The accompanying notes are an integral part of these
unaudited consolidated financial statements.
Notes to Unaudited Consolidated Financial
Statements
Note 1 – Organization and Description of Business
Kaival Brands Innovations Group, Inc. (the “Company,”
the “Registrant,” “we,” “us,” or “our”), formerly known as Quick Start Holdings, Inc.,
was incorporated on September 4, 2018 in the State of Delaware.
Description of Business
In March 2020, the Company commenced business operations
as a result of becoming the exclusive distributor of certain ENDS and related components (the “Products”) manufactured by
Bidi Vapor, LLC (“Bidi”), a related party company that is also owned by Nirajkumar Patel, the Chief Science and Regulatory
Officer of the Company.
On March 9, 2020, the Company entered into an exclusive
distribution agreement (the “Distribution Agreement”) with Bidi, which Distribution Agreement was amended and restated on
May 21, 2020 and again on April 20, 2021 (collectively, the “A&R Distribution Agreement”). Pursuant to the A&R Distribution
Agreement, Bidi granted the Company an exclusive worldwide right to distribute the Products for sale and resale to both retail level customers
and non-retail level customers. Currently, the Products consist primarily of the “BIDI® Stick.” The Company
ceased all retail/direct-to-consumer sales in February 2021. On June 10, 2022, the Company entered into a third amended and restated exclusive
distribution agreement (the “Third A&R Distribution Agreement”) which memorializes the Company’s current business
relationship with Bidi.
On August 31, 2020, the Company formed Kaival Labs,
Inc., a Delaware corporation (herein referred to as “Kaival Labs”), as a wholly owned subsidiary of the Company, for the purpose
of developing Company-branded and white-label products and services. On March 11, 2022, the Company formed Kaival Brands International,
LLC, a Delaware limited liability company (herein referred to as “KBI”), as a wholly owned subsidiary of the Company, for
the purpose of entering into an international licensing agreement with Philip Morris Products S.A. (“PMPSA”), a wholly owned
affiliate of Philip Morris International Inc. (“PMI”).
On July 16, 2021, the Company filed a Certificate
of Amendment to the Restated Certificate of Incorporation, as amended, with the Secretary of State of the State of Delaware to effect
a 1-for-12 reverse stock split (the “Reverse Stock Split”) of the shares of the Company’s common stock, par value $0.001
per share (the “Common Stock”). The Reverse Stock Split was effective as of 12:01 a.m. Eastern time on July 20, 2021. No fractional
shares were issued in connection with the Reverse Stock Split. Any fractional shares of Common Stock that would have otherwise resulted
from the Reverse Stock Split were rounded up to the nearest whole number. In connection with the Reverse Stock Split, the Board of Directors
(the “Board”) approved appropriate and proportional adjustments to all outstanding securities or other rights convertible
or exercisable into shares of Common Stock, including, without limitation, all preferred stock, warrants, options, and other equity compensation
rights. All historical share and per-share amounts reflected throughout our consolidated financial statements and other financial information
in this Quarterly Report have been adjusted to reflect the Reverse Stock Split as if the split occurred as of the earliest period presented.
The par value per share of the Common Stock was not affected by the Reverse Stock Split.
Current Product Offerings
Pursuant to the Third A&R Distribution Agreement, the Company sells and resells electronic nicotine delivery systems, which it may refer to herein as “ENDS Products”, or “e-cigarettes”, to non-retail level customers. The sole Product the Company resells is the “BIDI® Stick,” a disposable, tamper-resistant ENDS product that comes in a variety of flavor options for adult cigarette smokers. The Company does not manufacture any of the Products it resells. The BIDI® Stick is manufactured by Bidi. Pursuant to the terms of the Third A&R Distribution Agreement, Bidi provides the Company with all branding, logos, and marketing materials to be utilized by the Company in connection with its marketing and promotion of the Products.
On July 14, 2021, the Company announced plans to launch its first Kaival-branded product, a Hemp CBD vaping product. In addition to its branded formulation, the Company anticipates that it will also provide white label, wholesale solutions for other product manufacturers through its subsidiary, Kaival Labs. The Company has not yet launched any branded product, nor has it begun to provide white label wholesale solutions for other product manufacturers.
COVID-19 Impact
In March 2020, the World
Health Organization (the “WHO”) announced a global health emergency because of a new strain of coronavirus (“COVID-19”)
originating in Wuhan, China and the risks to the international community as the virus spread globally beyond its point of origin. In March
2020, the WHO classified the COVID-19 outbreak as a pandemic based on the rapid increase in global exposure.
The Company was indirectly impacted by supply chain
issues and regulatory oversight. The Company believes that many retailers and distributers relaxed their compliance standards as an indirect
result of COVID-19 for two reasons: (i) government enforcement of regulations was very limited due to imposed social restrictions, resulting
in less in-person monitor enforcement by government officials and (ii) retail stores experienced light foot traffic from customers due
to COVID-19 restrictions and fears, which resulted in relaxed compliance in an effort to generate additional revenue.
Impact of the FDA PMTA Decision and Subsequent
Court Actions
As of March 2022, the FDA announced that it has taken
action on over 99% of applications and issued Marketing Denial Orders (“MDOs”) for more than 1,167,000 non-tobacco flavored
ENDS products, while issuing zero marketing authorizations for such products.
Bidi, along with nearly every other company in the
ENDS industry, received a MDO for its non-tobacco flavored ENDS products. With respect to Bidi, the MDO covered all non-tobacco flavored
BIDI® Sticks, including its Arctic (menthol) BIDI® Stick. As a result, beginning in September 2021, Bidi pursued multiple avenues
to challenge the MDO. First, on September 21, 2021, separate from the judicial appeal of the MDO in its entirety, Bidi filed a 21 C.F.R.
§ 10.75 internal FDA review request specifically of the decision to include the Arctic (menthol) BIDI® Stick in the MDO. In May
2022, the FDA issued a determination that it views the Arctic BIDI® Stick as a flavored ENDS product, and not strictly a menthol flavored
product.
On September 29, 2021, Bidi petitioned the U.S. Court
of Appeals for the Eleventh Circuit (the “11th Circuit”) to review the FDA’s denial of the PMTAs for its non-tobacco
flavored BIDI® Stick ENDS, arguing that it was arbitrary and capricious under the Administrative Procedure Act (“APA”),
as well as ultra vires, for the FDA not to conduct any scientific review of Bidi’s comprehensive applications, as required by the
Tobacco Control Act (“TCA”), to determine whether the BIDI® Sticks are “appropriate for the protection of the public
health”. Bidi further argued that the FDA violated due process and the APA by failing to provide fair notice of the FDA’s
new requirement for ENDS companies to conduct long-term comparative smoking cessation studies for their flavored products, and that FDA
should have gone through the notice and comment rulemaking process for this requirement.
