Charlotte's Web Holdings, Inc. 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with, and is qualified in its entirety by, the audited consolidated financial statements and the accompanying notes. Except for historical information, the discussion in this section contains forward-looking statements that involve risks and uncertainties. Future results could differ materially from those discussed below for many reasons, including the risks described in Item 1A—“Risk Factors.” MD&A of Charlotte's Web Holdings, Inc. For purposes of this discussion, “Charlotte’s Web,” “CW,” “we,” “our,” “us," or the “Company” refers to Charlotte’s Web Holdings, Inc. and its subsidiaries: Charlotte’s Web, Inc. and Abacus Products, Inc., and its wholly-owned subsidiaries; Abacus Wellness, Inc. and CBD Pharmaceuticals Ltd. This management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as of Mar ch 23, 2023 an d should be read together with the Company’s audited consolidated financial statements and the accompanying notes for the years ended December 31, 2022 and December 31, 2021. The results herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Amounts are presented in thousands of United States dollars, unless otherwise indicated. BUSINESS OVERVIEW Charlotte’s Web Holdings, Inc. is a Certified B Corp headquartered in Louisville, Colorado, that does the majority of its business in the United States. The Company is a market leader in innovative hemp extract wellness products under a family of brands which includes Charlotte’s Web™, CBD Medic™, CBD Clinic™, and Harmony Hemp™. Charlotte’s Web branded premium quality products start with proprietary hemp genetics that are 100% North American farm grown and manufactured into hemp extracts containing naturally occurring phytocannabinoids including CBD, cannabichromene ("CBC"), cannabigerol ("CBG"), terpenes, flavonoids and other beneficial hemp compounds. The Company moved into its new cGMP facility in Louisville, Colorado during the second quarter of 2020 at which the Company conducts its production of tinctures, distribution, and quality control activities, and has 83 expanded its research and development ("R&D"). Charlotte’s Web product categories include full spectrum hemp extract oil tinctures (liquid products), gummies (sleep, calm, immunity, exercise recovery), capsules, CBD topical creams and lotions, as well as products for pets. As of October 2022, the Company produces NSF Certified for Sports broad spectrum tincture products. Charlotte’s Web products are distributed to retailers and health care practitioners, and online through the Company’s website at www.CharlottesWeb.com. The information provided on the Charlotte’s Web website is not part of this MD&A. The business of the Company consists of the farming, manufacturing, sales, and marketing of products of hemp-derived CBD wellness products. As of December 31, 2022, the Company operated in a single operating and reportable segment, hemp-derived CBD wellness products, as its executive officers reviewed overall operating results in order to assess financial performance and to make resource allocation decisions, rather than to assess a lower-level unit of operations in isolation. The Company’s primary products are made from high quality and proprietary strains of whole-plant hemp extracts containing a full spectrum of phytocannabinoids, terpenes, flavonoids and other hemp compounds. The Company believes the presence of these various compounds work synergistically to heighten the effects of the products, making them superior to single-compound isolates. Hemp extracts are produced from the plant Cannabis and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a THC concentration of not more than 0.3% on a dry weight basis. The Company is engaged in research involving a broad variety of compounds derived from Hemp. Where research provides evidence that a greater than 0.3% THC level may have a potential therapeutic use, the Company may consider pursuing development of that use in jurisdictions where it is legal to do so in accordance with applicable regulations and if consistent with the Company’s founding principles. The Company does not currently produce or sell medicinal or recreational marijuana or products derived from high-THC Cannabis plants. On March 2, 2021, Charlotte’s Web executed the SBH Purchase Option pursuant to which the Company has the option to acquire Stanley Brothers USA, a Cannabis wellness incubator. Until the SBH Purchase Option is exercised, both Charlotte’s Web and Stanley Brothers USA will continue to operate as standalone entities in the US. Outside the US, the companies are able to explore opportunities where Cannabis is federally permissible. At this time, however, the Company does not have any plans to expand into high-THC products in the near future. On October 12, 2022, the Company announced the launch of Charlotte’s Web TM SPORT – Daily Edge, the first broad-spectrum hemp-derived tincture to be Certified for Sport® by NSF, the highly respected global third-party organization that establishes standards for safety, quality, sustainability, and performance as well as certifies manufacturers and products against them. NSF's Certified for Sport ® program verifies that products do not contain unsafe levels of contaminants, prohibited substances or masking agents, and that what is on the label matches what is in the product. The Certified for Sport ® certification is the only independent third-party certification program recognized by Major League Baseball. In the US, the Company holds the number one market share position in the CBD market relative to retail dollars, this is based on market share data from leading third-party analysts such as Nielsen Company (US), LLC (“Nielsen”), SPINS, LLC (“Spins”) and Brightfield Group (“Brightfield”), respectively. The Company grows its proprietary hemp domestically in the United States on farms leased in northeastern Colorado and sources high quality Hemp through contract farming operations in Kentucky, Oregon, and Canada. The Hemp grown in Canada is utilized exclusively in the Canadian market and not in products sold in the United States. Effective November 1, 2022, the Company entered into a Manufacturing and Sales License Agreement with Aphria, Inc., an Ontario corporation, an affiliate of Tilray, pursuant to which the parties entered into a strategic alliance by which Tilray will have the rights to licensing, manufacturing, marketing and distribution of Charlotte’s Web TM CBD hemp extract products in Canada. 