You should read the following discussion and analysis in conjunction with our
financial statements, including the notes thereto contained in this Annual
Report. This discussion contains forward-looking statements that involve risks,
uncertainties and assumptions. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of a variety
of certain factors, including those set forth under "Risk Factors Associated
with Our Business" and elsewhere in this Annual Report.
Overview
Our objective is to become a significant leader in the rapidly growing, global
e-cigarette segment of the broader nicotine related products industry. Through
Charlie's, we formulate, market and distribute branded e-cigarette liquid for
use in both open and closed e-cigarette and vaping systems. Charlie's products
are mostly produced domestically through contract manufacturers for sale through
select distributors, specialty retailers and third-party online resellers
throughout the United States, as well as more than 80 countries worldwide.
Charlie's primary international markets include the United Kingdom, Italy,
Spain, Belgium, Australia, Sweden and Canada. In June 2019, we launched
distribution, through Don Polly, of certain premium vapor, tincture and topical
wellness products containing hemp-derived cannabidiol ("CBD") and we currently
intend to develop and launch additional products containing hemp-derived CBD in
the future.
-28-
Table of Contents
Industry Specific Challenges
Beginning in late 2019, our industry experienced significant news stories and
health alerts related to flavored nicotine vaping, leading to some states
banning the sale of flavored nicotine products and causing the Food and Drug
Administration ("FDA") to review its policies on controlling the sale of these
products. Initial research indicated that a vitamin E acetate related compound
could be causing the health-related issues. On November 8, 2019, officials at
the Centers for Disease Control and Prevention ("CDC") reported a breakthrough
in the investigation into the outbreak of vaping-related lung injuries. The
CDC's principal deputy director, Dr. Anne Schuchat, in fact stated that "vitamin
E acetate is a known additive used to dilute liquid in e-cigarettes or vaping
products that contain THC", suggesting the possible culprit for the series of
lung injuries across the U.S. All of Charlie's e-liquid products are tested by
third party laboratories which have confirmed that none of our products contain
any vitamin E acetate orTetrahydrocannabinol ("THC").
However, these developments have had a negative effect on our sales since
mid-September 2019 (see further discussion below) and therefore, in response to
these developments and while government regulators are formulating future
polices, management has adopted the following plan of operation.
First, we plan to increase the sales of our CBD related products, including
topicals and ingestibles. We feel there is a significant upside in the CBD
space, and we have begun to focus on numerous vertical markets for the sale of
our isolate, full and broad-spectrum products. These vertical markets include,
but aren't limited to the medical and wellness markets. We have also dedicated
an internal team as well as additional financial resources to increase
direct-to-consumer e-commerce sales of CBD products.
Secondly, we continue to see a significant opportunity for sales growth in
international markets for our e-liquid and other vapor products. Presently,
approximately 20% of our vapor product sales come from the international market
and we are well positioned to increase those sales in the countries that we
presently sell, and in additional overseas markets, as we have already built an
international distribution platform.
Most importantly, we feel that the e-liquid and other vapor products will
continue to be a significant growth opportunity, once all the rightful
regulatory changes have been made. We are continuing with our plan to obtain
marketing authorization for certain of our products through the completion of a
Premarket Tobacco Application ("PMTA"), which we submitted in September 2020.
Obtaining a marketing order from the United States Food and Drug Administration
("FDA") would, in our opinion, help to remediate the disruption caused by any
perceived health issues related to vaping, and further position the Company as a
trusted, industry leader. We feel that a significant amount of our competitors
will not have the resources and/or expertise to complete the extensive and
costly PMTA process and that once complete, we will be able to benefit from
being one of only a select group of companies operating in the flavored vapor
products space.
Impact of COVID-19
The outbreak of a novel strain of COVID-19 ("Coronavirus") which was identified
in Wuhan, China around December 2019, 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. We have updated
certain sales, accounting and administrative processes, and corresponding
information technology platforms, in an effort to help facilitate the virtual
work environment in which we now operate. During 2020, 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 Denver, CO office and Huntington Beach, CA warehouse locations have fully
returned to on premise status, while our corporate headquarters in Costa Mesa,
CA remains remote for most employees. We will continue to monitor the COVID-19
situation in all regions we operate and will maintain strict adherence to local
health guidelines and mandates. We may have to take further actions that we
determine are in the best interests of our employees or as required by federal,
state, or local authorities.
Supply Chain
Our ability to manufacture products is dependent on the availability of certain
raw materials and components that our contract manufacturers purchase from
Europe and China. In February 2020, we started to experience disruptions across
several key areas of our global supply chain. Our domestic and international
contract manufacturers source many of our high-quality flavorings from suppliers
located in Italy, a region that was severely affected by COVID-19-related
restrictions throughout most of 2020. Mandated stay-at-home orders in this
region ultimately caused increased manufacturing lead times and delayed customer
order deliveries for certain of our products, resulting in revenue declines.
