What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-05-16 compared with 2021-11-15 · 137 added, 204 removed, 127 unchanged (73% of the section changed)

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Report ”

) and without audited financial statements and other information presented in our Annual Report on Form 10-K for the year ended December 31, 2021 (the “

2021 Annual Report ”) .

Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties.

You should read the “

Risk Factors ”

section in this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements.

Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this Report, and in our other filings with the Securities and Exchange Commission ( “

), including particularly matters set forth under Part I, Item 1A (Risk Factors) of the 2021 Annual Report.

Furthermore, such forward-looking statements speak only as of the date of this Report.

Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

As used in this Report, unless otherwise stated or the context otherwise requires, references to the “

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Through Charlie’s, we formulate, market and distribute premium, nicotine-based vapor products.

Charlie’s products are mostly produced domestically through contract manufacturers for sale through select distributors, specialty retailers and third-party online resellers throughout the United States, as well as more than 80 countries worldwide.

Charlie’s primary international markets include the United Kingdom, Italy, Spain, Belgium, Australia, Sweden and Canada.

Charlie’s products are produced by the Company's contract manufacturers for sale through select distributors, specialty retailers and third-party online resellers throughout the United States, and in more than 80 countries worldwide.

Charlie’s primary international markets include the United Kingdom, Italy, Spain, New Zealand, Australia, and Canada.

In June 2019, we launched distribution, through Don Polly, of certain premium vapor, tincture and topical wellness products containing hemp-derived cannabidiol (“

CBD ”) and we currently intend to develop and launch additional products containing other synthetic compounds derived from hemp in the future.

CBD ”).

In the future we intend to develop and launch additional products containing other 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.

Considering industry-specific hurdles, as well as the potential for future regulatory changes, management has targeted several opportunities for growth and has adopted the following operational plan.

First, we plan to increase the sales of our hemp-derived products, including topicals, 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 market for products containing compounds synthetically derived from hemp, including Delta-8-Tetrahydrocannabinol ( "Delta-8-THC" ) and other synthetic tetrahydrocannabinol ( "Synthetic THC" ) compounds.

These product categories have grown rapidly, as they offer consumers a range of therapeutic benefits across varying potencies and product formats.

We have also recently enhanced our focus on our direct-to-consumer business and have allocated additional financial resources to increase e-commerce sales of hemp-derived products.

Secondly, we continue to see a significant opportunity for sales growth in international markets for our e-liquid and other vapor products.

Presently, approximately 15% of our vapor product sales come from the international market and we are well positioned to increase those sales in the countries that we presently sell, and in additional overseas markets, as we have already built an international distribution platform.

We believe 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 market for products containing compounds that are synthetically derived from hemp, including Delta-8-Tetrahydrocannabinol ( "Delta-8-THC" ) and other synthetic tetrahydrocannabinol ( "Synthetic THC" ) compounds.

These product categories have grown rapidly, as they offer consumers a range of benefits across varying potencies and product formats.

Second, we continue to see a significant opportunity for sales growth in international markets for our e-liquid and other vapor products.

Presently, approximately 15% of our vapor product sales come from international markets.

We are well positioned to increase sales in countries where we already have a presence, and leveraging our existing distribution platform, we intend to exploit new overseas markets.

Specifically, the Company intends to launch proprietary new disposables, containing synthetically derived nicotine, that have been specially formulated for the European and Middle East markets.

In partnership with our international distributors, Charlie’s will sell award wining products in markets where more than 20% of the population consumes nicotine in some format.

Most importantly, we feel that tobacco and synthetically derived nicotine vapor products will continue to provide a significant growth opportunity domestically.

During the quarter ended March 31, 2021, we launched our synthetic nicotine (not derived from tobacco) Pachamama Disposable product line, which will provide access to additional sales channels and broaden our customer base.

These innovative product formats are not currently subject to review by the United States Food and Drug Administration (“

) and currently represent Charlie’s most important, fastest-growing product category.

We are continuing with our plan to obtain marketing authorization for certain of our tobacco derived nicotine vapor products through the completion of a Premarket Tobacco Application (" PMTA "), which we submitted in September 2020.

Obtaining a marketing order from the FDA would, in our opinion, help to remediate any perceived health issues related to vaping, and further position the Company as a trusted, industry leader.

We feel that a significant amount of our competitors will not have the resources and/or expertise to complete the extensive and costly PMTA process and that once complete, we will be able to benefit from being one of only a select group of companies operating in the flavored vapor products space.

In partnership with our international distributors, Charlie’s will sell the Company’s award-winning products in target markets where more than 20% of the population consumes nicotine in some format.

Finally, we believe that tobacco and synthetically derived nicotine vapor products will continue to provide a significant growth opportunity domestically.

During the quarter ended March 31, 2021, we launched our synthetic nicotine (not derived from tobacco) Pacha Syn Disposable product line (formerly Pachamama Disposables), which will provide access to additional sales channels and broaden our customer base.

These innovative product formats currently represent Charlie’s fastest-growing product category.

We are continuing with our plan to obtain marketing authorization for certain of our nicotine-based vapor products through the submission of our September 2020 Premarket Tobacco Applications (" PMTAs ").