84 The Company continues to invest in R&D efforts to identify new product opportunities. The Company is working to capitalize on the rapidly emerging botanical wellness products industry by driving customer acquisition and retention, as well as accelerating national and international retail expansion. In addition, the Company may consider expanding its product line beyond Hemp-based products should the science and the Company’s founding principles support such expansion. In furtherance of the Company’s R&D efforts, in February 2020, the Company established CW Labs, an internal division for R&D, to expand the Company’s efforts around the science of Hemp derived compounds. CW Labs is currently engaged in clinical trials addressing Hemp-based health solutions. CW Labs is located in Louisville, Colorado at the Company’s cGMP production and distribution facility. Selected Financial Information Year Ended December 31, 2022 2021 Total revenues $ 74,139 $ 96,092 Cost of goods sold 54,728 47,507 Gross profit $ 19,411 $ 48,585 Selling, general, and administrative expenses 70,060 97,641 Goodwill and asset impairments 1,837 98,003 Operating loss $ (52,486) $ (147,059) Other income (expense), net 744 51 Change in fair value of financial instruments and other (7,480) 9,429 Income tax expense (91) (143) Net loss $ (59,313) $ (137,722) Total assets $ 187,642 $ 171,513 Long-term liabilities $ 88,710 $ 20,897 Revenue The majority of the Company’s revenue is derived from sales of branded products to consumers via the Company’s DTC e-commerce website, distributors, and retail B2B customers. Year Ended December 31, % Increase (Decrease) 2022 2021 Direct-to-consumer ("DTC") revenue $ 50,700 $ 62,334 (18.7) % Business-to-business ("B2B") revenue 23,439 33,758 (30.6) % Total revenue $ 74,139 $ 96,092 (22.8) % Total revenue for the year ended December 31, 2022 was $74,139, a decrease of (22.8)% compared to the year ended December 31, 2021. DTC e-commerce revenue decreased (18.7)% compared to the year ended December 31, 2021. The decrease was primarily due to lower traffic at our online store due to lower organic search, less paid media and less effective earned and affiliate traffic generation, resulting in approximately $11,000 decrease year over year. Additional drivers include an increase in price promotions for gummies and topicals. The decrease was partially offset by higher customer subscription orders through its loyalty program and a more favorable product mix compared to prior year. 85 B2B revenue decreased (30.6)% compared to the year ended December 31, 2021. The decrease was due to the Food Drug Mass retail and Natural channels reducing CBD products shelf space resulting in a decrease of approximately $12,000 year over year. Additional drivers include higher depth and frequency of price promotions. The decrease was partially offset by new retail distribution following the passing of Assembly Bill 45 in California in late 2021. Cost of Goods Sold Cost of goods sold includes the cost of inventory sold, changes in inventory provisions, and other production costs expensed. Other production costs include direct and indirect production costs including direct labor, processing, testing, packaging, quality assurance, security, shipping, depreciation of production equipment, indirect labor, including production management, and other related expenses. The primary factors that can impact cost of goods sold on a period-to-period basis include the volume of products sold, mix of product sold, third-party quality costs, transportation, overhead allocations and changes in inventory provisions. The components of cost of goods sold are as follows: Year Ended December 31, % Increase (Decrease) 2022 2021 Inventory expensed to cost of goods sold 23,161 28,620 (19.1) % Inventory provision, net 23,394 9,729 140.5 % Other production costs 4,768 6,180 (22.8) % Depreciation and amortization 3,405 2,978 14.3 % Cost of goods sold $ 54,728 $ 47,507 15.2 % Cost of goods sold increased 15.2% for the year ended December 31, 2022 compared to the same period in 2021, primarily due to $13,665 or 140.5% increase in the inventory provision. The inventory provision is estimated by management based on its assessment of market conditions, including forecasted demand compared to quantities on hand, as well as other factors such as potential excess, or aged inventories based on product shelf life. Additionally, inventory obsolescence is impacted by changes or prospective probable changes in the regulatory environments. The inventory provision increase was primarily due to an increase in the reserve for Hemp inventory of $20,349 , based on management's determination during the fourth quarter that this inventory would no longer be used in product formulations as a result of Colorado's anticipated regulatory changes based on Senate Bill 22-205 , as well as aged finished goods. The increase was partially