F-5

F-6

F-7

Revenue Recognition

The Company adopted ASC 606, Revenue from Contracts with Customers (Topic 606) (“ASC 606”), in the second quarter of fiscal year 2020, as this was the first quarter that the Company generated revenues. Under ASC 606, the Company recognizes revenue when a customer obtains control of promised goods, in an amount that reflects the consideration that the Company expects to receive in exchange for the goods. To determine revenue recognition for arrangements within the scope of ASC 606, the Company performs the following five steps: (1) identify the contracts 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 the entity satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods it transfers to the customer. Under ASC 606, disaggregated revenue from contracts with customers depicts the nature, amount, timing, and uncertainty of revenue and cash flows affected by economic factors. The Company has evaluated revenues recognized and substantially all of our revenues were derived from sales of flavored BIDI® Sticks, including the Arctic (menthol) BIDI® Stick, sales of which constituted approximately 12.5% and 19.9% of our total sales of BIDI® Sticks for the fiscal quarters ended January 31, 2022 and 2021, respectively. On October 31, 2021, the Company and one of its customers, Favs Business, entered into a Consignment Agreement. As of October 31, 2021, the value of the Products stored at Favs Business under the Consignment Agreement was approximately $2,556,930. At January 31, 2022, the value of the Products stored at Favs Business under the Consignment Agreement was approximately $1,433,730.

Deferred Revenue

The Company accepts partial payments for orders from wholesale customers, which it holds as deposits or deferred revenue, until the Company has received full payment and orders are shipped to the customer. Revenue for these orders is recognized at time of shipment to the customer. As of January 31, 2022 and October 31, 2021, the Company had not received any deposits from customers, respectively, which would be included with the Company’s current liabilities, if they existed.

Customer Refunds

The Company infrequently has a need to adjust the size of an order after it has been shipped, received and paid for, due to the customer oversizing the order for more product that it can realistically sell at that time. If and when this occurs, the Company will ask the customer to return the over allotted Products. Once received and inspected, the Company will issue a refund for the Product return. As of January 31, 2022 and October 31, 2021, the Company had customer refunds due in the amounts equal to approximately $147,690 and $316,800, respectively, which was the result of one of the Company’s sub-distributor customers returning Product that had become defective in storage. The approximately $147,690 due at January 31, 2022 represents the amount of the refund the Company will make to this customer.

Products Revenue

The Company generates revenue from the sale of the Products (as defined above) to non-retail customers. The Company recognizes revenue at a point in time based on management’s evaluation of when performance obligations under the terms of a contract with the customer are satisfied and control of the Products has been transferred to the customer. In most situations, transfer of control is considered complete when the Products have been shipped to the customer. The Company determines that a customer obtains control of the Product upon shipment when title of such product and risk of loss transfer to the customer. The Company’s shipping and handling costs are fulfillment costs and such amounts are classified as part of cost of sales. The Company’s sales arrangements for retail sales usually require full prepayment before delivery of the Products. The advance payment is not considered a significant financing component because the period between when the Company transfers a promised good to a customer and when the customer pays for that good is short. The Company offers credit sales arrangements to non-retail (or wholesale) customers and monitors the collectability of each credit sale routinely.

Revenue is measured by the transaction price, which is defined as the amount of consideration expected to be received in exchange for providing goods to customers. The transaction price is adjusted for estimates of known or expected variable consideration, which includes refunds and returns as well as incentive offers and promotional discounts on current orders. Estimates for sales returns are based on, among other things, an assessment of historical trends, information from customers, and anticipated returns related to current sales activity. These estimates are established in the period of sale and reduce revenue in the period of the sale. Variable consideration related to incentive offers and promotional programs are recorded as a reduction to revenue based on amounts the Company expects to collect. Estimates are regularly updated and the impact of any adjustments are recognized in the period the adjustments are identified. In many cases, key sales terms such as pricing and quantities ordered are established at the time an order is placed and incentives have very short-term durations.

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

Concentration of Revenues and Accounts Receivable

For the three months ended January 31, 2022, approximately 45%, or $1,287,180, of the revenue from the sale of Products was generated from Favs Business, approximately 12%, or $352,554, of the revenue from the sale of Products was generated from Lakshmi Distributor Inc., doing business as C Store Master (“C Store Master”), and approximately 12%, or $332,595, of the revenue from the sale of Products was generated from The H.T. Hackney Company.

Favs Business and C Store Master had outstanding balances of approximately $374,400 and $282,414, respectively, which accounted for approximately 29% and 22%, respectively, of the total accounts receivable from customers as of January 31, 2022.

For the three months ended January 31, 2021, approximately 37%, or $13,888,376, of the revenue from the sale of Products was generated from Favs Business, approximately 18%, or $6,708,752, of the revenue from the sale of Products was generated from MMS Distribution, LLC (“MMS Distro”), and approximately 13%, or $4,879,427, of the revenue from the sale of Products was generated from C Store Master.

Favs Business, with an outstanding balance of approximately $8,601,200, and GPM Investment, LLC, with an outstanding balance of approximately $1,262,985, accounted for approximately 68% and 10% of the total accounts receivable from customers, respectively, as of January 31, 2021.

Share-Based Compensation

The Company measures the cost of services received in exchange for an award of equity instruments (share-based payments, or SBP) based on the grant-date fair value of the award. That cost is recognized over the period during which a recipient is required to provide service in exchange for the SBP award—the requisite service period (vesting period). For SBP awards subject to conditions, compensation is not recognized until the performance condition is probable of occurrence. The grant-date fair value of share options is estimated using the Black-Scholes-Merton option-pricing model. Compensation expense for SBP awards granted to nonemployees is remeasured each period as the underlying options vest.

The fair value of each option granted during the fiscal three month period ended January 31, 2022 and at October 31, 2021 was estimated on the date of grant using the Black-Scholes-Merton option-pricing model with the weighted average assumptions in the following table:

The expected term of options granted represents the period of time that options granted are expected to be outstanding. The expected volatility was based on the volatility in the trading of the Common Stock. The assumed discount rate was the default risk-free ten-year interest rate for U.S. Treasury bills. The Company stock option expense for the fiscal three months ended January 31, 2022 and for the fiscal year October 31, 2021 was approximately $309,700 and $1,773,947, respectively.

The Company’s stock-based compensation for the fiscal three months ended January 31, 2022 and fiscal year October 31, 2021 was approximately $110,250 and $9,449,421, respectively.

Income Tax

Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the recorded book basis and the tax basis of assets and liabilities for financial and income tax reporting. Deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future federal income taxes. The Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company’s financial condition, results of operations, or cash flow.

The Company has Federal net operating loss (“NOL”) carryforwards of approximately $4,000,000 and state NOL carryforwards of approximately $1,800,000. With the changes instituted by the CARES Act, the Federal NOLs have an indefinite life and will not expire. The Company’s federal and state tax returns for the 2018 and 2019 tax years generally remain subject to examination by U.S. and various state authorities. A valuation allowance is recorded to reduce the deferred tax asset if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. After evaluation of the evidence, management determined that a valuation allowance of approximately $1,256,059 for the year ended on October 31, 2021, and the fiscal three month period ended January 31, 2022, is necessary to reduce the deferred tax asset to the amount that will more likely than not be realized pursuant to ASC 740.

Fair Value of Financial Instruments

The Company’s balance sheet includes certain financial instruments. The carrying amounts of current assets and current liabilities approximate their fair value because of the relatively short period of time between the origination of these instruments and their expected realization.

ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of January 31, 2022. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These financial instruments include cash, restricted cash, accounts receivable, inventory, accounts payable and accrued expenses.

Recent Accounting Pronouncements

The Company does not believe that any recently issued effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the accompanying financial statements.

