SRX Global Inc.: Form 10-Q for the period ended Sep 30, 2024

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. The financial condition, results of operations and cash flows discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are those of Better Choice Company Inc. and its consolidated subsidiaries, collectively, the “Company,” “Better Choice Company,” “we,” “our,” or “us”. 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. Accordingly, readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. We undertake no obligation to publicly release the results of any revision to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview and Outlook

Better Choice is a pet health and wellness company committed to leading the 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 believe that our broad portfolio of pet health and wellness products are well positioned to benefit from the trends of growing pet humanization and an increased consumer focus on health and wellness, and have adopted a laser focused, channel specific approach to growth that is driven by new product innovation.

We sell our premium and super-premium products (which we believe generally includes products with a retail price greater than $0.20 per ounce) under the Halo brand umbrella, including Halo Holistic™, Halo Elevate® and the former TruDog brand, which was rebranded and successfully integrated under the Halo brand umbrella during the third quarter of 2022. Our core products sold under the Halo brand are made with high-quality, thoughtfully sourced ingredients for natural, science based nutrition. Each innovative recipe is formulated with leading veterinary and nutrition experts to deliver optimal health. Our diverse and established customer base has enabled us to penetrate multiple channels of trade, which we believe enables us to deliver on core consumer needs and serve pet parents wherever they shop. We group these channels of trade into three distinct categories: Digital, which includes the sale of product to online retailers such as Amazon and Chewy, as well as direct to consumer (“DTC”) which included the sale of product through the Company’s website, halopets.com, through June 1, 2024; International, which includes the sale of product to foreign distribution partners and to select international retailers; and Brick & Mortar, which primarily includes the sale of product to pet specialty retailers, independent pet stores, and regional distributors.

A concerted effort to drive brand awareness behind distinctive positioning and messaging is the cornerstone of our growth plan, supported by innovation. Halo’s future growth is driven through an extensive brand positioning workstream executed over the last year. New consumer messaging will build awareness with pet parents, persuade them that Halo is the right choice for their pet, and move the consumer towards purchase. The creative campaign will be brought to life on Amazon and Chewy platforms as well as outside those platforms. By shifting media investment from bottom-of-funnel-driven DTC activities to full funnel activation across the Amazon and Chewy platforms, Halo will see improvements in both media effectiveness, efficiency, and reach.

In addition to incremental consumer media activation, innovation plays a key role in Halo’s growth plans, supported by our own research and development, and acquisitions. Our established supply and distribution infrastructure allows us to bring new products to market in less than a year. Our outsourced manufacturing model is flexible, scalable and encourages innovation allowing us to offer a breadth of assortment in dog and cat food main meal as well as pet treat products under the Halo brand, serving a wide variety of consumer needs, dayparts, and occasions.

The Halo portfolio offers a variety of platforms through which to innovate. Halo Holistic™ is designed for the pet parent seeking complete digestive health with prebiotics, probiotics and postbiotics. Additionally, it’s one of the only brands made with only whole animal proteins and no meat meals. Halo Elevate®, features leading nutrient levels supporting the top five pet parent health concerns including digestive health, heart and immunity support, healthy skin and coat, hip and joint support and strength and energy. Halo Freeze Dried Raw recipes preserve the natural flavor and nutrition of raw food with 100% protein from natural sources.

The Global Pet Food and Treat Market

The U.S. represents the largest and most developed market for pet food globally, with food and treats accounting for approximately $64 billion of total spend in the pet care market in 2023. According to the American Pet Product Association (“APPA”), approximately 63% of all households in the U.S. own a pet, equating to a 180 million adult consumers living in a household with a pet. Pet spending represents a significant portion of household spend on consumer products, as this translates to an average annual spend on pet products of more than $738 in 2023, which represents a 7.4% increase over the previous year.

