Management's Discussion and Analysis of Financial Condition and Results of
Operations is designed to provide a reader of the financial statements with a
narrative report on our financial condition, results of operations, and
liquidity. This discussion and analysis should be read in conjunction with the
unaudited Financial Statements and notes thereto for the three months ended
January 31, 2022 included under Item 1 - Financial Statements in this Quarterly
Report and our audited Financial Statements and notes thereto for the year ended
October 31, 2021 contained in 2021 Annual Report. The following discussion
contains forward-looking statements that involve risks and uncertainties, such
as statements of our plans, objectives, expectations, and intentions. Our actual
results could differ materially from those discussed in the forward-looking
statements. Please also see the cautionary language at the beginning of this
Quarterly Report regarding forward-looking statements.
Impact of COVID-19
In March 2020, the WHO declared the outbreak of COVID-19 as a pandemic based on
the rapid increase in global exposure. COVID-19 continues to spread throughout
the world, including the United States. Our business operations, which commenced
during this pandemic, continue to be operational; however, we were indirectly
negatively impacted by COVID-19.
We were indirectly impacted by supply chain issues and regulatory oversight.
First, COVID-19 impacted Bidi's ability to quality test and develop its new
product, the BIDI® Pouch, in line with its targeted release date, which
negatively impacted our ability to begin distribution of the BIDI® Pouch.
Secondly, we believe that many retailers and distributers relaxed their
compliance standards as an indirect result of COVID-19 for two reasons: (i)
government enforcement of regulations was very limited due to imposed social
restrictions, resulting in less in-person monitor enforcement by government
officials and (ii) retail stores experienced light foot traffic from customers
due to COVID-19 restrictions and fears, which resulted in relaxed compliance in
an effort to generate revenue. We believe this relaxation of standards by
certain retailers significantly impacted our revenues.
Impact of the FDA PMTA Decision
In September 2021, in connection with the PMTA process, the FDA effectively
"banned" flavored ENDS by denying nearly all then-pending PMTAs for such
products. Following the issuance of an MDO, manufacturers are required to stop
selling non-tobacco flavored ENDS product. As of September 10, 2021, the FDA
announced that it has taken action on over 93% of applications and issued MDOs
for more than 1,167,000 flavored ENDS products, while issuing zero marketing
authorizations.
Bidi, along with nearly every other company in the ENDS industry, received a MDO
for its non-tobacco flavored ENDS products. With respect to Bidi, the MDO
covered all non-tobacco flavored BIDI® Sticks, including its Arctic (menthol)
BIDI® Stick, which Bidi believes the FDA mischaracterized as "flavored." BIDI
believes that because its Arctic BIDI® Stick is menthol, it should not be
subject to the MDO. Bidi and the Company believe this position is aligned with
the FDA's public statements and press releases stating that tobacco and menthol
ENDS are not deemed flavored products subject to the MDOs.
As a result, beginning in September 2021, Bidi pursued three avenues to
challenge the MDO. First, on September 21, 2021, separate from the judicial
appeal of the MDO in its entirety, Bidi filed a 21 C.F.R. § 10.75 internal FDA
review request specifically of the decision to include the Arctic (menthol)
BIDI® Stick in the MDO. The Company anticipates a decision from the FDA on the
internal review in the second or third quarter of 2022, although we cannot
provide any assurances as to the timing or outcome.
Separately, on September 29, 2021, Bidi petitioned the U.S. Court of Appeals for
the Eleventh Circuit to review the FDA's denial of the PMTAs for its non-tobacco
flavored BIDI® Stick ENDS, arguing that it was arbitrary and capricious under
the APA, as well as ultra vires, for the FDA not to conduct any scientific
review of the company's comprehensive applications, as required by the Tobacco
Control Act, to determine whether the BIDI® Sticks are "appropriate for the
protection of the public health". Bidi further argued that the FDA violated due
process and the APA by failing to provide fair notice of the FDA's new
requirement for ENDS companies to conduct long-term comparative smoking
cessation studies for their flavored products. On February 1, 2022, U.S. Court
of Appeals for the Eleventh Circuit granted Bidi's motion to stay (i.e., put on
hold) the MDO, pending the litigation on the merits. The court-ordered stay
means that the MDO is not legally in force. Accordingly, we anticipate being
able to continue marketing and selling the Products, subject to the FDA's
enforcement discretion, while Bidi continues with its merits case challenging
the legality of the MDO. The FDA has indicated that it is prioritizing
enforcement against companies that have either not submitted PMTAs, or whose
PMTAs have been refused acceptance or filing by the FDA, or whose PMTAs remain
subject to MDOs. Oral arguments in the merits-based proceeding are currently
scheduled for May 2022.
