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 electronic nicotine delivery
system (“ENDS”) and related components (the “Products”) manufactured by Bidi Vapor, LLC (“Bidi”),
a related party company that is owned by Nirajkumar Patel, the Chief Science and Regulatory Officer and a director of the Company.
On March 9, 2020, the Company entered into
an exclusive distribution agreement (the “Distribution Agreement”) with Bidi, which 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 entirely of the “BIDI®
Stick.” The Company ceased all direct-to-consumer sales in February 2021. On June 10, 2022, and again on November 17,
2022 the Company and Bidi 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. The Company has not yet launched any Kaival-branded
product, nor has it begun to provide white label wholesale solutions for other product manufacturers. The Company may also utilize
Kaival Labs to acquire or license complimentary businesses or assets. 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”).
Current Product Offerings
Pursuant to the 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
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.
COVID-19 Impact
In January 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.
During the Company’s
fiscal year 2021 and early part of fiscal 2022, the Company was indirectly impacted by supply chain issues and regulatory oversight arising
out of COVID-19. The Company believes that many retailers and distributers relaxed their ENDS 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. While the impact
of COVID-19 decreased during the Company’s fiscal 2022 year and the first quarter of its fiscal 2023 year, outbreaks of COVID-19
or its variants, either locally, nationally or globally,
as well as related supply chain issues, could adversely impact the Company’s business.
Impact of the FDA
PMTA Decision and Subsequent Court Actions
As of January 31, 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 supervisory 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 non-tobacco 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 comprehensive 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 the
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, permitting the Company to continue sales. 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, again allowing the Company to continue sales 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 back to the 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.
The 11th Circuit’s opinion further found
indicated that the FDA did not properly review the data and evidence that it has long made clear are critical to the appropriate for the
protection of the public health (“APPH”) standard for PMTAs set forth in the Tobacco Control Act including, in Bidi’s
case, “product information, scientific safety testing, literature reviews, consumer insight surveys, and details about the company’s
youth access prevention measures, distribution channels, and adult-focused marketing practices,” which “target only existing
adult vapor product users, including current adult smokers,” as well as our retailer monitoring program and state-of-the-art anti-counterfeit
authentication system. Because a MDO must be based on a consideration of the relevant factors, such as the marketing and sales-access-restrictions
plans, the denial order was deemed arbitrary and capricious, and vacated by the FDA.
The FDA did not appeal
to the 11th Circuit’s decision. The FDA had until October 7, 2022 (45 days from the August 23, 2022 decision) to either request
a panel rehearing or a rehearing “en banc” (a review by the entire 11th Circuit, not just the 3-judge panel that issued the
decision), and until November 21, 2022 (90 days after the decision) to seek review of the decision by the U.S. Supreme Court. No request
for a rehearing was filed, and no petition for a writ of certiorari was made to the Supreme Court. In the meantime, the Company anticipates
continued ability to market and sell the non-tobacco flavored BIDI® Sticks, subject to the FDA’s enforcement discretion, for
the duration of the PMTA scientific review.
Separately, on or about May 13, 2022, FDA placed the
tobacco-flavored Classic BIDI® Stick into the final Phase III scientific review, and in September 2022 completed a remote regulatory
assessment of Bidi and its contract manufacturer in China, SMISS Technology Co. LTD, in relation to the pending PMTA for the Classic BIDI®
Stick.
Risks
and Uncertainties
FDA has indicated that it is prioritizing enforcement
of unauthorized ENDS against companies (1) that never submitted PMTAs, (2) whose PMTAs have been refused acceptance or filing by the FDA,
(3) whose PMTAs remain subject to MDOs, and (4) that are continuing to market unauthorized synthetic nicotine products after the July
13, 2022, cutoff. Subject to FDA’s enforcement discretion, until the scientific review process is complete on each of Bidi’s
PMTAs, the Company views the risk of FDA enforcement against Bidi as low. The Company anticipates FDA will move forward with a review
of Bidi’s PMTA on remand, as directed by the Court; however, the Company cannot provide any assurances as to the timing or outcome.
Accordingly,
the Company anticipates FDA will move forward with a review of Bidi’s PMTA on remand, as directed by the Court.