According to the APPA, consumer spending on pets grew at an approximately 5% compound annual growth rate (“CAGR”) in the decade leading up to the COVID-19 pandemic, with a significant spike during the pandemic, fueled by steady annual increases in household pet ownership, the continued premiumization of the category and the humanization of pets. Pet spending is forecasted to grow at a 15% CAGR between 2020 and 2024, with total pet spending to reach $251 billion by 2030. The surge in pet acquisition has led to an increase in the forecasted growth of the pet care industry over the next ten years. Moreover, according to the APPA, the vegan dog food industry expanded at a CAGR of 2.6% from 2018 to 2022, and it is anticipated that market growth for vegan dog food may continue from 2023 to 2033 at a CAGR of 7%. Human diets with less or no animal meat have gained popularity throughout the preceding decade.

From a demographic perspective, younger pet owners are more likely to spend a higher percentage of their income on pets, treat their pet as an important member of the family and to purchase products from pet specialty and online retailers rather than from grocery stores. Along these lines, women are 3.2 times more interested in purchasing pet food than men, and are 2.4 times more likely to engage with search ads than men. Taken holistically, these traits suggest a preference to purchase more premium and super-premium pet food and treats from brands like Halo, with a tendency to purchase products in the channels where we compete.

Globally, Asia is the second largest market for pet products, with China representing the largest market opportunity for growth. Like the U.S., growth in the Asian pet care industry has been driven by dramatic increases in household pet ownership. The global plant-based pet food market is set to expand its roots in the global market at a promising CAGR of 9.2%, while the market is anticipated to hold a revenue of USD $57.43 billion in 2032. We believe that growth in Asia is fueled by increasing levels of economic financial status and demand for premium, western manufactured products as a result of product quality concerns. This demand has been supported by a rapidly growing middle class in China, where a McKinsey report estimated that in 2018 roughly 730 million people in urban areas fell into the income categories of “aspirants” and “affluents,” with the Brookings group estimating that approximately 60 million people are added to these income categories each year. We believe that this growth drove the increase in the number of dog-owning Chinese households as measured by Euromonitor, which increased from 12% in 2015 to 20% in 2020, according to Euromonitor. 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, suggesting that the Chinese pet market has significant room for growth in the foreseeable future. We are focused on targeting Chinese pet owners with the highest willingness to pay, which tend to be urban dwelling millennial and Gen-Z women. In 2021, 80% of our products were purchased online, and approximately 50% of our end-consumers were born after 1990.

Our Growth Strategy

• Build the Halo Brand with sharpened positioning, improved storytelling, increased share-of-voice, and a defined innovation strategy and platform-based approach to consumer qualified new products
• Capture Fair Share Online via increased and efficient investment, full funnel activation, enhanced discoverability, and maximizing tent-pole events
• Omnichannel Expansion strategy development while maximizing current distribution relationships, expanding independent distributor network, and introducing innovation across core product lines
• Win Globally with scalable go-to-market strategy and long-term partnerships to accelerate growth, with disproportionate focus on asia-pacific while actively pursuing new latin american markets
• Create Fuel for Growth via continuous supply chain improvements, pursuing global formula harmonization for cost savings and improving portfolio efficiency through more effective portfolio managements
• Maximize Operating Leverage to optimize overhead infrastructure for scale efficiency, driving greater governance through financial visibility and KPI tracking with a ruthless focus on working capital

Recent Corporate Developments

On March 2, 2023, we announced that Robert Sauermann was resigning from his role as Chief Operating Officer (“COO”), effective March 17, 2023. On March 21, 2023, we announced that Sharla Cook was resigning from her role as Chief Financial Officer (“CFO”), effective April 3, 2023. Also on March 21, 2023, we announced that Carolina Martinez was appointed as Interim CFO, effective April 3, 2023.

On May 11, 2023, we announced that Lionel F. Conacher was resigning from his role as Interim CEO of the Company, effective May 22, 2023. Mr. Conacher will still continue to serve on the Board as a Director. On May 11, 2023, we announced that Kent Cunningham was appointed as Chief Executive Officer of the Company, effective May 22, 2023.

On August 2, 2023, we announced that Carolina Martinez was appointed as Chief Financial Officer, Treasurer and Secretary of the Company, effective August 7, 2023. On August 28, 2023, we announced that Donald Young, was resigning from his role as Chief Sales Officer of the Company, effective September 8, 2023.

