BETTER CHOICE COMPANY INC. The following discussion includes forward-looking statements about our business, financial condition and results of operations, including discussions about management's expectations for our business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and in light of recent events and trends, and you should not construe these statements either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause our actual performance and management's actions to vary, and the results of these variances may be both material and adverse. A description of material factors known to us that may cause our results to vary or may cause management to deviate from its current plans and expectations, is set forth under "Risk Factors." See "Cautionary Note Regarding Forward-Looking Statements." The following discussion should also be read in conjunction with our audited consolidated financial statements including the notes thereto appearing elsewhere in this filing. Overview and OutlookBetter Choice is a growing animal health and wellness company ready to lead the global industry shift toward pet products and services that help dogs and cats live healthier, happier and longer lives. Our mission is to become the most innovative premium pet food company in the world, and we are motivated by our commitment to making products with integrity and treating pets and their parents with respect. We position our portfolio of brands to benefit from the trends of growing pet humanization and an increased consumer focus on health and wellness, and have adopted a laser focused approach to growth that is driven by new product innovation. Our executive team has a proven history of success in both pet and consumer-packaged goods, and has over 50 years of combined experience in the pet industry and over 100 years of combined experience in the consumer-packaged goods industry.Better Choice's best-in-class product offering is sold today under the Halo and TruDog brands and has enabled the Company to penetrate multiple channels of trade, which we believe enables us to deliver on core consumer needs and respond to changing channel dynamics that have only accelerated as a result of the COVID-19 pandemic. We group these channels of trade into four distinct categories: E-Commerce, which includes the sale of product to online retailers such as Amazon and Chewy; Brick & Mortar, which includes the sale of product to pet specialty chains such as Petco, PetSmart, select grocery chains and neighborhood pet stores; Direct to Consumer ("DTC") which includes the sale of product through our online web platform; and International, which includes the sale of product to foreign distribution partners and to select international retailers. We believe our omni-channel approach is a significant competitive advantage, as it allows us to design and sell products purpose-built for success in specific channels while maintaining our ability to leverage marketing and sales resources cross-channel. Although the COVID-19 pandemic has dramatically changed theU.S. retail landscape, the pet industry has proven to be resilient, with Packaged Facts recently increasing their projected 2021 growth rate forU.S. retail sales of pet food and supplies from 5.3% to 7.6%. While the industry-wide E-Commerce sales have retreated somewhat following theMarch 2020 pantry stocking, the sale of pet food and supplies online has increased 35% year-over-year according to Packaged Facts, with subscription sales nearly equal to theMarch 2020 peak. We anticipate our ability reach a growing base of diverse customers online will only increase as approximately 59% ofBetter Choice's sales in 2020 were made via our DTC and E-Commerce channels. Conversely, we believe that our long-established relationships with key Brick & Mortar customers will enable us to jointly launch new products in the future that are designed for in-store success. 26 -------------------------------------------------------------------------------- Table of Contents In addition to our domestic sales channels, the Halo brand's international sales grew in 2020, driven primarily by Halo's ability to secure Product Import Registrations for 15 Dog and Cat Food Diets from theMinistry of Agriculture and Rural Affairs of China ("MOA") inJune 2020 . We believe that our growth inAsia is fueled by increasing levels of economic financial status and demand for premium, western manufactured products, withChina representing the largest market opportunity for growth and 48% ofBetter Choice's international sales in 2020. According to Euromonitor, the Chinese market for premium dry dog and cat food is anticipated to grow at a 20% CAGR and 28% CAGR, respectively, from 2015 through 2025. This growth rate is driven by dramatic increases in pet ownership, which has seen the number of dog-owning Chinese households increase from 12% in 2015 to 20% in 2020. On a relative basis, 67% ofU.S. households owned a pet in 2020 according to theAmerican Pet Products Association , suggesting that the Chinese pet market has significant room to grow in the foreseeable future. New product innovation represents the cornerstone of our growth plan, and our established supply and distribution infrastructure allows us to develop, manufacture and bring new products to market in generally under nine months. Our flexible and scalable outsourced manufacturing model also promotes innovation, as we offer a wide variety of dog and cat food products under the Halo and TruDog brands that serve many different consumer needs. Founded in 1986, the Halo brand consists of a diversified, premium natural dog and cat portfolio, with products derived from real whole meat, no rendered meat meal and non-genetically modified (non-"GMO") fruits and vegetables, unlike