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, this section's discussion contains forward-looking statements involving 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 March 21, 2024 an d should be read together with the Company’s audited consolidated financial statements and the accompanying notes for the years ended December 31, 2023 and December 31, 2022. 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, which conducts 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™, ReCreate TM , CBD Medic™, CBD Clinic™, and Harmony Hemp™. Charlotte’s Web premium quality products start with proprietary hemp genetics that are 100% North American farm-grown and are then manufactured into hemp extracts containing naturally occurring phytocannabinoids including CBD, cannabichromene ("CBC"), cannabigerol ("CBG"), terpenes, flavonoids and other cannabinoids and beneficial hemp compounds. The Company is headquartered in a cGMP compliant facility in Louisville, Colorado, where the Company conducts its production of tinctures, distribution, and quality control activities as well as research and development ("R&D"). Charlotte’s Web product categories include full spectrum hemp extract oil tinctures (liquid products), gummies, capsules, CBD topical creams and lotions, and pet products. The Company also offers NSF Certified for Sports® broad spectrum tincture and gummy 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 website is not part of this MD&A. 59 The Company's business consists of the farming, manufacturing, marketing, and sales of hemp-derived CBD wellness products. As of December 31, 2023, the Company operated in a single operating and reportable segment, hemp-derived CBD wellness products. The 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 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 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 have any plans to expand into high THC products in the near future. The Company grows its proprietary hemp domestically in the United States on farms leased in northeastern Colorado and sources hemp through contract farming operations in Arizona, Kentucky, Oregon, and Canada. The Hemp grown in Canada is utilized exclusively in the Canadian markets or for research purposes and not in the Company's products sold within the United States. Recent Developments On April 6, 2023, the Company jointly formed an entity, DeFloria LLC ("DeFloria"), with AJNA BioSciences PBC ("AJNA") and a subsidiary of British American Tobacco PLC (LSE: BATS and NYSE: BTI) ("BAT"). BAT holds an equity interest in DeFloria in the form of 200,000 preferred units following its $10 million investment and has the right to participate in future equity issuances to maintain its pro rata equity position. The Company and AJNA each hold 400,000 of DeFloria’s voting common units. The Company’s contribution to DeFloria was a license permitting the use of certain proprietary hemp intellectual property, including clinical and consumer data. Additionally, the Company has a Supply Agreement with DeFloria, under which the Company supplies the oils at production cost to develop the new drug. AJNA's contribution to the entity is laboratory and regulatory services, clinical expertise and the provision of clinical services. DeFloria is utilizing the investments for the clinical development of a novel hemp botanical Investigational New Drug application and has commenced Phase I clinical development. On July 11, 2023, the Company expanded its product footprint with the launch of NSF Certified for Sports® broad spectrum gummy products, the Company's lifestyle and botanical wellness brand focused on the combination of organic broad-spectrum CBD and functional botanicals. In June of 2023, the Company announced its partnership as the Official CBD of the Premier Lacrosse League ("PLL"). In early 2023, Charlotte’s Web initiated a plan to move the production of topicals and gummies in-house, and in the third quarter, construction progressed with an initial capital expenditure. On-site manufacturing better utilizes the Company’s existing Louisville production facility, improving gross margins and aligns with the Company’s ongoing efforts to improve overall operating efficiencies. As of December 31, 2023, several states, including, but not limited to, Alaska, Florida, Maryland, Minnesota, New York, Utah, and Virginia, have adopted new regulations that will impact the Company's ability to sell certain products as currently formulated or packaged in these states. Many of these states have also implemented new THC/CBD limits, age verification, labeling and packaging requirements. The Company continues to assess the business and financial impacts of the new regulations, including steps that can be taken to address the new product formulation and labeling requirements, as well as costs and potential revenue impacts and anticipated timing for such impacts to the Company in these states. 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 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. 60 Selected Financial Information Year Ended December 31, 2023 2022 Total revenues $ 63,155 $ 74,139 Cost of goods sold 27,589 54,728 Gross profit $ 35,566 $ 19,411 Selling, general, and administrative expenses 75,630 70,060 Goodwill and asset impairments 548 1,837 Operating loss $ (40,612) $ (52,486) Gain on initial investment in unconsolidated entity 10,700 — Change in fair value of financial instruments 9,339 (7,480) Other income (expense), net (2,694) 744 Income tax expense (529) (91) Net loss $ (23,796) $ (59,313) Total assets $ 152,548 $ 187,642 Long-term liabilities $ 73,344 $ 88,710 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) 2023 2022 Direct-to-consumer ("DTC") revenue $ 42,625 $ 50,700 (15.9) % Business-to-business ("B2B") revenue 20,530 23,439 (12.4) % Total revenue $ 63,155 $ 74,139 (14.8) % Total revenue for the year ended December 31, 2023, was $63,155, a decrease of 14.8% compared to the year ended December 31, 2022. DTC e-commerce revenue decreased 15.9% compared to the year ended December 31, 2022. Lower year-over-year revenue was primarily due to lower traffic and sales through the Company’s webstore. The Company is revamping its e-commerce platform and upgrading its overall technology platform to enhance the consumer experience and increase traffic. B2B revenue decreased 12.4% compared to the year ended December 31, 2022. The decrease was primarily due to lower comparable shipments to some of the Company’s retail customers in 2023 who reduced total shelf space for CBD products, exited the CBD category, or closed retail locations. Charlotte’s Web remains the market share leader in combined SPINs and LLC/IRI measurements of total retail. 