Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion
and Analysis of Financial Condition and Results of Operations (the “MD&A”) should be read in conjunction with our financial
statements and the related notes thereto included elsewhere herein. The MD&A contains forward-looking statements that involve risks
and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Any statements that are not statements of
historical fact are forward-looking statements. When used, the words “believe,” “plan,” “intend,”
“anticipate,” “target,” “estimate,” “expect,” and the like, and/or future-tense or conditional
constructions (“will,” “may,” “could,” “should,” etc.), or similar expressions, identify
certain of these forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause
actual results or events to differ materially from those expressed or implied by the forward-looking statements in this Annual Report.
Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result
of several factors.
Historical results may not indicate future
performance. Our forward-looking statements reflect our current views about future events, are based on assumptions and are subject to
known and unknown risks and uncertainties that could cause actual results to differ materially from those contemplated by these statements.
We undertake no obligation to publicly update or revise any forward-looking statements, including any changes that might result from any
facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. Furthermore, we cannot guarantee
future results, events, levels of activity, performance, or achievements.
Overview
Driven by tech and data, iPower
Inc. is an online supplier of consumer goods, including hydroponics equipment, general gardening supplies, and consumer home goods. Through
the operations of our e-commerce platforms and channel partners, our combined 121,000 square foot fulfillment centers in Rancho Cucamonga
and Los Angeles, California, we believe we are one of the leading marketers, distributors and retailers in the consumer gardening and
home goods categories, based on management’s estimates. Our core strategy continues to focus on expanding our geographic reach across
the United States and internationally through organic growth, both in terms of expanding customer base as well as brand and product development.
iPower has developed a set of methodologies driven by proprietary data formulas to effectively bring products to market and sales.
We are actively developing our
in-house branded products and through supply chain partners, which to date include the iPower and Simple Deluxe
brands and more, some of which have been designated as Amazon best seller product leaders and Amazon Choice products, among others.
Trends and Expectations
Product and Brand Development
We plan to increase investments
in product and brand development. We actively evaluate potential acquisition opportunities of companies and product brand names that can
complement our product catalog and improve on existing products and supply chain efficiencies.
Global Economic Disruption
While at present the majority
of our products are sourced either in the United States or China, the military conflict between Russia and Ukraine may nonetheless increase
the likelihood of supply chain interruptions and hinder our ability to find the materials we need to make our products. Thus far, as a
result of the general global economic disruption, we have experienced a decrease in the speed with which we are able to purchase new inventory,
as well as an increase in costs due to delays in shipping, resulting increase in time with which products remain in our warehouse facilities,
thus resulting in reduced profits. In addition, supply chain disruptions may make it harder for us to find favorable pricing and reliable
sources for the materials we need, putting upward pressure on our costs and increasing the risk that we may be unable to acquire the materials
and services we need to continue to make certain products.
32
Regulatory Environment
We sell hydroponic gardening
products to end users that may use such products in new and emerging industries or segments, including the growing of cannabis. The demand
for hydroponic gardening products depends on the uncertain growth of these industries or segments due to varying, inconsistent, and rapidly
changing laws, regulations, administrative practices, enforcement approaches, judicial interpretations, and consumer perceptions. For
example, certain countries and a total of 46 U.S. states plus the District of Columbia have adopted frameworks that authorize, regulate
and tax the cultivation, processing, sale and use of cannabis for medicinal and/or non-medicinal use, including legalization of hemp and
CBD, while the U.S. Controlled Substances Act and the laws of U.S. states prohibit growing cannabis. Demand for our products could be
impacted by changes in the regulatory environment with respect to such industries and segments.
Recent Developments
On June 18, 2024, we closed
on the Registered Direct offering of 2,083,334 Shares and a concurrent Private Placement of Warrants to purchase 2,083,334 Warrant Shares,
which were sold for gross aggregate proceeds of $5,000,002. The Shares were sold pursuant to a prospectus supplement, filed on June 18,
2024, to the Registration Statement on Form S-3, originally filed on September 25, 2023, with the SEC (File No. 333-274665), and declared
effective by the SEC on September 29, 2023. The Warrants, which were issued pursuant to an exemption from registration under Section 4(a)(2)
or Regulation D of the Securities Act, have a term of five years and are immediately exercisable at $2.40 per share. The Shares and Warrants
were sold to a Purchase Agreement to a securities purchase agreement, dated June 16, 2024, between the Company and the purchaser. Roth
Capital Partners, LLC acted as Placement Agent, pursuant to a Placement Agency Agreement. The Company paid the Placement Agent as compensation
a cash fee equal to 6.5% of the gross proceeds of the Offering plus reimbursement of certain expenses and legal fees.
On July 9, 2024, as required
by the Purchase Agreement, we filed a resale registration statement on Form S-1 with the SEC (the "Resale Form S-1"). Upon filing
an amendment on July 23, 2024, the Resale Form S-1 was declared effective by the SEC on July 26, 2024.
RESULTS OF OPERATIONS
For the fiscal years ended June, 2024 and
2023
The following table presents
certain consolidated statement of operations information and presentation of that data as a percentage of change from period to period.