many other kibble and canned products currently in the marketplace. In addition to its dry kibble and canned wet food offering, Halo also has a successful line of freeze-dried treats for dogs and cats and a growing line of award-winning vegan products for dogs. Founded in 2013, the TruDog brand offers ultra-premium, freeze-dried raw dog food, toppers, treats and supplements sold predominantly on its DTC website. Freeze-dried raw dog food is one of the fastest growing sub-category of premium pet food, with Packaged Facts reporting 39% YoY growth in the sub-category in 2019. We strongly believe that both brands are well positioned to take advantage of pet parents' increasing desire to feed only the highest quality ingredients to their pets, and that there will continue to be innovative opportunities for brand consolidation over time. Our marketing strategies are designed to clearly communicate to consumers about the benefits of our products and to build awareness of our brands. We deploy a broad set of marketing tools across various forms of media to reach consumers through multiple touch points and engage with a number of marketing agencies to develop content and product packaging. Our marketing initiatives include the use of social and digital marketing, Search Engine Optimization, email and SMS marketing, and paid media (Facebook, Instagram & YouTube), among other proven strategies to generate and convert sales prospects into loyal, satisfied customers. In addition to directly targeting and educating consumers of our products, we partner with a number of retailers such as Amazon, Chewy and Petco to develop joint sales and marketing initiatives to increase sales and acquire new customers. OnFebruary 2, 2019 andFebruary 28, 2019 , respectively,Better Choice Company entered into definitive agreements to acquire through stock exchange agreements, approximately 93% of the outstanding interest ofTruPet LLC and all of the outstanding shares ofBona Vida, Inc. , an emerging hemp-based CBD platform focused on developing a portfolio of brand and product verticals within the animal health and wellness space. OnMay 6, 2019 ,Better Choice Company consummated the stock exchange transactions wherebyTruPet LLC andBona Vida, Inc. became wholly owned subsidiaries ofBetter Choice Company . For accounting and financial reporting purposes, the transaction was treated as a reverse acquisition whereby TruPet is considered the acquiror ofBetter Choice Company andBona Vida, Inc. Thus, the historical financial information of the registrant is that of TruPet even though the legal registrant remainsBetter Choice Company . OnDecember 19, 2019 , the Company acquired 100% of the issued and outstanding capital stock ofHalo, Purely for Pets, Inc. , in exchange for a combination of cash consideration, shares of our common stock, and convertible subordinated notes and accompanying stock purchase warrants. Unless otherwise stated or the context otherwise requires, the historical business information described in this report prior to consummation of the May Acquisitions is that of TruPet and, following consummation of the May Acquisitions throughDecember 19, 2019 , reflects business information of the Company, TruPet, and Bona Vida. FromDecember 19, 2019 onward, the results of operations reflects business information of the Company and Halo as a combined business. See "Note 2 - Acquisitions" to our audited consolidated financial statements included in this Annual Report on Form 10-K for more information. Although Bona Vida remains a wholly owned subsidiary of theBetter Choice Company , as ofDecember 31, 2020 Better Choice does not currently sell or market any CBD products, does not currently own any CBD related inventory or raw materials and does not currently have plans to re-enter the CBD market at this time. The impact that COVID-19 will have on our consolidated results of operations is uncertain. Although we have not observed a material reduction in sales as ofDecember 2020 as a result of the COVID-19 pandemic, we will continue to evaluate the nature and extent of COVID-19's impact to our business, consolidated results of operations, financial condition, and liquidity, and our results presented herein are not necessarily indicative of the results to be expected for future periods in 2021 or the full fiscal year. Management cannot predict the full impact of the COVID-19 pandemic on the Company's sourcing, manufacturing and distribution of its products or to economic conditions generally, including the effects on consumer spending. The ultimate extent of the effects of the COVID-19 pandemic on the Company is highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic might end. 27 -------------------------------------------------------------------------------- Table of Contents Fiscal Year End OnMay 21, 2019 , our board of directors approved a change in fiscal year end fromAugust 31 to December 31 to align with the TruPet fiscal year end. The fiscal year change became effective with our 2019 fiscal year, which beganJanuary 1, 2019 and endedDecember 31, 2019 . Following its acquisition by us, Halo has adopted the same fiscal year end. Results of Operations for the Years EndedDecember 31, 2020 and 2019 The following table sets forth our consolidated results for the periods presented (in thousands): Years Ended December 31, Change 2020 2019 $ % Net sales$ 42,590 $ 15,577 $ 27,013 173 % Cost of goods sold 26,491 9,717 16,774 173 % Gross profit 16,099 5,860 10,239 175 % Operating expenses: General and administrative 25,966 19,782 6,184 31 % Share-based compensation 8,940 10,280 (1,340) (13) % Sales and marketing 7,892 10,138 (2,246) (22) % Customer service and warehousing 623 1,097 (474) (43) % Impairment of intangible