Notes to Consolidated Financial Statements
December 31, 2021 and 2020
NOTE 1: NATURE OF OPERATIONS
In these notes, the terms “us”, “we”, “it”, “its”, “ToughBuilt”, the “Company” or “our” refer to ToughBuilt Industries, Inc. ToughBuilt was incorporated under the laws of the State of Nevada on April 9, 2012 under the name Phalanx, Inc., and on December 29, 2015, Phalanx, Inc. changed its name to ToughBuilt Industries, Inc.
The Company designs and distributes innovative and superior quality tools and accessories to the home improvement community and the building industry. The Company aspires to augment brand loyalty in part from the enlightened creativity of its end users throughout the global tool market industry. The Company holds exclusive licenses to develop, manufacture, market, and distribute various home improvement and construction product lines for both Do-it-Yourself and professional trade markets under the TOUGHBUILT® brand name.
TOUGHBUILT® distributes products in the following categories, all designed and engineered in the United States and manufactured by third party vendors in China:
| ● | tool belts, tool bags and other personal tool organizer products; |
| ● | complete line of knee pads for various construction applications; and |
| ● | jobsite tools and material support products consisting of a full line of miter-saws and table saw stands, saw horses/job site tables and roller stands. |
On January 28, 2020, the Company closed on a public offering of 4.5 million shares of common stock and 49.45 million warrants (each exercisable into 1/20
th
of a share of common stock for a total of 2.4725 million shares of common stock) from which it received net proceeds of $8,549,470, after deducting underwriting discounts and expenses.
On February 24, 2020, the Company closed on the public offering of 445,000 additional shares of common stock for net proceeds of $839,270, after deducting underwriting discounts and expenses, due to the exercise of the over-allotment option issued to the underwriter in the January 28, 2020 public offering.
On April 15, 2020, the Company effected a 1-for-10 reverse stock split (the “Reverse Split”) of its issued and outstanding common stock. As a result of the Reverse Split, each 10 shares of issued and outstanding prior to the Reverse Split were converted into one share of common stock. All share and per share numbers in the consolidated financial statements and notes below have been revised retroactively to reflect the Reverse Split.
On June 2, 2020, the Company closed on a public offering of 19 million shares of common stock and 20.7 million warrants pursuant to a Form S-1 from which it received net proceeds of $17,185,640, after deducting underwriting discounts and expenses. On June 12, 2020, the Company closed on the public offering of 1.7 million additional shares of common stock for net proceeds of $1,548,360, after deducting underwriting discounts and expenses, pursuant to the underwriter exercising the overallotment option from the June 2, 2020 public offering.
On January 19, 2021, the Company filed a prospectus supplement dated January 15, 2021 (the “ATM Prospectus Supplement”) to the First Form S-3 for the offer and sale shares of common stock having an aggregate value of $8,721,746 from time to time through H.C. Wainwright & Co., LLC, as sales agent (“Wainwright”), pursuant to the At The Market Offering Agreement, dated December 7, 2020 (the “ATM Agreement”), between the Company and Wainwright. During January 2021, through the sale of 14,962,139 million shares of the Company’s common stock the Company has raised net proceeds of $16,242,904 after deducting underwriting discounts and expenses.
On February 2, 2021, the Company filed a second registration statement on Form S-3 (File No. 333-252630) (the “Second Form S-3”) containing a base prospectus covering the offering, issuance and sale by the Company of up to $100,000,000 of the Company’s common stock, preferred stock, warrants and units; and a sales agreement prospectus covering the offering, issuance and sale by us of up to a maximum aggregate offering price of $100,000,000 (which amount was included in the aggregate offering price set forth in the base prospectus) of the Company’s common stock that may be issued and sold under a second At The Market Offering Agreement, dated February 1, 2021, we entered into with Wainwright, as sales agent. The Second S-3 was declared effective by the SEC on February 8, 2021. The Company terminated the First S-3 simultaneously with the filing of the Second S-3. From February 2021 to July 2021, the Company sold an aggregate of 18,826,177 shares of common stock through the Wainwright under the Second S-3 with net proceeds of $24,602,110, after deducting underwriting discounts and expenses.
On July 14, 2021, the Company raised gross proceeds of $40,000,000 in a registered direct offering pursuant to a Form S-3 involving the sale of shares and warrants to several institutional and accredited investors. These shares were sold pursuant to the Second S-3. There was a total of 46,029,920 shares of common stock sold with net proceeds of $36,259,050, after deducting underwriting discounts and expenses.
Risk and Uncertainty Concerning COVID-19
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic which continues to spread throughout the United States and the world. We are currently monitoring the outbreak of COVID-19 and the related business and travel restrictions and changes to behavior intended to reduce its spread. All of our Chinese facilities were temporarily closed for a period of time. Most of these facilities have been reopened. Depending on the progression of the outbreak, our ability to obtain necessary supplies and ship finished products to customers may be partly or completely disrupted globally. Also, our ability to maintain appropriate labor levels could be disrupted. If the coronavirus continues to progress, it could have a material negative impact on our results of operations and cash flow, in addition to the impact on its employees. We have concluded that while it is reasonably possible that the virus could have a negative impact on the results of operations, the specific impact is not readily determinable as of the date of these consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Company has incurred substantial operating losses since its inception. As reflected in the consolidated financial statements, the Company had an accumulated deficit of approximately $98.3 million at December 31, 2021, a net loss of approximately $37.5 million, and approximately $66.1 million of net cash used in operating activities for the year ended December 31, 2021. The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty. The Company anticipates incurring additional losses until such time, if ever, that it can obtain marketing approval to sell, and then generate significant sales, of its technology that is currently in development. As such it is likely that additional financing will be needed by the Company to fund its operations and to develop and commercialize its technology. These factors raise substantial doubt about the Company’s ability to continue as a going concern. For the next twelve months from issuance of this Annual Report on Form 10-K. The Company will seek to obtain additional capital through the sale of debt or equity financings or other arrangements to fund operations; however, there can be no assurance that the Company will be able to raise needed capital under acceptable terms, if at all. The sale of additional equity may dilute existing stockholders and newly issued shares may contain senior rights and preferences compared to currently outstanding shares of common stock. Issued debt securities may contain covenants and limit the Company's ability to pay dividends or make other distributions to stockholders. If the Company is unable to obtain such additional financing, future operations would need to be scaled back or discontinued. Due to the uncertainty in the Company's ability to raise capital, management believes that there is substantial doubt in the Company's ability to continue as a going concern for twelve months from the issuance of these consolidated financial statements.
Basis of Presentation and Preparation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the United States Securities and Exchange Commission (“SEC”). The consolidated financial statements and accompanying notes are the representations of the Company’s management, who is responsible for their integrity and objectivity. In the opinion of the Company’s management, the consolidated financial statements reflect all adjustments, which are normal and recurring in nature, necessary for fair financial statement presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Toughbuilt Industries UK Limited. All intercompany balances and transactions are eliminated.
Any foreign currency translation and transactions are de minimis to the consolidated financial statements.
