ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of Charlie’s Holdings, Inc. should be read in
conjunction with the financial statements and the notes to those
statements appearing elsewhere in this Quarterly Report on Form
10-Q (this
“Report”). Some of the information contained in
this discussion and analysis or set forth elsewhere in this Report,
including information with respect to our plans and strategy for
our business, includes forward-looking statements that involve
risks and uncertainties. You should read the “Risk
Factors” section in this Report for a discussion of important
factors that could cause actual results to differ materially from
the results described in or implied by the forward-looking
statements contained in the following discussion and
analysis.
As used in this Report, unless otherwise stated or the context
otherwise requires, references to the “Company,”
“we,” “us,” “our,” or similar
references mean Charlie’s Holdings, Inc. (formerly True
Drinks Holdings, Inc.), its subsidiaries and consolidated variable
interest entity on a consolidated basis. References to
“Charlie’s” and “CCD” refer to
Charlie’s Chalk Dust, LLC, a California limited
liability company and wholly-owned subsidiary of the Company, and
“Don Polly” refers to Don Polly, LLC, a Nevada limited
liability company that is owned by entities controlled by
Brandon and Ryan Stump, the Company’s Chief Executive Officer
and Chief Operating Officer, respectively, and a consolidated
variable interest for which the Company is the primary
beneficiary.
Overview
Our objective is to become a significant leader in
the rapidly growing, global e-cigarette segment of the broader
nicotine related products industry. Through Charlie’s, we
formulate, market and distribute branded e-cigarette liquid for use
in both open and closed nicotine-only e-cigarette and vaping
systems. Charlie’s products are produced domestically through
contract manufacturers for sale through select distributors,
specialty retailers and third-party online resellers throughout the
United States, as well as more than 80 countries worldwide.
Charlie’s primary international markets include the United
Kingdom, Italy, Spain, Belgium, Australia, Sweden and Canada. In
June 2019, we launched distribution, through Don Polly, of certain
premium vapor, tincture and topical wellness products containing
hemp-derived cannabidiol (“CBD”) and we currently intend to develop and
launch additional products containing hemp-derived CBD in the
future. Prior to the Share Exchange (defined below), our
primary business was the development, marketing, sale and
distribution of all-natural, vitamin-enhanced drinks, including
AquaBall® Naturally Flavored Water and Bazi® All Natural
Energy (“Bazi”). We continue to sell limited amounts of
Bazi, but have ceased all production and sales of AquaBall®
Naturally Flavored Water.
Recently
there have been significant news stories and health alerts related
to flavored nicotine vaping, leading to some states banning the
sale of flavored nicotine products and causing the Food and Drug
Administration (“FDA”) to review its policies on
controlling the sale of these products. The most recent health
related concerns seem to indicate that a vitamin E acetate related
compound may be causing the health issues. On November 8, officials
at the Centers for Disease Control and Prevention
(“CDC”)
reported a breakthrough in the investigation into the outbreak of
vaping-related lung injuries. The CDC's principal deputy
director, Dr. Anne Schuchat, stated that "vitamin E acetate is a
known additive used to dilute liquid in e-cigarettes or vaping
products that contain THC,” suggesting the possible
culprit for the series of lung injuries across the U.S.
All of
Charlie's nicotine-only, e-liquid products are tested by third
party laboratories which have confirmed that none of our products
contain any vitamin E acetate or Tetrahydrocannabinol (“THC”).
However, these developments have had a negative
effect on our sales since mid-September 2019 (see further
discussion below) and therefore, in response to these developments
and while government regulators are formulating future polices
management has adopted the following plan of
operation.
First, we plan to focus on increasing the sales of
our CBD related products, including topicals, tinctures and vaping
liquids. We feel there is a significant upside in the CBD space,
and we have begun to focus on numerous vertical markets for the
sale of our isolate, full and broad-spectrum products. These
vertical markets include the medical and wellness markets. In addition, we have begun
conversations with various companies and organizations that, if
successful, will allow us to significantly expand our marketing and
distribution reach.
Secondly,
we see a significant opportunity for sales growth in international
markets for nicotine e-liquids. Presently 25% of our e-liquid
product sales come from the international market and we are well
positioned to increase those sales in the countries that we
presently sell, and in additional overseas markets, as we have
already built an international distribution platform.
Lastly,
we feel that the nicotine based flavored vaping products will
continue to be a significant growth opportunity, once all the
rightful regulatory changes have been made. We will continue with
our plan to obtain marketing authorization for certain of our
products through the submission of a Premarket Tobacco Application
(“PMTA”), which
is due in May 2020. We feel that a significant amount of our
competitors will not have the resources and/or expertise to
complete the extensive and costly PMTA process and that once
complete, we will be able to benefit from being one of only a
select group of companies operating in the flavored nicotine
product space.
Risks and Uncertainties
The
Company operates in an environment that is subject to rapid changes
and developments in laws and regulations that could have a
significant impact on the Company’s ability to sell its
products. Beginning in September 2019, certain states temporarily
banned the sale of flavored e-cigarettes, and several states and
municipalities are considering implementing similar restrictions.
Federal, state, and local governmental bodies across the United
States have indicated that flavored e-cigarette liquid,
vaporization products and certain other consumption accessories may
become subject to new laws and regulations at the federal, state
and local levels. The application of any new laws or regulations
that may be adopted in the future, at a federal, state, or local
level, directly or indirectly implicating flavored e-cigarette
liquid and products used for the vaporization of nicotine could
significantly limit the Company’s ability to sell such
products, result in additional compliance expenses, and/or require
the Company to change its labeling and/or methods of distribution.
Any ban of the sale of flavored e-cigarettes directly limits the
markets in which the Company may sell its products. In the event
the prevalence of such bans and/or changes in laws and regulations
increase across the United States, or internationally, the
Company’s business, results of operations and financial
condition could be adversely impacted.
For the three months ended September 30, 2019 and
2018, our revenues from operations were $5,590,000 and $5,223,000,
respectively. Net income for
the three months ended September 30, 2019 was $1,557,000, which
included a non-cash gain on change in fair value of derivative
liabilities of $2,747,000, as compared to a net income of
$1,886,000 for the three months ended September 30, 2018. Non-cash
stock-based compensation costs of approximately $599,000 related to
the Share Exchange were expensed in the quarter ended September 30,
2019. We expect to continue to incur these costs over the next six
reporting quarters, however, we believe they will not have a
significant impact on operating results.
For
the nine months ended September 30, 2019 and 2018, our revenues
from operations were $19,056,000 and $16,142,000, respectively. Net
income for the nine months ended September 30, 2019 was $999,000,
which included a non-cash gain on change in fair value of
derivative liabilities of $2,925,000, as compared to a net income
of $6,069,000 for the nine months ended September 30, 2018.
Significant transaction costs of approximately $5.0 million were
expensed in the nine months ended September 30, 2019, offset by
non-cash gain on derivative liability of $2,925,000 which, along
with increased operating cost, accounted for the $5,070,000 decline
in net income from the prior year.