asset - 889 (889) (100) % Total operating expenses 43,421 42,186 1,235 3 % Loss from operations$ (27,322) $ (36,326) $ 9,004 (25) % Net Sales We sell our products through online retailers, pet specialty retailers, our online portal directly to our consumers and internationally through domestic distributors. During 2019, our net sales were primarily driven by our distribution of TruPet products through our DTC channel. However, with the acquisition of Halo, our sales became more diversified through the E-commerce, Brick & Mortar and International channels. For many customers, sales transactions are single performance obligations that are recorded at the time the product is shipped from our distribution centers, when control transfers. We record a revenue reserve based on past return rates to account for customer returns. DTC net sales include revenue derived from the sale of our products and related shipping fees offset by promotional discounts, refunds and loyalty points earned. We offer a variety of promotions and incentives to our customers including daily discounts, multi-bag purchase discounts and coupon codes for initial purchases. For our DTC loyalty program, a portion of revenue is deferred at the time of the sale as points are earned based on the relative stand-alone selling price, and not recognized until the redemption of the loyalty points, which do not expire. We have applied a redemption rate based on historical experience. Information about the Company's revenue channels is as follows (in thousands): Twelve Months Ended December 31, 2020 2019 E-commerce$ 14,218 34 %$ 1,952 13 % Brick & Mortar 8,982 21 % 194 1 % DTC 10,778 25 % 13,392 86 % International 8,612 20 % 39 - % Net Sales$ 42,590 100 %$ 15,577 100 % Net sales increased$27.0 million , or 173%, to$42.6 million for the year endedDecember 31, 2020 compared to$15.6 million for the year endedDecember 31, 2019 . Net sales include an increase of$29.6 million from Halo for the year endedDecember 31, 2020 compared toDecember 31, 2019 following the closing of the Halo acquisition inDecember 2019 and an increase of$0.2 million in net sales for the year endedDecember 31, 2020 related to Bona Vida as compared to the comparable prior period. This was partially offset by a$2.8 million decrease for the year endedDecember 31, 2020 in net sales related to TruPet as compared to the comparable prior period. Key factors that affect our future sales growth include new product innovation and expansion in each of the sales channels. 28 -------------------------------------------------------------------------------- Table of Contents Cost of Goods Sold and Gross Profit Our products are manufactured to our specifications by contracted manufacturing plants using raw materials sourced by our contracted manufacturers. We design our packaging in-house for manufacture by third parties, and packaging is shipped directly to contracted manufacturing plants. We work with our co-manufacturers to secure a supply of raw materials that meet our specifications, such asUSA farm-raised beef, GAP 2 certified cage-free whole chicken and associated broths, GAP 2 certified cage-free whole turkey and associated broths, MSC certified wild-caught salmon and MSC certified wild-caught whitefish and associated broths, and select non-GMO fruits and vegetables, such as peas, sweet potatoes and lentils. In addition to procuring raw materials that meet our formulation requirements, our contract manufacturers manufacture, test and package our products. Cost of goods sold consists primarily of the cost of product obtained from third-party contract manufacturing plants, packaging materials, inventory freight for shipping product from third-party contract manufacturing plants to our warehouse and third-party fulfillment and royalties. We review inventory on hand periodically to identify damages, slow moving inventory, and/or aged inventory. Based on the analysis, we record inventories at the lower of cost or net realizable value, with any reduction in value expensed as cost of goods sold. We calculate gross profit as net sales, including any shipping revenue collected from our customers, less cost of goods sold. Our gross profit has been and will continue to be affected by a variety of factors, primarily product sales mix, volumes sold, discounts offered to newly acquired and recurring customers, the cost of our manufactured products, and the cost of freight from the manufacturer to the warehouse. Cost of goods sold increased$16.8 million , or 173%, to$26.5 million for the year endedDecember 31, 2020 compared to$9.7 million for the year endedDecember 31, 2019 . As a percentage of revenue, cost of goods sold remained consistent at 62% for the years endedDecember 31, 2020 and 2019. Cost of goods sold includes an additional$19.9 million of Halo product costs for the year endedDecember 31, 2020 following the closing of the Halo Acquisition inDecember 2019 . In addition, cost of goods sold during the year endedDecember 31, 2020 included$0.9 million of non-cash expense related to the amortization of a purchase accounting adjustment to inventory recorded in connection with the Halo Acquisition. These increases were partially offset by a comparable decrease in cost of goods sold related to lower TruPet sales. During the year endedDecember 31, 2020 , gross profit increased$10.2 million , or 175%, to$16.1 million compared to$5.9 million during the year endedDecember 31, 2019 . Gross profit margin remained consistent at 38% for the years endedDecember 31, 2020 and 2019. Gross profit includes an additional$9.7 million from Halo for the year endedDecember 31, 2020 following the closing of the Halo Acquisition inDecember 2019 . The Halo line of products for the current period carried a gross