You should read the following discussion and analysis in conjunction with our financial statements, including the notes thereto contained in this Annual Report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of certain factors, including those set forth under "Risk Factors Associated with Our Business" and elsewhere in this Annual Report. 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 produced through contract manufacturers for sale through select distributors, specialty retailers and third-party online resellers throughoutthe United States , and in more than 80 countries worldwide. Charlie's primary international markets include theUnited Kingdom ,Italy ,Spain ,New Zealand ,Australia , andCanada . InJune 2019 , we launched distribution, throughDon 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 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 benefits across varying potencies and product formats. We have also recently allocated additional financial resources to increase e-commerce sales of certain of our 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 17% of our vapor product sales come from the international market and we are well positioned to increase sales in countries where we already have presence, and in additional overseas markets, as we have already built an international distribution platform. We have recently hired an Account Executivewho will be dedicated to driving our efforts in international expansion. More 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 winning products in markets where more than 20% of the population currently 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) Pacha Syn (formerly Pachamama Disposable) product line, which will provide access to additional sales channels and broaden our customer base. These innovative product formats currently represent Charlie's most important, fastest-growing product category. We are continuing with our plan to obtain marketing authorization for certain of our 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, we believe, help to remediate perceived health issues related to vaping, and further position the Company as a trusted, industry leader. We feel that a significant number of our competitors will not have the necessary resources and/or expertise to complete the extensive and costly PMTA process and that, once authorized by the FDA, we will benefit significantly by emerging as one of a select group of companies able to continue operating in the flavored vapor products space. -31-
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Table of Contents 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 which still persists for some employees. During the year endedDecember 31, 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 returned fully to on "premise status", while our corporate headquarters inCosta Mesa, CA remains remote for some employees. We will continue to monitor the COVID-19 situation in all regions in which we operate and will maintain strict adherence to local health guidelines and mandates. We may need to take further actions that we determine are in the best interests of our employees or are required by federal, state, or local authorities. Supply Chain Our ability to manufacture products is dependent on the availability of certain raw materials and components that our contract manufacturers purchase fromEurope andChina . InFebruary 2020 , we started to experience disruptions across several key areas of our global supply chain. Our domestic and international contract manufacturers source many of our high-quality flavorings from suppliers located inItaly , a region that was severely affected by COVID-19-related restrictions throughout most of 2020. Mandated stay-at-home orders in this region ultimately caused increased manufacturing lead times and delayed customer order deliveries for certain of our products, resulting in revenue declines. We have been successful in mitigating some of the supply chain risks through bulk purchases of certain flavorings and components and adjusting the production allocation amongst our contract manufacturers. Shifting production to contract manufacturers in regions with fewer restrictions and/or an enhanced ability to procure larger supplies of raw materials has helped alleviate disruptions in our supply chain. Certain of our products are sourced fromChina and require delivery to our warehouse locations inthe United States prior to shipment to customers. Although we currently use air freight for Chinese shipments, ongoing disruptions in the global supply chain could continue to affect the costs associated with such shipments and could put additional pressure on our sales and margins. If a resurgence of COVID-19 and associated shutdowns were to occur inEurope orChina , this would likely have an adverse effect on our ability to manufacture and sell our products due to related shortages of materials and components. Depending on the severity of any such future shutdowns, we could experience a materially diminished ability to produce products and be exposed to significantly longer lead times. This would result in delayed or reduced revenue from the affected products in production and potentially higher operating costs. Sales and Marketing Our sales and marketing efforts have also been directly and indirectly affected by COVID-19. Most of our sales through Charlie's andDon Polly are to resellers of our products, typically distributors or brick and mortar retail