Recent Developments
Share Exchange
On April 26, 2019 (the “Closing
Date”), we entered into a
Securities Exchange Agreement with each of the former members
(“Members”) of Charlie’s, and certain direct
investors in the Company (“Direct
Investors”), pursuant to
which we acquired all outstanding membership interests of
Charlie’s beneficially owned by the Members in exchange for
the issuance by the Company of units, with such units consisting of
an aggregate of (i) 15,655,538,349 shares of common stock (which
includes the issuance of an aggregate of 1,396,305 shares of a
newly created class of Series B Convertible Preferred Stock, par
value $0.001 per share (“Series B
Preferred”), convertible
into an aggregate of 13,963,047,716 shares of common stock, issued
to certain individuals in lieu of common stock); (ii) 206,249
shares of a newly created class of Series A Convertible Preferred
Stock, par value $0.001 per share (“Series A
Preferred”), convertible
into an aggregate of 4,654,349,239 shares of common stock; and
(iii) warrants to purchase an aggregate of 3,102,899,493 shares of
common stock (the “Investor
Warrants”) (the
“Share Exchange”). As a result of the Share Exchange,
Charlie’s became a wholly owned subsidiary of the
Company.
Immediately prior to, and in connection with, the
Share Exchange, Charlie’s consummated a private offering of
membership interests that resulted in gross proceeds to
Charlie’s of approximately $27.5 million (the
“Charlie’s
Financing”). Katalyst
Securities LLC (“Katalyst”) acted as the sole placement agent in
connection with the Charlie’s Financing pursuant to an
Engagement Letter entered into by and between Katalyst,
Charlie’s and the Company on February 15, 2019, which was
amended on April 16, 2019 (“Amended Engagement
Letter”). As
consideration for its services in connection with the
Charlie’s Financing and Share Exchange, the Company issued to
Katalyst and its designees five-year warrants to purchase an
aggregate of 930,869,848 shares of common stock at a price of
$0.0044313 per share (the “Placement Agent
Warrants”). The Placement
Agent Warrants have substantially the same terms as those set forth
in the Investor Warrants. As additional consideration for advisory
services provided in connection with the Charlie’s Financing
and the Share Exchange, the Company issued an aggregate of
902,661,671 shares of common stock (the “Advisory
Shares”), including to
Scot Cohen, a member of the Company’s Board of Directors,
pursuant to a subscription agreement.
The Share Exchange resulted in a change of control of the Company,
with the Members and Direct Investors owning approximately 85.7% of
the Company’s outstanding voting securities immediately after
the Share Exchange, and the Company’s current stockholders
beneficially owning approximately 14.3% of the issued and
outstanding voting securities, which includes the Advisory Shares.
Following the Share Exchange, Ryan Stump and Brandon Stump, the
founders of Charlie’s and the Company’s Chief Executive
Officer and Chief Operating Officer, respectively, held in excess
of 50% of the Company’s issued and outstanding voting
securities.
Launch of CBD Products
In June 2019, we introduced, through Don Polly,
full-spectrum hemp extract and CBD isolate wellness products across
a variety of formats and with different strengths. Our initial
launch consisted of six vapor, eight tincture and two topical
product variations. The newly released products were launched under
the Pachamama™ brand by way of a licensing agreement between
Don Polly and Charlie’s, entered on April 25, 2019. In the
near term, we expect to expand the hemp-derived CBD-based products
line to include additional CBD isolate products and
THC-free, broad spectrum hemp
extract products currently in development.
Pachamama™
CBD products are currently available in the U.S., Mexico, U.K. and
Switzerland, and we expect to continue expanding both our domestic
and international distribution efforts.
Filing of Amended and Restated Charter; Automatic Conversion of
Series B Preferred
On June 28, 2019, we amended and restated our
Articles of Incorporation (the “Amended and Restated
Charter”) to (i) change
our corporate name to Charlie’s Holdings, Inc. and (ii)
increase the number of shares authorized as common stock from 7.0
billion to 50.0 billion shares. The Amended and Restated Charter
was approved by our Board of Directors and holders of a majority of
our outstanding voting securities on May 8, 2019, and the Amended
and Restated Charter was filed with the State of Nevada on June 28,
2019.
As
a result of the filing of the Amended and Restated Charter and the
increase of our authorized common stock to 50.0 billion shares,
all 1,396,305 outstanding shares of Series B Preferred
automatically converted into a total of 13,963,047,716 shares of
common stock in accordance with the Certificate of
Designations, Preferences and Rights of the Series B Convertible
Preferred Stock.
Our Products
Charlie’s Product Line
Our business efforts consist primarily
of formulating, marketing and distributing our portfolio
of branded e-cigarette liquid and other premium vapor products
for use in consumer e-cigarette and vaping systems, which we
collectively refer to as the “Charlie’s Product
Line” or
“Charlie’s
Products.”
E-Liquids
E-liquids used to produce vapor in vaping devices
are sold separately for use in refillable tanks of open system
vaporizers. Liquids are available in differing nicotine
concentrations (0 mg, 3 mg and 6 mg per milliliter) to suit user
preferences. Liquids are available in a variety of flavors,
including our proprietary blends. Liquid solution consists of
flavoring and/or nicotine dissolved in one or several hygroscopic
components, which turns the water in the solution into the
smoke-like vapor when heated. The most commonly used hygroscopic
components are propylene glycol (“PG”), vegetable glycerin
(“VG”) or polyethylene glycol 400. VG imparts
sweetness and produces vapor clouds, while PG produces more
“throat hit”, which simulates the feeling of smoking.
Our proprietary brands of e-liquids are manufactured by ISO Class 7
certified manufacturers in the United States, which helps ensure
their purity and quality.
Charlie’s
e-liquid products are produced under seven brand names
distinguished by their flavor profiles, packaging art and
ingredient transparency. All products are packaged in plastic drip
containers that are typically available in seven sizes ranging from
10 mil to 100ml, as well as bulk concentrate formats.
●
Black Label and White
Label . CCD’s original
black and white product line launched in 2015. Black Label is
currently available in five flavors and White Label is currently
available in four flavors.
●
CCD3 . Launched in 2016, is a sea salt caramel ice
cream flavor.
●
Pachamama™
. A line launched in 2016 consisting
of eight eclectic mixes of natural fruit flavors such as passion
fruit raspberry yuzu, blood orange banana gooseberry and
huckleberry pear acai.
●
Meringue . The third brand launched in 2016, based on
creative character stories, currently includes three
flavors.
●
Campfire™
. Outdoors and Smores flavor inspired
by camp vibes.
●
Stumps™
. Line of four flavors inspired by the
founders and their families broadly released in 2017 across various
formats. Currently active in select markets.
●
The Creator of
Flavor™ . Two flavors
broadly released in 2018 across various formats. Currently active
in select markets.
