The following discussion of the financial condition and results of operations of
Charlie's Holdings, Inc. should be read in conjunction with the financial
statements and the notes to those statements appearing elsewhere in this
Quarterly Report on Form 10-Q (this "Report") and without audited financial
statements and other information presented in our Annual Report on Form 10-K for
the year ended December 31, 2021 (the "2021 Annual Report"). Some of the
information contained in this discussion and analysis or set forth elsewhere in
this Report, including information with respect to our plans and strategy for
our business, includes forward-looking statements that involve risks and
uncertainties. Such forward-looking statements are subject to a number of risks,
uncertainties, assumptions and other factors that could cause actual results and
the timing of certain events to differ materially from future results expressed
or implied by the forward-looking statements. Factors that could cause or
contribute to these differences include, but are not limited to, those discussed
below and elsewhere in this Report, and in our other filings with the Securities
and Exchange Commission ("SEC"), including particularly matters set forth under
Part I, Item 1A (Risk Factors) of the 2021 Annual Report. Furthermore, such
forward-looking statements speak only as of the date of this Report. Except as
required by law, we undertake no obligation to update any forward-looking
statements to reflect events or circumstances after the date of such statements.



As used in this Report, unless otherwise stated or the context otherwise
requires, references to the "Company", "we", "us", "our", or similar references
mean Charlie's Holdings, Inc. (formerly True Drinks Holdings, Inc.), its
subsidiaries and consolidated variable interest entity on a consolidated basis.
References to "Charlie's" and "CCD" refer to Charlie's Chalk Dust, LLC, a
California limited liability company and wholly-owned subsidiary of the Company,
and "Don Polly" refers to Don Polly, LLC, a Nevada limited liability company
that is owned by entities controlled by Brandon and Ryan Stump, the Company's
former Chief Executive Officer and current Chief Operating Officer,
respectively, and a consolidated variable interest ("VIE") for which the Company
is the primary beneficiary.



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 by the Company's
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"). In
the future we intend to continue developing and launching additional products
containing other compounds derived from hemp.



Operational Plan

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





First, we plan to increase the sales of our hemp-derived products, primarily
including ingestibles and disposable vapor devices. We believe there is a
significant growth potential in the hemp-derived products space, and we have
shifted our focus in this business to the market for products containing
compounds that are synthetically derived from hemp, including
Delta-8-Tetrahydrocannabinol ("Delta-8-THC") and other synthetic
tetrahydrocannabinol ("Synthetic THC") compounds. Also referred to as
"alternative cannabis products," hemp-derived products mitigate the current PMTA
regulatory risk that is related to the Company's nicotine products. Because our
alternative cannabis products contain only cannabinoids that are derived from
the hemp plant, they are not subject to the Controlled Substances Act and are
legal throughout most of the United States.  Further, alternative cannabis
products are not currently subject to FDA review. Accordingly, the category
represents a unique opportunity for our Company to (i) market to adult
consumers, and (ii) sell directly to adult consumers.  For these reasons, the
Company's alternative cannabis products enable us to pursue what we believe is a
significant commercial opportunity in a category that has grown rapidly in
recent years.



Second, we continue to see a significant opportunity for sales growth in
international markets for our e-liquid and other vapor products. Presently,
approximately 15% of our vapor product sales come from international markets. We
are well positioned to increase sales in countries where we already have a
presence and, leveraging our existing distribution platform, we intend to
exploit new overseas markets. Specifically, the Company intends to launch
proprietary new disposables, along with e-liquids, both of which have been
specially formulated for the European and Middle East markets. In partnership
with our international distributors, Charlie's will sell the Company's products
in target markets where more than 20% of the population consumes nicotine in
some format.



Finally, we believe 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 Disposable product line (formerly Pachamama
Disposables), which we expect will provide access to additional sales channels
and broaden our customer base. Ever-changing nicotine vapor products continue to
represent one of Charlie's principal product categories. We are continuing with
our plan to seek and obtain marketing authorization for certain of our
nicotine-based vapor products through the submission of our September 2020
Premarket Tobacco Applications ("PMTAs"). We have allocated further resources
and new personnel to support our research and development initiatives in order
to submit additional PMTAs, including our May 13, 2022 submissions pertaining to
the Company's synthetically derived nicotine Pacha product line. Obtaining a
marketing order from the United States Food and Drug Administration ("FDA")
would, we believe, advance the Company's position as a trusted, industry leader
committed to full regulatory compliance. We believe 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, Charlie's will benefit significantly by emerging as one of a select group
of companies able to continue operating in the nicotine vapor products space.



