ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with our financial statements, including the notes thereto contained in this Annual Report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of certain factors, including those set forth under “Risk Factors Associated with Our Business” and elsewhere in this Annual Report.
Overview
The Company’s objective is to become a leader in three broad product categories: (i) non-combustible nicotine-related products, (ii) alternative alkaloid vapor products, and (iii) hemp-derived vapor and edible products. Through our Charlie’s subsidiary, we formulate, market, and distribute premium, nicotine-based and alternative alkaloid vapor products. Charlie’s products are produced through contract manufacturers for sale through select distributors, specialty retailers, and third-party online resellers throughout the United States, as well as in more than 80 countries worldwide. Charlie’s primary international markets include the United Kingdom, Italy, Spain, New Zealand, Australia, and Canada. Through Don Polly, we develop, market and distribute products containing compounds derived from hemp.
Operational Plan
Considering industry-specific hurdles, as well as the potential for future regulatory changes, management has targeted opportunities for growth and has adopted the following operational plan.
Priority 1: In 2022, we initiated a plan and began to invest substantial time and resources to develop various proprietary products and new technologies in order to achieve competitive advantages in the vapor and alternative products marketplace. In conjunction with internal and external research and development resources, we have endeavored to identify a nicotine substitute (“Metatine™”) to be used in lieu of tobacco-based and synthetically derived nicotine. We believe adult consumers will enjoy Metatine vapor products in much the same way that they enjoy traditional vapor products. However, because Metatine is not made or derived from tobacco, and because Metatine does not consist of or contain nicotine from any source, the FDA's Center for Tobacco Products does not have jurisdiction to regulate Metatine. Accordingly, if the Company is successful utilizing Metatine in the development of a viable commercial product, such a product would allow us additional flexibility in offering both flavored and non-flavored vapor products to adult consumers looking to transition away from traditional combustible and smokeless tobacco products.
The Company has also begun to develop intellectual property around technologies designed to prevent youth access to nicotine vapor products. Edward Carmines, Ph.D., a member of Charlie’s Board of Directors and an accomplished scientist and regulatory affairs expert, is spearheading Charlie's development of patented "age-gating technology" for both Charlie's and potential licensees of the Company. Currently, there is a need for age-gated product technologies that can satisfy or accommodate concerns the FDA has related to under-age youth access in the ENDS market. If our age-gated e-cigarettes-in-development are recognized as "products of merit" by the FDA, Charlie's e-cigarettes could emerge among the select minority of flavored nicotine disposables able to be sold legally in the $7 billion U.S. vapor products market.
Rounding out the Company’s research and development initiatives are Charlie’s efforts to expand and enhance the PINWEEL product line. PINWEEL is Charlie’s alternative cannabis brand that contains only cannabinoids derived from the hemp plant. Since our PINWEEL product line contains only cannabinoids made from 100% hemp extract, we are able to legally manufacture, distribute and sell to consumers in the United States. As a result of the Agriculture Improvement Act (the “Farm Bill”), ratified and signed into law in December 2018, cannabis containing less than 0.3% Delta 9-THC is legally classified as hemp and is thus legal under federal law. Accordingly, with the objective of developing an array of new purpose-driven alternative cannabis products that offer adult consumers an enjoyable alternative to alcohol and traditional cannabis products, the Company continues to develop new PINWEEL vapor products, edibles, and other novel products.
Priority 2: In November 2022, we successfully launched our PINWEEL brand of alternative cannabis products. In 2023, we plan to increase sales and marketing efforts of our PINWEEL product line, including ingestibles and disposable vapor devices. We feel there is a significant upside in the hemp-derived products space, and we have begun to shift our focus in this business to the burgeoning “alternative cannabis” market for products containing live resin blends of hemp-derived cannabinoids. These product categories have grown rapidly, as they offer consumers a range of benefits across varying potencies and product formats. Alternative cannabis products contain only cannabinoids that are derived from the hemp plant, are not subject to the Controlled Substances Act and are legal throughout most of the United States. Further, alternative cannabis products are not currently subject to FDA review.
Priority 3: We will expand and refocus our sales team. Currently, we are increasing the number of independent contractor account executives, as well as refining the skill set of our existing sales team. An expanded sales team will more effectively manage key customer relationships across a larger number of reps, mitigating concentration risks and assuring adequate coverage. The sales team is organized into two groups, each with a specific mandate for targeting customers. One group will focus on direct-to-retail (smoke shops, chain stores, adult beverage/liquor stores, gas stations, and grocery stores) with the goal of acquiring 1,000 new customer accounts in 2023. The second group will focus on satisfying the requirements of mega-distributors (McLane, Coremark, HT Hackney, Eby-Brown) in order to sell into the nation’s largest chain store accounts. Additionally, to broaden our footprint with customers and to minimize order size variability, sales reps will rebalance their product sales mix, placing enhanced focus on alternative cannabis and legacy e-liquid products.
Priority 4: In order to mitigate FDA regulatory risk in the domestic market and to capture what management believes is a significant commercial opportunity, we have dedicated additional resources to efforts focused on growing our market share internationally. Presently, approximately 17% of our vapor product sales come from the international market and we are well positioned to increase sales in countries where we already have presence and, in additional overseas markets, as we have already built an international distribution platform. To facilitate this plan, we recently hired an Account Executive who will be dedicated to driving our efforts in international expansion. More specifically, we plan to build-out a dedicated international team, including country managers and marketing coordinators, to market and sell a suite of custom-made products to new and existing international customers.
Impact of COVID-19
The outbreak of a novel strain of coronavirus (“COVID-19”, or, “Coronavirus”) has had a negative impact on the global economy and the markets in which we operate. Beginning in March 2020, the Company transitioned nearly all employees to a remote working environment for their safety and to protect the integrity of Company operations, which have largely returned to the office. We will continue to monitor the COVID-19 situation in all regions in which we operate and will maintain strict adherence to local health guidelines and mandates. We may need to take further actions that we determine are in the best interests of our employees or are required by federal, state, or local authorities.
Risks and Uncertainties and Ability to Continue as a Going Concern
The Company operates in an environment that is subject to rapid changes and developments in laws and regulations that could have a significant impact on the Company’s ability to sell its products. Beginning in September 2019, certain states temporarily banned the sale of flavored e-cigarettes, and several states and municipalities are considering implementing similar restrictions. Federal, state, and local governmental bodies across the United States have indicated that flavored e-cigarette liquid, vaporization products and certain other consumption accessories may become subject to new laws and regulations at the federal, state, and local levels. In addition, in June 2022, the FDA announced a plan to reduce nicotine levels in cigarettes to minimally or non-addictive levels. The application of any new laws or regulations that may be adopted in the future, at a federal, state, or local level, directly or indirectly implicating nicotine, flavored e-cigarette liquid, and other electronic nicotine delivery system (“ENDS”) products, could significantly limit the Company’s ability to sell such products, result in additional compliance expenses, and/or require the Company to change its labeling and/or methods of distribution. Any ban of the sale of flavored e-cigarettes directly limits the markets in which the Company may sell its products. In the event the prevalence of such bans and/or changes in laws and regulations increase across the United States, or internationally, the Company’s business, results of operations, and financial condition could be adversely impacted. In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products. The Company’s applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell its approved products in the United States. Beginning in August 2021, the FDA began issuing Marketing Denial Orders (“MDO”) for ENDS products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. The Company has not received an MDO for any of its submissions; however, there is no assurance that regulatory approval to sell our products will be granted or that we would be able to raise additional financing if required, which could have a significant impact on our sales. On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine. These regulations make the Company’s synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products. As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha brands by May 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs, for its synthetic Pacha products on May 13, 2022, prior to the May 14, 2022 deadline. On November 3, 2022, FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA refused to accept certain other PMTAs for these products, rendering the latter products subject to FDA enforcement. The Company submitted an administrative appeal with FDA regarding its refusal to accept certain of the PMTAs, and has resubmitted PMTAs for, and continues to sell, the affected synthetic nicotine products while the administrative appeal process is pending. There can be no guarantee that FDA will grant our administrative appeal, and the FDA may bring an enforcement action against our synthetic nicotine products for lack of premarket authorization and/or issue an MDO to our pending applications at any time. More generally, FDA’s regulatory initiatives and enforcement priorities regarding ENDS products are unpredictable and continue to evolve, and we cannot predict whether FDA’s priorities and review of our premarket submissions will impact our products to a greater degree than our competitors in the industry. In the event the FDA denies our PMTAs, we would be required to remove products and cease selling them.
As discussed below, our financial statements and working capital raise substantial doubt about the Company’s ability to continue as a going concern. Our financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. See Liquidity and Capital Resources below for additional information.
Recent Developments
April 2022 Note Financing
On April 6, 2022, the Company issued a secured promissory note (the “Note”) to one of its large individual stockholders, Michael King (the “Lender"), in the principal amount of $1,000,000, which Note is secured by accounts receivable of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and the Lender (the "Note Financing"). On September 28, 2022, the Company and the Lender entered into a modification to the Note to extend the maturity date to March 28, 2023 and the Company paid all accrued interest under the Note through such date.
On March 28, 2023, the Company entered into a second modification to the Note to extend the maturity date to April 28, 2024, contingent upon the payment of all interest accrued under the Note through March 28, 2023 and certain other modifications to the Note. Principal shall be payable on the 28th day of each month in installments of $25,000, commencing April 28, 2023, continuing up to and including April 28, 2024 whereby a balloon payment for the remaining principal balance will be paid. Interest shall accrue on the aggregate outstanding principal amount at a rate equal to 20% simple interest per annum and shall be payable on the same day as installments of principal are payable. The Company may prepay all or any portion of the principal amount, together with all accrued but unpaid interest thereon, at any time without premium or penalty. All outstanding principal and interest are due earlier of April 28, 2024, or a liquidity event.
August 2022 Note Financing – Related Party
On August 17, 2022, the Company and its Chief Operating Officer and Director, Ryan Stump (the "Stump Lender") entered into a loan agreement (the “Loan”) in the principal amount of $300,000. The Loan will be due in full in 120 days or sooner if, before the end of term, the Company secures (i) new debt financing or (ii) sufficient PMTA strategic partnership funds. The Loan bears an annual interest rate of 10%. The Company also incurred additional $3,000 issuance cost resulting from the payment of the Stump Lender’s legal fees. On December 17, 2022, the Company and Stump Lender entered into a modification to the Loan to extend the maturity date to April 16, 2023 and the Company has paid all accrued interest under the Loan through such date. On April 13, 2023, the Company and Stump Lender entered into a second modification to the Loan to extend the maturity date to August 14, 2023.