We’ve allocated further resources and new personnel to support our research and development initiatives in order to submit additional PMTAs, including our May 13, 2022 submissions pertaining to the Company’s synthetically derived nicotine Pacha Syn product line.

Obtaining a marketing order from the United States Food and Drug Administration (“

FDA ”) would, we believe, advance the Company’s position as a trusted, industry leader committed to full regulatory compliance.

We believe that a significant number of our competitors will not have the necessary resources and/or expertise to complete the extensive and costly PMTA process and that once authorized by the FDA, Charlie’s will benefit significantly by emerging as one of a select group of companies able to continue operating in the nicotine vapor products space.

Recent Developments

April 2022 Note Financing

On April 6, 2022, the Company, Charlie's, and its VIE, Don Polly, issued a secured promissory note (the " Note ") to one of the Company's largest individual stockholders, Michael King (the " Lender ") in the principal amount of $1,000,000, which the Note is secured by certain assets of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and the Lender (the " Note Financing ").

The Note requires the payment of principal and guaranteed interest in the amount of at least $90,000 on or before the earlier date of (i) a Liquidity Event, as defined under the terms of the Note;

or (ii) September 28, 2022.

The Company intends to use the proceeds from the Note Financing for general corporate purposes, and its working capital requirements, pending the availability of alternative debt financing.

Resignation of Brandon Stump

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Our Board of Directors approved a reverse stock split of our authorized, issued, and outstanding shares of common stock, par value $0.001 per share (the “

Common Stock ”), at a ratio of 1-for-100 (the “Reverse Split”).

The Reverse Split was effective as of June 16, 2021 (the “

Effective Date ”).

All share and per share amounts in this Report have been retroactively adjusted to account for the reverse stock split.

Common Stock ”), at a ratio of 1-for-100 (the “

Reverse Split ”).

The Reverse Split was effective as of June 16, 2021.

All share and per share amounts in this Report have been retroactively adjusted to account for the Reverse Split .

March 2021 Private Placement

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Red Beard Holdings, LLC Note Payable

On April 1, 2020, the Company, Charlie's and its VIE, Don Polly, issued a secured promissory note (the "Red Beard Note" ) to one of the Company's largest stockholders, Red Beard Holdings, LLC ( "Red Beard" ) in the principal amount of $750,000 (the "Principal Amount" ), requiring a guaranteed minimum interest amount of $75,000 (“

Minimum Interest ”), which Red Beard Note is secured by all assets of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and Red Beard (the "Red Beard Note Financing" ).

Red Beard Note was subsequently amended on August 27, 2020, September 30, 2020, October 29, 2020, December 1, 2020, and January 19, 2021, ultimately increasing Principal Amount to $1,400,000 and Minimum Interest to $150,000.

On April 1, 2020, the Company, Charlie's and its VIE, Don Polly, issued a secured promissory note (the "Red Beard Note" ) to one of the Company's largest stockholders, Red Beard Holdings, LLC ( "Red Beard" ) in the principal amount of $750,000 (the "Principal Amount" ), and required a guaranteed minimum interest amount of $75,000 (“

Minimum Interest ”).

The Red Beard Note was secured by all assets of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and Red Beard (the "Red Beard Note Financing" ).

The Red Beard Note was subsequently amended on August 27, 2020, September 30, 2020, October 29, 2020, December 1, 2020, and January 19, 2021, ultimately increasing Principal Amount to $1.4 million and Minimum Interest to $150,000.

On March 24, 2021, the Company and Red Beard entered into a Satisfaction and Release (the " Red Beard Release "), pursuant to which the Company made a payment to Red Beard in the amount of $1.55 million in exchange for an acknowledgment of satisfaction and full release of the Company by Red Beard from liability and obligations arising under the Red Beard Note.

Small Business Administration Loan Programs

On April 30, 2020, Charlie's, a wholly owned subsidiary of the Company, received approval to enter into a U.S.

Small Business Administration (" SBA ") Promissory Note (the " Charlie's PPP Loan ") with TBK Bank, SSB (the " SBA Lender "), pursuant to the Paycheck Protection Program (" PPP ") of the Coronavirus Aid, Relief, and Economic Security Act (the " CARES Act ") as administered by the SBA (the " PPP Loan Agreement ").

The Charlie's PPP Loan provides for working capital to CCD in the amount of $650,761.

The Charlie's PPP Loan was set to mature on April 30, 2022 and accrued interest at a rate of 1.00% per annum.

Payments of principal and interest were deferred for six months from the date of the Charlie's PPP Loan, or until November 30, 2020.

Interest, however, continued to accrue during that time.

On April 14, 2020, Don Polly also obtained a loan pursuant to the PPP enacted under the CARES Act (the " Polly PPP Loan " and together with the Charlie's PPP Loan, the " PPP Loans ") from Community Banks of Colorado, a division of NBH Bank (the " Polly Lender ").

The Polly PPP Loan obtained by Don Polly provided for working capital to Don Polly in the amount of $215,600.