Year Ended
June 30, 2024
Year Ended
June 30, 2023
Variance
Revenues
$
86,071,485
$
88,902,048
(3.18%
)
Cost of goods sold
46,818,232
54,104,587
(13.47%
)
Gross profit
39,253,253
34,797,461
12.80%
Operating expenses
40,216,145
48,281,004
(16.70%
)
Loss from operations
(962,892
)
(13,483,543
)
(92.86%
)
Other expenses
(829,921
)
(1,184,030
)
(29.91%
)
Loss before income taxes
(1,792,813
)
(14,667,573
)
(87.78%
)
Income tax benefit
(251,365
)
(2,690,500
)
(90.66%
)
Net loss
(1,541,448
)
(11,977,073
)
(87.13%
)
Non-controlling interest
(13,289
)
(11,683
)
13.75%
Net loss attributable to iPower Inc.
(1,528,159
)
(11,965,390
)
(86.61%
)
Other comprehensive loss
(148,272
)
(67,812
)
118.65%
Comprehensive loss attributable to iPower Inc.
$
(1,676,431
)
$
(12,033,202
)
(86.07%
)
Gross profit % of revenues
45.61%
39.14%
16.51%
Operating loss % of revenues
(1.12%
)
(15.17%
)
(92.62%
)
Net loss attributable to iPower Inc. % of revenues
(1.78%
)
(13.46%
)
(86.81%
)
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Revenues
Revenues for the year ended
June 30, 2024 decreased 3.18% to $86,071,485 as compared to $88,902,048 for the year ended June 30, 2023. While pricing remained stable,
the decreased revenue mainly resulted from a slight decrease in sales volume.
Costs of Goods Sold
Costs of goods sold for the
year ended June 30, 2024 decreased 13.47% to $46,818,232 as compared to $54,104,587 for the year ended June 30, 2023. The decrease was
mainly due to the decrease in sales, freight costs, and lowered product costs resulted from management’s efforts on supply chain
management.
Gross Profit
Gross profit was $ 39,253,253
for the year ended June 30, 2024 as compared to $34,797,461 for the year ended June 30, 2023. The gross profit ratio increased to 45.61%
for the year ended June 30, 2024 from 39.14% for the year ended June 30, 2023. The increase in gross profit ratio was mainly driven by
the decrease in costs of goods sold during the year ended June 30, 2024, as discussed above.
Operating Expenses
Operating expenses for the
year ended June 30, 2024 decreased 16.70% to $40,216,145 as compared to $48,281,004 for the year ended June 30, 2023. The decrease was
mainly due to the combination of a decrease in selling and fulfillment expenses of $4.33 million, including vendor warranty credits for
prior year purchases of $2.48 million recorded during the year ended June 30, 2024 and decreased costs related to advertising, merchant
fees, delivery fees, rental expenses, storage costs and fulfillment workforce, a decrease in general and administrative expenses of $0.67
million, which included payroll expenses, stock-based compensation expense, insurance expenses, legal fees related to the Boustead case,
and other operating expenses including expenses associated with being a publicly traded company, and a decrease of $3.06 million of impairment
loss on goodwill triggered by a decrease in the Company’s share price of its common stock and the net loss incurred during the quarter
ended September 30, 2022. We have seen decreased operating expenses during the year ended June 30, 2024; however, we can provide no assurance
that this trend will continue.
Loss from Operations
Loss from operations was 962,892
for the year ended June 30, 2024 as compared to $13,483,543 for the year ended June 30, 2023. The decrease was due to combination of the
decrease in operating expenses and the increase in gross profit as discussed above.
Other Expenses
Other expenses consist of
interest expense and other non-operating income (expenses). Other expenses for the year ended June 30, 2024 were $829,921 as
compared to $1,184,030 for the year ended June 30, 2023. The decrease in other expenses was mainly due to decrease in other
non-operating loss of $71,761, and in interest, including amortization of debt discount, on the revolving loan of $277,855 during
the year ended June 30, 2024 resulted from the decreasing loan balance.
Net Loss Attributable to iPower Inc.
Net loss attributable to iPower
Inc. for the year ended June 30, 2024 was $1,528,159 as compared to $11,965,390 for the year ended June 30, 2023, representing a decrease
of net loss of $10,437,231. The decrease was primarily due to the increase in gross profit and decrease in operating expenses as discussed
above.
34
Comprehensive loss Attributable to iPower
Inc.
Comprehensive loss attributable
to iPower Inc. for the year ended June 30, 2024 was $1,676,431 as compared to $12,033,202 for the year ended June 30, 2023, representing
a decrease of comprehensive loss of $10,356,771. The decrease was due to the reasons discussed above, along with other comprehensive loss
of $148,272 as a result of foreign currency translation adjustments resulting from the translation of RMB, the functional currency of
our VIE in the PRC, to USD, the reporting currency of the Company.
LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity
During the fiscal year ended
June 30, 2024 we primarily funded our operations with cash and cash equivalents generated from operations, as well as through borrowing
under our credit facility from JPMorgan Chase Bank (“JPM”). Additionally, on June 18, 2024, we closed on the Registered Direct
offering of 2,083,334 Shares and a concurrent Private Placement of Warrants to purchase 2,083,334 Warrant Shares, which were sold for
gross aggregate proceeds of $5,000,002. We had cash and cash equivalents of $7,377,837 as of June 30, 2024, representing a $3,642,195
increase from $3,735,642 in cash as of June 30, 2023. The cash increase was primarily the result of the cash we received in the Registered
Direct in June 2024.
Based on our current operating
plan, we believe that our existing cash and cash equivalents and cash flows from operations will be sufficient to finance our operations
during the next 12 months. However, our liquidity and our ability to meet our obligations and fund our capital requirements are dependent
on our future financial performance, which is subject to general economic, financial and other factors that are beyond our control, such
as rising inflation and potential recession, and our anticipated funding requirements could increase. See the “Risk Factors”
section in this Annual Report.
Our cash requirements consist
primarily of day-to-day operating expenses and obligations with respect to warehouse leases. We lease all our office and warehouse facilities.
We expect to make future payments on existing leases from cash generated from operations. We have credit terms in place with our major
suppliers, however as we bring on new suppliers, we are often required to prepay our inventory purchases from them. This is consistent
with our historical operating model which allowed us to operate using only cash generated by the business. Beyond the next 12 months we
believe that our cash flow from operations should improve as supply chain operations normalize and new suppliers we are bringing online
transition to credit terms more favorable to us. In addition, we plan to increase the size of our in-house product catalog, which will
have a net beneficial impact to our margin profile and ability to generate cash. Currently, we have approximately $18.0 million in unused
credit under the revolving line with JPM, which will be expired and we are in negotiations on a renewal in November 2024.
Given our current working
capital position and available funding from our revolving credit line and proceeds from our June Registered Direct offering, we believe
we will be able to manage through the current challenges by managing payment terms with customers and vendors.
Working Capital
As of June 30, 2024 and 2023,
our working capital was $11.2 million and $17.9 million, respectively. The historical seasonality in our business during the year can
cause cash and cash equivalents, inventory and accounts payable to fluctuate, resulting in changes in our working capital. We anticipate
that past historical trends to remain in place through the balance of the fiscal year with working capital remaining near this level for
the foreseeable future.
35
Cash Flows
Operating Activities
Our largest source of cash
provided by operations is from sales of products. Our primary uses of cash from operating activities include payments to suppliers for
products, to employees for compensation, and other general expenses. Net cash provided by operating activities for the years ended June
30, 2024 and 2023 was $6,164,076 and $9,211,269, respectively. The decrease in cash provided by operating activities mainly resulted from
a decrease in cash received from customers and an increase in cash paid for cost of revenues and operating expenses.
Investing Activities
For the years ended June 30,
2024 and 2023, net cash used in investing activities was $0 and $140,813, respectively. The decrease in cash used in investing activities
was because the Company did not purchase any additional equipment during the year ended June 30, 2024, whereas such equipment had been
purchased in the same period during 2023.
Financing Activities
Net cash used in financing activities
was $2,397,801 and $7,153,620, respectively, for the years ended June 30, 2024 and 2023. The decrease in net cash used in financing activities
was primarily due to a combination of increase in proceeds from our registered offering and loans and our payment of approximately $16.8
million for: (1) $3.8 million to pay off the notes payable to White Cherry; (2) $12 million to pay down the outstanding balance of the
asset-based revolving loan facility with JPM; and (3) $1.0 million of offering cost settlement payment to Boustead.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance
sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material
effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated
financial statements in accordance with accounting principles generally accepted in the United States, or GAAP and pursuant to the rules
and regulations of the SEC. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could
differ from those estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period.
Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these
estimates and actual results, our financial condition and results of operations will be affected. We base our estimates on experience
and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We
refer to accounting estimates of this type as critical accounting policies, which we discuss further below. While our significant accounting
policies are more fully described in Note 2 to our audited consolidated financial statements, we believe that the following accounting
policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial
statements.
Revenue recognition
The Company recognizes revenue from service and product sales revenues,
net of promotional discounts and return allowances, when the following revenue recognition criteria are met: a contract has been identified,
separate performance obligations are identified, the transaction price is determined, the transaction price is allocated to separate performance
obligations and revenue is recognized upon satisfying each performance obligation. The Company transfers the risk of loss or damage upon
shipment or completion of service, therefore, revenue from product sales is recognized when it is shipped to the customer and the revenue
from services is recognized upon completion of services. For the years ended June 30, 2024 and 2023, the revenues from services were immaterial.
Return allowances, which reduce product revenue by the Company’s best estimate of expected product returns, are estimated using
historical experience.
36
The Company evaluates the
criteria of ASC 606 - Revenue Recognition Principal Agent Considerations in determining whether it is appropriate to record the gross
amount of product sales and related costs or the net amount earned as commissions. Generally, when the Company is primarily responsible
for fulfilling the promise to provide a specified good or service and the Company has discretion in establishing the price, revenue is
recorded at gross.
Payments received prior to the delivery of goods
to customers are recorded as customer deposits.