Nicotine Salt Products
Nicotine salt e-liquids
(“NIC
salts”) are traditionally
formulated for use in lower wattage open, semi-open and closed
system vaporizers and are available in higher nicotine
concentrations (25mg and 50mg per milliliter) than traditional
e-liquids. Nicotine salts consist of nicotine dissolved in an acid
that results in a lower PH level than other e-liquids. This form of
nicotine has a higher bioavailability resulting in faster blood
stream absorption and more closely mimics the effects of
combustible tobacco products. We recently released lower
concentration, NIC salt versions of certain flavors. These products
are designed to offer consumers access to the favorable
characteristics of NIC salts, such as increased flavor presence and
smoother draw, in a low nicotine concentration format. These
products can be used with a variety of vaping devices, making them
appealing to a broader consumer base. We broadly released
Pachamama™ Salts, an extension of the Pachamama™ line,
in late December 2018 to a select group of key accounts, which now
includes seven flavors packaged in 10ml, 30ml and 60ml bottles in
both high and low concentration formats. During the third quarter
of 2019, we launched NIC salt extensions of the Black, Gold and
White Label Charlie’s Chalk Dust brands and have plans to
further release additional products in this category as demand
continues to grow.
Don
Polly
The Company, through Don Polly, a related company
under common ownership, has been engaged in the development of
proprietary and innovative hemp-derived, non-THC, CBD wellness
products, which we refer to as the “Don Polly
Products” and
“Don
Polly Product Line”. Don
Polly’s efforts have been focused on developing and producing
high quality CBD products made from single-strain-sourced hemp
extract and high purity CBD isolate crystals. In addition, good
manufacturing practices and quality control parameters are of the
utmost importance to the Don Polly Products, which contribute to
the differentiation of the Don Polly Products in the CBD product
industry.
In
June 2019, Don Polly launched a suite of full-spectrum and isolate
CBD products Pachamama™ line across three categories
including vapor, tinctures, and topicals.
Isolate CBD Products
Our CBD isolate products contain a minimum purity
of 99% isolate crystals, tested by independent, third-party
facilities to ensure it is free of pesticides and heavy metals.
Vape, as a CBD delivery method, has grown in popularity due to the
high level of bioavailability and reported therapeutic responses.
In response to demand for CBD infused e-liquids from our existing
distribution channels, we launched a new line of CBD infused vapor
products in June 2019. We refer to these products as the
“Don
Polly Vape Product Line”
or the “Don Polly Isolate
Products.” The Don Polly
Vape Product Line is currently available in 30ml chubby bottles
across three flavors (Minty Mango, Grape Berry and Strawberry
Watermelon) and two strengths (250mg and 500mg). We are continuing
to research and develop isolate products as both vape line
extensions and in other product categories.
Full Spectrum CBD Products
Our
full spectrum hemp extract comes from whole plant extraction which
retains the plant’s natural compounds. This extraction method
ensures each product preserves the holistic benefits of the plant,
including minimal amounts of THC (0.3% or less), which allows for
optimal absorption of the plant’s nutrients. While CBD alone
is a beneficial cannabinoid, full spectrum products provide the
body access to all the plant’s cannabinoids, allowing the end
user to achieve a wide range of therapeutic benefits. The full
spectrum products are formulated with single-source and single
strain hemp extracts. Don Polly believes this sourcing practice
yields various compounds that work synergistically to heighten the
effects of the products, making them superior to single-compound
CBD isolates. In June 2019, we introduced the Pachamama™
tincture and topical full spectrum products. The tincture offering
now includes six flavors (the Natural, Green Tea Echinacea, Goji
Cacao, Kava Kava Valerian, Ylang Ylang Holy Basil and Black Pepper
Turmeric). available in 30ml bottle sizes and both 750mg and 1750mg
strengths. Our topical products include the Cooling Ointment,
available in a one ounce jar and 750mg strength, and the Athletic
Rub, available in a two ounce jar and 500mg strength. We plan on
continuing to research, develop, and launch products in these
categories.
Broad Spectrum CBD Products
In
addition to isolate and fill spectrum CBD products, we believe
there is an opportunity to develop broad spectrum hemp-derived CBD
extracts that provide the same benefits of full spectrum CBD
products but, through additional processing of hemp-derived
extracts, eliminate the presence of THC. This category of THC-free,
broad spectrum products will provide consumers with concerns about
THC access to the same level of quality and nutrients we value in
our full spectrum products. We are currently developing certain
broad spectrum products, which, ultimately, will allow us to launch
products which match the consumer accessibility of our CBD isolate
products with the experience and benefits of our full spectrum
products.In October 2019, we launched our first three broad
spectrum products including Body Lotion, Icy Muscle Gel and Pain
Cream.
True Drinks – Legacy
Product -- Bazi®
Prior to the Share Exchange, we marketed and
distributed products, including AquaBall® and Bazi®,
offering a healthful, natural alternative to high sugar, high
calorie and nutritionally deficient beverages. A discussed below
in “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations,” we
ceased producing AquaBall® in early 2018. We continue to
market and sell Bazi®, but on a very limited basis and only as
we sell off existing inventory, as we focus our resources on the
marketing, distribution and selling of the Charlie’s Products
and the Don Polly Products. Bazi® is a liquid nutritional
drink packed with eight different super fruits, including the
Chinese jujube and seven other super fruits, plus 12 vitamins.
Management is currently exploring the value of continuing the
marketing and sale of Bazi®.
Manufacturing and Distribution
Manufacturing
Charlie’s
Product Line. We work closely with
contract manufacturing partners in the United States, Ireland and
Scotland to manufacture our products. Our e-liquid and NIC salts
products are manufactured to meet our proprietary formula
specifications in facilities that are ISO Class 7
certified, which helps
ensure their purity and quality. In 2018, we sourced
97% of our products from three suppliers in the United States.
While we have developed long-standing relationships with our
manufacturing sources and take great care to ensure that they share
our commitment to quality, we do not have any long-term term
contracts with these parties for the production of our product
lines. We maintain redundancies in our supply chain and are aware
of several alternative sources for our
products.
Don
Polly Product Line. Our hemp-derived,
CBD-based Don Polly Products are manufactured with contract
manufacturers to meet our formula specifications. While we do not
have any long-term contracts with these parties, we are
strengthening our supplier partnerships as well as identifying
additional supplier and contract manufacturing
opportunities.
Bazi®.
Bazi® had been manufactured by Arizona Packaging and
Production since 2007. Presently, we are not manufacturing Bazi
Product, and we have sold all of the existing
inventory.
Distribution
Charlie’s
Product Line. Once manufactured,
Charlie’s Products are directly distributed throughout the
United States and in more than 80 countries, primarily the United Kingdom, Italy, Spain,
Belgium, Australia, Sweden and Canada. We
distribute our products to more than 2,100 specialty retailers
through direct sales and to distributors and wholesalers both in
the United States and internationally. Retailers of our
products include specialty retailers throughout the United States
and in over 80 other countries. We also distribute our
products on a very limited basis through convenience stores and gas
stations. With respect to products that we sell through
third-party distributors and wholesalers, we typically sell our
products to these customers for their re-sale. In select markets we
maintain exclusive arrangements with distributors and, when
warranted, will memorialize these agreements contractually.