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 products sold, third-party quality costs, transportation, overhead allocations, and changes in inventory provisions. 61 The components of cost of goods sold are as follows: Year Ended December 31, % Increase (Decrease) 2023 2022 Inventory expensed to cost of goods sold 19,757 23,161 (14.7) % Inventory provision, net 1,039 23,394 (95.6) % Other production costs 3,222 4,768 (32.4) % Depreciation and amortization 3,571 3,405 4.9 % Cost of goods sold $ 27,589 $ 54,728 (49.6) % Cost of goods sold decreased 49.6% for the year ended December 31, 2023 compared to the same period in 2022. Inventory and other production costs that were expensed to cost of goods declined for the current year proportionately with revenue, with a further reduction of inventory provisions. 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. Inventory obsolescence is impacted by changes or prospective probable changes in the regulatory environments. For the year ended December 31, 2022, the Company's inventory provision was primarily due to the reserve for Hemp inventory of $20,349. Management determined 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. For the year ended December 31, 2023, there was no similar inventory provision. Depreciation and amortization expense for the year ended December 31, 2023 and 2022 was $15,160 and $8,968, respectively, of which $3,571 and $3,405, respectively, was expensed to cost of goods sold. The remaining depreciation and amortization expenses of $11,589 and $5,563, 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, revenue mix between DTC e-commerce and B2B, product sales mix, promotional and sales discount rate, manufacturing spend, transportation costs, and changes in inventory provisions. Gross profit for the years ended December 31, 2023 and 2022 is as follows: Year Ended December 31, % Increase (Decrease) 2023 2022 Gross profit $ 35,566 $ 19,411 83.2 % Gross margin 56.3 % 26.2 % 114.9 % Gross profit for the year ended December 31, 2023 was $35,566, compared to $19,411 for the year ended December 31, 2022, which included much larger inventory provisions of $23,394 in cost of goods sold. Before inventory provisions, gross profit was $36,605 and $42,805, respectively. The decrease in 2023 reflects the lower revenue in both DTC and B2B channels as discussed above. Gross margin reported for the years ended December 31, 2023 and 2022 was 56.3%, and 26.2% respectively. Before inventory provisions, gross margin for the years ended December 31, 2023 and 2022 was 58.0% and 57.7%, benefiting in 2023 from manufacturing efficiencies and improved costs of goods sold, despite lower year-over-year sales volume. 62 Selling, General, and Administrative Expenses Total Selling, general, and administrative expenses are as follows: Year Ended December 31, % Increase (Decrease) 2023 2022 Selling, general, and administrative expenses $ 75,630 $ 70,060 8.0 % Total Selling, general, and administrative expenses for the year ended December 31, 2023 and 2022 were $75,630 and $70,060, respectively. The 8.0% increase for the current year is primarily due to the amortization related to the MLB license and media rights assets of $9,794, compared to $2,034 for the year ended December 31, 2022. Additionally, for the year ended December 31, 2022, an Employee Retention Credit ("ERC") tax benefit of $4,106 was recognized reducing Selling, general, and administrative expense. Depreciation and amortization expensed to Selling, general, and administrative expenses for the year ended December 31, 2023 and 2022 were $11,589 and $5,563, respectively. Total research and development expenses for the year ended December 31, 2023 and 2022 were $2,964 and $3,435, 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. Gain on Initial Investment in Unconsolidated Entity The initial gain on investment in unconsolidated entity is as follows: Year Ended % (Decrease)/ Increase December 31, 2023 2022 Gain on initial investment in unconsolidated entity $ 10,700 $ — 100 % The gain on initial investment in unconsolidated entity for the year ended December 31, 2023 was $10,700. The gain was due to the Company jointly forming an entity, DeFloria, with AJNA, and BAT. DeFloria was established to pursue FDA approval for a novel botanical drug to target a neurological condition, with the botanical drug being developed from certain proprietary hemp genetics of the Company. The Company has the ability to select and elected to utilize the fair value option for the investment in DeFloria. As such the initial investment is measured at fair value and remeasured at each reporting date, with changes recognized in changes in fair value of financial instruments. Total Change in Fair Value of Financial Instruments The total change in fair value of financial instruments is as follows: Year Ended December 31, % Increase (Decrease) 2023 2022 Change in fair value of financial instruments $ 9,339 $ (7,480) 224.9 % Total change in fair value of financial instruments for the year ended December 31, 2023 and December 31, 2022 was a gain of $9,339 and a loss of $7,480, respectively. For the year ended December 31, 2023, the increase in the change in fair value of financial instruments was primarily due to the revaluation