Item 1. Business
As used in this annual report, the terms we, us, our and our company mean Vapor Hub International Inc., unless otherwise indicated.
Cautionary Statement Regarding Forward-Looking Statements
This Annual Report on Form 10-K (Annual Report) contains forward-looking statements. Such statements contain words such as believe, estimate, expect, intend, plan, project, may, will, might, should, could, would, seek, pursue, and anticipate or the negative or other variation of these or similar words, or may include discussions of strategy or risks and uncertainties. Forward-looking statements in this Annual Report include, among other things, statements concerning:
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expectations regarding our business, results of operations and prospects for future development;
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expenses and our ability to operate efficiently;
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expectations regarding trends that will affect our market and the electronic cigarette industry generally and the impact of those trends on our business and results of operations; and
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the potential impact of governmental regulation on our industry.
Any forward-looking statement is based upon a number of estimates and assumptions that, while considered reasonable by us, is inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, and are subject to change. Actual results of operations may vary materially from any forward-looking statement made herein. Forward-looking statements should not be regarded as a representation by us or any other person that the forward-looking statements will be achieved. Undue reliance should not be placed on any forward-looking statements. Some of the contingencies and uncertainties to which any forward-looking statement contained herein is subject include, but are not limited to, the following:
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the risk that we will not be able to fund our operations and continue as a going concern;
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the potential impact of governmental regulation on our ability to operate our business;
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the effects of intense competition that exists in the electronic cigarette industry;
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general economic and business conditions including changes in customer demand; and
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adverse outcomes of legal proceedings.
For additional contingencies and uncertainties, see
Item 1A. Risk Factors
.
Given these risks and uncertainties, we can give no assurances that results contemplated by any forward-looking statements will in fact occur and therefore caution investors not to place undue reliance on them. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report might not occur.
Market and Industry Data
Some of the market and industry data contained in this Annual Report are based on independent industry publications or other publicly available information. Although we believe that these independent sources are reliable, we have not independently verified and cannot assure you as to the accuracy or completeness of this information. As a result, you should be aware that the market and industry data contained herein, and our beliefs and estimates based on such data, may not be reliable.
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Overview
We design, source, market and sell the next generation of smokeless electronic cigarettes which are popularly known as vaping devices. We provide a selection of premium vaping devices and related accessories which we design and source, including our popular Limitless Mods and Limitless Atomizers, and we also purchase vaping devices and related accessories from third parties for resale. We distribute our products nationally and internationally to wholesale customers and retail customers, including through our website www.vapor-hub.com. We also market and sell our products through a retail location located in southern California.
History of the Company
Vapor Hub International Inc. was incorporated in the State of Nevada on July 15, 2010 under the name DogInn, Inc. On February 14, 2014, we entered into a Share Exchange Agreement with Vapor Hub, Inc., a California corporation (Vapor), Delite Products, Inc., a California corporation (Delite) and the shareholders of both companies (the Exchange Agreement). Pursuant to the terms of Exchange Agreement, we agreed to acquire all 30,000 of the issued and outstanding shares of Vapors common stock, as well as all 30,000 of the issued and outstanding shares of Delites common stock in exchange for the issuance by us of 38,000,001 shares of our common stock to the shareholders of both companies. On March 14, 2014, we completed the acquisition of Vapor and issued all of the 38,000,001 shares to the shareholders of Vapor, who were also the shareholders of Delite. On March 26, 2014, we completed the acquisition of Delite. As a result of the closing of the transactions contemplated by the Exchange Agreement, Vapor and Delite became our wholly owned subsidiaries. In connection with the acquisition of Vapor, we changed our corporate name from Doginn, Inc. to Vapor Hub International Inc. and our stock symbol changed from DOGI to VHUB. On May 18, 2015, Vapor and Delite were merged with and into the company, ending the separate existences of Vapor and Delite. Prior to our acquisition of Vapor, we existed as a shell company with nominal assets whose sole business was to identify, evaluate and investigate various companies to acquire or with which to merge.
Our principal executive office is located at 1871 Tapo Street, Simi Valley CA 93063. The telephone number at our principal executive office is (805) 309-0530.
Our Products - Vaping Devices
Vaping devices (as well as electronic cigarettes, also known as e-cigarettes) are battery-powered products that allow users to inhale vapor instead of the smoke, ash, tar and carbon monoxide associated with traditional cigarettes. In contrast to e-cigarettes, vaping devices are often precision manufactured from metallic materials and do not look like traditional cigarettes. Vaping devices, as compared to e-cigarettes, also offer a unique user experience as a result of greater vapor production, enriched taste, and an ability to highly customize a device with different mechanical components and fashionable accessories, including different colors and finishes. Vaping devices generally consist of three primary components: a battery unit, an atomizer (which includes a heating element), and a tank filled with an e-liquid, which e-liquids are available with or without nicotine and in a myriad of flavors.
Battery
Most vaping devices are powered by a lithium-ion rechargeable battery. The housing for the battery and electronic circuitry is usually the largest component of a vaping device. It is generally referred to simply as the battery. This unit may contain an electronic airflow sensor for automated operation, or a button for manual operation. A timed cutoff switch (to prevent overheating) and/or a colored LED may also be included. To recharge the batteries, many different types of battery chargers such as AC outlet, car, and USB adaptors are usually available. Some manufacturers also offer a Portable Charging Case, or PCC, which contains a large rechargeable battery that is then used to charge a smaller battery within the individual vaping device.
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Atomizer
The atomizer is a heating element that serves to vaporize the e-liquid so it can be inhaled. The atomizer contains a filament that degrades over time due to a buildup of sediment, or "burns out" entirely, requiring periodic replacement. To address atomizer degradation, manufacturers introduced swappable replacement parts.
Tank
The tank is a small, sometimes disposable, plastic container with openings on each end. It generally houses an absorbent, sponge-like material saturated with the e-liquid solution to be vaporized. The mouthpiece is constructed so that the vapor produced can flow past the solution container to reach the user's mouth. When the e-liquid in the tank has been depleted, the user can refill the tank with an e-liquid of their choice.
E-Liquid
Liquids used to produce vapor in vaping devices are sold separately for use in refillable tanks. Liquids may or may not contain nicotine and are available in differing nicotine concentrations to suit user preferences. Liquids are available in a myriad of flavors and we offer flavors such as blackberry, krazy kola, blueberry, churro, lemonade, menthol, root beer float and watermelon, as well as proprietary blends we have innovated. Liquid solution consists of flavoring and/or nicotine dissolved in one or several hygroscopic components, which turns the water in the solution into the smoke-like vapor when heated. The most commonly used hygroscopic components are propylene glycol, vegetable glycerin or polyethylene glycol 400. Our proprietary brands of E-liquids are sourced from an ISO Class 7 certified manufacturer in the USA, which helps ensure their purity and quality.
Device Operation
The above-described components may work in conjunction in an assembled vaping device as follows:
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User presses button to activate the lithium ion battery.
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User draws on the vaping device through a mouth piece.
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The battery charges the atomizer.
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The atomizer vaporizes the e-liquid.
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User gets the smoking experience, which includes water vapor in place of smoke.