offset by a decrease of 19.1% in inventory expensed to cost of goods sold for the year ended December 31, 2022 compared to December 31, 2021. The decrease was primarily due to lower unit volume sold and mix, as lower cost gummies volume decreased 13% compared to higher cost tinctures which decreased 41% year over year. Depreciation and amortization expense for the year ended December 31, 2022 and 2021 was $8,968 and $11,025, respectively, of which $3,405 and $2,978, respectively, was expensed to cost of goods sold. The remaining depreciation and amortization expenses of $5,563 and $8,047, respectively, was expensed to Selling, general, and administrative expenses. Gross Profit The primary factors that can impact gross profit margins include the volume of products sold, mix of revenue between DTC e-commerce and B2B, mix of products sold, promotional and sales discount rate, manufacturing spend, transportation costs, and changes in inventory provisions. 86 Gross profit for the years ended December 31, 2022 and 2021 is as follows: Year Ended December 31, % Increase (Decrease) 2022 2021 Gross profit $ 19,411 $ 48,585 (60.0) % Gross margin 26.2 % 50.6 % (48.2) % Gross profit decreased 60.0% for the year ended December 31, 2022 compared to 2021. The decrease is primarily related to lower revenue in both the DTC and B2B channels which was discussed above, and an increase in inventory provisions. The decrease is partially offset by lower inventory expenses. Gross profit before the inventory provision was $42.8 million and $58.3 million, respectively, and gross margin before inventory provision was 58% and 61% for the year ended December 31, 2022 and 2021, respectively. Selling, General, and Administrative Expenses Total Selling, general, and administrative expenses are as follows: Year Ended December 31, % Increase (Decrease) 2022 2021 Selling, general, and administrative expenses $ 70,060 $ 97,641 (28.2) % Total Selling, general, and administrative expenses for the year ended December 31, 2022 and 2021 were $70,060 and $97,641, respectively. The 28.2% decrease was primarily attributable to activities during the year which lowered personnel costs by $10,569, an Employee Retention Credit ("ERC") tax benefit of $4,106, a decrease in media marketing spend of $5,154, along with lower depreciation and amortization. Depreciation and amortization expensed to Selling, general, and administrative expenses for the year ended December 31, 2022 and 2021 were $5,563 and $8,047. Total research and development expenses for the year ended December 31, 2022 and 2021 were $3,435 and $5,502, respectively, expensed to Selling, general, and administrative expense. Research and development expenses primarily include personnel costs related to our R&D science division as well as R&D related projects advancing Hemp cannabinoid science through research programs that provide a better understanding of the therapeutic uses of cannabinoids. Goodwill and asset impairments For the year ended December 31, 2022, the Company recorded an impairment of $1,837 related to operating leases. During the year, the Company made the decision to cease utilizing the Denver office space and plans to sublease the office space at current market rents. Based on an analysis of the estimated undiscounted cash flows relative to a potential sublease arrangement, the Company evaluated the recoverability of the assets associated with the subleased space, including, the right-of-use asset and concluded the asset was impaired. This analysis resulted in a full impairment charge totaling $1,822 included in Goodwill and asset impairments charges on the consolidated statements of operations for the year ended December 31, 2022. For the year ended December 31, 2021, the Company fully impaired the goodwill and intangible assets related to customer relationships and trade names recorded from the acquisition of Abacus during the year ended totaling $76,039. The Company determined the sustained decrease in our share price in the fourth quarter of 2021, along with a significant decline to the equity value of the Company's peers and overall U.S. stock market, represented a goodwill impairment triggering event. The Company performed a quantitative analysis as of December 31, 2021 to 87 determine if impairment to our goodwill existed for the one reporting unit. We used a blended approach in calculating fair value of our one reporting unit including the income approach, market approach, and market capitalization approach. This analysis resulted in full impairment of our goodwill balance totaling $76,039 included in Goodwill and asset impairments charges on the consolidated statements of operations for the year ended December 31, 2021 . The goodwill impairment was measured as the amount by which the carrying value of the reporting unit, including goodwill, exceeded its fair value. The factors listed above representing a goodwill triggering event also indicated a triggering event for the Company's acquired customer relationships and trade name intangible assets. The Company performed a quantitative analysis as of December 31, 2021 to determine if impairment existed by comparing the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate over their remaining lives. This analysis resulted in full impairment of the of customer relationships and trade name intangible assets acquired and total an impairment loss of $19,750 was recorded for the year ended December 31, 2021. Total Change in Fair Value of Financial Instruments and Other Total change in fair value of financial instruments and other is as follows: Year Ended December 31, % Increase (Decrease) 2022 2021 Change in fair value of financial instruments and other $ (7,480) $ 9,429 (179.3) % Total change in fair value of financial instruments and other for the year ended December 31, 2022 and December 31, 2021 was a loss of $7,480 and a gain of $9,429, respectively. For the year ended December 31, 2022, there was a loss in the fair value of the Company's SBH Purchase Option of $10,700 compared to a gain of $5,000 as of December 31, 2021. The fair value of the Company's SBH Purchase option is revalued at each reporting date with changes primarily based on financial projections of Stanley Brothers USA and the probability and timing of exercise. Additionally, for the year ended December 31, 2022, the change in fair value of financial instruments and other was partially offset by the revaluation of the fair value of the Company's debt interest rate conversion feature and debt conversion option resulting in a gain of $138 and $3,082, respectively. For the year ended December 31, 2021, the change in fair value of financial instruments and other was driven by the revaluation of the fair value of the Company's warrant liabilities resulting in a gain of $4,304. As of December 31, 2022, all outstanding warrants have expired. The fair value of the Company's financial derivative instruments and SBH purchase option are revalued at each reporting date. Provision for Income Taxes Year Ended December 31, % Increase (Decrease) 2022 2021 Income tax (expense) benefit $ (91) $ (143) (36.4) % Effective tax rate (0.1) % (0.1) % The Company’s effective tax rate during the year ended December 31, 2022 and December 31, 2021 was (0.1)% and (0.1)%, respectively. The effective tax rate for the year en ded December 31, 2022 is (0.1)% as the Company continues to believe its deferred tax assets are not more-likely-than-not to be realized and a full valuation allowance remains recorded against net deferred taxes as of December 31, 2022 and December 31, 2021. The effective rate for the year ended December 31, 2022 is consistent with the year ended December 31, 2021, as the Company has been in a full valuation allowance for both year ends. 88 Liquidity and Capital Resources As of December 31, 2022 and December 31, 2021, the Company had total current liabilities of $21,427 and $20,170, respectively, and cash and cash equivalents of $66,963 and $19,494, respectively, to meet its current obligations. Despite lower revenues than 2021, the Company has taken actions to reduce operating costs by approximately $30,000 by eliminating positions and lowering employee costs, simplifying the business by rationalizing the number of products produced and sold, reducing the number of third-party co-manufacturers, and lowering spend on non-employee related SG&A costs. For the year ended December 31, 2022, the Company collected the outstanding IRS receivable of approximately $10,841, partially offset by cultivation payments of $3,049. Effective as of November 14, 2022, the Company entered into a subscription agreement with BT DE Investments, Inc. a wholly-owned subsidiary of BAT Group (LSE: BATS and NYSE: BTI), providing for the issuance of an approximately $56.8 million convertible debenture (the “debenture”). The debenture is convertible into 19.9% ownership of the Company’s Common Shares at a conversion price of C$2.00 per Common Share of the Company on the Toronto Stock Exchange (TSX). The debenture will accrue interest at a stated annualized rate of 5% until such time that there is federal regulation permitting the use of CBD as an ingredient in food products and dietary supplements in the United States. Following federal regulation of CBD, the stated annualized rate of interest shall reduce to 1.5%. Interest is accrued annually and payable on the maturity date or date of earlier conversion. The maturity date for the debenture is November 2029. The Subscription Agreement contains customary representations, warranties and covenants. The funds from this debenture can be used for operating purposes to fund the Company, as approved by the board of directors or in accordance with the Company’s board-approved budget. The Company expects its selling, general and administrative expenses in 2023 to be slightly higher than 2022 reflecting the incremental costs of the MLB Promotional Rights Agreement and related marketing activations. The investments in paid license and media rights as well as the launch of the new NSF Certified for Sports brand products are intended to combat the decline in revenues in the current year. The Company’s primary sources of liquidity are its net cash on hand from operations and sales of its securities from time to time. The Company’s ability to fund its operations for the next twelve months and thereafter will depend on its future operating performance, particularly revenue growth, which can be affected by general economic conditions, industry regulatory changes, and other factors beyond the Company’s control. Management continually assesses liquidity in terms of the ability to generate sufficient cash flow to fund the business. Net cash flow is affected by the following items: (i) operating activities, including the cash impacts from the statements of operations, the level of accounts receivables, accounts payable, accrued liabilities and unearned revenue and deposits; (ii) investing activities, including the purchase of property and equipment; and (iii) financing activities, including bank line of credits and the issuance of capital shares. The Company filed a final short form base shelf prospectus on May 5, 2021 with Canadian regulators, with a term of 25-months, which allowed the Company to qualify the distribution by way of prospectus in Canada of up to C$350,000 of common shares, preferred shares, warrants, subscription receipts, units, or any combination