locations. Stay-at-home mandates across theU.S. and internationally created a challenge for these customers to maintain continuity in their businesses, and therefore we experienced lower sales volumes in some regions. Periodic labor shortages, indirectly related to COVID-19, have also influenced our customers' ability to operate their businesses effectively. We've since seen activity approach pre-pandemic levels, however a resurgence of COVID-19, causing subsequent shutdowns and labor shortages, could have a significant effect on our business. Historically, most of our business-to-business sales and marketing efforts have been generated through industry events in both the vapor products and hemp-derived products spaces. During 2019, we also initiated a program of in-store marketing events to help facilitate relationship building and sell-through for our retail partners. Beginning in 2020, the suspension of certain trade shows and disruption of business travel weakened our new customer pipeline, which negatively affected our sales during the years endedDecember 31, 2021 and 2020. Though trade show activity has since rebounded, it remains uncertain how the effects of COVID-19 will persist and what effect they will have on our sales and marketing efforts. In response, we have shifted some of our focus to digital marketing campaigns aimed at customer engagement and education. We also continue to allocate additional resources towards certain key distributors and retail partners that are better positioned to interact directly with our consumers and to continue growing our brands. -32-
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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 nicotine based vapor products. Our PMTA applications were submitted inSeptember 2020 on a timely basis, which if approved, will allow the Company to continue to sell certain of 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. 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. -33-
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Table of ContentsMarch 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"). The 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"). The 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$1.4 million 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"). The Charlie's PPP Loan provided 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 byDon Polly provided for working capital toDon 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 ofDon 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 byDon Polly provided general working capital in the amount of$184,200 . The Polly PPP Loan 2 was set to mature onMarch 17, 2026 and accrued interest at a rate of 1.00% per annum. Payments of principal and interest were deferred, however interest continued to accrue during that time. -34-
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Table of Contents 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. OnNovember 9, 2021 ,Don Polly received notice from the Polly Lender, that the Polly PPP Loan 2 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 ofDon Polly 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") toDon 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$4.4 million for our initial PMTA submission. We engaged a team of more than 200 professionals, including doctors, scientists, biostatisticians, data analysts, and numerous contract research organizations to create our comprehensive PMTA submission. During the quarter endedSeptember 30, 2021 , the FDA began issuing Marketing Denial Orders ("MDO") for electronic nicotine delivery system ("ENDS") products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. As ofDecember 31, 2021 , the Company had not received an MDO for any of its submissions. This news highlights our progress toward achieving full regulatory compliance and our objective of providing customers with a trusted product portfolio. Basis of Presentation The consolidated financial statements contained within this Annual Report and the disclosure in this Management's Discussion and Analysis of Financial Condition and Results of Operations with respect to the years endedDecember 31, 2021 and 2020 have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission (the "SEC"). In the opinion of the Company, all adjustments, including normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company for the interim period have been included. Results of Operations for the Year EndedDecember 31, 2021 Compared to the Year EndedDecember 31, 2020 For the years ended December 31, Change 2021 2020 Amount Percentage ($ in thousands) Revenues: Product revenue, net$ 21,496 $ 16,692 $ 4,804 28.8 % Total revenues 21,496 16,692 4,804 28.8 % Operating costs and expenses: Cost of goods sold - product revenue 10,423 7,478 2,945 39.4 % General and administrative 8,750 10,873 (2,123 ) -19.5 % Sales and marketing 1,734 1,733 1 0.1 % Research and development 24 3,378 (3,354 ) -99.3 % Total operating costs and expenses 20,931 23,462 (2,531 ) -10.8 % Income (loss) from operations 565 (6,770 ) 7,335 -108.3 % Other income (expense): Interest expense (34 ) (134 ) 100 -74.6 % Change in fair value of derivative liabilities 3,545 (300 ) 3,845 -1281.7 % Gain on debt extinguishment 1,060 - 1,060 100 % Other income 14 17 (3 ) -17.6 % Total other income (loss) 4,585 (417 ) 5,002 -1199.5 % Income (loss) before income taxes 5,150 (7,187 ) 12,337 -171.7 % Income tax expense (342 ) - (342 ) 100 % Net income (loss)$ 4,808 $ (7,187 ) $ 11,995 -166.9 % -35-