In order to facilitate the Company's primary objectives of increasing sales and
profits across all our product lines - in addition to our ambition of meeting
the listing criteria necessary to up-list Charlie's Holdings, Inc. shares to a
major national exchange - management is expanding and refining the Company's
sales team to prioritize: (i) alternative cannabis products (over nicotine
products), (ii) direct-to-retail sales (as opposed to purely distributor sales),
and (iii) the independent convenience store channel.  In these pursuits, we plan
to increase the number of Company Account Executives and Brand Advocates; ensure
that no Account Executive manages a book of business that represents greater
than 25% of the Company's domestic sales; and focus the sales team on
direct-to-retail sales.





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Recent Developments



April 2022 Note Financing



On April 6, 2022, the Company issued a secured promissory note (the "Note") to
one of its largest individual stockholders, Michael King (the "Lender") in the
principal amount of $1,000,000, which Note is secured by certain assets of the
Company pursuant to the terms of a Security Agreement entered into by and
between the Company and the Lender (the "Note Financing"). On September 28,
2022, the Company and the Lender entered into a modification to the Note to
extend the maturity date to March 28, 2023 and the Company paid all accrued
interest under the Note through such date.



The Note requires the payment of principal and guaranteed interest in the amount
of at least $90,000 on or before the earlier date of (i) a Liquidity Event, as
defined under the terms of the Note; or (ii) March 28, 2023. The Company used
the proceeds from the Note Financing for general corporate purposes, and its
working capital requirements, pending the availability of alternative debt
financing.

August 2022 Note Financing - Related Party





On August 17, 2022, the Company and its Chief Operating Officer and Director,
Ryan Stump (the "Stump Lender") entered into a loan agreement (the "Loan") in
the principal amount of $300,000. The Loan will be due in full in 120 days or
sooner if, before the end of term, the Company secures (i) new debt financing or
(ii) sufficient PMTA strategic partnership funds. The Loan bears an annual
interest rate of 10%. The Company also incurred additional $3,000 issuance cost
resulting from the payment of the Stump Lender's legal fees.



PMTA



During the quarter ended September 30, 2020, the FDA's Center for Tobacco
Products informed us that our PMTA received a valid submission tracking number,
passed the FDA's filing review phase, and recently entered the substantive
review phase. To date, the Company has invested more than $5.1 million for our
PMTA submissions. 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
("MDOs") 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.



On March 15, 2022, a new rider to the Federal Food, Drug and Cosmetic Act was
passed granting the FDA authority over synthetic nicotine.  These regulations
make synthetic nicotine products subject to the same FDA rules as
tobacco-derived nicotine products.  As such, the Company was required to file a
PMTA for its existing synthetic nicotine products marketed under the Pacha
brands by May 14, 2022 or be subject to FDA enforcement.  The Company filed new
PMTAs for its synthetic Pacha products, on May 13, 2022, prior to the May 14,
2022, deadline. On November 3, 2022, FDA accepted for scientific review certain
of our PMTAs for synthetic nicotine products and, on November 4, 2022, FDA
refused to accept certain other PMTAs for these products, rendering the latter
products subject to FDA enforcement.  The Company intends to pursue an
administrative appeal with FDA regarding its refusal to accept certain of the
PMTAs we submitted for our synthetic nicotine products, and in parallel we
intend to resubmit PMTAs for, and to continue to sell, the affected products
while the administrative appeal process is pending.



As of September 30, 2022, Charlie's 2020 PMTA remains among the select minority
of applications submitted to the FDA for a tobacco-derived nicotine ENDS product
that has not received an MDO or Refuse-to-File designation. This fact highlights
our progress toward achieving full regulatory compliance and demonstrates the
emphasis our Company places on providing customers with a trusted product
portfolio.



