ITEM 1A.RISK
FACTORS
We
are subject to various risks that could have a negative effect on
the Company and its financial condition. These risks could cause
actual operating results to differ from those expressed in certain
“forward looking statements” contained in this Annual
Report on Form 10-K as well as in other
communications.
Risks Related to the Company
Our operations are now primarily dependent on the business of
Charlie’s, and our ability to achieve positive cash flow
under our new business plan is uncertain.
As
a result of the Share Exchange, our continued operations are now
primarily dependent on the business of Charlie’s. Although
Charlie’s generated net revenue of approximately $16.7
million during the year ended December 31, 2020 and $22.7 million
for the year ended December 31, 2019, there can be no guarantee
that the Company will continue to grow revenue or achieve positive
cash flow in the future.
Our operating results in the past will not reflect our operating
results in the future, which makes it difficult to evaluate our
future business, prospects, and forecast revenue.
Until
recently, our business was comprised primarily of the development,
marketing, sale and distribution of all-natural, vitamin-enhanced
drinks. As a result of our decision to consummate the Share
Exchange, our future revenue will substantially differ from past
revenue, and our operating results will vary significantly compared
to past operating results. It is too early to predict whether
consumers will accept, and continue to use on a regular basis, our
new products, due in part to the fact that we have had limited
recent operating history as a combined entity with Charlie’s.
Factors that will significantly affect our operating results
include, without limitation, the following:
●
the expected increase in revenue due to the addition of those
products developed and marketed by Charlie’s prior to the
Share Exchange, as well as any products that we may release in the
future, to our revenue stream;
●
our decision in early 2018 to discontinue the production and sale
of AquaBall®, that in the year ended December 31, 2018,
contributed approximately $1,767,802 in revenue;
●
our previous sole reliance on sales of Bazi®, that in the
years ended December 31, 2019 and 2018, contributed approximately
$22,207 and $179,250 in revenue to the Company, respectively;
and
●
the restructuring of substantially all of our previously
outstanding debt and shares of Preferred Stock onApril 26, 2019, in connection with the
Share Exchange.
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Our cash resources are currently insufficient to submit each of our
anticipated PMTA applications with the FDA, and otherwise satisfy
our projected short-term liquidity and capital
requirements.
As of December 31, 2020, we had negative working
capital of approximately $6,020,000, which consisted of current
assets of approximately $4,723,000 and current liabilities of
approximately $10,743,000. In addition, the cost associated
with the preparation and submission of Premarket Tobacco
Applications ("PMTAs") with
the FDA is approximately $4.4 million to date. As a result, in
March 2021 we issued shares of the Company’s common stock
worth $3 million, which provided additional financing in order to
reduce debt, further invest in the
PMTA application process, and otherwise carry out our business
plan. There can be no assurance that the Company will not require
additional financing in the future, or that the 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 our best interests.
The failure of the Company to pay a required one-time dividend on
its Series A Preferred, or obtain a waiver of such payment or
consent to amend the Series A Preferred to allow the Company to pay
such dividend in shares of its Common Stock, may have a material
adverse effect on the Company’s financial
condition.
The
Company was required to pay a one-time dividend equal to eight
percent (8%) of the stated value of its Series A Preferred, equal
to $1,650,000 (“Dividend
Amount”), which Dividend Amount was required to be
paid in cash on or before April 25, 2020. The Company failed to pay
the required dividend and has requested that holders of more than
50% of the Series A Preferred issued and outstanding
(“Required
Holders”) consent to an amendment to the Series A
Preferred to allow the Company to pay such Dividend Amount in
shares of the Company’s Common Stock. To date, the Company
has not obtained such consent from the Required Holders. In the
event the Company is unable to obtain consents from the Required
Holders to pay the Dividend Amount in shares of Common Stock in
lieu of cash, or does not otherwise pay such Dividend Amount in
cash or obtain a waiver, any claims asserted by the holders of the
Series A Preferred could have a material adverse effect on the
Company’s financial condition.