Finally, on October 14, 2021, Bidi requested that the FDA re-review the MDO and
reconsider its position that Bidi did not include certain scientific data in its
applications sufficient to allow the PMTAs to proceed to scientific review. In
light of this request, on October 22, 2021 pursuant to 21 C.F.R. § 10.35(a), the
FDA issued an administrative stay of Bidi's MDO pending its re-review.
Subsequently, the FDA lifted its administrative stay on December 17, 2021.
Following the lifting of the FDA's administrative stay, Bidi filed a renewed
motion to stay the MDO with the U.S. Court of Appeals for the Eleventh Circuit,
which was granted on February 1, 2022.
In the event that the U.S. Court of Appeals issues for the Eleventh Circuit a
ruling adverse to Bidi, or if the FDA otherwise chooses to enforce against Bidi,
Bidi will be forced to cease the continued sale of its non-tobacco flavored
BIDI® Stick products in the United States, thereby resulting in the Company
being unable to distribute such products, the Company's business and financial
condition would be materially adversely affected. The Company cannot provide any
assurances as to the timing or outcome of the merits-based case.
Future Strategic Opportunities
In addition to the continued domestic opportunity, we believe that international
markets provide an exciting growth opportunity for us. The estimated total
addressable global market for ENDS products is approximately $36.7 billion. Bidi
has received approval to market and distribute products within 11 international
markets, including the United Kingdom, France, Russia, and the Czech Republic.
Bidi has also secured significant intellectual property protections similar to
those received in the United States from the European Union, China, and several
other regions and countries. It is also important to note that the nicotine
formulation in the Bidi® Stick has been modified and approved at the 2% level to
meet the criteria for distribution in the United Kingdom and Europe.
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These international market approvals Bidi has previously secured are for the
full formulation lineup, including all flavors. Because the FDA's PMTA
restrictions and guidelines do not pertain to international markets, Bidi
intends to continue manufacturing its full product lineup, for distribution by
us in these international markets. Accordingly, in light of the pending MDO
appeal and uncertainty regarding the FDA's review of the PMTA, as well as the
ongoing threat of the FDA enforcement, Bidi intends to expedite the planned
product launches into foreign markets starting with the United Kingdom. We are
also actively exploring potential partnerships with international distribution
companies in order to possibly expand Product distribution more rapidly in these
international markets.
Corporate History
We were incorporated on September 4, 2018 in the State of Delaware. Effective
July 12, 2019, we changed our corporate name from Quick Start Holdings, Inc. to
Kaival Brands Innovations Group, Inc. The name change was effected through a
parent/subsidiary short-form merger of Kaival Brands Innovations Group, Inc.,
our wholly-owned Delaware subsidiary formed solely for the purpose of the name
change, with and into us. We were the surviving entity.
Change of Control
On February 6, 2019, we entered into a Share Purchase Agreement (the "Share
Purchase Agreement"), by and among us, GMRZ Holdings LLC, a Nevada limited
liability company ("GMRZ"), our then-controlling stockholder, and Kaival
Holdings, LLC, a Delaware limited liability company ("KH"), pursuant to which,
on February 20, 2019, GMRZ sold 504,000,000 shares of our restricted common
stock, representing approximately 88.06 percent of our then issued and
outstanding shares of common stock, to KH, and KH paid GMRZ consideration in the
amount set forth in the Share Purchase Agreement. The consummation of the
transactions contemplated by the Share Purchase Agreement resulted in a change
in control, with KH becoming our largest controlling stockholder. Nirajkumar
Patel and Eric Mosser are the sole voting members of KH.