The Polly PPP Loan was set to mature on April 14, 2022 and accrued interest at a rate of 1.00% per annum.

Payments of principal and interest were deferred for six months from the date of the Polly PPP Loan, or until November 14, 2020.

Interest continued to accrue during that time.

The aforementioned PPP Loans were made under the PPP enacted by Congress under the CARES Act.

The CARES Act (including the guidance issued by SBA and U.S.

Department of the Treasury) provides that all or a portion of the PPP Loans may be forgiven upon request from the respective borrower to the SBA Lender or the Polly Lender, as the case may be, subject to requirements in the PPP Loans and under the CARES Act.

On February 19, 2021 Don Polly received notice from the Polly Lender, that the Polly PPP Loan was fully repaid, and its promissory note was cancelled as a result of the loan forgiveness process set forth by the U.S.

Small Business Administration.

There is no further action required on the part of Don Polly to satisfy this liability.

On March 17, 2021, Don Polly obtained a second draw PPP loan (“

Polly PPP Loan 2 ”) under the CARES Act from Polly Lender.

The Polly PPP Loan 2 obtained by Don Polly provides general working capital in the amount of $184,200.

The Polly PPP Loan 2 will mature on March 17, 2026 and will accrue interest at a rate of 1.00% per annum.

Payments of principal and interest will be deferred, however interest will continue to accrue during this time.

On April 28, 2021, Charlie’s received notice from SBA Lender that the Charlie’s PPP Loan was fully repaid, and its promissory note was cancelled as a result of the loan forgiveness process set forth by the U.S.

Small Business Administration.

There is no further action required on the part of Charlie’s to satisfy this liability.

On June 24, 2020, SBA authorized (under Section 7(b) of the Small Business Act, as amended) an Economic Injury Disaster Loan (“

EID Loan ”) to Don Polly in the amount of $150,000.

Installment payments, including principal and interest of $731 monthly will begin twelve months from date of the EID Loan.

The balance of principal and interest will be payable thirty years from the date of the EID Loan and interest will accrue at the rate of 3.75% per annum.

During the quarter ended September 30, 2020, the FDA's Center for Tobacco Products informed us that our PMTA has received a valid submission tracking number, passed the FDA’s filing review phase, and recently entered the substantive review phase.

To date, Charlie’s has invested over $4.4 million for our initial PMTA submission.

During the quarter ended September 30, 2020, the FDA's Center for Tobacco Products informed us that our PMTA received a valid submission tracking number, passed the FDA’s filing review phase, and recently entered the substantive review phase.

To date, the Company has invested more than $4.4 million for our initial PMTA submission.

We engaged a team of more than 200 professionals, including doctors, scientists, biostatisticians, data analysts, and numerous contract research organizations to create our comprehensive PMTA submission.

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ENDS ”) products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health.

As of September 30, 2021, the Company had not received an MDO for any of its submissions.

This news highlights our progress toward achieving full regulatory compliance and our goal of providing customers with a trusted product portfolio.

On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine. 

These regulations make synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products. 

As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha Syn brands by May 14, 2022 or be subject to FDA enforcement. 

The Company filed new PMTAs for its synthetic Pacha Syn products, on May 13, 2022, prior to the May 14, 2022, deadline. 

As of March 31, 2022, Charlie’s 2020 PMTA remains among the select minority of applications submitted to the FDA that has not received an MDO or Refuse-to-File designation.

This fact highlights our progress toward achieving full regulatory compliance and demonstrates the emphasis our Company places on providing customers with a trusted product portfolio.

Impact of COVID-19

The outbreak of a novel strain of coronavirus (" COVID-19 ", or, “

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 in which we now operate.

During the nine months ended September 30, 2021, 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.

During the quarter ended March 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 Denver, CO office and Huntington Beach, CA warehouse locations have fully returned to on premise status, while our corporate headquarters in Costa Mesa, CA remains remote for many employees.

We will continue to monitor the COVID-19 situation in all regions we operate and will maintain strict adherence to local health guidelines and mandates.

We may have to take further actions that we determine are in the best interests of our employees or as required by federal, state, or local authorities.

Our Denver, CO office and Huntington Beach, CA warehouse locations have 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.

Risks and Uncertainties

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In the event the prevalence of such bans and/or changes in laws and regulations increase across the United States, or internationally, the Company’s business, results of operations and financial condition could be adversely impacted.

In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products.

Our PMTA applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell its products in the United States.

In addition, the Company is presently seeking to obtain marketing authorization for certain of its nicotine-based vapor products.

Our PMTA applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell certain of its products in the United States.

At this date, Charlie’s PMTA remains among the select minority of applications submitted to the FDA that has not received an MDO or Refuse-to-File designation.

However, it is possible that the FDA will request additional information or that the Company will need to amend its PMTA at some point in the future.

Further, the Company filed new PMTAs, for its synthetic Pacha Syn products, on May 13, 2022.

It is not a certainty that the Company will receive marketing orders for one or more of its products on any of its PMTAs. 

