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 and six months
ended April 30, 2021 included under Item 1 - Financial Statements in this
Quarterly Report and our audited Financial Statements and notes thereto for the
year ended October 31, 2020 contained in our Annual Report on Form 10-K. 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.
The discussions of our results as presented in this Quarterly Report include use
of the non-GAAP term "gross profit." Gross profit is determined by deducting the
cost of goods sold from operating revenue. Cost of goods sold includes direct
and indirect labor, materials, services, fixed costs, and variable overhead.
Gross profit should not be considered an alternative to operating income or net
income, which are determined in accordance with GAAP. We believe that gross
profit, although a non-GAAP financial measure, is useful and meaningful to
investors as a basis for making investment decisions. It provides investors with
information that demonstrates our cost structure and provides funds for our
total costs and expenses. We use gross profit in measuring the performance of
our business. Other companies may calculate gross profit in a different manner.
Potential 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 and, to date, we have not seen
any significant direct negative impact of COVID-19 to our newly commenced
business. However, we have encountered some logistical delays related to product
launches and distribution in international markets due to COVID-19 While the
spread of COVID-19 has begun to slow and social restrictions have begun to ease,
the full impact of the COVID-19 pandemic continues to evolve and remains
uncertain. The COVID-19 pandemic continues to impact economic conditions, which
could impact the short-term and long-term demand from our customers and,
therefore, has the potential to negatively impact our results of operations,
cash flows, and financial position in the future. Management is actively
monitoring this situation and any impact on our financial condition, liquidity,
and results of operations. However, given the daily evolution of the COVID-19
pandemic and the global responses to curb its spread, we are not presently able
to estimate the effects of the COVID-19 pandemic on our future results of
operations, financial condition, or liquidity for the remainder of fiscal year
2021 and, possibly, beyond.
13
Corporate History
We were incorporated on September 4, 2018 in the State of Delaware. We are
focused on growing and incubating innovative and profitable products into
mature, dominant brands.
USSE Corp. and USSE Delaware Merger
USSE Corp., a Nevada corporation ("USSE Nevada") was incorporated with the
Nevada Secretary of State on July 8, 1998 under the original name C&A
Restaurants, Inc. ("C&A Restaurants"). On June 15, 2009, C&A Restaurants changed
its name to USSE Corp.
Effective September 19, 2018, USSE Nevada re-domiciled from Nevada to Delaware
pursuant to a merger of USSE Nevada with and into USSE Delaware, Inc. ("USSE
Delaware"), with USSE Delaware as the surviving entity.
Holding Company Reorganization
On September 4, 2018, USSE Delaware acquired 1,000 shares of our common stock,
which represented 100% of our then-outstanding shares of common stock, for no
consideration, resulting in us becoming a wholly-owned subsidiary of USSE
Delaware. Also, immediately prior to the Holding Company Reorganization (as
defined below), USSE Merger Sub, Inc., a Delaware corporation ("USSE Merger
Sub"), was our wholly-owned subsidiary.
On September 19, 2018, and in accordance with the provisions set forth in
Section 251(g) of the Delaware General Corporation Law, USSE Merger Sub, an
indirect wholly-owned subsidiary of USSE Delaware and our direct wholly-owned
subsidiary, merged with and into USSE Delaware, our then-parent. USSE Delaware
was the surviving corporation and our wholly-owned subsidiary. USSE Delaware
also changed its name to USSE Corp. following this holding company
reorganization.
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.
Name Change
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.
14
Share Cancellation and Exchange Agreement
On August 19, 2020, we entered into a Share Cancellation and Exchange Agreement
(the "Exchange Agreement") with our controlling stockholder, KH. Nirajkumar
Patel and Eric Mosser, our current officers and directors, are the only voting
members of KH. Pursuant to the Exchange Agreement, KH returned to us 300,000,000
shares of our common stock (the "Cancellation Shares"), which were cancelled and
retired by us.
