Empery Digital Inc.: Form 10-Q/A for the period ended Sep 30, 2023

The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and the Company’s Annual Report on Form 10-K, which contains audited financial statements of the Company as of and for the year ended December 31, 2022, previously filed with the Securities and Exchange Commission. Results for the three and nine months ended September 30, 2023 are not necessarily indicative of results for the year ending December 31, 2023 or any future period.

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, together with other statements and information publicly disseminated by the Company, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions.

In addition, from time to time, we or our representatives may make forward-looking statements orally or in writing. We base these forward-looking statements on our expectations and projections about future events, which we derive from the information currently available to us. Such forward-looking statements relate to future events or our future performance, including: our financial performance and projections; our growth in revenue and earnings; and our business prospects and opportunities. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “should,” “expects,” “anticipates,” “contemplates,” “estimates,” “believes,” “plans,” “projected,” “predicts,” “potential,” or “hopes” or the negative of these or similar terms. In evaluating these forward-looking statements, you should consider various factors, including: our ability to change the direction of the Company; our ability to keep pace with new technology and changing market needs; our capital needs, and the competitive environment of our business. These and other factors may cause our actual results to differ materially from any forward-looking statement. Forward-looking statements are only predictions. The forward-looking events discussed in this document and other statements made from time to time by us or our representatives, may not occur, and actual events and results may differ materially and are subject to risks, uncertainties and assumptions about us. We are not obligated to publicly update or revise any forward-looking statement, whether as a result of uncertainties and assumptions, the forward-looking events discussed in this document and other statements made from time to time by us or our representatives might not occur.

While we believe we have identified material risks, these risks and uncertainties are not exhaustive. Other sections of this Form 10-Q describe additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible to predict all risks and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of this Form 10-Q to conform our prior statements to actual results or revised expectations, and we do not intend to do so.

Forward-looking statements include, but are not limited to, statements about:

• our ability to generate revenues from sales, generate cash from operations, or obtain additional funding to market our vehicles and develop new products;
• our ability to successfully implement and effectively manage our outsourced manufacturing, design and development model and achieve any anticipated benefits;
• the ability of third-party manufacturers to produce our vehicles in accordance with our design and quality specifications, with sufficient scale to satisfy customers and within a reasonable cost;
• anticipated timing for the manufacture, design, production, shipping and launch of our vehicles;
• the inability of our suppliers to deliver the necessary components for our vehicles at prices and volumes acceptable to our third-party manufacturers, and within the timeframes that we require;
• our ability to establish a network of dealers and international distributors to sell and service our vehicles on the timeline we expect;
• whether our vehicles will perform as expected;
• our facing product warranty claims or product recalls;
• our facing adverse determinations in significant product liability claims;
• customer adoption of electric vehicles;
• the development of alternative technology that adversely affects our business;
• increased government regulation of our industry;
• tariffs and currency exchange rates; and
• the conflict with Russia and the Ukraine and the potential adverse effect it may have on the availability of materials used in the manufacturing of batteries for our vehicles.

Overview

We are an all-electric, off-road powersports vehicle company developing electric two and four-wheel motorcycles and utility terrain vehicles, or UTVs, also known as side-by-sides, along with a complete line of upgrades and accessories. In October 2020, we began building and testing prototypes for our future offerings with two off-road motorcycles – the Grunt and the Runt. Our motorcycles feature unique frame designs protected by design patents. Additional utility and design patents have been filed for other aspects of Volcon’s vehicles.

We initially began to sell and distribute the Grunt and related accessories in the United States on a direct-to-consumer sales platform. We terminated our direct-to-consumer sales platform in November 2021. Prior to the termination of our direct-to-consumer sales platform, U.S. consumers made deposits for 360 Grunts (net of cancellations) and five Runts, plus accessories and a delivery fee representing total deposits of $2.2 million. These orders were cancelable by the consumer until the vehicle was delivered and after a 14-day acceptance period, therefore the deposits were recorded as deferred revenue. As of June 30, 2022, we had completed shipping of all Grunts sold through our direct-to-consumer sales platform. Due to delays in developing the Runt, we refunded the deposits made for all Runts.

Beginning in November 2021, we began negotiating dealership agreements with powersports dealers to display and sell our vehicles and accessories. Customers can now, or will soon be able to, buy our vehicles and accessories directly from a local dealership. Some of these dealers will also provide warranty and repair services to customers. As of September 29, 2023, we have 133 active dealers. Dealers can order any of our available products provided they are current on their accounts receivable and are within their established credit limit. We are offering dealers payment terms of up to 90 days to make larger purchases of our vehicles. We have entered into an accounts receivable factoring arrangement to allow the Company the ability to generate cash for working capital. We have agreements with third-party financing companies to provide financing to qualified customers of each dealer. There is no recourse to the Company or the dealer if the dealer’s customer defaults on the financing agreement with the third-party.

