CHARLIE’S HOLDINGS, INC. MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND OPERATING RESULTS (Form 10-K)

You should read the following discussion and analysis in conjunction with our
financial statements, including the notes thereto contained in this Annual
Report. This discussion contains forward-looking statements that involve risks,
uncertainties and assumptions. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of a variety
of certain factors, including those set forth under "Risk Factors Associated
with Our Business" and elsewhere in this Annual Report.



Overview



Our objective is to become a significant leader in the rapidly growing, global
e-cigarette and e-liquid segments of the broader nicotine related products
industry. Through Charlie's, we formulate, market and distribute premium,
nicotine-based 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, and in more than 80
countries worldwide. Charlie's primary international markets include the United
Kingdom, Italy, Spain, New Zealand, Australia, and Canada. In June 2019, we
launched distribution, through Don Polly, of certain premium vapor, tincture and
topical wellness products containing hemp-derived cannabidiol ("CBD") and we
currently intend to develop and launch additional products containing other
compounds derived from hemp in the future.



Operational Plan


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



First, we plan to increase the sales of our hemp-derived products, including
topicals, ingestibles and disposable vapor devices. We feel there is a
significant upside in the hemp-derived products space, and we have begun to
shift our focus in this business to the burgeoning market for products
containing compounds synthetically derived from hemp, including
Delta-8-Tetrahydrocannabinol ("Delta-8-THC") and other synthetic
tetrahydrocannabinol ("Synthetic THC") compounds. These product categories have
grown rapidly, as they offer consumers a range of benefits across varying
potencies and product formats. We have also recently allocated additional
financial resources to increase e-commerce sales of certain of our hemp-derived
products.



Secondly, we continue to see a significant opportunity for sales growth in
international markets for our e-liquid and other vapor products. 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. We have recently hired an Account Executive
who will be dedicated to driving our efforts in international expansion. More
specifically, the Company intends to launch proprietary new disposables,
containing synthetically derived nicotine, that have been specially formulated
for the European and Middle East markets. In partnership with our international
distributors, Charlie's will sell award winning products in markets where more
than 20% of the population currently consumes nicotine in some format.



Most importantly, we feel that tobacco and synthetically derived nicotine vapor
products will continue to provide a significant growth opportunity domestically.
During the quarter ended March 31, 2021, we launched our synthetic nicotine (not
derived from tobacco) Pacha Syn (formerly Pachamama Disposable) product line,
which will provide access to additional sales channels and broaden our customer
base. These innovative product formats currently represent Charlie's most
important, fastest-growing product category. We are continuing with our plan to
obtain marketing authorization for certain of our nicotine vapor products
through the completion of a Premarket Tobacco Application ("PMTA"), which we
submitted in September 2020. Obtaining a marketing order from the FDA would, we
believe, help to remediate perceived health issues related to vaping, and
further position the Company as a trusted, industry leader. We feel that a
significant number of our competitors will not have the necessary resources
and/or expertise to complete the extensive and costly PMTA process and that,
once authorized by the FDA, we will benefit significantly by emerging as one of
a select group of companies able to continue operating in the flavored vapor
products space.





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Impact of COVID-19



The outbreak of a novel strain of coronavirus ("COVID-19", or, "Coronavirus")
has had, and continues to have, a negative impact on the global economy and the
markets in which we operate. Beginning in March 2020, the Company transitioned
nearly all employees to a remote working environment for their safety and to
protect the integrity of Company operations. We have updated certain sales,
accounting and administrative processes, and corresponding information
technology platforms, in an effort to help facilitate the virtual work
environment which still persists for some employees. During the year ended
December 31, 2021, we engaged in periodic, informal testing of our business
operations, and we do not believe that our financial position, work efficiency
and overall operational integrity have been materially affected. However, we
recognize that a certain degree of employee enthusiasm, teamwork, creativity,
and support is normally generated by being present at a physical location, and
we believe that prolonged remote working may have a negative impact over time on
our business, and on employee productivity. Our Denver, CO office and Huntington
Beach, CA warehouse locations have returned fully to on "premise status", while
our corporate headquarters in Costa Mesa, CA remains remote for some employees.
We will continue to monitor the COVID-19 situation in all regions in which we
operate and will maintain strict adherence to local health guidelines and
mandates. We may need to take further actions that we determine are in the best
interests of our employees or are required by federal, state, or local
authorities.