In December 2023, the Company made a strategic exit out of Petco stores (while remaining on Petco.com), and Pet Supplies Plus. As of June 1, 2024, the Company has exited its DTC channel, in an effort to improve profitability. On March 25, 2024, Better Choice Company, Inc. (“BTTR”) initiated a legal action to enforce a right of first refusal (“ROFR”) option exercised by Alphia, Inc. (“Alphia”), which is controlled by a Paris-based private equity firm, PAI Partners. On June 20, 2024, the Company agreed to settlement terms of the lawsuit. The agreement dismisses the Company’s ongoing litigation with Alphia and provides for the forgiveness of the Company’s term loan, including $5.0 million in principal and $0.5 million of payable-in-kind (“PIK”) accrued interest, the termination of 335,640 warrants with a strike price of $11.44 per share that were set to expire in 2028, and the forgiveness of up to $2.6 million in accounts payable due to Alphia, provided the remaining outstanding accounts payable balance is paid within 90 days of the settlement date. These accounts payable were paid and settled prior to September 30, 2024, resulting in a gain of $2.6 million.

The Company was not in compliance with certain covenants related to the Alphia Term Loan Facility as of December 31, 2023 and the debt was callable by the lender. Refer to the Going concern considerations for additional information.

On April 15, 2024, the Company’s board of directors authorized and approved a stock repurchase plan (the “Repurchase Plan”) for up to $5 million of the currently outstanding shares of the Company’s common stock through December 31, 2024. Under the Repurchase Plan, the Company is authorized to repurchase shares through open market purchases, privately negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Exchange Act. The Board also authorized the Company to enter into written trading plans under Rule 10b5-1 of the Exchange Act. Adopting a trading plan that satisfies the conditions of Rule 10b5-1 would allow a company to repurchase its shares at times when it might otherwise be prevented from doing so due to self-imposed trading blackout periods or pursuant to insider trading laws. Under any Rule 10b5-1 trading plan, the Company’s third-party broker, subject to Securities and Exchange Commission regulations regarding certain price, market, volume and timing constraints, would have authority to purchase the Company’s common stock in accordance with the terms of the plan. The Company may from time to time enter into Rule 10b5-1 trading plans to facilitate the repurchase of its common stock pursuant to its Repurchase Plan. The Company has purchased 190 shares of common stock under the Repurchase Plan, during the nine months ended September 30, 2024. The Company does not intend to make any more repurchases of its Common Stock but reserves the right to evaluate the market for the Common Stock and make a determination regarding additional repurchases at that time prior to December 31, 2024.

On April 24, 2024, the Company received a notice of noncompliance from the NYSE American. On May 24, 2024, we submitted a plan of compliance to NYSE American addressing how we intend to regain compliance. The plan has been accepted by the NYSE American. However, if we are not in compliance with the continued listing standards before the end of the cure period, or if we do not make progress consistent with the plan, the NYSE American may take steps to delist our common stock. Further, we received correspondence from the NYSE American on July 9, 2024, indicating noncompliance under a different requirement of the listing standards, since we reported stockholders’ equity of $1.1 million as of March 31, 2024, and had losses from continuing operations and/or net losses in three out of its four most recent fiscal years ended December 31, 2023, and that which requires us to maintain a minimum stockholders’ equity of $4.0 million. We will need to take additional steps to regain compliance under this requirement as well, or the NYSE American may take steps to delist our common stock.

Arrangement Agreement

On September 3, 2024, the Company announced it entered into an Arrangement Agreement (the “Arrangement Agreement”) with SRx Health Solutions, Inc., a corporation organized under the laws of the Province of Ontario (“SRx” or “SRx Health”), 1000994476 Ontario Inc., an indirect wholly-owned subsidiary of the Company and a corporation existing under the laws of the Province of Ontario (“AcquireCo”), and 1000994085 Ontario Inc., a direct wholly-owned subsidiary of the Company and corporation existing under the laws of the Province of Ontario (“CallCo”). Pursuant to the Arrangement Agreement, and the Plan of Arrangement adopted in connection therewith, the Company will acquire SRx in an all-stock transaction pursuant to a statutory amalgamation of SRx and AcquireCo under Canadian law (the “Amalgamation”). As a result of the Amalgamation, all of the property, rights, interests and obligations of SRx shall become the property, rights, interests and obligations of the resulting entity (“Amalco”), and Amalco will be an indirect wholly-owned subsidiary of the Company.