Note 3 – LeasesGoing Concern

A recent court ruling on behalf of Bidi in the U.S. Court of Appeals for the Eleventh Circuit, granted a judicial stay of the MDO previously issued by the FDA to Bidi in September 2021. The ruling, issued on February 1, 2022, means that all BIDI^® Stick flavors remain marketable by the Company in the United States, subject to the FDA’s enforcement discretion, while Bidi continues with its merits case challenging the legality of the MDO. As the FDA has indicated that it is prioritizing enforcement against companies that have not submitted PMTAs or who have MDOs in place, the Company views the risk of FDA enforcement against Bidi as low. Oral arguments in the merits case are currently scheduled in May 2022.

If the U.S. Court of Appeals for the Eleventh Circuit agrees with Bidi in the merits case, the Company anticipates that the FDA will be compelled to place the flavored ENDS back into the PMTA scientific review process. If this is the outcome of the merits case, the Company will be able to fully market and sell the Products, subject to the FDA’s enforcement discretion, until the scientific review process is complete on each of Bidi’s PMTA for flavored ENDS and the FDA issues its decision on each.

If the U.S. Court of Appeals for the Eleventh Circuit disagrees with Bidi on the merits case, or if the FDA otherwise chooses to enforce against Bidi, the Company will be forced to cease sales on the flavored ENDS in the United States market, leaving only the Tobacco and Menthol (Arctic) ENDS products for sale in the United States (pending the outcome of the specific PMTA filings and the administrative review request for the classification of “Arctic” as a standard menthol ENDS). If this is the outcome of the merits case, this combined with the negative cash flows from operations, raises substantial doubt on the Company’s ability to continue as a going concern.

Management plans to continue similar operations with increased marketing, which the Company believes will result in increased revenue and net income. However, there is no assurance that management’s plan will be successful due to the current economic climate in the United States and globally.

These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be necessary in the event that we cannot continue as a going concern.

Note 4 – Leases

The Company capitalizes all leased assets pursuant to ASU 2016-02, “Leases (Topic 842),” which requires lessees to recognize right-of-use assets and lease liability, initially measured at present value of the lease payments, on its balance sheet for leases with terms longer than 12 months and classified as either financing or operating leases. The Company excludes short-term leases having initial terms of 12 months or less from Topic 842 as an accounting policy election and recognizes rent expense on a straight-line basis over the lease term. The Company adopted the standard in the fourth quarter of fiscal year 2020. The adoption of the amended ASU 2016-02 did not have any impact on the Company’s previously reported financial statements in any prior period nor did it result in a cumulative effect adjustment to retained earnings.

Office Space

On August 1, 2020, the Company began leasing office space for its main corporate office in Grant, Florida. The five-year lease agreement is with a related party, Just Pick, LLC (“Just Pick”). The Company’s Chief Executive Officer is an officer of Just Pick. Prior to this, the Company utilized the home office space and warehouse of its management at no cost through July 31, 2020. The Company does not have financing leases and only one operating lease for office space.space, with a related party. The operating lease is for a term of5 five years, beginning August 1, 2020, with rent of $1,000$1,000 payable monthly. Certain of the Company’s leases include renewal options and have not been included in the calculation of the lease liabilities and right of use assets as the Company is not reasonably certain to exercise the option. As the operating lease does not provide for an implicit interest rate, we estimated a current borrowing rate of 4.5%4.5% in determining the present value of the lease. As of January 31, 2022 and October 31, 2021, the right-to-use (“ROU”) lease asset, net of accumulated amortization, was $66,511.approximately $51,955 and $55,604, respectively. The initial recognition of the ROU operating lease was $73,749approximately $73,749 for both the ROU asset and ROU liability. The amortization expense for ROU asset for the twelve months ended October 31, 20202021 was $3,616approximately $14,529 and one paymentno payments were made on the ROU liability was $2,836.liability. The amortization expense for the ROU asset for the three months ended January 31, 20212022 was $3,949approximately $3,649 and one paymentno payments were made on the ROU liability was $3,169.liability. At JanuaryOctober 31, 2021, short-term ROU lease liability was $12,036approximately $13,020 and long-term liability was $56,035,approximately $46,185, totaling $68,071. Operating lease expense totaling $6,000 for August 2020 until January 2021 was accrued atapproximately $59,205. At January 31, 2021.2022, short-term ROU lease liability was approximately $13,349 and long-term liability was approximately $42,686, totaling approximately $56,035.

Storage Space

On November 1, 2021, the Company entered into a month-to-month lease agreement with Ranger Enterprises, LLC, located in Seymour, Indiana, to store product inventory at this satellite location. The Company made four payments on this lease, totaling approximately $10,139, during the three months ended January 31, 2022. On November 11, 2021, the Company entered into a month-to-month lease agreement with FFE Solutions Group, located in Salt Lake City Utah, to store additional product inventory at this satellite location. The Company made one payment in the amount of approximately $10,713 on December 15, 2021 for the rent on this lease during the three months ended January 31, 2022.

Note 45 – Stockholder Equity

Additional Paid-In Capital

During the three months ended January 31, 2022, approximately $309,700 of stock option expense was recognized and contributed an addition to Additional Paid-In Capital. Also, during the three months ended January 31, 2022, on November 1, 2021, RSUs previously granted to employees vested and shares of Common Stock were issued, which contributed approximately $74,451 to Additional Paid-In Capital, resulting in a total increase in Additional Paid-In Capital during the three months ended January 31, 2022 of approximately $384,151.

Preferred Shares Issued

The authorized preferred stock of the Company consists of 5,000,000 shares with a par value of $0.001$0.001 per share, of which 3,000,000 shares were designated as Series A Convertible Preferred Stock (the “Series A Preferred Stock”). Each share of the Series A Preferred Stock arewas initially convertible into 100 shares of common stock.Common Stock; however, as a result of the Reverse Stock Split, the conversion rate was adjusted such that each share of the Series A Preferred Stock is convertible into approximately 8.33 shares of Common Stock. All 3,000,000 shares of Series A Preferred Stock were issued and outstanding as of January 31, 2021.2022.

Common Shares Issued

The Company implemented the Reverse Stock Split, effective prior to the opening of the market on Tuesday, July 20, 2021. The Reverse Stock Split was implemented by the Company in support of its application to list on the Nasdaq Capital Market (“Nasdaq”). As a result of the Reverse Stock Split at the 1-for-12 ratio, every 12 shares of the Common Stock were exchanged for one share of the Common Stock. The Company has retroactively adjusted all share amounts and per share data herein to give effect to the Reverse Stock Split.

The authorized common stockCommon Stock of the Company consists of 1,000,000,000 shares with a par value of $0.001.$0.001. There were 279,671,67730,236,696 shares of common stockCommon Stock issued and outstanding as of January 31, 2021.2022.

RestrictedWarrants Shares Issued

As part of the Company’s firm underwritten public offering during fiscal 2021, the Company issued warrants to purchase a total of 4,053,750 shares of Common Stock Unit Awards

at an exercise price of $1.90 per share. These warrants expire in the year 2026. During the year ended October 31, 2021, warrants for 879,828 shares were exercised for $1,665,113. No warrants were exercised during the three-month period ended January 31, 2022. The aggregate intrinsic value of the outstanding Common Stock warrants as of January 31, 2022 and October 31, 2021 was $0. The weighted average remaining term of the outstanding Common Stock warrants is 4.68 years as of January 31, 2022.

The following is a summary of the stock warrant plan activity during the fiscal three months ended January 31, 2022 and the year ended October 31, 2021.

Restricted Stock Unit Awards

On November 5, 2021, 535,000the Company issued 61,250 shares of common stock were issuedCommon Stock to seven7 employees ofin accordance with the Company under restricted stock unit (“RSU”)vesting schedules set forth in RSU agreements previously entered into with such employees, resulting in $76,700the recognition of approximately $110,250 of share-based compensation. Of the shares issued to employees, 211,50019,866 shares were withheld by the Company to satisfy tax withholding obligations equaland/or satisfy cash settlement options to $30,511.employees, equaling approximately $35,759. As of January 31, 2022, there remained 437,917 unvested RSUs with approximately $900,769 of related unvested compensation.