Though the Company’s 2020 PMTA is currently in substantive review with the FDA and though we believe that each of our PMTA’s are of the highest quality, there is no guarantee that we will receive an “acceptance filing”

from the FDA for our May 2022 submission.

The Company may also require additional financing in the future to support potential PMTA related expenses and general working capital.

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Basis of Presentation

The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “

SEC ”).

The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“

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nevertheless, the Company believes that the disclosures are adequate to make the information presented in this Report not misleading.

Amounts related to disclosure of December 31, 2020 balances within the interim condensed consolidated financial statements were derived from audited financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2020, filed with the SEC on April 5, 2021.

Amounts related to disclosure of December 31, 2021 balances within the interim condensed consolidated financial statements were derived from audited financial statements and notes thereto included in the 2021 Annual Report, filed with the SEC on April 12, 2022.

The operating results of Don Polly are also included.

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Management currently considers the following events, trends and uncertainties to be important in understanding the Company’s results of operations and financial condition for the most recent calendar quarter and full year:

Regarding results from operations for the quarter ended September 30, 2021, we generated revenue of approximately $5,219,000, as compared to revenue of $3,894,000 for the three months ended September 30, 2020.

This $1,325,000 increase in revenue was due primarily to a $1,168,000 increase in sales of our nicotine-based vapor products, as well as a $157,000 increase in sales of our hemp-derived wellness products.

We generated net income for the three months ended September 30, 2021 of approximately $3,107,000, as compared to net loss of approximately $6,824,000 for the three months ended September 30, 2020.

The net income for the three months ended September 30, 2021 includes non-cash stock-based compensation expense of approximately $39,000 and a non-cash gain in fair value of derivative liabilities of $2,729,000.

Regarding results from operations for the nine months ended September 30, 2021, we generated revenue of approximately $15,013,000, as compared to revenue of $12,462,000 for the nine months ended September 30, 2020.

This increase in revenue was due primarily to a $2,551,000 increase in sales of our nicotine-based vapor products, while sales of our hemp-derived products remained relatively unchanged.

We generated net income for the nine months ended September 30, 2021 of approximately $2,734,000, as compared to net loss of approximately $11,384,000 for the nine months ended September 30, 2020.

The net income for the nine months ended September 30, 2021 includes non-cash stock-based compensation expense of approximately $563,000 and a non-cash gain in fair value of derivative liabilities of $1,901,000.

A review of the three-month period ended September 30, 2021 follows:

Regarding results from operations for the quarter ended March 31, 2022, we generated revenue of approximately $8,074,000, as compared to revenue of $4,361,000 for the three months ended March 31, 2021.

This $3,713,000 increase in revenue was due primarily to a $2,807,000 increase in sales of our nicotine-based vapor products, as well as a $906,000 increase in sales of our hemp-derived products.

We generated net income for the three months ended March 31, 2022, of approximately $706,000, as compared to net loss of approximately $20,137,000 for the three months ended March 31, 2021.

The net income for the three months ended March 31, 2022, includes a non-cash gain in fair value of derivative liabilities of $340,000.

A review of the three-month period ended March 31, 2022, follows:

For the three months ended

September 30,

($ in thousands)

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Change in fair value of derivative liabilities

Gain on debt extinguishment

Total other income (loss)

Net income (loss)

Results of Operations for the Three Months Ended September 30, 2021 Compared to the Three Months Ended September 30, 2020

Revenue for the three months ended September 30, 2021 increased approximately $1,325,000 or 34%, to approximately $5,219,000, as compared to approximately $3,894,000 for same period in 2020 due to a $1,168,000 increase in sales of our nicotine-based vapor products and a $157,000 increase in sales of our hemp-derived wellness products.

The increase in our nicotine-based vapor product sales is directly related to the launch of our Pachamama Disposable product line, which is not currently subject to FDA review and currently represents Charlie’s most important, fastest-growing product category.

Pachamama 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.

However, ongoing uncertainty surrounding the FDA’s recent issuance of MDO’s and Refuse-to-File designations, as well as the addition of vapor products to the Prevent All Cigarette Trafficking Act (“

PACT Act ”) (See Regulatory and Market Risks) continue to affect buying patterns in the domestic vapor products market as customers reduce inventories of non-PMTA submitted products and adjust their business models to suit recent changes in regulation.

Lingering effects of COVID-19 as well as shifting consumer preferences in our channels have both continued to affect sales of our CBD wellness products.

As a result, during the quarter ended March 31, 2021, we began to streamline our existing hemp-derived wellness product offering and pursue the developing market for products containing synthetically derived cannabinoids, including Delta-8-THC and other Synthetic THC compounds.

We view this market segment as having higher growth potential, as well as better alignment with our existing sales channels.

Results of Operations for the Three Months Ended March 31, 2022 Compared to the Three Months Ended March 31, 2021

Revenue for the three months ended March 31, 2022, increased by approximately $3,713,000 or 85.1%, to approximately $8,074,000, as compared to approximately $4,361,000 for same period in 2021 due to a $2,807,000 increase in sales of our nicotine-based vapor products and a $906,000 increase in sales of our hemp-derived products.