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 nine months
ended September 30, 2022, 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 Huntington
Beach, CA warehouse location has 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.



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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 addition, in June 2022, the FDA announced a plan to reduce nicotine
levels in cigarettes to minimally or non-addictive levels. 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 authorized by FDA, 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
for tobacco-derived nicotine products. 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. Further, the Company filed new PMTAs, for its
synthetic Pacha products, on May 13, 2022. On November 3, 2022, FDA accepted for
scientific review certain of these PMTAs and, on November 4, 2022, FDA refused
to accept others.  The Company intends to pursue an administrative appeal with
FDA regarding its refusal to accept certain of the PMTAs, and in parallel we
intend to resubmit PMTAs for, and to continue to sell, the affected synthetic
nicotine products while the administrative appeal process is pending.



There can be no guarantee that FDA will grant our administrative appeal, and the
FDA may bring an enforcement action against our synthetic nicotine products for
lack of premarket authorization and/or issue an MDO to our pending applications
at any time.  Further, it is not a certainty that the Company will ultimately
receive marketing orders for one or more of its products on any of its PMTAs.
The Company may require additional financing in the future to support potential
PMTA related expenses and general working capital. There is no assurance that
regulatory authorization 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.

In addition, the impact from COVID-19 has affected our supply chain, and if disruptions from the COVID-19 outbreak persist and are prolonged, it will continue to have an adverse impact on our business.

Results of Operations for the Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 2021





Regarding results from operations for the quarter ended September 30, 2022, we
generated revenue of approximately $6.4 million, as compared to revenue of $5.2
million for the three months ended September 30, 2021. This $1.2 million
increase in revenue was due primarily to a $1.2 million increase in sales of our
nicotine-based vapor products.





We generated net income for the three months ended September 30, 2022, of
approximately $241,000 as compared to net income of approximately $3,107,000 for
the three months ended September 30, 2021. The net income for the three months
ended September 30, 2022 includes a non-cash gain in fair value of derivative
liabilities of $246,000 compared to a non-cash gain in fair value of derivative
liabilities of $2,729,000 during the three months ended September 30, 2021. The
net income for the three months ended September 30, 2021 also includes non-cash
stock-based compensation expense of approximately $39,000.



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A review of the three-month period ended September 30, 2022, follows:







                                              For the three months ended
                                                     September 30,                         Change
                                               2022                2021           Amount        Percentage

($ in thousands)
Revenues:
Product revenue, net                       $       6,427       $       5,219     $   1,208             23.1 %
Total revenues                                     6,427               5,219         1,208             23.1 %
Operating costs and expenses:
Cost of goods sold - product revenue               3,671               2,310         1,361             58.9 %
General and administrative                         2,066               2,084           (18 )           -0.9 %
Sales and marketing                                  635                 442           193             43.7 %
Research and development                               9                   5             4             80.0 %
Total operating costs and expenses                 6,381               4,841         1,540             31.8 %
Income (loss) from operations                         46                 378          (332 )          -87.8 %
Other income (expense):
Interest expense                                      (7 )                (2 )          (5 )          250.0 %
Change in fair value of derivative
liabilities                                          246               2,729        (2,483 )          -91.0 %
Other income                                           1                   2            (1 )          -50.0 %
Total other income                                   240               2,729        (2,489 )          -91.2 %
Income before income taxes                           286               3,107        (2,821 )          -90.8 %
Provision for income taxes                            45                   -            45              100 %
Net income                                 $         241       $       3,107     $  (2,866 )          -92.2 %