On
August 13, 2020, the Company received a formal notice of default
from a holder of its Series A Preferred requesting full payment of
dividends due and payable with respect to the Series A Preferred
held by such holder on or before August 23, 2020
(“Dividend
Default”). As disclosed, the aggregate amount of
dividends due and payable to holders of the Series A Preferred is
$1,650,000.
Our auditors have issued a going concern opinion on our financial
statements as of December 31, 2020
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. 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 is required to apply for FDA approval to continue selling
and marketing its products used for the vaporization of nicotine in
the United States. There is significant cost associated with the
application process and there can be no assurance the FDA will
approve the application(s). In addition, the recent outbreak of a
novel strain of COVID-19 (“Coronavirus”) which was identified in Wuhan, China
around December 2019 and continues to spread globally, has had a
negative impact on the global economy and markets which could
impact the Company’s supply chain and/or sales. For the year
ended December 31, 2020 the Company has incurred losses from
operations of $6,770,000 and a consolidated net loss of
approximately $7,187,000 and the Company has negative
stockholders’ equity of $5,996,000. These factors raise
substantial doubt about the Company’s ability to continue as
a going concern. 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.
Our business is difficult to evaluate because we have recently
significantly modified our product offerings and customer
base.
As
a result of the Share Exchange, we have recently modified our
operations, engaging in the sale of new products in a new market
through new distributors and new lines of business. There is a risk
that we will be unable to successfully integrate the newly acquired
businesses with our current structure. Our estimates of capital,
personnel and equipment required for our newly acquired businesses
are based on the historical experience of management and businesses
they are familiar with. Our management has limited direct
experience in operating a business of our current size, as well as
one that is publicly traded.
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Our products could fail to attract or retain users or generate
revenue and profits.
As
a result of the Share Exchange, our customer base has changed
significantly. Our ability to develop, increase, and engage our new
customer base and to increase our revenue depends heavily on our
ability to continue to evolve our existing products and to create
successful new products, both independently and in conjunction with
developers or other third parties. We may introduce significant
changes to our existing products or acquire or introduce new and
unproven products, including using technologies with which we have
little or no prior development or operating experience. If new or
enhanced products fail to engage our customers, or if we are
unsuccessful in our monetization efforts, we may fail to attract or
retain customers or to generate sufficient revenue, operating
margin, or other value to justify our investments, and our business
may be adversely affected.
Our significant stockholders may have certain personal interests
that may affect the Company.
Together,
Brandon Stump and Ryan Stump, the founders of Charlie’s and
our Chief Executive Officer and Chief Operating Officer,
respectively, collectively own approximately 39% of our issued and
outstanding voting securities as a result of the Share
Exchange. As a result, Ryan Stump and Brandon Stump have the
ability to exert influence over both the actions of our Board of
Directors, the outcome of issues requiring approval by our
stockholders, as well as the execution of management’s plans.
This concentration of ownership may have effects such as delaying
or preventing a change in control of the Company that may be
favored by other stockholders or preventing transactions in which
stockholders might otherwise recover a premium for their shares
over current market prices.
We will need to hire additional qualified accounting and
administrative personnel in order to remediate material weaknesses
in our internal control over financial accounting, and we will need
to expend additional resources and efforts to establish and
maintain the effectiveness of our internal control over financial
reporting and our disclosure controls and procedures.
As a public company, we are subject to the
reporting requirements of the Securities Exchange Act of 1934, as
amended (the “Exchange
Act”), and the
Sarbanes-Oxley Act of 2002. Our management is required to evaluate
and disclose its assessment of the effectiveness of our internal
control over financial reporting as of each year-end, including
disclosing any “material weakness” in our internal
control over financial reporting. A material weakness is a control
deficiency, or combination of control deficiencies, that results in
more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or
detected. As a result of its assessment, management has determined
that there were material weaknesses due to the lack of segregation
of duties and sufficient internal controls (including
technology-based general controls) that encompass our Company as a
whole with respect to entity and transactions level controls in
order to ensure complete documentation of complex and non-routine
transactions and adequate financial reporting. If we continue to
experience material weaknesses in our internal controls or fail to
maintain or implement required new or improved controls, such
circumstances could cause us to fail to meet our periodic reporting
obligations or result in material misstatements in our financial
statements, or adversely affect the results of periodic management
evaluations and, if required, annual auditor attestation
reports.