Certain amounts in the prior periods presented have been reclassified to conform to the current period financial statement presentation. These reclassifications have no effect on previously reported net income or cash flows.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of consolidated financial statements in conformity with 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 date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company regularly evaluates estimates and assumptions related to the valuation of accounts and factored receivables, valuation of long-lived assets, accrued liabilities, and deferred income tax asset valuation allowances. The Company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with maturity of three months or less at the time of issuance to be cash equivalents. The Company did not have any cash equivalents at December 31, 2021 and 2020, respectively.
Accounts receivable represent income earned from the sale of tools and accessories for which the Company has not yet received payment. Accounts receivable are recorded at the invoiced amount and adjusted for amounts management expects to collect from balances outstanding at period-end. The Company estimates the allowance for doubtful accounts based on an analysis of specific accounts and an assessment of the customer’s ability to pay, among other factors. At December 31, 2021 and 2020, no allowance for doubtful accounts was recorded.
The Company accounts for the transfer of accounts receivable to a third party under a factoring type arrangement in accordance with Accounting Standards Codification (“ASC”) 860, “
Transfers and Servicing
”. ASC 860 requires that several conditions be met in order to present the transfer of accounts receivable as a sale. Even though the Company has isolated the transferred (sold) assets and has the legal right to transfer its assets (accounts receivable), it does not meet the third test of effective control since its accounts receivable sales agreement with a third-party factor requires it to be liable in the event of default by one of its customers. Because it does not meet all three conditions, it does not qualify for sale treatment of its accounts receivable, and its debt thus incurred is presented as a secured loan liability, entitled “Loan payable - factor”, on its balance sheet, of which there was no amount outstanding as of December 31, 2021. The Company recorded a sales discount of $13,000 at December 31, 2021 and 2020.
Inventory is valued at the lower of cost or net realizable value using the first-in, first-out method. The reported net value of inventory includes finished salable products that will be sold or used in future periods. The Company reserves for obsolete and slow-moving inventory. At December 31, 2021 and 2020, there were no reserves for obsolete and slow-moving inventory.
Property and equipment are recorded at cost, less accumulated depreciation. The Company provides for depreciation on a straight-line basis over the estimated useful lives of the assets which are as follows: furniture 5 years, computers 3 years, production equipment 5 years, auto 5 years, tooling and molds 3 years, application development 3 years and website design in progress 4 years. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the related assets when they are placed into service. The Company evaluates property and equipment for impairment periodically to determine if changes in circumstances or the occurrence of events suggest the carrying value of the asset or asset group may not be recoverable. Maintenance and repairs are charged to operations as incurred. Expenditures which substantially increase the useful lives of the related assets are capitalized.
In accordance with ASC 360, “
Property, Plant, and Equipment
”, the Company tests long-lived assets or asset groups for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable. Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life. Recoverability is assessed based on the carrying amount of the asset compared to the estimated future undiscounted cash flows expected to result from the use and the eventual disposal of the asset, as well as specific appraisal in certain instances. An impairment loss equal to the excess of the carrying value over the assets fair market value is recognized when the carrying amount exceeds the undiscounted cash flows. The impairment loss is recorded as an expense and a direct write-down of the asset. No impairment loss was recorded during the years ended December 31, 2021 and 2020.
Common stock purchase warrants
The Company accounts for the common stock purchase warrants in accordance with the guidance contained in ASC 815-40, under which the Warrants do not meet the criteria for equity treatment and must be recorded as liabilities. Accordingly, the Company classifies the Warrants as liabilities at their fair value and adjusts the Warrants to fair value in respect of each reporting period. This liability is subject to re-measurement at each balance sheet date until the Warrants are exercised, and any change in fair value is recognized in the statements of operations.
Fair Value of Financial Instruments and Fair Value Measurements
The Company adheres to ASC 820
“Fair Value Measurement”,
which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
| ● | Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. |
| ● | Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. |
| ● | Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity’s own assumptions, as there is little, if any, related market activity. |
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
The fair value of the Company’s warrant liability recorded in the Company’s consolidated financial statements was determined using a Black-Scholes valuation methodology and the quoted price of the Company’s common stock in an active market, a Level 3 measurement. Volatility was based on the actual market activity of the Company for the period in which the Company was public and its peer group for the remaining period. The expected life was based on the remaining contractual term of the warrants, and the risk-free interest rate was based on the implied yield available on U.S. Treasury Securities with a maturity equivalent to the warrants’ expected life.
The Company calculated the estimated fair value of warrants on the date of issuance and at each subsequent reporting date using the following assumptions:
| | For the Year Ended December 31, 2021 | |
Risk-free interest rate | | | 0.80% - 1.19% | |
Contractual term | | | 4.54 – 5 years | |
Dividend yield | | | 0% | |
Expected volatility | | | 56.27% - 88.3% | |
From time to time, the Company sells common stock warrants that are derivative instruments. The Company does not enter into speculative derivative agreements and does not enter into derivative agreements for the purpose of hedging risks.
The fair value of the warrant liability includes the estimated volatility and risk-free rate. The higher/lower the estimated volatility, the higher/lower the value of the debt conversion feature liability. The higher/lower the risk-free interest rate, the higher/lower the value of the debt conversion feature liability.
The table below provides a reconciliation of the beginning and ending balances for the warrant liability which is measured at fair value using significant unobservable inputs (Level 3):
Balance, January 1, 2021 | | $ | - | |
Fair value of warrant liability at issuance (2021 Offering Warrants as defined and described in Note 6) | | | 7,463,005 | |
Change in the fair value of warrant liability | | | (2,661,076 | ) |
Balance, December 31, 2021 | | $ | 4,801,929 | |
The Company recognizes revenues when product is delivered to the customer, and the ownership is transferred. The Company’s revenue recognition policy is based on the revenue recognition criteria established under the Financial Accounting Standards Board (“FASB”) – Accounting Standards Codification 606
“Revenue From Contracts With Customers
” which has established a five-step process to govern contract revenue and satisfy each element is as follows: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when or as you satisfy a performance obligation. The Company records the revenue once all the above steps are completed. See Note 10 for further information on revenue recognition.
Advertising costs are expensed as incurred. Advertising expense totaled $9,626,374 and $3,494,559 for the years ending December 31, 2021 and 2020, respectively.
Legal fees and similar costs incurred relating to patents are capitalized and are amortized over their estimated useful life once determined. Such costs amounted to $615,439 as of December 31, 2021, and are included in other assets on the accompanying consolidated balance sheet.
Expenditures for research activities relating to patents and product development are charged to expense as incurred. Such expenditures amounted to $6,980,453 and $5,056,811 for the years ending December 31, 2021 and 2020, respectively.
The Company accounts for income taxes following the asset and liability method in accordance with ASC 740 “Income Taxes.” Under such method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company applies the accounting guidance issued to address the accounting for uncertain tax positions. This guidance clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the consolidated financial statements as well as provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company classifies interest and penalty expense related to uncertain tax positions as a component of income tax expense. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years that the asset is expected to be recovered or the liability settled. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the period in which related temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in its assessment of a valuation allowance.
During 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was passed, which temporarily removed 80% limitations on net operating loss carryforwards for the years 2019 and 2020.