Product Examples
The following are examples of some of the products that we market and distribute:
Limitless Mechanical Mods
: Our Limitless Mechanical Mod (pictured below) was developed in August 2014 by our CEO Kyle Winther and our President Jake Perlingos. The Limitless Mechanical Mod allows a consumer to change the look and feel of their device by interchanging sleeves and is available in aluminum, brass, copper, black rhodium plated aluminum and gold plated brass finishes to accommodate market demand. We market and sell our Limitless Mechanical Mods directly to consumers at prices ranging from $99 to $180 and also sell our Limitless Mechanical Mods through our wholesale distribution channels at prices ranging from $45 to $135.
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Binary Premium E-Liquid:
Our Binary Premium e-liquid was developed internally over a period of approximately six months and is currently available in five flavors at a retail price point of approximately $12 per bottle. To provide consumers with alternatives when reducing their nicotine consumption, we offer our Binary Premium e-liquid with 0mg, 2.5mg, 5.0mg, 7.5mg, or 10mg of nicotine per bottle. In contrast, it is typical for bottles of e-liquid to be available with the following nicotine levels per bottle: 0mg, 3mg, 6mg, 12mg, and 18mg. To help ensure quality, our Binary Premium e-liquid is manufactured by a third party supplier in the United States in an ISO and GMP certified lab.
Our Business
Sourcing
We use third party contract manufacturers to produce and finish our mods (Mods), including our Limitless Mechanical Mod, from facilities located in both Southern California and China. Our Mods, which are made from a metallic material such as steel, brass or copper, are custom machined to meet our design specifications. Once machined, unfinished products are delivered to our location in Simi Valley or to a third party service provider to be buffed, polished and to add various treatments and embellishments, such as paint and engravings. Finished products are then held in inventory for distribution and sale. In our fiscal year ended June 30, 2015, we relied on one manufacturer to machine all of our Mods and in the fiscal year ended June 30, 2016, we relied on two. Although we have relied on a limited number of manufacturers to machine our Mods, we believe manufacturing capacity is available to meet our current and planned needs. We do not currently have any long term agreements in place for the manufacture of our Mods.
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With respect to our custom designed atomizers which we market and distribute globally, in our fiscal year ended June 30, 2016, we sourced these products from one manufacturer located in the United States. In our fiscal year ended June 30, 2015, we sourced our atomizers from two manufacturers located in the United States. We believe that suppliers for our atomizers are available to meet our current and planned needs.
We source our proprietary E-liquids (such as our Binary Premium E-Liquid) from an ISO Class 7 certified manufacturer in the USA, which helps ensure their purity and quality. In addition to sourcing our own e-liquids, we also purchase e-liquid from other reputable American suppliers for resale through our distribution channels.
Product Distribution
Products distributed by the Company include vaping devices and related accessories purchased from third parties for resale as well as our own vaping devices and related accessories, which we design and source, including our popular Limitless Mechanical Mods, Limitless Box Mod and Limitless Atomizer, as well as Binary Premium e-Liquid.
We market and sell our vaping devices and related products to end customers through our website www.vapor-hub.com, to retail stores through direct sales both in the United States and internationally, and through third party wholesalers both in the United States and internationally who then resell our products to retailers in their territory. Retailers of our products include vaping shops throughout the United States and in approximately 23 other countries. We also distribute our products on a limited basis through convenience stores and gas stations. In 2016, approximately 28% of our sales were to customers outside of the United States.
With respect to vaping devices and related products that we sell through third party wholesalers, we typically sell our products to these wholesalers for their re-sale on a non-exclusive basis and we also typically do not have long term contractual arrangements with any of our wholesalers.
Operation of Retail Stores
We sell our products and those of third parties to end consumers directly through our retail location located in Simi Valley, California. Through our retail location, we sell and market vaping devices as well as e-liquid, accessories, and supplies relating to vaping devices to both novice users as well as consumers who demand high end technical devices. October 15, 2015, we closed a second retail location that we previously operated in Chatsworth, California and we have no plans to open additional stores.
We opened our retail locations in order to create brand recognition for our products and also to enable us to gather information about user preferences in the rapidly evolving vaping industry. In 2016 and 2015, our retail sales accounted for approximately 6.6% and 10% of our revenue, respectively.
Marketing
We advertise our products primarily through our websites, through email marketing campaigns, magazines, paid social media advertisements, at industry trade shows and through point of sale materials and displays at our retail locations. We also attempt to build brand awareness through innovative social media marketing activities on Facebook, Instagram and Twitter, through in-store and on-premise promotions and through public relation initiatives, such as radio interviews and press releases. We intend to strategically expand our advertising activities in fiscal year 2017 and also increase our public relations campaigns to gain editorial coverage for our products.
Competition
Our industry is highly competitive and there are low barriers to entry. We compete with numerous regional, national and international electronic cigarette companies, and several large tobacco companies offer or are in the process of developing electronic cigarette products. We also compete to some extent with traditional tobacco products for customers, and to a lesser extent, we compete with companies that offer smoking cessation aids.
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We compete for customers based on a variety of factors, including the design and quality of our products which we target to the premium segment of the vaping market, price and customer service. We believe that we compete effectively in our industry as a result of, among other reasons, our innovative products, our team of experienced industry professionals, our marketing initiatives and the reputation of our brands. At a retail price point between $99 to $250, we believe that our Mods are competitively priced in the premium vaping market segment to which we cater.
Markets
According to estimates released by Euromonitor International, growth in global vapor products slowed substantially in 2015 but the market still recorded an increase of 21% to reach US$8 billion. Euromonitor International further reports that the United States and the United Kingdom are the worlds biggest markets for vaping products and the western european region alone is larger than all other regions (aside from North America). Euromonitor International also noted a continuing shift in 2015 in the market from traditional e-cigarettes to tank systems. Euromonitor International notes that excluding the US market where the split between traditional e-cigarettes to tank systems is closer to 50/50 largely due to the stronger involvement of tobacco companies 85% of world e-cigarette use was in tank systems against just 15% of world vapers consuming traditional e-cigarettes. Euromonitor International estimates that the vaping market will continue to grow to about US $20 billion by 2020. There can be no assurances, however, that such predictions will manifest, especially since governmental regulations could severely impact the growth of the electronic cigarette market both in the United States and internationally.
Intellectual Property
We are the registered owner of the federal trademarks for Vapor Hub, Tac Mods USA and T TAC MODS USA MADE IN USA and design.
We plan to continue to expand our brand names and our proprietary trademarks, designs and patents worldwide as our business grows.