Moreover, the Company believes that Bidi’s
application is particularly comprehensive, and now includes, among other things, a randomized, crossover, clinical study to assess nicotine
pharmacokinetics and subjective effects of the BIDI® Stick, several behavioral, perception and intention studies, as well as a nationally-representative
population prevalence study. A complete scientific review of the PMTA would require FDA to review all this information before making
an APPH determination, and while FDA could narrowly interpret the Court’s ruling as an order to review only Bidi’s marketing
and sales-access restrictions plans, the 11th Circuit’s opinion, in the Company’s view, makes clear that all “relevant
evidence” in an application must be considered. For applications that are in scientific review, FDA typically issues a deficiency
letter identifying its questions before making a marketing authorization decision and gives the applicant at least 90 days to respond.
This further solidifies the Company’s belief that the scientific review of Bidi’s non-tobacco flavored applications could
take 1-2 years or longer. However, the Company cannot provide any assurances as to the timing or outcome.
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 audited financial
statements contained within the Company’s Annual Report on Form 10-K, filed with the SEC on January 30, 2023 (the “2022 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 fiscal 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 2022 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 Cash Equivalents
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
and restricted cash as of January 31, 2023 and October 31, 2022. Cash as of January 31, 2023 and October 31, 2022 was
$3,773,628 and $3,685,893, respectively.
The
Federal Deposit Insurance
Corporation (“FDIC”) insures deposits according to the ownership category in which the funds are insured and
how the accounts are titled. The standard deposit insurance coverage limit is $250,000 per
depositor, per FDIC-insured bank, per ownership category. The Company had uninsured cash and cash equivalents of $3,250,651 and
$2,912,793 at
January 31, 2023, and October 31, 2022, respectively.
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 receivable. 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 January 31, 2023 and October 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
is required.
Inventories
All product inventory is purchased from a related party,
Bidi. 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 (“FIFO”) 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. As of January 31, 2023 and October 31, 2022,
the inventories only consisted of finished goods and were located in three locations: the Company’s main warehouse
located in Florida and two customer warehouses whose service agreements are on a consignment basis with the Company. Based upon fiscal year 2022 inventory management procedures, as well as those inventory management procedures performed
during the first fiscal quarter ended January 31, 2023 and their results for both periods of time, the Company has determined that
no allowance for inventory was required as of January 31, 2023 and October 31, 2022.
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.
Deferred Revenue
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 the time of shipment to the customer. As of January
31, 2023, and October 31, 2022, the Company has $12,098
and $44,973
in deposits from customers, respectively, which is included with the Company’s current liabilities. As of January 31, 2023,
and October 31, 2022, the Company has $129,701 and $235,274
in deferred income from PMI guaranteed royalty revenue prepayments, respectively, which is included with the Company’s current
liabilities.
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 product.
Once received and inspected, the Company will issue a refund for the product return. As of January 31, 2023, and October 31, 2022, the
Company had customer refunds due in the amounts equal to $366,956
and $0,
respectively.
Products Revenue
The Company generates products revenue from the sale
of the Products (as defined above) 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 determined that a customer obtains control of the Product upon shipment when title of such product and
risk of loss transfer to the customer. However, when the Company enters a consignment agreement with a new customer, once it ships and
delivers the requested amount of ordered Products to its distribution center for its retail sales locations, the Company retains ownership
of the delivered Products until they are delivered to the actual retail stores (as opposed to the Company’s consignment customer).
The Company’s shipping and handling costs are fulfillment costs, and such amounts are classified as part of cost of sales. 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 receivable since payments are unconditional and only the passage of time related
to credit terms is required before payments are due. The Company does not grant payment financing terms greater than one year.
Payments received in advance of revenue recognition are recorded as deferred revenue, as noted above.
Royalty Revenue
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 a percentage 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 based on 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 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. Royalty revenue earned from the PMI License Agreement is recognized
in the period the sales of the Product manufactured occurs.
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). These royalties may be initially offset on a limited basis by jointly agreed upon costs such as development costs
incurred for entry to specific international markets.
The KBI License agreement provides that
KBI shall pay Bidi license fees equivalent to 50% of the adjusted earned royalty payments, after any offsets due to jointly
agreed costs such development costs incurred for entry to specific international markets. Consequently, the Company has determined
that no license fees are owed to Bidi as of January 31, 2023.
Concentration of Revenues and Accounts Receivable
For the three months ended January 31, 2023,
(i) 25% or $599,201
of the revenue from the sale of Products, solely consisting
of the BIDI® Stick, was generated from GPM Investments, LLC, (“GPM”), (ii) 18% or $432,000
of the revenue from the sale of the Products
was generated from FAVS Business, (“FAVS”), and (iii) approximately 15% or $372,518 of the revenue from the sale of Products,
solely consisting of the BIDI Stick, was generated from H.T. Hackney Co.