We have been successful in mitigating some of the supply chain risks though bulk
purchases of certain flavorings and components and adjusting the production
allocation amongst our contract manufacturers. Shifting production to contract
manufacturers in regions with fewer restrictions and/or an enhanced ability to
procure larger supplies of raw materials has helped alleviate disruptions in our
supply chain.
If a resurgence of COVID-19 and associated shutdowns were to occur in Europe or
China, this would likely have an adverse effect on our ability to manufacture
and sell our products due to related shortages of materials and components.
Depending on the severity of any such future shutdowns, we could experience a
materially diminished ability to produce products and be exposed to
significantly longer lead times. This would result in delayed or reduced revenue
from the affected products in production and potentially higher operating costs.
-29-
Table of Contents
Sales and Marketing
Our sales and marketing efforts have also been affected by COVID-19. Most of our
sales through Charlie's and Don Polly are to resellers of our products,
typically distributors or brick and mortar retail locations. Stay-at-home
mandates across the U.S. and internationally created a significant challenge for
these customers to maintain continuity in their businesses, and therefore we
experienced lower sales volumes as a result. However, customers for our vapor
products have proven to be more resilient during these challenging times and
have been able to maintain more consistent performance. The Company did
experience increased order volume for CBD wellness products through its
ecommerce platform because of consumers seeking alternative means to purchase
our products.
Historically, most of our business-to-business sales and marketing efforts have
been generated through industry events in both the vapor products and
hemp-derived products spaces. Beginning in 2019, we also initiated a program of
in-store marketing events to help facilitate relationship building and
sell-through for our retail partners. With the suspension of all trade shows and
most business travel, our new customer pipeline has been negatively impacted,
which has negatively affected and may continue to negatively affect our sales in
the coming quarters. In response, we have shifted our focus to digital marketing
campaigns aimed at customer engagement and education. We also continue to
allocate additional resources towards certain key distributors and retail
partners that are better positioned to interact directly with our consumers and
continue growing our brands.
Risks and Uncertainties
The Company operates in an environment that is subject to rapid changes and
developments in laws and regulations that could have a significant impact on the
Company's ability to sell its products. Federal, state, and local governmental
bodies 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.
Beginning in September 2019, certain states temporarily banned the sale of
flavored e-cigarettes, and on January 2, 2020, the FDA issued an enforcement
policy effectively banning the sale of flavored cartridge-based e-cigarettes
marketed primarily by large manufacturers without prior authorization from the
FDA. The application of any new laws or regulations that may be adopted in the
future, at a federal, state, or local level, directly or indirectly implicating
flavored e-cigarette liquid and products used for the vaporization of nicotine
could significantly limit the Company's ability to sell such products, result in
additional compliance expenses, and/or require the Company to change its
labeling and/or methods of distribution. Any ban of the sale of flavored
e-cigarettes directly limits the markets in which the Company may sell its
products. In the event the prevalence of such bans and/or changes in laws and
regulations increase 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 nicotine-based e-liquid products. Our PMTA
applications were submitted in September 2020 on a timely basis, which if
approved, will allow the Company to continue to sell its products in the United
States. The Company is also seeking additional financing to support potential
future PMTA related expenses and general working capital. There is no assurance
that regulatory approval to sell our products will be granted or that we can
raise the additional financing required, and if not, this could have a
significant impact on our sales.
On March 11, 2020, the World Health Organization designated the ongoing and
evolving COVID-19 outbreak as a pandemic. The outbreak has caused substantial
disruption in international and U.S. economies and markets as it continues to
spread. The outbreak is having a temporary adverse impact on our industry as
well as our business, with regards to certain supply chain disruptions and sales
volume. While the disruption from COVID-19 is currently expected to be
temporary, there is uncertainty around the duration.
Recent Developments
Share Exchange
On April 26, 2019 (the "Closing Date"), we entered into a Securities Exchange
Agreement with each of the former members ("Members") of Charlie's, and certain
direct investors in the Company ("Direct Investors"), pursuant to which we
acquired all outstanding membership interests of Charlie's beneficially owned by
the Members in exchange for the issuance by the Company of units, with such
units consisting of an aggregate of (i) 15,655,538,349 shares of common stock on
an as-converted basis (which includes the issuance of an aggregate of 1,396,305
shares of a newly created class of Series B Convertible Preferred Stock, par
value $0.001 per share ("Series B Preferred"), convertible into an aggregate of
13,963,047,716 shares of common stock, issued to certain individuals in lieu of
common stock); (ii) 206,249 shares of a newly created class of Series A
Convertible Preferred Stock, par value $0.001 per share ("Series A Preferred"),
convertible into an aggregate of 4,654,349,239 shares of common stock; and (iii)
warrants to purchase an aggregate of 3,102,899,493 shares of common stock (the
"Investor Warrants") (the "Share Exchange"). As a result of the Share Exchange,
Charlie's became a wholly owned subsidiary of the Company.