The increase in our nicotine-based vapor product sales was driven by our new 8ml Pacha Syn Disposable line, which launched in December 2021, as well as incremental market penetration of our existing Pacha Syn Disposable products.

Pacha Syn 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.

However, regulatory challenges including the recently announced requirement for synthetic nicotine products to obtain approval from the FDA as well as continued uncertainty surrounding the FDA’s issuance of MDO’s and Refuse-to-File designations, tempered buying patterns in the domestic market as customers reduced inventories of related products.

The increase in sales for our hemp-derived business was directly related to strong performance in our alternative cannabinoid category, which includes products containing synthetically derived cannabinoids, including Delta-8-THC and other synthetic THC compounds.

We view this market segment as having higher growth potential, as well as better alignment with our existing sales channels in comparison to our CBD “wellness”

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 $644,000, or 38.7%, to approximately $2,310,000, or 44.3% of revenue, for the three months ended September 30, 2021, as compared to approximately $1,666,000, or 42.8% of revenue, for the same period in 2020.

This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pachamama Disposable product line, which carries a lower margin per unit relative to our other vapor products.

Cost of revenue was partially offset by a lower than expected provision for inventory obsolescence across both business lines.

Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs increased by approximately $2,491,000, or 128.2%, to approximately $4,434,000, or 54.9% of revenue, for the three months ended March 31, 2022, as compared to approximately $1,943,000, or 44.6% of revenue, for the same period in 2021.

This cost, as a percent of revenue, increased due to a higher sales mix consisting of our Pacha Syn Disposable product line, which carries a lower margin per unit relative to our other products, as well as higher comparative freight and delivery expense and reserve for inventory obsolescence.

Cost of revenue was partially offset by a favorable inventory quantity adjustment.

General and Administrative Expenses

For the three months ended September 30, 2021, total general and administrative expense increased approximately $11,000 to $2,084,000 as compared to approximately $2,073,000 for the same period in 2020.

Notably, this change is primarily comprised of increases of approximately $175,000 in the provision for bad debt, $124,000 in professional fees as well as $109,000 in other general and administrative expenses.

The increase in provision for bad debt was primarily related to the increase in sales and accounts receivable balance during the period.

The increase in professional fees was the result of several internal projects, most of which focused on the creation of a solution “network”

necessary to effectively meet the requirements of both the Consolidated Appropriations Act of 2021 and the PACT Act.

These increases were offset by reductions in non-cash stock-based compensation and salaries and benefits costs of approximately $342,000 and $55,000, respectively.

The reduction in non-cash, stock-based compensation is primarily due to the conclusion of the vesting period for shares of Common Stock awarded to several employees in conjunction with Share Exchange in April 2019 (as defined in Note 3 of Item 1, Part 1 of this Report).

For the three months ended March 31, 2022, total general and administrative expense increased by approximately $341,000 to $2,559,000 as compared to approximately $2,218,000 for the same period in 2021.

Notably, this change was primarily comprised of increases of approximately $284,000 in payroll and benefits, $181,000 in professional fees as well as $217,000 in other general and administrative expenses.

The increase in payroll and benefits expense was primarily due to taxes paid on behalf of employees and directors in relation to restricted stock awards issued on March 2, 2022 (see Note 11).

The increase in professional fees during the quarter ended March 31, 2022, was directly related to higher audit and director fees.

Other general and administrative expenses, including merchant processing fees and provision for bad debt, increased due to higher net sales relative to the quarter ended March 31, 2021.

These increases were offset by a reduction in non-cash stock-based compensation of approximately $341,000.

The reduction in non-cash, stock-based compensation was primarily due to the conclusion of the vesting period for shares of Common Stock previously awarded to certain employees as a result of the Share Exchange (See Note 3).

Sales and Marketing Expense

For the three months ended September 30, 2021, total sales and marketing expense increased approximately $107,000, or 31.9%, to approximately $442,000 as compared to approximately $335,000 for the same period in 2020, which was primarily due to a return to normalized trade-show activity during the quarter.

Sales commissions increased marginally due to revenue growth across our businesses, however the increase was mitigated by a restructuring of our sales team and compensation program at the beginning of 2021.

For the three months ended March 31, 2022, total sales and marketing expense increased by approximately $283,000, or 67.4%, to approximately $703,000 as compared to approximately $420,000 for the same period in 2021, which was primarily due to a return to normalized trade-show activity during the quarter.

Sales commissions increased due to revenue growth across our businesses, however the increase was mitigated by further restructuring of our sales team and compensation program at the beginning of 2022.

Research and Development Expense

For the three months ended September 30, 2021, total research and development costs decreased approximately $736,000, or 99.3%, to approximately $5,000 as compared to approximately $741,000 for the same period in 2020, which was primarily due to reduced costs associated with our PMTA registrations.

For the three months ended March 31, 2022, total research and development costs increased by approximately $2,000, or 22.2%, to approximately $11,000 as compared to approximately $9,000 for the same period in 2021, which was primarily due to costs associated with previous PMTA submissions.

Income from Operations

We had operating income of approximately $378,000 for the three months ended September 30, 2021, due primarily to an increase in sales across both Charlie’s and Don Polly.