As of September 30, 2023, we have signed agreements with six importers in Latin America and one importer for the Caribbean Region, collectively referred to herein as the LATAM importers, to sell our vehicles and accessories in their assigned countries/markets. In June 2022, we signed an exclusive distribution agreement with Torrot Electric Europa S.A., referred to herein as Torrot, to distribute their electric motorcycles for youth riders in Latin America. As discussed below, the agreement with Torrot was superseded by the December 2022 agreement to sell Volcon co-branded Torrot youth motorcycles. We use our LATAM importers to sell Volcon co-branded Torrot youth motorcycles in Latin America.

In October 2022, we signed an expanded agreement with Torrot to also be the exclusive distributor of Torrot and Volcon co-branded youth electric motorcycles in the United States as well as Latin America. This agreement supersedes the original Torrot agreement and once all Torrot branded inventory is sold, we will no longer distribute Torrot branded motorcycles. Finally, in December 2022, we signed an expanded agreement with Torrot to be the exclusive distributor of Volcon co-branded youth electric motorcycles in Canada. In June 2023, we wrote down all remaining Torrot branded inventory in the amount of $84,000. On September 27, 2023, we wrote down the Volcon co-branded Torrot youth motorcycles by $1,622,262 to reduce their cost to the estimated net realizable value.

We expect to expand our global sales of our vehicles and accessories beyond our current LATAM importer base. We expect to sign more LATAM importers in 2023. We expect export sales to be executed with individual importers in each country that buy vehicles by the container. Each importer will sell vehicles and accessories to local dealers or directly to customers. Local dealers will provide warranty and repair services for vehicles purchased in their country. In October 2023, the Company made a decision to postpone expanding our dealer network in Canada for the foreseeable future and we have terminated the employment of our Canadian regional sales managers.

In July 2022, we expanded our offerings with the introduction of the first of our Volcon UTV models, the Stag, which we initially anticipated would be available for delivery to customers in October 2023, followed by additional models of the Stag expected in 2024 and 2025. Due to a delay in certain parts from third-party vendors, we expect delivery to customers to begin in November 2023. The Stag will be manufactured by a third-party and incorporate electrification units, which include batteries, drive units and control modules provided by General Motors. Beginning in June 2022, we have taken non-binding pre-production orders which are cancelable prior to delivery. We also expect to introduce a higher performance, longer range UTV (to be named) but development of this vehicle has not yet begun and no timeline for its development and release has been determined.

Through August 2022, we assembled the Grunt in a leased production facility in Round Rock, Texas. In August 2022, we announced that we would outsource the manufacturing of the Grunt to a third-party manufacturer, which has reduced costs and improved profitability on the Grunt. We also outsourced the manufacturing of the 2023 Grunt EVO to the same third-party manufacturer. The 2023 Grunt EVO has replaced the Grunt and has a belt drive rather than a chain drive as well as an updated rear suspension. We received prototypes of the Grunt EVO in the first quarter of 2023 and began selling the Grunt EVO in the third quarter of 2023.

In September 2022, we reduced our headcount in our product development and administration departments as we outsourced the design and development of certain components of our vehicle development. We also hired our Chief Marketing Officer and hired additional sales and marketing employees and increased marketing activities to further support our brand and products. In September 2023, we reduced our headcount in several departments to reduce costs and we continue to evaluate other cost reduction opportunities.

We began taking pre-orders for an E-Bike, the Brat, in September 2022 and shipments to customers began in the fourth quarter of 2022. The Brat is being manufactured by a third-party. In January 2023, we began selling the Brat directly to consumers through our website. Consumers who order the Brat from our website can have the Brat shipped to their specified destination.

In November 2022, we finalized an agreement with a third-party to manufacture the Runt LT. We received prototypes of the Runt LT in the first quarter of 2023 and expect to begin sales in the first quarter of 2024.

The estimated fulfillment of all orders we have received assumes that our third-party manufacturers can successfully meet our order quantities and deadlines. If they are unable to satisfy orders on a timely basis, our customers may cancel their orders.

Results of Operations

The following financial information is for the three and nine months ended September 30, 2023 and 2022.

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Revenue

Revenue for the three months ended September 30, 2023, was $487,430 which represents sales of Brats of $686,331, Grunt EVO motorcycles of $37,193, Volcon Youth and Torrot motorcycles of $43,407 and accessories and parts of $52,613 offset by an adjustment of $333,524 to increase dealer rebates due to a change in the rebate program for remaining unsold Grunts in dealer inventory and for discounts to dealers for a reduction in the manufacturer’s suggested retail price for Brats and Volcon Youth motorcycles.

Revenue for the nine months ended September 30, 2023, was $2,177,188 which represents sales of Grunt motorcycles of $170,388, Grunt EVO motorcycles of $37,193, Brats of $1,728,528, Volcon Youth of $303,886 and accessories and parts of $204,593. offset by an adjustment of $269,218 to increase dealer rebates due to a change in the rebate programs during the period for remaining unsold Grunts in dealer inventory and for discounts to dealers for a reduction in the manufacturer’s suggested retail price for Brats and Volcon Youth motorcycles.