Immediately prior to, and in connection with, the Share Exchange, Charlie's
consummated a private offering of membership interests that resulted in gross
proceeds to Charlie's of approximately $27.5 million (the "Charlie's
Financing"). Katalyst Securities LLC ("Katalyst") acted as the sole placement
agent in connection with the Charlie's Financing pursuant to an Engagement
Letter entered into by and between Katalyst, Charlie's and the Company on
February 15, 2019, which was amended on April 16, 2019 ("Amended Engagement
Letter"). As consideration for its services in connection with the Charlie's
Financing and Share Exchange, the Company issued to Katalyst and its designees
five-year warrants to purchase an aggregate of 930,869,848 shares of common
stock at a price of $0.0044313 per share (the "Placement Agent Warrants"). The
Placement Agent Warrants have substantially the same terms as those set forth in
the Investor Warrants.
-30-
Table of Contents
As additional consideration for advisory services provided in connection with
the Charlie's Financing and the Share Exchange, the Company issued an aggregate
of 902.7 million shares of Common Stock (the "Advisory Shares"), including to a
member of the Company's Board of Directors, pursuant to a subscription
agreement. The fair value of a share of common stock was $0.0032 which is based
upon a valuation prepared by the Company on the date of the Share Exchange.
The Share Exchange resulted in a change of control of the Company, with
the Members and Direct Investors owning approximately 86.1% of the Company's
outstanding voting securities immediately after the Share Exchange, and the
Company's current stockholders beneficially owning approximately 13.9% of the
issued and outstanding voting securities, which includes the Advisory Shares.
Following the Share Exchange, Ryan Stump and Brandon Stump, the founders of
Charlie's and the Company's Chief Executive Officer and Chief Operating Officer,
respectively, held in excess of 50% of the Company's issued and outstanding
voting securities.
Following the consummation of the Share Exchange, the business operations of the
Company consist of those of Charlie's, which is principally engaged in
formulating, marketing and distributing branded e-cigarette liquid and other
products for use in nicotine-only e-cigarette and vaping systems.
Launch of CBD Products
In June 2019, we introduced, through Don Polly, full-spectrum hemp extract and
CBD isolate wellness products across a variety of formats and with different
strengths. Our initial launch consisted of six vapor, eight tincture and two
topical product variations. The newly released products were launched under the
Pachamama™ brand by way of a licensing agreement between Don Polly and
Charlie's, entered on April 25, 2019. In the near term, we expect to expand the
hemp-derived CBD-based products line to include additional CBD isolate products
and THC-free, broad spectrum hemp extract products currently in development.
Pachamama™ CBD products are currently available in the U.S., Mexico, U.K.,
Switzerland and Australia, and we expect to continue expanding both our domestic
and international distribution efforts.
Filing of Amended and Restated Charter; Automatic Conversion of Series B
Preferred
On June 28, 2019, we amended and restated our Articles of Incorporation (the
"Amended and Restated Charter") to (i) change our corporate name to Charlie's
Holdings, Inc. and (ii) increase the number of shares authorized as common stock
from 7.0 billion to 50.0 billion shares. The Amended and Restated Charter was
approved by our Board of Directors and holders of a majority of our outstanding
voting securities on May 8, 2019, and the Amended and Restated Charter was filed
with the State of Nevada on June 28, 2019.
As a result of the filing of the Amended and Restated Charter and the increase
of our authorized common stock to 50.0 billion shares, all 1,396,305 outstanding
shares of Series B Preferred automatically converted into a total of
13,963,047,716 shares of common stock in accordance with the Certificate of
Designations, Preferences and Rights of the Series B Convertible Preferred
Stock.
Default on Payment of Dividend
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. The Company failed to pay the required dividend and has
requested that holders of more than 50% of the Series A Preferred issued and
outstanding ("Required Holders") consent to an amendment to the Series A
Preferred to allow the Company to pay such Dividend Amount in shares of the
Company's Common Stock. To date, the Company has not obtained such consent from
the Required Holders. In the event the Company is unable to obtain consents from
the Required Holders to pay the Dividend Amount in shares of Common Stock in
lieu of cash, or does not otherwise pay such Dividend Amount in cash or obtain a
waiver, any claims asserted by the holders of the Series A Preferred could have
a material adverse effect on the Company's financial condition.
-31-
Table of Contents
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"). As disclosed, the aggregate amount of
dividends due and payable to holders of the Series A Preferred is $1,650,000.