Stock Options

During fiscal year 2021, the Company granted options exercisable for up to 150,000 shares of Common Stock of which 15,000 fully vested on March 17, 2021, 7,500 fully vested on June 30, 2021, 41,667 fully vested on December 1, 2021, 68,333 vest over the next 2 years on March 17, 2022, and 2023, and 17,500 vest over the next 2 years on June 30, 2022 and 2023. The options have exercise prices ranging from $9.12 to $28.68 per share. These options have a weighted average remaining life of 9.43 years as of October 31, 2021 and of 9.08 years as of January 31, 2022. The options expire in the year 2031. On July 19, 2021, two of the stock option agreements, exercisable for an aggregate of 50,000 shares of Common Stock, were modified to accelerate the full vesting period from 3 years to 2 years. The Company granted no new options during the three months ended January 31, 2022. The aggregate intrinsic value of these outstanding options as of October 31, 2021 2,065,547 sharesand January 31, 2022 was $0.

The fair values of commonthe options on the grant dates was approximately $3,088,002 using a Black-Scholes option pricing model with the following assumptions: stock were issuedprice range of $9.12 to 6 non-employee vendors as compensation for professional services rendered to$27.36 per share (based on the Company. These shares were expensed to the Company using the closing sharequoted trading price on the share issue datesdate of grant), volatility range of 294.57% to compute301.53%, expected term of 10 years, and a risk-free interest rate range of 1.19% to 1.63%. The Company is amortizing the expense over the vesting terms of each option. The total of $1,034,596.stock option expense for the three months ended January 31, 2022 was approximately $309,700. The fiscal year 2021 total unamortized stock option expense at October 31, 2021 was approximately $1,314,056. The fiscal year 2022 unamortized stock option expense at January 31, 2022 was approximately $1,004,356.

Note 56 – Related-Party Transactions

Revenue and Accounts Receivable

During the three months ended January 31, 2022, the Company recognized revenue of approximately $23,765 from four companies owned by Nirajkumar Patel, the Chief Executive Officer of the Company, and/or his wife. As of January 31, 2022, the Company has accounts receivable from this related party in the amount of approximately $245.

During the three months ended January 31, 2021, the Company recognized revenue of $50,300approximately $50,300 from three companies owned by Nirajkumar Patel, the Chief Executive Officer and Chief Financial Officer of the Company, and/or his wife.

Concentration Purchases and Accounts Payable

During the three months ended January 31, 2022, the Company did not purchase Products from Bidi, a related party company that is also owned by Nirajkumar Patel, the Company’s Chief Executive Officer. As of January 31, 2021,2022, the Company hashad accounts receivable from this related partypayable to Bidi of approximately $9,129,759 and Products valued at approximately $11,841,750 were held in the amount of $18,575.inventory.

Purchases and Accounts Payable

During the three months ended January 31, 2021, the Company purchased Products of $32,479,100approximately $32,479,100 from Bidi, a related party company that is also owned by Nirajkumar Patel, our Chief Executive Officer and Chief Financial Officer.company. As of January 31, 2021, the Company had accounts payable to Bidi of $6,247,882.approximately $6,247,882. During the three months ended January 31, 2021, 100% of all Product purchases were made by the Company from Bidi.

Leased Office Space and Storage Space

On August 1, 2020, the Company began leasing office space for its main corporate office in Grant, Florida. The five-year lease agreement is with a related party, Just Pick, LLC (“Just Pick”).Pick. The Company’s Chief Executive Officer is an officer of Just Pick.

Prior to this, During fiscal year 2021, the Company utilizedwas not charged for the home officeleased space under the terms and warehouseconditions of its management at no cost through July 31, 2020.

Note 6 - Concentrations

Financial instruments, which potentially subjectthe lease between the Company to concentrations of credit risk, consist primarily of purchases of inventories, accounts payable, accounts receivable, and revenue.

Concentration of PurchasesJust Pick and Accounts Payable- Related Party

Forwas not charged for the separate warehouse space provided by Just Pick; thus, no payments were made on the lease. During the three months ended January 31, 2021, 100% of2022, no payments were made on the inventories of products, primarily consisting oflease because the “Bidi Stick,” were purchased from Bidi, a related party company that is also owned by Nirajkumar Patel,Company continued to not be charged under the Company’s Chief Executive Officerfive-year lease agreement for this office and Chief Financial Officer, in the amount of $32,479,100. It also accounted for 100% of the total accounts payable as of January 31, 2021.storage space.

Concentration of Revenues and Accounts Receivable

For the three months ended January 31, 2021, approximately 37% of the revenue from the sale of Products, primarily consisting of the “Bidi Stick,” was generated from Favs Business, LLC in the amount of $13,888,376, approximately 18% of the revenue from the sale of Products was generated from MMS Distro, Inc. in the amount of $6,708,752 and approximately 13% of the revenue from the sale of Products was generated from Lakshmi Distributer Inc., doing business as C Store Master (“C Store Master”), in the amount of $4,879,427.

Favs Business, LLC, with an outstanding balance of $8,601,200 and GPM Investment, LLC, with an outstanding balance of $1,262,985, accounted for approximately 68% and 10% of the total accounts receivable from customers, respectively, as of January 31, 2021.

Note 7 – Commitments and Contingencies

The Company follows ASC 450-20, Loss Contingencies, to report accounting for contingencies. Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. There were no commitments or contingencies as of January 31, 20212022 and January 31, 20202021 other than the below:

Patent Contribution Agreement

On May 4, 2021, Next Generation Labs, LLC (“Next Generation”) notified the Company that a “reversion event” had occurred under that certain Patent Contribution Agreement, dated September 28, 2020 (the “Patent Contribution Agreement”). Pursuant to the Patent Contribution Agreement, Next Generation agreed to contribute certain patents, patent applications, and patent data, described on Exhibit “A” of the Patent Contribution Agreement (the “Patents”), and to the Company and the Company would subsequently transfer the Patents to Kaival Labs.

Pursuant to the Patent Contribution Agreement, the Company agreed to pay Next Generation a purchase price of $3 million for the Patents (the “Purchase Price”), which was expected to be paid over-time upon two events. First, the Company expected to pay part of the Purchase Price from proceeds generated from a future securities offering (the “Offering Payment”). Additionally, on the first date that Kaival Labs sold a product that was developed using any portion of the Patents or based on the Patents, the Company agreed to pay Next Generation the difference between the Purchase Price and the Offering Payment.

Pursuant to the terms of the Patent Contribution Agreement, the parties agreed that the Company would file a Form 1-A offering statement no later than January 31, 2021, unless extended in writing by the Company in good faith to no later than March 15, 2021 (the “Filing Date”). The Patent Contribution Agreement further provided that in the event the Company or Kaival Labs materially breached the terms of the Patent Contribution Agreement and the material breach is not cured within fifteen (15) business days after Next Generation provides written notice of such material breach, then a reversion event would occur, and the Patents would revert from Kaival Labs to Next Generation.

The Company did not undertake a securities offering by filing a Form 1-A offering statement by the Filing Date. The Company attempted to negotiate an amendment to the Patent Contribution Agreement, which would allow the Company additional time to undertake a securities offering. However, on April 8, 2021, Next Generation notified the Company that it was in material breach of the Patent Contribution Agreement and that the Company would have fifteen (15) business days, or April 30, 2021, to cure such breach. Ultimately, the Company decided not to cure such breach within the requisite time and, on May 4, 2021, Next Generation notified the Company that a reversion event occurred.