Revenue for the three and nine months ended September 30, 2022, was $242,710 and $3,795,065 which represents sales of Grunts of $953,429 and $4,493,951, and accessories and parts of $81,125 and $196,845, respectively. The sales of Grunts are offset by promotional rebates provided to dealers and distributors in the third quarter of 2022 on inventory held by them as of August 1, 2022 resulting in $812,600 being recorded to reduce revenue. The rebate is provided as a year-end incentive to dealers and distributors to sell their remaining 2022 Model Year Grunt inventory.

Cost of Goods Sold

Cost of goods sold for the three months ended September 30, 2023 were $3,542,468 including payroll costs of $287,117 and stock-based compensation of $131,526 for employees performing warehouse and logistics management and quality control testing. Product costs for Brats, Grunt EVOs, and Volcon Youth sold during the period were $555,265, $96,332 and $40,018 (before net realizable value write down), respectively. We recorded a write down of Volcon Youth motorcycles of $1,622,262 to reduce their costs to the expected net realizable value. We recorded an expense of $19,500 related to fees paid to cancel purchase orders to reduce raw material quantities. Facilities costs were $126,501 for our warehouse facility and third-party warehousing costs. The Company also recorded an expense of $350,000 due to a reduction of the credit per Grunt EVO our third-party manufacturer will provide for inventory previously provided to it. The credit was reduced to $1,250 from $1,600 due to inventory provided by the Company that is in excess of the 1,000 units. Future credits could be received if the Company has the third-party manufacturer build more than 1,000 units.

Cost of goods sold for the nine months ended September 30, 2023, were $5,107,096. Costs include payroll costs of $969,461 and stock-based compensation of $487,605 for share-based awards for employees performing warehouse and logistics management and quality control testing. Product costs for Brats, Grunts, Grunt EVOs, and Volcon Youth, sold during the period were $1,150,905, $459,690, $97,051, and $295,427 (before inventory write down), respectively. We recorded write downs of Volcon Youth and Torrot Youth motorcycles of $1,622,262 to reduce the inventory value to its expected net realizable value. We recorded expense of $158,252 related to fees paid to cancel purchase orders to reduce raw material quantities, which was offset by a reduction in the net realizable valuation expense of $198,061 the Company was recording for excess quantities of raw materials that it was no longer obligated to purchase by paying these fees. Also, the one-year warranty for parts and labor on Grunts sold prior to September 30, 2022 expired (excluding the battery which is warranted for 2 years) and an adjustment to reduce the warranty accrual in the amount of $459,800 was recorded which reduced cost of goods sold. Facilities costs were $337,658 for our warehouse facility and third-party warehousing costs. Shipping costs were reduced by $347,729 due to the reversal of an accrual for shipping costs and tariffs expected to be incurred to ship our Grunt raw materials and work-in-process inventory to our third-party manufacturer in Mexico which was no longer needed.

Cost of goods sold for the three months ended September 30, 2022 were $2,012,828 including labor costs of $504,830 for employees and contractors performing assembly and quality control testing of Grunts and stock-based compensation of $113,795 for share-based awards for employees. Part costs for Grunts sold during the period were $48,627. We paid $223,758 for fees owed to cancel purchase orders to reduce quantities ordered to expected sales demand. Facilities costs were $131,344 for our manufacturing facility and inventory warehousing costs. Shipping costs and duties/tariffs for inventory purchases and shipments to customers were $701,825, which includes an accrual of $350,000 for costs expected to be incurred to ship our raw materials and work-in-process inventory to our third-party manufacturer. Depreciation expense of $123,008 was recorded in the period and a loss on the write-off of property and equipment of $170,657 was recognized for the disposal of manufacturing assets due to the outsourcing of Grunt assembly.

Cost of goods sold for the nine months ended September 30, 2022 were $11,549,871 including labor costs of $1,868,801 for employees and contractors performing assembly and quality control testing of Grunts and stock-based compensation of $392,244 for share-based awards for employees. Part costs for Grunts during the period were $5,402,140 which included parts costs for Grunts sold of $3,080,033, inventory adjustments for excess and obsolete inventory of $364,322 and adjustments of $1,643,505 to record inventory at its net realizable value. Facilities costs were $458,650 for our manufacturing facility and inventory warehousing costs. Shipping costs and duties/tariffs for inventory purchases and shipments to customers were $2,041,022 which includes an accrual of $350,000 for costs expected to be incurred to ship our raw materials and work- in-process inventory to our third-party manufacturer. Accrued warranty costs were $556,314. Depreciation expense of $270,526 was recorded in the period and a loss on the write-off of property and equipment of $170,657 was recognized for the disposal of manufacturing assets due to the outsourcing of Grunt assembly.