thereof. The final short form base prospectus was set to expire on June 6, 2023. The Company filed a prospectus supplement to distribute up to C$60,000 of common shares of the Company (the "Offered Shares") under the ATM Program. As of January 4, 2022, the ATM Program ceased to be available to the Company. Thereafter, the manner in which the Company raises capital will likely require that the Company file registration statements with the SEC related to such activities, which will likely increase the time and expense associated with such activities. The Company expects to meet our long-term liquidity requirements through various sources of capital, including cash provided by operations. The Company regularly considers fundraising opportunities and may decide, from time to time, to raise capital through borrowings or issuances of additional equity and/or debt securities. The Company's ability to incur additional debt is dependent upon a number of factors, including the state of the credit markets, our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by lenders, including restrictions on the industry. The Company's ability to raise funds through the issuance of additional equity and/or debt securities is also dependent on a number of factors including the current state of the capital markets, investor 89 sentiment and intended use of proceeds. The Company's ability to raise funds through the issuance of equity securities depends on, among other things, general market conditions for companies in the Hemp industry and market perceptions about us. Cash Flows Cash Flow from Operating Activities Net cash used in operating activities for the year ended December 31, 2022 and December 31, 2021 were as follows: (in thousands) Year Ended December 31, 2022 2021 Net cash used in operating activities $ (5,315) $ (29,559) For the year ended December 31, 2022, the decrease in cash used in op erations is primarily related to lower operating expenses, collection of the $10,841 from income tax refunds and its related interest, partially offset by lower revenues and cultivation payments. Cash Flow from Investing Activities Net cash provided by (used in) investing activities for the year ended December 31, 2022 and December 31, 2021 were as follows: (in thousands) Year Ended December 31, 2022 2021 Net cash provided by (used in) investing activities $ 395 $ (11,789) For the year ended December 31, 2022, the decrease in cash used in investing activities was driven by lower capital expenditures, and partially offset by proceeds from the sale of assets. For the year ended December 31, 2021 the outflow was related to the SBH Purchase Option executed for total consideration of $8,000 and the purchase of $4,918 in capital expenditures, partially offset by other investing activities. Cash Flow from Financing Activities Net cash provided by financing activities for the year ended December 31, 2022 and December 31, 2021 were as follows: (in thousands) Year Ended December 31, 2022 2021 Net cash provided by financing activities $ 52,389 $ 8,039 For the year ended December 31, 2022, the increase in cash provided by financing activities was primarily due to proceeds from the issuance of $56.8 million convertible debenture, partially offset by debt issuance costs, share issuance costs, and employee equity vestings. For the year ended December 31, 2021, the net cash provided by financing activities during the period was primarily from ATM Program proceeds of $8,257. Outstanding Share Data The Company’s authorized share capital consists of (i) an unlimited number of common shares; (ii) an unlimited number of proportionate voting shares (each proportionate voting share is equal to 400 common shares in terms of voting and economic rights); and (iii) an unlimited number of preferred shares, issuable in series. On November 3, 90 2021, all outstanding proportionate voting shares of the Company were converted by way of mandatory conversion in accordance with the Company’s Articles and at the discretion of the Company, into common shares. Following this conversion, and as of the close of business on November 3, 2021, 142,335,464 common shares were issued and outstanding, nil proportionate voting shares were issued and outstanding and nil preferred shares were issued and outstanding. Pursuant to the Company’s Articles, the Company is no longer authorized to issue additional proportionate voting shares. As of March 20, 2023, 152,422,498 common shares were issued and outstanding and nil preferred shares were issued and outstanding. As of March 20, 2023, potential dilutive securities include (i) stock options exercisable to purchase 985,012 common shares pursuant to the Company’s 2015 legacy option plan with a weighted average exercise price of $0.5600; (ii) stock options exercisable to purchase 3,380,129 common shares pursuant to the Company’s 2018 option plan, as amended, with a weighted average exercise price of $1.28; (iii) 2,270,605 restricted share units ("RSUs"); (iv) 28,937,417 convertible shares related to convertible debenture. Each option, restricted share award, and convertible share entitles the holder to purchase one common share. Off-Balance Sheet Arrangements As of December 31, 2022, we do not have any off-balance-sheet arrangements that have, or are reasonably likely to have, a current or future effect on our results of operations or financial condition, including, and without limitation, such considerations as liquidity and capital resources. Related party transactions Aidance Scientific, Inc. (“Aidance”) is the manufacturer of nearly all Abacus products. The former Chief Executive Officer of Abacus Health ("Abacus"), and a former officer of the Company through March 2022, also serves on