Government Regulation
On May 5, 2016, the U.S. Food and Drug Administration (FDA) issued a final rule deeming certain products to be subject to the Federal Food, Drug, and Cosmetic Act and regulations thereunder (the FD&C Act), which products include electronic cigarettes and their component parts, including e-liquids, atomizers, batteries, cartomizers, tank systems, flavors, vials that contain e-liquids and programmable software. On August 8, 2016, the newly deemed products became subject to all provisions of the FD&C Act and FDA regulations applicable to cigarettes, cigarette tobacco and other tobacco products. However, for certain provisions that require labeling changes or information submission to the FDA, the FDA has provided an extended compliance period. Among other requirements, under the new rules:
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The sale of covered tobacco products to individuals under the age of 18 is prohibited beginning August 8, 2016;
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Vending machine sales of covered tobacco products are prohibited unless sold in adult-only facilities beginning August 8, 2016;
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Beginning August 8, 2016, the newly deemed products are subject to rules and regulations relating to adulterated or misbranded products, including rules that prohibit the sale and distribution of products with modified risk descriptors (such as light, low and mild) unless authorized by the FDA;
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The distribution of free samples of the newly deemed tobacco products is prohibited as of August 8, 2016;
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Companies that own or operate domestic manufacturing establishments engaged in the manufacturing of newly deemed tobacco products are required to register with the FDA and submit details about their products beginning August 8, 2016;
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Subject to certain exceptions, packaging and advertisements of all covered tobacco products will be required to bear an addictiveness warning beginning May 10, 2018; and
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Newly deemed tobacco products that were not commercially marketed in the United States as of February 15, 2007 or any modification (including a change in design, any component, any part, or any constituent or in the content, delivery or form of nicotine, or any other additive or ingredient) of a tobacco product where the modified product was commercially marketed in the United States after February 15, 2007 are required to have premarket authorization prior to commercial distribution.
The FDA process to obtain pre-market authorization will be phased in. For newly deemed tobacco products that were on the market as of August 8, 2016, but that were not on the market as of February 15, 2007, FDA is providing two compliance periods: one for submission to the FDA of applications and one for obtaining premarket authorization. During these compliance periods, the FDA does not intend to take enforcement action for products remaining on the market without authorization. New products for which no application has been submitted by August 8, 2018 will be subject to enforcement. With certain exceptions, newly deemed tobacco products for which timely premarket submissions have been submitted will be subject to an additional compliance period of twelve months after the initial compliance period for submissions ends. Once the continued compliance period ends, new tobacco products on the market without authorization will be subject to enforcement. For newly deemed tobacco products that were not on the market as of August 8, 2016, the above compliance periods will not apply and the new products must obtain a marketing order from FDA specific to the product prior to commercial distribution.
As a result of the new regulations, we will have until August 8, 2018 to submit applications to obtain approval to continue to sell our products in the United States which were on the market as of August 8, 2016. We may continue to sell these existing products during this two-year period and, provided we timely submit applications, we can continue to sell existing products for an additional year while the FDA reviews our applications. Failure to submit applications for any of our existing products would prevent us from marketing and selling such products in the United States beginning in August 2018, which could have a material adverse effect on our business, financial condition and results of operations at that time.
State and Local Regulations
State and local governments currently legislate and regulate tobacco products, including what is considered a tobacco product, how tobacco taxes are calculated and collected, to whom and by whom tobacco products can be sold and where tobacco products may or may not be smoked. Certain municipalities have enacted local ordinances which preclude the use of electronic cigarettes where traditional tobacco burning cigarettes cannot be used and certain states like California have adopted legislation that categorize electronic cigarettes as tobacco products, equivalent to their tobacco burning counterparts. If a significant number of jurisdictions enact prohibitive laws and regulations, electronic cigarettes may lose their appeal as an alternative to cigarettes, which may have the effect of reducing the demand for our products and as a result have a material adverse effect on our business, results of operations and financial condition. In addition, additional regulations will increase our regulatory compliance costs, which will adversely impact our results from operations and financial condition.
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International Regulations
The tobacco industry expects significant regulatory developments to take place over the next few years, driven principally by the WHO Framework Convention on Tobacco Control (FCTC). The objective of the FCTC is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. Regulatory initiatives that have been proposed, introduced or enacted include:
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the levying of substantial and increasing tax and duty charges;
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restrictions or bans on advertising, marketing and sponsorship;
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the display of larger health warnings, graphic health warnings and other labeling requirements;
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restrictions on packaging design, including the use of colors and generic packaging;
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restrictions or bans on the display of tobacco product packaging at the point of sale, and restrictions or bans on cigarette vending machines;
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requirements regarding testing, disclosure and performance standards for tar, nicotine, carbon monoxide and other smoke constituents levels;
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requirements regarding testing, disclosure and use of tobacco product ingredients;
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increased restrictions on smoking in public and work places and, in some instances, in private places and outdoors;
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elimination of duty free allowances for travelers; and
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encouraging litigation against tobacco companies.
Any additional regulations, to the extent they are applicable to our business, will increase our regulatory compliance costs and will adversely impact our results from operations and financial condition.
Research and Development Expenditures
We do not have a formal research and development department. However, an in-house team of approximately four employees is responsible for the design and development of our Mods and related accessories, including e-liquids.
Employees
As of June 30, 2016, we had 22 full-time employees in general and administrative, operations, engineering, research and development, business development, sales and marketing, and finance.
Emerging Growth Company
We are an emerging growth company as defined in the Jumpstart Our Business Startups Act (the
JOBS Act
). As an "emerging growth company," we are able to take advantage of specified reduced reporting and other burdens that are otherwise generally applicable to public companies.
The JOBS Act permits emerging growth companies to take advantage of an extended transition period to comply with new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Additionally, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies." These provisions include, among other matters:
the ability to provide fewer years of financial statements and other financial data in an initial public offering registration statement;
an exemption from the auditor attestation requirement in the assessment of the emerging growth company's internal control over financial reporting;
the ability to omit the compensation discussion and analysis and reduce compensation disclosure in our periodic reports and proxy statements; and
no requirement to seek non-binding advisory votes on executive compensation or golden parachute arrangements.
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We intend to take advantage of these exemptions as long as we qualify as an emerging growth company. We will remain an emerging growth company until the earliest of:
the last day of the fiscal year following the fifth anniversary of the date of the first sale of our common equity securities pursuant to an effective registration statement;
the last day of the fiscal year in which we have annual gross revenues of $1.0 billion or more;
the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and
the date on which we are deemed to be a "large accelerated filer," which will occur at such time as we (a) have an aggregate worldwide market value of common equity securities held by non-affiliates of $700 million or more as of the last business day of our most recently completed second fiscal quarter, (b) have been required to file annual and quarterly reports under the Securities Exchange Act of 1934, or the Exchange Act, for a period of at least 12 months, and (c) have filed at least one annual report pursuant to the Exchange Act.
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ITEM 1A. RISK FACTORS
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this annual report before purchasing shares of our common stock. If any of the following risks occur, our business, financial condition and/or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment.
Risks Related to Our Business and Our Industry
We have incurred losses in the past and cannot assure you that we will achieve or maintain profitable operations.
As of June 30, 2016, we had an accumulated deficit of $1,672,246 due to our continuing losses from operations. For the years ended June 30, 2016 and 2015, we had net losses of $634,643 and $613,997, respectively. We cannot assure you that we will generate operating profits on a sustainable basis or at all as we continue to expand our infrastructure, further develop our marketing efforts and otherwise implement our business initiatives.
There is doubt about our ability to continue as a going concern due to insufficient cash resources to meet our business objectives.