Revenue



Revenue for the three months ended September 30, 2022, increased by
approximately $1,208,000 or 23.1%, to approximately $6,427,000, as compared to
approximately $5,219,000 for same period in 2021 due to a $1,209,000 increase in
sales of our nicotine-based vapor products, but was offset by a $1,000 decrease
in sales of hemp-derived products. The increase in our nicotine-based vapor
product sales was driven by sales of our new 12ml Pacha Disposable line and our
refreshed Pacha e-liquid line, both of which launched in the second quarter of
2022, as well as incremental market penetration of our existing Pacha Disposable
products. Pacha Disposables became Charlie's first-ever entrant into the rapidly
expanding, disposable e-cigarette market and offer adult users a variety of
premium flavors containing synthetic nicotine (not derived from tobacco) in a
compact, discrete format. However, increased competition from low-priced Chinese
products and brands, regulatory challenges including the recently announced
requirement for synthetic nicotine products to obtain marketing authorization
from the FDA, as well as continued uncertainty surrounding the FDA's issuance of
MDO's and Refuse-to-File designations, tempered buying patterns in the domestic
market as customers scrutinized inventories of related products. The slight
decrease in sales for our hemp-derived business was directly related to an
intentional sunsetting of certain SKUs as the Company prepares to rebrand and
launch new, innovative product formats in the fourth quarter. The hemp-derived
products market is currently experiencing a condensed and rapidly evolving
product development cycle which requires corporate agility and swift market
penetration; however, we continue to believe that this category offers
significant short- and medium-term growth potential for our Company and will
place enhanced focus on growing this segment as a portion of overall sales.



Cost of Revenue



Cost of revenue, which consists of direct costs of materials, direct labor,
third party subcontractor services, and other overhead costs increased by
approximately $1,361,000 or 58.9%, to approximately $3,671,000 or 57.1% of
revenue, for the three months ended September 30, 2022, as compared to
approximately $2,310,000, or 44.3% of revenue, for the same period in 2021. This
cost, as a percent of revenue, increased due to a higher sales mix consisting of
our Pacha Disposable product line, which carries a lower margin per unit
relative to our other products. Pricing pressure in certain channels due to
enhanced competition has also contributed to higher cost of goods relative to
sales.

General and Administrative Expenses





For the three months ended September 30, 2022, total general and administrative
expense decreased by approximately $18,000 to $2,065,000 as compared to
approximately $2,084,000 for the same period in 2021. This change was primarily
comprised of decreases of approximately $40,000 in our bad debt provision,
$37,000 in rent and maintenance costs and $24,000 in other general and
administrative expenses. The decrease in bad debt expense was primarily due to
an improved workflow for managing and collecting on aged receivables resulting
in fewer delinquent invoices. The decrease in rent and maintenance costs during
the quarter ended September 30, 2022 was primarily due to the centralizing of
certain administrative and shipping functions related to Don Polly, which
resulted from the permanent closure of our Denver, Colorado office and warehouse
location. The decrease in other general and administrative costs was due to a
reduction in certain state filing fees and property taxes. This decrease in
overall general and administrative expenses was offset by increases of $36,000
in payroll and benefits, $28,000 in professional fees, and $19,000 of other
general and administrative expenses. The increase in payroll and benefits was
the result of employees added to our supply chain and procurement team during
the quarter ended September 30, 2022. The increased professional fees were
directly related to tax analysis and tax return preparation as well as the
addition of Dr. Edward Carmines to the Board of Directors on March 2, 2022. The
increase in other general and administrative costs was primarily comprised of
higher merchant processing fees associated with higher sales during the quarter
ended September 30, 2022.



Sales and Marketing Expense



For the three months ended September 30, 2022, total sales and marketing expense
increased by approximately $193,000, 43.7%, to approximately $635,000 as
compared to approximately $442,000 for the same period in 2021, which was
primarily due to enhanced trade-show activity during the quarter in furtherance
of our plan to grow market share across the nicotine and hemp-derived product
categories. Sales commissions increased due to revenue growth across our
businesses, however the increase was mitigated by further restructuring of our
sales team and compensation program at the beginning of 2022.

Research and Development Expense





For the three months ended September 30, 2022, total research and development
costs increased to approximately $9,000 as compared to approximately $5,000 for
the same period in 2021, which was primarily due to costs associated with our
2022 PMTA submissions.