PMTA
During the quarter ended September 30, 2020, the FDA's Center for Tobacco Products informed us that our PMTA received a valid submission tracking number, passed the FDA’s filing review phase, and entered the substantive review phase. To date, the Company has invested more than $5.1 million for our PMTA submissions. We engaged a team of more than 200 professionals, including doctors, scientists, biostatisticians, data analysts, and numerous contract research organizations to create our comprehensive PMTA submission. During the quarter ended September 30, 2021, the FDA began issuing Marketing Denial Orders (“MDOs”) for electronic nicotine delivery system (“ENDS”) products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health.
On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine. These regulations make synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products. As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha brands by May 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs for its synthetic Pacha products, on May 13, 2022, prior to the May 14, 2022, deadline. On November 3, 2022, FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA refused to accept certain other PMTAs for these products, rendering the latter products subject to FDA enforcement. The Company submitted an administrative appeal with FDA regarding its refusal to accept certain of the PMTAs, and has resubmitted PMTAs for, and continues to sell, the affected synthetic nicotine products while the administrative appeal process is pending.
As of December 31, 2022, Charlie’s 2020 PMTA remains among the select minority of applications submitted to the FDA for a tobacco-derived nicotine ENDS product that has not received an MDO or Refuse-to-File designation. This fact highlights our progress toward achieving full regulatory compliance and demonstrates the emphasis our Company places on providing customers with a trusted product portfolio.
Impact of COVID-19
The outbreak of a novel strain of coronavirus (“COVID-19”, or, “Coronavirus”) has had, and continues to have, a negative impact on the global economy and the markets in which we operate. Beginning in March 2020, the Company transitioned nearly all employees to a remote working environment for their safety and to protect the integrity of Company operations. We have updated certain sales, accounting, and administrative processes, and corresponding information technology platforms, in an effort to help facilitate the virtual work environment which still persists for some employees. During the year ended December 31, 2022, we engaged in periodic, informal testing of our business operations, and we do not believe that our financial position, work efficiency, and overall operational integrity have been materially affected. However, we recognize that a certain degree of employee enthusiasm, teamwork, creativity, and support is normally generated by being present at a physical location, and we believe that prolonged remote working may have a negative impact over time on our business, and on employee productivity. Our Huntington Beach, CA warehouse location has returned fully to “on premise” status, while our corporate headquarters in Costa Mesa, CA remains remote for some employees. We will continue to monitor the COVID-19 situation in all regions in which we operate and will maintain strict adherence to local health guidelines and mandates. We may need to take further actions that we determine are in the best interests of our employees or are required by federal, state, or local authorities.
Basis of Presentation
The consolidated financial statements contained within this Annual Report and the disclosure in this Management’s Discussion and Analysis of Financial Condition and Results of Operations with respect to the years ended December 31, 2022 and 2021 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company, all adjustments, including normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company for the interim period have been included.
Results of Operations for the Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021
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For the years ended
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December 31,
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Change
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2022
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2021
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Amount
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Percentage
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($ in thousands)
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Revenues:
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Product revenue, net
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$ |
26,424 |
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$ |
21,496 |
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$ |
4,928 |
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22.9 |
% |
Total revenues
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26,424 |
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21,496 |
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4,928 |
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22.9 |
% |
Operating costs and expenses:
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Cost of goods sold - product revenue
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16,439 |
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10,423 |
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6,016 |
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57.7 |
% |
General and administrative
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8,381 |
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8,750 |
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(369 |
) |
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-4.2 |
% |
Sales and marketing
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2,605 |
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1,734 |
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871 |
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50.2 |
% |
Research and development
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804 |
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24 |
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780 |
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3250.0 |
% |
Total operating costs and expenses
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28,229 |
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20,931 |
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7,298 |
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34.9 |
% |
(Loss) income from operations
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(1,805 |
) |
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565 |
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(2,370 |
) |
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-419.5 |
% |
Other income (expense):
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Interest expense
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(155 |
) |
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(34 |
) |
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(121 |
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355.9 |
% |
Change in fair value of derivative liabilities
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270 |
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3,545 |
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(3,275 |
) |
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-92.4 |
% |
Gain on debt extinguishment
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- |
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1,060 |
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(1,060 |
) |
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-100.0 |
% |
Other income
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6 |
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14 |
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(8 |
) |
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-57.1 |
% |
Total other income
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121 |
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4,585 |
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(4,464 |
) |
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-97.4 |
% |
(Loss) income before income taxes
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(1,684 |
) |
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5,150 |
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(6,834 |
) |
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-132.7 |
% |
Income taxes (benefit) provision
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(92 |
) |
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342 |
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(434 |
) |
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-126.9 |
% |
Net (loss) income
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$ |
(1,592 |
) |
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$ |
4,808 |
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|
$ |
(6,400 |
) |
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-133.1 |
% |
Revenue
Revenue for the year ended December 31, 2022, increased approximately $4,928,000, or 22.9%, to approximately $26,424,000, as compared to approximately $21,496,000 for the year ended December 31, 2021, due to a $4,030,000 increase in our nicotine-based product sales, and a $898,000 increase in sales of our hemp-derived products. The increase in our nicotine-based vapor product sales is directly related to the launch of our Pacha (formerly Pachamama Disposable) product line which grew significantly during the first half of 2022 with the launch of additional size and flavor offerings. Pacha Disposables became Charlie’s first-ever entrant into the rapidly expanding, disposable e-cigarette market and offer users a variety of premium flavors containing synthetic nicotine (not derived from tobacco) in a compact, discrete format. Ongoing uncertainty surrounding the FDA’s application review timeline, following the May 13, 2022 PMTA submission deadline, as well as the entrant of lower-priced competitors selling direct from China affected buying patterns of disposable nicotine products in domestic vape market during the second half of 2022. Sales growth slowed during the quarter ended December 31, 2022 as customers reduced emphasis on offering a wide product variety and focused on low-cost, high-sales velocity offerings.
During the quarter ended March 31, 2021, we began to streamline our existing hemp-derived wellness product offering and to pursue the developing market for products containing hemp-derived cannabinoids. We view this market segment as having higher growth potential and better alignment with our existing sales channels, and therefore, we will continue to develop and launch additional products in this category.
Cost of Revenue
Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs increased approximately $6,016,000 or 57.7%, to approximately $16,439,000, or 62.2% of revenue, for the year ended December 31, 2022, as compared to approximately $10,423,000, or 48.5% of revenue, for the year ended December 31, 2021. This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pacha Disposable product line, which carries a lower margin per unit relative to our other vapor products. Cost of revenue was also significantly affected by a large provision for inventory obsolescence related to certain of our nicotine and alternative cannabis disposable products. The increased provision for inventory obsolescence was mostly the result of compressed product lifecycles in both the nicotine disposable and alternative cannabis product categories.
General and Administrative Expense
For the year ended December 31, 2022, total general and administrative expense decreased approximately $369,000 to approximately $8,381,000, or 31.7% of revenue, as compared to approximately $8,750,000, or 40.7% of revenue, for the year ended December 31, 2021. This decrease is primarily comprised of reductions of approximately $509,000 of wages and benefits and $391,000 of non-cash stock-based compensation. The decrease in payroll and benefits expense during the year ended December 31, 2022, was primarily due to strategic headcount reduction, salary reductions and cancelled bonuses for Company officers and senior managers, as well as Employee Retention Credits received in conjunction with the Infrastructure Investment and Jobs Act which was enacted in November 2021. The reduction in non-cash stock-based compensation is primarily related to the conclusion of the vesting period for shares of Common Stock awarded to several employees in conjunction with the Share Exchange completed in April 2019 (See Note 3). The decreases were primarily offset by increases of $161,000 in provision for bad debt, $91,000 of merchant processing and bank fees as well as $279,000 in other general and administrative expenses. The increases in provision for bad debt and merchant processing fees were primarily related to higher sales achieved during the year ended December 31, 2022. The increase in other general and administrative costs was primarily related to additional infrastructure and information technology system upgrades as well as higher audit fees and costs related to the calculation of our 2021 income taxes.
Sales and Marketing Expense
For the year ended December 31, 2022, total sales and marketing expense increased to approximately $2,605,000 as compared to approximately $1,734,000 for the year ended December 31, 2021, which was primarily due to a shift in spending on product sales support materials and digital marketing campaigns related to the launch of our new alternative cannabis product lines. Our participation in tradeshows increased substantially during the year as we continue to believe it is the best method for directly reaching consumers and distributors of our products.
Research and Development Expense
For the year ended December 31, 2022, total research and development expense increased approximately $780,000, to $804,000 as compared to approximately $24,000 for the year ended December 31, 2021. During the year ended December 31, 2022, we (i) filed new PMTAs for our synthetic nicotine Pacha products, (ii) invested in “age-gating technology” research and development, and (iii) invested in the development of new novel products which resulted in higher research and development expenses relative to the year ended December 31, 2021.
Income (Loss) from Operations
We generated loss from operations of approximately $1,805,000 for the year ended December 31, 2022, as compared to income from operations of approximately $565,000 for the year ended December 31, 2021. Net income (loss) is determined by adjusting income (loss) from operations by the following items:
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Change in fair value of derivative liabilities. For the years ended December 31, 2022 and 2021, the gain in fair value of derivative liabilities was approximately $270,000 and $3,545,000, respectively. The derivative liability is associated with the issuance of the Investor Warrants and the Placement Agent Warrants (see Note 3) in connection with the Share Exchange. The gain for the year ended December 31, 2022, reflects the effect of the decrease in stock price as of December 31, 2022 compared to December 31, 2021. Due to the limited supply of shares currently freely trading, our stock price may experience volatility and therefore, considerable fluctuations in the value of our warrant derivative liability may occur in the future. We had warrants to purchase approximately 40,424,000 shares of common stock outstanding as of December 31, 2022.
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Interest Expense. For the years ended December 31, 2022 and 2021, we recorded interest expense related to notes payable of $155,000 and $34,000, respectively.
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Gain on debt extinguishment. For the years ended December 31, 2022, and 2021 we recorded a gain on debt extinguishment of $0 and $1,060,000, respectively, related to forgiveness of Paycheck Protection Program loans extended to Charlie’s and Don Polly.
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Other Income. For the years ended December 31, 2022 and 2021, we recorded other income related to interest and sublease income of $6,000 and $14,000, respectively.
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Income Taxes (Benefit) Provision
The Company’s income tax benefit was $92,000, or 5.5% of income before income taxes, for the year ended December 31, 2022. The Company’s income tax expense was $342,000 for the year ended December 31, 2021.