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Table of Contents Revenue Revenue for the year endedDecember 31, 2021 , increased approximately$4,804,000 , or 28.8%, to approximately$21,496,000 , as compared to approximately$16,692,000 for the year endedDecember 31, 2020 , due to a$4,420,000 increase in our nicotine-based product sales, and a$384,000 increase in sales of our hemp-derived products. The increase in our nicotine-based vapor product sales is directly related to the launch of our Pacha Syn (formerly Pachamama Disposable) product line, which currently represents Charlie's most important, fastest-growing product category. Pacha Syn 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. Uncertainty surrounding theFDA's application review timeline, following the PMTA submission deadline, affected buying patterns of tobacco-derived nicotine products in the domestic vape market as customers reduced inventories of non-PMTA submitted products. InDecember 2020 , the Prevent All Cigarette Tracking Act ("PACT Act") was signed into law which requires that theUnited States Postal Service ("USPS") promulgate regulations clarifying the applicability of the prohibition on delivery sales of cigarettes to ENDS products. The resulting shipping and logistical challenges that ensued, affected industry-wide sales to consumers and smaller, single-location resellers. 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. The addition of these new product categories, coupled with a narrowed focus in our existing portfolio, resulted in higher sales velocity and overall growth compared to the year endedDecember 31, 2020 . We view this market segment as having higher growth potential and better alignment with our existing sales channels, and therefore, we will continue to develop and launch additional products in this category. 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$2,945,000 or 39.4%, to approximately$10,423,000 , or 48.5% of revenue, for the year endedDecember 31, 2021 , as compared to approximately$7,478,000 , or 44.8% of revenue, for the year endedDecember 31, 2020 . This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pacha Syn 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, as well as higher per unit shipping costs due to implications of the Pact Act.
General and Administrative Expense
For the year endedDecember 31, 2021 , total general and administrative expense decreased approximately$2,123,000 to approximately$8,750,000 , or 40.7% of revenue, as compared to approximately$10,873,000 , or 65.1% of revenue, for the year endedDecember 31, 2020 . This decrease is primarily comprised of reductions of approximately$2,519,000 of non-cash stock-based compensation as well as$418,000 of salary and benefits expenses. 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 in salary and benefits costs is the result of lower overall salary expenses, Paid-Time-Off benefits and employee bonuses. This overall decrease in total general and administrative expense was offset by increases of$442,000 in professional fees as well as$372,000 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 . Other general administrative expenses including, merchant account fees and bad debt provision, increased due to an increase in sales activity during the period.
Sales and Marketing Expense
For the year endedDecember 31, 2021 , total sales and marketing expense increased to approximately$1,734,000 as compared to approximately$1,733,000 for the year endedDecember 31, 2020 , which was primarily due to a shift in spending on product sales support materials and other marketing activities in favor of increased trade show attendance, as activity returned to pre-pandemic levels. -36-
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Table of Contents
Research and Development Expense
For the year endedDecember 31, 2021 , total research and development expense decreased approximately$3,354,000 , or 99.3%, to approximately$24,000 as compared to approximately$3,378,000 for the year endedDecember 31, 2020 . During the year endedDecember 31, 2021 , we incurred significantly less expense related to our PMTA submission, which resulted in lower overall research and development costs. Income (Loss) from Operations We generated income from operations of approximately$565,000 for the year endedDecember 31, 2021 , as compared to loss from operations of approximately$6,770,000 for the year endedDecember 31, 2020 . Net income (loss) is determined by adjusting income (loss) from operations by the following items:
? Change in fair value of derivative liabilities. For the years ended December
31, 2021 and 2020, the gain (loss) in fair value of derivative liabilities was
approximately
liability is associated with the issuance of the Investor Warrants and the
Placement Agent Warrants (see Note 3) in connection with the Share Exchange.
The gain for the year ended
decrease in stock price as of
During the year ended
variation in trading 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 may occur in the future. We had
warrants to purchase approximately 40,424,000 shares of common stock outstanding as ofDecember 31, 2021 .
? Interest Expense. For the years ended
interest expense related to notes payable of$34,000 and$134,000 , respectively.
? Gain on debt extinguishment. For the years ended
we recorded a gain on debt extinguishment of
related to forgiveness of Paycheck Protection Program loans extended to Charlie's andDon Polly .