The Company adopted FASB ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting of Income Taxes,” as of January 1, 2021. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. The adoption of this guidance did not have a material impact on its consolidated financial statements.
The Company accounts for stock-based compensation in accordance with ASC 718-10, “
Share-Based Payment
,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, restricted stock units, and employee stock purchases based on estimated fair values. In addition, as of January 1, 2020, the Company adopted Accounting Standards Update (“ASU”) 2018-07,
Compensation – Stock Compensation (Topic 718), Improvements to Non-employee Share-Based Payment Accounting
. This ASU simplified aspects of share-based compensation issued to non-employees by making the guidance consistent with accounting for employee share-based compensation. The adoption of this guidance did not have a material impact on the consolidated financial statements.
The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The Company’s determination of fair value using an option-pricing model is affected by the stock price as well as assumptions regarding the number of highly subjective variables.
The Company estimates volatility based upon the historical stock price of the comparable companies and estimates the expected term for employee stock options using the simplified method for employees and directors and the contractual term. The risk-free rate is determined based upon the prevailing rate of United States Treasury securities with similar maturities.
The Company recognizes forfeitures as they occur rather than applying a prospective forfeiture rate in advance.
The Company computes net loss per share in accordance with ASC 260, “
Earnings per Share”
. ASC 260 requires presentation of both basic and diluted net earnings per share (“EPS”) on the face of the statement of operations. Basic EPS is computed by dividing loss available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of warrants, options, and restricted stock units. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.
Potentially dilutive securities that are not included in the calculation of diluted net loss per share because their effect is anti-dilutive are as follows (in common equivalent shares):
|
|
Year Ended |
|
|
|
December 31, 2021 |
|
|
December 31, 2020 |
|
Warrants |
|
|
42,274,795 |
|
|
|
21,925,102 |
|
Options and restricted stock units |
|
|
203,135 |
|
|
|
203,135 |
|
Total anti-dilutive weighted average shares |
|
|
42,477,930 |
|
|
|
22,128,237 |
|
The Company operates one reportable segment referred to as the tools segment. A single management team that reports to the Chief Executive Officer comprehensively manages the business. Accordingly, the Company does not have separately reportable segments.
Recent Accounting Pronouncements
As an emerging growth company, the Company has elected to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended.
In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, “
Leases
(Topic 842).” The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022 and is to be applied utilizing a modified retrospective approach. The Company is currently evaluating this guidance to determine the impact it may have on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (“Topic 326”)”. The ASU introduces a new accounting model, the Current Expected Credit Losses model (“CECL”), which requires earlier recognition of credit losses and additional disclosures related to credit risk. The CECL model utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses at the time the financial asset is originated or acquired. ASU 2016-13 is effective for annual period beginning after December 15, 2022, including interim reporting periods within those annual reporting periods. The Company is currently evaluating this guidance to determine its impact it may have on its consolidated financial statements.
In August 2020, the FASB issued ASU 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 also removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception and simplifies the diluted earnings per share calculation in certain areas. The amendments in this ASU are effective for annual and interim periods beginning after December 15, 2023, although early adoption is permitted. The Company is in the process of evaluating the impact of this new guidance on its consolidated financial statements.
NOTE 3: FACTOR RECEIVABLES
,
LETTERS OF CREDIT PAYABLE AND LOAN PAYABLE
In April 2013, the Company entered into a financing arrangement with a third-party purchase order financing company (the “Factor”), whereby the Company assigned to the Factor selected sales orders from its customers in exchange for opening a letter of credit (“LC”) with its vendors to manufacture its products. The Company paid an initial fixed fee of 5% of the cost of products it purchased from the vendor upon opening the LC, and 1% each 30 days thereafter, after the LC is funded by the Factor until such time as the Factor receives the payment from the Company’s customers. The factoring agreement provides for full recourse against the Company for factored accounts receivable that are not collected by the Factor for any reason, and the collection of such accounts receivable is fully secured by substantially all of the receivables of the Company. As of March 2021, the Company no longer factors its receivables.
Inventory consists of the following:
Description |
|
December 31, 2021 |
|
|
December 31, 2020 |
|
Finished goods |
|
$ |
38,432,012 |
|
|
$ |
8,915,345 |
|
NOTE 5: PROPERTY AND EQUIPMENT
,
NET
Property and equipment consist of the following:
|
December 31, 2021 |
|
|
December 31, 2020 |
|
Furniture |
$ |
1,066,219 |
|
|
$ |
183,672 |
|
Computers |
|
1,038,154 |
|
|
|
586,749 |
|
Production equipment |
|
245,713 |
|
|
|
182,446 |
|
Tooling and molds |
|
6,390,962 |
|
|
|
1,989,366 |
|
Auto |
|
635,542 |
|
|
|
635,542 |
|
Application development |
|
2,398,919 |
|
|
|
93,435 |
|
Website design |
|
814,733 |
|
|
|
507,088 |
|
Steelbox |
|
882,000 |
|
|
|
|
|
Leasehold Improvements |
|
2,862,079 |
|
|
|
42,249 |
|
Less: accumulated depreciation |
|
(2,992,692 |
) |
|
|
(1,153,623 |
) |
Property and Equipment, net |
$ |
13,341,629 |
|
|
$ |
3,066,924 |
|
Depreciation expense for the years ended December 31, 2021 and 2020, was $1,839,069 and $626,652,
respectively
.
NOTE 6 – SENIOR SECURED CONVERTIBLE NOTES AND NOTES PAYABLE
On August 19, 2019, the Company entered into a Securities Purchase Agreement with an institutional investor pursuant to which it sold an aggregate principal amount of $11.5 million of promissory notes (at an aggregate original issue discount of 15%) to the investor in a transaction exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended. The first note (the “Series A Note”) had a face amount of $6.72 million for which the investor paid $5 million in cash. The second note (the “Series B Note” and with the Series A Note, collectively referred to as the “Notes”) had a principal amount of $4.78 million for which the investor paid $4.78 million in the form of a full recourse promissory note issued by the investor to the Company (the “Investor Note”) secured by $4.78 million in cash or cash equivalents of the investor (i.e., an original issue discount of approximately 15% to the face amount of the Series B Note). No portion of the Series B Note was able to be converted into shares of our common stock (the “common stock”) until the corresponding portion of the Investor Note has been prepaid to the Company in cash, at which point in time such portion of the Series B Note shall be deemed “unrestricted”. The Investor Note was subject to optional prepayment at any time at the option of the investor and mandatory prepayment, at the Company’s option, subject to certain equity conditions, at any time 45 trading days after the effectiveness of a resale registration statement (or otherwise the applicability of Rule 144 promulgated under the Securities Act of 1933, as amended). Notwithstanding the foregoing, the Company may not effect a mandatory prepayment if the shares underlying the Series A Note and the portion of the Series B Note that has become unrestricted exceeds 35% of the market capitalization of the Company.