Net Income (Loss)
For the years ended December 31, 2022, and 2021, we had a net loss of $1,592,000 and net income of $4,808,000, respectively.
Effects of Inflation
Inflation has not had a material impact on our business.
Liquidity and Capital Resources
As of December 31, 2022, we had working capital of approximately $1,067,000, which consisted of current assets of approximately $5,850,000 and current liabilities of approximately $4,783,000, as compared to working capital of approximately $2,460,000 at December 31, 2021. The current liabilities include approximately $2,333,000 of accounts payable and accrued expenses, notes payable of $1,000,000, note payable from a related party of $300,000, approximately $148,000 of deferred revenue associated with product shipped but not yet received by customers, approximately $373,000 of lease liabilities, and $629,000 of derivative liability associated with the Investor Warrants and Placement Agent Warrants (the derivative liability of $629,000 is included in determining the working capital of $1,067,000 but is not expected to use any cash to ultimately satisfy the liability).
On April 6, 2022, the Company issued a secured promissory note (the “Note”) to one of its large individual stockholders, Michael King (the “Lender"), in the principal amount of $1,000,000, which Note is secured by accounts receivable of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and the Lender (the "Note Financing"). On September 28, 2022, the Company and the Lender entered into a modification to the Note to extend the maturity date to March 28, 2023 and the Company paid all accrued interest under the Note through such date. On March 28, 2023, the Company entered into a second modification to the Note to extend the maturity date to April 28, 2024, contingent upon the payment of all interest accrued under the Note through March 28, 2023 and certain other modifications to the Note (see Note 8). The Company used the proceeds from the Note for general corporate purposes, and its working capital requirements, pending the availability of alternative debt financing.
On August 17, 2022, the Company and its Chief Operating Officer and Director, Ryan Stump (the "Stump Lender") entered into a loan agreement (the “Loan”) in the principal amount of $300,000. The Loan will be due in full in 120 days or sooner if, before the end of term, the Company secures (i) new debt financing or (ii) sufficient PMTA strategic partnership funds. The Loan bears an annual interest rate of 10%. The Company also incurred additional $3,000 issuance cost resulting from the payment of the Stump Lender’s legal fees. On December 17, 2022, the Company and Stump Lender entered into a modification to the Loan to extend the maturity date to April 16, 2023 and the Company has paid all accrued interest under the Loan through such date. On April 13, 2023, the Company and Stump Lender entered into a second modification to the Loan to extend the maturity date to August 14, 2023.
Our cash and cash equivalents balance at December 31, 2022 was approximately $257,000.
For the year ended December 31, 2022, net cash used in operating activities was approximately $1,720,000, resulting from a net loss of $1,592,000 and a change in operating assets and liabilities of $996,000, offset by net non-cash activity of $868,000. For the year ended December 31, 2021, net cash used in operating activities was approximately $1,347,000, resulting from a net income of $4,808,000, offset by a $3,545,000 of change in fair value of derivative liabilities, $1,060,000 from debt extinguishment, and $2,866,000 changes in our operating assets and liabilities.
For the year ended December 31, 2022, we used cash for investment activities of approximately $189,000 as compared to $110,000 for the same period in 2021. The cash used for investment activities is primarily for the on-going development and configuration of enterprise resource planning software as well as the disposal of fixed assets related to the permanent closure of our Denver, Colorado location.
For the year ended December 31, 2022, we generated approximately $1,300,000 cash from financing activities related to the issuance of a promissory note to a large shareholder and a short-term loan from our chief operating officer and director, Ryan Stump, each as discussed above. For the year ended December 31, 2021 we generated approximately $3,184,000 cash from financing activities from the Private Placement (as defined in Note 10 of Item 1, Part 1 of this Report) offset by the repayment of the Red Beard Note (as defined in Note 8 of Item 1, Part 1 of this Report). We also paid cash dividends of $883,000 during the nine months ended September 30, 2021 to our preferred stockholders.
Going Concern Uncertainty Regarding the Legal and Regulatory Environment, Liquidity and Management’s plan of operation
Our financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company operates in a rapidly changing legal and regulatory environment; new laws and regulations or changes to existing laws and regulations could significantly limit the Company’s ability to sell its products, and/or result in additional costs. Additionally, the Company was required to apply for FDA approval to continue selling and marketing its products used for the vaporization of nicotine in the United States. Currently, a substantial portion of the Company’s sales are derived from products that are subject to approval by the FDA. There was significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future application. For the year ended December 31, 2022, the Company generated a loss from operations of approximately $1,805,000, and a consolidated net loss of approximately $1,592,000 and used cash in operations of approximately $1,720,000. The Company had stockholders’ equity of $1,700,000 at December 31, 2022. During the year ended December 31, 2022, the Company’s working capital requirements continued to evolve as current assets decreased to $5,850,000 from $7,994,000 as of December 31, 2021 and currently liabilities decreased to $4,783,000 from $5,534,000 as of December 31, 2021. Considering these facts, the issuance of one or several MDOs from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables and the removal of certain products for sale. These regulatory risks, as well as other industry-specific challenges and our low working capital and cash position, remain factors that raise substantial doubt about the Company’s ability to continue as a going concern.
Our plans and growth depend on our ability to increase revenues, procure cost-effective financing, and continue our business development efforts, including the expenditure of approximately $5,100,000 to date, to support our PMTA process for the Company’s submissions to the FDA. The Company has undergone cost-cutting measures including salary reductions of up to 25% for officers and certain managers and a reduction in headcount for certain departments. During 2023, we also plan to launch additional products that are not subject to FDA review or covered under the Agriculture Improvement Act (the “Farm Bill”). During 2023, the Company intends to allocate further resources and new personnel to support research and development initiatives in order to support existing, or subsequent PMTAs. The Company may require additional financing in the future to support subsequent PMTA filings, and/or in the event the FDA requests additional testing for one, or several, of the Company’s prior PMTA submissions. There can be no assurance that additional financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and, in the Company’s best interests. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. If we do not have sufficient funds to continue operations, we could be required to seek bankruptcy protection or other alternatives that would likely result in our stockholders losing some or all their investment in us.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other than operating lease commitments.
Critical Accounting Policies
Included below is a discussion of critical accounting policies used in the preparation of our financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates.
We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.
The accounting policies identified as critical are as follows:
Revenue Recognition
The Company recognizes revenues in accordance with Accounting Standards Codification (“ASC”) 606 – Contracts with Customers. Revenues are generated from contracts with customers that consist of sales to retailers and distributors. Contracts with customers are generally short term in nature with the delivery of product as a single performance obligation. Revenue from the sale of product is recognized at the point in time when the single performance obligation has been satisfied and control of the product has transferred to the customer. In evaluating the timing of the transfer of control of products to customers, The Company considers several indicators, including significant risks and rewards of products, the right to payment, and the legal title of the products. Based on the assessment of control indicators, sales are generally recognized when products are received by customers. Shipping generally occurs prior to the transfer of control to the customer and is therefore accounted for as a fulfillment expense. In circumstances where shipping and handling activities occur after the customer has obtained control of the product, the Company has elected to account for shipping and handling activities as a fulfillment cost rather than an additional promised service. Contract durations are generally less than one year, and therefore costs paid to obtain contracts, which generally consist of sales commissions, are recognized as expense in the period incurred. Revenue is measured by the transaction price, which is defined as the amount of consideration expected to be received in exchange for providing goods to customers. The transaction price is adjusted for estimates of known or expected variable consideration, which includes refunds and returns as well as incentive offers, volume rebates, and promotional discounts on current orders. Our volume rebates are short-term in nature and reset on a quarterly basis. Sales returns are generally not material to the financial statements, and do not comprise a significant portion of variable consideration. Estimates for sales returns are based on, among other things, an assessment of historical trends, information from customers, and anticipated returns related to current sales activity. These estimates are established in the period of sale and reduce revenue in the period of the sale. Variable consideration related to incentive offers and promotional programs are recorded as a reduction to revenue based on amounts the Company expects to collect. Estimates are regularly updated and the impact of any adjustments are recognized in the period the adjustments are identified. In many cases, key sales terms such as pricing and quantities ordered are established at the time an order is placed and incentives have very short-term durations.
Amounts billed and due from customers are short term in nature and are classified as receivables since payments are unconditional and only the passage of time related to credit terms is required before payments are due. The Company does not grant payment financing terms greater than one year. Payments received in advance of revenue recognition are recorded as deferred revenue.
Accounts receivable is recorded at the invoiced amount and does not bear interest. We determine the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history and current economic conditions and set up an allowance for doubtful accounts when collection is uncertain. Customers’ accounts are written off against the allowance when all attempts to collect have been exhausted. Recoveries of accounts receivable previously written off are recorded as income when received. As of December 31, 2022, and 2021, the allowance for bad debt totaled $158,000 and $109,000, respectively.
Inventories
Inventories primarily consist of finished goods and are stated at the lower of cost (determined by the average cost method) or net realizable value. We calculate estimates of excess and obsolete inventories determined primarily by reviewing inventory on hand, historical sales activity, industry trends and expected net realizable value. As of December 31, 2022, and 2021, the reserve for excess and obsolete inventories totaled $733,000 and $156,000, respectively.
Stock-Based Compensation
We account for all stock-based compensation using a fair value-based method. The fair value of equity-classified awards granted to employees is estimated on the date of the grant using the Black-Scholes option-pricing model, or it is based on valuation observed from publicly traded companies in a similar industry, often with a discount for lack of marketability applied. The related stock-based compensation expense is recognized over the vesting period during which an employee is required to provide service in exchange for the award.
Income Taxes
Income taxes are computed under the liability method. This method requires the recognition of deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.
Financial statement effects of a tax position are initially recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that meets the more-likely-than-not threshold of being realized upon ultimate settlement with a taxing authority. We recognize potential accrued interest and penalties related to unrecognized tax benefits as income tax expense.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required for smaller reporting companies.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION
Description of the Business
Charlie’s Holdings, Inc., a Nevada corporation, together with its wholly owned subsidiaries and consolidated variable interest entity (collectively, the “Company”, “we”), currently formulates, markets and distributes premium, non-combustible nicotine-related products, alternative alkaloid vapor products, and hemp-derived vapor and edible products. The Company’s products are produced through contract manufacturers for sale by select distributors, specialty retailers, and third-party online resellers throughout the United States, as well as in more than 80 countries worldwide. The Company’s primary international markets include the United Kingdom, Italy, Spain, New Zealand, Australia, and Canada.