We had operating income of approximately $367,000 for the three months ended March 31, 2022, due primarily to an increase in sales across both Charlie’s and Don Polly.

We also incurred certain non-cash, general and administrative expenses during the period including a $18,000 expense related to stock-based compensation.

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Change in Fair Value of Derivative Liabilities.

For the three months ended September 30, 2021, the gain in fair value of derivative liabilities was $2,729,000, compared to a loss of $5,874,000 for the three months ended September 30, 2020.

The derivative liability is associated with the issuance of the Investor Warrants and the Placement Agent Warrants (as defined in Note 3 of this Report) in connection with the Share Exchange.

The gain for the quarter ended September 30, 2021, reflects the effect of the decrease in stock price as of September 30, 2021, compared to June 30, 2021.

Due to the limited supply of shares currently freely trading, our stock price may experience volatility and therefore, considerable fluctuations in the value of our warrant derivative liability in the future.

We had 40,337,693 warrants outstanding as of September 30, 2021.

Interest Expense.

For the three months ended September 30, 2021, and 2020, we recorded interest expense related to notes payable of $2,000 and $29,000, respectively.

Other Income.

For the three months ended September 30, 2021 and 2020, we recorded other income of $2,000 and $0, respectively.

Net Income (Loss)

For the three months ended September 30, 2021, we had net income of $3,107,000 as compared to a net loss of $6,824,000 for the same period in 2020.

A review of the nine-month period ended September 30, 2021 follows:

For the nine months ended

September 30,

($ in thousands)

Product revenue, net

Total revenues

Operating costs and expenses:

Cost of goods sold - product revenue

General and administrative

Sales and marketing

Research and development

Total operating costs and expenses

Loss from operations

Other income (expense):

Interest expense

Change in fair value of derivative liabilities

Gain on debt extinguishment

Total other income (loss)

Net income (loss)

Results of Operations for the Nine Months Ended September 30, 2021 Compared to the Nine Months Ended September 30, 2020

Revenue for the nine months ended September 30, 2021 increased approximately $2,551,000 or 20.5%, to approximately $15,013,000, as compared to approximately $12,462,000 for same period in 2020 due to a $2,551,000 increase in sales of our nicotine-based vapor products, while sales of our hemp-derived products remained relatively unchanged.

Lingering effects of COVID-19 as well as shifting consumer preferences in our channels have both continued to affect sales of our CBD wellness products.

As a result, during the quarter ended March 31, 2021, we began to streamline our existing hemp-derived wellness product offering and pursue the developing market for products containing synthetically-derived cannabinoids, including Delta-8-THC and other Synthetic THC compounds.

We view this market segment as having higher growth potential, as well as better alignment with our existing sales channels.

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 $1,686,000, or 31.4%, to approximately $7,047,000, or 46.9% of revenue, for the nine months ended September 30, 2021, as compared to approximately $5,361,000, or 43% of revenue, for the same period in 2020.

Cost of revenue was also negatively affected by a larger than normal provision for inventory obsolescence during the period related to certain of our hemp-derived wellness products.

General and Administrative Expenses

For the nine months ended September 30, 2021, total general and administrative expense decreased approximately $1,741,000 to $6,759,000 as compared to approximately $8,500,000 for the same period in 2020.

Notably, this decrease is comprised of reductions of approximately $2,153,000 of non-cash, stock-based compensation and $61,000 of salaries and benefits costs.

The reduction in non-cash, stock-based compensation is primarily due to the forfeiture of stock awards by Brandon Stump and Ryan Stump pursuant to the adoption of the Amended Employment Agreements entered February 12, 2020, as well as the conclusion of the vesting period for shares of Common Stock awarded to several employees in conjunction with the Share Exchange in April 2019.

The decrease was primarily offset by increases of approximately $325,000 in professional fees, $97,000 of merchant processing costs and $51,000 of other general administrative expenses.

The increase in professional fees was largely the result of several internal projects largely focused on the creation of a solution “network”

necessary to effectively meet the requirements of both the Consolidated Appropriations Act of 2021 and the PACT Act as well as costs associated with certain corporate actions including our Reverse Split, completed June 16, 2021, and the private sale of 3,517,000 shares of our common stock to the Company’s founders Brandon Stump and Ryan Stump completed March 23, 2021.

Sales and Marketing Expense

For the nine months ended September 30, 2021, total sales and marketing expense decreased approximately $47,000, or 3.7%, to approximately $1,212,000 as compared to approximately $1,259,000 for the same period in 2020, which was primarily due to a shift away from broad-based advertising efforts and focusing on targeted sales and marketing programs with certain of our large key distribution partners.

Our sales mix to large distributors has increased as a result of logistical changes in our business following the addition of ENDS products to the PACT Act earlier this year.

During the nine months ended September 30, 2021, we also continued to refine our use of certain point-of-sale materials in favor of increased digital marketing campaigns, however we will continue to remain agile in how we focus our resources in the future.

Research and Development Expense

For the nine months ended September 30, 2021, total research and development expense decreased approximately $3,358,000, to approximately $14,000 as compared to $3,372,000 for the same period in 2020, which was primarily due to reduced costs associated with our PMTA registrations.

