CHARLIE'S HOLDINGS, INC. 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 throughoutthe United States , as well as in more than 80 countries worldwide. Charlie's primary international markets include theUnited Kingdom ,Italy ,Spain ,New Zealand ,Australia , andCanada . ThroughDon 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.
-29-
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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 inSeptember 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 acrossthe 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, inJune 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 acrossthe 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 inSeptember 2020 on a timely basis, which if approved, will allow the Company to continue to sell its approved products inthe United States . Beginning inAugust 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. OnMarch 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 byMay 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs, for its synthetic Pacha products onMay 13, 2022 , prior to theMay 14, 2022 deadline. OnNovember 3, 2022 , FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, onNovember 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 whetherFDA'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. -30- --------------------------------------------------------------------------------
Recent DevelopmentsApril 2022 Note Financing OnApril 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"). OnSeptember 28, 2022 , the Company and the Lender entered into a modification to the Note to extend the maturity date toMarch 28, 2023 and the Company paid all accrued interest under the Note through such date. OnMarch 28, 2023 , the Company entered into a second modification to the Note to extend the maturity date toApril 28, 2024 , contingent upon the payment of all interest accrued under the Note throughMarch 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 , commencingApril 28, 2023 , continuing up to and includingApril 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 ofApril 28, 2024 , or a liquidity event.
OnAugust 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. OnDecember 17, 2022 , the Company andStump Lender entered into a modification to the Loan to extend the maturity date toApril 16, 2023 and the Company has paid all accrued interest under the Loan through such date. OnApril 13, 2023 , the Company andStump Lender entered into a second modification to the Loan to extend the maturity date toAugust 14, 2023 . PMTA During the quarter endedSeptember 30, 2020 , theFDA's Center for Tobacco Products informed us that our PMTA received a valid submission tracking number, passed theFDA'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 endedSeptember 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. OnMarch 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 byMay 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs for its synthetic Pacha products, onMay 13, 2022 , prior to theMay 14, 2022 , deadline. OnNovember 3, 2022 , FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, onNovember 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 ofDecember 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. -31-
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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
For the years ended
December 31, Change
2022 2021 Amount Percentage
($ in thousands)
Revenues:
Product revenue, net $ 26,424 $ 21,496 $ 4,928 22.9 %
Total revenues 26,424 21,496 4,928 22.9 %
Operating costs and expenses:
Cost of goods sold - product revenue 16,439 10,423 6,016 57.7 %
General and administrative 8,381 8,750 (369 ) -4.2 %
Sales and marketing 2,605 1,734 871 50.2 %
Research and development 804 24 780 3250.0 %
Total operating costs and expenses 28,229 20,931 7,298 34.9 %
(Loss) income from operations (1,805 ) 565 (2,370 ) -419.5 %
Other income (expense):
Interest expense (155 ) (34 ) (121 ) 355.9 %
Change in fair value of derivative
liabilities 270 3,545 (3,275 ) -92.4 %
Gain on debt extinguishment - 1,060 (1,060 ) -100.0 %
Other income 6 14 (8 ) -57.1 %
Total other income 121 4,585 (4,464 ) -97.4 %
(Loss) income before income taxes (1,684 ) 5,150 (6,834 ) -132.7 %
Income taxes (benefit) provision (92 ) 342 (434 ) -126.9 %
Net (loss) income $ (1,592 ) $ 4,808 $ (6,400 ) -133.1 %
-32---------------------------------------------------------------------------------
Revenue Revenue for the year endedDecember 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 endedDecember 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 theFDA's application review timeline, following theMay 13, 2022 PMTA submission deadline, as well as the entrant of lower-priced competitors selling direct fromChina affected buying patterns of disposable nicotine products in domestic vape market during the second half of 2022. Sales growth slowed during the quarter endedDecember 31, 2022 as customers reduced emphasis on offering a wide product variety and focused on low-cost, high-sales velocity offerings. During the quarter endedMarch 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 endedDecember 31, 2022 , as compared to approximately$10,423,000 , or 48.5% of revenue, for the year endedDecember 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 endedDecember 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 endedDecember 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 endedDecember 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 theInfrastructure Investment and Jobs Act which was enacted inNovember 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 inApril 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 endedDecember 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 endedDecember 31, 2022 , total sales and marketing expense increased to approximately$2,605,000 as compared to approximately$1,734,000 for the year endedDecember 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. -33- --------------------------------------------------------------------------------
Research and Development Expense
For the year endedDecember 31, 2022 , total research and development expense increased approximately$780,000 , to$804,000 as compared to approximately$24,000 for the year endedDecember 31, 2021 . During the year endedDecember 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 endedDecember 31, 2021 .
Income (Loss) from Operations
We generated loss from operations of approximately$1,805,000 for the year endedDecember 31, 2022 , as compared to income from operations of approximately$565,000 for the year endedDecember 31, 2021 . Net income (loss) is determined by adjusting income (loss) from operations by the following items:
? 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
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
stock price as of
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 .
? Interest Expense. For the years ended
interest expense related to notes payable of $155,000 and $34,000 ,
respectively.
? Gain on debt extinguishment. For the years ended
we recorded a gain on debt extinguishment of
related to forgiveness of Paycheck Protection Program loans extended to
Charlie's and Don Polly .
? Other Income. For the years ended
other income related to interest and sublease income of
respectively.
Income Taxes (Benefit) Provision
The Company's income tax benefit was$92,000 , or 5.5% of income before income taxes, for the year endedDecember 31, 2022 . The Company's income tax expense was$342,000 for the year endedDecember 31, 2021 . Net Income (Loss)
For the years ended
Effects of Inflation
Inflation has not had a material impact on our business.
Liquidity and Capital Resources
As ofDecember 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 atDecember 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). OnApril 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"). OnSeptember 28, 2022 , the Company and the Lender entered into a modification to the Note to extend the maturity date toMarch 28, 2023 and the Company paid all accrued interest under the Note through such date. OnMarch 28, 2023 , the Company entered into a second modification to the Note to extend the maturity date toApril 28, 2024 , contingent upon the payment of all interest accrued under the Note throughMarch 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. -34-
-------------------------------------------------------------------------------- OnAugust 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. OnDecember 17, 2022 , the Company andStump Lender entered into a modification to the Loan to extend the maturity date toApril 16, 2023 and the Company has paid all accrued interest under the Loan through such date. OnApril 13, 2023 , the Company andStump Lender entered into a second modification to the Loan to extend the maturity date toAugust 14, 2023 .
Our cash and cash equivalents balance at
For the year endedDecember 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 endedDecember 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 endedDecember 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 ourDenver, Colorado location. For the year endedDecember 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 endedDecember 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 endedSeptember 30, 2021 to our preferred stockholders. -35- --------------------------------------------------------------------------------
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 inthe 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 endedDecember 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 atDecember 31, 2022 . During the year endedDecember 31, 2022 , the Company's working capital requirements continued to evolve as current assets decreased to$5,850,000 from$7,994,000 as ofDecember 31, 2021 and currently liabilities decreased to$4,783,000 from$5,534,000 as ofDecember 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.
-36-
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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.
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--------------------------------------------------------------------------------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.
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