For the three
months ended January 31, 2022, 45%, or $1,287,180,
of the revenue from the sale of Products was generated from FAVS, 12%, or $352,554,
of the revenue from the sale of Products was generated from Lakshmi Distributor Inc., doing business as C Store Master (“C
Store Master”), and 12%, or $332,595,
of the revenue from the sale of Products was generated from H.T. Hackney Company.
FAVS, with an outstanding balance of
$201,600,
GPM, with an outstanding balance of $126,158,
and Stewart Distribution with an outstanding balance of $59,404,
accounted for 39%, 24%, and 11% of the total accounts receivable from customers, respectively, as of January 31, 2023. FAVS and C
Store Master had outstanding balances of $374,400 and
$282,414,
respectively, which accounted for 29% and 22%, respectively, of the total accounts receivable from customers as of January 31,
2022.
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 performance 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 three-month period ended January 31, 2023, and January 31, 2022, 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 January | |
As
of January |
| |
31,
2023 | |
31,
2022 |
Expected
dividend yield | |
| 0 | % | |
| 0 | % |
Expected
option term (years) | |
| 10 | | |
| 10 | |
Expected
volatility | |
| 275.68 | % | |
| 294.57%-
301.53 | % |
Risk-free
interest rate | |
| 4.12 | % | |
| 1.19-1.63% | |
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 Company’s 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 months ended January 31, 2023, and ended January 31, 2022 were $1,435,787
and $309,700,
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 January 31, 2023. 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, accounts receivable, inventory, accounts payable and accrued expenses .
As of January 31, 2023 and October 31, 2022, the Company
did not have any financial assets or liabilities measured and recorded at fair value on a recurring basis.
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.
Note 3 – Going Concern
The Company’s financial statements
are prepared in accordance with U.S. GAAP applicable to a going concern, which contemplates realization of assets and the satisfaction
of liabilities in the normal course of business within one year after the date the consolidated financial statements are issued.
In accordance with Financial
Accounting Standards Board (the “FASB”), Accounting Standards Update (“ASU”) No. 2014-15, Presentation of Financial
Statements – Going Concern (Subtopic 205-40), our management evaluates whether there are conditions or events, considered in aggregate,
that raise substantial doubt about our ability to continue as a going concern within one year after the date that the financial statements
are issued. As shown in the accompanying consolidated financial statements, the Company has incurred significant recurring losses,
which raises substantial doubt about the Company’s ability to continue as a going concern.
In response to the above, the Company assessed
its management’s plans to alleviate that doubt. The Company has positive working capital as of January 31, 2023, of $6,503,841.
The Company considered that its losses were due to various factors such as: (i) uncertainty surrounding the PMTA process with FDA
and (ii) the MDO that was issued to Bidi Vapor on its non-tobacco flavored ENDS products. However, the MDO was set aside and vacated
by the 11th Circuit in August 2022, and the ability to appeal such decision has passed, thereby facilitating the continued
sales of the non-tobacco flavored BIDI® Sticks for sale in the United States (pending FDA’s review of the pending PMTAs and
subject to FDA enforcement). Concurrently, the PMTA for the tobacco-flavored (Classic) BIDI® Sticks for sale in the United States
continues to move through the PMTA scientific review phase. Management’s assessment included the preparation of cash flow forecasts
which considered increases in revenues considering the favorable ruling obtained on the MDO as disclosed above.
The Company believes that its available cash and the
cash to be provided by future operating activities should enable the Company to meet its estimated liquidity needs for the next 12 months
after the date that the financial statements are issued. Because of the above factors, the Company believes that this alleviates the substantial
doubt in connection with the Company’s ability to continue as a going concern.
However, there is
no assurance that the Company’s plans will be able to generate expected or greater amounts of revenues or ever achieve
profitability, due to the current economic climate in the United States and globally, the regulation and public perception of ENDS
products and the various other risks faced by the Company. The consolidated financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these or other risks or uncertainties.
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 Just Pick, LLC (“Just Pick”), a related party owned and controlled by Nirajkumar Patel, the Chief
Science and Regulatory Officer and a director of the Company, as of January 31, 2023, and October 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 November 1, 2021, the Company entered
into a month-to-month lease agreement with Ranger Enterprises, LLC, located in Seymour, Indiana, to store product inventory at
this satellite location. The Company made payments on this lease in the amount of $19,959. The lease was terminated in June 2022.