Loss from Operations

We had operating losses of approximately $19,000 for the nine months ended September 30, 2021, due primarily to a $325,000 increase in professional fees as well as a $148,000 increase in other general and administrative costs.

We also incurred certain non-cash general and administrative expenses that contributed to the loss from operations including a $563,000 expense related to stock-based compensation.

Net loss is determined by adjusting loss from operations by the following items:

Change in Fair Value of Derivative Liabilities.

For the nine months ended September 30, 2021, the gain in fair value of derivative liabilities was $1,901,000, compared to loss of $5,264,000 for the same period in 2020.

For the three months ended March 31, 2022, the gain in fair value of derivative liabilities was $340,000, compared to a loss of $ 20,102,000 for the three months ended March 31, 2021.

The derivative liability is associated with the issuance of the Investor Warrants and the Placement Agent Warrants (as defined in Note 3 of this Report) in connection with the Share Exchange.

The gain for the nine months ended September 30, 2021, reflects the effect of the decrease in stock price as of September 30, 2021, compared to December 31, 2020.

During the nine months ended September 30, 2021, we experienced a substantial variation in trading volume for our stock, which may persist in the future.

The gain for the quarter ended March 31, 2022, reflects the effect of the decrease in stock price as of March 31, 2022, compared to December 31, 2021.

We had 40,337,693 warrants outstanding as of September 30, 2021.

We had 40,337,693 warrants outstanding as of March 31, 2022.

Interest Expense.

For the nine months ended September 30, 2021, and 2020, we recorded interest expense related to notes payable of $33,000 and $105,000, respectively.

Gain on debt extinguishment.

For the nine months ended September 30, 2021, and 2020, we recorded a debt extinguishment gain of $875,000 and $0, respectively, including principal and accrued interest, related to the forgiveness of the Don Polly PPP Loan and the Charlie’s PPP Loan.

For the three months ended March 31, 2022, and 2021, we recorded interest expense related to notes payable of $1,000 and $28,000, respectively.

Other Income.

For the nine months ended September 30, 2021, and 2020, we recorded other income of $10,000 and $15,000, respectively.

For the three months ended March 31, 2022, and 2021, we recorded other income of $0 and $222, respectively.

Net Income (Loss)

For the nine months ended September 30, 2021, we had a net income of $2,734,000 as compared to a net loss of $11,384,000 for the same period in 2020.

Effects of Inflation

Inflation has not had a material impact on our business.

For the three months ended March 31, 2022, we had net income of $706,000 as compared to a net loss of $20,137,000 for the same period in 2021.

Liquidity and Capital Resources

As of September 30, 2021, we had working capital of approximately $505,000, which consisted of current assets of approximately $5,667,000 and current liabilities of approximately $5,162,000.

This compares to negative working capital of approximately $6,020,000 at December 31, 2020.

The current liabilities, as presented in the condensed consolidated balance sheet at September 30, 2021 included elsewhere in this Report primarily include approximately $2,006,000 of accounts payable and accrued expenses, approximately $221,000 of deferred revenue associated with product shipped but not yet received by customers, approximately $392,000 of lease liabilities, and $2,543,000 of derivative liability associated with the Investor Warrants and Placement Agent Warrants (the derivative liability of $2,543,000 is included in determining the working capital of $505,000 but is not expected to use any cash to ultimately satisfy the liability).

In addition, the effect of the COVID-19 pandemic may have a negative impact on our liquidity and capital reserves.

Our cash and cash equivalents balance at September 30, 2021 was approximately $1,270,000.

For the nine months ended September 30, 2021, net cash used in operating activities was approximately $980,000, as compared to $3,502,000 for the same period in 2020.

This resulted from a net income of $2,734,000, partially offset by $563,000 of share-based compensation, $1,901,000 of change in fair value of derivative liabilities and $2,080,000 changes in our operating assets and liabilities.

For the nine months ended September 30, 2021, we used cash for investment activities of approximately $73,000 as compared to $153,000 for the same period in 2020.

The cash used for investment activities is primarily for the on-going development and configuration of enterprise resource planning software during the nine months ended September 30, 2021.

For the nine months ended September 30, 2021 we generated approximately $901,000 cash from financing activities as compared to $2,416,000 for the same period in 2020.

In the 2021 period, we generated cash from financing activities from the Polly PPP Loan 2 (as defined in Note 8 of Item 1, Part 1 of this Report) and the Private Placement (as defined in Note 10 of Item 1, Part 1 of this Report).

We paid cash dividends of $883,000 and notes payable of $1,400,000 during the nine months ended September 30, 2021.

As of March 31, 2022, we had working capital of approximately $3,224,000, which consisted of current assets of approximately $8,048,000 and current liabilities of approximately $4,824,000, as compared to working capital of approximately $2,460,000 at December 31, 2021.