Due
to these material weaknesses, management concluded that, as of
December 31, 2020 and 2019, our internal control over financial
reporting was ineffective. Management also concluded that our
disclosure controls and procedures were ineffective as of December
31, 2020 and 2019, as well as for the quarters ended September 30,
2020, June 30, 2020 and March 31, 2020. These weaknesses were first
identified in our Annual Report on Form 10-K for the year ended
December 31, 2012. In 2018, we reduced our staff to one
employee, and outsourced our accounting and financial
functions, further exacerbating our weaknesses in our
internal control over financial reporting and our disclosure
controls and procedures. Although the number of employees has grown
as a result of the Share Exchange and the addition of
Charlie’s operations, including the hiring of a new Chief
Executive Officer, Chief Financial Officer and additional
accounting and information technology staff, no assurances can be
provided that we will have sufficient resources to resolve these
material weaknesses. These weaknesses have the
potential to adversely impact our financial reporting
process and our financial reports. We will need to hire additional
qualified accounting and administrative personnel in order to
resolve these material weaknesses.
The loss of one or more of our key personnel or our failure to
attract and retain other highly qualified personnel in the future,
could harm our business.
We
currently depend on the continued services and performance of key
members of our management team, in particular, Brandon Stump and
Ryan Stump, Charlie’s founders and our Chief Executive
Officer and Chief Operating Officer, respectively, and David Allen,
our Chief Financial Officer. If we cannot call upon them
or other key management personnel for any reason, our operations
and development could be harmed. We have not yet developed a
succession plan. Furthermore, as we grow, we will be required to
hire and attract additional qualified professionals such as
accounting, legal, finance, production, market and sales experts.
We may not be able to locate or attract qualified individuals for
such positions, which will affect our ability to grow and expand
our business.
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We rely on contractual arrangements with Don Polly, our
consolidated variable interest entity for our CBD-related
business operations, which may not be as effective as direct
ownership in providing operational control.
We
have relied and expect to continue to rely on contractual
arrangements with Don Polly and its shareholders, consisting of
entities controlled by Brandon Stump and Ryan Stump, for the
operation of our CBD-related operations. These contractual
arrangements may not be as effective as direct ownership in
providing us with control over our consolidated variable interest
entity. For example, Don Polly and its shareholders could breach
their contractual arrangements with us by, among other things,
failing to conduct their operations, including maintaining our
website and using the domain names and trademarks, in an acceptable
manner or taking other actions that are detrimental to our
interests.
If we had direct ownership of Don Polly, we would
be able to exercise our rights as a shareholder to effect changes
in the board of directors of Don Polly, which in turn could
implement changes, subject to any applicable fiduciary obligations,
at the management and operational level. However, under the current
contractual arrangements, we rely on the performance by Don Polly,
and its shareholders of their obligations under the contracts. The
shareholders of Don Polly may not act in the best interests of our
Company or may not perform their obligations under these contracts.
Such risks exist throughout the period in which we intend to
operate our business through the contractual arrangements with Don
Polly. Therefore, our contractual arrangements with Don Polly, our
consolidated variable interest entity ("VIE"), may not be as effective in ensuring our
control over the relevant portion of our business operations as
direct ownership would be.
The shareholders of Don Polly, our consolidated variable interest
entity, may have potential conflicts of interest with us, which may
materially and adversely affect our business and financial
condition.
The
equity interests of Don Polly, our consolidated VIE, are held by
entities controlled by Brandon Stump, our Chief Executive Officer,
and Ryan Stump, our Chief Operating Officer. Their interests in Don
Polly may differ from the interests of our company as a whole.