Supply Chain



Our ability to manufacture products is dependent on the availability of certain
raw materials and components that our contract manufacturers purchase from
Europe and China. In February 2020, we started to experience disruptions across
several key areas of our global supply chain. Our domestic and international
contract manufacturers source many of our high-quality flavorings from suppliers
located in Italy, a region that was severely affected by COVID-19-related
restrictions throughout most of 2020. Mandated stay-at-home orders in this
region ultimately caused increased manufacturing lead times and delayed customer
order deliveries for certain of our products, resulting in revenue declines.



We have been successful in mitigating some of the supply chain risks through
bulk purchases of certain flavorings and components and adjusting the production
allocation amongst our contract manufacturers. Shifting production to contract
manufacturers in regions with fewer restrictions and/or an enhanced ability to
procure larger supplies of raw materials has helped alleviate disruptions in our
supply chain.



Certain of our products are sourced from China and require delivery to our
warehouse locations in the United States prior to shipment to customers.
Although we currently use air freight for Chinese shipments, ongoing disruptions
in the global supply chain could continue to affect the costs associated with
such shipments and could put additional pressure on our sales and margins.



If a resurgence of COVID-19 and associated shutdowns were to occur in Europe or
China, this would likely have an adverse effect on our ability to manufacture
and sell our products due to related shortages of materials and components.
Depending on the severity of any such future shutdowns, we could experience a
materially diminished ability to produce products and be exposed to
significantly longer lead times. This would result in delayed or reduced revenue
from the affected products in production and potentially higher operating costs.



Sales and Marketing



Our sales and marketing efforts have also been directly and indirectly affected
by COVID-19. Most of our sales through Charlie's and Don Polly are to resellers
of our products, typically distributors or brick and mortar retail locations.
Stay-at-home mandates across the U.S. and internationally created a challenge
for these customers to maintain continuity in their businesses, and therefore we
experienced lower sales volumes in some regions. Periodic labor shortages,
indirectly related to COVID-19, have also influenced our customers' ability to
operate their businesses effectively. We've since seen activity approach
pre-pandemic levels, however a resurgence of COVID-19, causing subsequent
shutdowns and labor shortages, could have a significant effect on our business.



Historically, most of our business-to-business sales and marketing efforts have
been generated through industry events in both the vapor products and
hemp-derived products spaces. During 2019, we also initiated a program of
in-store marketing events to help facilitate relationship building and
sell-through for our retail partners. Beginning in 2020, the suspension of
certain trade shows and disruption of business travel weakened our new customer
pipeline, which negatively affected our sales during the years ended December
31, 2021 and 2020. Though trade show activity has since rebounded, it remains
uncertain how the effects of COVID-19 will persist and what effect they will
have on our sales and marketing efforts. In response, we have shifted some of
our focus to digital marketing campaigns aimed at customer engagement and
education. We also continue to allocate additional resources towards certain key
distributors and retail partners that are better positioned to interact directly
with our consumers and to continue growing our brands.



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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. 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.
Beginning in September 2019, certain states temporarily banned the sale of
flavored e-cigarettes, and 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 without prior authorization from the
FDA. The application of any new laws or regulations that may be adopted in the
future, at a federal, state, or local level, directly or indirectly implicating
flavored e-cigarette liquid and products used for the vaporization of nicotine
could significantly limit the Company's ability to sell such products, result in
additional compliance expenses, and/or require the Company to change its
labeling and/or methods of distribution. Any ban of the sale of flavored
e-cigarettes directly limits the markets in which the Company may sell its
products. In the event the prevalence of such bans and/or changes in laws and
regulations increase across the United States, or internationally, the Company's
business, results of operations and financial condition could be adversely
impacted. In addition, the Company is presently seeking to obtain marketing
authorization for certain of its nicotine based vapor products. Our PMTA
applications were submitted in September 2020 on a timely basis, which if
approved, will allow the Company to continue to sell certain of its products in
the United States. At this date, Charlie's PMTA remains among the select
minority of applications submitted to the FDA that has not received an MDO or
Refuse-to-File designation. However, it is possible that the FDA will request
additional information or that the Company will need to amend its PMTA at some
point in the future. The Company may also require additional financing in the
future to support potential PMTA related expenses and general working capital.
There is no assurance that regulatory approval to sell our products will be
granted or that we can raise the additional financing required, and if not, this
could have a significant impact on our sales.



On March 11, 2020, the World Health Organization designated the ongoing and
evolving COVID-19 outbreak as a pandemic. The outbreak has caused substantial
disruption in international and U.S. economies and markets as it continues to
evolve. The outbreak is having a temporary adverse impact on our industry as
well as our business, with regards to certain supply chain disruptions and sales
volume. While the disruption from COVID-19 is currently expected to be
temporary, there is uncertainty around the duration.



Recent Developments



Resignation of Brandon Stump



On October 29, 2021, Brandon Stump resigned from his position as: (i) Chief
Executive Officer and Chairman of the Board of Directors; and (ii) all positions
held for each direct and indirect subsidiary of the Company (each, a
"Subsidiary"), including as a member of the Board of Directors of the Company
and each Subsidiary.



In connection with Mr. Stump's resignation, the Company and Mr. Stump entered
into an agreement regarding Mr. Stump's resignation (the "Termination
Agreement"), which Termination Agreement is dated October 29, 2021. Pursuant to
the Termination Agreement, in consideration for Mr. Stump agreeing to terminate
his employment agreement with the Company, as amended and restated on February
12, 2020 (the "Employment Agreement"), and agreeing to certain restrictions and
covenants, the Company will: (i) continue to pay Mr. Stump his base salary (as
defined in the Employment Agreement), through April 22, 2022; (ii) pay Mr. Stump
certain bonus compensation owed to Mr. Stump in an amount equal to $300,000,
payable in installments of $75,000 on each of November 1, 2021, December 1,
2021, January 1, 2022, and February 1, 2022; and (iii) continue to make
available to Mr. Stump certain employee benefits offered by the Company until
April 22, 2022.



Reverse Stock Split



Our Board of Directors approved a reverse stock split of our authorized, issued,
and outstanding shares of common stock, par value $0.001 per share (the "Common
Stock"), at a ratio of 1-for-100 (the "Reverse Split"). The Reverse Split was
effective as of June 16, 2021 (the "Effective Date"). All share and per share
amounts in this Report have been retroactively adjusted to account for the
reverse stock split.



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March 2021 Private Placement



On March 19, 2021, the Company entered into Securities Purchase Agreements by
and between the Company and certain family trusts in which Mr. Brandon Stump,
the Company's former Chief Executive Officer and significant shareholder of the
Company, and Mr. Ryan Stump, the Company's Chief Operating Officer, are trustees
and beneficiaries (the "Purchase Agreements"), for the private placement of an
aggregate of 3,517,000 shares of its Common Stock, at a purchase price per share
of $0.853 (the "Private Placement"), which Private Placement was consummated on
March 22, 2021. The Private Placement resulted in gross proceeds to the Company
of approximately $3.0 million. The Private Placement was undertaken pursuant to
Rule 506 promulgated under the Securities Act of 1933, as amended, and was
consummated in a transaction approved by the Company's independent directors in
accordance with Rule 16b-3(d)(1) of the Securities Exchange Act of 1934, as
amended.



Red Beard Holdings, LLC Note Payable



On April 1, 2020, the Company, Charlie's and its VIE, Don Polly, issued a
secured promissory note (the "Red Beard Note") to one of the Company's largest
stockholders, Red Beard Holdings, LLC ("Red Beard") in the principal amount of
$750,000 (the "Principal Amount"), requiring a guaranteed minimum interest
amount of $75,000 ("Minimum Interest"). The Red Beard Note is secured by all
assets of the Company pursuant to the terms of a Security Agreement entered into
by and between the Company and Red Beard (the "Red Beard Note Financing"). The
Red Beard Note was subsequently amended on August 27, 2020, September 30, 2020,
October 29, 2020, December 1, 2020, and January 19, 2021, ultimately increasing
Principal Amount to $1.4 million and Minimum Interest to $150,000.



On March 24, 2021, the Company and Red Beard entered into a Satisfaction and
Release (the "Red Beard Release"), pursuant to which the Company made a payment
to Red Beard in the amount of $1.55 million in exchange for an acknowledgment of
satisfaction and full release of the Company by Red Beard from liability and
obligations arising under the Red Beard Note.



Small Business Administration Loan Programs



On April 30, 2020, Charlie's, a wholly owned subsidiary of the Company, received
approval to enter into a U.S. Small Business Administration ("SBA") Promissory
Note (the " Charlie's PPP Loan") with TBK Bank, SSB (the "SBA Lender"), pursuant
to the Paycheck Protection Program ("PPP") of the Coronavirus Aid, Relief, and
Economic Security Act (the "CARES Act") as administered by the SBA (the "PPP
Loan Agreement").



The Charlie's PPP Loan provided for working capital to CCD in the amount of
$650,761. The Charlie's PPP Loan was set to mature on April 30, 2022 and accrued
interest at a rate of 1.00% per annum. Payments of principal and interest were
deferred for six months from the date of the Charlie's PPP Loan, or until
November 30, 2020. Interest, however, continued to accrue during that time.



On April 14, 2020, Don Polly also obtained a loan pursuant to the PPP enacted
under the CARES Act (the "Polly PPP Loan" and together with the Charlie's PPP
Loan, the "PPP Loans") from Community Banks of Colorado, a division of NBH Bank
(the "Polly Lender"). The Polly PPP Loan obtained by Don Polly provided for
working capital to Don Polly in the amount of $215,600. The Polly PPP Loan was
set to mature on April 14, 2022 and accrued interest at a rate of 1.00% per
annum. Payments of principal and interest were deferred for six months from the
date of the Polly PPP Loan, or until November 14, 2020. Interest continued to
accrue during that time.



The aforementioned PPP Loans were made under the PPP enacted by Congress under
the CARES Act. The CARES Act (including the guidance issued by SBA and U.S.
Department of the Treasury) provides that all or a portion of the PPP Loans may
be forgiven upon request from the respective borrower to the SBA Lender or the
Polly Lender, as the case may be, subject to requirements in the PPP Loans and
under the CARES Act.



On February 19, 2021, Don Polly received notice from the Polly Lender, that the
Polly PPP Loan was fully repaid, and its promissory note was cancelled as a
result of the loan forgiveness process set forth by the U.S. Small Business
Administration. There is no further action required on the part of Don Polly to
satisfy this liability.



On March 17, 2021, Don Polly obtained a second draw PPP loan ("Polly PPP Loan
2") under the CARES Act from Polly Lender. The Polly PPP Loan 2 obtained by Don
Polly provided general working capital in the amount of $184,200. The Polly PPP
Loan 2 was set to mature on March 17, 2026 and accrued interest at a rate of
1.00% per annum. Payments of principal and interest were deferred, however
interest continued to accrue during that time.



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On April 28, 2021, Charlie's received notice from SBA Lender that the Charlie's
PPP Loan was fully repaid, and its promissory note was cancelled as a result of
the loan forgiveness process set forth by the U.S. Small Business
Administration. There is no further action required on the part of Charlie's to
satisfy this liability.



On November 9, 2021, Don Polly received notice from the Polly Lender, that the
Polly PPP Loan 2 was fully repaid, and its promissory note was cancelled as a
result of the loan forgiveness process set forth by the U.S. Small Business
Administration. There is no further action required on the part of Don Polly to
satisfy this liability.



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. Installment payments, including principal and interest of
$731 monthly will begin twelve months from date of the EID Loan. 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.



PMTA



During the quarter ended September 30, 2020, the FDA's Center for Tobacco
Products informed us that our PMTA has received a valid submission tracking
number, passed the FDA's filing review phase, and recently entered the
substantive review phase. To date, Charlie's has invested over $4.4 million for
our initial PMTA submission. We engaged a team of more than 200 professionals,
including doctors, scientists, biostatisticians, data analysts, and numerous
contract research organizations to create our comprehensive PMTA submission.
During the quarter ended September 30, 2021, the FDA began issuing Marketing
Denial Orders ("MDO") for electronic nicotine delivery system ("ENDS") products
that lack evidence to demonstrate that permitting the marketing of such products
would be appropriate for the protection of the public health. As of December 31,
2021, the Company had not received an MDO for any of its submissions. This news
highlights our progress toward achieving full regulatory compliance and our
objective of providing customers with a trusted product portfolio.



Basis of Presentation



The consolidated financial statements contained within this Annual Report and
the disclosure in this Management's Discussion and Analysis of Financial
Condition and Results of Operations with respect to the years ended December 31,
2021 and 2020 have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). In the opinion of the Company,
all adjustments, including normal recurring adjustments necessary to present
fairly the financial position, results of operations, and cash flows of the
Company for the interim period have been included.



Results of Operations for the Year Ended December 31, 2021 Compared to the Year
Ended December 31, 2020



                                              For the years ended
                                                 December 31,                      Change
                                              2021           2020         Amount        Percentage
($ in thousands)
Revenues:
Product revenue, net                       $    21,496     $  16,692     $   4,804             28.8 %
Total revenues                                  21,496        16,692         4,804             28.8 %
Operating costs and expenses:
Cost of goods sold - product revenue            10,423         7,478         2,945             39.4 %
General and administrative                       8,750        10,873        (2,123 )          -19.5 %
Sales and marketing                              1,734         1,733             1              0.1 %
Research and development                            24         3,378        (3,354 )          -99.3 %
Total operating costs and expenses              20,931        23,462        (2,531 )          -10.8 %
Income (loss) from operations                      565        (6,770 )       7,335           -108.3 %
Other income (expense):
Interest expense                                   (34 )        (134 )         100            -74.6 %
Change in fair value of derivative
liabilities                                      3,545          (300 )       3,845          -1281.7 %
Gain on debt extinguishment                      1,060             -         1,060              100 %
Other income                                        14            17            (3 )          -17.6 %
Total other income (loss)                        4,585          (417 )       5,002          -1199.5 %
Income (loss) before income taxes                5,150        (7,187 )      12,337           -171.7 %
Income tax expense                                (342 )           -          (342 )            100 %
Net income (loss)                          $     4,808     $  (7,187 )   $  11,995           -166.9 %






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Revenue



Revenue for the year ended December 31, 2021, increased approximately
$4,804,000, or 28.8%, to approximately $21,496,000, as compared to approximately
$16,692,000 for the year ended December 31, 2020, due to a $4,420,000 increase
in our nicotine-based product sales, and a $384,000 increase in sales of our
hemp-derived products. The increase in our nicotine-based vapor product sales is
directly related to the launch of our Pacha Syn (formerly Pachamama Disposable)
product line, which currently represents Charlie's most important,
fastest-growing product category. Pacha Syn Disposables became Charlie's
first-ever entrant into the rapidly expanding, disposable e-cigarette market and
offer users a variety of premium flavors containing synthetic nicotine (not
derived from tobacco) in a compact, discrete format. Uncertainty surrounding the
FDA's application review timeline, following the PMTA submission deadline,
affected buying patterns of tobacco-derived nicotine products in the domestic
vape market as customers reduced inventories of non-PMTA submitted products. In
December 2020, the Prevent All Cigarette Tracking Act ("PACT Act") was signed
into law which requires that the United States Postal Service ("USPS")
promulgate regulations clarifying the applicability of the prohibition on
delivery sales of cigarettes to ENDS products. The resulting shipping and
logistical challenges that ensued, affected industry-wide sales to consumers and
smaller, single-location resellers.



During the quarter ended March 31, 2021, we began to streamline our existing
hemp-derived wellness product offering and pursue the developing market for
products containing synthetically-derived cannabinoids, including Delta-8-THC
and other Synthetic THC compounds. The addition of these new product categories,
coupled with a narrowed focus in our existing portfolio, resulted in higher
sales velocity and overall growth compared to the year ended December 31, 2020.
We view this market segment as having higher growth potential and better
alignment with our existing sales channels, and therefore, we will continue to
develop and launch additional products in this category.



Cost of Revenue



Cost of revenue, which consists of direct costs of materials, direct labor,
third party subcontractor services, and other overhead costs increased
approximately $2,945,000 or 39.4%, to approximately $10,423,000, or 48.5% of
revenue, for the year ended December 31, 2021, as compared to approximately
$7,478,000, or 44.8% of revenue, for the year ended December 31, 2020. This
cost, as a percent of revenue, increased due to a higher sales mix consisting of
our Pacha Syn Disposable product line, which carries a lower margin per unit
relative to our other vapor products. Cost of revenue was also negatively
affected by a larger than normal provision for inventory obsolescence during the
period related to certain of our hemp-derived wellness products, as well as
higher per unit shipping costs due to implications of the Pact Act.



General and administrative costs



For the year ended December 31, 2021, total general and administrative expense
decreased approximately $2,123,000 to approximately $8,750,000, or 40.7% of
revenue, as compared to approximately $10,873,000, or 65.1% of revenue, for the
year ended December 31, 2020. This decrease is primarily comprised of reductions
of approximately $2,519,000 of non-cash stock-based compensation as well as
$418,000 of salary and benefits expenses. The reduction in non-cash stock-based
compensation is primarily due to the forfeiture of stock awards by Brandon Stump
and Ryan Stump pursuant to the adoption of the Amended Employment Agreements
entered February 12, 2020, as well as the conclusion of the vesting period for
shares of Common Stock awarded to several employees in conjunction with the
Share Exchange in April 2019. The decrease in salary and benefits costs is the
result of lower overall salary expenses, Paid-Time-Off benefits and employee
bonuses. This overall decrease in total general and administrative expense was
offset by increases of $442,000 in professional fees as well as $372,000 of
other general administrative expenses. The increase in professional fees was
largely the result of several internal projects largely focused on the creation
of a solution "network" necessary to effectively meet the requirements of both
the Consolidated Appropriations Act of 2021 and the PACT Act as well as costs
associated with certain corporate actions including our Reverse Split, completed
June 16, 2021, and the private sale of 3,517,000 shares of our common stock to
the Company's founders Brandon Stump and Ryan Stump, completed March 23, 2021.
Other general administrative expenses including, merchant account fees and bad
debt provision, increased due to an increase in sales activity during the
period.



Sales and marketing expenses



For the year ended December 31, 2021, total sales and marketing expense
increased to approximately $1,734,000 as compared to approximately $1,733,000
for the year ended December 31, 2020, which was primarily due to a shift in
spending on product sales support materials and other marketing activities in
favor of increased trade show attendance, as activity returned to pre-pandemic
levels.



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Research and development costs



For the year ended December 31, 2021, total research and development expense
decreased approximately $3,354,000, or 99.3%, to approximately $24,000 as
compared to approximately $3,378,000 for the year ended December 31, 2020.
During the year ended December 31, 2021, we incurred significantly less expense
related to our PMTA submission, which resulted in lower overall research and
development costs.



Income (Loss) from Operations



We generated income from operations of approximately $565,000 for the year ended
December 31, 2021, as compared to loss from operations of approximately
$6,770,000 for the year ended December 31, 2020. Net income (loss) is determined
by adjusting income (loss) from operations by the following items:



? Change in fair value of derivative liabilities. For fiscal years ending in December

31, 2021 and 2020, the fair value gain (loss) of derivative liabilities was

approximately $3,545,000 and ($300,000), respectively. The derivative

liability is associated with the issuance of investor warrants and the

Placement Agent Warrants (see note 3) as part of the share exchange.

Earnings for the year ended December 31, 2021reflects the effect of

decline in the share price from December 31, 2021 compared to December 31, 2020.

During the year ended December 31, 2021we experienced a significant

change in our stock’s trading volume, which may persist in the future.

Due to the limited supply of shares currently freely traded, the price of our shares

may experience volatility and therefore considerable fluctuations in the

value of our warrant liability may arise in the future. We have had

    warrants to purchase approximately 40,424,000 shares of common stock
    outstanding as of December 31, 2021.



? Interest charges. For the years ended December 31, 2021 and 2020 we recorded

    interest expense related to notes payable of $34,000 and $134,000,
    respectively.



? Gain on extinguishment of debt. For the years ended December 31, 2021and 2020

we recorded a gain on extinguishment of debt of $1,060,000 and $0respectively,

    related to forgiveness of Paycheck Protection Program loans extended to
    Charlie's and Don Polly.


? Other income. For the years ended December 31, 2021 and 2020 we recorded

other income related to interest and income from the subletting of $14,000 and $17,000,

    respectively.




Income Tax Expense



The Company's income tax expense was $342,000, or 6.6% of income before income
taxes, for the year ended December 31, 2021. The Company's income tax expense
was $0 for the year ended December 31, 2020.



Net Income (Loss)


For the years ended December 31, 2021and 2020 we had a net income of
$4,808,000 and net loss of $7,187,000respectively.


Effects of Inflation


Inflation has not had a material impact on our business.

Cash and capital resources



As of December 31, 2021, we had working capital of approximately $2,460,000,
which consisted of current assets of approximately $7,994,000 and current
liabilities of approximately $5,534,000. This compares to negative working
capital of approximately $6,020,000 at December 31, 2020. The current
liabilities, as presented in the consolidated balance sheet at December 31, 2021
included elsewhere in this Report, primarily include approximately $4,068,000 of
accounts payable and accrued expenses, approximately $238,000 of deferred
revenue associated with product shipped but not yet received by customers,
approximately $329,000 of lease liabilities, and $899,000 of derivative
liability associated with the Investor and Placement Agent Warrants (the
derivative liability of $899,000 is included in determining the working capital
of $2,460,000 but is not expected to use any cash to ultimately satisfy the
liability).



Our balance of cash and cash equivalents at December 31, 2021 was approximately
$866,000.



For the year ended December 31, 2021, we used cash from operations of
$1,347,000, as compared to $3,273,000 for the year ended December 31, 2020. This
decrease in the cash used by operations is due primarily to increased net income
and accounts payables, but was offset by an increase in inventory.



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For the year ended December 31, 2021, we used cash for investment activities of
$110,000 as compared to $169,000 for the year ended December 31, 2020. For the
year ended December 31, 2021, the cash used for investment activities was
primarily for the ongoing development and configuration of enterprise resource
planning software. For the year ended December 31, 2020, the cash used for
investment activities was primarily for the ongoing development and
configuration of enterprise resource planning software.



For the year ended December 31, 2021, we generated cash from financing
activities of $901,000 as compared to generated cash from financing activities
of $2,416,000 for the year ended December 31, 2020. In the 2021 period, we
generated cash from financing activities from the Polly PPP Loan 2 and the
Private Placement. We paid cash dividends of $883,000 and notes payable of
$1,400,000 during the year ended December 31, 2021. In the 2020 period, we
generated cash from financing activities from the Red Beard Note, PPP Loans and
EID Loan (as defined in Note 8 of Item 1, Part 1 of this Report).



Going concern uncertainty regarding legal and regulatory environment, liquidity and management’s operating plan



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 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 significant cost associated with the application process and there can be no
assurance the FDA will approve previous and/or future application. In addition,
the recent outbreak of Coronavirus in March 2020 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, 2021, the Company generated income
from operations of $565,000 and a consolidated net income of approximately
$4,808,000 and the Company has stockholders' equity of $3,131,000. During the
year ended December 31, 2021, the Company's working capital requirements changed
significantly as inventory increased to $5.0 million, from $1.6 million as of
December 31, 2020, and cash on hand decreased to approximately $0.9 million,
from $1.4 million as of December 31, 2020. Though the Company's balance sheet
and overall performance generally improved during 2021, the issuance of one or
several Marketing Denial Orders ("MDO") from the FDA would increase the
potential for inventory obsolescence and uncollectable accounts receivables.
These regulatory risks, as well as other industry-specific challenges remain
factors that 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.



Management's plans depend on its ability to increase revenues and continue its
business development efforts, including the expenditure of approximately
$4,400,000 to date, to complete the PMTA registration process. On March 23,
2021, The Company closed a $3,000,000 capital raise through the private sale of
3,517,000 shares of its common stock to the Company's founders Brandon Stump and
Ryan Stump. The Company used the proceeds to fund future growth, increase
working capital, retire outstanding debt, and for other general corporate
purposes. However, the Company may require additional financing in the future
should the FDA require additional testing for one, or several, of the Company's
PMTA submissions. There can be no assurance that such 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.



Off-balance sheet arrangements

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



Critical Accounting Policies



Included below is a discussion of critical accounting policies used in the
preparation of our financial statements. While all these significant accounting
policies impact our financial condition and results of operations, we view
certain of these policies as critical. Policies determined to be critical are
those policies that have the most significant impact on our financial statements
and require management to use a greater degree of judgment and estimates. Actual
results may differ from those estimates.



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We believe that given current facts and circumstances, it is unlikely that
applying any other reasonable judgments or estimate methodologies would cause a
material effect on our consolidated results of operations, financial position or
liquidity for the periods presented in this report.