The Company has completed the process of completing the necessary documentation to transfer the Patents from Kaival Labs to Next Generation. Neither the Company, nor Kaival Labs, has developed or otherwise relied on the Patents to date and does not expect the reversion of the Patents to materially affect the Company’s business.

Cash and Equity Bonus Awards

On May 28, 2020, the Board of Directors approved cash bonus awards to each of the Company’s Chief Executive Officer and its Chief Operating Officer. With respect to the Chief Executive Officer, the Board of Directors approved a cash bonus award equal to $30,000 for every $25 million in gross revenues generated by the Company. With respect to the Chief Operating Officer, the Board approved a cash bonus award equal to $20,000 for every $25 million in gross revenues generated by the Company. On May 28, 2020, the Board of Directors also approved an equity bonus award for each of the Chief Executive Officer and the Chief Operating Officer. With respect to the Chief Executive Officer, the Board of Directors approved an award of 90,0007,500 restricted shares of the Company’s common stockCommon Stock for every $50 million in accumulated gross revenues generated by the Company. With respect to the Chief Operating Officer, the Board approved an award of 75,0006,250 restricted shares of the Company’s common stockCommon Stock for every $50 million in accumulated gross revenues generated by the Company. The Company’s accumulated gross revenues will be evaluated on a quarterly basis, beginning with the second quarter of fiscal year 2020. At October 31, 2020, the Company determined that the fair value of the equity bonus shares, or $165,000, should be accrued as it was deemed likely that the $50 million revenue target would be met. The Company issued these shares to the Chief Executive Officer and Chief Operating Office on January 1, 2021. During the three monthsquarter ended January 31, 2021, the $75 million and $100 million accumulated revenue targets were both achieved and the Company determined that the fair market value of the 165,00013,750 shares, or $495,000,approximately $70,785, and the cash bonuses totaling $100,000 should be accrued at January 31, 2021.

During the quarter ended January 31, 2022, the $125 million accumulated revenue targets were achieved and the Company determined that cash bonuses totaling $50,000 should be accrued at January 31, 2022.

Service Agreement

On March 31, 2020, the Company entered into a service agreement (the “Service Agreement”) with QuikfillRx LLC, a Florida limited liability company (“QuikfillRx”), whereby QuikfillRx provides the Company with certain services and support relating to sales management, website development and design, graphics, content, public communication, social media, management and analytics, and market and other research (collectively, the “Services”). The Services are provided by QuikfillRx as requested from time to time by the Company.

On June 2, 2020, the Company entered into the First Amendment to the Service Agreement (the “First Amendment” and, collectively with the Service Agreement, the “Amended Service Agreement”) with QuikfillRx. Effective as of March 16, 2021, the Company entered into the Second Amendment to Service Agreement (the “Second Amendment” and, collectively with the Amended Service Agreement, the “Further Amended Service Agreement”) with QuikfillRx. Pursuant to the terms of the First Amendment,Further Amended Service Agreement, the parties modifiedagreed to the amount of General Compensation (as defined below) to be paid to QuikfillRx.following “General Compensation” consists of the following:payments: (i) for the Services provided in

March 2020, the Company paid QuikfillRx an amount equal to $86,000; (ii) for the Services provided in April 2020, the Company paid QuikfillRx an amount equal to $100,000; (iii) each calendar month commencing May 2020 through October 2020, the Company paid QuikfillRx an amount equal to $125,000 per month for the Services to be performed during such calendar month; (iv) if the parties agree to extend the term of the Amended Service Agreement beyond the original expiration date of October 31, 2020, then for the periodeach calendar month between November 1, 2020 and October 31, 2021, the Company will paypaid QuikfillRx $125,000 per month for the Services to be performed during such calendar month; and (iv) if the parties agree to extend the term of the Further Amended Service Agreement beyond October 31, 2021, then for the period between November 1, 2021 and October 31, 2022, the Company will pay QuikfillRx $150,000 per month for the Services to be performed during such calendar month.  Inmonth; and (v) if the parties agree to extend the term of the Further Amended Service Agreement beyond October 2020,31, 2022, then for the period between November 1, 2022 and October 31, 2021, the Company will pay QuikfillRx $150,000 per month for the Services to be performed during such calendar month. On November 1, 2021, the parties agreed to extend the term of the Amended Service Agreement.for an additional one-year period. In addition, the Company will pay the following quarterly bonuses:

On March 17, 2021, the Company entered into a consulting agreement with Russell Quick which granted stock options to purchase 41,667 shares of the Company’s common stock in exchange for consulting services. The shares underlying the stock option fully vested on December 1, 2021. The exercise price per share is $28.68. The Company hasrecognized approximately $190,000 in expense to account for the stock options. Russell Quick is the Chief Executive Officer of QuikfillRx. The Company accrued $437,817 approximately $34,524 for a quarterly bonus payable to QuikfillRx, based on the Applicable Gross Quarterly Sales results of the three months ended January 31, 2021.2022.

On September 28, 2020, the Company, entered into a patent contribution agreement (the “Patent Contribution Agreement”) with Kaival Labs, the Company’s wholly-owned subsidiary, and Next Generation Labs, LLC, a California limited liability company (“Next Generation”), whereby Next Generation will contribute certain patents, patent applications, and patent data (collectively, the “Patents”) to the Company.

Pursuant to the Patent Contribution Agreement, the Company has agreed to pay Next Generation a purchase price of $3 million for the Patents (the “Purchase Price”), which is expected to be paid over-time upon two events. First, the Company expects to pay part of the Purchase Price from proceeds generated from a future securities offering (the “Offering Payment”). Additionally, on the first date that Kaival Labs sells a product that was developed using any portion of the Patents or based on the Patents, the Company will pay Next Generation the difference between the Purchase Price and the Offering Payment.

Kaival Labs has also agreed to pay Next Generation a quarterly royalty equal to fifteen percent (15%) of the profits from sales of a product that was developed using any portion of the Patents or based on the Patents, on an accrued basis. Finally, the Company has agreed to pay all of the applicable costs associated with obtaining product approval(s) from the United States Food and Drug Administration. 

As of the date of issuance of these consolidated financial statements, none of the Patents have been transferred, no payments have been made to Next Generation, and none of the triggering events listed in the Patent Contribution Agreement have occurred.

Note 8 – Income Tax

The Company is subject to federal income taxes and state income tax in the United States. Significant judgment is required in determining the provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws.

The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017, and reduced the U.S. federal corporate tax rate from 35% to 21%, eliminated corporate Alternative Minimum Tax, modified rules for expensing capital investment, and limited the deduction of interest expense for certain companies. The Company fulfilled and shipped all of the Products from Florida and, thus, it is subject to the state corporate income tax of Florida with a tax rate of 4.458%.

During the three months ended January 31, 2021, the Company generated taxable income of $417,887 and, thus, accrued $87,756 of federal income tax and $18,629 of state income tax.

Significant components of the Company’s deferred tax assets and liabilities as of January 31, 2021 and October 31, 2020 after applying enacted corporate income tax rate, is net operating loss carryforward of $0 and $15,377, and a valuation allowance of $0 and $15,377, respectively, which is a total deferred tax asset of $0. The Company’s tax returns for 2018 and 2019 remain open to examination. 

Note 8 – Subsequent Events

Share-based Compensation

On February 4, 2022, the Company entered into a Consulting Agreement with Oakhill Europe Ltd (“Oakhill Europe”), pursuant to which the Company engaged Oakhill Europe to provide strategic advising and negotiation assistance for potential international distribution agreements (collectively, the “Oakhill Services”), in exchange for a $15,000 monthly retainer, incentive compensation bonuses of up to $175,000, and an incentive compensation bonus value of $75,000 paid in fully-vested non-qualified stock options, upon the achievement of certain events.