On October 14, 2021, Bidi requested that the FDA re-review
the MDO and reconsider its position that Bidi did not include certain scientific data in its applications sufficient to allow the PMTAs
to proceed to scientific review. In light of this request, on October 22, 2021, pursuant to 21 C.F.R. § 10.35(a), the FDA issued
an administrative stay of Bidi’s MDO pending its re-review. Subsequently, the FDA decided not to rescind the MDO and lifted its
administrative stay on December 17, 2021. Following the lifting of the FDA’s administrative stay, Bidi filed a renewed motion to
stay the MDO with the 11th Circuit. On February 1, 2022, the appellate court granted Bidi’s motion to stay (i.e., put on hold) the
MDO, pending the litigation on the merits. Oral arguments in the merits-based proceeding were held on May 17, 2022.
On August 23, 2022, the U.S. Court of Appeals for
the Eleventh Circuit set aside the MDO issued to the non-tobacco flavored BIDI® Sticks and remanded Bidi’s Premarket Tobacco
Product Application (“PMTA”) back to FDA for further review. Specifically, the Court held that the MDO was “arbitrary
and capricious” in violation of the Administrative Procedure Act (“APA”) because FDA failed to consider the relevant
evidence before it, specifically Bidi’s aggressive and comprehensive marketing and sales-access-restrictions plans designed to prevent
youth appeal and access. See Bidi Vapor LLC v. U.S. Food & Drug Administration, __ F.4th __, No. 21-13340, 2022 U.S. App. LEXIS
23607 (11th Cir. Aug. 23, 2022).
FDA could appeal the 11th Circuit’s decision
by seeking a panel rehearing or a rehearing “en banc” (a review by the entire 11th Circuit, not just the panel that issued
the decision) within 45 days of the decision (i.e., by October 7, 2022) or, within 90 days of the final judgment being entered, by filing
a petition for writ of certiorari seeking review by the U.S. Supreme Court. If FDA files a petition for a panel rehearing or rehearing
en banc, then the 11th Circuit’s mandate (which is when the judgement takes effect) will not issue. In the event of a
petition for writ of certiorari to the Supreme Court, the mandate issues unless FDA files a motion to stay the mandate. If a petition
for an en banc hearing is granted, the underlying decision and judgment is vacated. Accordingly, if FDA chooses to appeal the 11th Circuit’s
decision or seek review from the Supreme Court, the Company anticipates Bidi will be able to continue marketing and selling the non-tobacco
flavored BIDI® Sticks, subject to FDA’s enforcement discretion, for at least the duration of such an appeal.
Alternatively, FDA could decide not to appeal the
11th Circuit’s decision and move forward with a review of Bidi’s PMTA on remand, as directed by the Court. It is unclear how
long this process could take or how FDA might prioritize Bidi’s application. For example, earlier in 2022, in a PMTA MDO challenge
in the 9th Circuit, FDA agreed to re-review its basis of the petitioner My Vape Order’s MDO; the parties accordingly requested the
court place the MDO appeal in abeyance pending completion of FDA’s re-review. FDA estimated that it would not be able to complete
its re-review of those PMTAs until at least January 2024. See My Vape Order, Inc. v. U.S. Food & Drug Administration, No. 21-71302,
9th Cir., 2022 U.S. App. LEXIS 20306.
While FDA could narrowly
interpret the Court’s ruling as an order to review only Bidi’s marketing and sales-access restrictions plans, the Company
believes that the 11th Circuit’s opinion makes clear that all relevant evidence in an application must be considered. A complete
scientific review of the PMTA would require FDA to review all of this information before making an “appropriate for the protection
of public health” (known as “APPH”) determination; based on FDA’s history, this scientific review process could
take 1-2 years to complete, or longer.
In the event of a decision adverse to Bidi following
a rehearing by the 11th Circuit or from the Supreme Court, or if the FDA otherwise chooses to enforce against Bidi, because its products
are not yet authorized, or if the FDA issues another MDO for Bidi’s non-tobacco flavored ENDS after completing its review of the
PMTAs on remand, Bidi will be forced to cease the continued sale of its non-tobacco flavored BIDI® Stick products in the United States,
thereby resulting in the Company being unable to distribute such products, leaving only the tobacco-flavored (Classic) BIDI® Sticks
for sale in the United States (pending FDA’s review of that PMTA), and the Company’s business and financial condition would
be materially adversely affected. The Company cannot provide any assurances as to the timing or outcome of a potential appeal of the 11th
Circuit’s decision, or FDA’s review of the PMTAs on remand.
Separately, on or about May 13, 2022, FDA placed the
tobacco-flavored Classic BIDI® Stick into the final Phase III scientific review.
Note 2 – Basis of Presentation and Significant
Accounting Policies
Principles of Consolidation
The consolidated financial statements include the
financial statements of the Company’s wholly-owned subsidiaries, Kaival Labs and KBI. Intercompany transactions are eliminated.
Basis of Presentation
The accompanying unaudited interim consolidated financial
statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America
(“GAAP”) and the rules of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with
the audited financial statements and notes thereto contained in the Company’s most recent Annual Financial Statements filed with
the SEC on Annual Report on Form 10-K on February 16, 2022 (the “2021 Annual Report”). In the opinion of management, all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for
the interim period presented have been reflected herein. The results of operations for the interim period are not necessarily indicative
of the results to be expected for the full year. Notes to the consolidated financial statements, which would substantially duplicate the
disclosures contained in the audited financial statements for the most recent fiscal period, as reported in the 2021 Annual Report have
been omitted.
Use of Estimates
The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. In the opinion of management, all adjustments necessary in order to make the financial statements not misleading
have been included. Actual results could differ from those estimates.
Cash and Restricted Cash
The Company considers all highly liquid investments
with an original maturity of three months or less when purchased to be cash equivalents. There were no cash equivalents at July 31, 2022
and October 31, 2021. Cash and restricted cash at July 31, 2022 and October 31, 2021 were $3,358,124 and $7,825,235, respectively.
Restricted cash consists
of cash held in short-term escrow as required. As of July 31, 2022, and October 31, 2021, the Company had $0 and $65,007 in restricted
cash, respectively, for amounts held in escrow.
The following table sets
forth a reconciliation of cash, and restricted cash reported in the consolidated balance sheet and the consolidated statements of cash
flows that agrees to the total of those amounts presented in the consolidated statements of cash flows.
| Restrictions on Cash and Cash Equivalents | |
| | | |
| | |
| | |
July 31, 2022 | |
October 31, 2021 |
| Cash | |
$ | 3,358,124 | | |
$ | 7,760,228 | |
| Restricted cash | |
| — | | |
| 65,007 | |
| Total cash and restricted cash shown in statement of cash flows | |
$ | 3,358,124 | | |
$ | 7,825,235 | |
Advertising and Promotion
All advertising, promotion and marketing expenses, including commissions,
are expensed when incurred.