On November 11, 2021, the Company entered
into a month- to-month lease agreement with FFE Solutions Group, located in Salt Lake City Utah, to store additional product inventory
at this satellite location. The Company made payments on this lease in the amount of $19,108. This lease was terminated in April
2022.
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. 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 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. 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 Company had $46,949 and
$3,649 in
operating lease expense for the three months ended January 31, 2023, and January 31, 2022, respectively.
Cash flow information related to leases
was as follows:
Schedule of cash flow information related to leases |
|
|
|
|
|
|
|
|
|
|
January 31, 2023 |
|
January 31, 2022 |
Other Lease Information |
|
|
|
|
|
|
|
|
Cash paid for amounts included in the measurement of lease liabilities: |
|
|
|
|
|
|
|
|
Operating cash flows from operating leases |
|
$ |
(46,949 |
) |
|
$ |
(3,649 |
) |
The following table summarizes the lease-related
assets and liabilities recorded in the consolidated balance sheets as of January 31, 2023, and October 31, 2022:
Schedule Of Condensed Balance Sheet |
|
|
|
|
|
|
|
|
Lease Position |
|
January 31, 2023 |
|
October 31, 2022 |
Operating Leases |
|
|
|
|
|
|
|
|
Operating lease right-of-use assets |
|
$ |
1,152,020 |
|
|
$ |
1,198,969 |
|
Right of use liability operating lease current portion |
|
$ |
170,603 |
|
|
$ |
166,051 |
|
Right of use liability operating lease long term |
|
|
1,006,435 |
|
|
|
1,050,776 |
|
Total operating lease liabilities |
|
$ |
1,177,038 |
|
|
$ |
1,216,827 |
|
The following table provides the maturities
of lease liabilities at January
31, 2023:
Schedule of Lessee Operating Lease Liability Maturity |
|
|
|
|
|
|
|
Operating
Leases |
Maturity
of Lease Liabilities on January 31, 2023 |
|
|
2023 |
|
|
$ |
164,139 |
|
2024 |
|
|
|
228,134 |
|
2025 |
|
|
|
238,800 |
|
2026 |
|
|
|
253,614 |
|
2027
and thereafter |
|
|
|
450,934 |
|
Total
future undiscounted lease payments |
|
|
$ |
1,335,621 |
|
Less:
Interest |
|
|
|
(158,583 |
) |
Present
value of lease liabilities |
|
|
$ |
1,177,038 |
|
At January 31, 2023, the Company had
no additional leases which had not yet commenced.
Note 5 – Stockholders’
Equity
Common Stock
During the three months ended January
31, 2023:
No shares of Common Stock were issued
during the three months ended January 31, 2023.
Preferred Stock 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 and the Company’s majority shareholder. 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 October
31, 2022.
Stock Options
Summary of stock options information
is as follows:
Schedule of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Aggregate |
|
Aggregate |
|
Exercise Price |
|
Average |
|
|
Number |
|
Exercise Price |
|
Range |
|
Exercise Price |
Outstanding, October 31, 2022 |
|
|
3,202,265 |
|
|
|
8,921,419 |
|
|
|
1.03-28.68 |
|
|
|
2.79 |
|
Granted |
|
|
3,250,000 |
|
|
|
3,207,425 |
|
|
|
0.99 |
|
|
|
0.99 |
|
Exercised |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Cancelled, forfeited, or expired |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Outstanding, January 31, 2023 |
|
|
6,452,265 |
|
|
$ |
12,128,844 |
|
|
$ |
0.99-28.69 |
|
|
$ |
1.88 |
|
Exercisable,
January 31, 2023 |
|
|
2,151,217 |
|
|
$ |
6,085,555 |
|
|
$ |
0.99-28.69 |
|
|
$ |
2.83 |
|
During the three months
ended January 31, 2023, and 2022, the Company recognized $1,435,787
and $309,700,
respectively of stock option expense related to outstanding stock options. On January 31, 2023, the Company had $3,488,735
of unrecognized expenses related to options. The weighted average remaining contractual life is approximately 9.38
years for stock options outstanding on January 31, 2023. The aggregate intrinsic value of these outstanding options as of January
31, 2023, was $0.
Compensation expense related to performance-based options is recognized on a straight-line basis over the requisite service period,
provided that it is probable that performance conditions will be achieved, with probability assessed on a quarterly basis and any
changes in expectations recognized as an adjustment to earnings in the period of the change. Compensation cost is not recognized for
service- and performance-based awards that do not vest because service or performance conditions are not satisfied, and any
previously recognized compensation cost is reversed. If vesting occurs prior to the end of the requisite service period, expense is
accelerated and fully recognized through the vesting date.