Note 9 – Subsequent Events

On February 5, 2021, 528,9452022, the Company issued 61,250 shares of common stock were issuedCommon Stock to eight7 employees ofin accordance with the Company undervesting schedules set forth in RSU agreements resulting in $708,786 of share-based compensation.previously entered into with such employees. Of the shares issued to employees, 246,05524,058 shares were withheld by the Company to satisfy tax withholding obligations equaland/or satisfy cash settlement options to $329,714.employees, equaling approximately $23,336.

On February 27, 2022, the Company’s Compensation Committee (the “Committee”) and the Board approved the grant of a stock option award to Mark Thoenes, Interim Chief Financial Officer, to acquire up to 100,000 shares of Common Stock under the Company’s 2020 Stock and Incentive Compensation Plan. The option shares are exercisable at a price of $2.45 per share, which equaled the closing price of the Common Stock as of the date immediately prior to the grant date. At the grant date, 50,000 option shares became immediately vested, with the remaining 50,000 option shares vesting on the one-year anniversary of the grant date. The option has a ten-year term.

On February 5, 2021, 597,13627, 2022, the Committee and the Board approved the grant of a stock option award to Russell Quick, as an independent consultant providing strategic advising and negotiation assistance for potential international distribution agreements, to acquire up to 100,000 shares of commonCommon Stock under the Company’s 2020 Stock and Incentive Compensation Plan. The option shares are exercisable at a price of $2.45 per share, which equaled the closing price of the Common Stock as of the date immediately prior to the grant date. At the grant date, 50,000 option shares became immediately vested, with the remaining 50,000 option shares vesting on the one-year anniversary of the grant date. The option has a ten-year term.

On March 5, 2022, the Committee and the Board approved the grant of a stock option award to Nirajkumar Patel, Chief Executive Officer, to acquire up to 600,000 shares of Common Stock under the Company’s 2020 Stock and Incentive Compensation Plan. The option shares are exercisable at a price of $2.85 per share, which equaled the closing price of the Common Stock as of the date immediately prior to the grant date. At the grant date, 300,000 option shares became immediately vested, with the remaining 300,000 option shares vesting on the one-year anniversary of the grant date. The option has a ten-year term.

Previously, the Company granted Mr. Patel 250,000 RSUs , which vest over a three-year period (the “Patel Time Vesting RSUs”), and 500,000 RSUs that vest only upon a change of control of the Company or if the Company achieves in excess of $1 billion in accumulated total gross revenues (the “Patel Event Vesting RSUs”). On March 5, 2022, the Company and Mr. Patel agreed to terminate the (i) 120,833 unvested Patel Time Vesting RSUs and (ii) 500,000 unvested Patel Event Vesting RSUs.

On March 5, 2022, the Committee and the Board approved the grant of stock option awards to Eric Mosser, Chief Operating Officer, to acquire up to 500,000 shares of Common Stock under the Company’s 2020 Stock and Incentive Compensation Plan. The option shares are exercisable at a price of $2.85 per share, which equaled the closing price of the Common Stock as of the date immediately prior to the grant date. At the grant date, 250,000 option shares became immediately vested, with the remaining 250,000 option shares vesting on the one-year anniversary of the grant date. The option has a ten-year term.

Similarly, the Company previously granted Mr. Mosser 250,000 RSUs, which vest over a three-year period (the “Mosser Time Vesting RSUs”), and 333,334 RSUs that vest only upon a change of control of the Company or if the Company achieves in excess of $1 billion in accumulated total gross revenues (the “Mosser Event Vesting RSUs”). On March 5, 2022, the Company and Mr. Mosser agreed to terminate the (i) 120,833 unvested Mosser Time Vesting RSUs and (ii) 333,334 unvested Mosser Event Vesting RSUs.

On March 5, 2022, the Committee and the Board approved the grant of stock option awards to 5 employees, to acquire up to 285,600 shares of Common Stock under the Company’s 2020 Stock and Incentive Compensation Plan. The option shares are exercisable at a price of $2.85 per share, which equaled the closing price of the Common Stock as of the date immediately prior to the grant date. At the grant date, 142,800 option shares became immediately vested, with the remaining 142,800 option shares vesting on the one-year anniversary of the grant date. The options have a ten-year term.

Previously, we granted these 5 employees 317,499 RSUs, which vest over a three-year period (the “Employee Vesting RSUs”), and 317,499 RSUs that vest only upon a change of control of the Company or if the Company achieves in excess of $1 billion in accumulated total gross revenues (the “Employee Event Vesting RSUs”). On March 5, 2022, the Company and the 5 employees each agreed to terminate the (i) 135,001 unvested Employee Time Vesting RSUs and (ii) 317,499 unvested Employee Event Vesting RSUs.

On March 9, 2022, the Committee approved an annual base salary equal to $300,000 for Mr. Patel and $240,000 for Mr. Mosser. The annual base salaries will be reviewed by the Committee on an annual basis.

Further, the Board previously approved a cash bonus award to (i) Mr. Patel equal to $30,000 for every $25 million in gross revenues generated by us (the “Patel Cash Bonus Award”) and (ii) Mr. Mosser equal to $20,000 for every $25 million in gross revenues generated by us (the “Mosser Cash Bonus Award” and, together with the Patel Cash Bonus Award, the “Cash Bonus Awards”). On March 9, 2022, the Committee terminated the Cash Bonus Awards.

On February 28, 2022 and on March 3, 2022 the Company issued 10,000 shares and 2,963 shares, respectively, of the Company’s Common Stock to Mr. Rudy Singh as payment for the EDGAR filing services.

Warrants Shares Exercised

Between February 14, 2022 and March 1, 2022, 800,355 shares of Common Stock were issued to 4 non-employee vendors as compensation for professional services rendered toupon the Company. These shares were expensed toexercise of warrants, and the Company using the closing share price on the share issue dates to compute a total of $1,074,845.received approximately $1,520,693 in proceeds.

On February 28, 2021, 2,010,000 shares of common stock were issued to 2 non-employee vendors as compensation for professional services rendered to the Company. These shares were expensed to the Company using the closing share price on the previous business day to the issue dates to compute a total of $5,427,000.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of the financial statements with a narrative report on our financial condition, results of operations, and liquidity. This discussion and analysis should be read in conjunction with the unaudited Financial Statements and notes thereto for the three months ended January 31, 20212022 included under Item 1 – Financial Statements in this Quarterly Report and our audited Financial Statements and notes thereto for the yearyear ended October 31, 20202021 contained in our2021 Annual Report on Form 10-K.Report. The following discussion contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Our actual results could differ materially from those discussed in the forward-looking statements. Please also see the cautionary language at the beginning of this Quarterly Report regarding forward-looking statements.

The discussions of our results as presented in this Quarterly Report include use of the non-GAAP term “gross profit.” Gross profit is determined by deducting the cost of goods sold from operating revenue. Cost of goods sold includes direct and indirect labor, materials, services, fixed costs, and variable overhead. Gross profit should not be considered an alternative to operating income or net income, which are determined in accordance with GAAP. We believe that gross profit, although a non-GAAP financial measure, is useful and meaningful to investors as a basis for making investment decisions. It provides investors with information that demonstrates our cost structure and provides funds for our total costs and expenses. We use gross profit in measuring the performance of our business. Other companies may calculate gross profit in a different manner.

Potential Impact of COVID-19

In March 2020, the WHO declared the outbreak of COVID-19 as a pandemic based on the rapid increase in global exposure. COVID-19 continues to spread throughout the world, including the United States. Our business operations, which commenced during this pandemic, continue to be operationaloperational; however, we were indirectly negatively impacted by COVID-19.