Description of Business
We are focused on growing and incubating innovative and profitable products into
mature, dominant brands. Pursuant to the A&R Distribution Agreement, Bidi
granted us an exclusive worldwide right to distribute the Products for sale and
resale to both retail level customers and non-retail level customers. We ceased
all retail/direct-to-consumer sales in February 2021. Pursuant to the terms of
the A&R Distribution Agreement, Bidi provides us with all the branding, logos,
and marketing materials to be utilized by us in connection with our marking and
promotion of the Products. We do not manufacture any of the Products we resell.
Currently, the Products consist of the "BIDI® Stick," a disposable,
tamper-resistant ENDS Product and, once launched, of which there can be no
assurances, the "BIDI® Pouch," which provides a tobacco-derived nicotine
formulation, containing natural fibers and a chew-base filler.
In connection with the A&R Distribution Agreement, we entered into
Sub-Distribution Agreements, whereby we appointed the counterparties as
non-exclusive sub-distributors. Pursuant to the Sub-Distribution Agreements, the
sub-distributors agreed to purchase for resale the Products in such quantities
as they should need to properly service non-retail customers within the
Territory
We process all sales made only to non-retail customers, with all sales to
non-retail customers made through Bidi's age-restricted website,
www.wholesale.bidivapor.com. We ceased all retail/direct-to-consumer sales in
February 2021 in order to better ensure youth access prevention and to comply
with the Prevent All Cigarette Trafficking ("PACT") Act. We provide all customer
service and support at our own expense. Bidi sets the minimum prices for all
sales made by us. We maintain adequate inventory levels of the Products in order
to meet the demands of our non-retail customers, and deliver the Products sold
to these customers.
Current Product Offerings
Pursuant to the A&R Distribution Agreement, we sell and resell ENDS Products,
also referred to as ("e-cigarettes"), to non-retail level customers. Our primary
Product we resell is the "BIDI® Stick," a disposable, tamper-resistant ENDS
product that comes in a variety of flavor options for adult cigarette smokers.
The court-ordered stay means that the MDO is not legally in force. Accordingly,
we anticipate being able to continue marketing and selling the Products, subject
to the FDA's enforcement discretion, while Bidi continues with its merits case
challenging the legality of the MDO. The FDA has indicated that it is
prioritizing enforcement against companies that have either not submitted PMTAs,
or whose PMTAs have been refused acceptance or filing by the FDA, or whose PMTAs
remain subject to MDOs. All of our flavor options will continue to be available
to the 11 European Markets we have received marketing and distribution
approvals. We are wholly dependent on Bidi to supply the BIDI® Sticks to us for
distribution. Accordingly, any supply or other issues that impact Bidi,
indirectly impacts us and our ability to operate our business.
In addition to the BIDI® Stick, we anticipated launching distribution of the
"BIDI® Pouch," initially outside of the United States. The initial planned
February 2021 roll-out of the BIDI® Pouch was delayed due to COVID-19 based
manufacturing and supply chain constraints. Due to these complications, and in
effort to prevent future bottlenecks, Bidi decided to move manufacturing
in-house. In 2021, Bidi modified the planned formulation of the BIDI® Pouch. The
original BIDI® Pouch formulation intended to utilize a tobacco-free (synthetic)
nicotine formulation, along with natural fibers and a chew-base filler in six
different flavors. However, the BIDI® Pouch product is now being placed on
temporary hold domestically due to the likelihood of the FDA enforcement of
synthetic nicotine products as drugs, which will require a PMTA determination
from the FDA. More specifically, while the BIDI® Pouch, which made with
synthetic (tobacco-free) nicotine, would not fall within the meaning of a
tobacco product as set forth in the Food, Drug and Cosmetic Act ("FDCA"), the
FDA could take the position that such product is a drug. A drug is defined in
Section 201(g) of the FDCA, in pertinent part, as "articles intended for use in
the diagnosis, cure, mitigation, treatment, or prevention of disease in man or
other animals" (i.e., the "disease" or "therapeutic benefit" prong) or "articles
(other than food) intended to affect the structure or function of the body of
man or other animals" (i.e., the "structure/function" prong). Given nicotine's
well-known structure/function effect on the body there is a chance the FDA will
take the position that synthetic nicotine products, such as the BIDI® Pouch, are
subject to the FDA's drug authority and can only be marketed with an approved
New Drug Application (even if no disease or therapeutic benefit claims are
made). Indeed, prior to the enactment of the Tobacco Control Act (the "Tobacco
Control Act"), the FDA historically took the position that any product with
added nicotine (other than traditional tobacco products) was a drug, even when
marketed for recreational use and without specific claims of smoking cessation
or other therapeutic benefit. It is, of course, illegal to distribute a drug
without the FDA's approval. Given these concerns, Bidi has decided not to launch
the synthetic-nicotine BIDI® Pouch at this time, but will instead seek a PMTA
marketing authorization from the FDA for the BIDI® Pouch made with
tobacco-derived nicotine.