Our continuation as a going concern is dependent on our ability to generate sufficient cash flows from operations to meet our obligations, which we have not been able to accomplish to date, and/or obtain additional financing from equity financings, debt financings, or from other sources. The extent of our future capital requirements will depend on many factors, including results of operations and the growth rate of our business. At June 30, 2016, we had a working capital deficit of $934,884 and we currently face liquidity and capital resources constraints.
Our near term objective is to raise debt or equity capital on more favorable terms to the company to fund our immediate cash needs and to finance our longer term growth. We cannot provide assurance that we will be able to raise additional debt or equity capital, and if we are unsuccessful, we may not be able to grow our operations as planned, may not be able to meet our other obligations as they become due and may even need to cease our operations. If we are successfully able to raise capital, the issuance of additional equity securities by us could result in a significant dilution in the equity interests of our current stockholders and if capital is raised through debt facilities, such facilities will increase our liabilities and future cash commitments, and may also impose restrictive covenants relating to the operation of our business. We presently do not have any arrangements for additional financing and we continue to evaluate various financing strategies to support our current operations and fund our future growth.
Electronic cigarettes become subject to regulation by the FDA
On May 5, 2016, the U.S. Food and Drug Administration (FDA) issued a final rule deeming certain products to be subject to the Federal Food, Drug, and Cosmetic Act and regulations thereunder (the FD&C Act), which products include electronic cigarettes and their component parts, including e-liquids, atomizers, batteries, cartomizers, tank systems, flavors, vials that contain e-liquids and programmable software. On August 8, 2016, the newly deemed products became subject to all provisions of the FD&C Act and FDA regulations applicable to cigarettes, cigarette tobacco and other tobacco products. However, for certain provisions that require labeling changes or information submission to the FDA, the FDA has provided an extended compliance period. Among other requirements, under the new rules:
·
The sale of covered tobacco products to individuals under the age of 18 is prohibited beginning August 8, 2016;
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·
Vending machine sales of covered tobacco products are prohibited unless sold in adult-only facilities beginning August 8, 2016;
·
Beginning August 8, 2016, the newly deemed products are subject to rules and regulations relating to adulterated or misbranded products, including rules that prohibit the sale and distribution of products with modified risk descriptors (such as light, low and mild) unless authorized by the FDA;
·
The distribution of free samples of the newly deemed tobacco products is prohibited as of August 8, 2016;
·
Companies that own or operate domestic manufacturing establishments engaged in the manufacturing of newly deemed tobacco products are required to register with the FDA and submit details about their products beginning August 8, 2016;
·
Subject to certain exceptions, packaging and advertisements of all covered tobacco product will be required to bear an addictiveness warning beginning May 10, 2018; and
·
Newly deemed tobacco products that were not commercially marketed in the United States as of February 15, 2007 or any modification (including a change in design, any component, any part, or any constituent or in the content, delivery or form of nicotine, or any other additive or ingredient) of a tobacco product where the modified product was commercially marketed in the United States after February 15, 2007 are required to have premarket authorization prior to commercial distribution.
The FDA process to obtain pre-market authorization will be phased in. For newly deemed tobacco products that were on the market as of August 8, 2016, but that were not on the market as of February 15, 2007, FDA is providing two compliance periods: one for submission to the FDA of applications and one for obtaining premarket authorization. During these compliance periods, the FDA does not intend to take enforcement action for products remaining on the market without authorization. New products for which no application has been submitted by August 8, 2018 will be subject to enforcement. With certain exceptions, newly deemed tobacco products for which timely premarket submissions have been submitted will be subject to an additional compliance period of twelve months after the initial compliance period for submissions ends. Once the continued compliance period ends, new tobacco products on the market without authorization will be subject to enforcement. For newly deemed tobacco products that were not on the market as of August 8, 2016, the above compliance periods will not apply and the new products must obtain a marketing order from FDA specific to the product prior to commercial distribution.
As a result of the new regulations, we will have until August 8, 2018 to submit applications to obtain approval to continue to sell our products in the United States which were on the market as of August 8, 2016. We may continue to sell these existing products during this two-year period and, provided we timely submit applications, we can continue to sell existing products for an additional year while the FDA reviews our applications. Failure to submit applications for any of our existing products would prevent us from marketing and selling such products in the United States beginning in August 2018.
We believe our costs to comply with the new regulations will be substantial, both in terms of management time and out of pocket expenditures. Moreover, if we elect not to obtain or are unable to secure pre-market authorization to continue selling our existing products and any new products targeted for introduction, our future sales in the United States will be adversely impacted. We plan to further evaluate the impact of the new rules and regulations on our business and modify our business strategies accordingly to comply with the new rules and regulations. However, we cannot guarantee that we will be able to comply with the new rules and regulations, particularly the premarket authorization requirement, and the new legislation (including penalties imposed for failure to comply) could have a material adverse effect on our business, results of operations and financial condition.
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We may face liability for improper marketing, medical claims and labeling.
As a distributor and marketer of tobacco products, the Company faces potential fines, sanctions, administrative actions, penalties, and other liability for: improper labeling, making improper claims, referencing or publishing to its websites, marketing materials, advertisements, testimonials or representations that certain of our products have the ability or potential to treat, cure or otherwise improve a medical condition, and or provide a healthier alternative to other more traditional tobacco products.
Any violation of law with respect to the Companys marketing materials and or labeling could expose our company to liability including but not limited to fines, sanctions, administrative actions, penalties, civil actions and or criminal prosecution. Although our company maintains general liability insurance, our companys insurance may not cover potential claims of this type or may not be adequate to indemnify our company for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage could have a material adverse effect on our companys business, results of operations and financial condition.
We may experience product liability claims in our business, which could adversely affect our business.
The tobacco industry in general has historically been subject to frequent product liability claims. As a result, we may experience product liability claims from the marketing and sale of electronic cigarettes and defects in the products we distribute, including claims relating to exploding batteries or other product defects. Any product liability claim brought against us, with or without merit, could result in:
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liabilities that substantially exceed our product liability insurance, which we would then be required to pay from other sources, if available;
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an increase of our product liability insurance rates or the inability to maintain insurance coverage in the future on acceptable terms, or at all;
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damage to our reputation and the reputation of our products, resulting in lower sales;
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regulatory investigations that could require costly recalls or product modifications;
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litigation costs; and
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the diversion of managements attention from managing our business.
Any one or more of the foregoing could have a material adverse effect on our business, results of operations and financial condition.
Our Convertible Note financing may result in significant dilution to existing stockholders and could cause us to incur significant financial penalties
On December 24, 2015, we entered into a Senior Secured Credit Facility Agreement with TCA Global Credit Master Fund, LP (TCA) and issued to TCA a Convertible Promissory Note in the principal amount of $750,000 (the TCA Note). The payment and performance of all our indebtedness and other obligations to TCA, including all borrowings under the loan agreement and related agreements, are secured by liens on substantially all of our assets pursuant to a Security Agreement.
Upon the occurrence and during the continuance of an event of default under the transaction documents, including as a result of our failure to meet our payment obligations or to satisfy our covenants under the transaction documents, TCA may terminate its commitments to us and declare all of our obligations to TCA to be immediately due and payable. In addition, upon the occurrence and during the continuance of an event of default under the transaction documents, TCA may also exercise all of its rights as a secured creditor and obtain our assets. If we lose all or a substantial portion of our assets, our shares will likely significantly decline in value or become worthless.
