Basis of Presentation and Significant Accounting Policies

6 Months Ended

Apr. 30, 2022

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 subsidiaries, Kaival Labs, Inc. and Kaival Brands International, LLC. Intercompany transactions are eliminated.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s most recent Annual Financial Statements filed with the SEC on Annual Report on Form 10-K on February 16, 2022 (the “2021 Annual Report”). In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim period presented have been reflected herein. The results of operations for the interim period are not necessarily indicative of the results to be expected for the full year. Notes to the consolidated financial statements, which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal period, as reported in the 2021 Annual Report have been omitted.

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 April 30, 2022 and October 31, 2021. Cash and restricted cash at April 30, 2022 and October 31, 2021 were $4,727,037 and $7,825,235, respectively.

Restricted cash consists of cash held in short-term escrow as required. As of April 30, 2022, and October 31, 2021, the Company had $65,542 and $65,007 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.

	April 30, 2022		October 31, 2021
Cash	$	4,661,495	$	7,760,228
Restricted cash		65,542		65,007
Total cash and restricted cash shown in statement of cash flows	$	4,727,037	$	7,825,235

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 April 30, 2022, 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 was required. As of October 31, 2021, the Company also determined that no allowance for doubtful accounts was required. 

Inventories

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 (i) were purchased from Bidi, a related party, as of October 31, 2021 and April 30, 2022, (ii) only consisted of finished goods, (iii) were significant, and (iv) were located in three storage warehouses: (1) the primary leased warehouse, which is owned by a related party, Just Pick, LLC (“Just Pick”), (2) a customer/sub distributor warehouse, which is owned by Favs Business LLC (“Favs Business”), and (3) a third-party logistics services warehouse, which is owned by Ranger Enterprises, LLC (“Ranger”). Based upon fiscal year 2021 inventory management procedures and their results, that have continued through the quarter ended April 30, 2022, the Company has determined that no allowance for the inventory valuation was required at April 30, 2022, nor October 31, 2021.

Inventory deposit related party

In the fourth quarter of fiscal 2021, the Company placed an order for BIDI^® Sticks in anticipation of the distribution launch in the United Kingdom. In connection with this order, the Company paid $2,925,000 from its capital financing raise to Bidi, a related party, in advance to have the BIDI^® Sticks manufactured in compliance with the regulatory product requirements in the United Kingdom, which differs from the regulatory product requirements in the United States. The parties originally contemplated that delivery of the BIDI^® Sticks to the Company would occur by the end of April 2022. On April 29, 2022, the Company and Bidi agreed to cancel the order due to an internal change of approach to international distribution, and Bidi agreed to credit the $2,925,000 against the accounts payable balance owed by the Company to Bidi. As of April 30, 2022, the Company has on its balance sheet a zero balance for inventory deposits and inventory deposits related party. 

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. 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. As of April 30, 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 April 30, 2022, the Company had received $2,382 in deposits from customers, included with the Company’s current liabilities. As of October 31, 2021, the Company had not received any deposits from customers.

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 April 30, 2022 and October 31, 2021, the Company had customer refunds due in the amounts equal to approximately $0 and $316,800, respectively, which refund was the result of one of the Company’s sub-distributor customers returning Products that had become defective in storage.

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 six months ended April 30, 2022, approximately 40%, or $2,366,200, of the revenue from the sale of Products was generated from Favs Business, and approximately 15%, or $877,264, of the revenue from the sale of Products was generated from The H.T. Hackney Company.

Favs Business had an outstanding balance of approximately $305,430, which accounted for approximately 26% of the Company’s total accounts receivable from customers as of April 30, 2022. The H.T. Hackney Company had an outstanding balance of approximately $297,629, which accounted for approximately 25% of the Company’s total accounts receivable from customers as of April 30, 2022.  Grocery Supply Warehouse had an outstanding balance of $163,163, which accounting for approximately 14% of the Company’s total accounts receivable from customers as of April 30, 2022. Finally, MMS Distribution, LLC (“MMS Distro”) had an outstanding balance of approximately $116,444, which accounted for approximately 10% of the Company’s total accounts receivable from customers as of April 30, 2022.     

For the six months ended April 30, 2021, approximately 33%, or $18,129,136, of the revenue from the sale of Products was generated from Favs Business, approximately 16%, or $9,069,455, of the revenue from the sale of Products was generated from MMS Distro, and approximately 12%, or $6,820,132, of the revenue from the sale of Products was generated from C Store Master (“C Store Master”).

Favs Business, with an outstanding balance of approximately $8,590,200, and GPM Investment, LLC, with an outstanding balance of approximately $2,482,553, accounted for approximately 47% and 14% of the total accounts receivable from customers, respectively, as of April 30, 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 six-month period ended April 30, 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:

	As of April 30, 2022			As of October 31, 2021
Expected dividend yield		0	%		0	%
Expected option term (years)		10			10
Expected volatility		294.55%-301.53	%		294.55%-301.53
Risk-free interest rate		1.19%-1.62	%		1.19%-1.62	%

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’s stock option expense for the fiscal three and six months ended April 30, 2022 was $2,616,193 and $2,925,892, respectively.

The Company’s stock-based compensation for the fiscal three and six months ended April 30, 2022 was $110,189 and $190,416, 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 six-month period ended April 30, 2022, is necessary to reduce the deferred tax asset to the amount that will more likely than not be realized pursuant to ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.

The Company has completed its federal and state tax returns for the 2020 tax year and intends on filing them shortly. Given the federal and state NOLs, the Company anticipates that its 2020 tax returns will report that it is eligible to apply those NOLs against the federal and state taxes it paid in 2019. The Company anticipates federal and state tax refunds of approximately $1,600,000 and $146,000, respectively, and expects to collect the refunds in the current fiscal year.

During the six months ended April 30, 2022, the Company generated no taxable income and, thus, no federal or state income taxes are accrued for fiscal year 2022.

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 April 30, 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.