profit margin of 32% compared to TruPet's gross margin of 53%. TruPet products have higher margins as compared to the Halo product line as Halo's food and pet food topper products have higher costs than the TruPet products. During the year endedDecember 31, 2020 , Halo incurred storage and fulfillment center costs of$0.7 million compared to$0.1 million for TruPet due to the outsourcing of the TruPet warehouse operations inNovember 2020 . During 2020, Halo also incurred an inventory reserve of$0.2 million and product obsolescence costs of$0.2 million . Operating Expenses General and administrative expenses include management and office personnel compensation and bonuses, warrant expense, information technology related costs, rent, travel, professional service fees, costs related to merchant credit card fees, insurance, product development costs, shipping DTC orders and general corporate expenses. During the year endedDecember 31, 2020 , General and administrative expenses increased$6.2 million , or 31% to$26.0 million compared to$19.8 million in the year endedDecember 31, 2019 . The increase includes additional expenses of$4.8 million during the year endedDecember 31, 2020 following the closing of the Halo Acquisition, including non-cash amortization of$1.5 million related to the trade name and customer relationship intangible assets acquired, additional salaries and wages and related costs of$2.2 million , as well as other costs such as professional and consulting fees, charitable contributions, and other miscellaneous costs. The remaining increase was primarily driven by higher warrant expense of$7.2 million and higher salaries and wages and related costs of$0.4 million as we continued building the infrastructure to support our status as a public company and the expansion of our corporate staff. These increases were partially offset by a decrease of$4.0 million as compared to the prior year period driven by reductions in TruPet compensation costs, professional fees, and outbound shipping costs and a decrease in consulting and other professional fees of$2.1 million mainly driven by a favorable legal settlement during the fourth quarter of 2020. 29 -------------------------------------------------------------------------------- Table of Contents Share-based compensation includes expenses related to stock options and warrants issued to employees and non-employee directors. During the year endedDecember 31, 2020 , Share-based compensation decreased$1.3 million , or 13%, to$8.9 million , as compared to share-based compensation of$10.3 million during the year endedDecember 31, 2019 . The decrease in equity-based compensation is primarily driven by terminations during 2020 and the acceleration of vesting of option awards in connection with the May Acquisitions in the prior year period, partially offset by$1.0 million related to a catch up of unrecognized stock-based compensation expense,$1.0 million of add-on warrant expense issued to two non-employee directors, and$0.5 million related to restricted shares issued to three non-employee directors during 2020. Sales and marketing expenses include costs related to compensation for sales personnel, other costs related to the selling platform, as well as marketing, including paid media and content creation expenses. Marketing expenses consist primarily of Facebook, Amazon and other media ads, and other advertising and marketing costs, all geared towards acquiring new customers and building brand awareness. During the year endedDecember 31, 2020 , Sales and marketing expenses, including paid media, decreased approximately$2.2 million or 22%, to$7.9 million from$10.1 million during the year endedDecember 31, 2019 . Marketing expenses include additional expenses of$3.6 million related to Halo products during the year endedDecember 31, 2020 following the closing of the Halo Acquisition and$0.4 million incurred by Bona Vida related to the write-off of a prepaid expense associated with a marketing contract that was terminated during 2020. This was partially offset by a decrease sales and marketing expenses related to TruPet products from$9.9 million for the year endedDecember 31, 2019 to$3.6 million for the year endedDecember 31, 2020 . Customer service and warehousing costs include the cost of our customer service department, including our in-house call center, and costs associated with warehouse operations. During the year endedDecember 31, 2020 , Customer service and warehousing decreased$0.5 million , or 43%, to$0.6 million , as compared to$1.1 million during the year endedDecember 31, 2019 due to a reduction in staff and related operating costs, as well as the full outsourcing of TruPet warehouse operations inNovember 2020 . Impairment of intangible asset consists of amortization expense recognized for impairment of a license intangible in connection with a contract termination. During the year endedDecember 31, 2019 , we recognized an impairment loss of$0.9 million related to the Elvis Presley Houndog license agreement which was terminated onJanuary 13, 2020 . We did not record any impairment losses during the year endedDecember 31, 2020 . Interest Expense,Net During the year endedDecember 31, 2020 , interest expense increased$8.6 million , or 1,280% to$9.2 million from$0.7 million for the fiscal year endedDecember 31, 2019 . Interest expense is comprised of interest on our term loan, revolving credit facility, PPP loans, payable in kind interest on our senior subordinated convertible notes, and the amortization of debt issuance costs and accretion of debt discounts. See "Note 10 - Debt" to our audited consolidated financial statements included in this Annual Report on Form 10-K for more information regarding our outstanding debt. Change in Fair Value