On August 19, 2020, we filed a Certificate of Designation of Preferences,
Rights, and Limitations of the Series A Preferred Stock (the "Series A
Certificate of Designation") with the Secretary of State of the State of
Delaware, which authorized a total of 3,000,000 shares of Series A Preferred
Stock.
In exchange for the Cancellation Shares, we issued 3,000,000 shares (the
"Preferred Shares") of our newly designated Series A Preferred Stock to KH. The
exchange of the Cancellation Shares and the issuance of the Preferred Shares is
intended to comply with Section 3(a)(9) of the Securities Act of 1933, as
amended (the "Act"), in that the issuance is exempt from the registration
requirements of the Act because the exchange of the Cancellation Shares for the
Preferred Shares was an exchange between us, as issuer, with an existing
stockholder, and no commission or other remuneration was paid or given directly
for the exchange.
Our Business
Currently, we market and place the Products into national distribution channels
through long-standing industry relationships in accordance with the A&R
Distribution Agreement entered into with Bidi, a related party, in March 2020
(and subsequently amended and restated in May 2020 and again in April 2021).
Pursuant to the A&R Distribution Agreement, we sell and resell the Products to
both retail level customers and non-retail level customers. Bidi's primary
product is the "Bidi Stick" and, once launched, the "Bidi Pouch." Bidi is
considered a related party to us because our Chief Executive Officer, Chief
Financial Officer, and director, Mr. Nirajkumar Patel, owns and controls Bidi.
Mr. Patel is also a beneficial owner of KH, the entity that is our largest
controlling stockholder. Thus, Bidi and we are under common control.
We process all sales made to retail customers and non-retail customers, with all
sales to retail customers historically made through the website,
www.bidivapor.com; however, we recently engaged goPuff who will handle sales to
retail customers going forward. We provide all customer service and support at
our own expense. Bidi sets the minimum prices for all sales made by us. With
respect to sales to non-retail customers, we submit purchase orders to Bidi,
Bidi delivers the Products to us, and we ship the Products directly to these
non-retail customers. In the case of retail customers, we maintain adequate
inventory levels of the Products in order to meet these customers' demand, and
deliver the Products sold to these retail customers. Pursuant to the terms of
the A&R Distribution Agreement, Bidi provides us with all branding, logos, and
marketing materials to be utilized by us in connection with our marketing and
promotion of the Products.
In connection with the A&R Distribution Agreement, we entered into the A&R
Sub-Distribution Agreements with certain counterparties, pursuant to which we
appointed such counterparties as non-exclusive sub-distributors of the Products
to non-retail customers within the Territory. Each of the A&R Sub-Distribution
Agreements set forth certain minimum purchase obligations.
We believe that over the course of the next twelve months, our business
operations will generate the capital needed to achieve our business objectives;
however, there can be no assurance that our business operations will continue to
generate the cash flows required for us to achieve our business objectives. If
we require additional capital, there can be no assurance that we will be able to
raise any required capital or that capital will be available to us at acceptable
terms, or at all. We believe that our cash provided by operations will be
sufficient for the next twelve months.
As a result of the commencement of business operations, in March 2020, we began
hiring employees and intend to hire additional independent contractors and/or
employees in the future. We cannot provide any assurance as to the timing of the
hiring of any additional independent contractors or employees, the number of
independent contractors or employees that we may hire, and whether acceptable
independent contractors or employees will be available to us at that time.
15
Liquidity and Capital Resources
We have no known demands or commitments and are not aware of any events or
uncertainties as of April 30, 2021 that will result in or that are reasonably
likely to materially increase or decrease our current liquidity.
At April 30, 2021, we had working capital of approximately $9.2 million and
total cash of approximately $2.1 million.
Now that we have commenced business operations, 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 COVID-19; however,
we are unable to presently estimate any potential future impacts from COVID-19
and an extended impact could have a material and adverse effect on our sales,
earnings, and liquidity.