The Company periodically provides
incentive offers to its customers to encourage purchases. Such offers include current discount offers, such as percentage discounts
off current purchases and other similar offers. Current discount offers, when accepted by the Company’s customers, are treated as
a reduction to the purchase price of the related transaction.
Sales discounts are recorded
in the period in which the related sale is recognized. Sales return allowances are estimated based on historical amounts and are recorded
upon recognizing the related sales. Shipping and handling costs are recorded as selling expenses.
Accounts receivable, net
During the
ordinary course of business, the Company extends unsecured credit to its customers. Accounts receivable are stated at the amount the Company
expects to collect from customers. Management reviews its accounts receivable balances each reporting period to determine if an allowance
for credit loss is required.
The Company
evaluates the creditworthiness of all of its customers individually before accepting them and continuously monitors the recoverability
of accounts receivable. If there are any indicators that a customer may not make payment, the Company may consider making provision for
non-collectability for that particular customer. At the same time, the Company may cease further sales or services to such customer. The
following are some of the factors that the Company develops allowance for credit losses:
·
the customer fails to comply with its payment schedule;
·
the customer is in serious financial difficulty;
·
a significant dispute with the customer has occurred regarding job progress or other matters;
·
the customer breaches any of its contractual obligations;
·
the customer appears to be financially distressed due to economic or legal factors;
·
the business between the customer and the Company is not active; and
·
other objective evidence indicates non-collectability of the accounts receivable.
Accounts
receivable are recognized and carried at carrying amount less an allowance for credit losses, if any. The Company maintains an allowance
for credit losses resulting from the inability of its customers to make required payments based on contractual terms. The Company reviews
the collectability of its receivables on a regular and ongoing basis. The Company has also included in calculation of allowance for credit
losses the potential impact of the COVID-19 pandemic on our customers’ businesses and their ability to pay their accounts receivable.
After all attempts to collect a receivable have failed, the receivable is written off against the allowance. The Company also considers
external factors to the specific customer, including current conditions and forecasts of economic conditions, including the potential
impact of the COVID-19 pandemic. In the event we recover amounts previously written off, we will reduce the specific allowance for credit
losses.
37
Inventory, net
Inventory consists of finished
goods ready for sale and is stated at the lower of cost or market. The Company values its inventory using the weighted average costing
method. The Company’s policy is to include as a part of inventory and cost of goods sold any freight incurred to ship the product
from its vendors to warehouses. Outbound freight costs related to shipping costs to customers are considered period costs and reflected
in selling and fulfillment expenses. The Company regularly review inventory and consider forecasts of future demand, market conditions
and product obsolescence.
If the estimated realizable
value of the inventory is less than cost, the Company makes provisions in order to reduce its carrying value to its estimated market value.
The Company also reviews inventory for slow moving and obsolescence and records allowance for obsolescence.
Variable interest entities
On February 15, 2022, the
Company acquired 100% of the ordinary shares of Anivia and its subsidiaries, including Daheshou (Shenzhen) Information Technology Co.,
Ltd., a company organized under the Laws of the PRC (“DHS”). Pursuant to the terms of the agreements, the Company does not
have direct ownership in DHS but is actively involved in DHS’s operations as the sole manager to direct the activities and significantly
impact DHS’s economic performance. DHS’s operational funding is provided by the Company after February 15, 2022. During the
term of the agreements, which run for a term of 10 years from February 2022 to February 2032, the Company bears all the risk of loss and
has the right to receive all of the benefits from DHS. As such, based on the determination that the Company is the primary beneficiary
of DHS, in accordance with ASC 810-10-25-38A through 25-38J, DHS is considered a variable interest entity (“VIE”) of the Company
and the financial statements of DHS have been consolidated from the date such control existed, February 15, 2022. See Note 4 for details on acquisition.
Goodwill
Goodwill represents the excess
of the purchase price over the fair value of assets acquired and liabilities assumed. The Company accounts for goodwill under ASC Topic
350, Intangibles-Goodwill and Other .
Goodwill is not amortized
but is reviewed for potential impairment on an annual basis, or if events or circumstances indicate a potential impairment, at the reporting
unit level. The Company’s review for impairment includes an assessment of qualitative factors to determine whether it is more likely
than not that the fair value of a reporting unit is less than its carrying value, including goodwill. If it is determined that it is more
likely than not that the fair value of a reporting unit is less than its carrying value, including goodwill, a quantitative goodwill impairment
test is performed, which compares the fair value of the reporting unit with its carrying amounts, including goodwill. If the fair value
of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. However, if the carrying
amount of the reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess, limited
to the total amount of goodwill allocated to that reporting unit. The Company engaged an independent third-party valuation firm in August
2022 to conduct an evaluation of goodwill impairment for the Company as a whole at the consolidated reporting unit level as of June 30,
2022, which evaluation was conducted prior to the Company’s filing of its Annual Report on Form 10-K for the period ended June 30,
2022. Due to the decrease in the Company’s share price subsequent to the filing of the June 30, 2022 Form 10-K and the net loss
incurred during the quarter ended September 30, 2022, the Company engaged the same valuation firm to review goodwill for impairment. Based
on this review, the Company concluded an impairment loss of $3,060,034 as of September 30, 2022 was required. The impairment amount was
determined based on the discounted cash flows with the revised projections reflecting the increase in freight and storage costs in the
current interim quarter. The Company also considered the Market Capital Method, which is an alternative market approach, suggested the
Company’s goodwill is partially impaired.