These shareholders may breach, or cause Don Polly to breach, the
existing contractual arrangements we have with them and Don Polly,
which would have a material adverse effect on our ability to
effectively control Don Polly and receive economic benefits from
it. For example, the shareholders may be able to cause our
agreements with Don Polly to be performed in a manner adverse to us
by, among other things, failing to remit payments due under the
contractual arrangements to us on a timely basis. We cannot assure
you that when conflicts of interest arise, any or all of these
shareholders will act in the best interests of our Company or such
conflicts will be resolved in our favor.
Currently,
we do not have any arrangements to address potential conflicts of
interest between these shareholders and the Company. If we cannot
resolve any conflict of interest or dispute between us and the
shareholders of Don Polly, we would have to rely on legal
proceedings, which could result in the disruption of our business
and subject us to substantial uncertainty as to the outcome of any
such legal proceedings.
We have no commercial manufacturing capacity and rely on
third-party contract manufacturers to produce commercial quantities
of our products.
We
do not have the facilities, equipment or personnel to manufacture
commercial quantities of our products and therefore must rely on
qualified third-party contract manufactures with appropriate
facilities and equipment to contract manufacture commercial
quantities of products. Any performance failure on the part of our
contract manufacturers could delay commercialization of any of our
products, depriving us of potential product revenue.
Failure
by our contract manufacturers to achieve and maintain high
manufacturing standards could result in product recalls or
withdrawals, delays or failures in testing or delivery, cost
overruns or other problems that could materially adversely affect
our business. Contract manufacturers may encounter difficulties
involving production yields, quality control and quality assurance.
If for some reason our contract manufacturers cannot perform as
agreed, we may be required to replace them. Although we believe
there are a number of potential replacements, we may incur added
costs and delays in identifying and obtaining any such
replacements.
The
inability of a manufacturer to ship orders of our products in a
timely manner or to meet quality standards could cause us to miss
the delivery date requirements of our customers for those items,
which could result in cancellation of orders, refusal to accept
deliveries or a reduction in purchase prices, any of which could
have a material adverse effect as our revenue would decrease and we
would incur net losses as a result of sales of the product, if any
sales could be made.
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We are subject to cyber-security risks, including those related to
customer, employee, vendor or other company data and including in
connection with integration of acquired businesses and
operations.
We
use information technologies to securely manage operations and
various business functions. We rely on various technologies, some
of which are managed by third parties, to process, transmit and
store electronic information, and to manage or support a variety of
business processes and activities, including reporting on our
business and interacting with customers, vendors and employees. In
addition, we collect and store certain data, including proprietary
business information, and may have access to confidential or
personal information that is subject to privacy and security laws,
regulations and customer-imposed controls. Our systems are subject
to repeated attempts by third parties to access information or to
disrupt our systems. Despite our security design and controls, and
those of our third-party providers, we may become subject to system
damage, disruptions or shutdowns due to any number of causes,
including cyber-attacks, breaches, employee error or malfeasance,
power outages, computer viruses, telecommunication or utility
failures, systems failures, service providers, natural disasters or
other catastrophic events. It is possible for such vulnerabilities
to remain undetected for an extended period. We may face other
challenges and risks as we upgrade and standardize our information
technology systems as part of our integration of acquired
businesses and operations. We have contingency plans in place to
prevent or mitigate the impact of these events, however, these
events could result in operational disruptions or the
misappropriation of sensitive data, and depending on their nature
and scope, could lead to the compromise of confidential
information, improper use of our systems and networks, manipulation
and destruction of data, defective products, production downtimes
and operational disruptions and exposure to liability. Such
disruptions or misappropriations and the resulting repercussions,
including reputational damage and legal claims or proceedings, may
adversely affect our results of operations, cash flows and
financial condition, and the trading price of our Common
Stock.
This risk is enhanced in certain jurisdictions
with stringent data privacy laws. For example, California recently
adopted the California Consumer Privacy Act of 2018
(“CCPA”), which provides new data privacy rights
for consumers and new operational requirements for businesses. The
CCPA includes a statutory damages framework and private rights of
action against businesses that fail to comply with certain CCPA
terms or implement reasonable security procedures and practices to
prevent data breaches. The CCPA went into effect in January
2020.
The business that we conduct outside the United States may be
adversely affected by international risk and
uncertainties.
Although
our operations are based in the United States, we conduct business
outside of the United States and expect to continue to do so in the
future. Any business that we conduct outside of the United States
is subject to additional risks that may have a material adverse
effect on our ability to continue conducting business in certain
international markets, including, without limitation:
●
Potentially reduced protection for intellectual property
rights;
●
Unexpected changes in tariffs, trade barriers and regulatory
requirements;
●
Economic weakness, including inflation or political instability, in
particular foreign economies and markets;
●
Business interruptions resulting from geo-political actions,
including war and terrorism or natural disasters, including
earthquakes, hurricanes, typhoons, floods and fires;
and
●
Failure to comply with Office of Foreign Asset Control rules and
regulations and the Foreign Corrupt Practices Act (“FCPA”).
These
factors or any combination of these factors may adversely affect
our revenue or our overall financial performance.
The recent outbreak of COVID-19, or coronavirus, may adversely
affect our business.
In
the event of a pandemic, epidemic or outbreak of an infectious
disease, our business may be adversely affected. In December 2019,
a novel strain of COVID-19 was identified in Wuhan, China which
continues to spread globally to, among other countries, the United
States. Such events may result in a period of business and travel
disruption, and in reduced sales and operations, any of which could
materially affect our business, financial condition and results of
operations. For example, the spread of COVID-19 in the United
States has resulted in travel restrictions impacting our sales
professionals and is causing disruptions to our manufacturing
supply chain. These conditions have begun to negatively affect our
sales and revenue, specifically relating to our CBD products,
although the magnitude of such a negative impact cannot be
determined at this time. However, if repercussions of the outbreak
are prolonged, it will have a further adverse impact on our
business.
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The
outbreak and persistence of COVID-19 in international markets that
we have targeted for our international expansion have also delayed
the preparation for and launch of such expansion efforts. The
spread of COVID-19 has resulted in the inability of certain of our
products being delivered and distributed to the overseas markets on
a timely basis. If there were a shortage or halt in distribution of
our products, the cost of these materials or components may
increase which could harm our ability to provide our products on a
timely and cost-effective basis.
The
extent to which COVID-19 impacts our business will depend on future
developments, which are highly uncertain and cannot be predicted.
The Company will continue to closely monitor new information as it
emerges and adjust our operations and sales
accordingly.
Regulatory and Market Risks
Our business is primarily involved in the sales of products that
contain nicotine and/or CBD, which faces significant regulation and
actions that may have a material adverse effect on our
business.
As
a result of the Share Exchange, our current business is primarily
involved in the sale of products that contain nicotine and/or
CBD. The general market in which our products are sold faces
significant governmental and private sector actions, including
efforts aimed at reducing the incidence of use in minors and
efforts seeking to hold the makers and sellers of these products
responsible for the adverse health effects associated with them.
More broadly, new regulatory actions by the FDA and other federal,
state or local governments or agencies, may impact the consumer
acceptability of or access to our products, including regulations
promulgated by the FDA which will require us to file PMTA(s) for
any of our products that are identified as “Deemed Tobacco
Products” by the FDA that we intend to market and sell after
September 9, 2020. See "-The regulation of tobacco products by the
FDA in the United States and the issuance of Deeming Regulations
may materially adversely affect the Company." Additionally, on
January 2, 2020 the FDA issued an enforcement policy
effectively banning the sale of flavored cartridge-based
e-cigarettes marketed primarily by large manufacturers in the
United States without prior authorization from the FDA. According
to the FDA, it is expected that the new policy will have minimal
impact on small manufacturers, such as vape shops, that sell
non-cartridge based products. We believe that any ban on
flavored e-cigarettes, or similar enforcement action by the FDA,
would have a significant adverse impact on Charlie’s
products, which would, in turn, have a material adverse impact on
our overall business material.