Beginning in the fourth quarter of 2023 we expect revenue and cost of goods sold, other than inventory write downs, to increase further due to the expected sales of the Grunt EVO, as there were minimal sales late in the third quarter, and Stag in November 2023. Our cost per Grunt EVO is fixed in our contract with the third-party manufacturer. We have identified a supplier who can build and deliver the Grunt EVO at a lower cost than we were able to source parts and assemble the Grunt EVO ourselves. We also transferred Grunt parts inventory of approximately $1.4 million to this supplier in exchange for a per unit reduction in the contractual cost the third-party manufacturer will charge the Company. Additional cost savings may be realized if the third-party manufacturer can source or manufacture parts at a lower cost.

Other than the cost of the batteries, we have a fixed cost per unit for the Stag in our contract with our third-party manufacturer. However, not all components have been fully sourced and additional costs for these components or price increases from suppliers for components already sourced could result in a higher cost per unit and we may not be able to increase the price we sell each unit to our customers which could negatively impact our expected margin.

The increase in costs for products will partially be offset by reductions in cost for salaries and benefits due to reductions in headcount completed in September and October 2023.

Sales and Marketing Expense

Sales and marketing expenses relate to costs to increase exposure and awareness for our products and developing our network of U.S. dealers and international distributors.

For the three months ended September 30, 2023, sales and marketing expenses were $1,870,532 and include $683,349 for promoting our products and brand, $816,564 for employee payroll costs, stock-based compensation expense of $134,073 for share-based awards granted to employees and consultants, $43,684 related to facilities costs, and travel costs of $79,500 primarily related to costs incurred for travel to build our dealer and distributor network and to attend events to promote our products. Bad debt expense was $15,792 and legal and consulting fees were $15,577.

Sales and marketing expenses were $6,040,519 for the nine months ended September 30, 2023 and were primarily related to expenses associated with promoting our products and brand of $2,239,652, employee payroll costs of $2,323,155, stock-based compensation of $678,944 for share-based awards granted to employees and consultants, and travel costs of $259,777 primarily related to costs incurred for travel to build our dealer and distributor network and to attend events to promote our products. Facilities costs were $128,821. Bad debt expense was $66,990 and legal and consulting fees mainly related to entering into international distribution agreements were $156,846.

For the three months ended September 30, 2022 sales and marketing expenses were $1,282,014 and include $432,640 for promoting our products and brand, $479,848 for employee payroll costs, stock-based compensation expense of $123,678 for share-based awards granted to employees and consultants, and travel costs of $76,555 primarily related to costs incurred for travel to build our dealer and distributor network.

For the nine months ended September 30, 2022 sales and marketing expenses were $3,942,827 and include $1,094,886 for promoting our products, employee payroll costs of $1,379,911, stock-based compensation of $550,563 for share-based awards granted to employees and consultants, $317,746 for facilities costs, including costs of $148,323 for closing our Denver store, primarily to operate our now closed dealership in Denver, Colorado and travel costs of $182,845 primarily related to costs incurred for travel to build our dealer network.

We expect sales and marketing expenses to decrease as we reduce costs for marketing our products once we start selling the Grunt EVO and Stag, which we expect to be offset partially for an increase in selling costs such as commissions. In addition, we decreased headcount in September 2023 to reduce selling costs.

Product Development Expense

Product development expenses relate to development and testing of our products and process to manufacture these products.

For the three months ended September 30, 2023, product development expenses totaled $2,983,198 and primarily relate to expenses associated with employee payroll costs of $426,332, stock-based compensation of $80,759 for share-based awards granted to employees, professional fees of $274,389 for consultants assisting with product design and programming, prototype vehicles and parts costs of $2,003,330, facilities costs of $49,879 and $38,000 for supplies and software.

Product development expenses were $5,936,280 for the nine months ended September 30, 2023 and were primarily related to expenses associated with employee payroll costs of $1,365,841, stock-based compensation of $389,729 for share-based awards granted to employees and consultants, professional fees of $570,364 for consultants assisting with product design and programming, prototype vehicles and parts costs of $2,913,425, tooling costs of $70,173 for prototype parts, testing costs of $143,072 to complete testing of vehicles including any required regulatory tests, shipping costs of $56,133 related to shipping prototypes, $133,571 for supplies and software and facilities costs of $143,185.

For the three months ended September 30, 2022, product development expenses totaled $2,177,347 and primarily relate to expenses associated with employee payroll costs of $1,199,179, stock-based compensation of $81,191 for share-based awards granted to employees and consultants, professional fees of $64,444 for product design, research and development costs of $115,034, prototype parts and tooling costs of $500,532, and facilities costs of $74,540.

For the nine months ended September 30, 2022, product development expenses totaled $6,775,768 and primarily related to expenses associated with employee payroll costs of $3,077,064, stock-based compensation of $646,350 for share-based awards granted to employees and consultants, professional fees of $293,706 including $173,001 for product design and $95,130 for employee recruiting, research and development costs of $624,984, prototype parts and tooling costs of $1,569,902, and facilities cost of $204,781.