Subsequent to the quarter
ended September 30, 2022, during the period ended June 30, 2023, the Company performed a qualitative and quantitative goodwill impairment
analysis following the steps laid out in ASC 350-20-35-3C and noted no goodwill impairment. As of June 30, 2024 and 2023, the goodwill
balance amounted to $3,034,110 and $3,034,110, respectively.
38
Intangible Assets, net
Finite life intangible assets
at June 30, 2024 include a covenant not to compete, supplier relationship and software recognized as part of the acquisition of Anivia.
Intangible assets are recorded at the estimated fair value of these items at the date of acquisition, February 15, 2022. Intangible assets
are amortized on a straight-line basis over their estimated useful life as followings:
Useful Life
Covenant Not to Compete
10 years
Supplier relationship
6 years
Software
5 years
The Company reviews the recoverability
of long-lived assets, including intangible assets, when events or changes in circumstances occur that indicate the carrying value of the
asset may not be recoverable. The assessment of possible impairment is based on the ability to recover the carrying value of the asset
from the expected future pretax cash flows (undiscounted and without interest charges) of the related operations. If these cash flows
are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying
value. The measurement of impairment requires management to make estimates of these cash flows related to long-lived assets, as well as
other fair value determinations. As of June 30, 2024, there were no indicators of impairment.
Stock-based Compensation
The Company applies ASC No.
718, “Compensation-Stock Compensation,” which requires that share-based payment transactions with employees and nonemployees
upon adoption of ASU 2018-07, be measured based on the grant date fair value of the equity instrument and recognized as compensation expense
over the requisite service period, with a corresponding addition to equity. Under this method, compensation cost related to employee share
options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the period
during which an employee is required to provide service in exchange for the award, which generally is the vesting period. In addition
to the requisite service period, the Company also evaluates the performance condition and market condition under ASC 718-10-20. For an
award that contains both a performance and a market condition, and where both conditions must be satisfied in order for the award to vest,
the market condition is incorporated into the fair value of the award, and that fair value is recognized over the employee’s requisite
service period or nonemployee’s vesting period if it is probable that the performance condition will be met. If the performance
condition is ultimately not met, compensation cost related to the award should not be recognized (or should be reversed) because the vesting
condition in the award has not been satisfied.
The Company will recognize
forfeitures of such equity-based compensation as they occur.
39
Income taxes
The Company accounts for income
taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable
to differences between the financial statement carrying amounts of existing assets and liabilities and their perspective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. Valuation allowances are recorded, when necessary, to reduce deferred tax assets
to the amount expected to be realized.
As a result of the implementation
of certain provisions of ASC 740, Income Taxes (“ASC 740”), which clarifies the accounting and disclosure for uncertainty
in tax position, as defined, ASC 740 seeks to reduce the diversity in practice associated with certain aspects of the recognition and
measurement related to accounting for income taxes. The Company has adopted the provisions of ASC 740 since its inception on April 11,
2018, and has subsequently analyzed filing positions in each of the federal and state jurisdictions where the Company is required to file
income tax returns, as well as open tax years in such jurisdictions. The Company has identified the U.S. federal jurisdiction and the
states of Nevada and California as its “major” tax jurisdictions. However, the Company has certain tax attribute carryforwards
which will remain subject to review and adjustment by the relevant tax authorities until the statute of limitations closes with respect
to the year in which such attributes are utilized.
The Company believes that
our income tax filing positions and deductions will be sustained on audit and do not anticipate any adjustments that will result in a
material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to ASC
740. The Company’s policy for recording interest and penalties associated with income-based tax audits is to record such items as
a component of income taxes.
Recently issued accounting pronouncements
In December 2023, The FASB
issued ASU 2023-09, Improvements to Income Tax Disclosures. Under this ASU, public business entities must annually “(1) disclose
specific categories in the rate reconciliation and (2) provide additional information for reconciling items that meet a quantitative threshold
(if the effect of those reconciling items is equal to or greater than 5 percent of the amount computed by multiplying pretax income [or
loss] by the applicable statutory income tax rate).” This ASU’s amendments are effective for public business entities for
annual periods beginning after December 15, 2024. For entities other than public business entities, the amendments are effective for annual
periods beginning after December 15, 2025. Entities are permitted to early adopt the standard “for annual financial statements that
have not yet been issued or made available for issuance.” The amendments should be applied on a prospective basis. Retrospective
application is permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial
statements.
In November 2023, The FASB
issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The amendments apply to all public
entities that are required to report segment information in accordance with Topic 280, Segment Reporting. The amendments in this ASU are
intended to improve reportable segment disclosure requirements primarily through enhanced disclosures about significant segment expenses.