Additional
regulatory challenges may come in future months and years,
including the FDA’s publication of new product standards or
additional rule making that may impact vape shops or other small
manufacturers, limit adult consumer choices, delay or prevent the
launch of new or modified risk tobacco products or products with
claims of reduced risk, require the recall or other removal of
certain products from the marketplace, restrict communications
including marketing, advertising, and educational campaigns
regarding the product category to adult consumers, restrict the
ability to differentiate products, create a competitive advantage
or disadvantage for certain companies, impose additional
manufacturing, labeling or packaging requirements, interrupt
manufacturing or otherwise significantly increase the cost of doing
business, or restrict or prevent the use of specified products in
certain locations or the sale of products by certain retail
establishments. Any of these actions may also have a material
adverse effect on our business. Each of our products are also
subject to intense competition and changes in adult consumer
preferences, which could have a material adverse effect on our
business.
We are affected by extensive laws, governmental regulations,
administrative determinations, court decisions and similar other
constraints, which can make compliance costly and subject us to
enforcement actions by governmental agencies.
The
formulation, manufacturing, packaging, labeling, holding, storage,
distribution, advertising and sale of our products are affected by
extensive laws, governmental regulations and policies,
administrative determinations, court decisions and similar
constraints at the federal, state and local levels, both within the
United States and in any country where we conduct business.
Moreover, the current trend is toward increasing regulation of the
tobacco industry, which is likely to differ between the various
U.S. states in which we currently conduct the majority of our
business. Extensive and inconsistent regulation by multiple states
and at different governmental levels could prove to be particularly
disruptive to our business as we may be unable to accommodate such
regulations in a cost-effective manner that allows us to continue
to compete in an economically viable way. Regulations are often
introduced without the tobacco industry’s input and have been
a significant reason behind reduced industry sales volumes and
increased illicit trade.
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There
can be no assurance that we, or our independent distributors, will
be in compliance with all of these regulations. A failure by us or
our distributors to comply with these laws and regulations could
lead to governmental investigations, civil and criminal
prosecutions, administrative hearings and court proceedings, civil
and criminal penalties, injunctions against product sales or
advertising, civil and criminal liability for us and/or our
principals, bad publicity, and tort claims arising out of
governmental or judicial findings of fact or conclusions of law
adverse to us or our principals. In addition, the adoption of new
regulations and policies or changes in the interpretations of
existing regulations and policies may result in significant new
compliance costs or discontinuation of product sales, and may
adversely affect the marketing of our products, resulting in
decreases in revenue.
In
1986, federal legislation was enacted regulating smokeless tobacco
products (including dry and moist snuff and chewing tobacco) by,
among other things, requiring health warnings on smokeless tobacco
packages and prohibiting the advertising of smokeless tobacco
products on media subject to the jurisdiction of the Federal
Communications Commission (“FCC”). Since 1986, other
proposals have been made at the federal, state, and local levels
for additional regulation of tobacco products. It is likely that
additional proposals will be made in the coming years. For example,
the Prevent All Cigarette Trafficking Act (“PACT Act”) initially prohibited
the use of the U.S. Postal Service to mail cigarette and smokeless
tobacco products and also amended the Jenkins Act, which
established cigarette sales reporting requirements for state excise
tax collection, to require individuals and businesses that make
interstate sales of certain cigarette or smokeless tobacco comply
with state tax laws. The PACT Act was recently amended expanding
the definition of “cigarette” to include
“electronic nicotine delivery systems,” or "ENDS", and
requires that the United States Postal Service ("USPS") promulgate regulations
clarifying the applicability of the prohibition on delivery sales
of cigarettes to ENDS. This amendment to the PACT Act applies to
certain products manufactured and sold by the Company, which has
impacts at the federal and state levels. Failure to comply with the
PACT Act could result in significant financial or criminal
penalties. To the extent we are unable to respond to, or comply
with, these new requirements, there could be a material adverse
effect on our business, results of operations and financial
condition.
On June
22, 2009, the Family Smoking Prevention and Tobacco Control Act
(the “Tobacco Control
Act”) granted the FDA regulatory authority over
tobacco products. The Act also amended the Federal Cigarette