? Other Income. For the years ended
other income related to interest and sublease income of
respectively. Income Tax Expense The Company's income tax expense was$342,000 , or 6.6% of income before income taxes, for the year endedDecember 31, 2021 . The Company's income tax expense was$0 for the year endedDecember 31, 2020 . Net Income (Loss)
For the years ended
Effects of Inflation
Inflation has not had a material impact on our business.
Liquidity and Capital Resources
As ofDecember 31, 2021 , we had working capital of approximately$2,460,000 , which consisted of current assets of approximately$7,994,000 and current liabilities of approximately$5,534,000 . This compares to negative working capital of approximately$6,020,000 atDecember 31, 2020 . The current liabilities, as presented in the consolidated balance sheet atDecember 31, 2021 included elsewhere in this Report, primarily include approximately$4,068,000 of accounts payable and accrued expenses, approximately$238,000 of deferred revenue associated with product shipped but not yet received by customers, approximately$329,000 of lease liabilities, and$899,000 of derivative liability associated with the Investor and Placement Agent Warrants (the derivative liability of$899,000 is included in determining the working capital of$2,460,000 but is not expected to use any cash to ultimately satisfy the liability).
Our cash and cash equivalents balance at
For the year endedDecember 31, 2021 , we used cash from operations of$1,347,000 , as compared to$3,273,000 for the year endedDecember 31, 2020 . This decrease in the cash used by operations is due primarily to increased net income and accounts payables, but was offset by an increase in inventory. -37-
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Table of Contents For the year endedDecember 31, 2021 , we used cash for investment activities of$110,000 as compared to$169,000 for the year endedDecember 31, 2020 . For the year endedDecember 31, 2021 , the cash used for investment activities was primarily for the ongoing development and configuration of enterprise resource planning software. For the year endedDecember 31, 2020 , the cash used for investment activities was primarily for the ongoing development and configuration of enterprise resource planning software. For the year endedDecember 31, 2021 , we generated cash from financing activities of$901,000 as compared to generated cash from financing activities of$2,416,000 for the year endedDecember 31, 2020 . In the 2021 period, we generated cash from financing activities from the Polly PPP Loan 2 and the Private Placement. We paid cash dividends of$883,000 and notes payable of$1,400,000 during the year endedDecember 31, 2021 . In the 2020 period, we generated cash from financing activities from the Red Beard Note, PPP Loans and EID Loan (as defined in Note 8 of Item 1, Part 1 of this Report).
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 nicotine inthe United States . Currently, a substantial portion of the Company's sales are derived from products that are subject to approval by the FDA. There was significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future application. In addition, the recent outbreak of Coronavirus inMarch 2020 has had a negative impact on the global economy and markets which could impact the Company's supply chain and/or sales. For the year endedDecember 31, 2021 , the Company generated income from operations of$565,000 and a consolidated net income of approximately$4,808,000 and the Company has stockholders' equity of$3,131,000 . During the year endedDecember 31, 2021 , the Company's working capital requirements changed significantly as inventory increased to$5.0 million , from$1.6 million as ofDecember 31, 2020 , and cash on hand decreased to approximately$0.9 million , from$1.4 million as ofDecember 31, 2020 . Though the Company's balance sheet and overall performance generally improved during 2021, the issuance of one or several Marketing Denial Orders ("MDO") from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables. These regulatory risks, as well as other industry-specific challenges remain factors that 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. Management's plans depend on its ability to increase revenues and continue its business development efforts, including the expenditure of approximately$4,400,000 to date, to complete the PMTA registration process. OnMarch 23, 2021 , The Company closed a$3,000,000 capital raise through the private sale of 3,517,000 shares of its common stock to the Company's foundersBrandon Stump andRyan Stump . The Company used the proceeds to fund future growth, increase working capital, retire outstanding debt, and for other general corporate purposes. However, the Company may require additional financing in the future should the FDA require additional testing for one, or several, of the Company's PMTA submissions. 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 the Company's best interests.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other than operating lease commitments.