On November 9, 2022, non-qualified
stock options exercisable for up to 250,000 shares of Common Stock were awarded to one supplier of the Company. These stock options
have a ten-year term from the grant date, with the shares fully vested on the issue date. The fair value of the options on the
grant date was $246,747 using a Black-Scholes option pricing model with the following assumptions: stock price $0.9869 per share
(based on the quoted trading price on the date of grant), a computed volatility of 275.68%, expected term of 10 years, and a risk-free
interest rate of 4.12%.
On November 9, 2022, non-qualified
stock options exercisable for up to 3,000,000 shares of Common Stock were awarded to one supplier of the Company. These stock
options have a ten-year term from the grant date, with the shares fully vesting based on achievement of certain net revenue and
profit margin targets up to $180,000,000 in total net revenues over a period of 3 years. The fair value of the options on the
grant date was $2,960,968 using a Black-Scholes option pricing model with the following assumptions: stock price $0.9869 per share
(based on the quoted trading price on the date of grant), a computed volatility of 275.68%, expected term of 10 years, and a risk-free
interest rate of 4.12%.
Warrants
Warrant information as of the periods
indicated is as follows:
Share-based Payment Arrangement, Option, Activity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Aggregate |
|
Aggregate |
|
Exercise
Price |
|
Average |
|
|
Number |
|
Exercise
Price |
|
Range |
|
Exercise
Price |
Outstanding,
October 31, 2022 |
|
|
2,318,317 |
|
|
|
4,404,802 |
|
|
|
1.90 |
|
|
|
1.90 |
|
Granted |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Exercised |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Cancelled,
forfeited, or expired |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Outstanding,
January 31, 2023 |
|
|
2,318,317 |
|
|
$ |
4,404,802 |
|
|
$ |
1.90 |
|
|
$ |
1.90 |
|
Exercisable,
January 31, 2023 |
|
|
2,318,317 |
|
|
$ |
4,404,802 |
|
|
$ |
1.90 |
|
|
$ |
1.90 |
|
The weighted average remaining
contractual life is approximately 3.66 years for Common Stock warrants outstanding as of January 31, 2023. As of January 31, 2023,
there was no intrinsic value of outstanding stock warrants.
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 and a director of the Company.
Other Receivable
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. On October 31, 2022, the Company and Bidi agreed to a return for short-coded or expiring
inventory. An additional credit of $1,543,545 and
$108,841 for
recycling cost was applied on October 31, 2022, to the related-party receivable balance due from Bidi.
As of January 31, 2023 and October 31,
2022, the Company has a related-party receivable balance due from Bidi of $3,509,542 and $3,704,132, respectively. The receivable
balance will be realized though Bidi applying 5% credits on all future orders of product purchased until the entire balance is
extinguished.
Revenue and Accounts Receivable
During the three months ended January 31,
2023, the Company recognized revenue of $3,085
from one company owned by Nirajkumar Patel, the Chief Science and Regulatory Officer and a director of the Company, and/or his wife.
There was no accounts receivable balance for these transactions as of January 31, 2023.
During the three months ended January 31,
2022, the Company recognized revenue of $23,765
from four companies owned by Nirajkumar Patel, the Chief Science and Regulatory Officer and a director of the Company, and/or his
wife. As of January 31, 2022, the Company had accounts receivable from this related party in the amount of $245.
Concentration
Purchases and Accounts Payable
During the three months ended January
31, 2023, 100% of the inventories of Products, consisting solely of the BIDI® Stick, were purchased from Bidi, a related party
controlled by Nirajkumar Patel, in the amount of $3,697,210. As of January 31, 2023, the Company had accounts payable to Bidi of
$2,350,787 and Products valued at $3,761,491 were held in inventory. In addition, as of January 31, 2023, the Company had accrued freight in
expense of $347,760. As of October 31,
2022, the Company did not have an accounts payable balance to Bidi.
During the three months ended January 31,
2022, the Company did not purchase Products from Bidi, a related party company that is owned by Nirajkumar Patel. As of January 31,
2022, the Company had accounts payable to Bidi of $9,129,759
and Products valued at $11,841,750
were held in inventory.