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Income from Operations



We had operating income of approximately $46,000 for the three months ended
September 30, 2022, compared with $378,000 for the three months ended September
30, 2021, due primarily to an increase in sales and marketing expenses and lower
margin sales mix. We also incurred certain non-cash, general and administrative
expenses during the period including a $31,000 expense related to stock-based
compensation. Net loss is determined by adjusting loss from operations by the
following items:

? Change in Fair Value of Derivative Liabilities. For the three months ended

September 30, 2022, the gain in fair value of derivative liabilities was

$246,000, compared to a gain in fair value of derivative liabilities of

$2,084,000 for the three months ended September 30, 2021. The derivative

liability is associated with the issuance of the Investor Warrants and the

Placement Agent Warrants (as defined in Note 3 of this Report) in connection

with the Share Exchange. The gain for the quarter ended September 30, 2022,

reflects the effect of the decrease in stock price as of September 30, 2022,

compared to June 30, 2022. Due to the limited supply of shares currently

freely trading, our stock price may experience volatility and therefore,

considerable fluctuations in the value of our warrant derivative liability

in the future. We had 40,337,693 warrants outstanding as of September 30,


    2022.

? Interest Expense. For the three months ended September 30, 2022, and 2021,

we recorded interest expense related to notes payable of $7,000 and $2,000,

respectively.

? Other Income. For the three months ended September 30, 2022, and 2021, we


    recorded other income of $1,000 and $2,000, respectively.




Income Tax Provision

For the three months ended September 30, 2022, we recorded a $45,000 provision for income taxes, or 15.7% of income before income taxes. No provision for income taxes was recognized for the three months ended September 30, 2021.





Net Income

For the three months ended September 30, 2022, we had net income of $241,000 as compared to a net income of $3,107,000 for the same period in 2021, which decrease was primarily the result of the change in fair value of derivative liabilities.

Results of Operations for the Nine Months Ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021

A review of the nine-month period ended September 30, 2022, follows:





                                               For the nine months ended
                                                     September 30,                         Change
                                               2022                2021           Amount        Percentage

($ in thousands)
Revenues:
Product revenue, net                       $      21,898       $      15,013     $   6,885             45.9 %
Total revenues                                    21,898              15,013         6,885             45.9 %
Operating costs and expenses:
Cost of goods sold - product revenue              12,663               7,047         5,616             79.7 %
General and administrative                         6,482               6,759          (277 )           -4.1 %
Sales and marketing                                2,125               1,212           913             75.3 %
Research and development                             764                  14           750           5357.1 %
Total operating costs and expenses                22,034              15,032         7,002             46.6 %
Loss from operations                                (136 )               (19 )        (117 )          615.8 %
Other income (expense):
Interest expense                                     (99 )               (33 )         (66 )          200.0 %
Change in fair value of derivative
liabilities                                          598               1,901        (1,303 )          -68.5 %
Gain on debt extinguishment                            -                 875          (875 )         -100.0 %
Loss on disposal of fixed assets                     (13 )                 -           (13 )          100.0 %
Other income                                           6                  10            (4 )          -40.0 %
Total other income                                   492               2,753        (2,261 )          -82.1 %
Income before income taxes                           356               2,734        (2,378 )          -87.0 %
Provision for income taxes                            45                  

-            45              100 %
Net income                                 $         311       $       2,734     $  (2,423 )          -88.6 %






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Revenue



Revenue for the nine months ended September 30, 2022 increased approximately
$6,885,000 or 45.9%, to approximately $21,898,000, as compared to approximately
$15,013,000 for same period in 2021 due to a $5,993,000 increase in sales of our
nicotine-based vapor products, as well as a $892,000 increase in sales of our
hemp-derived products. The increase in our nicotine-based vapor product sales
was driven by sales of our new 8ml Pacha Disposable line, which launched in
December 2021, as well as our 12ml Pacha Disposable and refreshed Pacha e-liquid
lines, which launched in the second quarter of 2022. Pacha Disposables became
Charlie's first-ever entrant into the rapidly expanding, disposable e-cigarette
market and offer adult users a variety of premium flavors containing synthetic
nicotine (not derived from tobacco) in a compact, discrete format. However,
competition from low-priced Chinese products and brands, regulatory challenges
including the recently announced requirement for synthetic nicotine products to
obtain marketing authorization from the FDA, as well as continued uncertainty
surrounding the FDA's issuance of MDO's and Refuse-to-File designations,
tempered buying patterns in the domestic market as customers scrutinized
inventories of related products. The increase in sales for our hemp-derived
business was directly related to strong performance in our alternative cannabis
category, which includes products containing synthetically derived cannabinoids,
including Delta-8-THC and other synthetic THC compounds. The hemp-derived
products market is currently experiencing a condensed and rapidly evolving
product development cycle which requires corporate agility and swift market
penetration; however, we continue to believe that this category offers
significant short- and medium-term growth potential for our Company and will
place enhanced focus on growing this segment as a portion of overall sales.



