Basis of Presentation and Significant Accounting Policies

12 Months Ended

Oct. 31, 2021

Accounting Policies [Abstract]

Basis of Presentation and Significant Accounting Policies

Note 2 – Basis of Presentation and Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the financial statements of the Company’s wholly-owned subsidiary, Kaival Labs. Intercompany transactions are eliminated.

Basis of Presentation

This summary of significant accounting policies is presented to assist in understanding the Company’s consolidated financial statements. These accounting policies conform to accounting principles, generally accepted in the United States of America (“GAAP”), and have been consistently applied in the preparation of the consolidated financial statements.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In the opinion of management, all adjustments necessary in order to make the financial statements not misleading have been included. Actual results could differ from those estimates.

Cash and Restricted Cash

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. There were no cash equivalents at October 31, 2021and October 31,2020. Cash and restricted cash at October 31, 2021 and October 31, 2020 were $7,825,235 and $7,421,701, respectively.

Cash and restricted consist of cash and cash held short-term in escrow as required. As of October 31, 2021, and October 31, 2020, the Company had $65,007 and $0 in restricted cash, respectively, for amounts held in escrow.

The following table sets forth a reconciliation of cash, and restricted cash reported in the consolidated balance sheet and the consolidated statements of cash flows that agrees to the total of those amounts presented in the consolidated statements of cash flows.

	October 31,		October 31,
	2021		2020
Cash	$	7,760,228	$	7,421,701
Restricted cash		65,007		—
Total cash and restricted cash shown in statement of cash flows	$	7,825,235	$	7,421,701

Advertising and Promotion

All advertising, promotion and marketing expenses, including commissions, are expensed when incurred.

Accounts Receivable and Allowance for Doubtful Accounts

Receivables are stated at cost, net of an allowance for doubtful accounts. The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of accounts receivables. A considerable amount of judgment is required in assessing the amount of the allowance and the Company considers the historical level of credit losses and collection history and applies percentages to aged receivable categories. The Company makes judgments about the creditworthiness of debtors based on ongoing credit evaluations and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the debtors were to deteriorate, resulting in their inability to make payments, a larger allowance may be required. As of October 31, 2021, based upon management’s assessment of the accounts receivable aging and the customers’ payment history, the Company has determined that no allowance for doubtful accounts is required. The Company had an allowance for doubtful accounts of $13,773, which was 1.0% of total accounts receivable customer balances, as of October 31, 2020.

Inventories

All product inventory is purchased from a related party, Bidi. Inventories are stated at the lower of cost and net realizable value. Cost includes all costs of purchase and other costs incurred in bringing the inventories to their present location and condition. The Company determines cost based on the FIFO method. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. All inventories are purchased from a related party of October 31, 2021, the inventories only consisted of finished goods, were significant and located in four storage locations, one of which is a related party, Bidi and one of which is a customer/sub distributor, Favs Business LLC (“Favs Business”). Based upon fiscal year 2021 inventory management procedures and their results, the Company has determined that no allowance for the inventory valuation is required at October 31, 2021. No inventory allowance was required as of October 31, 2020 either.

Inventory deposit – related party

The Company paid $2.9 million from its capital financing raise to Bidi, a related party, to have BIDI^® Sticks manufactured with regulatory product requirements, different from the United States, as stipulated by the United Kingdom. Once complete the European Bidi Sticks will be maintained in appropriate warehousing for distribution and sale there. As of the date these audited consolidated financial statements were issued, this has not been completed and no inventory has been transferred to the Company and this remains a deposit.

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 18.4% and 12.9% of our total sales of BIDI® Sticks for the fiscal years ended October 31, 2021 and 2020, respectively. OnOctober 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 $2,556,930.

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 October 31, 2021 and October 31, 2020 the Company has received $0 and $623,096  in deposits from customers, respectively, which is included with the Company’s current liabilities.

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 product. Once received and inspected, the Company will issue a refund for the product return. As of October 31, 2021, the Company had one customer refund due for $316,800, which was the result of one of the Company’s sub distributor customers returning Product that had become defective in storage. The $316,800 amount at October 31, 2021 represents the amount of refund the Company will make to this customer.

Products Revenue

The Company generates products 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 determined 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 fiscal year ended October 31, 2021, approximately 23%, or $13.9 million, of the revenue from the sale of Products, primarily consisting of the “BIDI^® Stick,” was generated from Favs Business LLC (“Favs Business”), approximately 16%, or $9.6 million, of the revenue from the sale of Products was generated from MMS Distributing, LLC (“MMS Distro”), and approximately 14%, or $8.2 million, of the revenue from the sale of Products was generated from C Store Master.

Favs Business and C Store Master had outstanding balances of $1 million and, $0.3 million respectively, and accounted for approximately 50%, and 16%, respectively, of the total accounts receivable from customers as of October 31, 2021.

For the year ended October 31, 2020, approximately 41% of the revenue from the sale of products, primarily consisting of the “BIDI® Stick,” was generated from Favs Business in the amount of approximately $26.4 million and approximately 6% of the revenue from the sale of products was generated from MMS Distro in the amount of approximately $3.9 million.

Go Brands, Inc., with an outstanding balance of approximately $0.3 million and GPM Investment, LLC, with an outstanding balance of approximately $0.6 million, accounted for approximately 33% and 56% of the total accounts receivable from customers, respectively, as of October 31, 2020. 

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 Company uses the Black-Scholes option-pricing model to estimate the fair value of stock-based awards on the date of grant and on each modification date. .Compensation expense for SBP awards granted to nonemployees is re-measured each period as the underlying options vest.

The fair value of each option granted during the year ended October 31, 2021 and 2020 was estimated on the date of grant using the Black-Scholes option-pricing model with the weighted average assumptions in the following table:

	2021		2020
Expected dividend yield	0	%	—
Expected option term (years)	10		—
Expected volatility	294.55%-301.53	%	—
Risk-free interest rate	1.19%-1.63	%	—

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 US Treasury bills. The Company stock option expense for the year ended October 31, 2021 and October 31, 2020 was $1,773,947 and $0, respectively.

The Company’s stock-based compensation for the fiscal years ended October 31, 2021 and October 31, 2020 was $9,449,421 and $769,437, 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 consideration of all the evidence, both positive and negative, management has determined that a valuation allowance of $1,256,059 for the year ended on October 31, 2021 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:

● Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

● Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

● Level 3 - Inputs that are both significant to the fair value measurement and unobservable.

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of October 31, 2021. 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.