of the fair value of the Company's debt conversion option and debt interest rate conversion feature 63 resulting in a net gain of $9,609. The fair value of the Company's embedded derivatives and options are revalued at each reporting date, with changes impacted by variability in the Company's share price and implied debt yields. For the year ended December 31, 2022, the change in fair value of financial instruments was primarily driven by a loss of $10,700 in the fair value of the Company's SBH Purchase Option. The 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 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 net gain of $3,220. Asset Impairments For the year ended December 31, 2023, an impairment loss to building assets of $548 was recorded within Asset Impairment in the consolidated statement of operations. The impairment resulted from a decline in market conditions at the Company's hemp farm that indicated a fair value less than the carrying value. For the year ended December 31, 2022, the Company recorded an impairment of $1,837 related to operating leases. During the prior year, the Company ceased utilizing the Denver office space and plans to sublease the office space at current market rents. Provision for Income Taxes Year Ended December 31, % Increase (Decrease) 2023 2022 Income tax expense $ (529) $ (91) 481.3 % Effective tax rate (2.3) % (0.2) % The Company’s effective tax rate during the year ended December 31, 2023 and December 31, 2022 was (2.3)% and (0.2)%, respectively. The effective tax rate for the year ended December 31, 2023 is (2.3)% 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, 2023 and December 31, 2022. The decrease in the effective rate for the year ended December 31, 2023 compared to the year ended December 31, 2022, is primarily due to the remeasurement of the valuation allowance as well as changes in convertible debenture. . 64 Liquidity and Capital Resources The Company’s objective when managing its liquidity and capital resources is to provide sufficient short and long-term liquidity to fund net operating losses and capital expenditures while executing strategic growth plans. In the near to mid-term, we are focused on reducing negative cash flows from operations. On 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 be reduced 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 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. As of December 31, 2023, the Company had total cash and cash equivalents of $47,820, compared to $66,963 at December 31, 2022. The decrease over the twelve-month period is primarily a result of cash used in operating activities of $15,386, and capital expenditures of $3,691 primarily allocated to enabling in-house production of topical and gummy products. As a result of delays in federal regulation of the hemp CBD industry and lower-than-expected revenue , management began taking actions in 2022 to reduce annual operating costs by lowering employee costs, simplifying the business through 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. Other than an increase in MLB spend, management has continued these cost saving measures throughout 2023. 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. We believe that our existing cash and cash equivalents, and short-term investments will provide sufficient liquidity to fund operations and planned capital expenditures for the next 12 months. The Company’s ability to fund its operations for the longer term will depend on our 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. In addition to cash provided by operations, the Company may fund long-term liquidity requirements through various sources of capital. 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 raise funds through the issuance of additional equity and/or debt securities is dependent on a number of factors, including the current state of the capital markets, investor sentiment, and intended use of proceeds. Cash Flows Cash Flow from Operating Activities Net cash used in operating activities for the year ended December 31, 2023 and December 31, 2022 were as follows: Year Ended December 31, 2023 2022 Net cash used in operating activities $ (15,386) $ (5,315) 65 For the year ended December 31, 2023, the increase in cash used in operations is primarily due to cash outflows of $8,000 associated with the MLB Promotional Rights Agreement, compared to $500 for the year ended December 31, 2022. Additionally, for the year ended December 31, 2022, the Company collected $10,841 from income tax refunds and related interest. Cash Flow from Investing Activities Net cash provided by (used in) investing activities for the year ended December 31, 2023 and December 31, 2022 were as follows: Year Ended December 31, 2023 2022 Net cash provided by (used in) investing activities $ (3,506) $ 395 For the year ended December 31, 2023, the increase in cash used in investing activities was driven primarily by machinery purchases as part of the Company's plan to in-source topical and gummy production. Cash Flow from Financing Activities Net cash provided by (used in) financing activities for the year ended December 31, 2023 and December 31, 2022 were as follows: Year Ended December 31, 2023 2022 Net cash provided by (used in) financing activities $ (251) $ 52,389 For the year ended December 31, 2023, the decrease in cash provided by financing activities was primarily due to proceeds from the issuance of a $56.8 million convertible debenture received as of December 31, 2022. 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, 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 18, 2024, 156,960,668 common shares were issued and outstanding, and nil preferred shares were issued and outstanding. As of March 18, 2024, 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 $0.56; (ii) stock options exercisable to purchase 4,537,930 common shares pursuant to the Company’s 2018 option plan, as amended, with a weighted average exercise price of $1.33; (iii) 4,125,000 restricted share units ("RSUs"). Each option, restricted share award, and convertible share entitles the holder to purchase one common share. Off-Balance Sheet Arrangements As of December 31, 2023, 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. 