Small Business Administration Loan Programs
On April 30, 2020, Charlie's, a wholly owned subsidiary of the Company, received
approval to enter into a U.S. Small Business Administration ("SBA") Promissory
Note (the " Charlie's PPP Loan") with TBK Bank, SSB (the "SBA Lender"), pursuant
to the Paycheck Protection Program ("PPP") of the Coronavirus Aid, Relief, and
Economic Security Act (the "CARES Act") as administered by the SBA (the "PPP
Loan Agreement").
The Charlie's PPP Loan provides for working capital to CCD in the amount of
$650,761. The Charlie's PPP Loan will mature on April 30, 2022 and will accrue
interest at a rate of 1.00% per annum. Payments of principal and interest will
be deferred for six months from the date of the Charlie's PPP Loan, or until
November 30, 2020. Interest, however, will continue to accrue during this time.
On April 14, 2020, Don Polly also obtained a loan pursuant to the PPP enacted
under the CARES Act (the "Polly PPP Loan" and together with the Charlie's PPP
Loan, the "PPP Loans")) from Community Banks of Colorado, a division of NBH Bank
(the "Polly Lender"). The Polly PPP Loan obtained by Don Polly provides for
working capital to Don Polly in the amount of $215,600. The Polly PPP Loan will
mature on April 14, 2022 and will accrue interest at a rate of 1.00% per annum.
Payments of principal and interest will be deferred for six months from the date
of the Polly PPP Loan, or until November 14, 2020. Interest, however, will
continue to accrue during this time.
The aforementioned PPP Loans were made under the PPP enacted by Congress under
the CARES Act. The CARES Act (including the guidance issued by SBA and U.S.
Department of the Treasury) provides that all or a portion of the PPP Loans may
be forgiven upon request from the respective borrower to the SBA Lender or the
Polly Lender, as the case may be, subject to requirements in the PPP Loans and
under the CARES Act.
On February 19, 2021 Don Polly received notice from the Polly Lender, that its
PPP Loan was fully repaid, and its promissory note was cancelled as a result of
the loan forgiveness process set forth by the U.S. Small Business
Administration. There is no further action required on the part of Don Polly to
satisfy this liability.
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. Installment payments, including principal and interest of
$731 monthly will begin twelve months from date of the EID Loan. The balance of
principal and interest will be payable thirty years from the date of the EID
Loan and interest will accrue at the rate of 3.75% per annum.
PMTA Submission
During the quarter ended September 30, 2020, the United States Food and Drug
Administration's ("FDA") Center for Tobacco Products informed us that our PMTA
has received a valid submission tracking number, passed the FDA's filing review
phase, and recently entered the substantive review phase. To date, Charlie's has
invested over $4.4 million for our initial PMTA submission. We engaged a team of
more than 200 professionals, including doctors, scientists, biostatisticians,
data analysts, and numerous contract research organizations to create our
comprehensive PMTA submission. This news highlights our progress toward
achieving full regulatory compliance and our goal of providing customers with a
trusted product portfolio. We are confident that during the substantive review
phase of the PMTA process, the FDA will recognize that our submission is both
distinguished and suitable for approval.
Red Beard Holdings, LLC Note Payable
On April 1, 2020, the Company, Charlie's and its VIE, Don Polly, issued a
secured promissory note (the "Red Beard Note") to one of the Company's largest
stockholders, Red Beard Holdings, LLC ("Red Beard") in the principal amount of
$750,000 (the "Principal Amount"), which Note is secured by all assets of the
Company pursuant to the terms of a Security Agreement entered into by and
between the Company and Red Beard (the "Red Beard Note Financing").
The Red Beard Note required the payment of the Principal Amount and guaranteed
minimum interest in the amount of $75,000 on or before the earlier date of (i) a
Liquidity Event, as defined under the terms of the Red Beard Note; or (ii)
October 1, 2020. In addition, if there was an occurrence of an event of default,
then, in addition to the guaranteed minimum interest, the Principal Amount and
unpaid interest and unpaid other amounts under the Red Beard Note shall, at the
election of the Red Beard in its sole and absolute discretion, bear interest at
the lesser of a rate equal to 20% per annum or the maximum default rate. Such
interest would accrue daily commencing on occurrence of such event of default
until payment in full of the Principal Amount, together with all accrued and
unpaid interest and other amounts which may become due hereunder, has been made.
-32-
Table of Contents
On August 27, 2020, the Company's Board of Directors, entered into Amendment No.
1 to Secured Promissory Note and Security Agreement ("Amended Red Beard Note"),
by and between the Company and Red Beard. Pursuant to the Amended Red Beard
Note, the terms of the Red Beard Note held by Red Beard were amended as follows
(i) the Principal Amount under the Red Beard Note was increased from $750,000 to
$1,400,000 and (ii) the guaranteed minimum interest due upon maturity of the Red
Beard Note was increased from $75,000 to $100,000. All other terms of the
respective Red Beard Note remain in full force and effect.