Accounts Receivable and Allowance for Doubtful Accounts
Receivables are stated at cost, net of an allowance
for doubtful accounts. The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability
of accounts receivables. A considerable amount of judgment is required in assessing the amount of the allowance and the Company considers
the historical level of credit losses and collection history and applies percentages to aged receivable categories. The Company makes
judgments about the creditworthiness of debtors based on ongoing credit evaluations and monitors current economic trends that might impact
the level of credit losses in the future. If the financial condition of the debtors were to deteriorate, resulting in their inability
to make payments, a larger allowance may be required. As of July 31, 2022, based upon management’s assessment of the accounts receivable
aging and the customers’ payment history, the Company has determined that no allowance for doubtful accounts was required. As of
October 31, 2021, the Company also determined that no allowance for doubtful accounts was required.
Inventories
Inventories are stated at the lower of cost and net
realizable value. Cost includes all costs of purchase and other costs incurred in bringing the inventories to their present location and
condition. The Company determines cost based on the “first in-first out” method. Net realizable value is the estimated selling
price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. All
inventories were stored at the primary leased warehouse, which is owned by Just Pick, LLC (“Just Pick”), a related party owned
and controlled by Nirajkumar Patel, and (i) were purchased from Bidi, a related party, as of October 31, 2021 and July 31, 2022, and;
(ii) only consisted of finished goods. Based upon fiscal year 2021 inventory management procedures and their results, that have continued
through the quarter ended July 31, 2022, the Company has determined that no allowance for the inventory valuation was required at July
31, 2022, nor October 31, 2021.
Revenue Recognition
The Company adopted ASC 606, Revenue from Contracts
with Customers (Topic 606) (“ASC 606”), in the second quarter of fiscal year 2020, as this was the first quarter that
the Company generated revenues. Under ASC 606, the Company recognizes revenue when a customer obtains control of promised goods, in an
amount that reflects the consideration that the Company expects to receive in exchange for the goods. To determine revenue recognition
for arrangements within the scope of ASC 606, the Company performs the following five steps: (1) identify the contracts with a customer;
(2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the
performance obligations in the contract; and (5) recognize revenue when or as the entity satisfies a performance obligation. The Company
only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in
exchange for the goods it transfers to the customer. Under ASC 606, disaggregated revenue from contracts with customers depicts the nature,
amount, timing, and uncertainty of revenue and cash flows affected by economic factors. On October 31, 2021, the Company and one of its
customers, Favs Business, entered into a Consignment Agreement. As of October 31, 2021, the value of the Products stored at Favs Business
under the Consignment Agreement was approximately $2,556,930. As of July 31, 2022, the Consignment Agreement between the Company and Favs
Business was complete and no further stored products remained at Favs Business. The Company continues to do business with Fav Business
as a customer (see “Concentration of Revenues and Accounts Receivable” below).
Customer Deposits
The Company accepts partial payments for orders from
wholesale customers, which it holds as deposits or deferred revenue, until the Company has received full payment and orders are shipped
to the customer. Revenue for these orders is recognized at time of shipment to the customer. As of July 31, 2022, the Company had received
$143,620 in deposits from customers, which is included with the Company’s current liabilities. As of October 31, 2021, the Company
had not received any deposits from customers.
Customer Refunds
The Company infrequently has a need to adjust the
size of an order after it has been shipped, received, and paid for, due to the customer oversizing the order for more product that it
can realistically sell at that time. If and when this occurs, the Company will ask the customer to return the over allotted Products.
Once received and inspected, the Company will issue a refund for the Product return. As of July 31, 2022 and October 31, 2021, the Company
had customer refunds due in the amounts equal to approximately $0 and $316,800, respectively, which was the result of one of the Company’s
sub-distributor customers returning Products that had become defective in storage.
Customer Agreements
In connection with the Distribution Agreement and
subsequent A&R Agreements, the Company entered into Sub-Distribution Agreements with the Company’s wholesale customers, whereby
the Company appointed the counterparties as non-exclusive sub-distributors. Pursuant to the Sub-Distribution Agreements, the sub-distributors
agreed to purchase for resale the Products in such quantities as they should need to properly service non-retail customers within the
Territory.
Products Revenue
The Company generates revenue from the sale of the
Products to non-retail customers. The Company recognizes revenue at a point in time based on management’s evaluation of when performance
obligations under the terms of a contract with the customer are satisfied and control of the Products has been transferred to the customer.
In most situations, transfer of control is considered complete when the Products have been shipped to the customer. The Company determines
that a customer obtains control of the Product upon shipment when title of such product and risk of loss transfer to the customer. The
Company’s shipping and handling costs are fulfillment costs and such amounts are classified as part of cost of sales. The Company’s
sales arrangements for retail sales usually require full prepayment before delivery of the Products. The advance payment is not considered
a significant financing component because the period between when the Company transfers a promised good to a customer and when the customer
pays for that good is short. The Company offers credit sales arrangements to non-retail (or wholesale) customers and monitors the collectability
of each credit sale routinely.
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
and promotional discounts on current orders. 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 customer deposits.
Concentration of Revenues and Accounts Receivable
For the nine months ended July 31, 2022, approximately
37%, or $3,628,691, of the revenue from the sale of Products was generated from Favs Business, and approximately 14%, or $1,399,106, of
the revenue from the sale of Products was generated from The H.T. Hackney Company.
Favs Business had an outstanding balance of approximately
$1,075,425, which accounted for approximately 74% of the Company’s total accounts receivable from customers as of July 31, 2022.
The H.T. Hackney Company had an outstanding balance of approximately $132,474, which accounted for approximately 9% of the Company’s
total accounts receivable from customers as of July 31, 2022.
For the nine months ended July 31, 2021, approximately
30%, or $18,435,648, of the revenue from the sale of Products was generated from Favs Business, approximately 16%, or $9,598,426, of the
revenue from the sale of Products was generated from MMS Distro, and approximately 13%, or $7,663,490, of the revenue from the sale of
Products was generated from C Store Master (“C Store Master”).
Favs Business, with an outstanding balance of approximately
$6,641,912, and C Store Master, with an outstanding balance of approximately $545,879, accounted for approximately 85% and 7% of the total
accounts receivable from customers, respectively, as of July 31, 2021.
Share-Based Compensation
The Company measures the
cost of services received in exchange for an award of equity instruments (share-based payments, referred to herein as “SBP”)
based on the grant-date fair value of the award. That cost is recognized over the period during which a recipient is required to provide
service in exchange for the SBP award—the requisite service period (vesting period). For SBP awards subject to conditions, compensation
is not recognized until the performance condition is probable of occurrence. The grant-date fair value of share options is estimated using
the Black-Scholes-Merton option-pricing model.