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While the TCA Note is outstanding, but only upon the occurrence of (i) an event of default under the loan agreement with TCA or any related transaction document or (ii) our mutual agreement with TCA, TCA may convert, subject to certain beneficial ownership limitations, all or any portion of the outstanding principal, accrued and unpaid interest and any other sums due and payable under the Note or any other transaction document (such total amount, the Conversion Amount) into a number of shares of our common stock equal to: (i) the Conversion Amount divided by (ii) eighty-five percent (85%) of the lowest of the daily volume weighted average price of our common stock during the five business days immediately prior to the conversion date (the Conversion Shares). Upon liquidation by TCA of Conversion Shares, if TCA realizes a net amount from such liquidation equal to less than the Conversion Amount, we are obligated to issue to TCA additional shares of our common stock equal to: (a) the Conversion Amount minus the net realized amount, divided by (b) the average volume weighted average price of our common stock during the five business days immediately prior to the date upon which TCA requests additional shares. In the event we issue Conversion Shares to pay obligations under the TCA Note, our existing stockholders will likely be significantly diluted pursuant to the terms of the TCA Note and our shares may significantly decline in value or become worthless.
Similarly, in connection with the loan agreement with TCA, we agreed to pay to TCA a fee for advisory services provided to us prior to the entry into the loan agreement in the amount of $126,000 (the Advisory Fee). As partial payment of the Advisory Fee, we issued to TCA 3,810,000 shares of our common stock on December 24, 2015 (the Advisory Fee Shares). In the event that TCA receives net proceeds from the sale of such shares that are less than the Advisory Fee, TCA may require us to issue additional shares of common stock in an amount sufficient such that, when sold and the net proceeds from such sale are added to the net proceeds from the sale of any of the previously issued and sold Advisory Fee Shares, TCA shall have received total net funds equal to the Advisory Fee. Notwithstanding the foregoing, subject to certain conditions, we have the right to redeem the Advisory Fee Shares then in TCAs possession for an amount payable in cash equal to the Advisory Fee, less any net cash proceeds received by TCA from previous sales of Advisory Fee Shares. In the event TCA has not realized net proceeds from the sale of Advisory Fee Shares equal to at least the Advisory Fee by the earlier to occur of: (i) December 24, 2016; (ii) the occurrence of an event of default under the transaction documents; or (iii) the Maturity Date, then at any time thereafter, TCA has the right to require us to redeem all of the Advisory Fee Shares then in TCAs possession for cash equal to the Advisory Fee, less any cash proceeds received by TCA from any previous sales of Advisory Fee Shares. In the event TCA sells its Advisory Fee Shares in the market, our share price may significantly decline. In addition, in the event we issue additional Advisory Fee Shares to pay the Advisory Fee, our existing stockholders will likely be significantly diluted and our shares may significantly decline in value or become worthless.
In addition to our agreements with TCA, we are party to a Second Exchange Note with Iliad Research & Trading, L.P. pursuant to which we may be required to issue shares of our common stock upon conversion of such note. See Note 14 for a further discussion of the Second Exchange Note. As of October 10, 2016, the outstanding balance on the Second Exchange Note was $23,264. In the event we issue shares of our common stock to pay obligations under the Second Exchange Note, our existing stockholders will likely be significantly diluted and our shares may significantly decline in value.
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Our lenders have rights that are senior to those of our common stockholders
Our ability to pay interest and principal on our indebtedness and to satisfy our other obligations will depend upon, among other things, our future financial and operating performance, which is affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt, or seeking additional equity capital. We may be unable to effect any of these actions on satisfactory terms, or at all. In the event we issue common stock or other equity securities to satisfy our debt obligations, our existing stockholders may suffer significant dilution. Furthermore, any proceeds that we could realize from any financings or the disposition of assets may not be adequate to meet our debt service or other obligations then due, which would have an immediate material adverse effect on our business, results of operations and financial condition. In the event of our bankruptcy, dissolution or liquidation, the claims of our lenders (including TCA) must be satisfied before any distributions can be made on our common stock. As a result, our common stockholders would receive distributions only after priority distributions to our lenders are satisfied and may receive nothing in the event of our bankruptcy, dissolution or liquidation.
We operate a developing business, and it is difficult to accurately predict our future sales and appropriately budget expenses.
Because our business is evolving, including as a result of recent regulatory changes announced by the FDA, it is difficult to accurately predict our future sales and appropriately budget our expenses. Our operations will be subject to risks inherent in the establishment of a developing business, including, among other things, efficiently deploying our capital, developing our products, developing and implementing our marketing campaigns and strategies and developing brand awareness and acceptance of our products. Our ability to generate future sales will be dependent on a number of factors, many of which are beyond our control, including the pricing of competing products, overall demand for our products, changes in consumer preferences, market competition and government regulation. While we believe that we have the opportunity to be successful in the electronic cigarette industry, there can be no assurance that we will be successful in accomplishing our business initiatives, or that we will be able to achieve any significant levels of revenues or net income, from the sale of our products.
Our failure to compete effectively could have a material adverse effect on our business, results of operations and financial condition.
We face competition from direct and indirect competitors, including tobacco companies, other known and established or yet to be formed electronic cigarette companies, and pharmaceutical companies that market smoking cessation aids and alternative nicotine delivery products, each of whom pose a competitive threat to our current business and future prospects. We compete primarily on the basis of product quality, brand recognition, brand loyalty, service, marketing, advertising and price. There can be no assurance that we will be able to compete successfully against any of the aforementioned competitors and our inability to successfully compete against these or any of our competitors could have a material adverse effect our business, results of operations and financial condition.
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Our products may become obsolete and unmarketable if we are unable to respond adequately to rapidly changing technology and customer demands.
Our industry is characterized by rapid changes in technology and customer demands. As a result, our products and services may quickly become obsolete and unmarketable. Our future success will depend on our ability to adapt to technological advances, anticipate customer demands, develop new products and enhance our current products on a timely and cost-effective basis. Further, our products must remain competitive with those of other companies with substantially greater resources. We may experience technical or other difficulties that could delay or prevent the development, introduction or marketing of new products or enhanced versions of existing products. Also, we may not be able to adapt new or enhanced services to emerging industry standards, and our new products may not be favorably received.
If we are unable to meet the changing demands of our customers, our business and financial condition will likely be materially adversely affected.
We must attract and maintain key personnel or our business could be materially adversely affected.
We must continue to attract and retain key personnel in order to successfully operate our business. We compete with other companies both within and outside the tobacco/ electronic cigarette industry to recruit and retain competent employees. If we cannot retain qualified employees to meet the needs of our anticipated growth, our business and financial condition could be materially adversely affected.
If we are not able to adequately protect our intellectual property, our financial performance may be adversely impacted.