We were indirectly impacted by supply chain issues and regulatory oversight. First, COVID-19 impacted Bidi’s ability to quality test and develop its new product, the BIDI^® Pouch, in line with its targeted release date, which negatively impacted our ability to begin distribution of the BIDI^® Pouch. Secondly, we have not seen any significant direct negative impactbelieve that many retailers and distributers relaxed their compliance standards as an indirect result of COVID-19 for two reasons: (i) government enforcement of regulations was very limited due to imposed social restrictions, resulting in less in-person monitor enforcement by government officials and (ii) retail stores experienced light foot traffic from customers due to COVID-19 restrictions and fears, which resulted in relaxed compliance in an effort to generate revenue. We believe this relaxation of standards by certain retailers significantly impacted our newly commenced business. However,revenues.

Impact of the COVID-19 pandemicFDA PMTA Decision

In September 2021, in connection with the PMTA process, the FDA effectively “banned” flavored ENDS by denying nearly all then-pending PMTAs for such products. Following the issuance of an MDO, manufacturers are required to stop selling non-tobacco flavored ENDS product. As of September 10, 2021, the FDA announced that it has taken action on over 93% of applications and issued MDOs for more than 1,167,000 flavored ENDS products, while issuing zero marketing authorizations.

Bidi, along with nearly every other company in the ENDS industry, received a MDO for its non-tobacco flavored ENDS products. With respect to Bidi, the MDO covered all non-tobacco flavored BIDI® Sticks, including its Arctic (menthol) BIDI® Stick, which Bidi believes the FDA mischaracterized as “flavored.” BIDI believes that because its Arctic BIDI® Stick is menthol, it should not be subject to the MDO. Bidi and the Company believe this position is aligned with the FDA’s public statements and press releases stating that tobacco and menthol ENDS are not deemed flavored products subject to the MDOs.

As a result, beginning in September 2021, Bidi pursued three avenues to challenge the MDO. First, on September 21, 2021, separate from the judicial appeal of the MDO in its entirety, Bidi filed a 21 C.F.R. § 10.75 internal FDA review request specifically of the decision to include the Arctic (menthol) BIDI® Stick in the MDO. The Company anticipates a decision from the FDA on the internal review in the second or third quarter of 2022, although we cannot provide any assurances as to the timing or outcome.

Separately, on September 29, 2021, Bidi petitioned the U.S. Court of Appeals for the Eleventh Circuit to review the FDA’s denial of the PMTAs for its non-tobacco flavored BIDI® Stick ENDS, arguing that it was arbitrary and capricious under the APA, as well as ultra vires, for the FDA not to conduct any scientific review of the company’s comprehensive applications, as required by the Tobacco Control Act, to determine whether the BIDI® Sticks are “appropriate for the protection of the public health”. Bidi further argued that the FDA violated due process and the APA by failing to provide fair notice of the FDA’s new requirement for ENDS companies to conduct long-term comparative smoking cessation studies for their flavored products. On February 1, 2022, U.S. Court of Appeals for the Eleventh Circuit granted Bidi’s motion to stay (i.e., put on hold) the MDO, pending the litigation on the merits. The court-ordered stay means that the MDO is not legally in force. Accordingly, we anticipate being able to continue marketing and selling the Products, subject to the FDA’s enforcement discretion, while Bidi continues with its merits case challenging the legality of the MDO. The FDA has indicated that it is prioritizing enforcement against companies that have either not submitted PMTAs, or whose PMTAs have been refused acceptance or filing by the FDA, or whose PMTAs remain subject to impact economic conditions,MDOs. Oral arguments in the merits-based proceeding are currently scheduled for May 2022.

Finally, on October 14, 2021, Bidi requested that the FDA re-review the MDO and reconsider its position that Bidi did not include certain scientific data in its applications sufficient to allow the PMTAs to proceed to scientific review. In light of this request, on October 22, 2021 pursuant to 21 C.F.R. § 10.35(a), the FDA issued an administrative stay of Bidi’s MDO pending its re-review. Subsequently, the FDA lifted its administrative stay on December 17, 2021. Following the lifting of the FDA’s administrative stay, Bidi filed a renewed motion to stay the MDO with the U.S. Court of Appeals for the Eleventh Circuit, which could impactwas granted on February 1, 2022.

In the short-term and long-term demand from our customers and, therefore, hasevent that the potentialU.S. Court of Appeals issues for the Eleventh Circuit a ruling adverse to negatively impact our resultsBidi, or if the FDA otherwise chooses to enforce against Bidi, Bidi will be forced to cease the continued sale of operations, cash flows,its non-tobacco flavored BIDI® Stick products in the United States, thereby resulting in the Company being unable to distribute such products, the Company’s business and financial positioncondition would be materially adversely affected. The Company cannot provide any assurances as to the timing or outcome of the merits-based case.

Future Strategic Opportunities

In addition to the continued domestic opportunity, we believe that international markets provide an exciting growth opportunity for us. The estimated total addressable global market for ENDS products is approximately $36.7 billion. Bidi has received approval to market and distribute products within 11 international markets, including the United Kingdom, France, Russia, and the Czech Republic. Bidi has also secured significant intellectual property protections similar to those received in the future. ManagementUnited States from the European Union, China, and several other regions and countries. It is actively monitoring this situationalso important to note that the nicotine formulation in the Bidi^® Stick has been modified and any impact on our financial condition, liquidity,approved at the 2% level to meet the criteria for distribution in the United Kingdom and results of operations. However, givenEurope.

These international market approvals Bidi has previously secured are for the daily evolutionfull formulation lineup, including all flavors. Because the FDA’s PMTA restrictions and guidelines do not pertain to international markets, Bidi intends to continue manufacturing its full product lineup, for distribution by us in these international markets. Accordingly, in light of the COVID-19 pandemicpending MDO appeal and uncertainty regarding the global responses to curb its spread, we are not presently able to estimate the effectsFDA’s review of the COVID-19 pandemic on our future resultsPMTA, as well as the ongoing threat of operations, financial condition, or liquidity for the remainder of fiscal year 2021 and,FDA enforcement, Bidi intends to expedite the planned product launches into foreign markets starting with the United Kingdom. We are also actively exploring potential partnerships with international distribution companies in order to possibly beyond.expand Product distribution more rapidly in these international markets.

Corporate History

We were incorporated on September 4, 2018 in the State of Delaware. We are focused on growing and incubating innovative and profitable products into mature, dominant brands.

USSE Corp. and USSE Delaware Merger

USSE Corp.,Effective July 12, 2019, we changed our corporate name from Quick Start Holdings, Inc. to Kaival Brands Innovations Group, Inc. The name change was effected through a Nevada corporation (“USSE Nevada”) was incorporated with the Nevada Secretary of State on July 8, 1998 under the original name C&A Restaurants, Inc. (“C&A Restaurants”). On June 15, 2009, C&A Restaurants changed its name to USSE Corp.

Effective September 19, 2018, USSE Nevada re-domiciled from Nevada to Delaware pursuant to aparent/subsidiary short-form merger of USSE NevadaKaival Brands Innovations Group, Inc., our wholly-owned Delaware subsidiary formed solely for the purpose of the name change, with and into USSE Delaware, Inc. (“USSE Delaware”), with USSE Delaware asus. We were the surviving entity.

Holding Company Reorganization

On September 4, 2018, USSE Delaware acquired 1,000 shares of our common stock, which represented 100% of our then-outstanding shares of common stock, for no consideration, resulting in us becoming a wholly-owned subsidiary of USSE Delaware. Also, immediately prior to the Holding Company Reorganization (as defined below), USSE Merger Sub, Inc., a Delaware corporation (“USSE Merger Sub”), was our wholly-owned subsidiary. 

On September 19, 2018, and in accordance with the provisions set forth in Section 251(g) of the Delaware General Corporation Law, USSE Merger Sub, an indirect wholly-owned subsidiary of USSE Delaware and our direct wholly-owned subsidiary, merged with and into USSE Delaware, our then-parent. USSE Delaware was the surviving corporation and our wholly-owned subsidiary. USSE Delaware also changed its name to USSE Corp. following this holding company reorganization.