The key amendments: 1. Require that a public entity disclose, on an annual and interim basis, significant segment expenses that are regularly
provided to the chief operating decision maker (CODM) and included within each reported measure of segment profit or loss. 2. Require
that a public entity disclose, on an annual and interim basis, an amount for other segment items by reportable segment and a description
of its composition. The other segment items category is the difference between segment revenue less the significant expenses disclosed
and each reported measure of segment profit or loss. 3. Require that a public entity provide all annual disclosures about a reportable
segment’s profit or loss and assets currently required by FASB Accounting Standards Codification® Topic 280, Segment Reporting,
in interim periods. 4. Clarify that if the CODM uses more than one measure of a segment’s profit or loss in assessing segment performance
and deciding how to allocate resources, a public entity may report one or more of those additional measures of segment profit. However,
at least one of the reported segment profit or loss measures (or the single reported measure, if only one is disclosed) should be the
measure that is most consistent with the measurement principles used in measuring the corresponding amounts in the public entity’s
consolidated financial statements. 5. Require that a public entity disclose the title and position of the CODM and an explanation of how
the CODM uses the reported measure(s) of segment profit or loss in assessing segment performance and deciding how to allocate resources.
6. Require that a public entity that has a single reportable segment provide all the disclosures required by the amendments in the ASU
and all existing segment disclosures in Topic 280. This ASU is effective for fiscal years beginning after December 15, 2023, and interim
periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. A public entity should apply the amendments
retrospectively to all prior periods presented in the financial statements. Upon transition, the segment expense categories and amounts
disclosed in the prior periods should be based on the significant segment expense categories identified and disclosed in the period of
adoption. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
40
In October 2023, the FASB
issued ASU 2023-06, Disclosure Improvements: Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative.
This ASU incorporates certain U.S. Securities and Exchange Commission (SEC) disclosure requirements into the FASB Accounting Standards
Codification™ (“Codification”). The amendments in the ASU are expected to clarify or improve disclosure and presentation
requirements of a variety of Codification Topics, allow users to more easily compare entities subject to the SEC’s existing disclosures
with those entities that were not previously subject to the requirements, and align the requirements in the Codification with the SEC’s
regulations. In SEC Release No. 33-10532, Disclosure Update and Simplification, issued August 17, 2018, the SEC referred certain of its
disclosure requirements that overlap with, but require incremental information to, generally accepted accounting principles to the FASB
for potential incorporation into the Codification. The ASU incorporates into the Codification 14 of the 27 disclosures referred by the
SEC. They modify the disclosure or presentation requirements of a variety of Topics in the Codification. The requirements are relatively
narrow in nature. Some of the amendments represent clarifications to, or technical corrections of, the current requirements. Because of
the variety of Topics amended, a broad range of entities may be affected by one or more of those amendments. For entities subject to the
SEC’s existing disclosure requirements and for entities required to file or furnish financial statements with or to the SEC in preparation
for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer, the effective date
for each amendment will be the date on which the SEC removes that related disclosure from its rules. For all other entities, the amendments
will be effective two years later. However, if by June 30, 2027, the SEC has not removed the related disclosure from its regulations,
the amendments will be removed from the Codification and not become effective for any entity. The Company does not expect the adoption
of this standard to have a material impact on its consolidated financial statements.
In September 2022, FASB issued
ASU 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. The amendments
in this ASU require that a company that uses a supplier finance program in connection with the purchase of goods or services disclose
sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during
the period, changes from period to period, and potential magnitude. ASU 2022-04 is effective for fiscal years, including interim periods
within those fiscal years, beginning after December 15, 2022, except for the rollforward of the supplier finance program obligations,
which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. An entity should apply ASU No. 2022-04
retrospectively to all periods in which a balance sheet is presented, except for the obligation rollforward, which should be applied prospectively.
The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In June 2022, FASB issued ASU
2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. The
amendments in this ASU clarify the guidance in ASC 820 on the fair value measurement of an equity security that is subject to a contractual
sale restriction and require specific disclosures related to such an equity security. This standard is effective for fiscal years beginning
after December 15, 2024. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial
statements.
In October 2021, the FASB
issued ASU 2021-08, Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.
This ASU clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business
combination in accordance with ASU 2014-09, Revenue from Contracts with Customers (Topic 606) as if the entity had originated the
contracts. The guidance is effective for fiscal years beginning after December 15, 2023, with early application permitted. The Company
does not expect the adoption of this standard to have a material impact on our 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).” This ASU reduces the number of accounting models for convertible debt
instruments and convertible preferred stock, as well as amend the guidance for the derivatives scope exception for contracts in an entity’s
own equity to reduce form-over-substance-based accounting conclusions. In addition, this ASU improves and amends the related EPS guidance.
This standard is effective for the Company on July 1, 2024, including interim periods within those fiscal years. Adoption is either a
modified retrospective method or a fully retrospective method of transition. The Company does not expect the adoption of this standard
to have a material impact on the consolidated financial statements.
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In March 2020 and January
2021, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial
Reporting and ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope, respectively (collectively, “Topic 848”). Topic 848
provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference
the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate
reform. The expedients and exceptions provided by Topic 848 are effective for all entities as of March 12, 2020 through December 31, 2022.