The accounting methods identified as critical are as follows:


Revenue Recognition



The Company recognizes revenues in accordance with Accounting Standards
Codification ("ASC") 606 - Contracts with Customers. Revenues are generated from
contracts with customers that consist of sales to retailers and distributors.
Contracts with customers are generally short term in nature with the delivery of
product as a single performance obligation. Revenue from the sale of product is
recognized at the point in time when the single performance obligation has been
satisfied and control of the product has transferred to the customer. In
evaluating the timing of the transfer of control of products to customers, The
Company considers several indicators, including significant risks and rewards of
products, the right to payment, and the legal title of the products. Based on
the assessment of control indicators, sales are generally recognized when
products are received by customers. Shipping generally occurs prior to the
transfer of control to the customer and is therefore accounted for as a
fulfillment expense. In circumstances where shipping and handling activities
occur after the customer has obtained control of the product, the Company has
elected to account for shipping and handling activities as a fulfillment cost
rather than an additional promised service. Contract durations are generally
less than one year, and therefore costs paid to obtain contracts, which
generally consist of sales commissions, are recognized as expense in the period
incurred. Revenue is measured by the transaction price, which is defined as the
amount of consideration expected to be received in exchange for providing goods
to customers. The transaction price is adjusted for estimates of known or
expected variable consideration, which includes refunds and returns as well as
incentive offers, volume rebates, and promotional discounts on current orders.
Our volume rebates are short-term in nature and reset on a quarterly basis.
Sales returns are generally not material to the financial statements, and do not
comprise a significant portion of variable consideration. Estimates for sales
returns are based on, among other things, an assessment of historical trends,
information from customers, and anticipated returns related to current sales
activity. These estimates are established in the period of sale and reduce
revenue in the period of the sale. Variable consideration related to incentive
offers and promotional programs are recorded as a reduction to revenue based on
amounts the Company expects to collect. Estimates are regularly updated and the
impact of any adjustments are recognized in the period the adjustments are
identified. In many cases, key sales terms such as pricing and quantities
ordered are established at the time an order is placed and incentives have very
short-term durations.



Amounts billed and due from customers are short term in nature and are
classified as receivables since payments are unconditional and only the passage
of time related to credit terms is required before payments are due. The Company
does not grant payment financing terms greater than one year. Payments received
in advance of revenue recognition are recorded as deferred revenue.



Accounts receivable is recorded at the invoiced amount and does not bear
interest. We determine the allowance for doubtful accounts by regularly
evaluating individual customer receivables and considering a customer's
financial condition, credit history and current economic conditions and set up
an allowance for doubtful accounts when collection is uncertain. Customers'
accounts are written off against the allowance when all attempts to collect have
been exhausted. Recoveries of accounts receivable previously written off are
recorded as income when received. As of December 31, 2021, and 2020, the
allowance for bad debt totaled $109,000 and $355,000, respectively.



Inventories



Inventories primarily consist of finished goods and are stated at the lower of
cost (determined by the average cost method) or net realizable value. We
calculate estimates of excess and obsolete inventories determined primarily by
reviewing inventory on hand, historical sales activity, industry trends and
expected net realizable value. As of December 31, 2021, and 2020, the reserve
for excess and obsolete inventories totaled $156,000 and $179,000, respectively.



Stock-Based Compensation



We account for all stock-based compensation using a fair value-based method. The
fair value of equity-classified awards granted to employees is estimated on the
date of the grant using the Black-Scholes option-pricing model, or it is based
on valuation observed from publicly traded companies in a similar industry,
often with a discount for lack of marketability applied. The related stock-based
compensation expense is recognized over the vesting period during which an
employee is required to provide service in exchange for the award. We measure
the fair value of liability-classified awards using a Monte Carlo valuation
model. Compensation cost is recognized over the service period and is remeasured
at each reporting period through settlement.



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Income Taxes



Income taxes are computed under the liability method. This method requires the
recognition of deferred tax assets and liabilities for temporary differences
between the financial reporting basis and the tax basis of our assets and
liabilities. The impact on deferred taxes of changes in tax rates and laws, if
any, are applied to the years during which temporary differences are expected to
be settled and are reflected in the consolidated financial statements in the
period of enactment. A valuation allowance is recorded when it is more likely
than not that some of the deferred tax assets will not be realized.



Financial statement effects of a tax position are initially recognized when it
is more likely than not, based on the technical merits, that the position will
be sustained upon examination by a taxing authority. A tax position that meets
the more-likely-than-not recognition threshold is initially and subsequently
measured as the largest amount of tax benefit that meets the
more-likely-than-not threshold of being realized upon ultimate settlement with a
taxing authority. We recognize potential accrued interest and penalties related
to unrecognized tax benefits as income tax expense.



SECTION 7A. QUANTITATIVE AND QUALITATIVE INFORMATION ON MARKET RISK

Not applicable.

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