Don Polly Product
Line. Although we only launched
the Don Polly Product Line in June 2019, our Don Polly Products are
currently distributed to key distribution and large retail accounts
in the United States, Mexico and Switzerland. Like the
Charlie’s Product Line, we will distribute Don Polly Products
directly to retailers, as well as through the use of distributors
and third-party wholesalers.
Online Sales
We now utilize direct-to-consumer
sales through a newly developed e-commerce platform where we market
our products and sell branded merchandise through our
websites www.charlieschalkdust.com and
www.enjoypachamama.com.
Bazi®.
Our e-commerce platform allows current and future consumers to
purchase Bazi® Energy Shot
through http://www.drinkbazi.com. All sales of Bazi®
Energy Shot are made through our online platform, and, to a lesser
extent, online marketplaces such as Amazon.
Sales and Marketing
Charlie’s Product
Line. We have a 15-person
sales team, based in the United States, that promotes our
Charlie’s Products globally. Salespeople seek to form
long-term “360” collaborative relationships with their
clients, partnering with them on sell-through efforts, providing
access to Charlie’s marketing and creative teams and advising
and educating them on the Charlie’s Product Line and other
industry-related issues. Currently, we advertise our products
primarily through direct customer engagement through social media
channels, print media, directed Internet marketing, industry
tradeshows and collaborative events with retail partners.
Historically, participation at industry-specific tradeshows played
a large role in our marketing and distribution strategy. However,
in 2018 we began shifting resources to collaborative events, and,
instead, our marketing team is now focusing its efforts on
fostering relationships with key distributors and retailers by
launching customer-specific marketing campaigns, in-person visits
to new customer accounts and other forms of direct customer
engagement. In 2018, approximately 30% of our sales were to
customers outside of the United States.
We
intend to strategically expand our advertising activities in 2019
and increase our public relations efforts to gain industry
awareness as well as editorial coverage for our brands. Some of our
competitors promote their brands through print media and through
celebrity endorsements and have substantial resources to devote to
such efforts. We believe that our and our competitors’
efforts have helped increase our sales, our product acceptance and
general industry awareness.
Don Polly Product
Line. Since the launch of the
Don Polly products in June 2019, we have employed similar sales and
marketing efforts used for the Charlie’s Product Line, and
intend to utilize those sales and marketing efforts in the near
term.
Source and Availability of Raw Materials
Charlie’s Product
Line. Our manufacturing
partners source the ingredients for our proprietary e-cigarette
liquids from a variety of sources, in accordance with our
formulations and quality specifications. We source our proprietary
e-liquids from multiple ISO Class 7 certified manufacturers in the
United States, which helps ensure their purity and quality. In an
effort to maintain consistency across our supply chain, we directly
purchase certain product packaging and are responsible for managing
various third-party supplier relationships.
Don Polly Product
Line. For our full spectrum CBD
products we currently source the individual components and CBD from
several suppliers. Each are delivered to our primary manufacturer
for storage prior to manufacturing. Our primary manufacturer for
isolate CBD products handles all raw material sourcing
internally.
Bazi®. During 2018, we relied significantly on one
supplier for 100% of our purchases of certain raw materials for
Bazi®. Bazi, Inc. has sourced these raw materials from this
supplier since 2007, and does not anticipate any issues with the
supply of these raw materials. Presently, we are not producing Bazi
product.
Although
we own the formulas for the Charlie’s Products, the Don Polly
Products and Bazi®, we obtain certain components, such as
packaging, flavors and certain raw materials, from third party
suppliers. None of the third party suppliers are considered to be
material to the business on a standalone basis and all are
components that are readily available from other suppliers on the
market. However, given the rapid growth of the vaping, e-cigarette
and CBD industries, there may be fluctuations in the availability
of certain of the materials we obtain from third-parties due to
high demand from our competitors. If any given supplier or
distributor is lost or unavailable in a specific region, and we are
unable to contract with alternative suppliers or distributors to
provide the requisite service(s) and product(s), we may be unable
to fulfill customer orders and our business could be materially
harmed.
Competition
The
industries in which we operate are highly competitive.
Charlie’s Product
Line. Our CCD Product Line
competes in a highly-fragment industry. Some identifiable
competitors of CCD include Naked100, Milkman, Humble, and Beard.
Other brands such as Juul, Vuse, Group Mark Ten, Green Smoke, Blu,
Vaporfi, Njoy, Logic, V2, and Apollo all participate in a different
segment of the electronic cigarette market which appeals to current
smokers and recently-converted electronic cigarette
users.
In
the e-liquid flavor space, new flavor brands emerge daily due to
low barriers to entry. Companies that produce electronic cigarettes
and vaporizers, including Vaporfi, Atmos and Njoy, carry their own
flavor lines for the refillable market. Other brands like Mount
Baker Vapor focus on wide variety of choice and value, while other
brands like Charlie’s Chalk Dust carve out their identity
with branding, and more nuanced flavor combinations. The nature of
our competitors is varied as the market is highly fragmented and
the barriers to entry into the business are low.
Part
of our business strategy focuses on the establishment of
relationships with distributors and prominent branding focused on
performance and quality. We are aware that e-cigarette
competitors in the industry are also seeking to enter into such
relationships and try to create brand loyalty. In many cases,
competitors for such relationships may have greater management,
human, and financial resources than we do for attracting
distributor relationships. Furthermore, certain of our
electronic cigarette competitors may have better control
of their supply and distribution, be, better established, larger
and better financed than our Company.
We
plan to compete primarily on the basis of product quality, brand
recognition, brand loyalty, service, marketing, and advertising. We
are subject to highly competitive conditions in all aspects of our
business. The competitive environment and our competitive position
can be significantly influenced by weak economic conditions,
erosion of consumer confidence, competitors’ introduction of
low-priced products or innovative products, cigarette excise taxes,
higher absolute prices and larger gaps between price categories,
and product regulation that diminishes the ability to differentiate
tobacco products.
We
also compete against “big tobacco”,
U.S. cigarette manufacturers of both conventional
tobacco cigarettes and
electronic cigarettes like Altria Group, Inc., Lorillard,
Inc. and Reynolds American, Inc. We compete against big tobacco who
offers not only conventional tobacco cigarettes and
electronic cigarettes but also smokeless tobacco products
such as “snus” (a form of moist ground smokeless
tobacco that is usually sold in sachet form that resembles small
tea bags), chewing tobacco and snuff. Big tobacco has nearly
limitless resources, global distribution networks in place and a
customer base that is fiercely loyal to their brands. Furthermore,
we believe that big tobacco will devote more attention and
resources to developing and offering
electronic cigarettes as the market for
electronic cigarettes grows. Because of their
well-established sales and distribution channels, marketing
expertise and significant resources, big tobacco may be better
positioned than small competitors like us to capture a larger share
of the electronic cigarette market.
Don Polly Product
Line. The market for CBD-based
hemp products is rapidly growing and is highly competitive. The
competition consists of publicly and privately-owned companies,
which tend to be highly fragmented in terms of both geographic
market coverage and products offered. With the Company’s
leading brand status, innovation capabilities, existing sales and
marketing platform, established distribution channels and
high-quality manufacturing, Management believes the Company is
well-positioned to capitalize on favorable long-term trends in the
hemp-based, CBD wellness products segment.
Bazi®. Bazi® competitors include Steaz®,
Guayaki Yerba Mate, POM Wonderful®, as well as sports and
energy drinks including Gatorade®, Red Bull®, 5-Hour
Energy®, RockStar®, Monster®, Powerade®,
Accelerade® and All Sport®. These competitors can use
their resources and scale to rapidly respond to competitive
pressures and changes in consumer preferences by introducing new
products, reducing prices or increasing promotional activities.
Many of our competitors have longer operating histories and have
substantially greater financial and other resources than we do.
They, therefore, have the advantage of established reputations,
brand names, track records, back office and managerial support
systems and other advantages that we cannot duplicate in the near
future, if ever. Moreover, many competitors, by virtue of their
longevity and capital resources, have established lines of
distribution to which we do not have access, and are not likely to
duplicate in the near term, if ever.
Intellectual Property
Patents and Trademarks
Charlie’s Product Line
and Don Polly Product Line. We are the registered owner of the federal
trademarks for CHARLIE’S CHALK DUST, PACHAMAMA, STUMPS, AUNT
MERINGUE & Design, CAMPFIRE & Design, Mr. MERINGUE &
Design, and THE CREATOR OF FLAVOR & Design. We also maintain
registrations in several international markets and will work with
our international distributors to manage intellectual property and
trademark registrations when necessary.
We
plan to continue to expand our brand names and our proprietary
trademarks and designs worldwide as our business
grows.
True Drinks -- Legacy
Products. We maintain
federal trademark registration for Bazi®. This trademark
registration is protected for a period of ten years and then is
renewable thereafter if still in use.
Licensing Agreements
Charlie’s Product
Line. CCD is currently
active in exploring several long-term licensing arrangements with
several well-known industry participants. The goal of such
relationships is to acquire additional revenue streams as well as
to introduce the Charlie’s Chalk Dust and Pachamama™
brands to a wider consumer base.
Don Polly Product
Line. On April 25, 2019, the
Company and Charlie’s entered into a License Agreement (the
“License
Agreement”) with Don
Polly. As previously noted, Don Polly is classified as a variable
interest entity for which the Company is the primary beneficiary,
and is owned by entities controlled by Brandon Stump and Ryan
Stump, the Company’s Chief Executive Officer and Chief
Operating Officer, respectively. Pursuant to the License Agreement,
Charlie’s provides Don Polly with a limited right and license
to use certain of Charlie’s intellectual property rights,
including certain trademarks, copyrights and original artwork, in
connection with certain of Don Polly’s branded CBD products.
In exchange for such license, Don Polly (i) pays Charlie’s
monthly royalties amounting to 75% of its net profits, (ii) uses
its best efforts to market, promote and advertise its products,
(iii) provides Charlie’s with most favored nations pricing in
the event that Charlie’s wishes to sell products sold by Don
Polly, (iv) provide Charlie’s with the exclusive right of
first refusal to purchase Don Polly, including all of its assets
and liabilities, for a purchase price of $111,618 on or before
December 31, 2025, and (v) will not license any intellectual
property from any other source other than Charlie’s in
connection with its design, manufacture, advertisement, promotion
distribution and sale of CBD infused products within the agreed
upon territory. The License Agreement will continue in perpetuity
unless terminated in accordance with its terms.
Concurrently with the execution of the License
Agreement, Charlie’s and Don Polly also entered into a
Services Agreement (the “Services
Agreement”), pursuant to
which Charlie’s provides certain services to Don Polly,
including, without limitation, (i) the development and creation of
Don Polly’s sales, marketing, brand development and customer
service strategies and (ii) performing sales, branding, marketing
and other business functions at the request of Don Polly.
Charlie’s will perform such services in the capacity of a
contractor, and all materials and work product created by
Charlie’s in its capacity as such will be the property of Don
Polly. As consideration for the Services provided by
Charlie’s, Don Polly (i) pays Charlie’s 25% of its net
profits on a quarterly basis, and (ii) reimburse Charlie’s
for all out-of-pocket business expenses that are preapproved in
writing by Don Polly. The Services Agreement will continue in
perpetuity unless terminated in accordance with its
terms.
True Drinks -- Legacy
Products. We previously
had a licensing agreement with Disney (the
“Disney
License”), which allowed
us to feature popular Disney characters on
AquaBall® Naturally
Flavored Water, allowing AquaBall® to
stand out among other beverages marketed towards children. As
discussed in the section entitled “Recent
Developments” above, in
connection with the discontinued production of
AquaBall®, we notified
Disney of our desire to terminate the Disney License in early
2018. As a result of our
decision to discontinue the production of
AquaBall® and terminate
the Disney License, and considering amounts due, Disney drew from a
letter of credit funded by Red Beard in the amount of $378,000 on
or about June 1, 2018. Subsequently, Disney agreed to a settlement
and release of all claims related to the Disney License in
consideration for the payment to Disney of
$42,000.
Current Operating Trends and Financial Highlights
Management
currently considers the following events, trends and uncertainties
to be important in understanding the Company’s results of
operations and financial condition for the most recent calendar
quarter and full year:
Regarding results from operations for the quarter
ended September 30, 2019, we generated revenue of approximately
$5,590,000, as compared to revenue of $5,223,000 for the
quarter ended September 30, 2018. This increase in revenue of
$367,000 was due, primarily, to
a $556,000 decrease in revenue generated from sales of our
nicotine-based products and a $920,000 increase resulting from the
sale of our CBD based products, which were introduced in June of
2019. In addition, for the quarter ended September 30, 2019, we had
approximately $3,000 of revenue from sales of Bazi. These sales are
the result of selling off product after the Share Exchange and we
do not expect future revenue from the sale of Bazi in its current
form.
We
generated a net income for the quarter ended September 30, 2019 of
approximately $1,557,000, as compared to net income of
approximately $1,886,000 for the quarter ended September 30, 2018.
This income includes non-cash stock-based compensation expense of
approximately $599,000, accrued executive bonus of $375,000 and
non-cash gain in fair value of derivative liabilities of
$2,747,000, both of which were associated with the Share
Exchange.
With
regard to results from operations for the nine months ended
September 30, 2019, we generated revenue of approximately
$19,056,000, as compared to revenue of $16,142,000 for the
nine months ended September 30, 2018. This $2,914,000 increase in
revenue was due primarily to a $949,000 increase in sales of our
nicotine-based products and a $1,942,000 increase resulting from
sales of our CBD based products, which were introduced in June of
2019. In addition, for the nine months ended September 30, 2019, we
had approximately $24,000 of revenue from sales for Bazi. These
sales are the result of selling off product after the Share
Exchange and we do not expect future revenue from the sale of Bazi
in its current form.
We
generated a net income for the nine months ended September 30, 2019
of approximately $999,000, as compared to net income of
approximately $6,069,000 for the nine months ended September 30,
2018. This income includes non-cash stock-based compensation
expense of approximately $3,359,000 and employee bonus payments of
approximately $1,728,000, offset by a non-cash gain in fair value
of derivative liabilities of $2,925,000, all of which were
associated with the Share Exchange.
A
review of both the three and nine month periods ended September 30,
2019 are as follows:
Basis of Presentation
The unaudited interim condensed consolidated
financial statements contained elsewhere in this Report and the
disclosure in this Management’s Discussion and Analysis of
Financial Condition and Results of Operations have been prepared
pursuant to the rules and regulations of the Securities and
Exchange Commission (the “SEC”). Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the
United States of America (“U.S. GAAP”) have been omitted pursuant to such SEC
rules and regulations; nevertheless, the Company believes that the
disclosures are adequate to make the information presented in this
Report not misleading.
Amounts
related to disclosure of December 31, 2018 balances within the
interim condensed consolidated financial statements were derived
from the audited 2018 financial statements and notes thereto of
Charlie’s. These financial statements and the notes hereto
should be read in conjunction with the audited December 31, 2018
financial statements and notes thereto contained in our
Registration Statement on Form S-1, filed with the SEC on July 11,
2019 and amended on September 30, 2019 and October 28, 2019 (File
No. 333-232596). In the opinion of the Company, all adjustments,
including normal recurring adjustments necessary to present fairly
the financial position, results of operations, and cash flows of
the Company for the interim period have been included. The results
of operations for the interim period are not necessarily indicative
of the results for any subsequent interim period or for the full
year.
The Share
Exchange is accounted for as a reverse recapitalization under U.S.
GAAP because the primary assets of the Company were nominal
following the close of the Share Exchange. Charlie’s was
determined to be the accounting acquirer based upon the terms of
the Share Exchange and other factors including: (i) Charlie’s
stockholders and other persons holding securities convertible,
exercisable or exchangeable directly or indirectly for
Charlie’s membership units now own approximately 49%, on a
fully diluted basis, of the Company’s outstanding securities
immediately following the effective time of the Merger, (ii)
individuals associated with Charlie’s now hold a majority of
the seats on the Company’s Board of Directors and (iii)
Charlie’s management holds all key positions in the
management of the combined Company.
The
disclosure in this Report, including the unaudited condensed
consolidated financial statements contained herein, are based on
Charlie’s historical financial statements and the
Company’s financial activity beginning April 26, 2019, as
adjusted, to give effect to Charlie’s reverse
recapitalization of the Company and the Charlie’s Financing.
In addition, from the period April 26, 2019 until September 30,
2019, there were minimal costs and revenue associated with the Bazi
product line which are included in the interim condensed
consolidated financial statements. We do not intend to continue to
produce and sell the Bazi product line, and these costs and
expenses are nominal and will continue to be so in the future. The
operating results of Don Polly for the quarter ended September 30,
2019 are also included.
Historical
financial information presented prior to April 26, 2019 is that of
Charlie’s only, while financial information presented after
April 26, 2019 includes Charlie’s, Don Polly, Bazi Drinks and
the Company, which includes the transactions associated with the
Share Exchange and Charlie’s Financing completed prior to the
Share Exchange, along with ongoing corporate costs.
Results of Operations for the Three Months Ended September 30, 2019
Compared to the Three Months Ended September 30, 2018.
|
|
For the
three months ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
Product
revenue, net
|
$5,590
|
$5,223
|
$367
|
7%
|
|
Total
revenues
|
5,590
|
5,223
|
367
|
7%
|
|
Operating costs and expenses:
|
|
|
|
|
|
Cost
of goods sold - product revenue
|
2,525
|
2,185
|
340
|
16%
|
|
General
and administrative
|
3,567
|
767
|
2,800
|
365%
|
|
Sales
and marketing
|
688
|
385
|
303
|
79%
|
|
Total
operating costs and expenses
|
6,780
|
3,337
|
3,443
|
103%
|
|
Income
(loss) from operations
|
(1,190)
|
1,886
|
(3,076)
|
-163%
|
|
Other income:
|
|
|
|
|
|
Change
in fair value of derivative liabilities
|
2,747
|
-
|
2,747
|
100%
|
|
Total
other income
|
2,747
|
-
|
2,747
|
100%
|
|
Net income
|
$1,557
|
$1,886
|
$(329)
|
-17%
|
We had operating losses of approximately
$1,190,000 for the three months ended September 30, 2019, due,
primarily to approximately $299,000 of stock based compensation
costs incurred in connection with the Share Exchange, a $2.8
million increase in general and administrative expenses as we grow
the business and a decline in our nicotine-based product sales of
$556,000 from the same period in 2018, offset by an increase in
sales from our newly launched CBD products business of $920,000.
For the three months ended September 30, 2018, we had operating
income of approximately $1,886,000 from our branded nicotine-based
e-cigarette liquid business.
Revenue
Revenue for the three months ended September 30,
2019 increased approximately $367,000, or 7%, to approximately
$5,590,000, as compared to approximately $5,223,000 for same period
last year due to a $556,000 decrease in our nicotine-based product
sales, offset by an increase in sales from our newly launched CBD
wellness products business of $920,000. The decrease in sales in
our nicotine based e-liquid flavor sales is directly related to the
current regulatory and health related news stories surrounding the
vaping industry. The nicotine
based e-liquid sales decline began late in the quarter ended
September 30, 2019 and we expect sales in future quarters to
decline until the rightful regulatory changes have been enacted.
For the period from mid September through mid November 2019 we have
experienced a decline in sales of 75% of our domestic nicotine
based e-liquid sales with little effect on our international
e-liquid sales and CBD product sales.
Cost of Revenue
Cost
of revenue, which consists of direct costs of materials, direct
labor, third party subcontractor services, and other overhead costs
increased approximately $340,000, or 16%, to approximately
$2,525,000, or 45% of revenue, for the three months ended September
30, 2019, as compared to approximately $2,185,000, or 42% of
revenue, for the same period in 2018. This 3% percent increase in
the cost of revenue is due to an increase in the sales mix to
distributors, marginally lower average wholesale prices, and lower
fixed cost absorption, but was slightly offset by relatively stable
manufacturing costs.
General and Administrative Expenses
For
the three months ended September 30, 2019, total general and
administrative expenses increased approximately $2,800,000 to
$3,567,000 as compared to approximately $767,000 for the same
period in 2018. Costs relating to the completion of our stock
exchange transaction on April 26, 2019 accounted for part of the
$2.8 million increase, including $599,000 of non-cash stock-based
compensation expense and $375,000 of accrued executive bonus
expenses. The remaining $1.8 million increase is primarily due to
professional fees and increased salaries associated with conducting
business as a public company and certain step-up costs related to
new business activities, including the launch of CBD
products.