Charlie’s Chalk Dust, LLC (“Charlie’s” or “CCD”), is the Company’s wholly owned subsidiary which produces and sells nicotine-based and alternative alkaloid vapor products. Don Polly is a consolidated variable interest entity, for which the Company is the primary beneficiary, which develops, markets and distributes products containing cannabinoids derived from hemp.
The Company's Common Stock, par value $0.001 per share (the "Common Stock"), trades under the symbol "CHUC" on the OTCQB Venture Market.
Reverse Stock Split
The Company’s Board of Directors approved a reverse stock split of the Company’s authorized, issued and outstanding shares of Common Stock, par value $0.001 per share, at a ratio of 1-for-100 (the “Reverse Split”). The Reverse Split was effective as of June 16, 2021 (the “Effective Date”). All share and per share amounts in the Form 10-K have been retroactively adjusted to account for the reverse stock split.
Basis of Presentation
The consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).
Going Concern Uncertainty Regarding the Legal and Regulatory Environment, Liquidity and Management’s plan of operation
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company operates in a rapidly changing legal and regulatory environment; new laws and regulations or changes to existing laws and regulations could significantly limit the Company’s ability to sell its products, and/or result in additional costs. Additionally, the Company was required to obtain approval from the United States Food and Drug Administration ("FDA") to continue selling and marketing certain of products used for the vaporization of nicotine in the United States. Currently, a substantial portion of the Company’s sales are derived from products that are subject to approval by the FDA. There was significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future application. For the year ended December 31, 2022, the Company generated a loss from operations of approximately $1,805,000, and a consolidated net loss of approximately $1,592,000 and used cash in operations of approximately $1,720,000. The Company had stockholders’ equity of $1,700,000 at December 31, 2022. During the year ended December 31, 2022, the Company’s working capital requirements continued to evolve as current assets decreased to $5,850,000 from $7,994,000 as of December 31, 2021 and currently liabilities decreased to $4,783,000 from $5,534,000 as of December 31, 2021. Considering these facts, the issuance of one or several MDOs from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables and potentially require us to remove products from circulation. These regulatory risks, as well as other industry-specific challenges, our low working capital and cash position remain factors that raise substantial doubt about the Company’s ability to continue as a going concern.
Management's plans depend on its ability to increase revenues, procure cost-effective financing, and continue its business development efforts, including the expenditure of approximately $5.1 million to date, to support the Pre-Market Tobacco Application (“PMTA”) process for the Company’s submissions to the FDA. The Company has undergone cost-cutting measures including salary reductions of up to 25% for officers and certain managers and a reduction in headcount for certain departments. During 2023, we also plan to launch additional products that are not subject to FDA review or covered under the Agriculture Improvement Act (the “Farm Bill”). The Company may require additional financing in the future to support subsequent PMTA filings, and/or in the event the FDA requests additional testing for one, or several, of the Company’s prior PMTA submissions. There can be no assurance that additional financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and, in the Company’s best interests. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. If we do not have sufficient funds to continue operations, we could be required to seek bankruptcy protection or other alternatives that would likely result in our stockholders losing some or all their investment in us.
Risks and Uncertainties
The Company operates in an environment that is subject to rapid changes and developments in laws and regulations that could have a significant impact on the Company’s ability to sell its products. Beginning in September 2019, certain states temporarily banned the sale of flavored e-cigarettes, and several states and municipalities are considering implementing similar restrictions. Federal, state, and local governmental bodies across the United States have indicated that flavored e-cigarette liquid, vaporization products and certain other consumption accessories may become subject to new laws and regulations at the federal, state, and local levels. In addition, in June 2022, the FDA announced a plan to reduce nicotine levels in cigarettes to minimally or non-addictive levels. The application of any new laws or regulations that may be adopted in the future, at a federal, state, or local level, directly or indirectly implicating nicotine, flavored e-cigarette liquid and other electronic nicotine delivery system (“ENDS”) products, could significantly limit the Company’s ability to sell such products, result in additional compliance expenses, and/or require the Company to change its labeling and/or methods of distribution. Any ban of the sale of flavored e-cigarettes directly limits the markets in which the Company may sell its products. In the event the prevalence of such bans and/or changes in laws and regulations increase across the United States, or internationally, the Company’s business, results of operations and financial condition could be adversely impacted. In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products. The Company’s applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell its approved products in the United States. Beginning in August 2021, the FDA began issuing Marketing Denial Orders (“MDO”) for ENDS products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. The Company has not received an MDO for any of its submissions; however, there is no assurance that regulatory approval to sell our products will be granted or that we would be able to raise additional financing if required, which could have a significant impact on our sales. On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine. These regulations make the Company’s synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products. As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha brands by May 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs, for its synthetic Pacha products on May 13, 2022, prior to the May 14, 2022 deadline. On November 3, 2022, FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA refused to accept certain other PMTAs for these products, rendering the latter products subject to FDA enforcement. The Company submitted an administrative appeal with FDA regarding its refusal to accept certain of the PMTAs, and has resubmitted PMTAs for, and continues to sell, the affected synthetic nicotine products while the administrative appeal process is pending. There can be no guarantee that FDA will grant our administrative appeal, and the FDA may bring an enforcement action against our synthetic nicotine products for lack of premarket authorization and/or issue an MDO to our pending applications at any time. More generally, FDA’s regulatory initiatives and enforcement priorities regarding ENDS products are unpredictable and continue to evolve, and we cannot predict whether FDA’s priorities and review of our premarket submissions will impact our products to a greater degree than our competitors in the industry.
In addition, the impact from COVID- has affected our supply chain, and if disruptions from the COVID- outbreak persist and are prolonged, it will continue to have an adverse impact on our business.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its 100% wholly owned subsidiary, Charlie’s Chalk Dust, LLC and Don Polly, LLC, a consolidated variable interest for which the Company is the primary beneficiary. All inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with U.S. 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Fair Value of Financial Instruments
U.S. GAAP requires disclosing the fair value of financial instruments to the extent practicable for financial instruments which are recognized or unrecognized in the balance sheet. The fair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement.
In assessing the fair value of financial instruments, the Company uses a variety of methods and assumptions, which are based on estimates of market conditions and risks existing at the time. The fair value of derivative liabilities was estimated using a Monte Carlo simulation method, based on both observable and unobservable inputs. For certain instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, it was estimated that the carrying amount approximated fair value because of the short maturities of these instruments. The Company determined that the carrying amounts of the current portion of outstanding notes payable approximate fair value due to the short-term nature of borrowings and current market interest rates. The Company determined the carrying amounts of the non-current portion of outstanding notes payable approximate fair value due to the current interest rates payable in relation to current market conditions.
Revenue Recognition
The Company recognizes revenues in accordance with Accounting Standards Codification (“ASC ”) 606 – Contracts with Customers. Revenues are generated from contracts with customers that consist of sales to retailers and distributors. Contracts with customers are generally short term in nature with the delivery of product as a single performance obligation. Revenue from the sale of product is recognized at the point in time when the single performance obligation has been satisfied and control of the product has transferred to the customer. In evaluating the timing of the transfer of control of products to customers, the Company considers several indicators, including significant risks and rewards of products, the right to payment, and the legal title of the products. Based on the assessment of control indicators, sales are generally recognized when products are received by customers. Shipping generally occurs prior to the transfer of control to the customer and is therefore accounted for as a fulfillment expense.
In circumstances where shipping and handling activities occur after the customer has obtained control of the product, the Company has elected to account for shipping and handling activities as a fulfillment cost rather than an additional promised service. Contract durations are generally less than one year and, therefore, costs paid to obtain contracts, which generally consist of sales commissions, are recognized as expenses in the period incurred. Revenue is measured by the transaction price, which is defined as the amount of consideration expected to be received in exchange for providing goods to customers. The transaction price is adjusted for estimates of known or expected variable consideration, which includes refunds and returns as well as incentive offers, volume rebates and promotional discounts on current orders. Our volume rebates are short-term in nature and reset on a quarterly basis. Estimates for sales returns are based on, among other things, an assessment of historical trends, information from customers, and anticipated returns related to current sales activity. These estimates are established in the period of sale and reduce revenue in the period of the sale. Variable consideration related to incentive offers and promotional programs are recorded as a reduction to revenue based on amounts the Company expects to collect. Estimates are regularly updated and the impact of any adjustments are recognized in the period the adjustments are identified. In many cases, key sales terms such as pricing and quantities ordered are established at the time an order is placed and incentives have very short-term durations.
Amounts billed and due from customers are short term in nature and are classified as receivables since payments are unconditional and only the passage of time related to credit terms is required before payments are due. The Company does not grant payment financing terms greater than one year. Payments received in advance of revenue recognition are recorded as deferred revenue.
Cash and Cash Equivalents
The Company considers all liquid investments purchased with original maturities of ninety days or less to be cash equivalents.
Accounts Receivable
Accounts receivable are recorded at the invoiced amount and do not bear interest. We determine the allowance for doubtful accounts by regularly evaluating historical customer information and individual customer receivables and considering a customer’s financial condition, credit history and current economic conditions and establish an allowance for doubtful accounts when collection is uncertain. Customers’ accounts are written off against the allowance when all attempts to collect have been exhausted. Recoveries of accounts receivable previously written off are recorded as income when received. As of December 31, 2022 and 2021, the allowance for bad debt totaled $158,000 and $109,000, respectively.
Inventories
Inventories primarily consist of finished goods and are stated at the lower of cost (determined by the average cost method) or net realizable value. We calculate estimates of excess and obsolete inventories determined primarily by reviewing inventory on hand, historical sales activity, industry trends and expected net realizable value. As of December 31, 2022 and 2021, the reserve for excess and obsolete inventories totaled $733,000 and $156,000, respectively.
Plant, Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are provided for using the straight-line method, in amounts sufficient to charge the cost of depreciable assets to operations over their estimated service lives. Repairs and maintenance costs are charged to operations as incurred.
Costs for capital assets not yet placed into service are capitalized as construction in progress on the consolidated balance sheets and will be depreciated once placed into service.
The Company assesses its long-lived assets for impairment whenever facts and circumstances indicate that the carrying amounts may not be fully recoverable. To analyze recoverability, the Company projects undiscounted net future cash flows over the remaining lives of such assets. If these projected undiscounted net future cash flows are less than the carrying amounts, an impairment loss would be recognized, resulting in a write-down of the assets with a corresponding charge to earnings. The impairment loss is measured based upon the difference between the carrying amounts and the fair values of the assets.