Change of Control

On February 6, 2019, we entered into a Share Purchase Agreement (the “Share Purchase Agreement”), by and among us, GMRZ Holdings LLC, a Nevada limited liability company (“GMRZ”), our then-controlling stockholder, and Kaival Holdings, LLC, a Delaware limited liability company (“KH”), pursuant to which, on February 20, 2019, GMRZ sold 504,000,000 shares of our restricted common stock, representing approximately 88.06 percent of our then issued and outstanding shares of common stock, to KH, and KH paid GMRZ consideration in the amount set forth in the Share Purchase Agreement. The consummation of the transactions contemplated by the Share Purchase Agreement resulted in a change in control, with KH becoming our largest controlling stockholder. Nirajkumar Patel and Eric Mosser are the sole voting members of KH.

Name ChangeDescription of Business

Effective July 12, 2019, we changed our corporate name from Quick Start Holdings, Inc. to Kaival Brands Innovations Group, Inc. The name change was effected through a parent/subsidiary short-form merger of Kaival Brands Innovations Group, Inc., our wholly-owned Delaware subsidiary formed solely for the purpose of the name change, withWe are focused on growing and incubating innovative and profitable products into us. We were the surviving entity.

Share Cancellation and Exchange Agreement

On August 19, 2020, we entered into a Share Cancellation and Exchange Agreement (the “Exchange Agreement”) with our controlling stockholder, KH. Nirajkumar Patel and Eric Mosser, our current officers and directors, are the only voting members of KH. Pursuant to the Exchange Agreement, KH returned to us 300,000,000 shares of our common stock (the “Cancellation Shares”), which were cancelled and retired by us.

On August 19, 2020, we filed a Certificate of Designation of Preferences, Rights, and Limitations of the Series A Preferred Stock (the “Series A Certificate of Designation”) with the Secretary of State of the State of Delaware, which authorized a total of 3,000,000 shares of Series A Preferred Stock.

In exchange for the Cancellation Shares, we issued 3,000,000 shares (the “Preferred Shares”) of our newly designated Series A Preferred Stock to KH. The exchange of the Cancellation Shares and the issuance of the Preferred Shares is intended to comply with Section 3(a)(9) of the Securities Act of 1933, as amended (the “Act”), in that the issuance is exempt from the registration requirements of the Act because the exchange of the Cancellation Shares for the Preferred Shares was an exchange between us, as issuer, with an existing stockholder, and no commission or other remuneration was paid or given directly for the exchange. 

Our Business

Currently, we market and place the Products into national distribution channels through long-standing industry relationships in accordance with the A&R Distribution Agreement entered into with Bidi, a related party, in March 2020 (and subsequently amended and restated in May 2020).mature, dominant brands. Pursuant to the A&R Distribution Agreement, we sellBidi granted us an exclusive worldwide right to distribute the Products for sale and resell the Productsresale to both retail level customers and non-retail level customers. Bidi’s primary product isWe ceased all retail/direct-to-consumer sales in February 2021. Pursuant to the “Bidi Stick”terms of the A&R Distribution Agreement, Bidi provides us with all the branding, logos, and most recently,marketing materials to be utilized by us in connection with our marking and promotion of the “Bidi Pouch.Products. We do not manufacture any of the Products we resell. Currently, the Products consist of the “BIDI^® Stick,” Bidi is considered a related partydisposable, tamper-resistant ENDS Product and, once launched, of which there can be no assurances, the “BIDI^® Pouch,” which provides a tobacco-derived nicotine formulation, containing natural fibers and a chew-base filler.

In connection with the A&R Distribution Agreement, we entered into Sub-Distribution Agreements, whereby we appointed the counterparties as non-exclusive sub-distributors. Pursuant to us because our Chief Executive Officer, Chief Financial Officer, and director, Mr. Nirajkumar Patel, owns and controls Bidi. Mr. Patel is also a beneficial owner of KH, the entity that is our largest controlling stockholder. Thus, Bidi and we are under common control.Sub-Distribution Agreements, the sub-distributors agreed to purchase for resale the Products in such quantities as they should need to properly service non-retail customers within the Territory

We process all sales made only to retail customers and non-retail customers, with all sales to retailnon-retail customers historically made through Bidi’s age-restricted website, www.wholesale.bidivapor.com. We ceased all retail/direct-to-consumer sales in February 2021 in order to better ensure youth access prevention and to comply with the website, www.bidivapor.com; however, we recently engaged goPuff who will handle sales to retail customers going forward.Prevent All Cigarette Trafficking (“PACT”) Act. We provide all customer service and support at our own expense. Bidi sets the minimum prices for all sales made by us. With respect to sales to non-retail customers, we submit purchase orders to Bidi, Bidi delivers the Products to us, and we ship the Products directly to these non-retail customers. In the case of retail customers, weWe maintain adequate inventory levels of the Products in order to meet these customers’ demand,the demands of our non-retail customers, and deliver the Products sold to these retail customers.

Current Product Offerings

Pursuant to the terms of the A&R Distribution Agreement, Bidi provides us with all branding, logos, and marketing materials to be utilized by us in connection with our marketing and promotion of the Products.

In connection with the A&R Distribution Agreement, we enteredsell and resell ENDS Products, also referred to as (“e-cigarettes”), to non-retail level customers. Our primary Product we resell is the “BIDI^® Stick,” a disposable, tamper-resistant ENDS product that comes in a variety of flavor options for adult cigarette smokers. The court-ordered stay means that the MDO is not legally in force. Accordingly, we anticipate being able to continue marketing and selling the Products, subject to the FDA’s enforcement discretion, while Bidi continues with its merits case challenging the legality of the MDO. The FDA has indicated that it is prioritizing enforcement against companies that have either not submitted PMTAs, or whose PMTAs have been refused acceptance or filing by the FDA, or whose PMTAs remain subject to MDOs. All of our flavor options will continue to be available to the 11 European Markets we have received marketing and distribution approvals. We are wholly dependent on Bidi to supply the BIDI® Sticks to us for distribution. Accordingly, any supply or other issues that impact Bidi, indirectly impacts us and our ability to operate our business.

In addition to the BIDI^® Stick, we anticipated launching distribution of the “BIDI^® Pouch,” initially outside of the United States. The initial planned February 2021 roll-out of the BIDI^® Pouch was delayed due to COVID-19 based manufacturing and supply chain constraints. Due to these complications, and in effort to prevent future bottlenecks, Bidi decided to move manufacturing in-house. In 2021, Bidi modified the planned formulation of the BIDI^® Pouch. The original BIDI^® Pouch formulation intended to utilize a tobacco-free (synthetic) nicotine formulation, along with natural fibers and a chew-base filler in six different flavors. However, the BIDI^® Pouch product is now being placed on temporary hold domestically due to the likelihood of the FDA enforcement of synthetic nicotine products as drugs, which will require a PMTA determination from the FDA. More specifically, while the BIDI^® Pouch, which made with synthetic (tobacco-free) nicotine, would not fall within the meaning of a tobacco product as set forth in the Food, Drug and Cosmetic Act (“FDCA”), the FDA could take the position that such product is a drug. A drug is defined in Section 201(g) of the FDCA, in pertinent part, as “articles intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in man or other animals” (i.e., the “disease” or “therapeutic benefit” prong) or “articles (other than food) intended to affect the structure or function of the body of man or other animals” (i.e., the “structure/function” prong). Given nicotine’s well-known structure/function effect on the body there is a chance the FDA will take the position that synthetic nicotine products, such as the BIDI^® Pouch, are subject to the FDA’s drug authority and can only be marketed with an approved New Drug Application (even if no disease or therapeutic benefit claims are made). Indeed, prior to the enactment of the Tobacco Control Act (the “Tobacco Control Act”), the FDA historically took the position that any product with added nicotine (other than traditional tobacco products) was a drug, even when marketed for recreational use and without specific claims of smoking cessation or other therapeutic benefit. It is, of course, illegal to distribute a drug without the FDA’s approval. Given these concerns, Bidi has decided not to launch the synthetic-nicotine BIDI^® Pouch at this time, but will instead seek a PMTA marketing authorization from the FDA for the BIDI^® Pouch made with tobacco-derived nicotine.