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On July 14, 2021, we announced plans to launch our first Kaival-branded product,
a Hemp CBD product. In addition to our Kaival-branded formulation, we anticipate
that we will also provide white label, wholesale solutions for other product
manufacturers through our subsidiary, Kaival Labs. However, as of the date of
this Quarterly Report, we have not launched any Kaival-branded products, nor
have we begun to offer white label, wholesale solutions to other product
manufacturers.
Going Concern
A recent court ruling on behalf of Bidi in the Eleventh Circuit Court of
Appeals, granted a judicial stay of the MDO previously issued by the FDA to Bidi
in September 2021. The ruling, which was issued on February 1, 2022, means that
the MDO is not legally in force. Accordingly, we anticipate being able to
continue marketing and selling the Products, subject to the FDA's enforcement
discretion, while Bidi continues with its merits case challenging the legality
of the MDO. FDA has indicated that it is prioritizing enforcement against
companies that have either not submitted PMTAs, or whose PMTAs have been refused
acceptance or filing by FDA, or whose PMTAs remain subject to MDOs. Oral
arguments in the merits case are currently scheduled in May 2022.
If the Eleventh Circuit Court of Appeals agrees with Bidi in the merits case, we
anticipate that the FDA will be compelled to place the flavored ENDS back into
the PMTA scientific review process. If this is the outcome of the merits case,
we anticipate being able to continue marketing and selling the Products, subject
to the FDA's enforcement discretion, until the scientific review process is
complete on each of Bidi's PMTA for flavored ENDS and the FDA issues its
decision on each.
If the Eleventh Circuit Court of appeals disagrees with Bidi on the merits case,
or if the FDA re-issues the MDO after completing its scientific review process
for each of Bidi's PMTAs for its flavored ENDS, or if The DA otherwise chooses
to enforce against Bidi, we will be forced to cease sales on the flavored BIDI®
Sticks in the United States market, leaving only the Tobacco (Classic) and
Menthol (Arctic) BIDI® Sticks products for sale in the United States (which,
with respect to the Menthol (Arctic) BIDI® Stick, depends on the outcome of the
specific PMTA filings and the administrative review request for the
classification of "Arctic" as a standard menthol ENDS). If this is the outcome
of the merits case, this combined with a negative cash flow from operations,
would raise substantial doubt on our ability to continue as a going concern.
Management plans to continue similar operations with increased marketing, which
we believe will result in increased revenue and net income. However, there is no
assurance that management's plan will be successful due to the current economic
climate in the United States and globally.
The unaudited consolidated financial statements filed as part of this Quarterly
Report do not include any adjustments relating to the recoverability and
classification of recorded assets, or the amounts and classification of
liabilities that might be necessary in the event that we cannot continue as a
going concern.
Liquidity and Capital Resources
We believe we have sufficient cash on hand as of March 17, 2022. However, we are
awaiting the outcome of Bidi's merit-based case pending in the Eleventh Circuit
Court of Appeals with respect to the MDO issued by the FDA in September 2021. If
the Eleventh Circuit Court of Appeals rules against Bidi, our business and
financial condition will be materially adversely affected, including our ability
to generate revenues and our liquidity. Other than the ongoing MDO matters, we
have no known current demands or commitments and are not aware of any events or
uncertainties as of January 31, 2022 that will result in or that are reasonably
likely to materially increase or decrease our current requirements for cash and
resulting improved liquidity.