of Warrant Liability Common stock warrants classified as liabilities are revalued at each balance sheet date subsequent to the initial issuance and changes in the fair value are reflected in the consolidated statement of operations as change in fair value of warrant liability. The change in fair value for the year endedDecember 31, 2020 relates to the increase in the fair value of common stock warrants issued in connection with the Series F Private Placement between the date of issuance andDecember 31, 2020 . Income Taxes Our income tax provision consists of an estimate of federal and state income taxes based on enacted federal and state tax rates, as adjusted for any allowable credits, deductions and uncertain tax positions as the arise. No provision has been made for federal and state income taxes prior to the date of the May Acquisitions as the proportionate share of TruPet's income or loss was included in the personal tax returns of its members as TruPet was a limited liability company. Subsequent to the acquisitions, the Company, as a corporation is required to provide for income taxes. During the fiscal years endedDecember 31, 2020 andDecember 31, 2019 , we did not record income tax expense due to the continued losses incurred by the Company. The effective tax rate subsequent to the acquisitions is 0%, which differs from theU.S. Federal statutory rate of 21% as our reported losses are offset by a valuation allowance due to uncertainty as to the realization of those losses. Liquidity and Capital Resources Since our founding, we have financed our operations primarily through sales of member units while a limited liability company, and since becoming a corporation, through the sales of shares of our common stock, warrants, preferred stock, and loans. OnDecember 31, 2020 andDecember 31, 2019 , we had cash and cash equivalents and restricted cash of$4.0 million and$2.5 million , respectively. 30 -------------------------------------------------------------------------------- Table of Contents We are subject to risks common in the pet wellness consumer market including, but not limited to, dependence on key personnel, competitive forces, successful marketing and sale of its products, the successful protection of its proprietary technologies, ability to grow into new markets, and compliance with government regulations. As ofDecember 2020 , we have not experienced a significant adverse impact to our business, financial condition or cash flows resulting from the COVID-19 pandemic. However, uncertainties regarding the continued economic impact of COVID-19 are likely to result in sustained market turmoil, which could negatively impact our business, financial condition, and cash flows in the future. We have historically incurred losses and have an accumulated deficit. We expect to continue to generate operating losses and consume significant cash resources for the foreseeable future. These conditions raise substantial doubt about our ability to continue as a going concern, meaning that we may be unable to continue operations for the foreseeable future or realize assets and discharge liabilities in the ordinary course of operations. We have implemented and continue to implement plans to achieve cost savings and other strategic objectives to address these conditions. We have achieved cost savings from the consolidation of our third-party logistics operations and reduction of overhead costs and we expect to achieve further cost savings from the consolidation of third-party manufacturers and optimization of shipping costs. The business is focused on growing the most profitable channels while reducing investments in areas that are expected to have lower long-term benefits. If we seek additional financing to fund our business activities in the future and there remains doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding on commercially reasonable terms or at all. If we are unable to raise the necessary funds when needed or achieve planned cost savings, or other strategic objectives are not achieved, we may not be able to continue our operations, or we could be required to modify our operations that could slow future growth. The accompanying audited consolidated financial statements have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and payments of liabilities in the ordinary course of business. Accordingly, the audited consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount of and classification of liabilities that may result should we be unable to continue as a going concern. A summary of our cash flows is as follows (in thousands):
Year Ended
2020 2019
Cash flows (used in) provided by:
Operating activities $ (7,505) $ (20,969)
Investing activities (151) (20,207)
Financing activities 9,111 39,764
Net increase (decrease) in cash and cash equivalents $ 1,455 $ (1,412)
Cash flows from Operating Activities
Cash used in operating activities decreased $13.5 million , or 64%, during the
year ended December 31, 2020 compared to the year ended December 31, 2019 . Net
loss from operations adjusted for non-cash expenses was $7.7 million for the
year ended December 31, 2020 compared to $22.2 million for the comparable prior
year period. The improvement was driven by an increase in revenue from the Halo
acquisition and a reduction in sales and marketing and customer service and
warehousing expenses. While general and administrative increased $6.2 million
for the year ended December 31, 2020 compared to the comparable prior year
period, a majority of the increase was related to non-cash expenses. As a
percentage of revenue, cash expenses from general and administrative activity
decreased year over year, reflecting continued optimization and leverage of
operating costs as a combined company.