On July 14, 2021, we announced plans to launch our first Kaival-branded product, a Hemp CBD product. In addition to our Kaival-branded formulation, we anticipate that we will also provide white label, wholesale solutions for other product manufacturers through our subsidiary, Kaival Labs. However, as of the date of this Quarterly Report, we have not launched any Kaival-branded products, nor have we begun to offer white label, wholesale solutions to other product manufacturers.

Going Concern

A recent court ruling on behalf of Bidi in the Eleventh Circuit Court of Appeals, granted a judicial stay of the MDO previously issued by the FDA to Bidi in September 2021. The ruling, which was issued on February 1, 2022, means that the MDO is not legally in force. Accordingly, we anticipate being able to continue marketing and selling the Products, subject to the FDA’s enforcement discretion, while Bidi continues with its merits case challenging the legality of the MDO. FDA has indicated that it is prioritizing enforcement against companies that have either not submitted PMTAs, or whose PMTAs have been refused acceptance or filing by FDA, or whose PMTAs remain subject to MDOs. Oral arguments in the merits case are currently scheduled in May 2022.

If the Eleventh Circuit Court of Appeals agrees with Bidi in the merits case, we anticipate that the FDA will be compelled to place the flavored ENDS back into the A&R Sub-Distribution AgreementsPMTA scientific review process. If this is the outcome of the merits case, we anticipate being able to continue marketing and selling the Products, subject to the FDA’s enforcement discretion, until the scientific review process is complete on each of Bidi’s PMTA for flavored ENDS and the FDA issues its decision on each.

If the Eleventh Circuit Court of appeals disagrees with certain counterparties, pursuantBidi on the merits case, or if the FDA re-issues the MDO after completing its scientific review process for each of Bidi’s PMTAs for its flavored ENDS, or if The DA otherwise chooses to enforce against Bidi, we will be forced to cease sales on the flavored BIDI® Sticks in the United States market, leaving only the Tobacco (Classic) and Menthol (Arctic) BIDI® Sticks products for sale in the United States (which, with respect to the Menthol (Arctic) BIDI® Stick, depends on the outcome of the specific PMTA filings and the administrative review request for the classification of “Arctic” as a standard menthol ENDS). If this is the outcome of the merits case, this combined with a negative cash flow from operations, would raise substantial doubt on our ability to continue as a going concern.

Management plans to continue similar operations with increased marketing, which we appointed such counterparties as non-exclusive sub-distributors of the Products to non-retail customers within the Territory. Each of the A&R Sub-Distribution Agreements set forth certain minimum purchase obligations.

We believe that over the course of the next twelve months, our business operations will generate the capital needed to achieve our business objectives; however,result in increased revenue and net income. However, there can beis no assurance that our business operationsmanagement’s plan will continuebe successful due to generate the cash flows required for uscurrent economic climate in the United States and globally.

The unaudited consolidated financial statements filed as part of this Quarterly Report do not include any adjustments relating to achieve our business objectives. If we require additional capital, there canthe recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be no assurancenecessary in the event that we will be able to raise any required capital or that capital will be available to us at acceptable terms, or at all. We believe that our cash provided by operations will be sufficient for the next twelve months.cannot continue as a going concern.

As a result of the commencement of business operations, in March 2020, we began hiring employees and intend to hire additional independent contractors and/or employees in the future. We cannot provide any assurance as to the timing of the hiring of any additional independent contractors or employees, the number of independent contractors or employees that we may hire, and whether acceptable independent contractors or employees will be available to us at that time.

Liquidity and Capital Resources

We believe we have sufficient cash on hand as of March 17, 2022. However, we are awaiting the outcome of Bidi’s merit-based case pending in the Eleventh Circuit Court of Appeals with respect to the MDO issued by the FDA in September 2021. If the Eleventh Circuit Court of Appeals rules against Bidi, our business and financial condition will be materially adversely affected, including our ability to generate revenues and our liquidity. Other than the ongoing MDO matters, we have no known current demands or commitments and are not aware of any events or uncertainties as of January 31, 20212022 that will result in or that are reasonably likely to materially increase or decrease our current requirements for cash and resulting improved liquidity.

At January 31, 2021,2022, we had working capital of approximately $5.8$13.9 million and total cash of approximately $2.0$5.7 million.

Now that we have commenced business operations, weWe intend to generally rely on cash from operations and equity and debt offerings, to the extent necessary and available, to satisfy our liquidity needs. There are a number of factors that could result in the need to raise additional funds, including a decline in revenue or a lack of anticipated sales growth and increased costs. Our efforts are directed toward generating positive cash flow and profitability. If these efforts are not successful, we may need to raise additional capital. Should capital not be available to us at reasonable terms, other actions may become necessary in addition to cost control measures and continued efforts to increase sales. These actions may include exploring strategic options for the sale of the Company, the creation of joint ventures or strategic alliances under which we will pursue business opportunities, or other alternatives. We believe we have the financial resources to weather any short-term impacts of COVID-19;the FDA’s PMTA process and Bidi’s receipt of a MDO from the FDA; however, we are unable to presently estimate any potential future impacts from COVID-19 and an extended impact, or a negative ruling in Bidi’s merits-based litigation case or the FDA ultimately not approving Bidi’s PMTA if it is re-evaluated could have a material and adverse effect on our sales, earnings, and liquidity. At this time, we do not foresee the need for further strategic financing for the next twelve months, given the financing we completed in September 2021, as indicated below, and our continual sales efforts and results.

In September 2021, we completed a firm commitment underwritten offering, which offering was made pursuant to our Registration Statement on Form S-3 (File No. 333-258339) (the “Registration Statement”). The SEC declared the Registration Statement effective on August 10, 2021. We sold 4,700,000 shares of our Common Stock and warrants to purchase an additional 3,525,000 shares of our Common Stock. We sold each share of our Common Stock and warrants to purchase 0.75 shares of our Common Stock at a combined public offering price of $1.70. We also granted the underwriter the option to purchase an additional 705,000 shares of our Common Stock and warrants to purchase an additional 528,750 shares of our Common Stock. We received net proceeds from the offering of approximately $8.3 million. We have also received approximately $1.7 million from the exercise of the warrants. We used the proceeds for general corporate purposes.

Cash Flows:

Cash flow used in operations was approximately $5.4$(2.1) million for the first three months of fiscal year 2021,2022, compared to $285 provided by$(5.4) million used in operations for the first three months of fiscal year 2020.2021. The decrease in cash flow fromused in operations for the first three months of fiscal year 2022 compared to the first three months of fiscal 2021 was mainlyprimarily due to the use of cash resulting from a very significant increase in accounts receivable. We anticipate continued improvement in our cash flows providedreceivable of approximately ($11.3) million as the result of very significant sales that occurred during the first three months of fiscal year 2021, offset to a lesser degree by operations in future yearsthe growth of accounts payable – related party of approximately $4.8 million and stock based on the minimum purchase obligations set forth in the A&R Sub-Distribution Agreements, partially offset by increases in costs as we ramp up our sales and marketing efforts. compensation of approximately $1.1 million.

Cash flow used in financing activities was approximately $30,500$35,759 for the first three months of fiscal year 2021,2022, compared to $0approximately $30,511 for the first three months of fiscal year 2020.2021. The cash used in financing activities for the first quarterthree months of fiscal year of 2022 and fiscal year 2021 consisted of cash used for the settlement of RSUs for cash.issued to employees.