Cost of Revenue



Cost of revenue, which consists of direct costs of materials, direct labor,
third party subcontractor services, and other overhead costs increased
approximately $5,616,000, or 79.7%, to approximately $12,663,000, or 57.8% of
revenue, for the nine months ended September 30, 2022, as compared to
approximately $7,047,000, or 46.9% of revenue, for the same period in 2021. This
cost, as a percent of revenue, increased due to a higher sales mix consisting of
our Pacha Disposable product line, which carries a lower margin per unit
relative to our other products. Pricing pressure in certain channels, due to
enhanced competition, has contributed to higher cost of goods relative to sales.

General and Administrative Expenses





For the nine months ended September 30, 2022, total general and administrative
expense decreased approximately $277,000, or 4.1%, to $6,482,000 as compared to
approximately $6,759,000 for the same period in 2021. Notably, this decrease is
comprised of reductions of approximately $476,000 of non-cash, stock-based
compensation, $225,000 of payroll and benefits costs, and $41,000 in rent and
maintenance costs. The decrease in non-cash stock-based compensation is
primarily related to the conclusion of the vesting period for shares of Common
Stock awarded to several employees in conjunction with the Share Exchange
completed in April 2019 (See Note 3). The decrease in payroll and benefits
expense during the nine months ended September 30, 2022, was primarily due to
Employee Retention Credits received in conjunction with the Infrastructure
Investment and Jobs Act which was enacted in November 2021. The decrease in rent
and maintenance costs during the nine months ended September 30, 2022 was
primarily due to the centralizing of certain administrative and shipping
functions related to Don Polly, which resulted from the permanent closure of our
Denver, Colorado office and warehouse location. The decreases were primarily
offset by increases of $126,000 in provision for bad debt, $100,000 in merchant
processing fees as well as $239,000 of other general and administrative
expenses. The increases in provision for bad debt and merchant processing fees
were directly related to higher sales achieved during the nine-month period
ended September 30, 2022. The increase in other general and administrative
expenses was primarily comprised of other consulting services related to an
internal project 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 higher than anticipated costs related to our
annual audit and costs related to the calculation of our 2021 income taxes.



Sales and Marketing Expense



For the nine months ended September 30, 2022, total sales and marketing expense
increased approximately $913,000, or 75.3%, to approximately $2,125,000 as
compared to approximately $1,212,000 for the same period in 2021, which was
primarily due to enhanced trade-show activity during the quarter in furtherance
of our plan to grow market share across the nicotine and hemp-derived product
categories. Sales commissions also increased due to revenue growth across our
businesses, however the increase was mitigated by further restructuring of our
sales team and compensation program at the beginning of 2022.

Research and Development Expense





For the nine months ended September 30, 2022, total research and development
expense increased approximately $750,000 to approximately $764,000 as compared
to $14,000 for the same period in 2021, which was primarily due to costs
associated with our 2022 PMTA submissions.



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Loss from Operations



We had operating losses of approximately $136,000 for the nine months ended
September 30, 2022, compared with operating losses of $19,000 for the nine
months ended September 30, 2022, due primarily to an increase of $750,000 in
research and development expense. We also incurred certain general and
administrative expenses that contributed to the loss from operations including a
$87,000 expense related to non-cash, stock-based compensation. Net income is
determined by adjusting loss from operations by the following items:



  ? Change in Fair Value of Derivative
    Liabilities. For the nine months ended
    September 30, 2022, the gain in fair
    value of derivative liabilities was
    $598,000 as compared to $1,901,000 during
    the nine months ended September 30, 2021.
    The derivative liability is associated
    with the issuance of the Investor
    Warrants and the Placement Agent Warrants
    (as defined in Note 3 of this Report) in
    connection with the Share Exchange. The
    gain for both nine months ended September
    30, 2022 and 2021 reflects the effect of
    the decrease in stock price as of
    September 30, 2022, compared to December
    31, 2021, as well as a decrease in stock
    price as of September 30, 2021, compared
    to December 31, 2020. Due to the limited
    supply of shares currently freely
    trading, our stock price may experience
    volatility and therefore, considerable
    fluctuations in the value of our warrant
    derivative liability in the future. We
    had 40,337,693 warrants outstanding as of
    September 30, 2022.