Cash flows from Investing Activities
Cash used in investing activities decreased to $0.2 million during the year
ended December 31, 2020 from $20.2 million during the year ended December 31,
2019 . The cash used in investing activities for the year ended December 31, 2020
is related to the purchase of property and equipment. The cash used in investing
activities for the year ended December 31, 2019 is related to the Halo
Acquisition.
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Cash flows from Financing Activities
Cash provided by financing activities decreased by $30.7 million , to $9.1
million , during the year ended December 31, 2020 from $39.8 million during the
year ended December 31, 2019 . The cash provided by financing activities for the
year ended December 31, 2020 was related to proceeds of $18.1 million associated
with the Series F Private Placement, proceeds of $1.5 million from the June 2020
Notes, proceeds from warrant exercises of $1.0 million , proceeds from the PPP
loans of $0.9 million and net proceeds from the revolving line of credit of $0.3
million , partially offset by a $12.5 million pay down on the term loan and debt
issuance costs of $0.1 million . Net cash provided by financing activities during
the year ended December 31, 2019 was related to proceeds from short term loan of
$20.5 million , net proceeds from shares issued pursuant to private placement of
$15.8 million , net proceeds from the exercise of warrants of $4.0 million ,
proceeds from November 2019 notes of $2.8 million , proceeds from an investor
prepayment of $0.5 million and net proceeds from lines of credit of $0.4
million , partially offset by a $1.9 million payment of a cash advance, payment
of a related party note for $1.6 million and $0.7 million of debt issuance
costs.
Indebtedness
Our indebtedness includes a term loan, a revolving credit facility, various
convertible notes payable, and PPP loans. See "Note 10 - Debt" to our audited
consolidated financial statements included in this Annual Report on Form 10-K
for more information.
Short term loan and line of credit
The short-term loan and line of credit were issued with customary affirmative
and negative covenants relating to the incurrence of debt, liens, declaring and
paying dividends, purchasing or redeeming our common stock, the making of
restricted payments and asset sales and certain fundamental changes and events
of default such as maintaining timely payments, filing tax and regulatory
documents in a timely manner, continuing the existing business with control over
existing assets, default on senior debt, and voluntary or involuntary bankruptcy
or insolvency proceedings. The term loan and line of credit are secured by
substantially all of our assets and our subsidiary guarantors, who include Halo,
TruPet and Bona Vida.
As of December 31, 2020 , the Company was in compliance with its debt covenants.
See "Note 21 - Subsequent events" for additional information related to changes
in our term loan and line of credit subsequent to December 31, 2020 .
Notes Payable
Our subordinated convertible notes were all issued with customary affirmative
and negative covenants relating to the incurrence of debt, prohibitions on liens
and restricted payments and events of default such as failure to pay, default on
senior debt, and voluntary or involuntary bankruptcy or insolvency proceedings.
It is also an event of default if the Company's common stock is suspended from
trading or the failure of the common stock to be listed on the OTC markets, the
pink sheets, NASDAQ, NYSE or other national securities exchange in the United
States or Canada for a period of five (5) consecutive days or for more than ten
(10) days in any 365-day period.
As of December 31, 2020 , the Company was in compliance with all covenant
requirements and there were no events of default. All notes payable are
subordinated to the short term loan and line of credit.
PPP Loans
Pursuant to the Paycheck Protection Program ("PPP") under Division A, Title I of
the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") we received
two PPP loans in response to the economic impact of COVID-19. Under the terms of
the PPP, certain amounts of the loans may be forgiven if they are used for
qualifying expenses as described in the CARES Act. The Company has used the
entire loan amounts for qualifying expenses and expects the full loan amounts to
be forgiven.