The Notes were senior secured obligations of the Company secured by a lien on all assets of the Company, bear no interest (unless an event default has occurred and is continuing) and had an original maturity date of December 31, 2020. The Notes were convertible at $1.00 into a fixed number of shares (the “Conversion Shares”). The Notes were convertible at the holder’s option, in whole or in part, at any time after closing. The Conversion Price was subject to adjustment for stock dividends, stock splits, anti-dilution and other customary adjustment events.
The Company was to repay the Principal Amount of the Notes in 12 installments, with the first installment starting on February 1, 2020 (each, an “Installment Date”). Installments 1-3 shall be 1/36th of the Principal Amount, Installments 4-6 shall be 1/18th of the Principal Amount and Installments 7-12 shall be 1/8th of the Principal Amount. The repayment amount shall be payable in cash, or, subject to the satisfaction of equity conditions, at the option of the Company, in registered common stock or a combination of cash and registered common stock. However, if the 30-day volume weighted average price of the common stock (the “VWAP”) of the Company falls below 50% of the market price of a share of the Company’s common stock or the Company fails to satisfy certain other equity conditions, the repayment amount is payable in shares of common stock only unless the Investor(s) waive any applicable equity condition. If the Company elects to satisfy all or any portion of an installment in shares of common stock, the Company will pre-deliver such shares of common stock to the investor on the 23rd trading day prior to the applicable Installment Date, with a true-up of shares (if necessary) on the Installment Date. Any excess shares of common stock shall be applied to subsequent installments.
The shares used to meet a Principal Repayment (“Installment Shares”) would be valued at a conversion price calculated as the lesser of (i) 85% of the arithmetic average of the three lowest daily VWAPs of the twenty trading days prior to the payment date or (ii) 85% of the VWAP of the trading day prior to payment date (“Installment Price”) with a floor of $0.10.
All amortization payments were subject to the Investors’ right to (a) defer some or all of any Installment Payment to a subsequent Installment Date; and (b) at any time during an installment period, convert up to four times the installment amount at the Installment Price; provided shares received pursuant to such accelerated conversions shall be subject to a leak-out provision that solely limits sales of such shares received by the investor in such accelerated conversion (and not any other sales) to the greater of (a) $500,000 per trading day or (b) 40% of the volume traded on a given day as reported by Bloomberg LP.
Upon completion of a Change of Control, the holders may require the Company to purchase any outstanding Notes in cash at 125% of par plus accrued but unpaid interest. The Company shall have the right to redeem any and all amounts of the outstanding Note at 125% of the greater of (a) Principal Amount plus accrued but unpaid interest (if any), or (b) Conversion Value plus accrued but unpaid interest (if any) provided the Company has satisfied certain equity conditions. The Company must give the Investor(s) ninety (90) business days’ prior notice of any such redemption.
Prior to all outstanding amounts under the Note being repaid in full, the Company will not create any new encumbrances on any of its or its subsidiaries’ assets without the prior written consent of the Lender, with a carve out for a working capital facility of which the details are to be determined. The Notes shall also be subject to standard events of default and remedies therefor.
The Company filed a registration statement (“Effectiveness Date”) on Form S-1 (file No: 333-233655) covering the resale of the shares underlying the Series A Note, the Series B Note and Warrants which was declared effective by the SEC on October 15, 2019.
In connection with the granting of the Notes, the Company shall issue detachable warrants to the Investor, exercisable in whole or in part at any time during the five years from the date of issuance, in an amount equal to 50% of the conversion shares underlying the Notes and have an exercise price of $1.00 per share. To the extent the Company has a change of control or a spinoff, the warrants provide for a put for the warrants to the Company at their Black-Scholes Valuation. The value of the warrants amounted to $575,000 and was recoded as debt discount in the accompanying balance sheet.
Until the 3 year anniversary of the maturity date, the investor shall have the right (but not the obligation) to participate in 50% of any subsequent equity or debt issuance. Consummation of the transaction has been subject to certain conditions precedent, including the Company agreeing to procure an approval of this transaction at its annual stockholder meeting scheduled no later than 180 days after the Closing Date and agrees to procure voting agreements from principal shareholders prior to closing of the Company.
On December 23, 2019, the Company entered into an Exchange Agreement with the institutional investor pursuant to which the investor exchanged $5.5 million principal amount of its August 19, 2019 Series A Senior Secured Note for 5,775 shares of its Series D Preferred Stock, which was authorized by the Company’s Board of Directors (“Board”) on December 21, 2019.
During the year ended December 31, 2020, the Company received $3,000,000 in connection with the Investor Note. Also, during the year ended December 31, 2020, $3,200,000 principal amount of Notes was converted into common stock.
On November 20, 2020, the Company and the investor entered into an Exchange Agreement (the “Exchange Agreement”) whereas the investor exchanged the balance of $2,131,050 of outstanding Notes for the following: an aggregate cash payment of $744,972, an aggregate of 1,850,000 shares of the Company’s common stock, a warrant to purchase up to an aggregate of 575,000 shares of the Company’s common stock for $1.00 per share, and nine shares of Series E Non-Convertible Preferred Stock of the Company. In addition, the Company relinquished their note receivable of $1,480,000 owed from the investor. As a result of this transaction, the Company recorded a loss of $1,810,712.
During April 2020, the Company entered into a promissory note with an approved lender in the principal amount of $399,300. The note was approved under the provisions of the CARES Act and the terms of the Paycheck Protection Program of the U.S. Small Business Administration’s 7(a) Loan Program (“PPP Loan”). The Company repaid the PPP Loan in full during June 2020.
NOTE 7 – COMMITMENTS AND CONTINGENCIES
On January 3, 2017, the Company executed a non-cancellable operating lease for its principal office with the lease commencing February 1, 2017 for a five (5) year term. The Company paid a security deposit of $29,297. The lease required the Company to pay its proportionate share of direct costs estimated to be 22.54% of the total property, a fixed monthly direct cost of $6,201 for each month during the term of the lease, and monthly rental pursuant to the lease terms.
The Company entered into a lease for office space at 8669 Research Drive, in Irvine, CA, which is to replace the current corporate headquarters. The lease commenced on December 1, 2019 with no rent due until April 1, 2020. From April 1, 2020 through March 31, 2025, base rent will be due on the first of each month in the amount of $25,200 escalating annually on December 1 of each year to $29,480 beginning December 1, 2023. The Company paid an initial amount of $68,128 comprising the rent for April 2020, a security deposit and the amount due for property taxes, insurance and association fees.
On August 30, 2018, the Company entered into an agreement with a customer to pay a slotting allowance of $1,000,000 payable in three annual installments of $333,334 on March 1, 2019, $333,333 on March 1, 2020 and $333,333 on March 1, 2021.
Future minimum lease commitments of the Company are as follows:
For the years ending December 31, |
|
|
Building leases |
|
|
2022 |
|
|
$ |
343,821 |
|
|
2023 |
|
|
|
341,293 |
|
|
2024 |
|
|
|
353,765 |
|
|
2025 |
|
|
|
88,441 |
|
|
|
|
|
$ |
1,127,320 |
|
The Company recorded rent expense of $861,004 and $853,062 for the years ended December 31, 2021 and 2020, respectively.