Leases
The Company recognizes a lease asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation. The Company determines whether an arrangement is, or contains a lease at contract inception. Operating leases with a duration greater than one year are included in right-of-use assets, lease liabilities, and lease liabilities, net of current portion in the Company’s consolidated balance sheets. Right-of-use assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. In determining the net present value of lease payments, the Company uses its incremental borrowing rate based on the information available at the lease commencement date. The incremental borrowing rate represents the interest rate the Company would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease. The Company considers a lease term to be the noncancelable period that it has the right to use the underlying asset.
The operating lease right-of-use assets also include any lease payments made and exclude lease incentives. Lease expense is recognized on a straight-line basis over the expected lease term. Variable lease expenses are recorded when incurred.
Stock-Based Compensation
The Company accounts for all stock-based compensation using a fair value-based method. The fair value of equity-classified awards granted to employees is estimated on the date of the grant using the Black-Scholes option-pricing model and the related stock-based compensation expense is recognized over the vesting period during which an employee is required to provide service in exchange for the award.
Income Taxes
Income taxes are computed under the liability method. This method requires the recognition of deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. A valuation allowance is recorded when it is more likely than not that some, or all of the deferred tax assets will not be realized.
Financial statement effects of a tax position are initially recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that meets the more-likely-than-not threshold of being realized upon ultimate settlement with a taxing authority. We recognize potential accrued interest and penalties related to unrecognized tax benefits as income tax expense.
Research and Development
We expense the cost of research and development as incurred. Research and development expenses include costs incurred in funding research and development activities, license fees, and other external costs. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity is performed or when the goods have been received, rather than when payment is made.
Segments
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker in making decisions regarding resource allocation and assessing performance. The Company views its operations and manages its business in one operating segment.
The following table disaggregates revenue from our single operating segment by geographic market and customer type for the periods ending December 31, 2022 and 2021, respectively:
|
|
December 31,
2022
|
|
|
December 31,
2021
|
|
Geographic Market
|
|
|
|
|
|
|
|
|
International
|
|
|
16 |
%
|
|
|
17 |
%
|
United States
|
|
|
84 |
%
|
|
|
83 |
%
|
|
|
|
|
|
|
|
|
|
Customer Type
|
|
|
|
|
|
|
|
|
Retailer
|
|
|
30 |
%
|
|
|
38 |
%
|
Distribution
|
|
|
70 |
%
|
|
|
62 |
%
|
Recently Issued Accounting Pronouncements
Measurement of Credit Losses on Financial Instruments
In June 2016 the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which supersedes current guidance requiring recognition of credit losses when it is probable that a loss has been incurred. The standard requires the establishment of an allowance for estimated credit losses on financial assets, including trade and other receivables, at each reporting date. The ASU will result in earlier recognition of allowances for losses on trade and other receivables and other contractual rights to receive cash. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption is permitted. The Company does not believe the impact of adopting this standard will be material to its consolidated financial statements and related disclosures.
Income Taxes
In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. On January 1, 2021, the Company adopted this standard without any material impact on its consolidated financial statements and related disclosures.
Debt – Debt with conversion and Other Options
In August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which simplifies accounting for convertible instruments by removing major separation models required under current GAAP. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception and it also simplifies the diluted earnings per share calculation in certain areas. The ASU is effective for the Company on December 1, 2022, Early adoption is permitted, but no earlier than December 1, 2021. The Company elected to early adopt this guidance on January 1, 2022 with no impact on its consolidated financial statements and related disclosures.
Earnings per Share
In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). This ASU reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. This ASU provides guidance for a modification or an exchange of a freestanding equity-classified written call option that is not within the scope of another Topic. It specifically addresses: (1) how an entity should treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; (2) how an entity should measure the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; and (3) how an entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange. This ASU will be effective for all entities for fiscal years beginning after December 15, 2021. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. Early adoption is permitted, including adoption in an interim period. On October 1, 2022, the Company adopted this standard with no impact on its consolidated financial statements and related disclosures.
NOTE 3 – FAIR VALUE MEASUREMENTS
In accordance with ASC 820 (Fair Value Measurements and Disclosures), the Company uses various inputs to measure the outstanding warrants on a recurring basis to determine the fair value of the liability. ASC 820 also establishes a hierarchy categorizing inputs into three levels used to measure and disclose fair value. The hierarchy gives the highest priority to quoted prices available in active markets and the lowest priority to unobservable inputs. An explanation of each level in the hierarchy is described below:
Level 1 – Unadjusted quoted prices in active markets for identical instruments that are accessible by the Company on the measurement date
Level 2 – Quoted prices in markets that are not active or inputs which are either directly or indirectly observable
Level 3 – Unobservable inputs for the instrument requiring the development of assumptions by the Company
The following table classifies the Company’s liabilities measured at fair value on a recurring basis into the fair value hierarchy as of December 31, 2022 and 2021 (amounts in thousands):
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|
Fair Value at December 31, 2022
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liability – Warrants
|
|
|
629 |
|
|
|
- |
|
|
|
- |
|
|
|
629 |
|
Total liabilities
|
|
$ |
629 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
629 |
|
|
|
Fair Value at December 31, 2021
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liability – Warrants
|
|
|
899 |
|
|
|
- |
|
|
|
- |
|
|
|
899 |
|
Total liabilities
|
|
$ |
899 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
899 |
|
There were no transfers between Level 1, 2 or 3 during the years ended December 31, 2022 and 2021.
The following table presents changes in Level 3 liabilities measured at fair value for the years ended December 31, 2022 and 2021. Both observable and unobservable inputs were used to determine the fair value of positions that the Company has classified within the Level 3 category. Unrealized gains and losses associated with liabilities within the Level 3 category include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long- dated volatilities) inputs (amounts in thousands).
|
|
Derivative liability - Warrants
|
|
Balance at January 1, 2021
|
|
|
4,444 |
|
Change in fair value
|
|
|
(3,545 |
) |
Balance at December 31, 2021
|
|
|
899 |
|
Change in fair value
|
|
|
(270 |
) |
Balance at December 31, 2022
|
|
$ |
629 |
|
A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in the Monte Carlo simulation measuring the Company’s derivative liabilities that are categorized within Level 3 of the fair value hierarchy as of December 31, 2022 and 2021 is as follows:
Warrant Liability
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31, |
|
|
|
2022
|
|
|
2021 |
|
Exercise price
|
|
$ |
0.4431 |
|
|
$ |
0.4431 |
|
Contractual term (years)
|
|
|
1.32 |
|
|
|
2.32 |
|
Volatility (annual)
|
|
|
100.0 |
% |
|
|
90.0 |
% |
Risk-free rate
|
|
|
4.6 |
% |
|
|
0.8 |
% |
Dividend yield (per share)
|
|
|
0 |
% |
|
|
0 |
% |
On April 26, 2019 (the “Closing Date”), the Company entered into a Securities Exchange Agreement (“Share Exchange”) with each of the former members (“Members”) of Charlie’s, and certain direct investors in the Company (“Direct Investors”), pursuant to which the Company acquired all outstanding membership interests of Charlie’s beneficially owned by the Members in exchange for the issuance by the Company of units. Immediately prior to, and in connection with, the Share Exchange, Charlie’s consummated a private offering of membership interests that resulted in net proceeds to Charlie’s of approximately $27.5 million (the “Charlie’s Financing”). In conjunction with the Share Exchange, the Company issued to holders of its Series A Convertible Preferred Stock (“Series A Preferred”) warrants to purchase an aggregate of 31,028,996 shares of Common Stock (the “Investor Warrants”) and to its placement agent Katalyst Securities LLC warrants to purchase an aggregate of 9,308,699 shares of Common Stock (the “Placement Agent Warrants”). Both the Investor Warrants and Placement Agent Warrants have a five-year term and a strike price of $0.44313 per share. Due to the exercise features of these warrants, they are not considered to be indexed to the Company’s own stock and are therefore not afforded equity treatment in accordance with ASC Topic 815, Derivatives and Hedging (“ASC 815”). In accordance with ASC 815, the Company has recorded the Investor Warrants and Placement Agent Warrants as derivative instruments on its consolidated balance sheet. ASC 815 requires derivatives to be recorded on the balance sheet as an asset or liability and to be measured at fair value. Changes in fair value are reflected in the Company’s earnings for each reporting period.
NOTE 4 – PROPERTY AND EQUIPMENT
Property and Equipment detail as of December 31, 2022, and 2021 are as follows (amounts in thousands):
PP&E
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31, |
|
|
|
|
2022
|
|
|
2021
|
|
Estimated Useful Life (in years)
|
Machinery and equipment
|
|
$ |
41 |
|
|
$
|
42 |
|
5 |
Trade show booth
|
|
|
202 |
|
|
|
171 |
|
5
|
Office equipment |
|
|
539 |
|
|
|
511 |
|
5 |
Leasehold improvements
|
|
|
254 |
|
|
|
380 |
|
Lesser of lease term or estimated useful life |
|
|
|
1,036 |
|
|
|
1,104 |
|
|
Accumulated depreciation
|
|
|
(725 |
) |
|
|
(673 |
) |
|
|
|
$ |
311 |
|
|
$ |
431 |
|
|
Depreciation and amortization expense totaled $296,000 and $210,000, respectively, during the years ended December 31, 2022 and 2021.
NOTE 5 – CONCENTRATIONS
Vendors
The Company’s concentration of purchases are as follows:
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Vendor A
|
|
|
40 |
%
|
|
|
42 |
%
|
Vendor B
|
|
|
36 |
% |
|
|
31 |
%
|
During the year ended December 31, 2022, purchases from two vendors represented 76% of total inventory purchases. During the year ended December 31, 2021, purchases from the same two vendors represented 73% of total inventory purchases.
As of December 31, 2022, and 2021, amounts owed to these vendors totaled $200,000 and $1,494,000 respectively, which are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.
Accounts Receivable
The Company’s concentration of accounts receivable are as follows:
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Customer A
|
|
|
15 |
% |
|
|
27
|
%
|
Customer B
|
|
|
11 |
% |
|
|
-
|
|
Two customers made up more than 10% of net accounts receivable at December 31, 2022 and 2021. Customer A owed the Company a total of $184,000, representing 15% of net receivables at December 31, 2022. Customer B owed the Company a total of $136,000, representing 11% of net receivables at December 31, 2022. Customer A owed the Company a total of $454,000, representing 27% of net receivables at December 31, 2021. No customer exceeded 10% of total net sales for the years ended December 31, 2022 and 2021, respectively.
NOTE 6 – DON POLLY, LLC.
Don Polly, LLC is a Nevada limited liability company that is owned by entities controlled by Brandon and Ryan Stump, a former and current executive officer of the Company, respectively, and a consolidated variable interest for which the Company is the primary beneficiary. Don Polly formulates, sells and distributes the Company’s hemp-derived product lines.