Our commercial success may depend, in part, on obtaining and maintaining patent protection of our technologies and product candidates as well as successfully defending third-party challenges to such technologies and candidates. We may also rely on trade secrets to protect our technologies, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. While we seek to protect trade secrets and confidential information, in part, through confidentiality agreements with our consultants and other advisors, they may unintentionally or willfully disclose our information to competitors. Enforcing a claim against a third party related to the illegal acquisition and use of trade secrets can be expensive and time consuming, and the outcome is often unpredictable. If we are not able to maintain patent or trade secret protection on our technologies and product candidates, then we may not be able to exclude competitors from developing or marketing competing products which could adversely impact our financial performance.
In addition to patents and trade secrets, we also consider our trademarks important in our ability to continue to develop and maintain the goodwill and recognition associated with our brands. If we are not able to maintain trademark protection on our brands, then our results of operations may be adversely effected.
Any litigation relating to the protection of our intellectual property could be time-consuming and costly.
We may need to bring legal claims to enforce or protect our intellectual property rights. Any litigation, whether successful or unsuccessful, could result in substantial costs and diversions of resources. In addition, notwithstanding any rights we have secured in our intellectual property, other persons may bring claims against us that we have infringed on their intellectual property rights and such parties may further argue that our intellectual property rights are not valid. Any claims against us, with or without merit, could be time consuming and costly to defend or litigate, divert our attention and resources, result in the loss of goodwill associated with our service marks or require us to make changes to our website or other of our technologies, all of which could negatively impact our stock price.
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If we are the subject of an intellectual property infringement claim, the cost of participating in any litigation could materially adversely affect our business.
There has been, and we believe that there will continue to be, significant litigation and demands for licenses in our industry regarding patent and other intellectual property rights. Although we anticipate having a valid defense to any allegation that our current products, production methods and other activities infringe the valid and enforceable intellectual property rights of any third parties, we cannot be certain that a third party will not challenge our position in the future. Other parties may own patent rights that we might infringe with our products or other activities, and our competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. These parties could bring claims against us that would cause us to incur substantial litigation expenses and, if successful, may require us to pay substantial damages. Some of our potential competitors may be better able to sustain the costs of complex patent litigation, and depending on the circumstances, we could be forced to stop or delay our research, development, manufacturing or sales activities. Any of these costs could cause us to go out of business.
If we fail to effectively manage our growth, our future business results could be harmed and our managerial and operational resources may be strained.
We anticipate that we will need to hire additional personnel as we grow, including staff to help source our products, manage operations, increase our sales and marketing efforts and perform finance and accounting functions. This growth is likely to place a strain on our management and operational resources. The failure to develop and implement effective systems, or to hire and retain sufficient personnel for the performance of all of the functions necessary to effectively service and manage our potential business, or the failure to manage growth effectively, could have a materially adverse effect on our business and financial condition.
Limitations by states and cities on sales of electronic cigarettes and other regulatory restrictions may have a material adverse effect on our ability to sell our products in the United States and will cause us to incur additional compliance costs
Certain states and cities have enacted laws which preclude the use of electronic cigarettes where traditional tobacco-burning cigarettes cannot be used and others have adopted or proposed legislation that categorize electronic cigarettes as tobacco products, equivalent to their tobacco burning counterparts. If a significant number of jurisdictions enact prohibitive laws and regulations, electronic cigarettes may lose their appeal as an alternative to cigarettes, which may have the effect of reducing the demand for our products and as a result have a material adverse effect on our business, results of operations and financial condition. In addition, additional regulations will increase our regulatory compliance costs, which will adversely impact our results from operations and financial condition.
The use of electronic cigarettes may pose health risks as great as, or greater than, regular tobacco products.
According to the FDA, electronic cigarettes may contain ingredients that are known to be toxic to humans and may contain other ingredients that may not be safe. Additionally, electronic cigarettes may be attractive to young people and may lead them to try other tobacco products, including conventional cigarettes that are known to cause disease. In addition, there have been instances of electronic cigarettes exploding, especially during charging. Consequently, there is a risk that an electronic cigarette can cause disease and/or serious bodily injury and the publicity from such instances of disease or injury could dramatically slow the growth of the market for electronic cigarettes and negatively impact our operations.
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The recent development of electronic cigarettes has not allowed the medical profession to sufficiently study the long-term health effects of electronic cigarette use.
Because electronic cigarettes were recently developed, the medical profession has not had a sufficient period of time to study the long-term health effects of electronic cigarette use and it is uncertain whether or not electronic cigarettes are safe for their intended use. If the medical profession were to determine conclusively that electronic cigarette usage poses long-term health risks, electronic cigarette usage could decline, which could have a material adverse effect on our business, results of operations and financial condition.
If we experience product recalls, we may incur significant and unexpected costs and our business reputation could be adversely affected.
We may be exposed to product recalls and adverse public relations if our products are alleged to cause illness or injury, or if we are alleged to have violated governmental regulations. A product recall could result in substantial and unexpected expenditures that could exceed our product recall insurance coverage limits and harm to our reputation, which could have a material adverse effect on our business, results of operations and financial condition. In addition, a product recall may require significant management time and attention and may adversely impact the value of our brands. Product recalls may also lead to greater scrutiny by federal or state regulatory agencies and increased litigation, which could have a material adverse effect on our business, results of operations and financial condition.
Our products contain nicotine which is considered to be a highly addictive substance.
Certain of our products contain nicotine, a chemical found in cigarettes and other tobacco products which is considered to be highly addictive. The Family Smoking Prevention and Tobacco Control Act empowers the FDA to regulate the amount of nicotine found in tobacco products, but may not require the reduction of nicotine yields of a tobacco product to zero. Any FDA regulation may require us to reformulate, recall and or discontinue certain of the products we may sell from time to time, which may have a material adverse effect on our ability to market our products and have a material adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects.
Our business may be affected if we are taxed like other tobacco products or if we are required to collect and remit sales tax on certain of our internet sales.
Presently our products are not taxed like cigarettes or other tobacco products, all of which have faced significant increases in the amount of taxes collected on the sale of their products. Should state and federal governments and or taxing authorities impose taxes similar to those levied against cigarettes and tobacco products on our products, it may have a material adverse effect on the demand for our products.
Our success is dependent upon our marketing efforts.
If we are unable to generate significant market awareness for our products and our brands, our operations may not generate sufficient revenues for us to execute our business plan. We rely, in part, on the efforts of our independent sales distributors and outside broker/dealer network to augment our internal sales efforts and distribute our product to wholesalers and or retailers to generate revenues. No single distributor currently accounts for a material percentage of our revenues and we believe that should any of these relationships terminate we would be able to find suitable replacements.
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We depend on a small number of third party suppliers and manufacturers for critical raw materials, components and certain of our electronic cigarette products.
We depend on a small number of third-party suppliers and manufacturers for raw materials, components and certain of our electronic cigarette products. We depend on such suppliers to supply materials, components and products in a timely manner, in adequate quantities, consistent quality and at reasonable costs. An interruption in supply and or consistency of our products may harm our relationships and goodwill with customers, and have a materially adverse effect on our cash flow and our operations.
Although we believe that several alternative and redundant sources for our products are available, any failure to obtain the components, chemical constituents and manufacturing services necessary for the production of our products could have a material adverse effect on our business and prevent us from timely execution of our business plan and may result in additional expenditures of time and money in seeking viable new sources of supply and manufacturer alternatives.