The KBI License agreement provides that KBI shall
pay Bidi license fees equivalent to 50% of the adjusted earned royalty payments, after any offsets due to jointly agreed costs such development
costs incurred for entry to specific international markets. Consequently, the Company has determined that no license fees are owed to
Bidi as of January 31, 2023 and October 31, 2022.
Leased Office Space and Storage Space
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. On June 10, 2022, the Company entered into the 2022 Lease with Just Pick for approximately 21,332 rentable square
feet combined in the office building and warehouse located at 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.
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 January 31, 2023, and October 31, 2022, other than the below:
QuikfillRx Service Agreement Amendment
Effective as of November 9, 2022, the Company entered
into its latest amendment to the Service Agreement with QuikfillRx (collectively with prior amendments, the “Amended Service Agreement”).
The November 9, 2022 amendment to the Service Agreement was captioned as the “Fourth Amendment” although it was the fifth
amendment to the Service Agreement. Pursuant to the Amended Service Agreement:
(a) the term of the Amended Service Agreement was
extended (unless earlier terminated pursuant to the terms of the Amended Service Agreement) from November 1, 2022 (the “Effective
Date”) until October 31, 2025, following which the term shall automatically renew for successive one (1) year periods beginning
November 1, 2025;
(b) QuikfillRx agreed to change its
“doing business as” name to “Kaival Marketing Services” within thirty (30) days following the Effective
Date;
(c) it was provided that either party
may terminate the Amended Service Agreement without cause upon not less than ninety (90) days prior written notice to the other
party;
(d) QuikfillRx was granted a one-time,
fully vested, ten-year non-qualified option award to purchase up to 250,000 shares of Company common stock with an exercise price
of $0.9869 per share (the closing price of the Company’s common stock on November 9, 2022)”)., which option grant was
memorialized pursuant to a Nonqualified Option Agreement, dated November 9, 2022, between the Company and QuikfillRx; and
(e) the parties agreed to revise the
compensation for services as follows: (i) payment of $125,000 per month; (ii) bonus equivalent to 0.27% of the applicable gross
quarterly sales and (iii) a grant of 3,000,000 nonqualified stock options to purchase shares of Company common stock which shall
vest based on achievement of certain net revenue and profit margin targets up to $180,000,000 in total net revenues over a period
of 3 years.
The Company accrued $28,318 for a quarterly
bonus payable to QuikfillRx, based on the Applicable Gross Quarterly Sales results of the three months ended January 31, 2023.
The Company accrued 33,871 for a quarterly bonus payable to QuikfillRx, based on the Applicable Gross Quarterly Sales results for
the three months ended October 31, 2022.
Note 8 – Subsequent Events
On February 1, 2023, the Company entered
into an agreement to cancel the 75,000
stock options that were previously issued to a third-party management consultant and agreed to pay such consultant monthly retainer
of $16,750,
and an incentive compensation bonus of $75,000.
On February 6, 2023, non-qualified stock options
exercisable for up to 375,000
shares of common stock were awarded to the three independent board members of the Company. These stock options have a ten-year
term from the grant date, with 375,000
fully vest on the earlier of February 6, 2024, or a change in control.
On February 6, 2023, non-qualified stock options
exercisable for up to 1,000,000
shares of common stock were awarded to two senior executives of the Company. These stock options have a ten-year term from the
grant date, with 500,000
vest on date of issuance and 500,000 vest on the earlier of February 6, 2024, or a change in control.
On February 6, 2023, non-qualified stock options
exercisable for up to 150,000
shares of common stock were awarded to five employees of the Company. These stock options have a ten-year term from the grant
date, with 150,000
fully vest on the earlier of February 6, 2024 or a change in control.
On February 6, 2023, non-qualified stock
options exercisable for up to 200,000 shares
of common stock were awarded to one consultant acting as a sales broker for the Company. These
stock options have a ten-year term from the grant date, with 200,000 shall
vest based on achievement of certain net sales targets up to $100,000,000. The term of the agreement is one year from the
effective date with an automatic renewal of one year if net sales defined in the agreement are met.
On March 3, 2023, the Company approved amending the
Consulting Agreement for Mark Thoenes, the Company’s Interim Chief Financial Officer and extend it through June 30, 2023. In order
to extend its term, on March 3, 2023, the Company also approved the grant of a stock option award to Mr. Thoenes to acquire up to 50,000
shares of common stock under the Company’s Amended 2020 Stock and Incentive Compensation Plan. All of the option shares
fully vest on the earlier of June 30, 2023, or upon meeting certain terms and conditions.