In December 2022, the FASB issued ASU 2022-06, Reference Rate reform (Topic 848): Deferral of the Sunset Date of Topic 848, which deferred
the sunset date of Topic 848, Reference Rate Reform to December 31, 2024, after which entities will no longer be permitted to apply the
relief in Topic 848. The Company does not expect the adoption of this standard to have a material impact on the Company's consolidated
financial statements.
In January 2017, the FASB
issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” which
eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount
by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit.
ASU 2017-04 became effective for accelerated filing companies for annual periods or any interim goodwill impairment tests in
fiscal years beginning after December 15, 2019. All other entities, including not-for-profit entities, that are adopting the amendments
in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2022.
Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The
Company has adopted ASU 2017-04. See disclosures above on Goodwill for further details.
The Company does not believe
other recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on the consolidated
financial position, statements of operations and cash flows.
Recent Financings
Asset-based revolving loan
On November 12, 2021, the
Company entered into a Credit Agreement with JPMorgan Chase Bank, N.A. (“JPM”), as administrative agent, issuing bank and
swingline lender, for an asset-based revolving loan (“ABL”) of up to $25 million with key terms listed as follows:
·
Borrowing base equal to the sum of
Ø
Up to 90% of eligible credit card receivables
Ø
Up to 85% of eligible trade accounts receivable
Ø
Up to the lesser of (i) 65% of cost of eligible inventory or (ii) 85% of net orderly liquidation value of eligible inventory
·
Interest rates of between LIBOR plus 2% and LIBOR plus 2.25% depending on utilization
·
Undrawn fee of between 0.25% and 0.375% depending on utilization
·
Maturity Date of November 12, 2024
In addition, the ABL includes
an accordion feature that allows the Company to borrow up to an additional $25 million. To secure complete payment and performance of
the secured obligations, the Company granted a security interest in all of its right, title and interest in, to and under all of the Company’s
assets as collateral to the ABL. Upon closing of the ABL, the Company paid $796,035 financing fees including 2% of $25.0 million or $500,000
paid to its financial advisor. The financing fees are recorded as debt discount and to be amortized over three years as financing expenses,
the term of the ABL.
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Below is a summary of the
interest expense recorded for the years ended June 30, 2024 and 2023:
2024
2023
Accrued interest
$ 402,675
$ 670,924
Credit utilization fees
71,332
43,931
Amortization of debt discount
265,219
265,218
Total
$ 739,226
$ 980,073
As of June 30, 2024 and 2023,
the outstanding amount of the JPM revolving loan payable, net of debt discount and including interest, was $5,500,739 and $9,791,191,
respectively.
On October 7, 2022, the Company
entered into a second amendment to the credit agreement and consent (the “Second Amendment to the Credit Agreement”), originally
dated November 12, 2021, as amended, with JPM, as administrative agent and lender. The Company entered into the Second Amendment to the
Credit Agreement primarily for the purpose of changing the interest rate repayment calculations from LIBOR to the Secured Overnight Financing
Rate, or SOFR, which adjustment had originally been anticipated under the terms of the original Credit Agreement. In addition, two of
the negative covenants set forth in the original credit agreement were amended in order to (i) adjust the definition of “Covenant
Testing Trigger Period” to increase the required cash availability from $3,000,000 to $4,000,000, or 10% of the aggregate revolving
commitment for the preceding 30 days, and (ii) require that the Company will not and will not permit any of its subsidiaries, after reasonable
due diligence and due inquiry, to knowingly sell their products, inventory or services directly to any commercial businesses that grow
or cultivate cannabis; it being acknowledged, however, that the Company does not generally conduct due diligence on its individual retail
customers.
On November 11, 2022, the
Company and JPM entered into a default waiver and consent agreement (the “Waiver Letter”) pursuant to which the parties recognized
that the Company was in default on its failure to satisfy the minimum Excess Availability requirement of $7,500,000, as defined in the
Credit Agreement, and deliver a certificate to JPM accurately reflecting the Excess Availability (together, the “Existing Defaults”).
Under the terms of the Waiver Letter, JPM agreed to waive the right to enforce an event of default based on the aforementioned Existing
Defaults. As of June 30, 2024 and 2023, the Company was in compliance with the ABL covenants.
Promissory note payable
On February 15, 2022, as part
of the consideration for the acquisition of Anivia, the Company issued a two-year unsecured 6% subordinated promissory note, payable in
equal semi-annual installments commencing August 15, 2022 (the “Purchase Note”). The principal amount of the Purchase Note
was $3.5 million with a fair value of $3.6 million as of February 15, 2022, the issuance date. In October 2022, the Company paid the first
installment of $875,000, and in February 2023, the Company paid the second installment of $875,000. In August 2023, the Company paid the
third installment of $875,000. In February 2024, the Company paid the fourth installment of $875,000. For the year ended June 30, 2024,
the Company recorded accrued interest of $39,429 and amortization of note premium of $31,602. For the year ended June 30, 2023, the Company
recorded accrued interest of $157,500 and amortization of note premium of $50,418. As of June 30, 2024, the total outstanding balance
of the Purchase Note was $0. As of June 30, 2023, including $236,250 of accrued interest and $31,602 of unamortized premium, the total
outstanding balance of the Purchase Note was $2,017,852, which is presented on the consolidated balance sheet as a current portion of
$2,017,852 and a non-current portion of $0.