At January 31, 2022, we had working capital of approximately $13.9 million and
total cash of approximately $5.7 million.
We intend to generally rely on cash from operations and equity and debt
offerings, to the extent necessary and available, to satisfy our liquidity
needs. There are a number of factors that could result in the need to raise
additional funds, including a decline in revenue or a lack of anticipated sales
growth and increased costs. Our efforts are directed toward generating positive
cash flow and profitability. If these efforts are not successful, we may need to
raise additional capital. Should capital not be available to us at reasonable
terms, other actions may become necessary in addition to cost control measures
and continued efforts to increase sales. These actions may include exploring
strategic options for the sale of the Company, the creation of joint ventures or
strategic alliances under which we will pursue business opportunities, or other
alternatives. We believe we have the financial resources to weather any
short-term impacts of the FDA's PMTA process and Bidi's receipt of a MDO from
the FDA; however, an extended impact, or a negative ruling in Bidi's
merits-based litigation case or the FDA ultimately not approving Bidi's PMTA if
it is re-evaluated could have a material and adverse effect on our sales,
earnings, and liquidity. At this time, we do not foresee the need for further
strategic financing for the next twelve months, given the financing we completed
in September 2021, as indicated below, and our continual sales efforts and
results.
In September 2021, we completed a firm commitment underwritten offering, which
offering was made pursuant to our Registration Statement on Form S-3 (File No.
333-258339) (the "Registration Statement"). The SEC declared the Registration
Statement effective on August 10, 2021. We sold 4,700,000 shares of our Common
Stock and warrants to purchase an additional 3,525,000 shares of our Common
Stock. We sold each share of our Common Stock and warrants to purchase 0.75
shares of our Common Stock at a combined public offering price of $1.70. We also
granted the underwriter the option to purchase an additional 705,000 shares of
our Common Stock and warrants to purchase an additional 528,750 shares of our
Common Stock. We received net proceeds from the offering of approximately $8.3
million. We have also received approximately $1.7 million from the exercise of
the warrants. We used the proceeds for general corporate purposes.
Cash Flows:
Cash flow used in operations was approximately $(2.1) million for the first
three months of fiscal year 2022, compared to $(5.4) million used in operations
for the first three months of fiscal year 2021. The decrease in cash flow used
in operations for the first three months of fiscal year 2022 compared to the
first three months of fiscal 2021 was primarily due to the use of cash resulting
from a very significant increase in accounts receivable of approximately ($11.3)
million as the result of very significant sales that occurred during the first
three months of fiscal year 2021, offset to a lesser degree by the growth of
accounts payable - related party of approximately $4.8 million and stock based
compensation of approximately $1.1 million.
Cash flow used in financing activities was approximately $35,759 for the first
three months of fiscal year 2022, compared to approximately $30,511 for the
first three months of fiscal year 2021. The cash used in financing activities
for the first three months of fiscal year of 2022 and fiscal year 2021 consisted
of cash used for the settlement of RSUs issued to employees.
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Results of Operations
Three months ended January 31, 2022, compared to three months ended January 31,
2021
Revenues:
Revenues, net for the first quarter of fiscal year 2022 were approximately $2.8
million, compared to approximately $37.4 million in the same period of the prior
fiscal year. Revenues decreased in the first quarter of fiscal year 2022,
generally due to (i) Bidi's receipt of the MDO, which limited our ability during
the first quarter of fiscal year 2022 to sell flavored BIDI® Sticks in the
United States and (ii) increased competition, which we believe was the result of
the lack of enforcement by federal and state authorities against sub-par and
low-priced vaping products that continued to enter the market illegally without
FDA authorization. A recent court ruling in favor of Bidi granted a judicial
stay on the MDO previously issued by the FDA banning the marketing and sale of
flavored BIDI® Sticks, amongst banning these flavored sticks with other industry
competitors. As a result of the judicial stay of Bidi's MDO, we revenues to
continue to resume an upward trajectory as renewed distribution ramps up and
sales of flavored BIDI® Sticks products increase, which sales remain subject to
FDA's enforcement discretion (and assuming that Bidi is successful in its
currently pending merits-based case). We also anticipate that if the FDA begins
enforcement against illegally-marketed or synthetic-nicotine vaping products,
there may be an increased demand for compliant and legal vaping products, such
as the BIDI® Stick.