Aidance’s Board of Directors. For the years ended December 31, 2022 and 2021, the Company made purchases of $3,293 and $3,570, respectively from Aidance. Payment terms on purchases are due 30 days after receipt. As of December 31, 2022 and 2021, the Company had a liability of $36 and $119, respectively, due to Aidance presented in accounts payable in the consolidated balance sheets. Effective November 2020, the Company entered into a note receivable with certain founders of the Company to negotiate a future binding transaction in good faith. This agreement included a secured promissory note, where $1,000 was loaned to one of the founders. The note receivable was secured by equity instruments with certain founders of the Company, and bore interest at 3.25% per annum, and required the unpaid principal and unpaid interest balances to be paid on or before the maturity date of November 13, 2021. On March 22, 2022, the founders requested an extension of the maturity date, as allowed under the terms of the promissory note, resulting in an extension of the maturity date to November 13, 2023. According to the terms of the agreement, no additional interest will accrue through the payment date. As of December 31, 2021, the note receivable of $1,037 consisted of principal and interest. As of December 31, 2022, the Company has fully reserved the collectability of the note receivable and expensed the outstanding balance of $1,037 due to the declining value in the collateral in the fourth quarter. Effective January 5, 2023, the Company entered into a Brand License and Option Agreement with JMS Brands LLC, an entity owned by one of the Company’s founders. Pursuant to the Brand License and Option Agreement, the Company licenses certain intellectual property from JMS Brands LLC, for an annual license fee of $500. Pursuant to the terms of the agreement, the Company has the option to purchase the intellectual property rights for $2,000. On March 2, 2021, the Company entered into the SBH Purchase Option with Stanley Brothers USA as discussed above (note "Fair Value Measurement"). The SBH Purchase Option was purchased for total consideration of $8,000. Certain founder s of the Company, who are or were employees at the time, are the majority shareholders of Stanley Brothers USA. Pursuant to an amendment to the Name and Likeness and License Agreement between the Company and Leeland & Sig LLC d/b/a Stanley Brothers Brand Company, the agreement was extended to June 30, 2023. The agreement includes the payment of a nominal per diem fee for specifically requested activities as brand ambassadors for the 91 Company. In addition, on April 16, 2021, the Company executed a separate consulting agreement which extended the services agreements of the Stanley brothers for a period of one year, expiring July 31, 2022. Upon execution of the consulting agreement, the Company paid $2,081 to Leeland & Sig LLC d/b/a Stanley Brothers Brand Company, on behalf of the Stanley Brothers, as consideration for the consulting services to be provided to the Company over the term of the agreement and certain restrictive covenants. For the year ended December 31, 2022 and 2021, the Company recognized $1,025 and $1,056, respectively, of sales and marketing expenses in the condensed consolidated statements of operations related to this agreement. As of December 31, 2022 , there is no remaining balance. Recently Adopted Accounting Pronouncements In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which aims to reduce complexity in accounting standards by improving certain areas of U.S. GAAP without compromising information provided to users of financial statements. ASU 2019-12 is effective for public entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the standard is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption is permitted. There was an immaterial impact upon adoption on the condensed consolidated financial statements. In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40):Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (“ASU 2020-06”), which simplifies the accounting for convertible instruments by removing the separation models for convertible debt instruments and convertible preferred stock with (1) cash conversion features, and (2) beneficial conversion features. In addition, ASU 2020-06 enhances information transparency by making targeted improvements to the disclosures for convertible instruments and earnings-per-share guidance and amends the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. ASU 2020-06 is effective for emerging growth companies for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. The Company evaluated the impact of the pronouncement, see further discussion within the note "Summary of Significant Accounting Policies and use of Estimates". In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance , which addresses that Current GAAP has no specific authoritative guidance on the accounting for, or the disclosure of, government assistance received by business entities. The pronouncement and subsequent amendments require the following annual disclosures about transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy: 1) Information about the nature of the transactions and the related accounting policy used to account for the transactions; 2) The line items on the balance sheet and income statement that are affected by the transactions, and the amounts applicable to each financial statement line item, 3) Significant terms and conditions of the transactions, including commitments and contingencies. ASU 2021-10 is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. The Company evaluated the impact of the pronouncement, see further discussion within the note "Income and Other Taxes". Critical Accounting Estimates Listed below are the accounting policies we believe are critical to our financial statements due to the degree of uncertainty regarding the estimates or assumptions involved and the magnitude of the asset, liability, revenue or expense being reported. Please also refer to note "Summary of Significant Accounting Policies and Use of Estimates" of our notes to consolidated financial statements for a discussion on recently adopted and issued accounting pronouncements. 