On September 30, 2020, the Company's Board of Directors entered into Amendment
No. 2 to Secured Promissory Note and Security Agreement ("Second Amended Red
Beard Note"), by and between the Company and Red Beard. The Red Beard Note, as
amended by Amendment 1, was further amended by the Second Amended Red Beard Note
to amend the definition of the "Maturity Date" in the Red Beard Note to mean
November 1, 2020.
On October 29, 2020, the Company entered into Amendment No. 3 ("Third Amended
Red Beard Note"), by and between the Company and Red Beard. The terms of the
Second Amended Red Beard Note held by Red Beard have been amended to revise the
maturity date from November 1, 2020 to December 1, 2020. Furthermore, Red Beard
has agreed to waive certain rights upon the occurrence of an Event of Default,
as defined in the Amended Red Beard Note, which was triggered by the Company's
receipt of that certain notice of default, dated August 13, 2020, from certain
holders of the Company's Series A Preferred.
On December 1, 2020, the Company entered into Amendment No. 4 to Secured
Promissory Note and Security Agreement ("Fourth Amended Red Beard Note"), by and
between the Company and Red Beard. The Fourth Amended Red Beard Note was
retroactively effective as of December 1, 2020, therefore avoiding an event of
default. The terms of the Third Amended Red Beard Note have been amended to
revise the maturity date from December 1, 2020 to January 1, 2021, and the
guaranteed minimum interest has been increased from $100,000 to $125,000.
On January 19, 2021, the Company entered into Amendment No. 5 to Secured
Promissory Note and Security Agreement ("Fifth Amended Red Beard Note"), by and
between the Company and Red Beard. The Fifth Amended Note is retroactively
effective as of January 1, 2020. The terms of the Amended Note held by Red Beard
have been amended to revise the maturity date from January 1, 2021 to February
15, 2021, and the guaranteed minimum interest has been increased from $125,000
to $150,000. Pursuant to the Fifth Amended Red Beard Note, Red Beard agreed to
waive its rights to declare a default under the Red Beard Note due to the
Dividend Default.
On March 24, 2021, the Company and Red Beard entered into a Satisfaction and
Release (the "Red Beard Release"), pursuant to which the Company made a payment
to Red Beard in the amount of $1.55 million in exchange for an acknowledgment of
satisfaction and full release of the Company by Red Beard from liability and
obligations arising under the Red Beard Note.
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,
2020 and 2019 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.
The Share Exchange is accounted for as a reverse recapitalization under U.S.
GAAP because the primary assets of the Company were nominal following the close
of the Share Exchange. Charlie's was determined to be the accounting acquirer
based upon the terms of the Share Exchange and other factors including: (i)
Charlie's stockholders and other persons holding securities convertible,
exercisable or exchangeable directly or indirectly for Charlie's membership
units now own approximately 32%, on a fully diluted basis, of the Company's
outstanding securities immediately following the effective time of the Share
Exchange, (ii) individuals associated with Charlie's now hold a majority of the
seats on the Company's Board of Directors and (iii) Charlie's management holds
all key positions in the management of the combined Company.
The disclosures in this Annual Report with respect to the years ended December
31, 2020 and 2019, including the consolidated financial statements contained
herein, are based on Charlie's historical financial statements and the Company's
financial activity beginning April 26, 2019, as adjusted, to give effect to
Charlie's reverse recapitalization of the Company and the Charlie's Financing.
In addition, from the period April 26, 2019 until December 2020, there were
minimal costs and revenue associated with the Bazi product line which are
included in the consolidated financial statements. We do not intend to continue
to produce and sell the Bazi product line, and these costs and expenses are
nominal and will continue to be so in the future. The operating results of Don
Polly for the year ended December 31, 2020 are also included.
-33-
Table of Contents
Historical financial information presented prior to April 26, 2019 is that of
Charlie's only, while financial information presented after April 26, 2019
includes Charlie's, Don Polly, Bazi Drinks and the Company, which includes the
transactions associated with the Share Exchange and Charlie's Financing
completed prior to the Share Exchange, along with ongoing corporate costs.