The current liabilities, as presented in the condensed consolidated balance sheet at March 31, 2022 included elsewhere in this Report primarily include approximately $3,684,000 of accounts payable and accrued expenses, approximately $316,000 of deferred revenue associated with product shipped but not yet received by customers, approximately $265,000 of lease liabilities, and $559,000 of derivative liability associated with the Investor Warrants and Placement Agent Warrants (the derivative liability of $559,000 is included in determining the working capital of $3,224,000 but is not expected to use any cash to ultimately satisfy the liability).

Our cash and cash equivalents balance at March 31, 2022 was approximately $409,000.

For the three months ended March 31, 2022, net cash used in operating activities was approximately $372,000, resulting from a net income of $706,000, offset by a $340,000 of change in fair value of derivative liabilities and $1,037,000 of changes in our operating assets and liabilities.

For the three months ended March 31, 2021, net cash provided by operating activities was approximately $268,000, resulting from a net loss of $20,137,000, offset by $359,000 of share-based compensation, $20,102,000 of change in fair value of derivative liabilities and $10,000 of change in our operating assets and liabilities.

For the three months ended March 31, 2022, we used cash for investment activities of approximately $85,000 as compared to $19,000 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 during the three months ended March 31, 2022.

For the three months ended March 31, 2021 we generated approximately $1,784,000 cash from financing activities.

In the 2021 period, we generated cash from financing activities from the Polly PPP Loan 2 (See Note 10) and the Private Placement.

Going Concern Uncertainty Regarding the Legal and Regulatory Environment, Liquidity and Management ’

3 unchanged sentences

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 tobacco derived nicotine in the United States.

There is significant cost associated with the application process and there can be no assurance the FDA will approve the application(s).

In addition, the recent outbreak of COVID-19 in March 2020 has had a negative impact on the global economy and markets which has negatively impacted the Company’s supply chain and sales.

For the nine months ended September 30, 2021, the Company has incurred a loss from operations of $19,000 and a consolidated net income of approximately $2,734,000 and the Company has a stockholders’

equity of $1,068,000 as of September 30, 2021.

However, net cash used in operating activities was approximately $980,000, and net income for the period was largely the result of $2,754,000 in other income, including a $1,901,000 gain in fair value of derivative liabilities.

These factors raise substantial doubt about the Company’s ability to continue as a going concern.

Additionally, the Company was required to apply for FDA approval to continue selling and marketing its products used for the vaporization of nicotine in the United States.

Currently, a substantial portion of the Company’s sales are derived from products that are subject to approval by the FDA.

There was significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future application.

In addition, the outbreak of a novel strain of COVID-19 (“

Coronavirus ”) which was identified in Wuhan, China around December 2019, has had a negative impact on the global economy and the Company’s supply chain and sales.

For the three months ended March 31, 2022, the Company generated income from operations of approximately $0.4 million, and a consolidated net income of approximately $0.7 million, but used cash in operations of approximately $0.4 million.

The Company had stockholders’

equity of $3.9 million at March 31, 2022.

During the three months ended March 31, 2022, the Company’s working capital requirements continued to evolve as current assets, excluding cash, increased to $7.6 million from $7.1 million as of December 31, 2021, and cash on hand decreased to $0.4 million from $0.9 million as of December 31, 2021.

Considering these facts, the issuance of one or several MDOs from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables.

These regulatory risks, as well as other industry-specific challenges 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, raise additional capital, and continue our business development efforts, including the expenditure of approximately $4,400,000 to date, to complete our PMTA process for the Company’s 2020 submissions to the FDA.

In 2022 the Company intends to allocate further resources and new personnel to support research and development initiatives in order to submit one or more additional 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.

Our plans and growth depend on our ability to increase revenues and continue our business development efforts, including the expenditure of approximately $4,400,000 to date, to complete our PMTA registration process.

On March 23, 2021, we closed a $3 million capital raise through the private sale of 3,517,000 shares of our common stock to the Company’s founders Brandon Stump and Ryan Stump (see Recent Developments).

We intend to use the proceeds to fund future growth, increase working capital, retire outstanding debt, and for other general corporate purposes.

If in the future our plans or assumptions change or prove to be inaccurate, or there is a significant change in the regulatory environment or the recent outbreak of COVID-19 continues to impact the global economy, we will need to raise additional funds through public or private debt or equity offerings, financings, corporate collaborations, or other means.

There can be no assurance that such financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and in our best interests.

Off-Balance Sheet Arrangements

5 unchanged sentences

however, due to inherent uncertainties in making estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods.

The critical accounting estimates that affect the consolidated financial statements and the judgments and assumptions used are consistent with those described under Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020.

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 3 –

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4 –

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

Our management, with the participation of our President and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “

Exchange Act ”) as of the end of the period covered by this Report.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on our evaluation, our President, the principal executive officer, and Chief Financial Officer concluded that, as of March 31, 2022, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15 of the Exchange Act that occurred during the quarter ended March 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Although we have modified our workplace practices due to the COVID-19 pandemic, resulting in many of our employees working remotely since March 2020, this has not materially affected our internal controls over financial reporting.

We continue to monitor and assess the COVID-19 situation on our internal controls to minimize the impact on their design and operating effectiveness.

PART II –

OTHER INFORMATION

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis