Charlie's Holdings, Inc. - Quarter Report: 2023 September (Form 10-Q)

CHARLIE’S HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2023

INDEX

PART I

ITEM 1. FINANCIAL STATEMENTS

CHARLIE’S HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

CHARLIE’S HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

CHARLIE’S HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

CHARLIE’S HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

CHARLIE'S HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Description of the Business

Charlie’s Holdings, Inc., a Nevada corporation, together with its wholly owned subsidiaries and consolidated variable interest entity (collectively, the “Company”), currently formulates, markets and distributes premium, non-combustible nicotine-related products, alternative alkaloid vapor products, and hemp-derived vapor and edible products. The Company’s products are produced through contract manufacturers for sale by select distributors, specialty retailers, and third-party online resellers throughout the United States, as well as in more than 80 countries worldwide. The Company’s primary international markets include the United Kingdom, Italy, Spain, New Zealand, Australia, and Canada.

Charlie’s Chalk Dust, LLC (“Charlie’s” or “CCD”), is the Company’s wholly owned subsidiary which produces and sells nicotine-based and alternative alkaloid vapor products. Don Polly is a consolidated variable interest entity, for which the Company is the primary beneficiary, which develops, markets and distributes products containing cannabinoids derived from hemp.

The Company's common stock, par value $0.001 per share (the “Common Stock”), trades under the symbol "CHUC" on the OTCQB Venture Market.

Substantial Doubt to Continue as a Going Concern Regarding the Legal and Regulatory Environment, Liquidity and Management’s Plan of Operation

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company operates in a rapidly changing legal and regulatory environment; new laws and regulations or changes to existing laws and regulations could significantly limit the Company’s ability to sell its products, and/or result in additional costs. Additionally, the Company was required to obtain approval from the United States Food and Drug Administration ("FDA") to continue selling and marketing certain of products used for the vaporization of nicotine in the United States. Currently, a substantial portion of the Company’s sales are derived from products that are subject to approval by the FDA. There was a significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future applications. For the nine months ended September 30, 2023, the Company’s revenue declined, the Company generated a loss from operations of approximately $2,301,000, and a consolidated net loss of approximately $2,066,000. Cash used in operations was approximately $736,000. The Company had stockholders’ deficit of $248,000 at September 30, 2023. During the nine months ended September 30, 2023, the Company’s working capital position decreased to $122,000 from $1,067,000, as of December 31, 2022. Considering these facts, the issuance of one or several Marketing Denial Orders ("MDOs”) from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables and potentially require us to remove products from circulation. These regulatory risks, as well as other industry-specific challenges, our low working capital and cash position remain factors that raise substantial doubt about the Company’s ability to continue as a going concern.

Management's plans depend on its ability to increase revenues, procure cost-effective financing, and continue its business development efforts, including the expenditure of approximately $5.1 million as of September 30, 2023, to support the Pre-Market Tobacco Application (“PMTA”) process for the Company’s submissions to the FDA. The Company has undergone cost-cutting measures including salary reductions of up to 25% for officers and certain managers and a reduction in headcount for several departments. During the quarter ended September 30, 2023, the Company prepared to launch SPREE BAR, a non-nicotine, disposable vapor product which is not subject to FDA review or covered under the Agriculture Improvement Act (the “Farm Bill”). The Company may require additional financing in the future to support the development of new product categories as well as subsequent PMTA filings, and/or in the event the FDA requests additional testing for one, or several, of the Company’s prior PMTA submissions. There can be no assurance that additional financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and, in the Company’s best interests. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. If the Company does not have sufficient funds to continue operations, the Company could be required to seek bankruptcy protection or other alternatives that would likely result in our stockholders losing some or all their investment in us.

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. In addition, in June 2022, the FDA announced a plan to reduce nicotine levels in cigarettes to minimally or non-addictive 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 nicotine, flavored e-cigarette liquid and other electronic nicotine delivery system (“ENDS”) products, 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. In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products. The Company’s applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell its approved products in the United States. Beginning in August 2021, the FDA began issuing Marketing Denial Orders (“MDO”) for ENDS products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. The Company has not received an MDO for any of its submissions; however, there is no assurance that regulatory approval to sell our products will be granted or that Charlie’s would be able to raise additional financing if required, which could have a significant impact on our sales. On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine. These regulations make the Company’s synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products. As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha brands by May 14, 2022 or be subject to FDA enforcement. The Company filed new PMTAs, for its synthetic Pacha products on May 13, 2022, prior to the May 14, 2022 deadline. On November 3, 2022, FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA refused to accept certain other PMTAs for these products, rendering the latter products subject to FDA enforcement. The Company intends to pursue an administrative appeal with FDA regarding its refusal to accept certain of the PMTAs Charlie’s submitted for our synthetic nicotine products, and in parallel the Company intends to resubmit PMTAs for, and to continue to sell, the affected products while the administrative appeal process is pending. There can be no guarantee that FDA will grant our administrative appeal, and the FDA may bring an enforcement action against our synthetic nicotine products for lack of premarket authorization and/or issue an MDO to our pending applications at any time. More generally, FDA’s regulatory initiatives and enforcement priorities regarding ENDS products are unpredictable and continue to evolve, and the Company cannot predict whether FDA’s priorities and review of our premarket submissions will impact our products to a greater degree than our competitors in the industry.

During the fourth quarter of 2023 the Company plans to launch new disposable vape products, under the “SPREE BAR™” brand, that the Company expects will (i) replace most of its legacy products and (ii) become the single largest, most important commercial opportunity in Charlie's history. The Company and its attorneys believe SPREE BAR products are not subject to FDA review. Based on the information provided by the Company’s contracted chemical suppliers and its consultants, the proprietary Metatine™ (patented in the United States and in China by the Company’s chemical supplier) in the Company’s SPREE BAR products does not meet the definition of nicotine set forth in 21 U.S.C. § 387(12) and therefore its products containing Metatine, as their active ingredient, are not subject to regulation as “tobacco products” under 21 U.S.C. § 321(rr). Further, according to information provided by the Company’s chemists, the other ingredients in the Company’s SPREE BAR vape liquid are not made or derived from tobacco, nor do they contain nicotine from any source. The documentary support for these facts, including a Certificate of Analysis (“COA”) for the Metatine used in the Company’s SPREE BAR products, corroborates these conclusions. However, should any of these understandings be incorrect, the Company’s position on Metatine not qualifying as a “tobacco product” would need to be revisited. Further, should Congress bestow regulatory control over Metatine to the FDA, or should the FDA deem Metatine disposable vape devices “tobacco products” despite the facts that Metatine is not a salt or complex of nicotine, and is not itself derived from nicotine or tobacco, SPREE BAR products might then be subject to the FDA tobacco requirements, including, but not limited to, the requirement that all newly deemed tobacco products obtain premarket authorization before entering the U.S. market. If this were to happen, the FDA could bring an enforcement action against our Metatine products for lack of premarket authorization. More generally, FDA’s regulatory initiatives and enforcement authority regarding our products are unpredictable and continue to evolve and we cannot predict whether FDA’s priorities and/or potential jurisdiction over our products will require us to remove our products from the market and to cease selling them.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited interim condensed consolidated financial statements 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 generally accepted accounting principles in the United States (“U.S. GAAP”) have been omitted pursuant to SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented in this Report not misleading. The unaudited interim financial statements furnished reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Significant Accounting Policies

There have been no material changes in the Company’s significant accounting policies to those previously disclosed in the 2022 Annual Report.

Recent Accounting Standards

Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued Accounting Standards Update ASU No. 2016‑13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which was codified with its subsequent amendments as ASC Topic 326, Financial Instruments – Credit Losses (“ASC 326”). ASC 326 seeks to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments, including trade receivables, and other commitments to extend credit held by a reporting entity at each reporting date. The amendments require an entity to replace the incurred loss impairment methodology in other GAAP with a methodology that reflects current expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The adoption of this guidance on January 1, 2023 did not have a material impact on the Company’s unaudited condensed consolidated financial statements and disclosures.

Debt–Debt with Conversion and Other Options

In August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which simplifies accounting for convertible instruments by removing major separation models required under current GAAP. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception and it also simplifies the diluted earnings per share calculation in certain areas. The ASU is effective for the Company on December 1, 2022, Early adoption is permitted, but no earlier than December 1, 2021. The Company elected to early adopt this guidance on January 1, 2022 with no impact on its consolidated financial statements and related disclosures.

Earnings per Share

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). This ASU reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. This ASU provides guidance for a modification or an exchange of a freestanding equity-classified written call option that is not within the scope of another Topic. It specifically addresses: (1) how an entity should treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; (2) how an entity should measure the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange; and (3) how an entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange. This ASU is effective for all entities for fiscal years beginning after December 15, 2021. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. On October 1, 2022, the Company adopted this standard with no impact on its consolidated financial statements and related disclosures.

NOTE 3 – FAIR VALUE MEASUREMENTS

In accordance with Accounting Standards Codification (“ASC”) Topic 820 “Fair Value Measurements and Disclosures” (“ASC 820”), the Company uses various inputs to measure the outstanding warrants on a recurring basis to determine the fair value of the liability. ASC 820 also establishes a hierarchy categorizing inputs into three levels used to measure and disclose fair value. The hierarchy gives the highest priority to quoted prices available in active markets and the lowest priority to unobservable inputs. An explanation of each level in the hierarchy is described below:

Level 1 – Unadjusted quoted prices in active markets for identical instruments that are accessible by the Company on the measurement date.

Level 2 – Quoted prices in markets that are not active or inputs which are either directly or indirectly observable.

Level 3 – Unobservable inputs for the instrument requiring the development of assumptions by the Company.

The following table classifies the Company’s liabilities measured at fair value on a recurring basis into the fair value hierarchy as of September 30, 2023 and December 31, 2022 (amounts in thousands):

There were no transfers between Level 1, 2 or 3 during the nine-month period ended September 30, 2023.

The following table presents changes in Level 3 liabilities measured at fair value for the nine-month period ended September 30, 2023. Both observable and unobservable inputs were used to determine the fair value of positions that the Company has classified within the Level 3 category. Unrealized gains and losses associated with liabilities within the Level 3 category include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs (amounts in thousands).

A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in the Monte Carlo simulation measuring the Company’s derivative liabilities that are categorized within Level 3 of the fair value hierarchy as of September 30, 2023 and December 31, 2022, is as follows:

On April 26, 2019 (the “Closing Date”), the Company entered into a Securities Exchange Agreement (“Share Exchange”) with each of the former members (“Members”) of Charlie’s, and certain direct investors in the Company (“Direct Investors”), pursuant to which the Company acquired all outstanding membership interests of Charlie’s beneficially owned by the Members in exchange for the issuance by the Company of units. Immediately prior to, and in connection with, the Share Exchange, Charlie’s consummated a private offering of membership interests that resulted in net proceeds to Charlie’s of approximately $27.5 million (the “Charlie’s Financing”). In conjunction with the Share Exchange, the Company issued to holders of its Series A Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred”), warrants to purchase an aggregate of 31,028,996 shares of Common Stock (the “Investor Warrants”) and to its placement agent, Katalyst Securities LLC, warrants to purchase an aggregate of 9,308,699 shares of Common Stock (the “Placement Agent Warrants”). Both the Investor Warrants and Placement Agent Warrants have a five-year term and a strike price of $0.44313 per share. Due to the exercise features of these warrants, they are not considered to be indexed to the Company’s own stock and are therefore not afforded equity treatment in accordance with ASC Topic 815, “Derivatives and Hedging” (“ASC 815”). In accordance with ASC 815, the Company has recorded the Investor Warrants and Placement Agent Warrants as derivative instruments on its consolidated balance sheet. ASC 815 requires derivatives to be recorded on the balance sheet as an asset or liability and to be measured at fair value. Changes in fair value are reflected in the Company’s earnings for each reporting period.

NOTE 4 – PROPERTY AND EQUIPMENT

Depreciation and amortization expense totaled $117,000 and $244,000, respectively, during the nine months ended September 30, 2023 and 2022. Property and equipment as of September 30, 2023 and December 31, 2022, are as follows (dollar amounts in thousands):

NOTE 5 – CONCENTRATIONS

Vendors

The Company’s concentration of inventory purchases is as follows:

During the three months ended September 30, 2023, and 2022, purchases from five vendors represented 74% and 89%, respectively, of total inventory purchases. During the nine months ended September 30, 2023, and 2022, purchases from 5 vendors represented 76% and 80%, respectively, of total inventory purchases.

As of September 30, 2023, and December 31, 2022, amounts owed to these vendors totaled $303,000 and $464,000 respectively, which are included in accounts payable and accrued expenses in the accompanying condensed consolidated balance sheets.

Accounts Receivable

The Company’s concentration of accounts receivable is as follows:

Six customers made up 89% of net accounts receivable at September 30, 2023. Four customers made up approximately 36% of net accounts receivable at December 31, 2022. Customer A owed the Company a total of $66,000, representing 22% of net receivables at September 30, 2023. Customer C owed the Company a total of $63,000, representing 21% of net receivables at September 30, 2023. Customer D owed the Company a total of $55,000, representing 18% of net receivables at September 30, 2023. Customer E owed the Company a total of $52,000, representing 17% of net receivables at September 30, 2023. Customer F owed the Company a total of $32,000, representing 11% of net receivables at September 30, 2023. Customer A owed the Company a total of $184,000, representing 15% of net receivables at December 31, 2022. Customer B owed the Company a total of $136,000, representing 11% of net receivables at December 31, 2022. No customer exceeded 10% of total net sales for the nine-month periods ended September 30, 2023 and 2022.

NOTE 6 – DON POLLY, LLC

Don Polly is a Nevada limited liability company that is owned by entities controlled by Brandon and Ryan Stump, a former and current executive officer of the Company, respectively, and a consolidated variable interest for which the Company is the primary beneficiary. Don Polly formulates, sells and distributes the Company’s hemp-derived product lines.

Don Polly is classified as a variable interest entity (“VIE”) for which the Company is the primary beneficiary. Under ASC 810-10-15, Variable Interest Entities, a VIE is an entity that: (1) has an insufficient amount of equity investment at risk to permit the entity to finance its activities without additional subordinated financial support by other parties; (2) the equity investors are unable to make significant decisions about the entity’s activities through voting rights or similar rights; or (3) the equity investors do not have the obligation to absorb expected losses or the right to receive residual returns of the entity. The Company is required to consolidate a VIE if it is determined to be the primary beneficiary, that is, the enterprise has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE. The Company evaluates its relationships with a VIE to determine whether it is the primary beneficiary of a VIE at the time it becomes involved with the entity and it re-evaluates that conclusion each reporting period. Effective April 25, 2019, the Company began consolidating the financial statements of Don Polly and it is still considered a VIE of the Company.

Don Polly operates under exclusive licensing and service contracts with the Company whereby the Company receives 100% of the net income, or incurs 100% of the net loss of the VIE. There are no non-controlling interests recorded.

NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses as of September 30, 2023 and December 31, 2022, are as follows (amounts in thousands):

NOTE 8 – NOTES PAYABLE

July 2023 Note Financing

Between July 17, 2023 and August 1, 2023, the Company issued unsecured promissory notes (the “Notes”) to several of its executives and employees, Ryan Stump, Henry Sicignano III, Keith Stump, and Jessica Greenwald, and to three of its largest stockholders, Brandon Stump, Red Beard Holdings LLC, and Michael King (the “Lenders"), in the cumulative principal amount of $1,400,000. The Company recognized $1,200,000 in Notes payable – related party on the condensed consolidated balance sheet as of September 30, 2023. Notes shall bear interest at twenty-one percent (21%) per annum and have maturity dates ranging from November 17, 2023 to December 10, 2023.

January 2023 Receivables Financing

On January 19, 2023 the Company entered into a future receivables sale agreement (“Receivables Financing” or “Receivables Financing Agreement”) with Austin Business Finance (“Austin Purchaser”) by which Austin Purchaser purchases from the Company, its future accounts and contract rights arising from the sale of goods or rendition of services to the Company’s customers. The purchase price, as defined by the Receivables Financing Agreement, was $650,000 which was paid to the Company on January 19, 2023, net of a 3% origination fee. The Receivables Financing Agreement required twenty-six equal payments of $29,500 to be paid weekly for a total repayment of $760,500 over the term of the agreement. As of September 30, 2023, the Company had fully repaid the outstanding principal balance and accrued interest totaling $760,500 on its Receivables Financing Agreement.

April 2022 Note Financing

On April 6, 2022, the Company issued a secured promissory note (the “Note”) to one of its individual stockholders, and a member of the Company’s Board of Directors since June 13, 2023, Michael King (the “Lender"), in the principal amount of $1,000,000, which Note is secured by accounts receivable of the Company pursuant to the terms of a Security Agreement entered into by and between the Company and the Lender (the "Note Financing"). The Note initially required the payment of principal in full and guaranteed interest in an amount the greater of 18% per annum, or $90,000, on or before the earlier date of (i) a Liquidity Event, as defined under the terms of the Note; or (ii) September 28, 2022. On September 28, 2022, the Company and the Lender entered into a modification to the Note to extend the maturity date to March 28, 2023 and the Company paid all accrued interest under the Note through such date.

On March 28, 2023, the Company entered into a second modification to the Note to extend the maturity date to April 28, 2024, contingent upon the payment of all interest accrued under the Note through March 28, 2023 and certain other modifications to the Note. Principal shall be payable on the 28th day of each month in installments of $25,000, commencing April 28, 2023, continuing up to and including April 28, 2024 whereby a balloon payment for the remaining principal balance will be paid. Immediately following the second modification, the Company entered into a third modification agreement to further extend the maturity date to March 28, 2025. The third modification agreement was effective on March 28, 2023 and superseded the second modification. Interest shall accrue on the aggregate outstanding principal amount at a rate equal to 20% simple interest per annum and shall be payable on the same day as installments of principal are payable. The Company may prepay all or any portion of the principal amount, together with all accrued but unpaid interest thereon, at any time without premium or penalty. All outstanding principal and interest are due earlier of March 28, 2025, or a liquidity event. The third modification was recognized as a debt extinguishment, resulting in a gain on debt extinguishment of approximately $35,000. The Company used the proceeds from the Note for general corporate purposes, and its working capital requirements, pending the availability of alternative debt financing.

August 2022 Note Financing – Related Party

On August 17, 2022, the Company and its Chief Operating Officer and Director, Ryan Stump (the "Stump Lender") entered into a loan agreement (the “Loan”) in the principal amount of $300,000. The Loan will be due in full in 120 days or sooner if, before the end of term, the Company secures (i) new debt financing or (ii) sufficient PMTA strategic partnership funds. The Loan bears an annual interest rate of 10%. The Company also incurred an additional $3,000 issuance cost resulting from the payment of the Stump Lender’s legal fees. On December 17, 2022, the Company and Stump Lender entered into a modification to the Loan to extend the maturity date to April 16, 2023 and the Company has paid all accrued interest under the Loan through such date. On April 13, 2023, the Company and Stump Lender entered into a second modification to the Loan to extend the maturity date to August 14, 2023. On August 7, 2023, the Company and Stump Lender entered into a third modification to the Loan to extend the maturity date to December 15, 2023.

Economic Injury Disaster Loan

On June 24, 2020, SBA authorized (under Section 7(b) of the Small Business Act, as amended) an Economic Injury Disaster Loan (“EID Loan”) to Don Polly in the amount of $150,000. The balance of principal and interest will be payable thirty years from the date of the EID Loan and interest will accrue at the rate of 3.75% per annum.

The following summarizes the Company’s notes payable maturities as September 30, 2023 (amounts in thousands):

NOTE 9 – (LOSS) EARNINGS PER SHARE APPLICABLE TO COMMON STOCKHOLDERS

Basic (loss) earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted (loss) earnings per common share is computed similar to basic earnings (loss) per common share except that it reflects the potential dilution that could occur if dilutive securities or other obligations to issue common stock were exercised or converted into common stock. Diluted weighted average common shares include common stock potentially issuable under the Company’s convertible preferred stock, warrants and vested and unvested stock options.

For the three and nine months ended September 30, 2023, net income is adjusted for gain from change in fair value of warrant liabilities.

The following table sets forth the computation of (loss) earnings per share (amounts in thousands, except share and per share amounts):

The following securities were not included in the diluted net income (loss) per share calculation because their effect was anti-dilutive as of the periods presented (in thousands):

NOTE 10 – STOCKHOLDERS’ EQUITY

Conversion of Series A Preferred Shares

During the nine months ended September 30, 2023, the Company issued approximately 1,183,000 shares of Common Stock upon conversion of 5,242 shares of Series A Preferred.

NOTE 11 – STOCK-BASED COMPENSATION

On May 8, 2019, our Board of Directors approved the Charlie’s Holdings, Inc. 2019 Omnibus Incentive Plan (the “2019 Plan”), and the 2019 Plan was subsequently approved by holders of a majority of our outstanding voting securities on the same date. Up to 11,072,542 stock options were originally grantable under the 2019 Plan.

On December 22, 2021, our Board of Directors unanimously adopted resolutions by written consent approving an amendment to increase the number of shares of Common Stock available for issuance under the 2019 Plan by 15.0 million shares, from 11,072,542 to 26,072,542 shares (the “2019 Plan Amendment”). Furthermore, the Company received written consents approving the 2019 Plan Amendment from holders of approximately 50.3% of our outstanding voting securities. In accordance with Rule 14c of the Exchange Act, our Board of Directors’ authority to implement the 2019 Plan Amendment became effective February 28, 2022, twenty calendar days after notification of our shareholders.

Non-Qualified Stock Options

The following table summarizes stock option activities during the nine months ended September 30, 2023 (all option amounts are in thousands):

As of September 30, 2023, there was a de-minimis amount of unrecognized compensation expense related to these option agreements.

Restricted Stock Awards

The following table summarizes restricted stock awards activities during the nine months ended September 30, 2023 (all share amounts are in thousands):

During the nine months ended September 30, 2023, the Company granted 4,700,000 restricted stock awards (“RSAs”) to officers and directors of the Company pursuant to the 2019 Plan, as amended. The RSAs are subject to a vesting schedule and have all the rights of a shareholder of the Company with respect to voting, share adjustments, receipt of dividends (if any) and distributions (if any) on such shares. The grant date fair value was approximately $147,000. During the nine months ended September 30, 2023, approximately 477,000 RSAs issued to employees and contractors were forfeited.

As of September 30, 2023, there was approximately $157,000 of total unrecognized compensation expense related to non-vested restricted share-based compensation arrangements granted under the 2019 Plan, as amended. That cost is expected to be recognized over a weighted average period of 2.0 years. The Company recorded total stock-based compensation of approximately $119,000 during the nine months ended September 30, 2023 related to the RSAs, respectively.

NOTE 12 – COMMITMENTS AND CONTINGENCIES

Leases

The Company leases office space under agreements classified as operating leases that expire on various dates through 2024. All of the Company’s lease liabilities result from the lease of its headquarters in Costa Mesa, California, which expires in 2024, and its warehouse in Huntington Beach, California, which was renewed in May 2022 and expires May 2025. On April 29, 2022, the Company entered into a commercial lease agreement for the Company’s sales and marketing operations in Williamsville, New York (“Williamsville Lease”) with Henry Sicignano Jr., a relative of the Company’s President, Henry Sicignano III. The Williamsville Lease, which became effective on May 1, 2022, has a term of one year and a base rent of $1,650 per month. The Williamsville Lease was extended for additional one year with same terms on May 1, 2023. The Williamsville Lease is considered a modified gross lease and therefore the Company will also be responsible for additional monthly expenses including gas, electricity, and internet. The Williamsville Lease was evaluated and approved by the Company’s Board of Directors.

Such leases do not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. Certain of the Company’s leases include renewal options and escalation clauses; renewal options have not been included in the calculation of the lease liabilities and right of use assets as the Company is not reasonably certain to exercise the options. Variable expenses generally represent the Company’s share of the landlord’s operating expenses. The Company does not act as a lessor or have any leases classified as financing leases.

The Company excludes short-term leases having initial terms of 12 months or less from ASC Topic 842, “Leases”, as an accounting policy election and recognizes rent expense on a straight-line basis over the lease term. The Company entered into a commercial lease for the Company’s corporate headquarters (the “Lease”) in Costa Mesa, California with Brandon Stump, the Company’s former Chief Executive Officer, Ryan Stump, the Company’s Chief Operating Officer, and Keith Stump, a former member of the Company’s Board of Directors. The Stumps purchased the property that is the subject of the Lease in July 2019. The Lease, which was effective as of September 1, 2019, on a month-to-month basis, was then formalized on November 1, 2019 to have a term of five years and a base rent rate of $22,940 per month, which rate is subject to annual adjustments based on the consumer price index, as may be mutually agreed upon by the parties to the Lease. The terms of the Lease were negotiated and approved by the independent members of the Board of Directors, after reviewing a detailed analysis of comparable properties and rent rates compiled by an independent, third-party consultant. The total rent paid to related parties for the nine months ended September 30, 2023 and 2022 was approximately $207,000 and $207,000, respectively.

Effective June 1, 2022, the Company’s lease at 5331 Production Drive, Huntington Beach, CA was renewed for an additional three-year term, concluding May 31, 2025.

At September 30, 2023, the Company had operating lease liabilities of approximately $526,000 and right of use assets of approximately $522,000 which were included in the condensed consolidated balance sheet.

The following table summarizes quantitative information about the Company’s operating leases for the three and nine months ended September 30, 2023 and 2022 (amounts in thousands):

Maturities of our operating leases as of September 30, 2023, excluding short-term leases, are as follows (amounts in thousands):

Legal Proceedings

As of the date hereof, the Company is not a party to any material legal or administrative proceedings. There are no proceedings in which any of our directors, executive officers or affiliates, or any registered or beneficial stockholder, is an adverse party or has a material interest adverse to our interest. From time to time, the Company may be involved in various claims and counterclaims and legal actions arising in the ordinary course of business. Litigation or any other legal or administrative proceeding, regardless of the outcome, is likely to result in substantial cost and diversion of our resources, including our management’s time and attention.

New Executive Employment Agreement

On June 15, 2023, the Company entered into a new employment agreement with Ryan Stump (the “New Agreement”). Pursuant to the New Agreement, Mr. Stump will earn a base salary of $300,000 per year and serve as Chief Operating Officer for a term of two years, renewable on an annual basis unless earlier terminated by the Company or Mr. Stump. In the event that Mr. Stump is terminated by the Company without Cause (as defined therein) or for Good Reason (as defined therein), he will be entitled to receive his base salary and benefits for a period of one year. In the event of a change in control, all unvested equity awards will immediately vest. Notwithstanding his contracted annual salary, to cut costs during a time when the Company is striving to launch the SPREE BAR line, Mr. Stump has elected to reduce his current compensation to the rate of $225,000 annually. As a point of reference, all the Company’s other executives have also elected to reduce their current compensation. It is anticipated that, after the launch of SPREE BAR, executive base salaries will revert to their previous levels.

NOTE 13 – SUBSEQUENT EVENTS

The Company evaluated subsequent events for their potential impact on the consolidated condensed financial statements and disclosures through the date the consolidated condensed financial statements were available to be issued and determined that, except as set forth below, no subsequent events occurred that were reasonably expected to impact the consolidated condensed financial statements presented herein.

Restricted Stock Award Forfeiture

On October 1, 2023, 100,000 shares of restricted stock, issued under the Company’s 2019 Plan, were forfeited by employees whose service was terminated.

SPREE BAR Launch

As of November 2, 2023, approximately $1.6 million of revenue related to the launch of the Company’s SPREE BAR product has been recognized as four of its Master Distributors received shipments from China.

Synthetic Nicotine PMTA Update

On November 4, 2022, FDA issued two Refuse to Accept Letters (“RTAs”) covering multiple PMTA submissions for certain of the Company's synthetic nicotine products. The Company exercised its right to appeal the decision with the FDA and on March 6, 2023, the Company filed a request for supervisory review with FDA's Center for Tobacco Products. On October 30, 2023, the Company received notification from the FDA that its supervisory review appeal had been granted. Therefore, the FDA has rescinded the RTAs, notified the Company that Acceptance Letters for the PMTAs will be issued, and will place these applications into filing review.

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”) and without audited financial statements and other information presented in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual 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. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this Report, and in our other filings with the Securities and Exchange Commission (“SEC”), including particularly matters set forth under Part I, Item 1A (Risk Factors) of the 2022 Annual Report. Furthermore, such forward-looking statements speak only as of the date of this Report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

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., its subsidiaries and consolidated variable interest entity on a consolidated basis.

Overview

The Company’s objective is to become a leader in three broad product categories: (i) non-combustible nicotine-related products, (ii) alternative alkaloid vapor products, and (iii) hemp-derived vapor and edible products. Through our Charlie’s subsidiary, we formulate, market, and distribute premium, nicotine-based and alternative alkaloid vapor products. Charlie’s products are produced through contract manufacturers for sale through select distributors, specialty retailers, and third-party online resellers throughout the United States, as well as in more than 80 countries worldwide. Charlie’s primary international markets include the United Kingdom, Italy, Spain, New Zealand, Australia, and Canada. Through Don Polly, we develop, market and distribute products containing compounds derived from hemp.

Operational Plan

Considering industry-specific hurdles, as well as the potential for future regulatory changes, management has targeted opportunities for growth and has adopted the following operational plan.

Priority 1: In 2022, we initiated a plan and began to invest substantial time and resources to develop various proprietary products and new technologies in order to achieve competitive advantages in the vapor and alternative products marketplace. In conjunction with internal and external research and development resources, we have endeavored to identify a nicotine substitute (“Metatine™”) to be used in lieu of tobacco-based and synthetically derived nicotine. We believe adult consumers will enjoy Metatine vapor products in much the same way that they enjoy traditional vapor products. However, because Metatine is not made or derived from tobacco, and because Metatine does not consist of or contain nicotine from any source, the FDA's Center for Tobacco Products does not have jurisdiction to regulate Metatine. Accordingly, if the Company is successful utilizing Metatine in a viable commercial product, such a product would allow us additional flexibility in offering both flavored and non-flavored vapor products to adult consumers looking to transition away from traditional combustible and smokeless tobacco products.

In September 2023 the Company began shipping its new Metatine-based, SPREE BAR™ disposable vape products to master distributors, in preparation for launch (and sales to be recognized) in October 2023. We believe that our transition to the SPREE BAR product line will give Charlie's an extraordinary opportunity to capture significant sales and market share in the vapor products marketplace in 2024 and beyond.

As of the end of the quarter, we have awarded SPREE BAR Master Distributor and Distributor contracts to seven large customers. As part of these agreements, we have accepted purchase orders, and corresponding 50% up-front deposits, for each distributor’s initial order. It is our plan to sign additional Master Distributor agreements with as many as ten new SPREE BAR Distributors before the end of 2023. Given the novelty of the product, its compelling value in the marketplace as a disposable pod system (with a reusable battery), and its very significant regulatory advantages, SPREE BAR represents the single largest, most important commercial opportunity in Charlie's history.

The Company has also begun to develop intellectual property around technologies designed to prevent youth access to nicotine vapor products. Edward Carmines, Ph.D., a member of Charlie’s Board of Directors and an accomplished scientist and regulatory affairs expert, is spearheading Charlie's development of patented "age-gating technology" for both Charlie's and potential licensees of the Company. Currently, there is a need for age-gated product technologies that can satisfy or accommodate concerns the FDA has related to under-age youth access in the ENDS market. If our age-gated e-cigarettes-in-development are recognized as "products of merit" by the FDA, Charlie's e-cigarettes could emerge among the select minority of flavored nicotine disposables able to be sold legally in the $7 billion U.S. vapor products market.

Underlining the importance of Charlie’s work with age-gating technology is an initiative taken by JUUL Labs, one of the largest competitors in our industry. In July JUUL announced that it has submitted a PMTA with the FDA for a new e-cigarette device that also included information on novel, data-driven technologies to restrict underage access. JUUL’s chief product officer explained, “With our next-generation platform, we have designed a technological solution for two public-health problems: improving adult-smoker switching from combustible cigarettes and restricting underage access to vapor products...” Similar to the age-gating technology under development at Charlie’s, the JUUL device includes a mobile and web-based app that enables age-verification technology, including device-locking, and real-time product information and usage insights for age-verified consumers with industry-leading data-privacy protections.

Rounding out the Company’s research and development initiatives are Charlie’s efforts to expand and enhance the PINWEEL product line. PINWEEL is Charlie’s alternative cannabis brand that contains only cannabinoids derived from the hemp plant. Since our PINWEEL product line contains only cannabinoids made from 100% hemp extract, we are able to legally manufacture, distribute and sell to consumers in the United States. As a result of the Agriculture Improvement Act (the “Farm Bill”), ratified and signed into law in December 2018, cannabis containing less than 0.3% Delta 9-THC is legally classified as hemp and is thus legal under federal law. Accordingly, with the objective of developing an array of new purpose-driven alternative cannabis products that offer adult consumers an enjoyable alternative to alcohol and traditional cannabis products, the Company continues to develop new PINWEEL vapor products, edibles, and other novel products.

Priority 2: With a new focus on the SPREE BAR product line and on the Master Distributors with whom we have awarded SPREE BAR distribution agreements, we will cost-effectively expand and strategically refocus our sales team. An expanded sales team will more effectively manage key customer relationships across a larger number of reps, mitigating concentration risks and assuring adequate coverage. The sales team is organized into two groups, each with a specific mandate for targeting unique classes of customers. One group will focus on direct-to-retail (smoke shops, chain stores, adult beverage/liquor stores, gas stations, and grocery stores) with the goal of acquiring 1,000 new customer accounts in 2023. The second group will focus on satisfying the requirements of mega-distributors (McLane, Coremark, HT Hackney, Eby-Brown) in order to sell into the nation’s largest chain store accounts. Additionally, to broaden our footprint with customers and to minimize order size variability, sales reps will rebalance their product sales mix, placing enhanced focus on SPREE BAR.

Priority 3: In order to mitigate FDA regulatory risk in the domestic market and to capture what management continues to believe is a significant commercial opportunity, we have dedicated additional resources to efforts focused on growing our market share internationally. Presently, approximately 17% of our vapor product sales come from the international market and we are well positioned to increase sales in countries where we already have presence and, in additional overseas markets, as we have already built an international distribution platform. To facilitate this plan, we recently hired an Account Executive who is dedicated to driving our efforts in international expansion. Further, in late 2023 and throughout 2024 we plan to build-out a dedicated international team, including country managers and marketing coordinators, to market and sell a suite of custom-made products to new and existing international customers.

Recent Developments

Synthetic Nicotine PMTA Update. On November 4, 2022, FDA issued two Refuse to Accept Letters (“RTAs”) covering multiple PMTA submissions for certain of the Company's synthetic nicotine products. The Company exercised its right to appeal the decision with the FDA and on March 6, 2023, the Company filed a request for supervisory review with FDA's Center for Tobacco Products. On October 30, 2023, the Company received notification from the FDA that its supervisory review appeal had been granted. Therefore, the FDA has rescinded the RTAs, notified the Company that Acceptance Letters for the PMTAs will be issued, and will place these applications into filing review.

New Executive Employment Agreement. On June 15, 2023, the Company entered into a new employment agreement with Ryan Stump (the “New Agreement”). Pursuant to the New Agreement, Mr. Stump will earn a base salary of $300,000 per year and serve as Chief Operating Officer for a term of two years, renewable on an annual basis unless earlier terminated by the Company or Mr. Stump. In the event that Mr. Stump is terminated by the Company without Cause (as defined therein) or for Good Reason (as defined therein), he will be entitled to receive his base salary and benefits for a period of one year. In the event of a change in control, all unvested equity awards will immediately vest. Notwithstanding his contracted annual salary, to cut costs during a time when the Company is striving to launch the SPREE BAR line, Mr. Stump has elected to reduce his current compensation to the rate of $225,000 annually. As a point of reference, all the Company’s other executives have also elected to reduce their current compensation. It is anticipated that, after the launch of SPREE BAR, executive base salaries will revert to their previous levels.

New Director. At the Company’s Annual Meeting of Stockholders, the Company’s stockholders appointed Michael D. King as a director. Mr. King is the Founder and current Chief Executive Officer of OEM Solutions, a private company that has developed a supply network in Asia with world-class manufacturing companies that offer a wide variety of custom-made medical products, scientific instruments, consumer products, and food service devices. Operating OEM Solutions has been Mr. King’s sole occupation and employment for the past 22 years. From 1998 until 2001, Mr. King worked as a Sales Representative at Allied Enterprises in Pittsburgh, Pennsylvania. From 1991 through 1998, Mr. King worked for the Ford Motor Company in the Finance Department as an analyst and eventually supervisor. Mr. King graduated with a Master of Business Administration degree from the State University of New York at Buffalo in 1991.

Risks and Uncertainties and Ability to Continue as a Going Concern

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. In addition, in June 2022, the FDA announced a plan to reduce nicotine levels in cigarettes to minimally or non-addictive 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 nicotine, flavored e-cigarette liquid, and other electronic nicotine delivery system (“ENDS”) products, 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. In addition, the Company is presently seeking to obtain marketing authorization for certain of its tobacco-derived nicotine e-liquid products. The Company’s applications were submitted in September 2020 on a timely basis, which if approved, will allow the Company to continue to sell its approved products in the United States. Beginning in August 2021, the FDA began issuing Marketing Denial Orders (“MDO”) for ENDS products that lack evidence to demonstrate that permitting the marketing of such products would be appropriate for the protection of the public health. The Company has not received an MDO for any of its submissions; however, there is no assurance that regulatory approval to sell our products will be granted or that we would be able to raise additional financing if required, which could have a significant impact on our sales. On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over synthetic nicotine.  These regulations make the Company’s synthetic nicotine products subject to the same FDA rules as tobacco-derived nicotine products.  As such, the Company was required to file a PMTA for its existing synthetic nicotine products marketed under the Pacha brands by May 14, 2022 or be subject to FDA enforcement.  The Company filed new PMTAs, for its synthetic Pacha products on May 13, 2022, prior to the May 14, 2022 deadline. On November 3, 2022, FDA accepted for scientific review certain of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA refused to accept certain other PMTAs for these products, rendering the latter products subject to FDA enforcement. The Company submitted an administrative appeal with FDA regarding its refusal to accept certain of the PMTAs, and has resubmitted PMTAs for, and continues to sell, the affected synthetic nicotine products while the administrative appeal process is pending. There can be no guarantee that FDA will grant our administrative appeal, and the FDA may bring an enforcement action against our synthetic nicotine products for lack of premarket authorization and/or issue an MDO to our pending applications at any time.  More generally, FDA’s regulatory initiatives and enforcement priorities regarding ENDS products are unpredictable and continue to evolve, and we cannot predict whether FDA’s priorities and review of our premarket submissions will impact our products to a greater degree than our competitors in the industry. In the event the FDA denies our PMTAs, we would be required to remove products and cease selling them.

In the fourth quarter of 2023 the Company plans to launch new disposable vape products, under the “SPREE BAR™” brand, that the Company expects will (i) replace most of its legacy products and (ii) become the single largest, most important commercial opportunity in Charlie’s history. The Company and its attorneys believe SPREE BAR products are not subject to FDA review. Based on the information provided by the Company’s contracted chemical suppliers and its consultants, the proprietary Metatine™ (patented in the United States and in China by the Company’s chemical supplier) in the Company’s SPREE BAR products does not meet the definition of nicotine set forth in 21 U.S.C. § 387(12) and therefore its products containing Metatine, as their active ingredient, are not subject to regulation as “tobacco products” under 21 U.S.C. § 321(rr).  Further, according to information provided by the Company’s chemists, the other ingredients in the Company’s SPREE BAR vape liquid are not made or derived from tobacco, nor do they contain nicotine from any source.  The documentary support for these facts, including a Certificate of Analysis (COA) for the Metatine used in the Company’s SPREE BAR products, corroborates these conclusions. However, should any of these understandings be incorrect, the Company’s position on Metatine not qualifying as a “tobacco product” would need to be revisited. Further, should Congress bestow regulatory control over Metatine to the FDA, or should the FDA deem Metatine disposable vape devices “tobacco products” despite the facts that Metatine is not a salt or complex of nicotine, and is not itself derived from nicotine or tobacco, SPREE BAR products might then be subject to the FDA tobacco requirements, including, but not limited to, the requirement that all newly deemed tobacco products obtain premarket authorization before entering the U.S. market. If this were to happen, the FDA could bring an enforcement action against our Metatine products for lack of premarket authorization. More generally, FDA’s regulatory initiatives and enforcement authority regarding our products are unpredictable and continue to evolve and we cannot predict whether FDA’s priorities and/or potential jurisdiction over our products will require us to remove our products from the market and to cease selling them.

As discussed below, our financial statements and working capital raise substantial doubt about the Company’s ability to continue as a going concern. Our financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. See Liquidity and Capital Resources below for additional information.

Results of Operations for the Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Regarding results from operations for the quarter ended September 30, 2023, we generated revenue of approximately $2,706,000, as compared to revenue of $6,427,000 for the three months ended September 30, 2022. This $3,721,000 decrease in revenue was due primarily to a $3,590,000 decrease in sales of our nicotine-based vapor products, as well as a $131,000 decrease in sales of our hemp-derived products.

We generated net loss for the three months ended September 30, 2023, of approximately $708,000 as compared to net income of approximately $241,000 for the three months ended September 30, 2022. The net loss for the three months ended September 30, 2023 includes a non-cash gain in fair value of derivative liabilities of $155,000 compared to a non-cash gain in fair value of derivative liabilities of $246,000 during the three months ended September 30, 2022.

A review of the three-month period ended September 30, 2023, follows:

Revenue

Revenue for the three months ended September 30, 2023, decreased by approximately $3,721,000 or 57.9%, to approximately $2,706,000, as compared to approximately $6,427,000 for same period in 2022 due to a $3,590,000 decrease in sales of our nicotine-based vapor products, and a $131,000 decrease in sales of our hemp-derived products. The decrease in our nicotine-based vapor product sales was primarily driven by decreased sales of our Pacha Disposable line as well as periodic, voluntary stockouts of our e-liquid products. Despite a strong performance during its initial launch, our Pacha Disposables line has faced challenges including increased competition from low-priced Chinese products, the requirement for synthetic nicotine products to obtain marketing authorization from the FDA, and continued uncertainty surrounding the FDA’s issuance of MDO’s and Refuse-to-File designations. The FDA has continued to enhance enforcement efforts in recent quarters, including the periodic halting of shipments into U.S. shipping ports which has caused supply chain issues and further marketplace unrest. As a result, the domestic market for nicotine-based disposable vapor products has continued to move “underground” as brands attempt to avoid attention from FDA. Voluntary stockouts of e-liquid products were the result of diverting working capital to the launch of our new SPREE BAR line of nicotine substitute vapor products.

The decrease in sales for our hemp-derived business during the quarter was directly related to the diversion of working capital and other resources towards the launch of our SPREE BAR line of nicotine substitute vapor products. Despite achieving increased market share for our PINWEEL brand of hemp-derived products, we believe that the market for alternative alkaloid products, such as SPREE BAR, offers the Company the most significant opportunity for growth. However, we continue to believe that the hemp-derived category offers short- and medium-term potential for our Company and we will continue to pursue actionable opportunities in this segment.

Cost of Revenue

Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs decreased by approximately $2,062,000 or 56.2%, to approximately $1,609,000, or 59.5% of revenue, for the three months ended September 30, 2023, as compared to approximately $3,671,000, or 57.1% of revenue, for the same period in 2022. This cost, as a percent of revenue, increased compared to last year due to lower overhead cost absorption resulting from reduced sales activity, as well as a decrease in the amount of shipping cost passed on to customers.

General and Administrative Expenses

For the three months ended September 30, 2023, total general and administrative expenses decreased by approximately $469,000 to $1,597,000 as compared to approximately $2,066,000 for the same period in 2022. This change was primarily due to decreases of approximately $356,000 in non-commission payroll and benefits costs, $40,000 in merchant account fees, $33,000 in provision for bad debt, and approximately $149,000 in other general and administrative expenses, but was offset by an increase of approximately $109,000 in certain professional fees. The decrease in payroll and benefits costs was primarily driven by elective salary reductions for executives and a reduced bonus accrual. The decrease in merchant account fees and bad debt provision was largely the result of lower sales activity during the period. The reduction in other general and administrative expenses largely consisted of decreased consulting expenses, fees paid to board members and tax preparation expenses. These reductions were offset by an increase in certain professional fees of approximately $109,000. Higher costs necessary to complete our 2022 audit were responsible for increased professional fees.

Sales and Marketing Expense

For the three months ended September 30, 2023, total sales and marketing expense decreased by approximately $434,000 to approximately $201,000 as compared to approximately $635,000 for the same period in 2022, which was primarily due to reduced marketing and commission costs during the period. Digital marketing, use of promotional materials and tradeshow costs were all adjusted for weaker anticipated sales activity during the quarter ended September 30, 2023. Our commission costs, included in sales and marketing expense, was also lower due to lower sales during the period.

Research and Development Expense

For the three months ended September 30, 2023, total research and development costs increased by approximately $32,000 to approximately $41,000 as compared to approximately $9,000 for the same period in 2022, which was primarily due to costs associated with the development of new technologies and product formats.

(Loss) Income from Operations

We incurred a loss from operations of approximately $742,000 for the three months ended September 30, 2023, compared to income of approximately $46,000 for the three months ended September 30, 2022, due primarily to a significant decrease in sales. We also incurred certain non-cash, general and administrative expenses during the period including a $36,000 expense related to stock-based compensation. Net loss is determined by adjusting loss from operations by the following items:

Net (Loss) Income

For the three months ended September 30, 2023, we incurred a net loss of $708,000 as compared to net income of $241,000 for the same period in 2022.

Results of Operations for the Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Regarding results from operations for the nine months ended September 30, 2023, we generated revenue of approximately $1,706,000, as compared to revenue of $21,898,000 for the nine months ended September 30, 2022. This $11,192,000 decrease in revenue was due primarily to a $10,270,000 decrease in sales of our nicotine-based vapor products, as well as a $922,000 decrease in sales of our hemp-derived products.

We generated a net loss for the nine months ended September 30, 2023, of approximately $2,066,000 as compared to a net income of approximately $311,000 for the nine months ended September 30, 2022. The net loss for the nine months ended September 30, 2023 includes a non-cash gain in fair value of derivative liabilities of $563,000 compared to a non-cash gain in fair value of derivative liabilities of $598,000 during the nine months ended September 30, 2022.

A review of the nine-month period ended September 30, 2023, follows:

Revenue

Revenue for the nine months ended September 30, 2023, decreased by approximately $11,192,000 or 51.1%, to approximately $10,706,000, as compared to approximately $21,898,000 for same period in 2022, primarily due to a $10,270,000 decrease in sales of our nicotine-based vapor products, as well as a $922,000 decrease in sales of our hemp-derived products . The decrease in our nicotine-based vapor product sales was primarily driven by decreased sales of our Pacha Disposable line as well as periodic, voluntary stockouts of our e-liquid products. Despite a strong performance during its initial launch in 2022, our Pacha Disposables line has faced challenges including increased competition from low-priced Chinese products, the requirement for synthetic nicotine products to obtain marketing authorization from the FDA, and continued uncertainty surrounding the FDA’s issuance of MDO’s and Refuse-to-File designations. The FDA has continued to enhance enforcement efforts in recent quarters, including the periodic halting of shipments into U.S. shipping ports which has caused supply chain issues and further marketplace unrest. As a result, the domestic market for nicotine-based disposable vapor products has continued to move “underground” as brands attempt to avoid attention from FDA. Voluntary stockouts of e-liquid products beginning in the second quarter were the result of diverting working capital to the launch of our new SPREE BAR line of nicotine substitute vapor products.

The decrease in sales for our hemp-derived business was directly related to an eight-week pause in manufacturing during the first quarter of 2023, and a subsequent lack of inventory, when the Company changed some of the ingredients in its PINWEEL products in order to avoid compounds that were newly deemed “controlled substances.” However, inventory was restored during the second quarter, resulting in a modest rise in sales. The decrease in sales for our hemp-derived business during the period was also related to the diversion of working capital and other resources towards the launch of our SPREE BAR line of nicotine substitute vapor products. Despite achieving increased market share for our PINWEEL brand of hemp-derived products during the nine-month period ended September 30, 2023, we believe that the market for alternative alkaloid products, such as SPREE BAR, offers the Company the most significant opportunity for long-term growth. However, we do recognize that the hemp-derived category offers short- and medium-term potential for our Company and we will continue to pursue actionable opportunities in this segment while available.

Cost of Revenue

Cost of revenue, which consists of direct costs of materials, direct labor, third party subcontractor services, and other overhead costs decreased by approximately $6,036,000 or 47.7%, to approximately $6,627,000 or 61.9% of revenue, for the nine months ended September 30, 2023, as compared to approximately $12,663,000, or 57.8% of revenue, for the same period in 2022. This cost, as a percent of revenue, increased significantly due to reduced overhead cost absorption resulting from lower sales during the period. Also contributing to the increase was an increase of approximately $49,000 in our provision for inventory obsolescence during the period related to certain of our nicotine and alternative cannabis disposable products. The increased provision for inventory obsolescence was mostly the result of compressed product lifecycles in both the nicotine disposable and alternative cannabis product categories.

General and Administrative Expenses

For the nine months ended September 30, 2023, total general and administrative expenses decreased by approximately $1,122,000 to $5,360,000 as compared to approximately $6,482,000 for the same period in 2022. This change was primarily due to decreases of $730,000 in non-commission payroll and benefits, $171,000 in merchant account fees, $126,000 in depreciation expense and $230,000 in other general and administrative expenses, but was offset by an increase of approximately $135,000 in professional fees. The decrease in payroll and benefits was primarily the result of staff consolidation, elective executive salary reductions and a reduced bonus accrual for the period. Merchant account fees decreased during the period due to reduced sales activity. During the nine months ended September 30, 2023, our depreciation expense decreased due to the permanent closure of our Denver, Colorado facilities. The decrease in other general and administrative expenses largely consisted of a reduced bad debt provision and lower occupancy costs resulting from the permanent closure of our Denver, Colorado facilities. These reductions were offset by an increase in other professional fees of approximately $135,000, including a $63,000 increase in audit fees related to our 2022 audit and a $72,000 increase in legal fees related to regulatory compliance and our annual meeting held in June 2023.

Sales and Marketing Expense

For the nine months ended September 30, 2023, total sales and marketing expense decreased by approximately $1,237,000, or 58.2%, to approximately $888,000 as compared to approximately $2,125,000 for the same period in 2022, which was primarily due to reduced marketing and commission costs during the period. Digital marketing, use of promotional materials and tradeshow costs were all adjusted for weaker anticipated sales activity during the quarter ended September 30, 2023. Our commission cost, included in sales and marketing expense, was lower due to significantly lower sales during the period.

Research and Development Expense

For the nine months ended September 30, 2023, total research and development costs decreased by approximately $632,000, 82.7%, to approximately $132,000 as compared to approximately $764,000 for the same period in 2022, which was primarily due to costs associated with the development of new technologies and product formats.

(Loss) Income from Operations

We incurred a loss from operations of approximately $2,301,000 for the nine months ended September 30, 2023, compared to an operating loss of approximately $136,000 for the nine months ended September 30, 2022, due primarily to a decrease in sales. We also incurred certain non-cash, general and administrative expenses during the period including an $118,000 expense related to stock-based compensation. Net loss is determined by adjusting loss from operations by the following items:

Net (Loss) Income

For the nine months ended September 30, 2023, we incurred a net loss of $2,066,000 as compared to net income of $311,000 for the same period in 2022.

Liquidity and Capital Resources

As of September 30, 2023, we had working capital of approximately $122,000, which consisted of current assets of approximately $5,804,000 and current liabilities of approximately $5,682,000, as compared to working capital of approximately $1,067,000 at December 31, 2022. The current liabilities include approximately $3,363,000 of accounts payable and accrued expenses, notes payable of $200,000, note payable from related parties of $1,500,000, approximately $142,000 of deferred revenue associated with product shipped but not yet received by customers, approximately $411,000 of current lease liabilities, and $66,000 of derivative liability associated with the Investor Warrants and Placement Agent Warrants (the derivative liability of $66,000 is included in determining working capital of $122,000 but is not expected to use any cash to ultimately satisfy the liability).

On January 19, 2023 the Company entered into a future receivables sale agreement (“Receivables Financing” or “Receivables Financing Agreement”) with Austin Business Finance (“Austin Purchaser”) by which Austin Purchaser purchases from the Company, its future accounts and contract rights arising from the sale of goods or rendition of services to the Company’s customers. The purchase price, as defined by the Receivables Financing Agreement, was $650,000 which was paid to the Company on January 19, 2023, net of a 3% origination fee. The Receivables Financing Agreement required twenty-six equal payments of $29,500 to be paid weekly for a total repayment of $760,500 over the term of the agreement. During nine months ended September 30, 2023, the Company made $760,500 in cash payments. As of September 30, 2023, the Company had fully repaid the outstanding principal balance and accrued interest totaling $760,500 on its Receivables Financing Agreement.

Our cash and cash equivalents balance at September 30, 2023 was approximately $739,000.  

For the nine months ended September 30, 2023, net cash used in operating activities was approximately $736,000, resulting from a net loss of $2,066,000, offset by a change in operating assets and liabilities of $1,157,000 and net non-cash activity of $173,000. For the nine months ended September 30, 2022, net cash used in operating activities was approximately $1,522,000, resulting from a net income of $311,000, offset by a $2,108,000 of changes in our operating assets and liabilities and net non-cash activity of $275,000.

For the nine months ended September 30, 2023, cash provided by financing activities was approximately $1,218,000, which related to sale of future receivables for approximately $631,000 and repayment of $761,000 under the same agreement, issuance of notes payable for $200,000, issuance of notes payable to related parties for $1,200,000 and repayment of notes payable to a related party for $52,000.

Substantial Doubt to Continue as a Going Concern Regarding the Legal and Regulatory Environment, Liquidity and Management’s Plan of Operation

Our consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company operates in a rapidly changing legal and regulatory environment; new laws and regulations or changes to existing laws and regulations could significantly limit the Company’s ability to sell its products, and/or result in additional costs. Additionally, the Company was required to apply for FDA approval to continue selling and marketing its products used for the vaporization of nicotine in the United States. Currently, a substantial portion of the Company’s sales are derived from products that are subject to approval by the FDA. There was a significant cost associated with the application process and there can be no assurance the FDA will approve previous and/or future applications. For the nine months ended September 30, 2023, the Company’s revenue declined, the Company generated a loss from operations of approximately $2,301,000, and a consolidated net loss of approximately $2,066,000 and cash used in operations of approximately $736,000. The Company had stockholders’ deficit of $248,000 at September 30, 2023. During the nine months ended September 30, 2023, the Company’s working capital position decreased to $122,000 from $1,067,000, as of December 31, 2022. Considering these facts, the issuance of one or several Marketing Denial Orders ("MDOs”) from the FDA would increase the potential for inventory obsolescence and uncollectable accounts receivables and the removal of certain products for sale. These regulatory risks, as well as other industry-specific challenges and our low working capital and cash position, remain factors that raise substantial doubt about the Company’s ability to continue as a going concern.

Our plans and growth depend on our ability to increase revenues, procure cost-effective financing, and continue our business development efforts, including the expenditure of approximately $5,100,000 as of September 30, 2023, to support our PMTA process for the Company’s submissions to the FDA. The Company has undergone cost-cutting measures including salary reductions of up to 25% for officers and certain managers and a reduction in headcount for certain departments. During the quarter ended September 30, 2023, the Company prepared to launch SPREE BAR, a non-nicotine, disposable vapor product which is not subject to FDA review or covered under the Agriculture Improvement Act (the “Farm Bill”). The Company intends to allocate further resources and new personnel to support research and development initiatives in order to support existing, or subsequent PMTAs as well as other vapor product technologies. The Company may require additional financing in the future to support the development of new product categories as well as subsequent PMTA filings, and/or in the event the FDA requests additional testing for one, or several, of the Company’s prior PMTA submissions. There can be no assurance that additional financing will be available on acceptable terms, or at all, and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and, in the Company’s best interests. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. If we do not have sufficient funds to continue operations, we could be required to seek bankruptcy protection or other alternatives that would likely result in our stockholders losing some or all their investment in us.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than operating lease commitments.

Critical Accounting Policies

The condensed consolidated financial statements are prepared in conformity with U.S. GAAP, which require the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of expense in the periods presented. We believe that the accounting estimates employed are appropriate and resulting balances are reasonable; however, due to inherent uncertainties in making estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. The critical accounting estimates that affect the consolidated financial statements and the judgments and assumptions used are consistent with those described under Part II, Item 7 of our Annual Report on the 2022 Annual Report.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4 – CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

Our management, with the participation of our President and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this Report. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on our evaluation, our President, the principal executive officer, and Chief Financial Officer concluded that, as of September 30, 2023, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15 of the Exchange Act that occurred during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

As of the date hereof, we are not a party to any material legal or administrative proceedings. There are no proceedings in which any of our directors, executive officers or affiliates, or any registered or beneficial stockholder, is an adverse party or has a material interest adverse to our interest. From time to time, the Company may be involved in various claims and counterclaims and legal actions arising in the ordinary course of business. Litigation or any other legal or administrative proceeding, regardless of the outcome, is likely to result in substantial cost and diversion of our resources, including our management’s time and attention.

ITEM 1A. RISK FACTORS

Our results of operations and financial condition are subject to numerous risks and uncertainties described in the 2022 Annual Report. In addition to the other information set forth in this Report, you should carefully consider the risk factors discussed in Part 1, Item 1A, of the 2022 Annual Report and subsequent reports filed pursuant to the Exchange Act which could materially and adversely affect the Company’s business, financial condition, results of operations, and stock price. Any losses or damages we incur could have a material adverse effect on our financial results and our ability to conduct business as expected. The risks described in our 2022 Annual Report and in our subsequent reports filed pursuant to the Exchange Act are not the only risks facing the Company. Additional risks and uncertainties not presently known to management, or that management presently believes not to be material, may also result in material and adverse effects on our business, financial condition, and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

During the quarter ended September 30, 2023, no director or Section 16 Officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.

ITEM 6. EXHIBITS

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.