Sales and Marketing Expenses
For
the three months ended September 30, 2019, total sales and
marketing expenses increased approximately $303,000, or 79%, to
approximately $688,000 as compared to approximately $385,000 for
the same period in 2018, which was primarily due to enhanced
marketing efforts for the launch of our CBD wellness
products.
Income (Loss) from Operations
We
had a net loss from operations of approximately $1,190,000 for the
three months ended September 30, 2019, as compared to net income
from operations of approximately $1,886,000 for the same period in
2018. Net (loss) Income is determined by adjusting income from
operations by the following items:
Gain in fair value of derivative liabilities
For
the three months ended September 30, 2019 and 2018, the gain in
fair value of derivative liabilities was $2,747,000 and $0
respectively. The derivative liability is associated with the
issuance of the Investor Warrants and the Placement Agent Warrants
in connection with the Share Exchange and the gain for the quarter
ended September 30, 2019 reflects the effect of the change in stock
price on the liability associated with the issuance of these
warrants. There were no warrants outstanding on September 30,
2018.
Net Income
For
the three months ended September 30, 2019, we had net income of
$1,557,000 as compared to net income of $1,886,000 for the same
period in 2018.
Results of Operations for the Nine Months Ended September 30, 2019
Compared to the Nine Months ended September 30, 2018
|
|
For the
nine months ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
Product
revenue, net
|
$19,056
|
$16,142
|
$2,914
|
18%
|
|
Total
revenues
|
19,056
|
16,142
|
2,914
|
18%
|
|
Operating costs and expenses:
|
|
|
|
|
|
Cost
of goods sold - product revenue
|
8,121
|
6,405
|
1,716
|
27%
|
|
General
and administrative
|
11,255
|
2,263
|
8,992
|
397%
|
|
Sales
and marketing
|
1,606
|
1,405
|
201
|
14%
|
|
Total
operating costs and expenses
|
20,982
|
10,073
|
10,909
|
108%
|
|
Income
(loss) from operations
|
(1,926)
|
6,069
|
(7,995)
|
-132%
|
|
Other income:
|
|
|
|
|
|
Change
in fair value of derivative liabilities
|
2,925
|
-
|
2,925
|
100%
|
|
Total
other income
|
-
|
-
|
-
|
100%
|
|
Net income
|
$999
|
$6,069
|
$(5,070)
|
-84%
|
Operating
Income
We had operating losses of approximately
$1,926,000 for the nine months ended September 30, 2019, due,
primarily to approximately $5.0 million of transaction related
costs, including costs incurred in connection with the Share
Exchange, but offset by revenue derived from our branded
nicotine-based e-cigarette liquid business and CBD products. For
the nine months ended September 30, 2018, we had operating income
of approximately $6,069,000 from our branded nicotine-based
e-liquid business.
Revenue
Revenue
for the nine months ended September 30, 2019 increased
approximately $2,914,000, or 18%, to approximately $19,056,000, as
compared to approximately $16,142,000 for comparable period in 2018
due to the release of additional e-liquid flavors and formats,
growth in customer base and sales territories and improved traction
with existing customers which accounted for approximately $949,000
of the revenue increase. In addition, in June 2019 we introduced
several CBD product lines which generated approximately $1,942,000
in revenue during the nine months ended September 30, 2019. Even
though our nicotine e-liquid flavored products had an increase in
revenue of $949,000 over the comparable period in 2018, we did
experience a decline in sales during the latter part of the nine
month period ended September 30, 2019 due to the current regulatory
and health related news stories surrounding the vaping industry and
we expect sales in future quarters to decline until permanent
regulatory changes have been enacted. For the period from mid
September through mid November 2019 we have experienced a decline
in sales of 75% of our domestic nicotine based e-liquid sales with
little effect on our international e-liquid sales and CBD product
sales.
Cost of Revenue
Cost
of revenue, which consists of direct costs of materials, direct
labor, third party subcontractor services, and other overhead costs
increased approximately $1,716,000, or 27%, to approximately
$8,121,000, or 43% of revenue, for the nine months ended September
30, 2019, as compared to approximately $6,405,000, or 40% of
revenue, for the same period in 2018. This 3% percent increase in
the cost of revenue is due to an increase in the sales mix to
distributors, marginally lower average wholesale prices, and lower
fixed cost absorption, but was slightly offset by relatively stable
manufacturing costs.
General and Administrative Expenses
For
the nine months ended September 30, 2019, total general and
administrative expenses increased approximately $8,992,000 to
approximately $11,255,000 as compared to approximately $2,263,000
for the same period in 2018. Costs relating to the completion of
the Share Exchange on April 26, 2019 accounted for a significant
part of the $9.0 million increase, including $3.7 million of
non-cash stock-based compensation and $1.7 million of employee
bonuses. The remaining $3.6 million increase is primarily due to
professional fees and increased salaries associated with conducting
business as a public company and certain step-up costs related to
new business activities, including the launch of CBD
products.
Sales and Marketing Expenses
For
the nine months ended September 30, 2019, total sales and marketing
expenses increased approximately $201,000, or 14%, to approximately
$1,606,000 as compared to approximately $1,405,000 for the same
period in 2018, which was primarily due to enhanced marketing
efforts for the launch of our CBD wellness products.
Income (Loss) from Operations
We
had a net loss from operations of approximately $1,926,000 for the
nine months ended September 30, 2019 as compared to net income from
operations of approximately $6,069,000 for the same period in 2018.
Net (loss) Income is determined by adjusting income from operations
by the following items:
Change in fair value of derivative liabilities
For
the nine months ended September 30, 2019 and 2018, the gain in fair
value of derivative liabilities was $2,925,000 and $0 respectively.
The derivative liability is associated with the issuance of the
Investor Warrants and the Placement Agent Warrants in connection
with the Share Exchange and the gain for the nine months ended
September 30, 2019 reflects the effect of the change in stock price
on the liability associated with the issuance of these warrants.
There were no warrants outstanding on September 30,
2018.
Net Income
For
the nine months ended September 30, 2019, we had a net income of
$999,000 as compared to net income of $6,069,000 for the same
period in 2018.
Effects of Inflation
Inflation
has not had a material impact on our business.
Liquidity and Capital Resources
As of September 30, 2019, we had working capital
of approximately $1,460,000, which consisted of current assets of
approximately $8,648,000 and current liabilities of approximately
$7,188,000. This compares to working capital of approximately
$704,000 at December 31, 2018. The current liabilities, as
presented in the balance sheet at September 30, 2019 included
elsewhere in this Report, primarily include approximately
$1,936,000 of accounts payable and accrued expenses, approximately
$158,000 of deferred revenue associated with product shipped but
not yet received by customers (see our revenue recognition policy
under the “Critical Accounting
Policies” section below),
approximately $257,000 of lease liabilities and $4,837,000 of
derivative liability associated with the Member
Warrants.