Results of Operations for the Year Ended December 31, 2020 Compared to the Year
Ended December 31, 2019
For the years ended
December 31, Change
2020 2019 Amount Percentage
($ in thousands)
Revenues:
Product revenue, net $16,692 $22,740 $(6,048) -26.6%
Total revenues 16,692 22,740 (6,048) -26.6%
Operating costs and expenses:
Cost of goods sold - product revenue 7,478 10,071 (2,593) -25.7%
General and administrative 10,873 15,017 (4,144) -27.6%
Sales and marketing 1,733 2,314 (581) -25.1%
Research and development 3,378 1,102 2,276 206.5%
Total operating costs and expenses 23,462 28,504 (5,042) -17.7%
Loss from operations (6,770) (5,764) (1,006) 17.5%
Other income (expense):
Interest expense (134) - (134) 100%
Change in fair value of derivative liabilities (300) 3,618 (3,918) -108.3%
Other income 17 - 17 100%
Total other income (expense) (417) 3,618 (4,035) -111.5%
Net loss $(7,187) $(2,146) $(5,041) 234.9%
Revenue
Revenue for the year ended December 31, 2020 decreased approximately $6,048,000,
or 26.6%, to approximately $16,692,000, as compared to approximately $22,740,000
for the year ended December 31, 2019 due to a $5,604,000 decrease in our
nicotine-based product sales, and a $422,000 decrease in sales of our CBD
wellness products. Sales discounts, key accounts participating in volume-based
rebate programs, and a relatively larger provision for returns generally
contributed to a decrease in net sales. Specifically, the decrease in our
nicotine-based e-liquid flavor sales is directly related to the current
regulatory and health related news stories surrounding the vaping industry. The
nicotine based e-liquid sales decline began late in the quarter ended September
30, 2019 and we expect sales in future quarters to be affected until the
regulatory environment becomes clear. Uncertainty surrounding the FDA's
application review timeline, following the PMTA submission deadline, has
continued to affect buying patterns in the domestic vape market as customers
reduce inventories of non-PMTA submitted products. In addition, in late February
2020, sales of our vapor products and CBD wellness products began to experience
a decrease as the effects of the global COVID-19 pandemic caused disruptions in
the global economy, including mandatory closures of and restrictions placed on
retail locations carrying our products.
Cost of Revenue
Cost of revenue, which consists of direct costs of materials, direct labor,
third party subcontractor services, and other overhead costs decreased
approximately $2,593,000, or 25.7%, to approximately $7,478,000, or 44.8% of
revenue, for the year ended December 31, 2020, as compared to approximately
$10,071,000, or 44.3% of revenue, for the year ended December 31, 2019. This
cost, as a percent of revenue, remained relatively unchanged due to a favorable
mix of higher margin sales for both Charlie's and Don Polly, but was marginally
offset by a higher provision for obsolescence.
-34-
Table of Contents
General and Administrative Expense
For the year ended December 31, 2020, total general and administrative expense
decreased approximately $4,144,000 to approximately $10,873,000, or 65.1% of
revenue, as compared to approximately $15,017,000, or 66.0% of revenue, for the
year ended December 31, 2019. This decrease is comprised of reductions of
approximately $3,906,000 of non-cash stock-based compensation, employee bonuses
and certain other transaction related costs, as well as $946,000 of other
general and administrative expenses. The reduction in transaction related costs
includes $2,437,000 of employee bonuses, $1,063,000 in non-cash, stock-based
compensation, and $406,000 of other costs, including legal and consulting fees,
most of which were linked to the Share Exchange in April 2019. Other
fluctuations in general and administrative costs netted out to a reduction of
approximately $946,000, largely consisting of a reduced provision for bad debt,
product testing fees and general travel expenses. The decrease was offset by an
increase of approximately $708,000 in salary costs, primarily due to a higher
average headcount year over year, as well as the addition of salaries for our
CEO and COO who, prior to the Share Exchange, did not receive annual salaries
from Charlie's.
During the year ended December 31, 2020, we routinely evaluated our business
forecast on a quarterly basis, and periodically made necessary changes in order
to align our cost structure with revenue production. Mid-year headcount
adjustments across several departments and intermittent salary reductions for
highly compensated employees accounted for the majority of intentional cost
cuts. We believe with our current staff, business processes and system
infrastructure, we can achieve our operational plan in the coming quarters as
well as retain the ability to swiftly adjust our cost structure to accommodate
any further changes in Company performance.
Sales and Marketing Expense
For the year ended December 31, 2020, total sales and marketing expense
decreased approximately $581,000, or 25.1%, to approximately $1,733,000 as
compared to approximately $2,314,000 for the year ended December 31, 2019, which
was primarily due to lower commissions paid for reduced sales, curtailed
spending on key marketing programs, and a decrease in trade show travel due to
uncertainty in the global economy resulting from effects of COVID-19.
Research and Development Expense
For the year ended December 31, 2020, total research and development expense
increased approximately $2,276,000, or 206.5%, to approximately $3,378,000 as
compared to approximately $1,102,000 for the year ended December 31, 2019, which
was primarily due to costs incurred with the PMTA registration process.
Loss from Operations
We had a net loss from operations of approximately $6,770,000 for the year ended
December 31, 2020 as compared to net loss from operations of approximately
$5,764,000 for the year ended December 31, 2019. Net loss is determined by
adjusting income from operations by the following items:
?
