Ispire Technology Inc. 10-Q

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed financial statements and the related notes appearing elsewhere in this report. See “Cautionary Forward-Looking Statements.” Actual results could differ materially from those discussed below. Overview We are engaged in the research and development, design, commercialization, sales, marketing and distribution of branded e-cigarettes and cannabis vaping products. We sell our tobacco vaping products worldwide except for the PRC and Russia. Our tobacco vaping products are marketed under the Aspire brand name and are sold primarily through our distribution network. We currently sell our cannabis vaping hardware only in the United States, and we have recently commenced marketing activities in Canada and Europe, primarily in the European Union. Most of our products are vaping hardware. Vaping refers to the practice of inhaling and exhaling the vapor produced by an electronic vaping device, and includes dabbing, which is the recreational inhalation of extremely concentrated tetrahydrocannabinol, the main psychotropic cannabinoid derived from the marijuana plant. Our cannabis vaping products are marketed under the Ispire brand name, primarily on an ODM basis to other cannabis vapor companies. ODM generally involves the design and customization of the core products to meet each brand’s unique image and needs, and our products are sold by our customers under their own brand names although they may also include our brand name on the products. Regulatory Risks The sale of tobacco and cannabis products is subject to regulations worldwide. Many countries prohibit the sale of any cannabis products, and many countries have regulations relating to tobacco products, with a particular emphasis on underage sales. As a result of regulations in the United States, we are able to sell only one tobacco vaping product line, the Nautilus Prime, in the United States. Our tobacco vaping sales in the United States were approximately $0.4 million and $0.1 million for the three months ended September 30, 2022 and 2023, respectively. Because the volume of sales did not justify the marketing and regulatory costs, we have ceased marketing tobacco vaping products in the United States. If any similar regulations are adopted with respect to cannabis products, our business will be severely impacted since all of our cannabis revenue for the three months ended September 30, 2022 and 2023 was generated from sales in the United States Effects of COVID-19 Pandemic In December 2019, coronavirus disease 2019 (COVID-19) was first reported to have surfaced in Wuhan, China. During 2020, the disease spread to many parts of the world. The epidemic has resulted in quarantines, travel restrictions, and the temporary closure of stores and facilities in much of the world, most of which are no longer in effect. The World Health Organization ended the global emergency status for COVID-19 on May 5, 2023, and the United States Department of Health and Human Services declared that the public health emergency from COVID-19 expired at the end of the day on May 11, 2023. The extent to which COVID-19 impacts our operations on an ongoing basis is highly uncertain. Since our products are presently manufactured in China by a related party, any changes in the outbreak in China and any changes in the Chinese government’s policy may affect our supplier’s operations which could affect its ability to manufacture and deliver product in a timely manner. 16 Supply Chain Risks One of the effects of the COVID-19 has been delays resulting from supply chain issues, which relate to the difficulty that companies have in having their products manufactured, shipped to the country of destination, and delivered from the port of entry to the customer’s location. As the port delays have significantly decreased, we do not believe that the supply chain issues that affected our operations are currently affecting us. We cannot assure you that delays will not affect our business in the future. In 2021, Shenzhen Yi Jia suffered a chip shortage resulting in a slowdown in delivery of its products to the Company from April to August 2021. To secure the supply of chips, Shenzhen Yi Jia changed the payment terms to chip suppliers from 30 days after delivery in the past to prepayment, and it engaged two new chip suppliers. Since September 2021, Shenzhen Yi Jia has advised us that it obtained a supply of chips to meet its production needs and the chip shortage no longer affects its production. In 2022, a slowdown in the delivery of components to Shenzhen Yi Jia resulting from supply chain slowdowns as a result of the effects of the PRC’s COVID policy resulted in an increase in cost of revenue during the period. We cannot assure you that we will not suffer from a chip shortage or that the effects of COVID or the PRC’s COVID policy will not affect Shenzhen Yi Jia’s ability or the ability of its suppliers to delivery products in a timely manner. Accounts Receivable Our business relies on the collection of accounts receivable from our customers in a timely manner to maintain liquidity and support our ongoing operations. The balance of the allowance for doubtful accounts was $0 and $1.1 million at September 30, 2022 and 2023, respectively. Our failure or inability to collect accounts receivable when due results from a number