92 Fair Value Option The Company has elected the fair value option in accordance with ASC 825-10 guidance to record its SBH Purchase Option. Under ASC 825-10, a business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The SBH Purchase Option is classified as a financial asset in the consolidated balance sheets and is remeasured at fair value at each reporting date, with changes to fair value recognized in the statements of operations for the period. The use of assumptions for the fair value determination includes a high degree of subjectivity and judgment using unobservable inputs (level 3 on the fair value hierarchy), which results in estimation uncertainty. Changes in assumptions that reasonably could have been different at the reporting date may result in a higher or lower determination of fair value. The Monte Carlo valuation model considers multiple revenue and EBITDA outcomes for Stanley Brothers USA and other probabilities in assigning a fair value. Primary assumptions utilized include financial projections of Stanley Brothers USA and the probability and timing of exercise asserted by the Company. Inventories Inventories are stated at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less any applicable selling expenses. Cost includes all expenses for direct raw materials inputs, as well as costs directly attributable to the manufacturing process as well as suitable portions of related production overheads, based on normal operating capacity. Cost is determined by use of the weighted average method. To determine if a provision for inventories is required, the Company periodically reviews the value of items in inventory and provides write-downs or write-offs of inventory based on its assessment of market conditions, including forecasted demand compared to quantities on hand, as well as other factors such as potential excess or aged inventories based on product shelf life, and other factors that affect inventory obsolescence. The Company’s inventories of harvested hemp are recorded at cost to grow and harvest. Raw materials costs as well as production costs are included in the carrying value of the Company’s finished goods inventory. The Company's inventory production process for cannabinoid products includes the cultivation of botanical raw material. Because of the duration of the cultivation process, a portion of the inventory will not be sold within one year. Consistent with the practice in other industries that cultivate botanical raw materials, all inventory is classified as a current asset. Impairment of Long-Lived Assets The Company reviews intangible assets with indefinite useful lives for impairment at least annually and reviews all intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. Long-lived assets, such as property and equipment and intangible assets subject to depreciation and amortization, as well as indefinite lived intangibles and goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable or that the useful life is shorter than the Company had originally estimated. Recoverability of these assets is measured by comparison of the carrying amount of each asset or asset group to the future undiscounted cash flows the asset or asset group is expected to generate over their remaining lives. If the asset or asset group is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset or asset group. If the useful life is shorter than originally estimated, the Company amortizes the remaining carrying value over the new shorter useful life. Impairment losses are recorded in selling, general, and administrative expense in the consolidated statements of operations. There was $1,837 and $21,964 of impairment losses recognized related to long-lived assets for the year ended December 31, 2022 and December 31, 2021, respectively. Additionally, the Company determined that there was $76,039 of impairment of its goodwill for the year ended December 31, 2021. Convertible Debenture The Company determined that the debenture is a freestanding financial instrument, which includes embedded derivatives. The embedded derivatives have been bifurcated from the debenture and accounted for separately in accordance with the provisions of ASC 815, Derivatives and Hedging . The Company reviewed the terms of the debenture and identified two material embedded features which required bifurcation and separate accounting 93 pursuant to the provisions of ASC 815: 1) the interest rate conversion feature based on changes in federal regulations, and 2) the debt conversion option to common shares. The debt interest rate conversion feature is classified as a derivative asset and measured at fair value using a probability weighted income approach. The debt conversion option is classified as a derivative liability and measured at fair value using a Black-Scholes option pricing model. The Company allocated proceeds first to the derivatives measured at fair value and the residual amount is allocated to the debenture. Debt issuance costs are allocated to the debenture. The debt issuance costs are presented as a direct reduction from the face value of the debenture and amortized over the stated term of the debenture. Income Taxes The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income tax assets or liabilities are computed based on the temporary difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal income tax rate in effect for the year in which the differences are expected to reverse. Deferred income tax expense or benefit is based on the changes in the deferred income tax assets or liabilities from period to period. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Significant judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against net deferred tax assets. The Company assesses the likelihood that deferred tax assets will be recovered as deductions from future taxable income. The evaluation of the need for a valuation allowance is performed on a jurisdiction-by-jurisdiction basis and includes a review of all available positive and negative evidence. Factors reviewed include projections of pre-tax book income for the foreseeable future, determination of cumulative pre-tax book income or loss, earnings history, and reliability of forecasting. It is the Company's policy to offset indefinite lived deferred tax assets with indefinite lived deferred tax liabilities. The Company provided a full valuation allowance on deferred tax assets because it is more likely than not that deferred tax assets will not be realized. The Company accounts for uncertainties in income taxes under ASC Topic 740, which prescribes a recognition threshold and measurement methodology to recognize and measure an income tax position taken, or expected to be taken, in a tax return. With respect to any tax positions that do not meet the recognition threshold, a corresponding liability, including interest and penalties, is recorded in the consolidated financial statements. The Company may be subject to examination by tax authorities where the Company conducts operations. The earliest income tax year that may be subject to examination is 2019. The Company has recorded an uncertain tax position as of December 31, 2022 and December 31, 2021. The Company’s policy is to recognize interest and penalties on taxes, if any, within the statement of operations as income tax expense. The Company qualified for federal government assistance through employee retention credit (“ERC”) provisions of the Consolidated Appropriations Act of 2021. As there is no authoritative guidance under U.S. GAAP on accounting for government assistance to for-profit business entities, we account for grants provided by the government, including accounting for certain refundable tax credits, by analogy to International Accounting Standard ("IAS") 20, Accounting for Government Grants and Disclosure of Government Assistance. In accordance with IAS 20, management determined it has reasonable assurance for receipt of the ERC and recorded the ERC benefit as of December 31, 2022 within the statement of operations as a payroll tax expense. Revenue Recognition The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customer (“ASC 606”). The Company elected to early adopt ASC 606 as of January 1, 2018, as permitted by the standard. The Company performs the following five steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company applies the five-step model to arrangements that meet the definition of a contract under the standard, including when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods 94 or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of revenue accounting, the Company evaluates the goods or services promised within each contract related performance obligation and assesses whether each promised good or service is distinct. The Company recognizes as revenue, the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. The Company recognizes revenue from customers when control of the goods or services are transferred to the customer, generally when products are shipped, at an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods and services. Freight revenue is included in revenue on the consolidated statements of operations, and is generally exempt from state sales taxes. Sales tax collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from revenue in the consolidated statements of operations. Contracts are written to include standard discounts and allowances. Contracts are not written to include advertising allowances, tiered discounts or any other performance obligation. Since the Company’s contracts involve the delivery of various tangible products, the arrangements are considered to contain only a single performance obligation, as such there is no allocation of the transaction price. The Company also offers e-commerce discounts and promotions through its online rewards program. The Charlotte’s Web Loyalty Program offers customers rewards points for every dollar spent through the Company website to earn store credit for future purchases. The Company defers recognition of revenue for unredeemed awards until the following occurs: (1) rewards are redeemed by the consumer, (2) points or certificates expire, or (3) an estimate of the expected unused portion of points or certificates is applied, which is based on historical redemption patterns. Any product that doesn’t meet the customer’s expectations can be returned within the first 30 days of delivery in exchange for another product or for a full refund. Generally, any product sold through a distributor or retailer must be returned to the original purchase location for any return or exchange. The Company accounts for customer returns utilizing the “expected value method.” Expected amounts are excluded from revenue and recorded as a “refund liability” that represents the Company’s obligation to return the customer’s consideration. Estimates are based on actual historical and current specific data.