Change in fair value of derivative liabilities. For the year ended December 31,
2020 and 2019, the (loss)/gain in fair value of derivative liabilities was
($300,000) and $3,618,000, respectively. The derivative liability is associated
with the issuance of the Investor Warrants and the Placement Agent Warrants in
connection with the Share Exchange. The loss for the year ended December 31,
2020 reflects the effect of the increase in stock price as of December 31, 2020
compared to December 31, 2019. We had warrants to purchase approximately 4,034
million shares of common stock outstanding as of December 31, 2020.
?
Interest Expense. For the year ended December 31, 2020 and 2019, we recorded
interest expense related to notes payable of $134,000 and $0, respectively.
?
Other Income. For the year ended December 31, 2020 and 2019, we recorded other
income related to interest and sublease income of $17,000 and $0, respectively.
Net Loss
For the years ended December 31, 2020 and 2019, we had a net loss of $7,187,000
and $2,146,000, respectively.
Effects of Inflation
Inflation has not had a material impact on our business.
-35-
Table of Contents
Liquidity and Capital Resources
As of December 31, 2020, we had negative working capital of approximately
$6,020,000, which consisted of current assets of approximately $4,723,000 and
current liabilities of approximately $10,743,000. This compares to negative
working capital of approximately $1,566,000 at December 31, 2019. The current
liabilities, as presented in the condensed consolidated balance sheet at
December 31, 2020 included elsewhere in this Report primarily include
approximately $2,525,000 of accounts payable and accrued expenses, approximately
$268,000 of deferred revenue associated with product shipped but not yet
received by customers, approximately $456,000 of lease liabilities, notes
payable of $1,400,000, dividends payable of $1,650,000 and $4,444,000 of
derivative liability associated with the Investor and Placement Agent Warrants
(the derivative liability of $4,444,000 is included in determining the negative
working capital of $6,020,000 but is not expected to use any cash to ultimately
satisfy the liability).
Our cash and cash equivalents balance at December 31, 2020 was approximately
$1,422,000.
For the year ended December 31, 2020 we used cash from operations of $3,273,000,
as compared to $2,036,000 for the year ended December 31, 2019. This increase in
the cash used by operations is due primarily to a net loss in 2020 of $7,187,000
compared to net loss of $2,146,000 in 2019 along with an increase in accounts
receivable.
For the year ended December 31, 2020 we used cash for investment activities of
$169,000 as compared to$571,000 for the year ended December 31, 2019. For the
year ended December 31, 2020, the cash used for investment activities was
primarily for the ongoing development and configuration of enterprise resource
planning software. For the year ended December 31, 2019, the cash used for
investment activities was primarily used for the purchase of fixed assets and
certain leasehold improvements for the buildout of our Don Polly operation.
For the year ended December 31, 2020 we generated cash from financing activities
of $2,416,000 as compared to generated cash from financing activities of
$4,751,000 for the year ended December 31, 2019. In the 2020 period, we
generated cash from financing activities from the Red Beard Note, PPP Loans and
EID Loan (as defined in Note 8 of Item 1, Part 1 of this Report). In the 2019
period, we generated cash from financing activities from the Charlie's
Financing, which was offset by Member distributions (as defined in Note 1 of
Item 1, Part 1 of this Report) to the former Members of Charlie's. The Charlie's
Member distributions were all prior to or part of the Share Exchange and no
further distributions will be made as Charlie's is now a wholly-owned subsidiary
of the Company.
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 is required to apply for FDA approval to
continue selling and marketing its products used for the vaporization of
nicotine in the United States. There is significant cost associated with the
application process and there can be no assurance the FDA will approve the
application(s). In addition, the recent outbreak of Coronavirus in March 2020
has had a negative impact on the global economy and markets which could impact
the Company's supply chain and/or sales. For the year ended December 31, 2020,
the Company has incurred losses from operations of $6,770,000 and a consolidated
net loss of approximately $7,187,000 and the Company has negative stockholders'
equity of $5,996,000. These factors raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments to the carrying amount and classification of recorded assets and
liabilities should the Company be unable to continue operations.
Our plans and growth depend on our ability to increase revenues and continue our
business development efforts, including costs beyond the approximately
$4,400,000 already expensed to complete our PMTA registration process. We
currently do not anticipate that our current cash position will be sufficient to
meet our working capital requirements, to continue our sales and marketing
efforts and complete the PMTA registration process. We are currently seeking
term debt or other sources of financing in order to ensure that we have
sufficient cash to operate for the next 12 months (refer to Note 14 - Subsequent
Events). If in the future our plans or assumptions change or prove to be
inaccurate, or there is a significant change in the regulatory environment or
the recent outbreak of COVID-19 continues to impact the global economy, we will
need to raise additional funds through public or private debt or equity
offerings, financings, corporate collaborations, or other means. There can be no
assurance that such financing will be available on acceptable terms, or at all,
and there can be no assurance that any such arrangement, if required or
otherwise sought, would be available on terms deemed to be commercially
acceptable and in our best interests.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other than operating lease
commitments.