Cash Flows:
Cash flow used in operations was approximately $5.2 million for the first six
months of fiscal year 2021, compared to $1.9 million provided by operations for
the first six months of fiscal year 2020. The decrease in cash flow from
operations for the first six months of fiscal year 2021 was mainly due to the
net loss during the first six months of fiscal year 2021 as compared to the net
profit during the comparable period for fiscal 2020. We anticipate improvement
in our cash flows provided by operations in future years based on the minimum
purchase obligations set forth in the A&R Sub-Distribution Agreements, partially
offset by increases in costs as we ramp up our sales and marketing efforts. Cash
flow used in financing activities was approximately $77,975 for the first six
months of fiscal year 2021, compared to $0 for the first six months of fiscal
year 2020. The cash used in financing activities for the first two quarters of
fiscal year of 2021 consisted of the settlement of RSUs for cash.
Results of Operations
Three months ended April 30, 2021, compared to three months ended April 30, 2020
Revenues:
Revenues for the second quarter of fiscal year 2021 were approximately $18.1
million, compared to $22.5 million in the same period of the prior fiscal year.
During the second quarter of fiscal year 2020, we entered into the A&R
Distribution Agreement, pursuant to which we were granted the exclusive,
worldwide right to distribute the Products. In connection therewith, we entered
into the A&R Sub-Distribution Agreements and other agreements with
counterparties and granted such sub-distributors the right to distribute the
Products to non-retail customers within the Territory. We have continued to
enter into additional A&R Sub-Distribution Agreements, thereby increasing our
distribution of the Products and, ultimately, we expect our revenues to increase
during the remainder of the current fiscal year. We recognize revenue when a
customer obtains control of promised goods. In some cases, we provide customers
with 120-day payment terms, with the ability for a full refund for products not
sold during that 120-day period. During such periods the risk of loss on the
products delivered remains with the Company. In such case, the customer
typically obtains control on the products when the customer purchases and ships
the product to their customer or pays the Company for the product.
Cost of Revenue and Gross Profit:
Gross profit in the second quarter of fiscal year 2021 was approximately $6.3
million, compared to $4.2 million for the second quarter of fiscal year 2020.
Total cost of revenue was approximately $11.9 million for the second quarter of
fiscal year 2021, compared to $18.3 million for the second quarter of fiscal
year 2020. The increase in gross profit is entirely driven by the decrease in
the cost of the Products sold in fiscal year 2021 as compared to the previous
year.
Operating Expenses:
Total operating expenses were approximately $10.4 million for the second
quarter of fiscal year 2021, compared to approximately $458,000 for the second
quarter of fiscal year 2020. For the second quarter of fiscal year 2021,
operating expenses consisted of commissions paid pursuant to the Further Amended
Service Agreement of approximately $801,000 and general and administrative
expenses of approximately $9.6 million . General and administrative expenses in
the second quarter of fiscal year 2021 consisted primarily of legal fees,
salaries, other professional fees, merchant fees, and other service fees. The
increase in general and administrative expenses is mostly attributable to the
expense related to the issuance of 2,000,000 shares of common stock as
compensation for investor relations consulting services. Total operating
expenses for the second quarter of fiscal 2020 were approximately $458,000,
which included approximately $260,000 in commissions paid pursuant to the
Further Amended Service Agreement.
16
Income Taxes:
During the second quarter of fiscal year 2021, we expensed approximately
$186,800 for prior year income taxes, compared to the accrual of income taxed of
approximately $950,400 for the second quarter of fiscal year 2020. The decrease
in the accrual for income taxes is as a result of having no taxable income
during fiscal year 2021, as compared to the previous fiscal year. Please refer
to Note 8, Income Tax, in the Notes to the Consolidated Financial Statements in
this Quarterly Report for additional information related to our income taxes.
Net Income (Loss):
Net loss for the second quarter of fiscal year 2021 was approximately $4.3
million, or $(0.02) basic and diluted earnings per share, compared to net
income of approximately $2.8 million, or $0.00 basic and diluted earnings per
share, for the second quarter of fiscal year 2020. The decrease in net income
for the second quarter of fiscal year 2021, as compared to the second quarter of
fiscal year 2020, is attributable to the increase in operating expenses and
commissions and the decrease in revenues.