of factors, including (i) our customer’s failure to pay as a result of adverse economic conditions affecting the customers; (ii) our failure to accurately assess the creditworthiness of our customers; (iii) our failure to implement effective collection efforts; and (iv) disputes over contract terms, product quality or delays in delivery. Although we may implement strategies to mitigate these risks, there can be no assurance that such measures will be entirely effective, and we may continue to incur write-offs of accounts receivable, which may impair our ability to operate profitably. Key Factors that Affect Our Results of Operations We believe the following key factors may affect our financial condition and results of operations: ● The effect of legislation and regulations affecting the tobacco and cannabis vaping products. ● If we elect to market tobacco vaping products in the United States, our ability to obtain regulatory approval to market additional tobacco vaping products in the United States. ● Our ability to develop and market tobacco and cannabis vaping products to meet the changing tastes of users. ● The effects of competition. ● The development of an international market for cannabis vaping products, which is presently primarily limited to certain states in the United States. ● The effect of the outbreak of another pandemic or other disease that results in restrictions imposed by governments which may impact our ability to purchase or assemble products as well as the ability of end users to purchase our products. 17 Results of Operations Three Months Ended September 30, 2022 and 2023 The following table sets forth a summary of our consolidated statements of operations and comprehensive income for the three months ended September 30, 2022 and 2023 (dollars in thousands except per share amounts). Three Months ended September 30, 2022 2023 % of Revenue % of Revenue Revenue $ 26,943 100.0 % $ 42,865 100.0 % Cost of revenue (22,151 ) (82.2 )% (35,976 ) (83.9 )% Gross profit 4,792 17.8 % 6,889 16.1 % Operating expenses (6,007 ) (22.3 )% (7,800 ) (18.2 )% Loss from operations (1,215 ) (4.5 )% (911 ) (2.1 )% Other income(loss), net (519 ) (1.9 )% 33 0.1 % Loss before income taxes (1,734 ) (6.4 )% (878 ) (2.0 )% Income taxes (267 ) (1.0 )% (496 ) (1.2 )% Net loss (2,001 ) (7.4 )% (1,374 ) (3.2 )% Other comprehensive (loss)income (7 ) (0.1 )% 44 0.1 % Comprehensive loss (2,008 ) (7.5 )% (1,330 ) (3.1 )% Net loss per ordinary share (basic and diluted) $ (0.04 ) $ (0.03 ) Weighted ordinary shares outstanding 50,000,000 54,246,212 Revenue The following tables set out the breakdown of our revenue percentage by region based on information provided to us by our distributors. For the Three Months ended September 31, 2022 2023 Europe 56.1 % 46.4 % North America 32.7 % 41.7 % Asia Pacific (excluding PRC) 10.8 % 11.8 % Others 0.4 % 0.1 % Total 100.0 % 100.0 % 18 Our revenue increased by $15,921,597, or 59.1%, from $26,943,050 for the three months ended September 30, 2022, to $42,864,647 for the three months ended September 30, 2023. All sales of cannabis vaping products are from United States, which were included in sales in North America. Sales in North America also include sales of tobacco vaping products in Canada. Sales to regions other than North America are from tobacco vaping products. The increase in revenue is the combined effect of (i) increases in sales of cannabis vaping products of $9.3 million from $8.0 million for the three months ended September 30, 2022 to approximately $17.3 million for the three months ended September 30, 2023, (ii) increases in sales of tobacco vaping products in Europe of $4.7 million from $15.1 million for the three months ended September 30, 2022 to approximately $19.9 million for the three months ended September 30, 2023, (iii) increases in sales of tobacco vaping products in Asia Pacific (excluding PRC) of $2.2 million from $2.9 million for the three months ended September 30, 2022 to approximately $5.1 million for the three months ended September 30, 2023. Cost of Revenue Cost of revenue mainly consists of cost of purchases of vaping products, which we purchased from Shenzhen Yi Jia. Cost of revenue increased by $13,825,408, or 62.4%, from $22,150,947 for the three months ended September 30, 2022 to $35,976,355 for the three months ended September 30, 2023. The increase in cost of revenue reflects the increase in period-to-period unit sales. Gross Profit The following tables show the revenue, cost of revenue and gross profit of our tobacco and cannabis vaping products (dollars in thousands). For the Three Months Ended September 30, 2022 Revenue Cost of revenue Gross profit Gross profit % Tobacco vaping products $ 18,947 $ 15,905 $ 3,042 16.1 % Cannabis vaping products 7,996 6,246 1,750 21.9 % Total $ 26,943 $ 22,151 $ 4,792 17.8 % For the Three Months Ended September 30, 2023 Revenue Cost of revenue Gross profit Gross profit % Tobacco vaping products $ 25,532 $ 21,497 $ 4,035 15.8 % Cannabis vaping products 17,333 14,479 2,854 16.5 % Total $ 42,865 $ 35,976 $ 6,889 16.1 % Gross profit increased by $2,096,189, or 43.7%, from $4,792,103 for the three months ended September 30, 2022 to $6,888,292 for the three months ended September 30, 2023, while our gross margin decreased from 17.8% to 16.1%. The gross margin for tobacco vaping products remained constant. The decrease in gross margin for cannabis vaping products was primarily due to (i) a new model of cannabis vaping product was launched in July 2023, that Aspire North America offered discounts to clear the inventories of the older model that led to a drop in gross margin, and (ii) a change in product mix with more lower margin products being sold during the three months ended September 30, 2023. 