Contractual Commitments and Obligations
The Company is contractually obligated to to make future cash payments for
various items, including debt arrangements, lease arrangements, as well as
certain purchase obligations. See "Note 10 - Debt" to our audited consolidated
financial statements included in this Annual Report on Form 10-K for more
information about our debt obligations. See "Note 8 - Operating leases" to our
audited consolidated financial statements included in this Annual Report on Form
10-K for more information about our lease obligations. Our purchase obligations
include certain software subscriptions as well as in-transit or in-production
purchase orders with our suppliers, for which amounts vary depending on the
purchasing cycle. The majority of our software subscriptions are not under
long-term contracts, and we do not have long-term contracts or commitments with
any of our suppliers beyond active purchase orders. These purchase obligations
were not material as of the date of this Annual Report.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined by applicable
regulations of the SEC , that are reasonably likely to have a current or future
material effect on our financial condition, results of operations, liquidity,
capital expenditures or capital resources.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with GAAP. The preparation of our consolidated financial
statements and related disclosures requires us to make estimates, assumptions
and judgments that affect the reported amounts of assets, liabilities, net
sales, costs and expenses and related disclosures. We believe that the
estimates, assumptions and judgments involved in the accounting policies
described below have the greatest potential impact on our financial statements
and, therefore, we consider these to be our critical accounting policies.
Accordingly, we evaluate our estimates and assumptions on an ongoing basis. Our
actual results may differ from these estimates under different assumptions and
conditions. See "Note 1 - Nature of business and summary of significant
accounting policies" to our audited consolidated financial statements included
in this Annual Report on Form 10-K for a description of our significant
accounting policies.
Accounting for Warrants
The fair value of warrants is estimated using a Monte Carlo and/or Black-Scholes
valuation model. The assumptions used in these models included the simulation of
future stock prices based on future financing events, likelihood of mandatory
exercise of the warrants, and timing and likelihood of fundamental transactions,
such as a change in control. Both valuation methodologies use key inputs,
including expected stock volatility, the risk-free interest rate, the expected
life of the option and the expected dividend yield. Expected volatility is
calculated based on the analysis of other public companies within the pet
wellness and internet commerce (e-commerce) sectors. Risk-free interest rates
are calculated based on risk-free rates for the appropriate term. The expected
life is estimated based on contractual terms as well expected exercise dates.
The divided yield is based on the historical dividends issued by the Company.
The valuation of the warrants is subject to uncertainty as a result of the
unobservable inputs. If the volatility rate or risk-free interest rate were to
change, the value of the warrants would be impacted.
Warrants that are classified as liabilities due to the terms of the warrant
obligation are measured at fair value on a recurring basis at the end of each
reporting period. The warrants accounted for as a derivative included a reset
function which is triggered if the Company issues or sells shares of common
stock or common stock equivalents at a price per share that is less than the
exercise price of the warrants. Subsequent to the issuance of the warrants,
additional common stock equivalents were awarded, triggering the reset clause
under the terms of the warrants. Accordingly, the fair value analysis performed
during the period ended December 31, 2019 included the impact of the trigger. As
a result, we recorded an adjustment to the derivative liability to reflect its
fair value as of December 31, 2019 . Warrants that are classified as equity or
considered compensation are measured at fair value on a non-recurring basis on
the date of issuance. See "Note 11 - Warrants" to our audited consolidated
financial statements included in this Annual Report on Form 10-K for more
information.
Share-Based Compensation
Share-based compensation expense is measured based on the estimated fair value
of awards granted to employees, directors, officers and consultants on the grant
date. Forfeitures are accounted for as they occur, therefore there are no
forfeiture related estimates required.
The fair value of an option award is estimated on the date of grant using the
Black-Scholes option valuation model, which requires the development of input
assumptions, as described in "Note 15 - Share-based compensation". Determining
the appropriate fair value model and calculating the fair value of share-based
payment awards requires the input of the subjective assumptions described in
"Note 15 - Share-based compensation". The assumptions used in calculating the
fair value of share-based payment awards represent management's best estimates,
which involve inherent uncertainties and the application of management's
judgment. See "Note 15 - Share-based compensation" to our audited consolidated
financial statements included in this Annual Report on Form 10-K for more
information.
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Accounting for Convertible Notes
Notes payable consist of the November 2019 Notes, the Seller Notes, ABG Notes
and June 2020 Notes. These subordinated convertible notes were measured at fair
value on a non-recurring basis. In connection with the issuance of the June 2020
Notes, the Company lowered the maximum conversion price of the November 2019
Notes, Seller Notes and ABG Notes from $4.00 to $3.75 , and as such, the Company
was required to re-value these notes. These notes were valued based on a
risk-neutral Monte Carlo simulation-based approach. The stock price was
simulated based on a Geometric Brownian Motion process, with a trend equal to
the risk-free rate. The fair value analysis included assumptions about the
probability of the occurrence of future events such as a change of control and
initial public offering. See "Note 10 - Debt" to our audited consolidated
financial statements included in this Annual Report on Form 10-K for more
information.