The fair value of each option
granted during the fiscal nine-month period ended July 31, 2022 and at October 31, 2021 was estimated on the date of grant using the Black-Scholes-Merton
option-pricing model with the weighted average assumptions in the following table:
| Schedule of Share-based Payment Award, Stock Options, Valuation Assumptions |
|
|
|
|
|
|
|
|
| |
|
As of July 31, 2022 |
|
As of October 31, 2021 |
| Expected dividend yield |
|
|
0 |
% |
|
|
0 |
% |
| Expected option term (years) |
|
|
10 |
|
|
|
10 |
|
| Expected volatility |
|
|
281.34%-301.53 |
% |
|
|
294.55%-301.53 |
|
| Risk-free interest rate |
|
|
1.62%-3.13 |
% |
|
|
1.19%-1.62 |
% |
The expected term of options
granted represents the period of time that options granted are expected to be outstanding. The expected volatility was based on the volatility
in the trading of the Common Stock. The assumed discount rate was the default risk-free ten-year interest rate for U.S. Treasury bills.
The Company’s stock option expense for the fiscal three and nine months ended July 31, 2022 was $1,928,421 and $4,854,313, respectively.
Fair Value of Financial Instruments
The Company’s balance sheet includes certain
financial instruments. The carrying amounts of current assets and current liabilities approximate their fair value because of the relatively
short period of time between the origination of these instruments and their expected realization.
ASC 820, Fair Value Measurements and Disclosures
(“ASC 820”), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability
(an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants
on the measurement date. ASC 820 also establishes a fair value hierarchy that distinguishes between (1) market participant assumptions
developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about
market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair
value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical
assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy
are described below:
| ● |
Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. |
| ● |
Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means. |
| ● |
Level 3 - Inputs that are both significant to the fair value measurement and unobservable. |
Fair value estimates discussed herein are based upon
certain market assumptions and pertinent information available to management as of July 31, 2022. The respective carrying value of certain
on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These financial
instruments include cash, restricted cash, accounts receivable, and accounts payable.
Recent Accounting Pronouncements
The Company does not believe that any recently issued
effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the accompanying
financial statements.
Reclassification
Certain prior year amounts have been reclassified
to conform to the current period presentation. These reclassifications had no impact on net earnings or financial position.
Note 3 – Going Concern
As shown in the accompanying consolidated financial statements, the Company
has incurred significant recurring losses and negative cash flows from operations due to various factors such as: (i) uncertainty surrounding
the PMTA process with FDA, (ii) lack of enforcement on illegally marketed competition, and (iii) the MDO that was issued to Bidi Vapor
on its flavored ENDS products. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
However, the MDO has now been set aside and remanded by the 11th Circuit.
It is possible that FDA could appeal the 11th Circuit’s
decision. Such a process could take months before a final decision is made, at which point Bidi could evaluate its legal options in the
event of an adverse decision. The Company anticipates being able to continue marketing and selling the BIDI® Sticks, subject to FDA’s
enforcement discretion, for at least the duration of such an appeal.
Alternatively, FDA could decide not to appeal the
11th Circuit’s decision and move forward with a review of Bidi’s PMTA on remand, as directed by the Court. A complete scientific
review of the PMTA would require FDA to review all of this information before making an APPH determination; based on FDA’s history,
this scientific review process could take 1-2 years to complete, or longer. An extended impact, or a negative ruling on an FDA appeal
of the decision, or the FDA ultimately not authorizing Bidi’s non-tobacco flavored applications upon re-evaluation could have a
material and adverse effect on the Company’s sales, earnings, and liquidity.
These consolidated financial statements do not include
any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classification of liabilities
that might be necessary in the event that the Company cannot continue as a going concern.
Note 4 – Leases
The Company capitalizes all leased assets pursuant
to ASU 2016-02, Leases (Topic 842) (“Topic 842”), which requires lessees to recognize right-of-use (“ROU”)
assets and lease liability, initially measured at present value of the lease payments, on its balance sheet for leases with terms longer
than 12 months and classified as either financing or operating leases. The Company excludes short-term leases having initial terms of
12 months or less from Topic 842 as an accounting policy election and recognizes rent expense on a straight-line basis over the lease
term. The Company does not have financing leases and only one operating lease for office space and
inventory storage space with a related party, as of July 31, 2022. Certain of the Company’s leases, have and may in the future,
include renewal options, which have been and might be in the future, included in the calculation of the lease liabilities and right of
use assets when the Company is reasonably certain to exercise the option.
Office and Storage Space
On June 10, 2022, the Company entered into a Lease
Agreement (the “2022 Lease”) with Just Pick for approximately 21,332 rentable square feet combined in the office building
and warehouse located at 4460 Old Dixie Highway, Grant Valkaria, Florida 32949 (the “Premises”), together with all improvements
thereon. Just Pick is considered a related party to the Company because the Company’s Chief Science and Regulatory Officer and director,
Mr. Nirajkumar Patel, owns and controls Just Pick.
The Company must pay Just Pick base rent equal
to $17,776.67 per month during the first year of the Lease Term with a five-year 5 lease renewal option. Thereafter, the monthly
base rent will be increased annually with a monthly base rent of $18,665.50 in the second year, $19,554.33 in the third year,
$20,443.17 in the fourth year, $22,220.83 in the fifth year, $23,998.50 in the sixth year, and one twelfth (1/12th) of the market
annual rent for the seventh through eleventh years, if applicable. In addition to the base rent, the Company must pay one hundred
percent (100%) of operating expenses, insurance costs, and taxes for each calendar year during the Lease term.
As of July 31, 2022 and October 31, 2021, the
ROU lease asset, net of accumulated amortization, was $1,245,474
and $55,604,
respectively. The initial recognition of the ROU operating lease was approximately $1,276,300
for both the ROU asset and ROU liability, the lease renewal option was considered in the calculation with an incremental borrowing
rate of 4.5%.
The amortization expense for ROU asset for the twelve months ended October 31, 2021 was $14,529
and no payments were made on the ROU liability. The amortization expense for the ROU asset for the nine months ended July 31, 2022
was $86,385. At October 31, 2021, short-term ROU lease liability was $13,020
and long-term liability was $46,185,
totaling $59,205.
At July 31, 2022, short-term ROU lease liability was $161,550 161,550 and
long-term liability was $1,094,622 1,094,622
totaling $1,256,172.
| Schedule of Future Minimum Rental Payments for Operating Leases | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
| | |
2022 | |
2023 | |
2024 | |
2025 | |
2026 | |
Thereafter | |
Total |
| Lease payments | |
$ | 53,330 | | |
$ | 217,467 | | |
$ | 228,134 | | |
$ | 238,800 | | |
$ | 253,614 | | |
$ | 450,935 | | |
$ | 1,442,280 | |
| Less discount imputed interest | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| (186,108 | ) |
| Present value of future payments | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| 1,256,172 | |
| Less current obligations | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| (161,550 | ) |
| Long term lease obligations | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
$ | 1,094,622 | |
Note 5 – Stockholders’ Equity
Additional Paid-In Capital
During the nine months ended July 31, 2022, $4,854,313
of stock option expense was recognized and contributed to Additional Paid-In Capital. Also, during the nine months ended July 31, 2022,
on November 5, 2021 and February 5, 2022, restricted stock units (“RSUs”) previously granted to employees vested and shares
of Common Stock were issued, which contributed $130,502 to Additional Paid-In Capital. Additionally, during the nine months ended July
31, 2022, warrants of the Company were exercised for shares of Common Stock resulting in a further contribution to Additional Paid-in
Capital of $1,571,013. All of these contributions resulted in a total increase in Additional Paid-In Capital during the nine months ended
July 31, 2022 of $6,555,828.