Cost of Revenue, net and Gross Profit (Loss):
Gross loss in the first quarter of fiscal year 2022 was approximately
($700,000), or approximately (24.3%), of revenues, net, compared to
approximately $4.8 million gross profit, or approximately11.2%, of revenues,
net, for the first quarter of fiscal year 2021. Total cost of revenue, net was
approximately $3.5 million, or approximately 124.3%, of revenue, net for the
first quarter of fiscal year 2022, compared to approximately $32.6 million, or
approximately 87.2%, of revenue, net for the first quarter of fiscal year 2021.
The decrease in gross profit is primarily driven by the decrease in overall
sales and the recognition of accumulated year-to-date credits/discounts/rebates
given to customers, totaling approximately $854,000, resulting in an offset to
revenue, net, during the first quarter of fiscal year 2022.
Operating Expenses:
Total operating expenses were approximately $2.1 million for the first quarter
of fiscal year 2022, compared to approximately $4.4 million for the first
quarter of fiscal year 2021. For the first quarter of fiscal year 2022,
operating expenses consisted primarily of advertising and promotion fees of
approximately $593,000, professional fees totaling approximately $481,000 and
general and administrative expenses of approximately $1.0 million. General and
administrative expenses in the first quarter of fiscal year 2022 consisted
primarily of salaries and wages, stock option expense, insurance, lease expense,
banking fees, business fees and state and franchise taxes. For the first quarter
of fiscal year 2021, operating expenses consisted primarily of advertising and
promotion fees of approximately $958,000, professional fees totaling
approximately $2.5 million and, general and administrative expenses of
approximately $942,000. General and administrative expenses in the first quarter
of fiscal year 2021 consisted primarily of salaries and wages, insurance,
banking fees, business fees, and other service fees. We expect future operating
expenses to continue to increase while we increase the footprint of our business
and generate increased sales growth.
Income Taxes:
During the first quarter of fiscal year 2022, we did not accrue for income
taxes, due to the pre-tax loss of approximately ($2.8) million, compared to a
tax provision of approximately $106,000 for the first quarter of fiscal year
2021, due to the amount of pre-tax income for that three-month period. The
reduction from the first quarter of fiscal year 2021 was due to the pre-tax
operating loss recognized during the first quarter of fiscal year 2022.
Net Income (Loss):
As a result of the items noted above, the net loss for the first quarter of
fiscal year 2022 was approximately ($2.8) million, or ($0.09) basic and diluted
loss per share, compared to net income of approximately $0.3 million, or $0.01
basic and diluted earnings per share, for the first quarter of fiscal year 2021.
The decrease in net income for the first quarter of fiscal year 2022, as
compared to the first quarter of fiscal year 2021, is primarily attributable to
the decreased revenues and increase in customer credits/discounts/rebates, as
noted above.
Critical Accounting Policies and Estimates
Other than the policy changes disclosed in Note 2, Basis of Presentation and
Significant Accounting Policies, to the unaudited Consolidated Financial
Statements in Item 1 of Part I of this Quarterly Report, there have been no
material changes to our critical accounting policies and estimates during the
three months ended January 31, 2022 from those disclosed in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations, of our
2021 Annual Report for the year ended October 31, 2021.
Recently Adopted Accounting Pronouncements
See Note 2, Basis of Presentation and Significant Accounting Policies, to the
unaudited Consolidated Financial Statements in Item 1 of Part I of this
Quarterly Report for a description of recent accounting pronouncements and
accounting changes.
Emerging Growth Company
We are an "emerging growth company," that is exempt from certain financial
disclosure and governance requirements for up to five years as defined in the
Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"). The JOBS Act eases
restrictions on the sale of securities and increases the number of stockholders
a company must have before becoming subject to the SEC's reporting and
disclosure rules. We have not elected to use the extended transition period for
complying with new or revised accounting standards under Section 102(b)(2) of
the JOBS Act, that allows us to delay the adoption of new or revised accounting
standards that have different effective dates for public and private companies
until those standards apply to private companies.
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