We expect product development costs related to employee costs to remain consistent with the expense level of the nine months ended September 30, 2023. We expect cost increases for outsourced design and development costs and costs related to prototype costs for the Stag and Runt LT and prototype costs, especially for the Stag. We will receive more design validation Stag units and expect to receive production validation units in the fourth quarter of 2023. These units will be used to validate engineering and manufacturing design. Beginning in 2024, we expect prototype costs to decrease as we will be in production for the Stag.

General and Administrative Expense

General and administrative expenses relate to costs for our finance, accounting and administrative functions to support the development, manufacturing and sales of our products.

For the three months ended September 30, 2023, general and administrative expenses were $1,544,344 and were primarily related to expenses associated with employee payroll costs of $509,914, stock-based compensation of $194,171 for share-based awards granted to employees and consultants, professional fees of $161,523 (including legal fees of $61,201 for legal services and tax and audit fees of $71,008), software costs of $93,190, insurance costs of $339,714, facilities costs of $131,974, which includes $85,756 of lease termination costs, other public company expenses of $23,555 and the special stockholders meeting cost $104,840.

For the nine months ended September 30, 2023, general and administrative expenses were $5,003,135 and were primarily related to expenses associated with employee payroll costs of $1,649,373, stock-based compensation of $667,077 for share-based awards granted to employees, professional fees of $665,463 (including legal fees of $276,082, tax and audit fees of $258,185 and recruiting fees of $30,098), software costs were $328,584, insurance costs of $1,022,905, facilities costs of $214,488, which includes $85,756 of lease termination costs, annual and special shareholder meeting costs of $192,155 and other public company expenses were $164,308.

For the three months ended September 30, 2022, general and administrative expenses were $2,085,211 and were primarily related to expenses associated with employee payroll costs of $659,262, stock-based compensation of $123,608, professional fees of $431,763, including legal fees of $331,483 and recruiting fees of $29,073, insurance costs of $419,581 and public company costs excluding legal fees of $190,083.

For the nine months ended September 30, 2022, general and administrative expenses were $7,409,601 and were primarily related to expenses associated with employee payroll costs of $2,085,487, stock-based compensation of $1,018,582, professional fees of $1,874,017, including legal fees of $1,450,289 and recruiting fees of $173,122, insurance costs of $1,165,738, and public company costs excluding legal fees of $349,073.

We expect general and administrative expenses to decrease over the next several quarters as we have taken actions to reduce costs through headcount reductions and lower expected legal costs. The reduction will be partially offset by costs such as product liability insurance which has increased due to new product offerings and increased costs due to public company reporting and compliance requirements.

Interest and Other Expenses

Interest and other income/expenses for the three and nine months ended September 30, 2023 were $1,874,785 and $21,745,717, respectively. A loss on extinguishment of the Convertible Notes of $22,296,988 was recognized in the nine months ended September 30, 2023 (see Note 6 to the consolidated financial statements). Non-cash interest expense of $1,130,837 and $4,516,041 was recognized for the amortization of debt issuance costs and accretion of principal on the Convertible Notes issued in August 2022 prior to extinguishment of the Convertible Notes and for the May 2023 Notes for the three and nine months ended September 30, 2023, respectively. A (loss) gain on the change in the valuation of derivative financial liabilities of ($684,994) and $5,107,794 was recognized in the three and nine months ended September 30, 2023 (see Note 7 to the consolidated financial statements).

Interest and other expenses for the three and nine months ended September 30, 2022 were $618,307 and $627,789. Non-cash interest expense of $614,366 was recognized for the amortization of debt issuance costs and accretion of principal on the Convertible Notes issued in August 2022.

We expect interest expense to increase in the future as we recognize interest on the New Notes and Exchange Notes issued in May 2023. The New Notes and Exchange Notes were discounted using a 14.9% interest rate This discount will be accreted to interest expense over the term of these notes and does not result in any cash payments to be made unless the Company has an event of default as discussed in Note 6 to the financial statements. Additional interest will be recognized for the amortization of issuance costs of $586,968 incurred for the New Notes and Exchange Notes.

Net Loss

Net loss for the three and nine months ended September 30, 2023, was $11,327,896 and $41,655,559, respectively.

Net loss for the three and nine months ended September 30, 2022, was $7,899,184 and $26,437,991, respectively.

Liquidity and Capital Resources

On September 30, 2023, we had cash and restricted cash of $3.0 million, including $0.5 million of restricted cash, and we had a working capital deficit of $22.7 million. Since inception we have funded our operations from proceeds from debt and equity sales.