Preferred Shares Converted
The authorized preferred stock of the Company consists
of 5,000,000 shares with a par value of $ 0.001 per share, of which 3,000,000 shares were designated as Series A Convertible Preferred
Stock (the “Series A Preferred Stock”). Each share of the Series A Preferred Stock was initially convertible into 100 shares
of Common Stock; however, as a result of the Reverse Stock Split, the conversion rate was adjusted such that each share of the Series
A Preferred Stock is convertible into approximately 8.33 shares of Common Stock. On June 24, 2022, all 3,000,000 shares of Series A Preferred
Stock were converted into shares of Common Stock by Kaival Holdings, LLC, a related party. The conversion of 3,000,000 shares of Series
A Preferred Stock, at a conversion rate of 8.33, equaled 25,000,000 shares of Common Stock. As a result, the authorized, preferred stock
of the Company consists of 5,000,000 shares with a par value of $0.001 per share, with 0 shares of preferred stock issued or outstanding
as of July 31, 2022.
Common Shares Issued
The Company implemented the Reverse Stock Split, effective
prior to the opening of the market on July 20, 2021. The Reverse Stock Split was implemented by the Company in support of its application
to list on the Nasdaq Capital Market (“Nasdaq”). As a result of the Reverse Stock Split at a ratio of 1-for-12, every 12 shares
of the Common Stock were exchanged for one share of the Common Stock. The Company has retroactively adjusted all share amounts and per
share data herein to give effect to the Reverse Stock Split.
During the three months ended July 31, 2022, on June
14, 2022, stockholders of the Company exercised 3,000 warrants to purchase 3,000 shares of the Common Stock for net proceeds of $5,700.
During the nine months ended July 31, 2022, stockholders of the Company exercised warrants to purchase 876,286 shares of the Company’s
common stock for net proceeds of $1,571,890.
The authorized Common Stock of the Company consists
of 1,000,000,000 shares with a par value of $0.001 per share. There were 56,169,090 shares of Common Stock issued and outstanding as
of July 31, 2022. There were 30,195,312 shares of the Common Stock issued and outstanding as of October 31, 2021.
During
the three months ended April 30, 2022, the Company issued 18,160
shares of Common Stock with the fair value of $18,160
to two vendors who provide legal and advertising and promotions services
to the Company. Those vendors preferred to be paid in shares of Common Stock instead of cash for the services they performed and billed
the Company.
Warrant Shares Issued
As part of the Company’s underwritten public
offering in September 2021, the Company issued warrants to purchase a total of 4,053,750 shares of Common Stock at an exercise price of
$1.90 per share. These warrants expire in 2026. Warrants for 876,286 shares of Common Stock were exercised during the nine-month period
ended July 31, 2022, 2022 for net proceeds of $1,571,890. The aggregate intrinsic value of the outstanding Common Stock warrants as of
July 31, 2022 and October 31, 2021 was $0. The weighted average remaining term of the outstanding Common Stock warrants is 4.25 years
as of July 31, 2022.
The following is a summary of the stock warrant activity
during the fiscal nine months ended July 31, 2022 and the year ended October 31, 2021.
| Share-based Payment Arrangement, Option, Activity | |
| | | |
| | | |
| | | |
| | |
| | |
Nine Months Ended July 31, 2022 | |
Year Ended October 31, 2021 |
| | |
Number of Warrants | |
Weighted Average Exercise Price | |
Number of Warrants | |
Weighted Average Exercise Price |
| Warrants Outstanding at Beginning of the Period | |
| 3,173,922 | | |
$ | 1.90 | | |
| — | | |
$ | 1.90 | |
| | |
| | | |
| | | |
| | | |
| | |
| Granted | |
| — | | |
| — | | |
| 4,053,750 | | |
| 1.90 | |
| Exercised | |
| (876,286 | ) | |
| 1.90 | | |
| (879,828 | ) | |
| 1.90 | |
| | |
| | | |
| | | |
| | | |
| | |
| Warrants Outstanding and Exercisable at End of Period | |
| 2,297,636 | | |
$ | 1.90 | | |
| 3,173,922 | | |
$ | 1.90 | |
Restricted Stock Unit Awards
On November
5, 2021, the Company issued 61,250 shares of Common Stock to 7 employees in accordance with the vesting schedules set forth in restricted
stock unit (“RSU”) agreements previously entered into with such employees, resulting in the recognition of approximately $110,250
of share-based compensation. Of the shares issued to employees, 19,866 shares were withheld by the Company to satisfy tax withholding
obligations and/or satisfy cash settlement options to employees, equaling approximately $35,759.
On February
5, 2022, the Company issued 62,006 shares of Common Stock to 7 employees in accordance with the vesting schedules set forth in RSU agreements
previously entered into with such employees, resulting in the recognition of $62,006 of share-based compensation. Of the
shares issued to employees, 24,058 shares were withheld by the Company to satisfy tax withholding obligations and/or satisfy cash settlement
options to employees, equaling approximately $24,058. On March 4, 2022, the Company’s Board approved the termination of the RSU
agreements with the consent of the employees. At the time these agreements were terminated, there remained 1,564,166 unvested RSUs with
approximately $4,457,875 of related unvested compensation. See Common Stock Compensation Transition Plan below for additional details.
Stock Options
During fiscal year 2021, the Company granted options
exercisable for up to 150,000 shares of Common Stock of which 15,000 fully vested on March 17, 2021, 7,500 fully vested on June 30, 2021,
41,667 fully vested on December 1, 2021, 17,500 vested on March 17, 2022, 8,750 vest on June 30, 2022 and 1,248 vest over the next year
on March 17, 2023 and June 30, 2023. The options have exercise prices ranging from $9.12 to $28.68 per share. On July 19, 2021, two of
the stock option agreements, exercisable for an aggregate of 50,000 shares of Common Stock, were modified to accelerate the full
vesting period from 3 years to 2 years. On June 24, 2022, 33,333 of the stock options reference above were canceled and a further
25,002 were cancelled in the current quarter. As of July 31, 2022, the amortized expense and unamortized expense of these stock options
was $2,448,412 and $376,249, respectively.
On February 27, 2022, non-qualified stock
options exercisable for up to 200,000 shares
of Common Stock were awarded to two consultants of the Company. These stock options have a ten-year term from the grant date, with
one-half of the shares vesting on the grant date and the remaining one-half of the shares vesting on the first anniversary of the
grant date. The stock options exercisable for an aggregate of up to 200,000 shares
of Common Stock. The fair value of the options on the grant dates was $489,998 using a Black-Scholes option pricing model with the
following assumptions: stock price $2.45 per share (based on the quoted trading price on the date of grant), a computed volatility
of 294.93%, expected term of 10 years, and a risk-free interest rate of 1.83%.