Weighted-average common stock shares outstanding were 282,143,504 in the second
quarter of fiscal year 2021 and 572,364,574 for the second quarter of fiscal
year 2020.
Six months ended April 30, 2021, compared to six months ended April 30, 2020
Revenues:
Revenues for the second quarter of fiscal year 2021 were approximately $18.1
million, compared to $22.5 million in the same period of the prior fiscal year.
During the second quarter of fiscal year 2020, we entered into the A&R
Distribution Agreement, pursuant to which we were granted the exclusive,
worldwide right to distribute the Products. In connection therewith, we entered
into the A&R Sub-Distribution Agreements and other agreements with
counterparties and granted such sub-distributors the right to distribute the
Products to non-retail customers within the Territory. We have continued to
enter into additional A&R Sub-Distribution Agreements, thereby increasing our
distribution of the Products and, ultimately, we expect our revenues to increase
during the remainder of the current fiscal year. We recognize revenue when a
customer obtains control of promised goods. In some cases, we provide customers
with 120-day payment terms, with the ability for a full refund for products not
sold during that 120-day period. During such periods the risk of loss on the
products delivered remains with the Company. In such case, the customer
typically obtains control on the products when the customer purchases and ships
the product to their customer or pays the Company for the product.
Cost of Revenue and Gross Profit:
Gross profit in the first six months of fiscal year 2021 was approximately $11.1
million, compared to approximately $4.2 million for the first six months of
fiscal year 2020. Total cost of revenue was approximately $44.4 million for the
first six months of fiscal year 2021, compared to $18.3 million for the first
six months of fiscal year 2020 and the decrease in cost of products sold.
Operating Expenses:
Total operating expenses were approximately $14.7 million for the first six
months of fiscal year 2021, compared to approximately $471,000 for the first six
months of fiscal year 2020. For the first six months of fiscal year 2021,
operating expenses consisted of commissions paid pursuant to the Further Amended
Service Agreement of approximately $1.8 million and general and administrative
expenses of approximately $13.0 million. General and administrative expenses in
the first six months of fiscal year 2021 consisted primarily of legal fees,
salaries, other professional fees, merchant fees, and other service fees. Total
operating expenses for the first six months of fiscal 2020 were approximately
$471,000 and consisted of general and administrative expenses , which were
primarily from professional fees, and approximately $260,000 in commissions paid
pursuant to the Further Amended Service Agreement.
Income Taxes:
During the first six months of fiscal year 2021, we expensed approximately
$293,100 for prior year income taxes, compared to the approximately $950,400
accrual for the first six months of fiscal year 2020. Please refer to Note 8,
Income Tax, in the Notes to the Consolidated Financial Statements in this
Quarterly Report for additional information related to our income taxes.
Net Income (Loss):
Net loss for the first six months of fiscal year 2021 was approximately $3.9
million, or $(0.01) basic and diluted earnings per share, compared to net
income of approximately $2.8 million, or $0.00 basic and diluted earnings per
share, for the first six months of fiscal year 2020. The decrease in net income
for the first six months of fiscal year 2021, as compared to the first six
months of fiscal year 2020, is attributable to the increase in operating
expenses and commissions and the decrease in revenues.
Weighted-average common stock shares outstanding were 280,242,288 in the first
six months of fiscal year 2021 and 572,364,574 for the first six months of
fiscal year 2020.
17
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures, or capital resources that is material to investors.
Critical Accounting Policies and Estimates
Other than the policy changes disclosed in Note 2, Basis of Presentation and
Significant Accounting Policies, to the unaudited 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 six months ended April 30,
2021 from those disclosed in Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, of our Annual Report on Form 10-K
for the year ended October 31, 2020.
Recently Adopted Accounting Pronouncements
See Note 2, Basis of Presentation and Significant Accounting Policies, to the
unaudited 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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KAIVAL BRANDS INNOVATIONS GROUP, INC. 