Cash used in operating activities

Net cash used in operating activities was $16.8 million for the nine months ended September 30, 2023 and includes all of our operating costs except stock-based compensation, write-down of inventory, depreciation and amortization, non-cash interest expense for the amortization of debt issuance costs and accretion of principal on Convertible Notes and May 2023 Notes, gain on change in derivative financial liabilities, loss on extinguishment of Convertible Notes, bad debt expense and gain on sale of assets and loss on lease termination. Cash used in operating activities includes a decrease in accounts receivable of $0.6 million for collections net of sales, increases in inventory of $3.2 million due to the purchase of Brats, Volcon Youth motorcycles and purchases of batteries for the Stag offset by the transfer of Grunt inventory of $1.4 million to one of our third-party manufacturers, an increase of $2.4 million in accounts payable primarily due to purchases of batteries for the Stag and amounts due to our third-party manufacturer of the Stag and Grunt EVO, a decrease of $0.3 million in accrued liabilities due reversal of an accrual for anticipated shipping and tariffs related to shipping raw material and subassembly inventory for the Grunt to our third-party manufacturer. As of September 30, 2023 we have $0.2 million in customer deposits, primarily from two of our Latin America distributors as prepayment for shipments of Brats and Grunt EVOs.

Net cash used in operating activities was $24.8 million for the nine months ended September 30, 2022 and includes all of our operating costs except stock-based compensation, write-down of inventory and prepaid inventory, depreciation and amortization, non-cash interest expense for the amortization of debt issuance costs and accretion of principal on Convertible Notes, and losses on write-off of assets and leases. Cash used in operating activities includes increases in accounts receivable of $1.5 million for sales made to dealers, an increase in inventory of $1.4 million offset by a reduction in inventory deposits of $1.1 million as we made fewer deposits based on outsourcing of the assembly of the Grunt in August 2022 as the third-party manufacturer will purchase raw materials prospectively, a decrease of $2.2 million of customer deposits as we fulfilled all direct to consumer orders, a decrease of $1.0 million due to timing of payments on accounts payables, an increase of $0.3 million in accrued liabilities and an increase in prepaid expenses of $0.3 million.

Cash used in investing activities

Net cash used in investing activities was $0.7 million for the nine months ended September 30, 2023, consisting of $0.8 million of purchases of equipment and tooling offset by proceeds of $0.1 million received for the sale of two vehicles. Net cash used in investing activities was $0.6 million for the nine months ended September 30, 2022, consisting of $0.2 million of purchases of equipment and tooling related to our Grunt manufacturing and product development, $0.2 million for the cost of Grunts capitalized as demonstration units, and $0.2 million related to computers and equipment due to the growth in headcount during the period.

Cash provided by financing activities

Cash provided by financing activities for the nine months ended September 30, 2023, was $9.0 million and was related primarily to proceeds from the public offerings of 1.5 million shares of our common stock for net proceeds of $4.6 million and issuance of convertible notes in a private offering with a principal amount of $4.9 million and net proceeds of $3.9 million. We also received proceeds of $0.5 million from the exercise of 307,001 warrants. In addition, we used $0.1 million from proceeds received from the sale of two vehicles to pay off the related notes payable on the vehicles.

Cash provided from financing activities for the period ended September 30, 2022, was $40.4 million and was related to proceeds received from both the public offering of our common stock in February 2022 where we sold 1,333,334 shares at $15.00 per share and the issuance of senior convertible notes and warrants in August 2022 for net cash proceeds of $22.3 million.

Our continuation as a going concern is dependent upon our ability to attain profitable operations and if necessary, obtain continued financial support from the issuance of debt or equity. As of September 30, 2023, we had incurred an accumulated deficit of $117.4 million since inception. Additionally, one of the covenants for our May 2023 Notes requires us to have $5 million of cash on hand if principal (and interest, if any) of $15 million or more of the May 2023 Notes are outstanding as of June 30, 2024 (subject to adjustment if the principal (and interest, if any) is below $15 million). Further, our May 2023 Notes require us to sell at least 250 units of our Stag UTV by December 31, 2023.

Management anticipates that our cash on hand as of September 30, 2023 plus the cash expected to be generated from operations will not be sufficient to fund planned operations and maintain required cash balances at June 30, 2024 for the May 2023 Notes beyond one year from the date of the issuance of the financial statements as of and for the three and nine months ended September, 2023. There can be no assurance that additional funding would be available to the Company on acceptable terms, or at all. These factors raise substantial doubt regarding our ability to continue as a going concern.

JOBS Act Accounting Election

The recently enacted JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.

We have implemented all new accounting pronouncements that are in effect and may impact our financial statements and we do not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on our financial position or results of operations.

Critical Accounting Policies

No critical accounting policies or estimates existed as of September 30, 2023.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

Evaluation of Disclosure Controls and Procedures

Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) are designed to ensure that information required to be disclosed by us in reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the appropriate time periods, and that such information is accumulated and communicated to our Chief Executive Officer, who serves as our principal executive officer, and Chief Financial Officer, who serves as our principal financial officer, as appropriate, to allow timely discussions regarding required disclosure. We, under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures were not effective as of September 30, 2023 to provide assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to management as appropriate, to allow timely decisions regarding disclosures as we have previously missed filing certain forms timely and we have not implemented and tested controls and procedures to conclude that we have remediated this deficiency. Notwithstanding this conclusion, we believe that our unaudited consolidated financial statements contained in this Quarterly Report fairly present our financial position, results of operations and cash flows for the periods covered thereby in all material respects. Management is working to identify corrective actions for the weakness and will periodically re-evaluate the need to add personnel and implement improved review procedures.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting during the nine months ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Except as set forth below, there have been no material changes to the risk factors included in the Form 10-K filed with the SEC on March 7, 2023, which is accessible on the SEC’s website atwww.sec.gov (http://www.sec.gov).