Critical Accounting Policies Included below is a discussion of critical accounting policies used in the preparation of our financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. -38-
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Table of Contents We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.
The accounting policies identified as critical are as follows:
Revenue Recognition The Company recognizes revenues in accordance with Accounting Standards Codification ("ASC") 606 - Contracts with Customers. Revenues are generated from contracts with customers that consist of sales to retailers and distributors. Contracts with customers are generally short term in nature with the delivery of product as a single performance obligation. Revenue from the sale of product is recognized at the point in time when the single performance obligation has been satisfied and control of the product has transferred to the customer. In evaluating the timing of the transfer of control of products to customers, The Company considers several indicators, including significant risks and rewards of products, the right to payment, and the legal title of the products. Based on the assessment of control indicators, sales are generally recognized when products are received by customers. Shipping generally occurs prior to the transfer of control to the customer and is therefore accounted for as a fulfillment expense. In circumstances where shipping and handling activities occur after the customer has obtained control of the product, the Company has elected to account for shipping and handling activities as a fulfillment cost rather than an additional promised service. Contract durations are generally less than one year, and therefore costs paid to obtain contracts, which generally consist of sales commissions, are recognized as expense in the period incurred. Revenue is measured by the transaction price, which is defined as the amount of consideration expected to be received in exchange for providing goods to customers. The transaction price is adjusted for estimates of known or expected variable consideration, which includes refunds and returns as well as incentive offers, volume rebates, and promotional discounts on current orders. Our volume rebates are short-term in nature and reset on a quarterly basis. Sales returns are generally not material to the financial statements, and do not comprise a significant portion of variable consideration. Estimates for sales returns are based on, among other things, an assessment of historical trends, information from customers, and anticipated returns related to current sales activity. These estimates are established in the period of sale and reduce revenue in the period of the sale. Variable consideration related to incentive offers and promotional programs are recorded as a reduction to revenue based on amounts the Company expects to collect. Estimates are regularly updated and the impact of any adjustments are recognized in the period the adjustments are identified. In many cases, key sales terms such as pricing and quantities ordered are established at the time an order is placed and incentives have very short-term durations. Amounts billed and due from customers are short term in nature and are classified as receivables since payments are unconditional and only the passage of time related to credit terms is required before payments are due. The Company does not grant payment financing terms greater than one year. Payments received in advance of revenue recognition are recorded as deferred revenue. Accounts receivable is recorded at the invoiced amount and does not bear interest. We determine the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history and current economic conditions and set up an allowance for doubtful accounts when collection is uncertain. Customers' accounts are written off against the allowance when all attempts to collect have been exhausted. Recoveries of accounts receivable previously written off are recorded as income when received. As ofDecember 31, 2021 , and 2020, the allowance for bad debt totaled$109,000 and$355,000 , respectively. Inventories Inventories primarily consist of finished goods and are stated at the lower of cost (determined by the average cost method) or net realizable value. We calculate estimates of excess and obsolete inventories determined primarily by reviewing inventory on hand, historical sales activity, industry trends and expected net realizable value. As ofDecember 31, 2021 , and 2020, the reserve for excess and obsolete inventories totaled$156,000 and$179,000 , respectively. Stock-Based Compensation We account for all stock-based compensation using a fair value-based method. The fair value of equity-classified awards granted to employees is estimated on the date of the grant using the Black-Scholes option-pricing model, or it is based on valuation observed from publicly traded companies in a similar industry, often with a discount for lack of marketability applied. The related stock-based compensation expense is recognized over the vesting period during which an employee is required to provide service in exchange for the award. We measure the fair value of liability-classified awards using aMonte Carlo valuation model. Compensation cost is recognized over the service period and is remeasured at each reporting period through settlement. -39-
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Table of Contents Income Taxes Income taxes are computed under the liability method. This method requires the recognition of deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. Financial statement effects of a tax position are initially recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that meets the more-likely-than-not threshold of being realized upon ultimate settlement with a taxing authority. We recognize potential accrued interest and penalties related to unrecognized tax benefits as income tax expense.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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