In the Amalgamation, each issued and outstanding common share of SRx will be converted based on the Exchange Ratio (as defined below) into shares of common stock of the Company (“BTTR Common Stock”) or, at the option of the holder thereof, exchangeable shares of Amalco that will be exchangeable at the option of the holder (or under certain other circumstances) on a one-for-one basis for shares of BTTR Common Stock. The Exchange Ratio will be determined five business days prior to the consummation of the Amalgamation (the “Closing”) and will be based on the trailing 30-day volume weighed average price of the Better Choice Common Stock on the NYSE America, subject to an aggregate share collar of 19,750,000 shares and 30,000,000 shares, with any resulting fractional shares to be rounded to the nearest whole share (the “Exchange Ratio”). The Amalgamation assigns an equity value of SRx of U.S. $80 million, assuming net debt at Closing of U.S. $43 million (which will be subject to a two-way adjustment prior to the Closing). All outstanding warrants and restricted stock units of SRx will be converted into common shares of SRx or terminated prior to the Closing.

The transaction has been unanimously approved by the boards of directors of the Company and SRx. The consummation of the Amalgamation is subject to customary closing conditions, including requisite approvals of the stockholders of the Company and SRx and the Ontario Superior Court of Justice (Commercial List), among other required regulatory approvals, and the absence of a material adverse effect with respect to the Company or SRx.

SRx Health operates one of the largest specialty pharmacy networks in Canada with specialty pharmacies, specialty health/infusion clinics, clinical trial sites and wholesale distribution facilities spanning the region. SRx Health is only one of a few specialty pharma operators in Canada with a network that extends across Canada, making it one of the most accessible providers of specialty healthcare in the country. Better Choice will continue to operate its portfolio of established premium and super-premium pet products under the Halo brand. Upon closing, Better Choice will emerge as a leading global health and wellness company by providing products and solutions for families to make better choices. The definitive agreement and announcement of plans for a business combination indicates the intentions of management but does not alter the independent operation status of the entities until the transaction is fully executed and approved.

Results of Operations for the three and nine months ended September 30, 2024 and 2023

The following table sets forth our consolidated results for the periods presented (in thousands):

Net sales

We sell our products through online retailers, pet specialty and independent pet retailers and distributors, internationally to foreign distribution partners (transacted in U.S. dollars), and our website directly to consumers. We offer a variety of trade promotions, discounts and incentives to our customers, which impacts the transaction price of our products and our net sales accordingly. DTC net sales within the Digital channel includes revenue derived from shipping fees and are net of loyalty points earned (a portion of revenue is deferred at the time of the sale as points are earned and not recognized until the redemption of the points, estimated based on historical experience). We record a revenue reserve based on historical return rates to account for customer returns.

Information about our revenue channels is as follows (in thousands):

(1) The Company’s Digital channel includes two wholesale customers that amounted to greater than 10% of the Company’s total net sales for the three and nine months ended September 30, 2024 and 2023, and represented $3.4 million and $10.0 million of net sales for the three and nine months ended September 30, 2024, and $3.1 million and $10.0 million of net sales during the three and nine months ended September 30, 2023, respectively. Additionally, DTC sales within the Digital channel amounted to greater than 10% of the Company’s total net sales for the three and nine months ended September 30, 2023. DTC sales within the Digital channel were approximately $1.3 million and $4.3 million for the three and nine months ended September 30, 2023, respectively. As of June 1, 2024, the Company has exited its DTC channel in an effort to improve profitability. The Company historically reported the sales in this channel as E-commerce and DTC separately and has been consolidated into one revenue stream as of September 30, 2024.

(2) One of the Company’s International customers amounted to greater than 10% of the Company’s total net sales during the three months and nine months ended September 30, 2024 and 2023, and represented $6.0 million and $11.2 million of net sales for the three and nine months ended September 30, 2024, and $6.0 million and $11.0 million of net sales for the three and nine months ended June 30, 2023, respectively.