Don Polly is classified as a variable interest entity (“VIE”) for which the Company is the primary beneficiary. Under ASC 810-10-15, Variable Interest Entities, a VIE is an entity that: (1) has an insufficient amount of equity investment at risk to permit the entity to finance its activities without additional subordinated financial support by other parties; (2) the equity investors are unable to make significant decisions about the entity’s activities through voting rights or similar rights; or (3) the equity investors do not have the obligation to absorb expected losses or the right to receive residual returns of the entity. The Company is required to consolidate a VIE if it is determined to be the primary beneficiary, that is, the enterprise has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE. The Company evaluates its relationships with VIE to determine whether it is the primary beneficiary of a VIE at the time it becomes involved with the entity and it re-evaluates that conclusion each reporting period. Effective April 25, 2019, we began consolidating the financial statements of Don Polly and it is still considered a VIE of the Company.
Don Polly operates under exclusive licensing and service contracts with the Company whereby the Company receives 100% of net income, or incurs 100% of the net loss of the VIE. There are no non-controlling interests recorded.
NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of December 31, 2022, and 2021 are as follows (amounts in thousands):
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2022 |
|
|
2021 |
|
Accounts payable
|
|
$ |
1,222 |
|
|
$ |
2,476 |
|
Accrued compensation
|
|
|
631 |
|
|
|
902 |
|
Accrued income taxes
|
|
|
137 |
|
|
|
342 |
|
Other accrued expenses
|
|
|
343 |
|
|
|
348 |
|
|
|
$ |
2,333 |
|
|
$ |
4,068 |
|
NOTE 8 – NOTES PAYABLE
April 2022 Note Financing
On April 6, 2022, the Company issued a secured promissory note (the “Note”) to one of its large individual stockholders, Michael King (the “Lender"), in the principal amount of $1,000,000, which Note is secured by accounts receivable of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and the Lender (the "Note Financing"). On September 28, 2022, the Company and the Lender entered into a modification to the Note to extend the maturity date to March 28, 2023 and the Company paid all accrued interest under the Note through such date.
On March 28, 2023, the Company entered into a second modification to the Note to extend the maturity date to April 28, 2024, contingent upon the payment of all interest accrued under the Note through March 28, 2023 and certain other modifications to the Note. Principal shall be payable on the 28th day of each month in installments of $25,000, commencing April 28, 2023, continuing up to and including April 28, 2024 whereby a balloon payment for the remaining principal balance will be paid. Interest shall accrue on the aggregate outstanding principal amount at a rate equal to 20% simple interest per annum and shall be payable on the same day as installments of principal are payable. The Company may prepay all or any portion of the principal amount, together with all accrued but unpaid interest thereon, at any time without premium or penalty. All outstanding principal and interest are due earlier of April 28, 2024, or a liquidity event. The Company used the proceeds from the Note for general corporate purposes, and its working capital requirements, pending the availability of alternative debt financing.
August 2022 Note Financing – Related Party
On August 17, 2022, the Company and its Chief Operating Officer and Director, Ryan Stump (the "Stump Lender") entered into a loan agreement (the “Loan”) in the principal amount of $300,000. The Loan will be due in full in 120 days or sooner if, before the end of term, the Company secures (i) new debt financing or (ii) sufficient PMTA strategic partnership funds. The Loan bears an annual interest rate of 10%. The Company also incurred additional $3,000 issuance cost resulting from the payment of the Stump Lender’s legal fees. On December 17, 2022, the Company and Stump Lender entered into a modification to the Loan to extend the maturity date to April 16, 2023 and the Company has paid all accrued interest under the Loan through such date. On April 13, 2023, the Company and Stump Lender entered into a second modification to the Loan to extend the maturity date to August 14, 2023.
Economic Injury Disaster Loan
On June 24, 2020, SBA authorized (under Section 7(b) of the Small Business Act, as amended) an Economic Injury Disaster Loan (“EID Loan”) to Don Polly in the amount of $150,000. The balance of principal and interest will be payable thirty years from the date of the EID Loan and interest will accrue at the rate of 3.75% per annum.
The following summarizes the Company’s notes payable maturities as of December 31, 2022 (amounts in thousands):
Year Ending December 31, 2023
|
|
|
1,300 |
|
Year Ending December 31, 2024
|
|
|
- |
|
Year Ending December 31, 2025
|
|
|
- |
|
Year Ending December 31, 2026
|
|
|
|
|
Year Ending December 31, 2027
|
|
|
|
|
Thereafter
|
|
|
150 |
|
Total
|
|
$ |
1,450 |
|
NOTE 9 – EARNINGS (LOSS) PER SHARE BASIC AND FULLY DILUTED
Basic (loss) earnings per common share is computed by dividing net (loss) income by the weighted average number of common shares outstanding during the reporting period. Diluted (loss) earnings per common share is computed similar to basic (loss) earnings per common share except that it reflects the potential dilution that could occur if dilutive securities or other obligations to issue common stock were exercised or converted into common stock. Diluted weighted average common shares include common stock potentially issuable under the Company’s convertible preferred stock, warrants and vested and unvested stock options.
For the years ended December 31, 2022, and 2021, net (loss) income is adjusted for gain (loss) from changes in the fair value of warrant liabilities.
The following table sets forth the computation of (loss) earnings per share (amounts in thousands, except share and per share amounts):
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Net (loss) income - basic
|
|
$ |
(1,592 |
) |
|
$ |
4,808 |
|
Reversal of gain due to change in fair value of warrant liability
|
|
|
- |
|
|
|
(3,545 |
) |
Net (loss) income - diluted
|
|
$ |
(1,592 |
) |
|
$ |
1,263 |
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding - basic
|
|
|
212,269,453 |
|
|
|
203,589,531 |
|
Diluted stock options
|
|
|
- |
|
|
|
168,309 |
|
Diluted warrants
|
|
|
- |
|
|
|
1,912,544 |
|
Diluted preferred shares
|
|
|
- |
|
|
|
32,016,491 |
|
Weighted average shares outstanding - diluted
|
|
|
212,269,453 |
|
|
|
237,686,875 |
|
|
|
|
|
|
|
|
|
|
Basic (loss) earnings per share
|
|
$ |
(0.01 |
) |
|
$ |
0.02 |
|
Diluted (loss) earnings per share
|
|
$ |
(0.01 |
) |
|
$ |
0.01 |
|
The following securities were not included in the diluted (loss) earnings per share calculation because their effect was anti-dilutive as of the periods presented (amounts in thousands):
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Options
|
|
|
6,003 |
|
|
|
6,955 |
|
Warrants
|
|
|
40,338 |
|
|
|
38,425 |
|
Total
|
|
|
46,341 |
|
|
|
45,380 |
|
NOTE 10 – STOCKHOLDERS’ EQUITY
Series A Preferred Share Dividend & Share Waiver
On April 25, 2020, the Company was required to pay a one-time dividend equal to eight percent (8%) of the stated value of its Series A Preferred, equal to $1,650,000 (“Dividend Amount”), which Dividend Amount was required to be paid in cash on or before April 25, 2020.
On August 13, 2020, the Company received a formal notice of default from a holder of its Series A Preferred requesting full payment of dividends due and payable with respect to the Series A Preferred held by such holder on or before August 23, 2020 (“Dividend Default”).
On April 21, 2021, the Company issued a waiver and exchange agreement (“Waiver Agreement”) to shareholders of its Series A Preferred shares (“Stock Payees”) requesting such Stock Payee's respective amount of the dividend payment (each individual Stock Payee's respective amount the "Stock Payee Indebtedness") to be paid in the form of shares of Common Stock (the "Stock Payment") and agreeing to consummate an exchange of such Stock Payee's right to the Stock Payee Indebtedness in cash for shares of Common Stock (the "Exchange"), pursuant to which the entire Stock Payee Indebtedness shall be exchanged for that number of shares of Common Stock (the “Shares”) equal to the total Stock Payee Indebtedness divided by $0.44313.
On May 25, 2021, the Company entered into a Dividend Waiver and Exchange Agreement (the “Exchange Agreement”), between the Company and the holders (the “Series A Holders”) of its Series A Convertible Preferred Stock, par value $0.001 (“Series A Preferred”), pursuant to which the Company paid to the Series A Holders total consideration of approximately $1,650,000 (the “Dividend Amount”), which Dividend Amount was paid in the form of 1,736,501 shares of the Company’s common stock, par value $0.001 (“Common Stock”), valued at $0.44313 per share (the “Shares”), and approximately $880,000 in cash.
During the year ended December 31, 2021, the Company incurred an additional $3,000 dividend payment in order to fully satisfy the Series A Preferred dividend.
As of December 31, 2021, all dividend liability has been satisfied, which is reflected on the Company’s consolidated balance sheet.
Conversion of Series A Preferred Shares
For the year ended December 31 2022, the Company issued approximately 1,907,000 shares of Common Stock upon conversion of 8,450 shares of Series A Preferred. For the year ended December 31, 2021, the Company issued approximately 13,977,000 shares of Common Stock upon conversion of 61,937 shares of Series A Preferred.
March 2021 Private Placement
On March 19, 2021, the Company entered into Securities Purchase Agreements by and between the Company and certain family trusts in which Mr. Brandon Stump and Mr. Ryan Stump, the Company's former Chief Executive Officer and Chief Operating Officer, respectfully, are trustees and beneficiaries (the "Purchase Agreements"), for the private placement of an aggregate of 3,517,000 shares of its common stock, par value $0.001 ("Common Stock"), at a purchase price per share of $0.853 (the "Private Placement"), which Private Placement was consummated on March 22, 2021. The Private Placement resulted in gross proceeds to the Company of approximately $3.0 million. The Private Placement was undertaken pursuant to Rule 506 promulgated under the Securities Act of 1933, as amended, and was consummated in a transaction approved by the Company's independent directors in accordance with Rule 16b-3(d)(1) of the Securities Exchange Act of 1934, as amended.
NOTE 11 – STOCK-BASED COMPENSATION
On May 8, 2019, our Board of Directors approved the Charlie’s Holdings, Inc. 2019 Omnibus Incentive Plan (the “2019 Plan”), and the 2019 Plan was subsequently approved by holders of a majority of our outstanding voting securities on the same date. Up to 11,072,542 stock options were originally grantable under the 2019 Plan.