66 Related party transactions Effective November 2020, the Company issued 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, 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. Effective December 28, 2023, the Company entered into a second amendment of the promissory note to extend the maturity date to November 13, 2024. According to the terms of the agreement, no additional interest will accrue through the payment date. For the year ended December 31, 2022 , the Company established a reserve against the note receivable due to a decline in collateral and risk associated with collectability and therefore expensed the outstanding balance of $1,037. On March 2, 2021, the Company entered into the SBH Purchase Option with Stanley Brothers USA as discussed above (Note 3 "Fair Value Measurement"). The SBH Purchase Option was purchased for total consideration of $8,000. Certain Company founders, who are or were employees at the time, are the majority shareholders of Stanley Brothers USA. 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. As of January 5, 2024 , the Brand License and Option Agreement has expired. On April 6, 2023, the Company jointly formed an entity, DeFloria, with AJNA and BAT. AJNA is a botanical drug development company. AJNA is partially owned and was co-founded by a co-founder of Charlotte's Web. BAT holds an equity interest in the entity in the form of 200,000 preferred units following its $10 million investment and has the right to participate in future equity issuances to maintain its pro rata equity position. On February 12, 2024, BAT invested an additional $3 million in the form of convertible debt. The Company and AJNA each hold 400,000 of the entity’s voting common units (Note 3). Effective May 1, 2023, the Company entered into an 8% interest-bearing note receivable with DeFloria for the sale of lab equipment in the amount of $170. The principal and interest of the note receivable will be paid in 36 monthly installments. As of December 31, 2023, the remaining note receivable of $128 is presented in other assets in the consolidated balance sheets. On February 12, 2024, the Company and DeFloria entered into a Master Services Agreement ("Services Agreement") in which the Company will be compensated for the provision of certain services to DeFloria. As of December 31, 2023, the Name and Likeness and License Agreement has reached its conclusion. The agreement included the payment of a nominal per diem fee for specifically requested activities as brand ambassadors for the Company. 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 , the Company recognized $1,025 of sales and marketing expenses in the condensed consolidated statements of operations related to this agreement. Recently Adopted Accounting Pronouncements There are no new accounting pronouncements adopted by the FASB that had or may have a material impact on the accompanying consolidated financial statements. Critical Accounting Policies and Estimates Listed below are the accounting policies and estimates 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. 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 67 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. Investment in Unconsolidated Entities The Company has a variable interest in the investment in DeFloria; however, the Company is not the primary beneficiary of DeFloria as it lacks the power to direct DeFloria's key activities. The Company concluded that the investment in DeFloria should not be consolidated. In accordance with ASC 825-10, equity method investments are eligible for the fair value option as they represent recognized financial assets. As the Company was not required to consolidate the investment and does not meet any of the other scope exceptions, the Company had the ability to adopt the fair value option for the investment at inception. The investment was remeasured at fair value after each reporting date, with changes recognized in consolidated statements of operations, as changes in fair value of financial instruments for the period. The use of assumptions for the fair value determination of the investment in Defloria included a high degree of subjectivity and judgment using unobservable inputs (level 3 on the fair value hierarchy), which results in estimation uncertainty. To determine the value of the investment, the Company utilizes an Option Pricing Model (OPM). The OPM considers the various terms of the stockholder agreements, including the level of seniority among the securities, dividend policy, conversion ratios, and cash allocations upon liquidation of the entity. The OPM is appropriate when the range of potential future outcomes is difficult to predict with any certainty. 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 cultivating 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 $548 and $1,837 of impairment losses recognized related to long-lived assets for the year ended December 31, 2023 and December 31, 2022, respectively. 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 pursuant to the provisions of ASC 815: 1) the interest rate conversion feature based on 68 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 was 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, forecasting reliability. 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, 2023 and December 31, 2022. The Company’s policy is to recognize interest and penalties on taxes, if any, within the statement of operations as income 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 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 is 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 69 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 does not 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.