilities. For the three months ended
of the Investor Warrants and the Placement Agent Warrants (as defined in Note
3 of this Report) in connection with the Share Exchange. The gain for the
quarter ended
price as of
supply of shares currently freely trading, our stock price may experience
volatility and therefore, considerable fluctuations in the value of our warrant derivative liability in the future. We had 40,337,693 warrants outstanding as ofSeptember 30, 2021 .
? Interest Expense. For the three months ended
recorded interest expense related to notes payable of
respectively.
? Other Income. For the three months ended
recorded other income of$2,000 and$0 , respectively. Net Income (Loss)
For the three months ended
- 24 -
--------------------------------------------------------------------------------
Table of Contents
A review of the nine-month period ended
For the nine months ended September 30, Change 2021 2020 Amount Percentage
($ in thousands) Revenues: Product revenue, net$ 15,013 $ 12,462 $ 2,551 20.5 % Total revenues 15,013 12,462 2,551 20.5 % Operating costs and expenses: Cost of goods sold - product revenue 7,047 5,361 1,686 31.4 % General and administrative 6,759 8,500 (1,741 ) -20.5 % Sales and marketing 1,212 1,259 (47 ) -3.7 % Research and development 14 3,372 (3,358 ) -99.6 % Total operating costs and expenses 15,032 18,492 (3,460 ) -18.7 % Loss from operations (19 ) (6,030 ) 6,011 -99.7 % Other income (expense): Interest expense (33 ) (105 ) 72 -68.6 % Change in fair value of derivative liabilities 1,901 (5,264 ) 7,165 -136.1 % Gain on debt extinguishment 875 - 875 100 % Other income 10 15 (5 ) -33.3 % Total other income (loss) 2,753 (5,354 ) 8,107 -151.4 % Net income (loss)$ 2,734 $ (11,384 ) $ 14,118 -124.0 %
Results of Operations for the Nine Months Ended
Revenue Revenue for the nine months endedSeptember 30, 2021 increased approximately$2,551,000 or 20.5%, to approximately$15,013,000 , as compared to approximately$12,462,000 for same period in 2020 due to a$2,551,000 increase in sales of our nicotine-based vapor products, while sales of our hemp-derived products remained relatively unchanged. The increase in our nicotine-based vapor product sales is directly related to the launch of our Pachamama Disposable product line, which is not currently subject to FDA review and currently represents Charlie's most important, fastest-growing product category. Pachamama Disposables became Charlie's first-ever entrant into the rapidly expanding, disposable e-cigarette market and offer users a variety of premium flavors containing synthetic nicotine (not derived from tobacco) in a compact, discrete format. However, ongoing uncertainty surrounding theFDA's recent issuance of MDO's and Refuse-to-File designations, as well as the addition of vapor products to the Prevent All Cigarette Trafficking Act ("PACT Act") (See Regulatory and Market Risks) continue to affect buying patterns in the domestic vapor products market as customers reduce inventories of non-PMTA submitted products and adjust their business models to suit recent changes in regulation. Lingering effects of COVID-19 as well as shifting consumer preferences in our channels have both continued to affect sales of our CBD wellness products. As a result, during the quarter endedMarch 31, 2021 , we began to streamline our existing hemp-derived wellness product offering and pursue the developing market for products containing synthetically-derived cannabinoids, including Delta-8-THC and other Synthetic THC compounds. We view this market segment as having higher growth potential, as well as better alignment with our existing sales channels. - 25 -
--------------------------------------------------------------------------------
Table of Contents Cost of Revenue Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs increased approximately$1,686,000 , or 31.4%, to approximately$7,047,000 , or 46.9% of revenue, for the nine months endedSeptember 30, 2021 , as compared to approximately$5,361,000 , or 43% of revenue, for the same period in 2020. This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pachamama Disposable product line, which carries a lower margin per unit relative to our other vapor products. Cost of revenue was also negatively affected by a larger than normal provision for inventory obsolescence during the period related to certain of our hemp-derived wellness products.