19 Operating Expenses Operating expenses increased $1,792,594 or 29.8%, from $6,006,971 for the three months ended September 30, 2022 to $7,799,565 for the three months ended September 30, 2023. Our sales and marketing expenses mainly consist of employees’ salaries and benefits, marketing expense, travel expenses and others. Sales and marketing expenses decreased by $432,493, or 28.8%, from $1,501,156 for the three months ended September 30, 2022 to $1,068,663 for the three months ended September 30, 2023. The decrease in sales and marketing expenses for the three-month periods ended September 30, 2023 was primarily due to a reduction in our marketing campaign and trade shows for our cannabis vaping products. Our general and administrative expenses mainly consist of compensation and benefits, rental expense, professional fees and other administrative expenses. General and administrative expenses increased by $2,225,087, or 49.4%, from $4,505,815 for the three months ended September 30, 2022 to $6,730,902 for the three months ended September 30, 2023. The increase was primarily due to (i) an increase of $0.9 million for payroll expenses as more employees were hired by us for expansion of our cannabis business and building a manufacturing plant in Malaysia, (ii) an increase in professional fees of $0.9 million for expenses incurred being a public company for the three months ended September 30, 2023, (iii) stock-based compensation expense of $1.0 million incurred in the three months ended September 30, 2023 as compensation for management, employees and service providers, offset by a decrease in sample expenses of $0.4 million as less samples were distributed during the three months ended September 30, 2023, a decrease in failed units expenses of $0.4 million as there were no failed units during the three months ended September 30, 2023 and the increase in our expenses is not the result of inflation. Inflation in Hong Kong, where Aspire Science is located, was relatively stable. Other expense(income), net Other income, net includes interest income, interest expense, exchange gain (loss), net and other income (expense). Interest income was $510 for the three months ended September 30, 2022 and $72,246 for the three months ended September 30, 2023. Exchange loss(gain) changes by $504,455, or 100.7%, from net exchange loss of $500,794 for the three months ended September 30, 2022 to net exchange gain of $3,661 for three months ended September 30, 2023. As a result of these factors, other expense(income), net increased by $552,188, from other expense, net of $519,485 for the three months ended September 30, 2022 to other income, net of $32,703 for three months ended September 30, 2023. Income Taxes Income taxes increased by $228,644, or 85.5%, from $267,401 for the three months ended September 30, 2022 to $496,045 for the three months ended September 30, 2023. We had a consolidated net loss for both three month periods ended September 30, 2022 and 2023, which was the combined effect of a profit by Aspire Science and a loss by Aspire North America and Ispire Malaysia. The profit from Aspire Science resulted in a current tax expense. The increase in valuation allowance reflects our view that the taxable income in the future will not be sufficient to utilize the carryforward loss. Net Loss As a result of the foregoing, net loss decreased by $627,139, from net loss of $2,001,754, or $(0.04) per share (basic and diluted) for the three months ended September 30, 2022 to a net loss of $1,374,615, or $(0.03) per share, for the three months ended September 30, 2023. 20 Liquidity and Capital Resources The following table summarizes our changes in working capital from June 30, 2023 to September 30, 2023 (dollars in thousands). June 30, 2023 September 30, 2023 Change % Change Current Assets $ 84,811 $ 81,613 $ (3,198 ) (3.8 )% Current Liabilities 55,962 54,006 (1,956 ) (3.5 )% Working Capital 28,849 27,607 (1,242 ) (4.3 )% The following table sets forth information as to consolidated cash flow information for the three months ended September 30, 2022 and 2023 (dollars in thousands). Three Months Ended September 30, Increase Consolidated cash flow data: 2022 2023 (Decrease) Net cash provided by (used in) operating activities $ 2,236 $ (12,880 ) $ (15,116 ) Net cash used in investing activities (325 ) (789 ) (464 ) Net cash used in financing activities (291 ) (946 ) (655 ) Net increase (decrease) in cash and cash equivalents 1,620 (14,615 ) (16,235 ) Net cash flow provided by operating activities for the three months ended September 30, 2022 of $2.2 million, reflected our net loss of $2.0 million, adjusted primarily as follows: an add-back of depreciation of right-of-use assets of $0.3 million, increase in accounts payable of $15.4 million, offset by an increase in accounts receivable of $5.9 million, an increase in inventories of $4.8 million and a decrease in contract liabilities of $1.0 million. Net cash flow used in operating activities