Employment Agreements with Officers
On January 3, 2017, the Company entered into an Employment Agreement with its President and Chief Executive Officer for a five-year term. The officer received a sign-on-bonus of $50,000 and was entitled to an annual base salary of $350,000 to increase by 10% each year commencing on January 1, 2018. The officer was also granted a stock option to purchase 125,000 shares of the Company’s common stock at an exercise price of $10.00 per share.
On January 3, 2017, the Company entered into an Employment Agreement with its Vice President of Design and Development for a five-year term. Under the terms of this agreement, the officer received a sign-on-bonus of $35,000 and is entitled to an annual base salary of $250,000 beginning on December 1, 2016 to increase by 10% each year commencing on January 1, 2018.
On January 3, 2017, the Company entered into an Employment Agreement with its Chief Operating Officer and Secretary for a three-year term. Under the terms of this agreement, the officer is entitled to an annual base salary of $180,000 beginning on January 1, 2017 to increase by 10% each year commencing on January 1, 2018. Such agreement expired upon the third anniversary.
The Company’s former Chief Financial Officer was appointed on June 14, 2019, with whom the Company entered into a verbal consulting arrangement at $10,000 per month. Effective July 2, 2020, such former Chief Financial Officer resigned from the Company.
Effective July 1, 2020, the Company and the Chief Financial Officer have agreed to a salary of $230,000 per annum.
The employment agreements also entitle the officers to receive, among other benefits, the following compensation: (i) eligibility to receive an annual cash bonus at the sole discretion of the Board and as determined by the Compensation Committee commensurate with the policies and practices applicable to other senior executive officers of the Company; (ii) an opportunity to participate in any stock option, performance share, performance unit or other equity based long-term incentive compensation plan commensurate with the terms and conditions applicable to other senior executive officers and (iii) participation in benefit plans, practices, policies and programs provided by the Company (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) to the extent available to the Company’s other senior executive officers.
Litigation Costs and Contingencies
From time to time, the Company may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm business. Other than as set forth below, management is currently not aware of any such legal proceedings or claims that could have, individually or in the aggregate, a material adverse effect on our business, financial condition, or operating results.
Edwin Minassian v
.
Michael Panosian an
d ToughBuilt Industries
,
Inc
.,
Los Angeles Superior Court Case No
.
EC065533
.
On August 16, 2016, Plaintiff Edwin Minassian filed a complaint against Defendants ToughBuilt Industries, Inc. and Michael Panosian in the Superior Court of California, County of Los Angeles, Case No. EC065533. The complaint alleges breach of oral contracts to pay Plaintiff for consulting and finder’s fees, and to hire him as an employee. The complaint further alleged claims of fraud and misrepresentation relating to an alleged payment in exchange for stock in the Company. The complaint seeks unspecified monetary damages, declaratory relief, stock in the Company, and other relief according to proof.
On April 12, 2018, the Court entered judgments of default against the Company and Mr. Panosian in the amounts of $7,080 and $235,542, plus awarding Mr. Minassian a 7% ownership interest in the Company (the “Judgments”). Mr. Minassian served notice of entry of the judgments on April 17, 2018 and the Company and Mr. Panosian received notice of the entry of the default judgments on April 19, 2018.
The Company and Panosian satisfied the Judgments on September 14, 2018 by payment of $252,949 to Plaintiff Minassian and by issuing Plaintiff Minassian 376,367 shares of common stock of the Company. On October 18, 2018, the Company and Panosian filed a Notice of Appeal from the Order denying their motion for relief from the above-referenced default judgment.
On October 1, 2019, the Second Appellate District of the California Court of Appeal issued its opinion reversing the trial court’s order denying ToughBuilt’s motion for relief from the default judgment and directing the trial court to grant ToughBuilt’s motion for relief, including allowing ToughBuilt to file an Answer and contest Minassian’s claims.
The appellate court recently issued a remittitur officially transferring the matter from the appellate court back to the trial court for further proceedings consistent with its ruling, and the Company and Panosian have filed an Answer to the Complaint. The trial court has not yet set a trial date, and discovery in this case is just now beginning. The Company intends to vigorously defend the complaint and seek to recover the compensation and stock previously paid to satisfy the now vacated default judgment. The Company believes it has a strong position, but cannot quantify the likelihood that it will prevail in the above litigation, or any likely liability or recoveries, because of the current status of the case and the unpredictability of litigation.
Plaintiff Minassian seeks damages and stock based on a breach of an alleged oral agreement. Discovery is presently ongoing. In addition, Plaintiff Minassian is in violation of a court order for restitution and the Company is engaged in collection efforts to enforce that order. A trial date has been set for April 25, 2022.
In the normal course of business, the Company incurs costs to hire and retain external legal counsel to advise it on regulatory, litigation and other matters. The Company expenses these costs as the related services are received. If a loss is considered and the amount can be reasonable estimated, the Company recognizes an expense for the estimated loss.
NOTE 8: STOCKHOLDERS
’
EQUITY
At December 31, 2021 and December 31, 2020, the Company had 200,000,000 shares of common stock, and 4,268 shares of Series C preferred stock authorized, both with a par value of $0.0001 per share. In addition, as of December 30, 2021 and December 31, 2020, the Company had 5,775 shares of Series D preferred stock, and as of December 31, 2021 the Company had 15 Series E Non-Convertible preferred stock authorized, with a par value of $1,000 and $0.0001 per share.
Common Stock and Preferred Stock
On February 24, 2020, the Company closed on the public offering of 0.445 million shares of its common stock, for gross proceeds of $912,250 based upon the overallotment option arising from the closing of its January 28, 2020 public offering. In the January 28, 2020 public offering, the Company sold 4.5 million shares of its common stock and 49.45 million warrants (each exercisable into 1/20 of a share of common stock for a total of 2.4725 million shares of common stock) from which it received gross proceeds of $9,472,250.
On June 12, 2020, the Company closed on the public offering of 1.7 million shares of its common stock, for gross proceeds of $1,683,000 based upon the overallotment option arising from the closing of its June 2, 2020 public offering. In the June 2, 2020 public offering, the Company sold 19 million shares of its common stock and 20.7 million warrants from which it received gross proceeds of $19,017,000.
During 2020, 1,268 shares of Series C Preferred Stock converted into 126,800 shares of the Company’s common stock and 3,563 shares of Series D Preferred Stock converted into 3,141,426 shares of the Company’s common stock.
During 2020, $3,200,000 principal amount of Notes was converted into the Company’s common stock.
During 2020, the Company granted 360,000 shares of common stock to consultants in consideration for services rendered.
On January 19, 2021, the Company filed a prospectus supplement dated January 15, 2021 to the First Form S-3 for the offer and sale shares of common stock having an aggregate value of $8,721,746 from time to time through Wainwright, pursuant to the ATM Agreement. During January 2021, the Company has raised approximately $16,200,000 through the sale of 14.9 million shares of the Company’s common stock.