General and Administrative Expenses
For the nine months endedSeptember 30, 2021 , total general and administrative expense decreased approximately$1,741,000 to$6,759,000 as compared to approximately$8,500,000 for the same period in 2020. Notably, this decrease is comprised of reductions of approximately$2,153,000 of non-cash, stock-based compensation and$61,000 of salaries and benefits costs. The reduction in non-cash, stock-based compensation is primarily due to the forfeiture of stock awards byBrandon Stump andRyan Stump pursuant to the adoption of the Amended Employment Agreements enteredFebruary 12, 2020 , as well as the conclusion of the vesting period for shares of Common Stock awarded to several employees in conjunction with the Share Exchange inApril 2019 . The decrease was primarily offset by increases of approximately$325,000 in professional fees,$97,000 of merchant processing costs and$51,000 of other general administrative expenses. The increase in professional fees was largely the result of several internal projects largely focused on the creation of a solution "network" necessary to effectively meet the requirements of both the Consolidated Appropriations Act of 2021 and the PACT Act as well as costs associated with certain corporate actions including our Reverse Split, completedJune 16, 2021 , and the private sale of 3,517,000 shares of our common stock to the Company's foundersBrandon Stump andRyan Stump completedMarch 23, 2021 . Sales and Marketing Expense For the nine months endedSeptember 30, 2021 , total sales and marketing expense decreased approximately$47,000 , or 3.7%, to approximately$1,212,000 as compared to approximately$1,259,000 for the same period in 2020, which was primarily due to a shift away from broad-based advertising efforts and focusing on targeted sales and marketing programs with certain of our large key distribution partners. Our sales mix to large distributors has increased as a result of logistical changes in our business following the addition of ENDS products to the PACT Act earlier this year. During the nine months endedSeptember 30, 2021 , we also continued to refine our use of certain point-of-sale materials in favor of increased digital marketing campaigns, however we will continue to remain agile in how we focus our resources in the future. Sales commissions increased marginally due to revenue growth across our businesses, however the increase was mitigated by a restructuring of our sales team and compensation program at the beginning of 2021.
Research and Development Expense
For the nine months endedSeptember 30, 2021 , total research and development expense decreased approximately$3,358,000 , to approximately$14,000 as compared to$3,372,000 for the same period in 2020, which was primarily due to reduced costs associated with our PMTA registrations. - 26 -
--------------------------------------------------------------------------------
Table of Contents Loss from Operations We had operating losses of approximately$19,000 for the nine months endedSeptember 30, 2021 , due primarily to a$325,000 increase in professional fees as well as a$148,000 increase in other general and administrative costs. We also incurred certain non-cash general and administrative expenses that contributed to the loss from operations including a$563,000 expense related to stock-based compensation. Net loss is determined by adjusting loss from operations by the following items:
? Change in Fair Value of Derivative Liabilities. For the nine months ended
derivative liability is associated with the issuance of the Investor Warrants
and the Placement Agent Warrants (as defined in Note 3 of this Report) in
connection with the Share Exchange. The gain for the nine months ended
ended
volume for our stock, which may persist in the future. Due to the limited
supply of shares currently freely trading, our stock price may experience
volatility and therefore, considerable fluctuations in the value of our warrant derivative liability in the future. We had 40,337,693 warrants outstanding as ofSeptember 30, 2021 .
? Interest Expense. For the nine months ended
recorded interest expense related to notes payable of
respectively.
? Gain on debt extinguishment. For the nine months ended
2020, we recorded a debt extinguishment gain of
including principal and accrued interest, related to the forgiveness of the
Don Polly PPP Loan and the Charlie's PPP Loan.
? Other Income. For the nine months ended
recorded other income of$10,000 and$15,000 , respectively. Net Income (Loss)
For the nine months ended
Effects of Inflation
Inflation has not had a material impact on our business.