Critical Accounting Policies
Included below is a discussion of critical accounting policies used in the
preparation of our financial statements. While all these significant accounting
policies impact our financial condition and results of operations, we view
certain of these policies as critical. Policies determined to be critical are
those policies that have the most significant impact on our financial statements
and require management to use a greater degree of judgment and estimates. Actual
results may differ from those estimates.
-36-
Table of Contents
We believe that given current facts and circumstances, it is unlikely that
applying any other reasonable judgments or estimate methodologies would cause a
material effect on our consolidated results of operations, financial position or
liquidity for the periods presented in this report.
The accounting policies identified as critical are as follows:
Revenue Recognition
The Company recognizes revenues in accordance with Accounting Standards
Codification ("ASC") 606 - Contracts with Customers. Revenues are generated from
contracts with customers that consist of sales to retailers and distributors.
Contracts with customers are generally short term in nature with the delivery of
product as a single performance obligation. Revenue from the sale of product is
recognized at the point in time when the single performance obligation has been
satisfied and control of the product has transferred to the customer. In
evaluating the timing of the transfer of control of products to customers, The
Company considers several indicators, including significant risks and rewards of
products, the right to payment, and the legal title of the products. Based on
the assessment of control indicators, sales are generally recognized when
products are received by customers. Shipping generally occurs prior to the
transfer of control to the customer and is therefore accounted for as a
fulfillment expense. In circumstances where shipping and handling activities
occur after the customer has obtained control of the product, the Company has
elected to account for shipping and handling activities as a fulfillment cost
rather than an additional promised service. Contract durations are generally
less than one year, and therefore costs paid to obtain contracts, which
generally consist of sales commissions, are recognized as expense in the period
incurred. Revenue is measured by the transaction price, which is defined as the
amount of consideration expected to be received in exchange for providing goods
to customers. The transaction price is adjusted for estimates of known or
expected variable consideration, which includes refunds and returns as well as
incentive offers, volume rebates, and promotional discounts on current orders.
Our volume rebates are short-term in nature and reset on a quarterly basis.
Sales returns are generally not material to the financial statements, and do not
comprise a significant portion of variable consideration. Estimates for sales
returns are based on, among other things, an assessment of historical trends,
information from customers, and anticipated returns related to current sales
activity. These estimates are established in the period of sale and reduce
revenue in the period of the sale. Variable consideration related to incentive
offers and promotional programs are recorded as a reduction to revenue based on
amounts the Company expects to collect. Estimates are regularly updated and the
impact of any adjustments are recognized in the period the adjustments are
identified. In many cases, key sales terms such as pricing and quantities
ordered are established at the time an order is placed and incentives have very
short-term durations.
Amounts billed and due from customers are short term in nature and are
classified as receivables since payments are unconditional and only the passage
of time related to credit terms is required before payments are due. The Company
does not grant payment financing terms greater than one year. Payments received
in advance of revenue recognition are recorded as deferred revenue.
Accounts receivable is recorded at the invoiced amount and does not bear
interest. We determine the allowance for doubtful accounts by regularly
evaluating individual customer receivables and considering a customer's
financial condition, credit history and current economic conditions and set up
an allowance for doubtful accounts when collection is uncertain. Customers'
accounts are written off against the allowance when all attempts to collect have
been exhausted. Recoveries of accounts receivable previously written off are
recorded as income when received. As of December 31, 2020, and 2019, the
allowance for bad debt totaled $355,000 and $639,000, 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, 2020, and 2019, the reserve
for excess and obsolete inventories totaled $179,000 and $83,000, 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 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. We
measure the fair value of liability-classified awards using a Monte Carlo
valuation model. Compensation cost is recognized over the service period and is
remeasured at each reporting period through settlement.
-37-
Table of Contents
Income taxes
Income taxes are computed under the liability method. This method
requires the recognition of deferred tax assets and liabilities for temporary
differences between the financial reporting basis and the tax basis of our
assets and liabilities. The impact on deferred taxes of changes in tax rates and
laws, if any, are applied to the years during which temporary differences are
expected to be settled and are reflected in the consolidated financial
statements in the period of enactment. A valuation allowance is recorded when it
is more likely than not that some of the deferred tax assets will not be
realized.
Financial statement effects of a tax position are initially recognized
when it is more likely than not, based on the technical merits, that the
position will be sustained upon examination by a taxing authority. A tax
position that meets the more-likely-than-not recognition threshold is initially
and subsequently measured as the largest amount of tax benefit that meets the
more-likely-than-not threshold of being realized upon ultimate settlement with a
taxing authority. We recognize potential accrued interest and penalties related
to unrecognized tax benefits as income tax expense.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
© Edgar Online, source Glimpses
CHARLIE'S HOLDINGS, INC. 