On February 2, 2021, the Company filed the Second Form S-3 containing a base prospectus covering the offering, issuance and sale by us of up to $100,000,000 of the Company’s common stock, preferred stock, warrants and units; and a sales agreement prospectus covering the offering, issuance and sale by us of up to a maximum aggregate offering price of $100,000,000 (which amount was included in the aggregate offering price set forth in the base prospectus) of the Company’s common stock that may be issued and sold under a second At The Market Offering Agreement, dated February 1, 2021, we entered into with Wainwright, as sales agent. The Second Form S-3 was declared effective by the SEC on February 8, 2021.
From February 2021 to July 2021, the Company sold an aggregate of 18,826,177 shares of common stock through the Wainwright under the Second S-3 with net proceeds of $24,602,110, after deducting underwriting discounts and expense.
On March 26, 2021, the Company filed with the Nevada Secretary of State a certificate of designation therein establishing the Series E Non-Convertible Preferred Stock consisting of fifteen (15) shares, and the Company issued nine (9) shares of such preferred stock to an institutional investor pursuant to an Exchange Agreement, dated November 20, 2020, between the Company and the investor.
On July 11, 2021, the Company entered into a Securities Purchase Agreement, dated July 11, 2021 (the “Agreement”) with several institutional and accredited investors (the “Purchasers”) pursuant to which the Company agreed to issue and sell in a registered direct offering (the “Offering”) an aggregate of 46,029,920 shares (the “Shares”) of its common stock and warrants (the “Warrants”) to purchase up to an aggregate of 23,014,960 shares of common stock at a combined offering price of $0.869 per share and accompanying warrant, for gross proceeds of approximately $40,000,000. The Warrants have an exercise price equal to $0.81 per share, and are immediately exercisable until the fifth anniversary of the date of issuance.
The net proceeds to the Company from the Offering were $36,259,050, after deducting placement agent fees and expenses payable by the Company. The Offering closed on July 14, 2021.
Pursuant to an engagement letter, dated July 10, 2021 (the “Engagement Letter”), with Wainwright (the “Placement Agent”), the Company agreed to pay the Placement Agent a cash fee equal to 7.0% of the gross proceeds received in the Offering and a management fee equal to 0.5% of the gross proceeds received in the Offering. The Company also agreed to pay the Placement Agent $25,000 for non-accountable expenses, up to $50,000 for fees and expenses of legal counsel and other reasonable and customary out of-pocket expenses, and $15,950 for clearing fees.
Also pursuant to the Engagement Letter, the Company, in connection with the Offering, issued to the Placement Agent or its designees warrants to purchase an aggregate of 2,761,795 shares of its common stock (which represents 6.0% of the Shares sold to investors in the Offering) at an exercise price equal to 125% of the offering price in the offering, or $1.08625 (the “2021 Placement Agent Warrants”). The 2021 Placement Agent Warrants are immediately exercisable until the fifth anniversary of the commencement of sales of the offering.
The Shares sold under the Agreement, the issuance of the Warrants and the 2021 Placement Agent Warrants, and the shares issuable pursuant to the Warrants and the 2021 Placement Agent Warrants were offered and sold by through a prospectus supplement included in the Company’s Second Form S-3 (as defined above).
The Company has issued an aggregate of 24,758 warrants to the placement agents to purchase one share of its common stock per warrant at an exercise price of $120 per share for 4,758 warrants and $10 for 20,000 warrants. The warrants issued in its October 2016 Private Placement expired on October 17, 2021, and the warrants issued in its March 2018 Private Placement, May 2018 Private Placement and August 2018 Financing shall expire on September 4, 2023. The exercise price and number of shares of common stock or other securities issuable on exercise of such warrants are subject to customary adjustment in certain circumstances, including in the event of a stock dividend, recapitalization, reorganization, merger or consolidation of the Company.
As of December 31, 2021 and December 31, 2020, 20,000 warrants issued to the placement agents at an exercise price of $10 and 1,365 at an exercise price of $120 are outstanding and are currently exercisable.
The holders of the Class B Warrants did not exercise any of their warrants during the year ended December 31, 2021. Class B Warrants have an exercise price of $120.00 per share and shall expire between October 17, 2021 and May 15, 2023.
As of December 31, 2021 and December 31, 2020, the Company had 15,100 and 26,550 Class B Warrants issued and outstanding, respectively.
Series A Warrants and Series B Warrants
On January 24, 2019, the Company entered into an Exchange Agreement with two institutional investors pursuant to which these investors exercised Series A Warrants to purchase 42,412 shares of the Company’s common stock for total cash proceeds of $2,172,680 to the Company, net of costs of $159,958. The two investors also exchanged Series A Warrants to purchase 50,894 shares of its common stock into 50,894 shares of its common stock and received new warrants to purchase an aggregate of 933,056 shares of its common stock. These new warrants have terms substantially similar to the terms of the Company’s Series A Warrants, except that the per share exercise price of the new warrants is $36.70, and the warrants are not exercisable until July 24, 2019, the six-month anniversary of the date of issuance. Each warrant expires on the fifth anniversary of the original issuance date.
As of December 31, 2021, and December 31, 2020, the Company had 519,001 Series A Warrants issued and outstanding.
In the January 28, 2020 public offering, the Company sold 49.45 million warrants (each exercisable into 1/20th of a share of common stock for a total of 2.4725 million shares of common stock). In the June 2, 2020 public offering, the Company sold 20.7 million warrants (each exercisable into 1 share of common stock for a total of 20.7 million shares of common stock). Each warrant expires on the fifth anniversary of the original issuance date. During the nine months ended September 30, 2021, 5,412,540 warrants were converted to common stock.
As of December 31, 2021, the Company had 15,367,574 2020 Offering Warrants issued and outstanding.
In the July 11, 2021 offering, the Company sold 23,014,960 warrants (each exercisable into 1 share of common stock) at an exercise price equal to $0.81 per share, and are immediately exercisable until the fifth anniversary of the date of issuance. In connection with the offering the Company issued to the Placement Agent or its designees warrants to purchase an aggregate of 2,761,795 shares of its common stock at an exercise price equal to 125% of the offering price in the offering, or $1.08625.
As of December 31, 2021, the Company had 23,014,960 and 2,761,795, 2021 Offering Warrants and 2021 Placement Agent Warrants issued and outstanding, respectively. The total fair value of such warrants amounted to $7,463,005 and $4,014,452 upon issuance, and December 31, 2021, respectively.
As disclosed in Note 6, on November 20, 2020, the Company and the investor entered into an Exchange Agreement and issued a warrant to purchase up to an aggregate of 575,000 shares of the Company’s common stock for $1.00 per share which expire on August 20, 2024. As of December 31, 2021, such warrant was outstanding.
The 2016 Equity Incentive Plan
The 2016 Equity Incentive Plan (the “2016 Plan”) was adopted by the Board and approved by the stockholders on July 6, 2016. The awards per the 2016 Plan may be granted through July 5, 2026 to the Company’s employees, consultants, directors and non-employee directors provided such consultants, directors and non-employee directors render good faith services not in connection with the offer and sale of securities in a capital-raising transaction. As of December 31, 2021, the maximum number of shares of our common stock that may be issued under the 2016 Plan is 200,000 shares, which amount will be (a) reduced by awards granted under the 2016 Plan, and (b) increased to the extent that awards granted under the 2016 Plan are forfeited, expire or are settled for cash (except as otherwise provided in the 2016 Plan). No employee will be eligible to receive more than 12,500 shares of common stock in any calendar year under the 2016 Plan pursuant to the grant of awards.
On January 3, 2017, the Board approved and granted to the President/Chief Executive Officer of the Company, an option to purchase 12,500 shares of the Company’s Common Stock (“Option”) under the Company’s 2016 Plan. The Option will have an exercise price that is no less than $100.00 per share and will vest over four (4) years, with 25% of the total number of shares subject to the Option vesting on the one (1) year anniversary of the date of grant and, the remainder vesting in equal installments on the last day of each of the thirty-six (36) full calendar months thereafter. Vesting will depend on the Officer’s continued service as an employee with the Company and will be subject to the terms and conditions of the 2016 Plan and the written Stock Option Agreement governing the Option. As of December 31, 2018, the Company estimated the fair value of the options using the Black-Scholes option pricing model was $448,861. The Company recorded compensation expense of $112,315 for the year ending December 31, 2020. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $3.060 at the issuance date; a risk-free interest rate of 1.72% and the expected volatility of the Company’s common stock of 315.83% (estimated based on the common stock of comparable public entities). As of December 31, 2021, there was no unrecognized compensation expense.
The 2018 Equity Incentive Plan
Effective July 1, 2018, the Board and the stockholders of the Company approved and adopted the Company’s 2018 Equity Incentive Plan (the “2018 Plan”). The 2018 Plan supplements, and does not replace, the existing 2016 Equity Incentive Plan. Awards may be granted under the 2018 Plan through September 30, 2023 to the Company’s employees, officers, consultants, and non-employee directors. As of December 31, 2021, the maximum number of shares of our common stock that may be issued under the 2018 Plan is 3.5 million (3,500,000) shares, which amount will be (a) reduced by awards granted under the 2018 Plan, and (b) increased to the extent that awards granted under the 2018 Plan are forfeited, expire or are settled for cash (except as otherwise provided in the 2018 Plan). Currently, no employee will be eligible to receive more than 350,000 shares of common stock (10% of authorized shares under the 2018 Plan) in any calendar year under the 2018 Plan pursuant to the grant of awards. When the Board first adopted the 2018 Plan on July 1, 2018, there were 100,000 shares authorized for issuance under the 2018 Plan. On September 12, 2018, the Board approved to increase the number of shares of common stock reserved for future issuance under the 2018 Plan from 100,000 shares to 200,000 shares. On June 9, 2019, the Board approved to increase the authorized shares under the 2018 Plan to 2 million (2,000,000) shares. On February 14, 2020, the Board approved to increase the number of shares of common stock reserved for future issuance under the 2018 plan to 3.5 million (3,500,000) shares. On September 14, 2018, 100,000 shares of common stock underlying awards under the 2018 Plan were granted to the employees and officers, 25% vesting immediately on the date of grant and 25% vesting each year thereafter on the three subsequent anniversaries of the grant date. The Company estimated the fair value of the options using the Black-Scholes option pricing model was $1,241,417. The key valuation assumptions used consist, in part, of the price of the Company’s common stock at $3.90 or $4.29 at the issuance date; a risk-free interest rate ranging of 1.9% and the expected volatility of the Company’s common stock ranging from of 40% (estimated based on the common stock of comparable public entities).
On April 4, 2020, the Company granted 90,635 restricted stock units to two officers of the Company. These units have the following vesting term: 33% on January 1, 2021, 34% on January 1, 2022 and 33% on January 1, 2023. The fair value of these units as of the grant date was $144,110 based upon the closing price of the Company’s stock.
The Company recorded compensation expense of $245,548 and $313,049, for the years ending December 31, 2021 and 2020, respectively. As of December 31, 2021, the unrecognized compensation expense was $52,403 which will be recognized as compensation expense over 1.02 years.
Income tax expense for the years ended December 31, 2021 and 2020 is summarized as follows.
| | December 31, 2021 | | | December 31, 2020 | |
Deferred: | | | | | | | | |
Federal | | $ | (8,581,566 | ) | | $ | (3,257,647 | ) |
State | | | (2,853,820 | ) | | | (1,083,338 | ) |
Change in valuation allowance | | | 11,435,386 | | | | 4,340,985 | |
Income tax expense (benefit) | | $ | - | | | $ | - | |
The following is a reconciliation of the provision for income taxes at the U.S. federal income tax rate to the income taxes reflected in the Statement of Operations:
| | December 31, 2021 | | | December 31, 2020 | |
Book income (loss) | | | 21.00 | % | | | 21.00 | % |
State taxes | | | 6.98 | % | | | 6.98 | % |
Change in the fair value of warrant derivative | | | 2.02 | % | | | - | % |
Other permanent items | | | 1.47 | % | | | (0.04 | )% |
Valuation allowance | | | (31.51 | )% | | | (27.94 | )% |
Tax expense at actual rate | | | - | | | | - | |
The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities at December 31, 2021 and 2020 are as follows:
| | December 31, 2021 | | | December 31, 2020 | |
Deferred tax assets: | | | | | | | | |
Net operating loss carryforward | | $ | 25,466,331 | | | $ | 13,240,919 | |
Depreciation | | | (827,012 | ) | | | - | |
Deferred rent | | | (8,267 | ) | | | 23,439 | |
Stock-based compensation | | | 457,224 | | | | 388,512 | |
Total gross deferred tax assets | | | 25,088,276 | | | | 13,652,870 | |
Less: valuation allowance | | | (25,088,276 | ) | | | (13,652,870 | ) |
Net deferred tax assets | | $ | - | | | $ | - | |
Deferred income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of deferred taxes
related
primarily to differences between the bases of certain assets and liabilities for financial and tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled.
Section 382 of the Internal Revenue Code (“Section 382”), imposes limitations on a corporation’s ability to utilize its Net Operating Losses (“NOLs”), if it experiences an “ownership change.” In general terms, an ownership change may result from transactions increasing the ownership percentage of certain stockholders in the stock of the corporation by more than 50% over a three-year period. In the event of an ownership change, utilization of the NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term tax-exempt rate. The Company has not completed a Section 382 study at this time; however, should a study be completed certain NOLs may be subject to such limitations. Any future annual limitation may result in the expiration of NOLs before utilization.
As of December 31, 2021, the Company had approximately $90,300,000 of federal net operating loss (“NOL”) carryforwards that may be available to offset future taxable income. As of that date, approximately $10,800,000 of federal net operating losses will expire in various amounts between 2035 and 2037. The remaining federal NOL have no expiration. The Company also had approximately $90,300,000 of state NOLs that begin to expire in 2035. The Company has recorded a 100% valuation allowance on the deferred tax assets due to the uncertainty of its realization. The net change in the valuation allowance for the years ended December 31, 2021 and 2020 was an increase of $11,435,386 and $4,340,985, respectively.