We will require additional capital funding in the near term, the receipt of which may impair the value of our common stock.

Our future capital requirements depend on many factors, including our sales and marketing activities. We will need to raise additional capital through public or private equity or debt offerings or through arrangements with strategic partners or other sources in the fourth quarter of 2023. There can be no assurance that additional capital will be available when needed or on terms satisfactory to us, if at all. To the extent we raise additional capital by issuing equity securities, our stockholders may experience substantial dilution and the new equity securities may have greater rights, preferences or privileges than our existing common stock.

The terms of the May 2023 Notes and May 2023 Warrants imposed additional challenges on our ability to raise capital.

The agreements related to the sale of the May 2023 Notes and May 2023 Warrants contain a number of restrictive covenants that may impose significant operating and financial restrictions on us while the May 2023 Notes and May 2023 Warrants remain outstanding, unless the restrictions are waived by consent of each holder, including, but not limited to, restrictions on our ability to incur additional indebtedness and guarantee indebtedness; incur liens or allow mortgages or other encumbrances; redeem, or repurchase certain other debt; pay dividends or make other distributions or repurchase or redeem our capital stock; sell assets or enter into or effect certain other transactions; issue additional equity; and enter into variable rate transactions, among other restrictions.

A breach of the covenants or restrictions under the agreements related to the May 2023 Notes and May 2023 Warrants governing our indebtedness could result in an event of default under such agreements. As a result of these restrictions, we may be limited in how we conduct our business, unable to finance our operations through additional debt or equity financings and/or unable to compete effectively or to take advantage of new business opportunities.

Further, while we could potentially receive up to an aggregate of $6.2 million in gross proceeds from the exercise of the May 2023 Warrants and Reload Warrants outstanding as of September 30, 2023, assuming the exercise in full of all of the May 2023 Warrants and Reload Warrants based on the adjusted exercise price of $1.369 per share after the adjustment for the reverse stock split (as discussed in Note 14 of the financial statements), no assurances can be made that the holders of such warrants will elect to exercise any or all of such warrants and, accordingly, no assurance that we will receive any proceeds from the exercise of the May 2023 Warrants and Reload Warrants. If the trading price for our common stock is less than the exercise price for the May 2023 Warrants and Reload Warrants, we believe the holders of such warrants will be unlikely to exercise their warrants. Accordingly, we may not receive cash proceeds with respect to the May 2023 Warrants and Reload Warrants and we are restricted in our ability to conduct additional debt or equity financings.

The issuance of our common stock in connection with the May 2023 Notes and May 2023 Warrants could cause substantial dilution, which could materially affect the trading price of our common stock.

The May 2023 Notes and May 2023 Warrants are exercisable or convertible, as applicable, for up to 27,952,678 shares of our common stock based on the adjusted conversion price of $1.369 after giving effect for the October 13, 2023 reverse stock split as discussed in Note 14 of the financial statements. The additional shares of common stock issued upon the exercise or conversion of the foregoing securities will result in dilution to our then existing holders of common stock and increase the number of shares eligible for resale in the public market. Sales of a substantial number of such shares in the public market could adversely affect the market price of our common stock.

The sale of our common stock by the holders of the May 2023 Notes and May 2023 Warrants, or the perception that stock sales may occur, could cause the price of our common stock to decline.

The sale of our common stock in the public market by the holders of our May 2023 Notes and May 2023 Warrants, or the perception that such sales could occur, could harm the prevailing market price of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate (which ability to sell equity securities is also subject to restrictions under the terms of the agreement related to the May 2023 Notes, May 2023 Warrants and Reload Warrants). If and when we do issue shares of common stock to the holders of the May 2023 Notes and May 2023 Warrants upon the conversion or exercise, as applicable, of the May 2023 Notes, May 2023 Warrants, and Reload Warrants, the holders may resell all, some or none of those shares of common stock at any time or from time to time in their discretion. Resales of our common stock may cause the market price of our securities to drop significantly, regardless of the performance of our business.

If we fail to satisfy all applicable continued listing requirements of the Nasdaq Capital Market our common stock may be delisted from Nasdaq, which could have an adverse impact on the liquidity and market price of our common stock.

Our common stock is currently listed on the Nasdaq Capital Market. In order to maintain that listing, we must satisfy minimum financial and other continued listing requirements and standards, including those regarding director independence and independent committee requirements, minimum stockholders’ equity, minimum bid price, and certain corporate governance requirements. There can be no assurances that we will be able to comply with the applicable listing standards.