Goodwill Impairment
The Company evaluates goodwill for impairment at least annually. The Company
monitors the existence of potential impairment indicators throughout the year
and will evaluate for impairment whenever events or circumstances indicate that
the fair value of a reporting unit is below its carrying value. Impairment
testing is based on the Company's current business strategy in light of present
industry and economic conditions, as well as future expectations.
When performing a quantitative assessment, the fair value units is determined
using widely accepted valuation techniques, including the discounted cash flow,
guideline transaction and guideline company methods. These types of analyses
contain uncertainties because they require management to make significant
assumptions and judgments including: (1) an appropriate rate to discount the
expected future cash flows; (2) the inherent risk in achieving forecasted
operating results; (3) long-term growth rates; (4) expectations for future
economic cycles; (5) market comparable companies and appropriate adjustments
thereto; and (6) market multiples. When performing a qualitative assessment,
qualitative factors are assessed to determine whether the existence of events or
circumstances indicated that it was more likely than not that the fair value of
the reporting unit was less than its carrying amount. Fair value measurements
used in the impairment review of goodwill are Level 3 measurements. See "Note 1
- Nature of business and summary of significant accounting policies" for further
information about our policy for fair value measurements. See "Note 9 -
Intangible assets, royalties, and goodwill" to our audited consolidated
financial statements included in this Annual Report on Form 10-K for more
information.
Revenue
The Company applies judgment in the determination of the amount of consideration
the Company receives from its customers. Revenue is measured as the amount of
consideration the Company expects to receive in exchange for transferring goods.
Revenue the Company recognizes varies with changes in trade incentives the
Company offers to its customers and their consumers, which is net of trade
incentives and allowances. Trade incentives consist primarily of customer
pricing allowances and merchandising funds. Estimates of trade promotion expense
and coupon redemption costs are based upon programs offered, timing of those
offers, estimated redemption/usage rates from historical performance,
management's experience and current economic trends.
The TLC loyalty program is a membership club where members enjoy certain
benefits including auto-shipments, free shipping, VIP access to TruDog's
Happiness Concierge and invitations to secret sales only for TLC members as well
as earning reward points with every TLC order, which can be used to purchase
TruDog products. For this program, a portion of revenue is deferred at the time
of the sale as points are earned based on the relative stand-alone selling
price, and not recognized until the redemption of the loyalty points. The
Company has applied a redemption rate based on historical experience. See "Note
3 - Revenue" to our audited consolidated financial statements included in this
Annual Report on Form 10-K for more information.
Accounting for Business Combinations
We allocate the purchase price of an acquired entity to the assets and
liabilities acquired based upon their estimated fair values at the business
combination date. We also identify and estimate the fair values of intangible
assets that should be recognized as assets apart from goodwill. A single
estimate of fair value results from a complex series of judgments about future
events and uncertainties and relies heavily on estimates and assumptions. The
estimated fair values related to intangible assets primarily consist of customer
relationships and trademarks which are determined primarily using discounted
cash flow models. Estimates in the discounted cash flow models include, but are
not limited to, certain assumptions that form the basis of the forecasted
results (e.g. revenue growth rates, customer attrition rates, and royalty
rates). These significant assumptions are forward looking and could be affected
by future economic and market conditions. The carrying values of acquired
receivables and trade accounts payable have historically approximated their fair
values at the business combination date. With respect to other acquired assets
and liabilities, we use all available information to make our best estimates of
their fair values at the business combination date.
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Table of Contents Our purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of the acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies. InMay 2019 , the Company completed a reverse acquisition, resulting in the combined operations of TruPet and Bona Vida. InDecember 2019 , the Company acquired Halo. See "Note 2 - Acquisitions" to our audited consolidated financial statements included in this Annual Report on Form 10-K for more information. Income Taxes Deferred taxes are recorded using an asset and liability approach. We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the consolidated financial statement and tax bases of assets and liabilities and for loss and credit carryforwards using enacted tax rates anticipated to be in effect for the year in which the differences are expected to reverse. Valuation allowances are provided if, based upon the weight of available evidence and management's estimates and judgments, it is more likely than not that some or all the deferred tax assets will not be realized. See "Note 18 - Income taxes" to our audited consolidated financial statements included in this Annual Report on Form 10-K for more information.
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