On December 22, 2021, our Board of Directors unanimously adopted resolutions by written consent approving an amendment to increase the number of shares of Common Stock available for issuance under the 2019 Plan by 15.0 million shares, from 11,072,542 to 26,072,542 shares (the “2019 Plan Amendment”). Furthermore, the Company received written consents approving the 2019 Plan Amendment from holders of approximately 50.3% of our outstanding voting securities. In accordance with Rule 14c of the Exchange Act, our Board of Directors’ authority to implement the 2019 Plan Amendment became effective February 28, 2022, twenty calendar days after notification of our shareholders.
Non-Qualified Stock Options
The following table summarizes stock option activities during the year ended December 31, 2022 and 2021 (all option amounts are in thousands):
Options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life (in years)
|
|
|
Aggregate Intrinsic Value
|
|
Outstanding at January 1, 2021
|
|
|
7,503 |
|
|
$ |
0.54 |
|
|
|
8.5 |
|
|
$ |
- |
|
Options granted
|
|
|
80 |
|
|
|
0.44 |
|
|
|
10.0 |
|
|
|
- |
|
Options forfeited/expired
|
|
|
(460 |
) |
|
|
0.44 |
|
|
|
- |
|
|
|
- |
|
Outstanding at December 31, 2021
|
|
|
7,123 |
|
|
|
0.54 |
|
|
|
7.5 |
|
|
$ |
- |
|
Options forfeited/expired
|
|
|
(1,120 |
) |
|
|
0.44 |
|
|
|
- |
|
|
|
- |
|
Outstanding at December 31, 2022
|
|
|
6,003 |
|
|
$ |
0.56 |
|
|
|
6.4 |
|
|
$ |
- |
|
Options vested and exercisable at December 31, 2022
|
|
|
5,986 |
|
|
$ |
0.56 |
|
|
|
6.4 |
|
|
$ |
- |
|
During the year ended December 31, 2022, no options were granted and 1,120,000 were forfeited under the 2019 Plan. During the year ended December 31, 2021, 80,000 options were granted and 460,000 were forfeited under the 2019 Plan. During the year ended December 31, 2021, the fair value of options granted on the issuance date totaled approximately $12,000 based on the following weighted average assumptions:
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2021
|
|
Exercise price
|
|
$ |
0.4431 |
|
Contractual term (years)
|
|
|
6.00 |
|
Volatility (annual)
|
|
|
85.0 |
% |
Risk-free rate
|
|
|
0.9 |
% |
Dividend yield (per share)
|
|
|
0 |
% |
As of December 31, 2022, there was approximately $340 of total unrecognized compensation expense related to non-vested share-based compensation arrangements granted under the 2019 Plan. That cost is expected to be recognized by December 31, 2023. For the year ended December 31, 2022, and 2021, the Company recorded compensation expense of $11,000 and $151,000, respectively, related to the issuance of stock options.
Common Stock Awards
Prior to the Share Exchange, Charlie’s employees held Member units, which were automatically converted into 71,000 shares of common stock and 69,815 shares of Series B Preferred (or 6.98 million shares of common stock equivalents) due to the effect of the Share Exchange. The 7.1 million shares of common stock vested over a two-year period. The fair value of a share of common stock was $0.32 which is based upon a valuation prepared by the Company on the date of the Share Exchange. The Company recognized the remaining stock-based compensation of approximately $376,000 during the year ended December 31, 2021.
Restricted Stock Awards
The following table summarizes restricted stock awards activities during the years ended December 31, 2022 and 2021 (all share amounts are in thousands).
|
|
Number of Shares
|
|
|
Weighted Average
Grant Date Fair
Value per Share
|
|
Nonvested at January 1, 2021
|
|
|
- |
|
|
$ |
- |
|
Restricted stock granted
|
|
|
1,750 |
|
|
|
0.044 |
|
Nonvested at December 31, 2021
|
|
|
1,750 |
|
|
|
0.044 |
|
Restricted stock granted
|
|
|
7,142 |
|
|
|
0.041 |
|
Vested
|
|
|
(1,500 |
) |
|
|
- |
|
Forfeited
|
|
|
(776 |
) |
|
|
- |
|
Nonvested at December 31, 2022
|
|
|
6,616 |
|
|
$ |
0.041 |
|
During the year ended December 31, 2022, the Company granted approximately 7,142,000 restricted shares (subject to forfeiture) (“RSAs”) to employees, officers and directors of the Company pursuant to the 2019 Plan, as amended. The RSAs are subject to a vesting schedule and have all the rights of a shareholder of the Company with respect to voting, share adjustments, receipt of dividends (if any) and distributions (if any) on such shares. The RSAs had a grant date fair value of approximately $290,000.
On April 1, 2021, the Board of Directors of the Company entered into an Employment Agreement (the "Agreement") with Henry Sicignano III, MBA, pursuant to which the Company appointed Mr. Sicignano to serve as President of the Company. Pursuant to the Agreement, Mr. Sicignano will serve as President for an initial period of two years, renewable on an annual basis unless earlier terminated by the Company or Mr. Sicignano. Mr. Sicignano was awarded 1,500,000 restricted shares (subject to forfeiture) of the Company. Mr. Sicignano will have all the rights of a shareholder of the Company with respect to voting the 1,500,000 restricted shares awarded under this grant and share adjustments, receipt of dividends (if any) and distributions (if any) on such shares. Restricted Shares, in the amount of 750,000, were no longer subject to forfeiture as of April 1, 2022, with the remaining 750,000 shares still subject to forfeiture until April 1, 2023. Restricted Shares are also subject to additional forfeiture-release features set forth in Addendum A to the Employment Agreement of Henry Sicignano, III, included in the Company’s 8-K filed April 6, 2021. The grant date fair value of the 1,500,000 restricted shares was approximately $65,000.
On November 1, 2021 (“Grant Date”) the Company granted to Jeff Fox, an Independent Director, 250,000 shares of Common Stock of the Company (“Fox Shares”) pursuant to the 2019 Plan. The grant of the Fox Shares was made in consideration for services rendered by Mr. Fox to the Company. Mr. Fox will have all the rights of a shareholder of the Company with respect to voting the 250,000 restricted shares awarded under this grant and share adjustments, receipt of dividends (if any) and distributions (if any) on such shares. Fox Shares will be subject to forfeiture in 125,000 share increments until the first to occur of the following: (i) each anniversary of the Grant Date; (ii) the event of a change in control of the Company; or (iii) the death, disability, or retirement of Mr. Fox. The fair value of the 250,000 restricted shares was approximately $12,775.
As of December 31, 2022, there was approximately $165,000 of total unrecognized compensation expense related to non-vested restricted share-based compensation arrangements granted under the 2019 Plan, as amended. That cost is expected to be recognized over a weighted average period of 2.5 years. The Company recorded total stock-based compensation of approximately $150,000 and $26,000 during the years ended December 31, 2022 and 2021 related to the RSAs, respectively.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office space under agreements classified as operating leases that expire on various dates through 2024. All of the Company’s lease liabilities result from the lease of its headquarters in Costa Mesa, California, which expires in 2024, its warehouse in Santa Ana, California, which was renewed in May 2022 and expires May 2025, its office and warehouse in Denver, Colorado, which expired in May 2022, and its warehouse space in Huntington Beach, California, which was renewed in June 2022. On April 29, 2022, the Company entered into a commercial lease agreement for the Company’s sales and marketing operations in Williamsville, New York (“Williamsville Lease”) with Henry Sicignano Jr., a relative of the Company’s President, Henry Sicignano III. The Williamsville Lease, which became effective on May 1, 2022, has a term of one year and a base rent of $1,650 per month. The Williamsville Lease is considered a modified gross lease and therefore the Company will also be responsible for additional monthly expenses including gas, electricity, and internet. The Williamsville Lease was evaluated and approved by the Company’s Board of Directors.
Such leases do not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. Certain of the Company’s leases include renewal options and escalation clauses; renewal options have not been included in the calculation of the lease liabilities and right of use assets as the Company is not reasonably certain to exercise the options. Variable expenses generally represent the Company’s share of the landlord’s operating expenses. The Company does not act as a lessor or have any leases classified as financing 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 entered into a commercial lease for the Company’s corporate headquarters (the “Lease”) in Costa Mesa, California with Brandon Stump, the Company’s former Chief Executive Officer, Ryan Stump, the Company’s Chief Operating Officer, and Keith Stump, a former member of the Company’s Board of Directors. The Stumps purchased the property that is the subject of the Lease in July 2019. The Lease, which was effective as of September 1, 2019, on a month-to-month basis, was then formalized on November 1, 2019 to have a term of five years and a base rent rate of $22,940 per month, which rate is subject to annual adjustments based on the consumer price index, as may be mutually agreed upon by the parties to the Lease. The terms of the Lease were negotiated and approved by the independent members of the Board, and executed by Mr. David Allen, the Company’s former Chief Financial Officer, after reviewing a detailed analysis of comparable properties and rent rates compiled by an independent, third-party consultant. The total amount paid to related parties for the years ended December 31, 2022 and 2021 was $293,536 and $278,040, respectively.
Effective June 1, 2022, the Company’s lease at 5331 Production Drive, Huntington Beach, CA was renewed for an additional three-year term, concluding May 31, 2025. The renewal was not reflected in the Company’s June 30, 2022 interim financial statements, but was corrected during the quarter ended September 30, 2022. Had it been properly recorded during the quarter ended June 30, 2022, the effect on the Company’s financial statements would have included an additional $429,000 in right-of-use assets, $430,000 in lease liabilities as well as an additional $1,000 in rent expense. The Company performed a thorough assessment to determine the significance of the prior period error and concluded that it was neither quantitatively or qualitatively material to the Company’s financial position, results of operations or cash flows for the quarters ended June 30, 2022 and September 30, 2022.
At December 31, 2022, the Company had operating lease liabilities of approximately $801,000 and right of use assets of approximately $799,000, which were included in the consolidated balance sheet.
The following summarizes quantitative information about the Company’s operating leases (amounts in thousands):
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Operating leases |
|
|
|
|
|
|
|
|
Operating lease cost
|
|
$ |
480 |
|
|
$ |
566 |
|
Variable lease cost
|
|
|
- |
|
|
|
- |
|
Operating lease expense
|
|
|
480 |
|
|
|
566 |
|
Short-term lease rent expense
|
|
|
13 |
|
|
|
- |
|
Total rent expense
|
|
$ |
493 |
|
|
$ |
566 |
|
|
|
For the years ended
|
|
|
|
December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Operating cash flows from operating leases
|
|
$ |
484 |
|
|
$ |
456 |
|
Right-of-use assets exchanged for operating lease liabilities
|
|
$ |
440 |
|
|
$ |
- |
|
Weighted-average remaining lease term – operating leases (in years)
|
|
|
2.06 |
|
|
|
2.38 |
|
Weighted-average discount rate – operating leases
|
|
|
12.0 |
% |
|
|
12.0 |
% |
Maturities of our operating leases, excluding short-term leases, are as follows (amounts in thousands):
Year Ending December 31, 2023
|
|
|
449 |
|
Year Ending December 31, 2024
|
|
|
385 |
|
Year Ending December 31, 2025
|
|
|
75 |
|
Total
|
|
|
909 |
|
Less present value discount
|
|
|
(108 |
) |
Operating lease liabilities as of December 31, 2022
|
|
$ |
801 |
|
Legal proceedings
From time to time, the Company may be involved in various claims and counterclaims and legal actions arising in the ordinary course of business. There are not material pending or threatened legal proceedings at this time.