Our financial results may vary significantly from period-to-period due to unpredictable sales cycles in certain of the markets into which we sell our products, and changes in the mix of products we sell during a period, which may lead to volatility in our stock price.
The size and timing of our potential revenue from sales to our customers is difficult to predict and is market-dependent. Our sales efforts will often require us to educate our customers about the use and benefits of our products, including their technical and performance characteristics. We intend to spend substantial amounts of time and money on our sales efforts and there is no assurance that these investments will produce any sales within expected time frames or at all.
Our profitability from period-to-period may also vary significantly due to the mix of products that we may sell in different periods. Consequently, sales of individual products may not necessarily be consistent across periods, which could affect product mix and cause gross and operating profits to vary significantly. As a result of these factors, we believe that quarter-to-quarter comparisons of our operating results cannot necessarily be relied upon to be meaningful and that these comparisons cannot be relied upon as indicators of future performance.
Product exchanges, returns and warranty claims may adversely affect our business.
If we are unable to maintain an acceptable degree of quality control of our products, we will incur costs associated with the exchange and return of our products as well as servicing our customers for warranty claims. Any of the foregoing on a significant scale may have a material adverse effect on our business, results of operations and financial condition.
Adverse economic conditions may adversely affect the demand for our products.
Electronic cigarettes are new to market and may be regarded by users as a novelty item and expendable. When economic conditions are prosperous, discretionary spending typically increases; conversely, when economic conditions are unfavorable, discretionary spending often declines. Any significant decline in economic conditions that affects consumer spending could have a material adverse effect on our business, results of operations and financial condition.
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Internet security poses a risk to our e-commerce sales.
At present, we generate revenues through the sale of our products through our websites. We manage our websites and e-commerce platform internally and as a result any compromise of our security or misappropriation of proprietary information could have a material adverse effect on our business, prospects, financial condition and results of operations. We rely on encryption and authentication technology licensed from other companies to provide the security and authentication necessary to effect secure Internet transmission of confidential information, such as credit and other proprietary information. Advances in computer capabilities, new discoveries in the field of cryptography or other events or developments may result in a compromise or breach of the technology used by us to protect client transaction data. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause material interruptions in our operations. We may be required to expend significant capital and other resources to protect against security breaches or to minimize problems caused by security breaches. To the extent that our activities or the activities of others involve the storage and transmission of proprietary information, security breaches could damage our reputation and expose us to a risk of loss or litigation, government sanction, and possible liability. Our failure to prevent these security breaches may further result in consumer distrust and may also adversely affect our business, results of operations and financial condition.
We may incur losses that are not adequately covered by insurance, which may harm our results of operations. In addition, our insurance costs may increase and we may not be able to obtain similar insurance coverage in the future.
Although we believe we maintain insurance that is customary and appropriate for our business and its size, each of our insurance policies is subject to certain exclusions. The lack of adequate insurance for certain types or levels of risk could expose us to significant losses in the event that a catastrophe occurred for which we are underinsured. In addition to the damage caused to our properties by a casualty loss, we may suffer business disruption as a result of the casualty event or be subject to claims by third parties that may be injured or harmed. While we carry general liability insurance and business interruption insurance, there can be no assurance that insurance will be available or adequate to cover all loss and damage to which our business or our assets might be subjected. In addition, certain casualty events, such as labor strikes, nuclear events, loss of income due to terrorism, deterioration or corrosion, insect or animal damage and pollution, may not be covered under our policies. Any losses we incur that are not adequately covered by insurance may decrease our future operating income, require us to fund replacements or repairs for destroyed property and reduce the funds available for payments of our obligations.
We renew our insurance policies on an annual basis. To the extent that the cost of insurance coverage increases, we may be required to reduce our policy limits or agree to exclusions from our coverage.
We are subject to litigation in the ordinary course of our business. An adverse determination with respect to any such disputed matter could result in substantial losses.
We are, from time to time, during the ordinary course of operating our businesses, subject to various litigation claims and legal disputes, including contract, lease, employment and regulatory claims as well as claims made by visitors to our retail locations. Certain litigation claims may not be covered entirely or at all by our insurance policies or our insurance carriers may seek to deny coverage. In addition, litigation claims can be expensive to defend and may divert our attention from the operations of our businesses. Further, litigation, even if without merit, can attract adverse media attention. As a result, litigation can have a material adverse effect on our businesses and, because we cannot predict the outcome of any action, it is possible that adverse judgments or settlements could significantly reduce our earnings or result in losses.
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Risks Relating to Ownership of Our Securities
Our stock price may be volatile, which may result in losses to our shareholders.
The stock markets have experienced significant price and trading volume fluctuations, and the market prices of companies listed on the Over-the-counter Bulletin Board quotation system in which shares of our common stock are listed, have been volatile in the past and have experienced sharp share price and trading volume changes. The trading price of our common stock is likely to be volatile and could fluctuate widely in response to many factors, including the following, some of which are beyond our control:
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variations in our operating results;
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changes in expectations of our future financial performance, including financial estimates by securities analysts and investors;
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changes in regulations that are applicable to our industry;
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changes in operating and stock price performance of other companies in our industry;
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additions or departures of key personnel; and
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future sales of our common stock, including common stock issued upon the conversion of existing indebtedness.
Domestic and international stock markets often experience significant price and volume fluctuations. These fluctuations, as well as general economic and political conditions unrelated to our performance, may also adversely affect the price of our common stock.
Our common shares may become thinly traded and you may be unable to sell at or near ask prices, or at all.
We cannot predict the extent to which an active public market for trading our common stock will be sustained. Our common stock has historically been sporadically or thinly-traded, meaning that the number of persons interested in purchasing our common shares at or near bid prices at certain given time may be relatively small or non-existent.
This situation is attributable to a number of factors, including the fact that we are a small company which is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community who generate or influence sales volume. Even if we came to the attention of such persons, those persons tend to be risk-averse and may be reluctant to follow, purchase, or recommend the purchase of shares of an unproven company such as ours until such time as we become more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained.
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Our stock is a penny stock, which may subject our common stock to abuse.
Shareholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the volatility of our share price.
Because our common stock is a penny stock, trading therein will be subject to regulatory restrictions.
Our common stock is currently, and in the near future will likely continue to be, considered a penny stock. The SEC has adopted rules that regulate broker-dealer practices in connection with transactions in penny stocks. Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system). The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from those rules, to deliver a standardized risk disclosure document prepared by the SEC, which specifies information about penny stocks and the nature and significance of risks of the penny stock market. The broker-dealer also must provide the customer with bid and offer quotations for the penny stock, the compensation of the broker-dealer and any salesperson in the transaction, and monthly account statements indicating the market value of each penny stock held in the customers account. In addition, the penny stock rules require that, prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchasers written agreement to the transaction. These disclosure and other requirements may adversely affect the trading activity in the secondary market for our common stock.
We do not anticipate paying any cash dividends to our common shareholders.