As of July 31, 2022, the amortized expense and unamortized expense of these stock options was $347,082 and
$142,916,
respectively.
On April 22, 2022, non-qualified stock options
exercisable for up to 75,000 shares
of Common Stock were awarded to one consultant of the Company. These stock options have a ten-year term from the grant date, with
one-half of the shares vesting on the June 30, 2022 and the remaining one-half of the shares vesting on October 31, 2022. The stock
options exercisable for an aggregate of up to 75,000 shares
of Common Stock. The fair value of the options on the grant date was $106,499 using a Black-Scholes option pricing model with the
following assumptions: stock price $1.42 per share (based on the quoted trading price on the date of grant), a computed volatility of
286.00%, expected term of 10 years, and a risk-free interest rate of 2.90%. As of July 31, 2022, the amortized expense and unamortized expense of these stock options was $80,984 and
$25,515,
respectively.
The Company granted new options during the three
months ended July 31, 2022. On May 18, 2022, non-qualified stock options exercisable for up to 500,000
shares of Common Stock were awarded to one consultant of the Company. These stock options have a ten-year term from the grant
date, with the shares fully vesting on December 1, 2022. The stock options exercisable for an aggregate of up to 500,000
shares of Common Stock. The fair value of the options on the grant date was $514,997 using a Black-Scholes option pricing model with the
following assumptions: stock price $1.03 per share (based on the quoted trading price on the date of grant), a computed volatility of
284.70%, expected term of 10 years, and a risk-free interest rate of 2.89%. As of July 31, 2022, the amortized expense and unamortized expense of these stock options was $193,451
and $321,546,
respectively.
On March 4, 2022 options exercisable for up to an
aggregate of 1,385,600
shares of Common Stock were granted from this new stock option program to the executive officers and employees, as a result of
the transition.
The fair values of the options on the grant dates,
as noted above, were approximately $3,948,948
using a Black-Scholes option pricing model with the following assumptions: stock price $2.85
per share (based on the quoted trading price on the date of grant), volatility of 294.55%,
expected term of 10
years, and a risk-free interest rate range of 1.62%.
The Company is amortizing the expense over the vesting terms of each option. The total stock option expense for the three and nine months
ended July 31, 2022 was approximately $493,619
and $2,797,172,
respectively. The fiscal year 2022 unamortized stock option expense at July 31, 2022 was approximately $1,151,771.
Please reference the Common Stock Compensation Transition Plan below.
On June 24, 2022, non-qualified
stock options exercisable for up to 875,000 shares of Common Stock were awarded to two officers and three board members of the Company.
These stock options have a ten-year term from the grant date, with 375,000 fully vested on June 24, 2022, and 500,000 vest over the next
2 years on June 23, 2023 and June 23, 2024. The fair value
of the options on the grant dates was $1,504,990 using a Black-Scholes option pricing model with the following assumptions: stock price
$1.72 per share (based on the quoted trading price on the date of grant), a computed volatility of 283.12%, expected term of 10 years,
and a risk-free interest rate of 3.13%. As of July 31, 2022, the amortization expense and unamortized expense for these stock options
for the three months ended July 31, 2022 was $712,183 and $792,807.
These options have a weighted average remaining
life of 9.43
years as of October 31, 2021 and of 9.78
years as of July 31, 2022. The options expire in the years 2031 and 2032. The aggregate intrinsic value of these outstanding options as
of October 31, 2021 and July 31, 2022 was $0.
Common Stock Compensation Transition Plan
During the second quarter of fiscal year 2021 the
Board and executive management began cost reduction discussions, including the reduction of non-cash items such as equity compensation
awards. Those discussions stalled primarily due to the focus on other corporate events of significant value.
In the first and second fiscal quarters of 2022, the
Board resumed serious discussions, assessments, and evaluations regarding the equity compensation awarded to its officers and employees.
The Board ultimately approved a stock option program for equity awards granted to its officers and employees. The Compensation Committee
spent considerable time, effort, and resources designing this program, which was finalized in February 2022 and approved in March 2022.
While evaluating and designing this program, the Compensation Committee did not utilize any aspects of value to the employees or other
features. Therefore, the termination of the RSU program and the newly adopted stock option program were developed completely independent
of each other and terminated and implemented, respectively, distinctly and simultaneously. Management
concluded under ASC 718 these transactions are a cancelation and replacement whereby total compensation cost measured at the date of a
cancellation and replacement is the portion of the grant-date fair value of the original award for which the service is expected to be
rendered at that date plus the incremental cost resulting from the cancellation and replacement. Incremental cost is measured as the excess
of the fair value of the replacement award over the fair value of the cancelled award at the cancellation date in which there was none
since the fair value of the replacement award was less than the fair value of the canceled award.
The outcomes of this decision and the transition on
March 4, 2022 resulting in: (i) the termination of the RSU program for all executive officers and employees, consisting of 1,564,166 unvested
RSUs and (ii) the implementation a new stock option program for executive officers and employees. The stock options granted pursuant to
the program will have ten-year terms from the grant date, with one-half of the shares vesting on the grant date and the remaining one-half
of the shares vesting on the first anniversary of the grant date. Please reference the Stock Options disclosure above.
Note 6 – Related-Party Transactions
In March 2020, the Company commenced business operations
as a result of becoming the exclusive distributor of certain ENDS and related components (the “Products”) manufactured by
Bidi, a related party company that is also owned by Nirajkumar Patel, the Chief Science and Regulatory Officer of the Company.
Revenue and Accounts Receivable
During the nine months ended July 31, 2022, the Company
recognized revenue of $60,469 from five companies owned by Nirajkumar Patel, the Chief Science and Regulatory Officer of the Company,
and/or his wife. There was no accounts receivable balance for these transactions as of July 31, 2022.
During the nine months ended July 31, 2021, the Company
recognized revenue of approximately $132,145 from three companies owned by Nirajkumar Patel, the Chief Science and Regulatory Officer
of the Company, and/or his wife. The accounts receivable balance for these transactions was $680 as of July 31, 2021.
Concentration Purchases and Accounts Payable
During the nine months ended July 31, 2022, the Company
did not purchase Products from Bidi, a related party controlled by Nirajkumar Patel. Sales of Products during the first nine months of
fiscal year 2022 were drawn from the inventory purchase made on September 6, 2021. Inventory quality control expenses were paid by the
Company on behalf of Bidi during the nine months ended July 31, 2022 in the amount of approximately $654,500, and were offset as a credit
against the existing accounts payable balance-related party as of July 31, 2022. As of July 31, 2022, the Company had accounts payable
to Bidi of approximately $790,242 and Products valued at approximately $5,849,310 were held in inventory.
Leased Office Space and Storage Space
On August 1, 2020, the Company began leasing office
space for its main corporate office in Grant, Florida. The five-year lease agreement is with a related party, Just Pick. The Company’s
Chief Science and Regulatory Officer is an officer of Just Pick. The liability for rent not paid from the beginning of this lease, which
ended June 9, 2022, through July 31, 2022 is $23,367.