  ? Interest Expense. For the nine months
    ended September 30, 2022, and 2021, we
    recorded interest expense related to
    notes payable of $99,000 and $33,000,
    respectively. We entered into additional
    debt financing arrangements during the
    nine months ended September 30, 2022.




  ? Gain on debt extinguishment. For the nine
    months ended September 30, 2021, we
    recorded a debt extinguishment gain of
    $875,000 related to the forgiveness of
    the Don Polly PPP Loan and the Charlie's
    PPP Loan.




  ? Loss on disposal of fixed assets. For the
    nine months ended September 30, 2022, and
    2021, we recorded a loss on disposal of
    fixed assets of $13,000 and $0,
    respectively.




  ? Other Income. For the nine months ended
    September 30, 2022 and 2021, we recorded
    other income of $6,000 and $10,000,
    respectively.




Income Tax Provision

For the nine months ended September 30, 2022, we recorded a $45,000 provision for income taxes, or 12.6% of income before income taxes. No provision for income taxes was recognized for the nine months ended September 30, 2021.





Net Income

For the nine months ended September 30, 2022, we had a net income of $311,000 as compared to a net income of $2,734,000 for the same period in 2021, which decrease was primarily the result of the change in fair value of derivative liabilities.

Liquidity and Capital Resources





As of September 30, 2022, we had working capital of approximately $2,879,000,
which consisted of current assets of approximately $8,145,000 and current
liabilities of approximately $5,266,000, as compared to working capital of
approximately $2,460,000 at December 31, 2021. The current liabilities include
approximately $3,061,000 of accounts payable and accrued expenses, notes payable
of $1,298,000, approximately $245,000 of deferred revenue associated with
product shipped but not yet received by customers, approximately $361,000 of
lease liabilities, and $301,000 of derivative liability associated with the
Investor Warrants and Placement Agent Warrants (the derivative liability of
$301,000 is included in determining the working capital of $2,879,000 but is not
expected to use any cash to ultimately satisfy the liability).



On April 6, 2022, the Company issued a secured promissory note (the "Note") to
one of its largest individual stockholders, Michael King (the "Lender") in the
principal amount of $1,000,000, which Note is secured by certain assets of the
Company pursuant to the terms of a Security Agreement entered into by and
between the Company and the Lender (the "Note Financing"). On September 28,
2022, the Company and the Lender entered into a modification to the Note to
extend the maturity date to March 28, 2023 and the Company paid all accrued
interest under the Note through such date. The Note requires the payment of
principal and guaranteed interest in the amount of at least $90,000 on or before
the earlier date of (i) a Liquidity Event, as defined under the terms of the
Note; or (ii) March 28, 2023. The Company used the proceeds from the Note
Financing for general corporate purposes, and its working capital requirements,
pending the availability of alternative debt financing.



On August 17, 2022, the Company and its Chief Operating Officer and Director,
Ryan Stump (the "Stump Lender") entered into a loan agreement (the "Loan") in
the principal amount of $300,000. The Loan will be due in full in 120 days or
sooner if, before the end of term, the Company secures (i) new debt financing or
(ii) sufficient PMTA strategic partnership funds. The Loan bears an annual
interest rate of 10%. The Company also incurred additional $3,000 issuance cost
resulting from the payment of the Stump Lender's legal fees.



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Our cash and cash equivalents balance at September 30, 2022 was approximately $466,000.





For the nine months ended September 30, 2022, net cash used in operating
activities was approximately $1,522,000, resulting from a net income of
$311,000, offset by a $598,000 of change in fair value of derivative liabilities
and $2,108,000 of changes in our operating assets and liabilities. For the nine
months ended September 30, 2021, net cash used in operating activities was
approximately $980,000, resulting from a net income of $2,734,000, offset by a
$1,901,000 of change in fair value of derivative liabilities, $563,000 of
share-based compensation, and $2,080,000 changes in our operating assets and
liabilities.