NOTE 13- INCOME TAXES
The Company is taxed as a C corporation and files a consolidated return with Charlie's Holdings, Inc. This tax footnote also includes the tax impact of the Company's VIE, Don Polly LLC, which is also taxed as a C corporation, but which files a separate return from Charlie's Holdings, Inc.
The table below presents the components of the (benefit) provision for income taxes. The Company's (benefit) provision is driven primarily current year operating income, nontaxable derivative fair value adjustments, and state taxes (in thousands).
|
|
As of December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Current |
|
|
|
|
|
|
|
|
US Federal
|
|
$ |
(89 |
) |
|
$ |
110 |
|
US State
|
|
|
(3 |
) |
|
|
232 |
|
Total current (benefit) provision
|
|
|
(92 |
) |
|
|
342 |
|
Deferred |
|
|
|
|
|
|
|
|
US Federal
|
|
|
- |
|
|
|
- |
|
US State
|
|
|
- |
|
|
|
- |
|
Total deferred (benefit) provision
|
|
|
- |
|
|
|
- |
|
Total (benefit) provision for income taxes
|
|
$ |
(92 |
) |
|
$ |
342 |
|
The tax effects of temporary differences and tax loss carryovers that give rise to significant portions of deferred tax assets and liabilities at December 31, 2022 and 2021 are comprised of the following (in thousands):
|
|
As of December 31,
|
|
|
|
2022
|
|
|
2021
|
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Bad debt
|
|
$ |
50 |
|
|
$ |
47 |
|
Inventory
|
|
|
190 |
|
|
|
43 |
|
Accrued expenses
|
|
|
128 |
|
|
|
222 |
|
Lease liability
|
|
|
218 |
|
|
|
208 |
|
Research and development credits
|
|
|
141 |
|
|
|
- |
|
Stock compensation
|
|
|
156 |
|
|
|
255 |
|
Net operating loss carryovers
|
|
|
1,642 |
|
|
|
1,224 |
|
Other
|
|
|
7 |
|
|
|
9 |
|
Derivatives
|
|
|
39 |
|
|
|
56 |
|
Total deferred income tax assets
|
|
|
2,571 |
|
|
|
2,064 |
|
|
|
|
|
|
|
|
|
|
Deferred income tax liabilities: |
|
|
|
|
|
|
|
|
ROU assets
|
|
|
(217 |
)
|
|
|
(206 |
)
|
Fixed assets
|
|
|
(27 |
)
|
|
|
(18 |
)
|
Total deferred income tax liabilities
|
|
|
(244 |
)
|
|
|
(224 |
)
|
|
|
|
|
|
|
|
|
|
Net deferred income tax assets
|
|
|
|
|
|
|
1,840 |
|
Valuation allowance
|
|
|
(2,327 |
)
|
|
|
(1,840 |
)
|
Deferred tax asset, net of allowance
|
|
$ |
- |
|
|
$ |
- |
|
The Company recognizes Federal, and state deferred tax assets or liabilities based on the Company's estimate of future tax effects attributable to temporary differences and carryovers. The Company records a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are not expected to be realized. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. The Company considers projected future taxable income and planning strategies in making this assessment. As of December 31, 2022, as a result of a three-year cumulative loss and lack of sufficient positive evidence, we concluded that a full valuation allowance was necessary to offset our deferred tax assets. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal. The Company will continue to evaluate its deferred tax balances to determine any assets that are more likely than not to be realized.
At December 31, 2022, the Company had federal and state net operating loss carryovers for income tax purposes of approximately $5,704,000 and $7,458,000, respectively. The Federal net operating losses can be carried forward indefinitely but are limited to offsetting only 80% of taxable income each year. The state net operating losses expire at various dates through 2042, if not utilized beforehand.
At December 31, 2022, the Company had federal research and development credit carryovers of approximately $218,000. The federal research credits expire by 2040 if not utilized beforehand.
The utilization of net operating loss carryforwards and research tax credit carryovers could be subject to annual limitations under Section 382 and 383 of the Internal Revenue Code of 1986, and similar state tax provisions, due to ownership change limitations that may have occurred previously or that could occur in the future. These ownership changes limit the amount of net operating loss carryforwards and other deferred tax assets that can be utilized to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382 and 383, results from transactions increasing ownership of certain stockholders or public groups in the stock of the corporation by more than 50 percent points over a three-year period. The Company has not conducted an analysis of an ownership change under section 382. The Company experienced an ownership change in 2019. Absent an analysis, the Company has assumed that net operating losses generated prior to the change are not available to offset income subsequent to the ownership change date. To the extent that a study is completed, and certain pre-acquisition losses are deemed to be available to be utilized to offset taxable income, the Company's tax liabilities could be reduced. To the extent that a study is completed and additional or future ownership changes are deemed to occur, the Company's net operating losses and tax credits could be further limited.
A reconciliation of the statutory income tax rates and the Company's effective tax rate for the years ended December 31, 2022 and December 31, 2021, are as follows:
|
|
Year ended
December 31,
2022
|
|
|
Year ended
December 31,
2021
|
|
Statutory federal income tax rate
|
|
|
21.0 |
%
|
|
|
21.0 |
%
|
Non-taxed loss from VIE
|
|
|
0.0 |
%
|
|
|
0.0 |
%
|
Research credits
|
|
|
13.5 |
%
|
|
|
0.0 |
%
|
State taxes, net of federal tax benefit
|
|
|
5.3 |
%
|
|
|
3.3 |
%
|
Stock compensation
|
|
|
(4.5 |
)%
|
|
|
10.1 |
%
|
Permanent Items
|
|
|
0.1 |
%
|
|
|
(4.3 |
)%
|
Section 382 NOL Adjustments
|
|
|
0.0 |
%
|
|
|
3.1 |
%
|
Derivatives
|
|
|
2.6 |
%
|
|
|
(11.1 |
)%
|
Return to provision adjustments
|
|
|
0.1 |
%
|
|
|
(2.2 |
)%
|
Other
|
|
|
(3.9 |
)%
|
|
|
(1.3 |
)%
|
Change in valuation allowance
|
|
|
(28.8 |
)%
|
|
|
(12.0 |
)%
|
Total effective tax rate
|
|
|
5.4 |
%
|
|
|
6.6 |
%
|
ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The following table summarizes the activity related to the Company’s gross unrecognized tax benefits at the beginning and end of the years ended December 31, 2022 and December 31, 2021 (in thousands):
|
|
Year ended
December 31,
2022
|
|
|
Year ended
December 31,
2021
|
|
Gross unrecognized tax benefits at the beginning of the year
|
|
$ |
32 |
|
|
$ |
- |
|
Increases related to current year positions
|
|
|
- |
|
|
|
- |
|
Increases related to prior year positions
|
|
|
77 |
|
|
|
32 |
|
Decreases related to prior year positions
|
|
|
- |
|
|
|
- |
|
Expiration of unrecognized tax benefits
|
|
|
- |
|
|
|
- |
|
Gross unrecognized tax benefits at the end of the year
|
|
$ |
109 |
|
|
$ |
32 |
|
The unrecognized tax benefit amounts are reflected in the determination of the Company’s deferred tax assets. If recognized, none of these amounts would affect the Company’s effective tax rate, since it would be offset by an equal corresponding adjustment in the deferred tax asset valuation allowance. The Company does not foresee material changes to its liability for uncertain tax benefits within the next twelve months.
The Company policy is to recognize interest and penalties related to uncertain tax positions as a component of income tax expense. As of December 31, 2022 and December 31, 2021, the Company had no accrued interest or penalties related to uncertain tax positions and no amounts have been recognized in the Company’s statement of operations.
The Company’s tax years from 2019 and 2018 forward remain open for examination by the Federal and state taxing authorities, respectively. In addition, to the extent that the Company's tax attributes are utilized in future years to offset income or income taxes, those years which generated the tax attributes are open and subject to examination by the taxing authorities. The Company is not aware of any examinations that are currently taking place by federal or state taxing authorities.
NOTE 14- SUBSEQUENT EVENTS
The Company evaluated subsequent events for their potential impact on the consolidated condensed financial statements and disclosures through the date the consolidated condensed financial statements were available to be issued and determined that, except as set forth below, no subsequent events occurred that were reasonably expected to impact the consolidated condensed financial statements presented herein.
Future Receivables Sale Agreement
On January 19, 2023 the Company entered into a future receivables sale agreement (“Receivables Financing” or “Receivables Financing Agreement”) with Austin Business Finance (“Austin Purchaser”) by which Austin Purchaser purchases from the Company, its future accounts and contract rights arising from the sale of goods or rendition of services to the Company’s customers. The purchase price, as defined by the Receivables Financing Agreement, was $650,000 which was paid to the Company on January 19, 2023, net of a 3% origination fee. The Receivables Financing Agreement requires twenty six equal payments of $29,500 to be paid weekly for a total repayment of $760,500 over the term of the agreement. The Company is eligible for an early repayment discount if the balance paid prior to the July 21, 2023 termination date.
Preferred A Shareholders Consent
The Board of Directors and the holders of a majority of our Series A Preferred approved an amendment (the “Amendment”) to the Company’s Certificate of Designations, Preferences, and Rights of the outstanding shares of Series A Convertible Preferred Stock (the “Certificate of Designations”). The Amendment (i) adds the New York Stock Exchange and the NYSE American markets to the list of national security exchanges that would satisfy the condition in Section 4(b)(i) of the Certificate of Designations which, upon a listing on such exchanges, causes an automatic conversion of the Series A Convertible Preferred Stock into shares of common stock and (ii) increases the amount of Permitted Indebtedness (as defined in the Certificate of Designations) from $2.5 million to an amount not to exceed $6.0 million. The Amendment was effectuated through the filing of the Certificate of Amendment with the Secretary of the State of Nevada on March 29, 2023 and effective on such date.