On June 10, 2022, the Company entered into a Lease
Agreement (the “2022 Lease”) with Just Pick for approximately 21,332 rentable square feet combined in the office building
and warehouse located at 4460 Old Dixie Highway, Grant Valkaria, Florida 32949 (the “Premises”), together with all improvements
thereon. Just Pick is considered a related party to the Company because the Company’s Chief Science and Regulatory Officer and director,
Mr. Nirajkumar Patel, owns and controls Just Pick.
Any changes, alterations, additions, or improvements
to the Premises made by the Company becomes the property of Just Pick unless prior to the 2022 Lease expiration, the Company removes such
improvements and restores the Premises to the same condition as existed on the Commencement Date.
The 2022 Lease contains customary representations,
warranties, covenants, indemnification provisions, default provisions, and termination provisions.
License Agreements
On June 10, 2022, Bidi entered into a License Agreement
(the “License Agreement”) with KBI, pursuant to which KBI has the exclusive irrevocable license to use Bidi’s licensed
intellectual property to the extent necessary for KBI to fulfill its obligations set forth in the Deed of Licensing Agreement, dated June
13, 2022 (the “PMI License Agreement”), by and between KBI and PMPSA. Such irrevocable license includes: (i) the right of
KBI to grant sub-licenses to PMPSA under the PMI License Agreement for the express purposes set forth in the PMI License Agreement, but
for no other purpose; (ii) the right of KBI to grant to PMPSA the right to grant sub-sub-licenses in the manner set forth in the PMI License
Agreement, but for no other purpose; and (iii) certain branding rights to the extent (but only to the extent) necessary to permit KBI
to perform its obligations to PMPSA as set forth in the PMI License Agreement.
Pursuant to the License Agreement, if at any time,
KBI receives any license of PMPSA intellectual property from PMPSA or any of its affiliates in the manner contemplated by the PMI License
Agreement, KBI will grant Bidi an irrevocable sub-license of all right, title, and interest of KBI in and to that PMPSA intellectual property.
In addition, Bidi and KBI agree that any amount payable and all net royalties payable to KBI under the PMI License Agreement will be apportioned
equally between Bidi and KBI in a manner such that each will ultimately receive fifty percent (50%) thereof.
The License Agreement contains customary representations,
warranties, covenants, and indemnification provisions.
Deed of Licensing Agreement
On June 13, 2022, KBI entered into the PMI License
Agreement with PMPSA, effective as of May 13, 2022 (the “PMI Commencement Date”). Pursuant to the PMI License Agreement, KBI
granted PMPSA an exclusive irrevocable license to use its technology, documentation, and intellectual property to make, distribute, and
sell disposable nicotine e-cigarettes Products based on the intellectual property in certain international markets set forth in the PMI
License Agreement (the “PMI Markets”). The Company has the exclusive international distribution rights to the Products and,
in order to allow KBI to fulfill its obligations set forth in the PMI License Agreement, has contributed the international distribution
rights for the PMI Markets to KBI as set forth in a Capital Contribution Agreement, dated June 10, 2022. The sublicense granted to PMPSA
is exclusive in the PMI Markets and neither KBI nor any of its affiliates can sell, promote, use, or distribute any competing products
in the PMI Markets for the duration of the term of the PMI License Agreement and any Sell-Out Period (as defined in the PMI License Agreement).
PMSPA will be responsible for any regulatory filings necessary to sell the Products in the PMI Markets. Both KBI and PMPSA agree to work
together in the registration and maintenance of the Intellectual Property, but KBI will bear all cost and expense to implement the registration
strategy. Finally, PMPSA has agreed to potential future development services with KBI in the PMI Markets and has been granted certain
rights with respect to potential future products.
The initial term of the PMI License Agreement is five
(5) years and automatically renews for an additional five-year period unless PMPSA has failed to meet the agreed upon minimum key performance
indicators set forth in the PMI License Agreement, in which case the PMI License Agreement will automatically terminate at the end of
the initial license term.
In consideration for the grant of the licensed rights,
PMPSA agreed to pay to KBI a royalty equal to 2.00% to 3.50% of the base price of the first sale of each unit of Product manufactured.
In addition, before the launch of the first product in a market and each anniversary of such launch, PMPSA agrees to pre-pay to KBI a
guaranteed minimum royalty equal to twenty percent (20%) of the estimated royalties payable by PMPSA to KBI in relation to all markets
in the twelve (12)-month period following the first launch or each successive anniversary of the first launch, subject to an aggregate
maximum guaranteed royalty payment of One Million Dollars ($1,000,000) for all markets for each applicable twelve (12)-month period. PMPSA
may require modification of certain products to be sold under the PMI Licensing Agreement to be modified for a PMI Market. Pursuant to
the PMI Licensing Agreement, PMPSA has absolute discretion over sales, marketing, product branding and packaging pertaining to sales in
the PMI Markets, as well as the right to select the specific PMI Markets in which to launch commercialization and determine what product
types are to be promoted in each market, subject to sales and marketing plans and annual business plans set by PMPSA and certain expansion
criteria agreed between PMPSA and KBI.
The PMI License Agreement contains customary representations,
warranties, covenants, and indemnification provisions; however, KBI’s liability under the PMI License Agreement is capped at the
greater of: (i) Ten Million Dollars ($10,000,000); or (ii) an amount equal to the total of the royalties due to KBI (but not yet paid)
plus the royalties (including the guaranteed royalty payment) paid to KBI pursuant to the PMI License Agreement during the immediately
preceding twelve (12) consecutive months, provided that such amount shall not exceed Thirty Million Dollars ($30,000,000).
In connection with the PMI License Agreement, the
Company, Bidi, and PMPSA also entered into a deed of letter (“Deed of Letter”) to require specific performance of the duties
and obligations set forth in the PMI License Agreement if KBI is unable or fails to sublicense the intellectual property to PMPSA pursuant
to the PMI License Agreement and/or is unable or fails to perform certain of its obligations or grant the rights pursuant to the PMI License
Agreement. In addition, the Company, Bidi, and PMPSA entered into a guarantee (“Guarantee”), whereby each of the Company and
Bidi guarantees to PMPSA up to 50% of all of KBI’s monetary obligations set forth in the PMI License Agreement if KBI fails to perform
or discharge certain of its obligations in the PMI License Agreement.
Note 7 – Commitments and Contingencies
The Company follows ASC 450-20, Loss Contingencies, to
report accounting for contingencies. Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties
and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably
estimated. There were no commitments or contingencies as of July 31, 2022 and July 31, 2021 other than the below:
Cash and Equity Bonus Awards
On May 28, 2020, the Board approved cash bonus awards
to each of Nirajkumar Patel, the Company’s then Chief Executive Officer, and Eric Mosser, the Company’s Chief Operating Officer.