43
Short-term loans payable
On July
8, 2023, the Company entered into an agreement with White Cherry Limited (“White Cherry”), a BVI company owned by the former
owner of DHS, for an on-demand, unsecured and subordinated loan (“On-demand Loan”). Pursuant to the agreement, White Cherry
agreed to loan the Company the amount requested. The On-demand Loan bears interest at the rate of the Secured Overnight Financing Rate,
or SOFR, plus 1% per annum. The On-demand Loan is due in 30 days upon receipt of White Cherry’s notice of repayment. On July 16,
2023, the Company borrowed $2,000,000 from White Cherry, repaid $1 million on July 31, 2023 and $1 million on January 31, 2024. For the
year ended June 30, 2024, the Company recorded interest of $32,911. As of June 30, 2024, the outstanding balance of the On-demand Loan
was fully paid off.
On April
8, 2024, the Company entered into an agreement with an unrelated accredited investor (the “Investor”) for an on-demand, unsecured
and subordinated loan (“On-demand Loan 2”). Pursuant to the agreement, the Investor agreed to loan the Company the amount
requested. The On-demand Loan 2 bears interest at the rate of the Secured Overnight Financing Rate, or SOFR, plus 1.5% per annum. The
On-demand Loan 2 is due in 30 days upon receipt of the Investor’s notice of repayment. For the year ended June 30, 2024, the Company
borrowed $483,599 and recorded interest expense of $7,615. As of June 30, 2024, the outstanding balance of the On-demand Loan 2, including
accrued interest of $7,615, was $491,214.
On April
1, 2024, the Company borrowed $350,000 short-term loan (“RP Loan”) from an entity owned by Mr. Allan Huang, one of the majority
shareholders of the Company. The RP Loan bears no interest and is due upon receipt of request of repayment. As of June 30, 2024, the outstanding
balance of the RP Loan was $350,000.
June 2024 Registered Direct Offering
On June 18, 2024, the Company,
closed on a Registered Direct Offering of 2,083,334 Shares and a concurrent Private Placement of Warrants to purchase 2,083,334 Warrant
Shares, which were sold for gross aggregate proceeds of $5,000,002. The Shares were sold pursuant to a prospectus supplement, filed on
June 18, 2024, to the Registration Statement on Form S-3, originally filed on September 25, 2023, with the SEC (File No. 333-274665),
and declared effective by the SEC on September 29, 2023. The Warrants, which were issued pursuant to an exemption from registration pursuant
to Section 4(a)(2) or Regulation D on the Securities Act, have a term of five years and are immediately exercisable at $2.40 per share.
The Shares and Warrants were sold to a purchaser pursuant to a securities purchase agreement, dated June 16, 2024, between the Company
and the purchaser (the “Purchase Agreement”). Roth Capital Partners, LLC (the “Placement Agent”) acted as placement
agent, pursuant to a placement agency agreement between the Company and the Placement Agent dated June 16, 2024 (the “Placement
Agency Agreement”). The Company paid the Placement Agent as compensation a cash fee equal to 6.5% of the gross proceeds of the offering
plus reimbursement of certain expenses and legal fees. The net proceeds of the offering, after deducting the Placement Agent’s fees
and expenses and other offering expenses payable by the Company, is approximately $4,543,089.
A holder will not have the
right to exercise any portion of the Warrants if the holder (together with its affiliates) would beneficially own in excess of 4.99% (or,
at the election of the holder, 9.99%), respectively, of the number of shares of common stock outstanding immediately after giving effect
to the exercise, as such percentage ownership is determined in accordance with the terms of the Warrants. However, upon notice from the
holder to the Company as described in the Purchase Agreement, the holder may increase the beneficial ownership limitation, which may not
exceed 9.99% of the number of shares of common stock outstanding immediately after giving effect to the exercise of Warrants.
According to the terms of
the Purchase Agreement, on July 9, 2024, we filed a Form S-1 to register the resale, from time to time, of up to an aggregate of 2,083,334
Warrant Shares, issuable upon the exercise of the Warrants issued in the Private Placement by the selling stockholder named therein. The
resale registration statement was declared effective by the SEC on July 26, 2024. As of June 30, 2024, no Warrants have been exercised.
44
Emerging Growth Company
We are an “emerging
growth company,” as defined in the JOBS Act. Accordingly, certain specified reporting and other regulatory requirements for public
companies are reduced for businesses that meet the qualifications for emerging growth companies.
These provisions include:
(1)
an exemption from the auditor attestation requirement in the assessment of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002;
(2)
an exemption from the adoption of new or revised financial accounting standards until they would apply to private companies;
(3)
an exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about our audit and our financial statements; and
(4)
reduced disclosure about our executive compensation arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
As a “smaller reporting
company,” this item is not required.
45
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.