On July 5, 2023, we received a notice from Nasdaq that we were not in compliance with Nasdaq’s Listing Rule 5550(b)(2), which requires that we maintain a market value of listed securities (“MVLS”) of $35 million. MVLS is calculated by multiplying our shares outstanding by the closing price of our common stock. On July 6, 2023, we received a notice from Nasdaq that we were not in compliance with Nasdaq’s Listing Rule 5550(a)(2), (the “Bid Price Rule”) as the minimum bid price of our common stock had been below $1.00 per share for 30 consecutive business days. On October 30, 2023, the Company received a notice from Nasdaq that it has now regained compliance with Rule 5550(a)(2), as the minimum bid price of its common stock was above $1.00 for 10 consecutive business days.

We have until January 2, 2024, to regain compliance with the MVLS requirement. To regain compliance with the MVLS requirement, our MVLS must close at $35 million or more for a minimum of ten consecutive business days during this grace period. If we do not regain compliance within the allotted compliance period, including any extensions that may be granted by Nasdaq, Nasdaq will provide notice that our shares of common stock will be subject to delisting.

In the event that our common stock is delisted from Nasdaq and is not eligible for quotation or listing on another market or exchange, trading of our common stock could be conducted only in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such an event, it could become more difficult to dispose of, or obtain accurate price quotations for, our common stock, and there would likely also be a reduction in our coverage by securities analysts and the news media, which could cause the price of our common stock to decline further. Also, it may be difficult for us to raise additional capital if we are not listed on a major exchange.

We completed a reverse stock split on October 13, 2023 in an effort to regain compliance with Nasdaq listing rules and we cannot predict the effect that such reverse stock split will have on the market price for shares of our common stock.

Our board of directors approved a one-for-five (1:5) reverse stock split of our common stock, which became effective on October 13, 2023, in order to regain compliance with the Bid Price Rule. We cannot predict the effect that the reverse stock split will have on the market price for shares of our common stock, and the history of similar reverse stock splits for companies in like circumstances has varied. Some investors may have a negative view of a reverse stock split. Even if the reverse stock split has a positive effect on the market price for shares of our common stock, performance of our business and financial results, general economic conditions and the market perception of our business, and other adverse factors which may not be in our control could lead to a decrease in the price of our common stock following the reverse stock split.

Furthermore, even if the reverse stock split does result in an increased market price per share of our common stock, the market price per share following the reverse stock split may not increase in proportion to the reduction of the number of shares of our common stock outstanding before the implementation of the reverse stock split. Accordingly, even with an increased market price per share, the total market capitalization of shares of our common stock after a reverse stock split could be lower than the total market capitalization before the reverse stock split. Also, even if there is an initial increase in the market price per share of our common stock after a reverse stock split, the market price may not remain at that level.

If the market price of shares of our common stock declines following the reverse stock split, the percentage decline as an absolute number and as a percentage of our overall market capitalization may be greater than would occur in the absence of the reverse stock split due to decreased liquidity in the market for our common stock. Accordingly, the total market capitalization of our common stock following the reverse stock split could be lower than the total market capitalization before the reverse stock split.

We primarily sell our vehicles and accessories through a network of third-parties, and there is no assurance that we will be able to successfully build out this network.

In November 2021 we began negotiating dealer agreements to sell our vehicles and accessories in the United States to powersport vehicle dealers. As of September 30, 2023, we have 133 active dealers to sell our vehicles and accessories. We hired our first regional sales manager in Canada in June 2022 to begin developing our dealer network for Canadian powersports vehicle dealers. To date we have not signed any Canadian dealers as we have not homologated our products to meet Canadian vehicle regulations. In October 2023, we determined that we will postpone expansion of our dealer network in Canada for the foreseeable future and we have eliminated our Canadian regional sales managers.

We are required to comply with manufacture/dealer laws in each state in which we sell our vehicles through dealers. Dealer laws vary by state and although our dealer agreements are intended to comply with these laws, we may be required to amend our agreements if these laws are changed or are challenged by dealers or other OEMs. Our dealer and distribution agreements are generally short-term in nature and the dealer, distributor or we may cancel these agreements under certain circumstances and we may not be able to retain or expand the scope of our dealer and/or distribution network in the future.

Many dealers will require us to identify financing sources for dealers to purchase vehicle inventory and to identify financing sources for the dealers’ customers to finance their purchase. Because we are a young company with limited sales history and recurring losses, we have not been able to obtain these inventory financing sources which may result in dealers not wanting to sell our vehicles. We continue to look for alternative financing sources, we may not be successful in obtaining a source that could finance dealer inventory at a scale that will allow us to be profitable. To the extent we do find a financing source, we will incur costs under these financing arrangements to incentivize dealers to buy our vehicles including free dealer financing for certain periods or based on purchase volumes, interest rate buydowns on the dealers’ customer financing to incentivize their customers’ purchase of our vehicles which will reduce our profit margin on our vehicles.

We believe our success will be highly dependent on our ability to build out this dealer network in the major markets in which we intend to compete for customers, and to maintain this network in the future. Our business model is dependent not only on our ability to create the foregoing network, but also on the commitment and motivation of these third-parties to promote our brand and products.