In the ordinary course of business, the Company’s income tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessment by these taxing authorities. Accordingly, the Company believes that it is more likely than not that it will realize the benefits of tax positions it has taken in its tax returns or for the amount of any tax benefit that exceeds the cumulative probability threshold in accordance with FASB ASC 740. Differences between the estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate, are not expected to have a material adverse effect on the Company’s financial position. The Company believes its tax positions are all highly certain of being upheld upon examination. As such, the Company has not recorded a liability for unrecognized tax benefits. The Company is no longer subject to the U.S. federal and state income tax examination to the extent the net operating losses are carried forward and impact a year that is open to examination by the authorities. The Company’s income tax returns for the years 2017-2019 are subject to examination.
NOTE 10: REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS AND ALLOWANCES
The Company’s contracts with customers only include one performance obligation (i.e., sale of the Company’s products). Revenue is recognized in the gross amount at a point in time when delivery is completed and control of the promised goods is transferred to the customers. Revenue is measured as the amount of consideration the Company expects to be entitled to in exchange for those goods. The Company’s contracts do not involve financing elements as payment terms with customers are less than one year. Further, because revenue is recognized at the point in time goods are sold to customers, there are no contract asset or contract liability balances. The Company does not disclose remaining performance obligations related to contracts with durations of one year or less as allowed by the practical expedient applicable to such contracts.
The Company disaggregates its revenues by major geographic region. See Note 11, Concentrations, Geographic Data, and Sales by Major Customers, for further information.
The Company accounts for fees paid to Amazon for products sold through its Amazon Stores as operating expense.
The Company offers various discounts, pricing concessions, and other allowances to customers, all of which are considered in determining the transaction price. Certain discounts and allowances are fixed and determinable at the time of sale and are recorded at the time of sale as a reduction to revenue. Other discounts and allowances can vary and are determined at management’s discretion (variable consideration). Specifically, the Company occasionally grants discretionary credits to facilitate markdowns and sales of slow-moving merchandise, and consequently accrues an allowance based on historic credits and management estimates. Further, the Company allows sales returns, consequently records a sales return allowance based upon historic return amounts and management estimates. These allowances (variable consideration) are estimated using the expected value method and are recorded at the time of sale as a reduction to revenue. The Company adjusts its estimate of variable consideration at least quarterly or when facts and circumstances used in the estimation process may change. The variable consideration is not constrained as the Company has sufficient history on the related estimates and does not believe there is a risk of significant revenue reversal.
The Company also participates in cooperative advertising arrangements with some customers, whereby it allows a discount from invoiced product amounts in exchange for customer purchased advertising that features the Company’s products. Generally, these allowances range from 2% to 5% of gross sales and are generally based upon product purchases or specific advertising campaigns. Such allowances are accrued when the related revenue is recognized. These cooperative advertising arrangements provide a distinct benefit and fair value, and are accounted for as direct selling expenses.
Sales commissions are expensed when incurred as the related revenue is recognized at a point in time and therefore, the amortization period is less than one year. As a result, these costs are recorded as direct selling expenses, as incurred.
The Company has also elected to adopt the practical expedient related to shipping and handling fees which allows the Company to account for shipping and handling activities that occur after control of the related good transfers as fulfillment activities instead of assessing such activities as performance obligations. Therefore, shipping and handling activities are considered part of the Company’s obligation to transfer the products and therefore are recorded as direct selling expenses, as incurred.
During the year ended December 31, 2020, the Company incurred costs to obtain a contract. Such costs amounted to $853,412. The Company expects to recover those costs through future revenue during the period of the contract. The Company is amortizing these costs over one year which is the stated term of the contract. The total amount was amortized as of December 31, 2021.
The Company’s reserve for sales returns and allowances amounted to $13,000 as of December 31, 2021 and December 31, 2020.
Concentration of Purchase Order Financing
The Company used a third-party financing company for the years ended December 31, 2021 and 2020, which provided letters of credit to vendors for a fee against the purchase orders received by the Company for sale of products to its customers. The letters of credit were issued to the vendors to manufacture Company’s products pursuant to the purchase orders received by the Company.
Concentration of Customers
The Company sold its products to two customers that account for approximately 53% (15% and 38%) of the total revenues for the year ended December 31, 2021.The Company sold its products to four customers that accounted for approximately 70% (15%, 18%, 26%, and 11%) of the total revenues for the years ended December 31, 2020.Two and four customers accounted for 45% and 68% of the total accounts receivable balance due to the Company at December 31, 2021 and 2020, respectively.
Concentration of Suppliers
The Company purchased products from four vendors for the year ended December 31, 2021 that accounted for approximately 51% (32% and 19%) of its total cost of goods sold.
The Company purchased products from four vendors for the year ended December 31, 2020 that accounted for approximately 71% (23%, 18%, 16%, and 14%) of its total cost of goods sold.
Concentration of Credit Risk
The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through December 31, 2021. The Company’s bank balances exceeded FDIC insured amounts at times during the years ended December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, the Company’s bank balance exceeded the FDIC insured amounts by $7,222,224 and $1,944,850 respectively.
Geographical distribution of net revenue consisted of the following for the years ended December 31, 2021 and 20
2
0, respectively, as follows:
|
|
For the Year Ended December 31, |
|
|
|
2021 |
|
|
2020 |
|
Australia |
|
|
- |
% |
|
|
5 |
% |
Canada |
|
|
4 |
% |
|
|
5 |
% |
Europe |
|
|
11 |
% |
|
|
8 |
% |
USA |
|
|
82 |
% |
|
|
78 |
% |
Other |
|
|
3 |
% |
|
|
4 |
% |
NOTE 12: SUBSEQUENT EVENTS
The Company evaluated subsequent events through the date of the filing of this Annual Report on Form 10-K with the SEC, to ensure that this filing includes appropriate disclosures of events both recognized in the consolidated financial statements as of December 31, 2021, and events which occurred subsequent to December 31, 2021 but were not recognized in the consolidated financial statements. The Company has determined that there were no subsequent events which required recognition, adjustment to or disclosure in the consolidated financial statements, except the events described below.
On February 15, 2022, the Company entered into a Securities Purchase Agreement with institutional investors named therein, pursuant to which the Company issued, in a registered direct offering, an aggregate of $5,000,000 of Preferred Stock (split evenly among the Series F Convertible Preferred Stock, par value $0.0001 per share (“Series F”), and Series G Convertible Preferred Stock, par value $0.0001 per share (“Series G,” and together with the Series F, the “Preferred Stock”)). The shares of Preferred Stock have a stated value of $1,000 per share and are convertible, following the date of the issuance thereof, into an aggregate of 12,500,000 shares of common stock of the Company upon the conversion of Series F and into an aggregate of 12,500,000 shares of common stock of the Company upon the conversion of Series G, at a conversion price of $0.20 per share each.
On April 1, 2022, the Company’s stockholders voted on and approved an amendment to the Company’s Articles of Incorporation, as amended, to effect a reverse stock split of the Company’s outstanding shares of common stock, par value $0.0001 per share, by a ratio between 1-for-100 and 1-for-200, at any time prior to December 31, 2022, the implementation and timing of which shall be subject to the discretion of the Company’s Board of Directors.