Our
cash and cash equivalents balance at September 30, 2019 was
approximately $4,166,000.
For the nine months ended September 30, 2019 we
used cash from operations of $524,000, as compared to generating cash of
$5,698,000 for the same period in
2018. This decline in the cash generated from operations is due
primarily to an increase in accounts receivable, inventories and
prepaid expenses.
For the nine months ended September 30, 2019 we
used cash for investment activities of $365,000 as compared
to $12,000 for the same period
in 2018. The cash used for investment activities is primarily used
for the purchase of fixed assets and certain leasehold improvements
for the buildout of our Don Polly operation.
For
the nine months ended September 30, 2019 we generated cash from
financing activities, of $4,751,000 as compared to a use of cash of
$5,352,000 for the same period in 2018. In 2019, we generated
financing cash from the Charlie’s Financing, which was offset
by Member distributions to the former Members of Charlie’s,
as compared to the 2018 period during which we used cash for Member
distributions to the former Members of Charlie’s. The
Charlie’s Member distributions were all prior to or part of
the Share Exchange and no further distributions will be made as
Charlie’s is now a wholly-owned subsidiary of the
Company.
Our
plans and growth depend on our ability to increase revenues and
continue our business development efforts. We currently anticipate
that our current cash position will be enough to meet our working
capital requirements to continue our sales and marketing efforts
for at least 12 months. If in the future our plans or assumptions
change or prove to be inaccurate, or there is a significant change
in the regulatory environment, we may need to raise additional
funds through public or private debt or equity offerings,
financings, corporate collaborations, or other means.
Off-Balance Sheet Arrangements
The
Company has no off-balance sheet arrangements other than operating
lease commitments.
Critical Accounting Policies
Included
below is a discussion of critical accounting policies used in the
preparation of our financial statements. While all these
significant accounting policies impact our financial condition and
results of operations, we view certain of these policies as
critical. Policies determined to be critical are those policies
that have the most significant impact on our financial statements
and require management to use a greater degree of judgment and
estimates. Actual results may differ from those
estimates.
We
believe that given current facts and circumstances, it is unlikely
that applying any other reasonable judgments or estimate
methodologies would cause a material effect on our consolidated
results of operations, financial position or liquidity for the
periods presented in this report.
The
accounting policies identified as critical are as
follows:
Revenue Recognition
The Company recognizes revenues in accordance with
Accounting Standards Codification (“ASC ”) 606 – Contracts with Customers.
Revenues are generated from contracts with customers that consist
of sales to retailers and distributors. Contracts with customers
are generally short term in nature with the delivery of product as
a single performance obligation. Revenue from the sale of product
is recognized at the point in time when the single performance
obligation has been satisfied and control of the product has
transferred to the customer. In evaluating the timing of the
transfer of control of products to customers, The Company considers
several indicators, including significant risks and rewards of
products, the right to payment, and the legal title of the
products. Based on the assessment of control indicators, sales are
generally recognized when products are received by customers.
Shipping generally occurs prior to the transfer of control to the
customer and is therefore accounted for as a fulfillment expense.
In circumstances where shipping and handling activities occur after
the customer has obtained control of the product, the Company has
elected to account for shipping and handling activities as a
fulfillment cost rather than an additional promised service.
Contract durations are generally less than one year, and therefore
costs paid to obtain contracts, which generally consist of sales
commissions, are recognized as expenses in the period incurred.
Revenue is measured by the transaction price, which is defined as
the amount of consideration expected to be received in exchange for
providing goods to customers. The transaction price is adjusted for
estimates of known or expected variable consideration, which
includes refunds and returns as well as incentive offers and
promotional discounts on current orders. Sales returns are
generally not material to the financial statements, and do not
comprise a significant portion of variable consideration. Estimates
for sales returns are based on, among other things, an assessment
of historical trends, information from customers, and anticipated
returns related to current sales activity. These estimates are
established in the period of sale and reduce revenue in the period
of the sale. Variable consideration related to incentive offers and
promotional programs are recorded as a reduction to revenue based
on amounts the Company expects to collect. Estimates are regularly
updated and the impact of any adjustments are recognized in the
period the adjustments are identified. In many cases, key sales
terms such as pricing and quantities ordered are established at the
time an order is placed and incentives have very short-term
durations.
Amounts
billed and due from customers are short term in nature and are
classified as receivables since payments are unconditional and only
the passage of time related to credit terms is required before
payments are due. The Company does not grant payment financing
terms greater than one year. Payments received in advance of
revenue recognition are recorded as deferred
revenue.
Accounts Receivable
Accounts
receivable is recorded at the invoiced amount and does not bear
interest. We determine the allowance for doubtful accounts by
regularly evaluating individual customer receivables and
considering a customer’s financial condition, credit history
and current economic conditions and set up an allowance for
doubtful accounts when collection is uncertain. Customers’
accounts are written off against the allowance when all attempts to
collect have been exhausted. Recoveries of accounts receivable
previously written off are recorded as income when received. As of
September 30, 2019, and December 31, 2018, the allowance for bad
debt totaled $379,000 and $151,000, respectively. We determine the
allowance for customer returns by evaluating historical trends in
customer refunds as well as changes in the regulatory environment
that could affect the future salability of certain products.
As of September 30, 2019 and December 31, 2018, the allowance for
customer returns totaled $346,000 and $0,
respectively.
Inventories
Inventories
primarily consist of finished goods and are stated at the lower of
cost (determined by the average cost method) or net realizable
value. We calculate estimates of excess and obsolete inventories
determined primarily by reviewing inventory on hand, historical
sales activity, industry trends and expected net realizable value.
As of September 30, 2019 and December 31, 2018, the reserve for
excess and obsolete inventories totaled $66,000 and $74,000,
respectively.
Stock-Based Compensation
We
account for all stock-based compensation using a fair value-based
method. The fair value of financial instruments granted to
employees is estimated on the date of the grant using the
Black-Scholes option-pricing model and the related stock-based
compensation expense is recognized over the vesting period during
which an employee is required to provide service in exchange for
the award. The fair value financial instruments granted to
non-employees is measured and expensed as the options
vest.
Income taxes
Income
taxes are computed under the liability method. This method requires
the recognition of deferred tax assets and liabilities for
temporary differences between the financial reporting basis and the
tax basis of our assets and liabilities. The impact on deferred
taxes of changes in tax rates and laws, if any, are applied to the
years during which temporary differences are expected to be settled
and are reflected in the consolidated financial statements in the
period of enactment. A valuation allowance is recorded when it is
more likely than not that some of the deferred tax assets will not
be realized.
Financial
statement effects of a tax position are initially recognized when
it is more likely than not, based on the technical merits, that the
position will be sustained upon examination by a taxing authority.
A tax position that meets the more-likely-than-not recognition
threshold is initially and subsequently measured as the largest
amount of tax benefit that meets the more-likely-than-not threshold
of being realized upon ultimate settlement with a taxing authority.
We recognize potential accrued interest and penalties related to
unrecognized tax benefits as income tax expense.