Liquidity and Capital Resources
As ofSeptember 30, 2021 , we had working capital of approximately$505,000 , which consisted of current assets of approximately$5,667,000 and current liabilities of approximately$5,162,000 . This compares to negative working capital of approximately$6,020,000 atDecember 31, 2020 . The current liabilities, as presented in the condensed consolidated balance sheet atSeptember 30, 2021 included elsewhere in this Report primarily include approximately$2,006,000 of accounts payable and accrued expenses, approximately$221,000 of deferred revenue associated with product shipped but not yet received by customers, approximately$392,000 of lease liabilities, and$2,543,000 of derivative liability associated with the Investor Warrants and Placement Agent Warrants (the derivative liability of$2,543,000 is included in determining the working capital of$505,000 but is not expected to use any cash to ultimately satisfy the liability). In addition, the effect of the COVID-19 pandemic may have a negative impact on our liquidity and capital reserves.
Our cash and cash equivalents balance at
For the nine months endedSeptember 30, 2021 , net cash used in operating activities was approximately$980,000 , as compared to$3,502,000 for the same period in 2020. This resulted from a net income of$2,734,000 , partially offset by$563,000 of share-based compensation,$1,901,000 of change in fair value of derivative liabilities and$2,080,000 changes in our operating assets and liabilities. - 27 -
--------------------------------------------------------------------------------
Table of Contents
For the nine months endedSeptember 30, 2021 , we used cash for investment activities of approximately$73,000 as compared to$153,000 for the same period in 2020. The cash used for investment activities is primarily for the on-going development and configuration of enterprise resource planning software during the nine months endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2021 we generated approximately$901,000 cash from financing activities as compared to$2,416,000 for the same period in 2020. In the 2021 period, we generated cash from financing activities from the Polly PPP Loan 2 (as defined in Note 8 of Item 1, Part 1 of this Report) and the Private Placement (as defined in Note 10 of Item 1, Part 1 of this Report). We paid cash dividends of$883,000 and notes payable of$1,400,000 during the nine months endedSeptember 30, 2021 .
Going Concern Uncertainty Regarding the Legal and Regulatory Environment, Liquidity and Management's Plan of Operation.
Our financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company operates in a rapidly changing legal and regulatory environment; new laws and regulations or changes to existing laws and regulations could significantly limit the Company's ability to sell its products, and/or result in additional costs. Additionally, the Company was required to apply for FDA approval to continue selling and marketing its products used for the vaporization of tobacco derived nicotine inthe United States . There is significant cost associated with the application process and there can be no assurance the FDA will approve the application(s). In addition, the recent outbreak of COVID-19 inMarch 2020 has had a negative impact on the global economy and markets which has negatively impacted the Company's supply chain and sales. For the nine months endedSeptember 30, 2021 , the Company has incurred a loss from operations of$19,000 and a consolidated net income of approximately$2,734,000 and the Company has a stockholders' equity of$1,068,000 as ofSeptember 30, 2021 . However, net cash used in operating activities was approximately$980,000 , and net income for the period was largely the result of$2,754,000 in other income, including a$1,901,000 gain in fair value of derivative liabilities. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. Our plans and growth depend on our ability to increase revenues and continue our business development efforts, including the expenditure of approximately$4,400,000 to date, to complete our PMTA registration process. OnMarch 23, 2021 , we closed a$3 million capital raise through the private sale of 3,517,000 shares of our common stock to the Company's foundersBrandon Stump andRyan Stump (see Recent Developments). We intend to use the proceeds to fund future growth, increase working capital, retire outstanding debt, and for other general corporate purposes. If in the future our plans or assumptions change or prove to be inaccurate, or there is a significant change in the regulatory environment or the recent outbreak of COVID-19 continues to impact the global economy, we will need to raise additional funds through public or private debt or equity offerings, financings, corporate collaborations, or other means. There can be no assurance that such financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and in our best interests.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other than operating lease commitments.
Critical Accounting Policies The condensed consolidated financial statements are prepared in conformity withU.S. GAAP, which require the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of expense in the periods presented. We believe that the accounting estimates employed are appropriate and resulting balances are reasonable; however, due to inherent uncertainties in making estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. The critical accounting estimates that affect the consolidated financial statements and the judgments and assumptions used are consistent with those described under Part II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2020 . - 28 -
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source