For the nine months ended September 30, 2022, we used cash for investment
activities of approximately $178,000 as compared to $73,000 for the same period
in 2021. The cash used for investment activities is primarily for the on-going
development and configuration of enterprise resource planning software as well
as the disposal of fixed assets related to the permanent closure of our Denver,
Colorado location.



For the nine months ended September 30, 2022 we generated approximately
$1,300,000 cash from financing activities related to the issuance of a
promissory note to a large shareholder and a short-term loan from our chief
operating officer and director, Ryan Stump, each as discussed above. For the
nine months ended September 30, 2021 we generated approximately $901,000 cash
from financing activities from the Private Placement (as defined in Note 10 of
Item 1, Part 1 of this Report) offset by the repayment of the Red Beard Note (as
defined in Note 8 of Item 1, Part 1 of this Report). We also paid cash dividends
of $880,000 during the nine months ended September 30, 2021.

Going Concern Uncertainty Regarding the Legal and Regulatory Environment, Liquidity and Management's Plan of Operation





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 outbreak of COVID-19 has had a negative impact on the Company's supply chain
and sales. For the nine months ended September 30, 2022, the Company generated
loss from operations of approximately $136,000, and a consolidated net income of
approximately $311,000 but used cash in operations of approximately $1,522,000.
The Company had stockholders' equity of $3.5 million at September 30, 2022.
During the three months ended September 30, 2022, the Company's working capital
requirements continued to evolve as current assets decreased to $8.1 million
from $8.8 million as of June 30, 2022 and currently liabilities decreased to
$5.3 million from $6.0 million as of June 30, 2022. Considering these facts, the
issuance of one or several MDOs 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.



Our plans and growth depend on our ability to increase revenues, raise
additional capital, and continue our business development efforts, including the
expenditure of approximately $5,100,000 to date, to support our PMTA process for
the Company's submissions to the FDA. On March 15, 2022, a new rider to the
Federal Food, Drug and Cosmetic Act was passed granting the FDA authority over
synthetic nicotine.  These regulations make the Company's synthetic nicotine
products subject to the same FDA rules as tobacco-derived nicotine products.  As
such, the Company was required to file a PMTA for its existing synthetic
nicotine products marketed under the Pacha brands by May 14, 2022 or be subject
to FDA enforcement.  The Company filed new PMTAs, for its synthetic Pacha
products on May 13, 2022, prior to the May 14, 2022 deadline. On November 3,
2022, FDA accepted for scientific review certain of these PMTAs and, on November
4, 2022, FDA refused to accept others.  The Company intends to pursue an
administrative appeal with FDA regarding its refusal to accept certain of the
PMTAs, and in parallel we intend to resubmit PMTAs for, and to continue to sell,
the affected synthetic nicotine products while the administrative appeal process
is pending. In the fourth quarter of 2022 and during 2023, the Company intends
to allocate further resources and new personnel to support research and
development initiatives in order to support existing, or subsequent PMTAs. The
Company may require additional financing in the future to support subsequent
PMTA filings, and/or in the event the FDA requests additional testing for one,
or several, of the Company's prior PMTA submissions. There can be no assurance
that additional financing will be available on acceptable terms, or at all, and
there can be no assurance that any such arrangement, if required or otherwise
sought, would be available on terms deemed to be commercially acceptable and, in
the Company's best interests. The financial statements do not include any
adjustments to the carrying amount and classification of recorded assets and
liabilities should the Company be unable to continue operations.

Off-Balance Sheet Arrangements

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





Critical Accounting Policies



The condensed consolidated financial statements are prepared in conformity with
U.S. GAAP, which require the use of estimates, judgments and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent liabilities at the date of the financial statements, and the reported
amounts of expense in the periods presented. We believe that the accounting
estimates employed are appropriate and resulting balances are reasonable;
however, due to inherent uncertainties in making estimates, actual results could
differ from the original estimates, requiring adjustments to these balances in
future periods. The critical accounting estimates that affect the consolidated
financial statements and the judgments and assumptions used are consistent with
those described under Part II, Item 7 of our Annual Report on the 2021 Annual
Report.



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