We presently do not anticipate that we will pay any cash dividends on any of our common stock in the foreseeable future. If payment of dividends does occur at some point in the future, it would be contingent upon our revenues and earnings, if any, capital requirements, and general financial condition. The payment of any cash dividends will be within the discretion of our Board of Directors, but subject to the terms of restrictive covenants that may be present in our contractual arrangements. We presently intend to retain all earnings to implement our business plan; accordingly, we do not anticipate the declaration of any cash dividends in the foreseeable future.
Volatility in our common share price may subject us to securities litigation.
The market for our common stock is characterized by significant price volatility as compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management's attention and resources.
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The elimination of monetary liability against our directors, officers and employees under Nevada law and the existence of indemnification rights of our directors, officers and employees may result in substantial expenditures by our company and may discourage lawsuits against our directors, officers and employees.
Our Articles of Incorporation include a specific provision to eliminate the liability of our directors and officers for monetary damages to our company and shareholders to the maximum extent provided for by Nevada law. We may also adopt contractual indemnification obligations under employment agreements that we may enter into with our officers. The foregoing indemnification obligations could result in our company incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. These provisions and resultant costs may also discourage our company from bringing a lawsuit against directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our shareholders against our directors and officers even though such actions, if successful, might otherwise benefit our company and shareholders.
Our board of directors is authorized to issue additional shares of stock which could dilute existing shareholders.
We are currently authorized to issue up to 1,010,000,000 shares of common stock, of which 90,292,443 shares are currently issued and outstanding and up to 10,000,000 shares of preferred stock, none of which are issued and outstanding. Additional shares of our common stock or preferred stock may be issued by our board of directors for such consideration as they may consider sufficient without seeking stockholder approval. The issuance of additional shares of common stock in the future will reduce the proportionate ownership and voting power of current stockholders and the issuance of preferred stock may also have a similar impact.
Provisions in our organizational documents and Nevada law will make it more difficult for someone to acquire control of us.
Our amended and restated articles of incorporation, amended and restated bylaws and Nevada law contain provisions that could discourage, delay or prevent a third party from acquiring our company, even if doing so may be beneficial to our stockholders. As an example, our restated articles of incorporation and amended and restated bylaws provide:
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The ability to our board of directors to issue shares of our preferred stock in one or more series without further authorization of our stockholders;
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A prohibition on stockholder action by written consent; and
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A requirement that stockholders provide advance notice of any stockholder nominations of directors or any proposal of new business to be considered at any meeting of stockholders.
In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock
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The majority of our board does not consist of independent directors, which limits our ability to establish effective independent corporate governance procedures.
Our board is composed of four directors, none of whom are independent based on the NASDAQ listing rules. Without a majority of independent directors on our board, our ability to establish effective corporate governance procedures to oversee functions such as audit, compensation and corporate governance is limited. Furthermore, a majority of our directors are also executive officers of the Company. This structure gives our executive officers significant control over all corporate issues and decisions.
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In the absence of a majority of independent directors, our executive officers, most of whom are also principal stockholders and directors, could establish policies and enter into transactions without independent review and approval. This could present the potential for a conflict of interest between us and our shareholders generally and the controlling officers, shareholders or directors. Although we anticipate seeking independent directors in the future, there can be no assurance as to whether or when we will be successful in appointing any new directors.
We are an emerging growth company under the JOBS Act of 2012, and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
We are an emerging growth company, as defined in the JOBS Act, and we 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 auditor attestation requirements of section 404 of the Sarbanes-Oxley Act (which may increase the risk that weaknesses or deficiencies in our internal control over financial reporting go undetected), reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We will remain an emerging growth company for up to five years, although we will lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three year period, or if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30.
Because we have elected to use the extended transition period for complying with new or revised accounting standards for an emerging growth company our financial statements may not be comparable to companies that comply with public company effective dates.
We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(1) of the JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates. Because our financial statements may not be comparable to companies that comply with public company effective dates, investors may have difficulty evaluating or comparing our business, performance or prospects in comparison to other public companies, which may have a negative impact on the value and liquidity of our common stock.
If securities analysts do not publish research or reports about our company, or if they issue unfavorable commentary about us or our industry and markets or downgrade our common stock, the price of our common stock could decline.
The trading market for our common stock will depend in part on the research and reports that third-party securities analysts publish about our company and our industry and markets. One or more analysts could downgrade our common stock or issue other negative commentary about our company or our industry or markets. In addition, we may be unable or slow to attract sufficient research coverage. Alternatively, if one or more of these analysts cease coverage of our company, we could lose visibility in the market. As a result of one or more of these factors, the trading price and volume of our common stock could decline.
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Our officers, directors and principal stockholders can exert significant influence over our business and may make decisions that are not in the best interests of all stockholders.
Our officers, directors and principal stockholders (greater than 5% stockholders) collectively own approximately 42.3% of our issued and outstanding common stock. As a result of such ownership, these stockholders will be able to affect the outcome of, or exert significant influence over, all matters requiring stockholder approval, including the election and removal of directors and any change in control. In particular, this concentration of ownership of our common stock could have the effect of delaying or preventing a change of control of our company or otherwise discouraging or preventing a potential acquirer from attempting to obtain control of our company. This, in turn, could have a negative effect on the market price of our common stock. It could also prevent our stockholders from realizing a premium over the market prices for their shares of our common stock.
The requirements of being a public company, including compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, and the requirements of the Sarbanes-Oxley Act of 2002, may strain our resources, increase our costs and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.
As a public company, we need to comply with laws, regulations and requirements, certain corporate governance provisions of the Sarbanes-Oxley Act of 2002, related regulations of the SEC, and requirements of the principal trading market upon which our common stock may trade, with which we are not required to comply as a private company. As a result, we will incur significant legal, accounting and other expenses that a private company would not incur. Complying with these statutes, regulations and requirements will occupy a significant amount of the time of our board of directors and management, will require us to have additional finance and accounting staff, may make it more difficult to attract and retain qualified officers and members of our board of directors, particularly to serve on the audit committee (upon its formation), and may make some activities more difficult, time consuming and costly. We will need to:
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institute a more comprehensive compliance function;
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maintain internal policies, such as those relating to disclosure controls and procedures and insider trading;
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design, establish, evaluate and maintain a system of internal control over financial reporting in compliance with the requirements of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board;
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prepare and distribute periodic reports in compliance with our obligations under the federal securities laws including the Securities Exchange Act of 1934, as amended (the Exchange Act);
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involve and retain to a greater degree outside counsel and accountants in the above activities; and
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establish an investor relations function.
If we are unable to accomplish these objectives in a timely and effective fashion for our business, our ability to comply with financial reporting requirements and other rules that apply to reporting companies could be impaired. If our finance and accounting personnel insufficiently support our business in fulfilling these public-company compliance obligations, or if we are unable to hire adequate finance and accounting personnel, we could face significant legal liability, which could have a material adverse effect on our financial condition and results of operations. Furthermore, if we identify any issues in complying with those requirements (for example, if our company or the independent registered public accountants identified a material weakness or significant deficiency in our companys internal control over financial reporting), we could incur additional costs rectifying those issues, and the existence of those issues could adversely affect our reputation or investor perceptions of our company.
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