With respect to the Chief Executive Officer, the Board approved a cash bonus award equal to $30,000 for every $25 million in gross revenues
generated by the Company. With respect to the Chief Operating Officer, the Board approved a cash bonus award equal to $20,000 for every
$25 million in gross revenues generated by the Company. On May 28, 2020, the Board also approved an equity bonus award for each of the
Chief Executive Officer and the Chief Operating Officer. With respect to the Chief Executive Officer, the Board approved an award of 7,500
restricted shares of the Common Stock for every $50 million in accumulated gross revenues generated by the Company. With respect to the
Chief Operating Officer, the Board approved an award of 6,250 restricted shares of the Common Stock for every $50 million in accumulated
gross revenues generated by the Company. The Company’s accumulated gross revenues will be evaluated on a quarterly basis, beginning
with the second quarter of fiscal year 2020. At October 31, 2020, the Company determined that the fair value of the equity bonus shares,
or $165,000, should be accrued as it was deemed likely that the $50 million revenue target would be met. The Company issued these shares
to the Chief Executive Officer and Chief Operating Office on January 1, 2021. During the quarter ended April 30, 2021, the $75 million
and $100 million accumulated revenue targets were both achieved and the Company determined that the fair market value of the 13,750 shares,
or approximately $70,785, and the cash bonuses totaling $100,000 should be accrued at April 30, 2021.
During the quarter ended April 30, 2022, the $125
million accumulated revenue targets were achieved and the Company determined that cash bonuses totaling $50,000 should be accrued at April
30, 2022.
On March 4, 2022, the Board terminated all future
cash and equity bonus awards for the Company’s Chief Executive Officer and its Chief Operating Officer.
Service Agreements
On March 31, 2020, the Company entered into a service agreement (the “Service
Agreement”) with QuikfillRx LLC, a Florida limited liability company (“QuikfillRx”), whereby QuikfillRx provides the
Company with certain services and support relating to sales management, website development and design, graphics, content, public communication,
social media, management and analytics, and market and other research (collectively, the “Services”). The Services are provided
by QuikfillRx as requested from time to time by the Company.
On June 2, 2020, the Company entered into the First
Amendment to the Service Agreement (the “First Amendment”) with QuikfillRx. Effective as of March 16, 2021, the Company entered
into the Second Amendment to Service Agreement (the “Second Amendment”) with QuikfillRx. Effective as of September 17, 2021,
the Company entered into the Third Amendment to the Service Agreement (the “Third Agreement”) with QuikfillRx. Effective as
of September 17, 2021, the Company entered into the Fourth Amendment to the Service Agreement (the “Fourth Agreement” and,
collectively with the First Amendment, Second Amendment, Third Amendment, and the Service Agreement, the “Amended Service Agreement”)
with QuikfillRx. Pursuant to the terms of the Amended Service Agreement, the parties agreed to the following “General Compensation”
payments: (i) for the Services provided in March 2020, the Company paid QuikfillRx an amount equal to $86,000; (ii) for the Services provided
in April 2020, the Company paid QuikfillRx an amount equal to $100,000; (iii) each calendar month commencing May 2020 through October
2020, the Company paid QuikfillRx an amount equal to $125,000 per month for the Services to be performed during such calendar month; (iv)
for each calendar month between November 1, 2020 and October 31, 2021, the Company paid QuikfillRx $125,000 per month for the Services
to be performed during such calendar month; (iv) for the period between November 1, 2021 and June 30, 2022, the Company paid QuikfillRx
$150,000 per month for the Services to be performed during such calendar month; (v) for the period between July 1, 2022 and October 31,
2024, the Company will pay QuikfillRx $125,000 per month for the Services to be performed during such calendar month; and (vi) parties
acknowledged that as a result of extensions to the term of the Service Agreement , such term of the Original Agreement will end on October
31, 2023. The parties have agreed to extend such term for an additional one year until October 31, 2024. In addition, the Company will
pay the following quarterly bonuses:
| |
● |
An amount equal to 0.9% of the Applicable Gross Quarterly Sales (as defined in the Amended Service Agreement), which amount shall, at the Company’s option be paid in (a) cash or (b) shares of the Common Stock, or (c) a combination of cash and Common Stock; and |
| |
|
|
| |
● |
An amount equal to 0.27% of the Applicable Gross Quarterly Sales, which amount must be paid in cash. |
On March 17, 2021, the Company entered into a consulting
agreement with Russell Quick, pursuant to which the Company granted stock options exercisable for up to 41,667 shares of Common Stock
in exchange for consulting services. The shares underlying the stock options fully vested on December 1, 2021. The exercise price per
share was $28.68. The Company recognized approximately $190,000 in expense to account for the stock options. Russell Quick is the Chief
Executive Officer of QuikfillRx.
On December 1, 2021 the Company and Russell Quick
agreed to renew his consulting agreement for one year, pursuant to which on May 18, 2022 the Company granted non-qualified stock options
exercisable for up to 500,000 shares of the Common Stock in exchange for on-going consulting services. The shares underlying the stock
options fully vest on December 1, 2022. They have a 10-year expiration. The exercise price per share is $1.03. The Company recognized approximately $193,500 in expense to account for the stock
options in the three-month fiscal period ended July 31, 2022. The Company accrued approximately $45,013 for a quarterly bonus payable
to QuikfillRx, based on the Applicable Gross Quarterly Sales results of the three months ended July 31, 2022.
Note 8 – Subsequent Events
Share-based Compensation
On August 1, 2022, the Company approved the grant
of a stock option award to 1 employee, to acquire up to 25,000 shares of Common Stock under the Company’s Amended 2020 Stock and
Incentive Compensation Plan. The option shares vest on August 1, 2023 and are exercisable at a price of $1.16 per share, which equaled
the closing price of the Common Stock as of the date immediately prior to the grant date. The option has a ten-year term. The issuance
was exempt from the registration requirements of the Securities Act by virtue of Section 4(a) (2) thereof as a transaction not involving
a public offering.
On August 24, 2022, the Company approved amending
the Consulting Agreement for Mark Thoenes, the Company’s Interim Chief Financial Officer, in order to extend its term, modify the
vesting terms of the previously granted stock option award, and approved the grant of a stock option award to acquire up to 50,000 shares
of Common Stock under the Company’s Amended 2020 Stock and Incentive Compensation Plan. The option shares vested on August 24, 2022
and are exercisable at a price of $1.32 per share, which equaled the closing price of the Common Stock as of the date immediately prior
to the grant date. The option has a ten-year term. The issuance was exempt from the registration requirements of the Securities Act by
virtue of Section 4(a)(2) thereof as a transaction not involving a public offering.
Related-Party Transactions
On August 1, 2022, the Company and Bidi agreed
to a price credit for short-coded or expiring inventory against the related-party accounts payable balance due to Bidi. A credit of
$2,924,655
was applied on August 1, 2022 resulting in a related-party accounts receivable balance due from Bidi of $2,134,413, to be applied on future orders of Product.