for the three months ended September 30, 2023 of $12.9 million, reflected our net loss of $1.4 million, adjusted primarily as follows: an add-back of depreciation of right-of-use assets of $0.3 million, an add-back of stock-based compensation expenses of $1.0 million, an add-back of accounts receivable impairment of $0.2 million, a decrease in inventories of $1.9 million, a decrease of prepaid expenses and other current assets of $1.6 million, an increase in income tax payable of $0.5 million, offset by an increase in accounts receivable of $14.7 million and a decrease in accounts payable of $2.5 million. Net cash flow used in investing activities for the three months ended September 30, 2022 of $0.3 million reflected primarily purchase of property, plant and equipment of $0.3 million. Net cash flow used in investing activities for the three months ended September 30, 2023 of $0.8 million reflected primarily purchase of property, plant and equipment of $0.5 million and acquisition of intangible assets of $0.3 million. Net cash flow used in financing activities for the three months ended September 30, 2022 of $0.3 million reflected primarily advances to related parties of $0.1 million, and principal portion of lease payment of $0.2 million. Net cash flow used in financing activities for the three months ended September 30, 2023 of $0.9 million reflected primarily advances to related parties of $0.7 million, and principal portion of lease payment of $0.2 million. To date, we have financed our operations primarily through cash flow from operations and working capital loans from our major stockholders, who are our co-chief executive officer and his wife, when necessary. We plan to support our future operations primarily from cash generated from our operations and cash on hand. We believe that our current cash and cash flows provided by operating activities, and the net proceeds from our initial public offering of $18.3 million will be sufficient to meet our working capital needs in the next 12 months. If we experience an adverse operating environment or incur unanticipated capital expenditure requirements, or if we decide to accelerate our growth, then additional financing may be required. We cannot give any assurance that additional financing will not be required or, if required, would be available on favorable terms if at all. Such financing may include the use of additional debt or the sale of additional equity securities. Any financing which involves the sale of equity securities or instruments that are convertible into equity securities could result in dilution to our stockholders which may be substantial. 21 The cash at bank held by our Hong Kong operating subsidiary can be freely transferred within our corporate structure without restriction. If our Hong Kong operating subsidiary were to incur additional debt on its own behalf in the future, the instruments governing the debt may restrict the ability of our operating subsidiaries to transfer cash to our U.S. investors. Contractual Obligations As of June 30 2023 and September 30 2023, we had contract liabilities of $988,556 and $1,290,061, respectively. These liabilities are advance deposits received from customers after an order has been placed. We expect all of the contract liabilities to be settled in less than one year. We have operating lease arrangements for office and factory premises for Hong Kong, California and Malaysia, which are treated as right-of-use assets. These leases typically have terms of two to five years. Leases with an initial term of 12 months or less are not presented as right-of-use assets and are expensed over the lease term. All other lease assets and lease liabilities are recognized based on the present value of lease payments over the lease term at commencement date. The balances for our right-of-use assets where we are the lessee are presented as follow: As of June 30, As of September 30, 2023 2023 Right-of-use assets $ 4,061,617 $ 4,285,182 Lease liabilities – current $ 944,525 $ 1,207,234 Lease liabilities – non-current 3,356,232 3,387,844 Total $ 4,300,757 $ 4,595,078 As of September 30, 2023, the maturities of our lease liabilities (excluding short-term leases) are as follows: As of September 30, 2023 2024 1,525,895 2025 1,549,132 2026 1,394,839 2027 806,759 Total future lease payments 5,276,625 Less: imputed interest (681,547 ) Total lease liabilities 4,595,078 Trend Information Other than as disclosed elsewhere in this registration statement, we are not aware of any trends, uncertainties, demands, commitments, or events that are reasonably likely to have a material effect on our net revenues, income from continuing operations, profitability, liquidity or capital resources, or that would cause reported financial information not necessarily to be indicative of future operating results or financial condition. Seasonality Seasonality does not materially affect our business or the results of our operations. Off-Balance Sheet Arrangements We do not have off-balance sheet arrangements. As a company with less than $1.235 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002 in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. We have elected to take advantage of such exemptions. 22 ITEM 3. Quantitative and Qualitative Disclosure About Market Risk As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this Item.