(3) None of the Company’s Brick & Mortar customers represented greater than 10% of net sales for the three and nine months ended September 30, 2024 or September 30, 2023. For the three and nine months ended September 30, 2023, Petco was included within the Brick & Mortar channel. Beginning in Q1 2024, Petco is presented within Digital as a result of the strategic exit out of Petco stores, while remaining on Petco.com.

Net sales decreased $(1.7) million, or (13)%, to $11.4 million for the three months ended September 30, 2024 compared to $13.1 million for the three months ended September 30, 2023. Net sales decreased $(5.1) million, or (15)%, to $27.8 million for the nine months ended September 30, 2024 compared to $32.9 million for the nine months ended September 30, 2023. The decrease in net sales for the three and nine months ended September 30, 2024 is primarily attributable to strategically exiting unprofitable customers in the Brick & Mortar channel at the end of 2023 and the shutdown of the DTC revenue stream in the second quarter of 2024.

Key factors that we expect to affect our future sales growth include new product innovation and launches, our expansion strategy in each of the sales channels and our key supplier relationships.

Gross profit

Cost of goods sold consists primarily of the cost of product obtained from co-manufacturers, packaging materials, freight costs for shipping inventory to the warehouse, as well as third-party warehouse and order fulfillment costs. We review inventory on hand periodically to identify damaged, slow-moving inventory, and/or aged inventory. Based on this analysis, we record inventories at the lower of cost or net realizable value, with any reduction in value expensed as cost of goods sold.

Our products are manufactured to our specifications by our co-manufacturers using raw materials. We work with our co-manufacturers to secure a supply of raw materials that meet our specifications. In addition to procuring raw materials that meet our formulation requirements, our co-manufacturers manufacture, test and package our products. We design our packaging for our co-manufacturers and the packaging is shipped directly to them.

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.

During the three months ended September 30, 2024, gross profit increased $0.1 million, or 2%, to $4.5 million compared to $4.4 million during the three months ended September 30, 2023. During the nine months ended September 30, 2024, gross profit decreased $(0.9) million, or (8)%, to $10.4 million compared to $11.3 million during the nine months ended September 30, 2023.

Gross margin increased 591 basis points to 40% for the three months ended September 30, 2024 compared to 34% for the three months ended September 30, 2023. Gross margin increased 308 basis points to 37% for the nine months ended September 30, 2024 compared to 34% for the nine months ended September 30, 2023. The increase in gross margin for the three and nine months ended September 30, 2024 is primarily attributable to improved pricing from our manufacturers, and a shift in product sales mix due to efficient portfolio rationalization.

We continue to actively work with our co-manufacturing and freight partners to generate future cost savings and realize improved gross margins in future periods. We could see continued margin variability due to the current economic environment and pricing pressures due to inflationary costs for both transportation and raw materials. We will continue to refine and optimize our overall pricing strategy as we evaluate the future impact of inflation and align ourselves with the market.

Operating expenses

Our Selling, general and administrative (“SG&A”) expenses consist of the following:

• Sales and marketing costs, for specific customer promotional programs, paid media, content creation expenses and our DTC selling platform. Marketing costs are geared towards customer acquisition and retention and building brand awareness. During the three months ended September 30, 2024, sales and marketing costs decreased approximately $(0.4) million or (14)%, to $2.4 million from $2.8 million during the three months ended September 30, 2023. During the nine months ended September 30, 2024, sales and marketing costs decreased approximately $(2.1) million or (30)%, to $4.9 million from $7.0 million during the nine months ended September 30, 2023. The decrease was driven primarily by lower marketing and advertising agency fees related to the Halo brand renovation and migration from the former TruDog brand, as well as decreased marketing support to our International sales channel.
• Employee compensation and benefits decreased approximately $(0.3) million or (20)% during the three months ended September 30, 2024 to $1.2 million from $1.5 million during the three months ended September 30, 2023. Employee compensation and benefits decreased approximately $(0.9) million or (20)% during the nine months ended September 30, 2024 to $3.8 million from $4.7 million during the nine months ended September 30, 2023. The decrease was primarily related to a reduction in employee headcount, partially offset by higher severance costs during the first half of 2024.
• Share-based compensation includes expenses related to equity awards issued to employees and non-employee directors. During the three months ended September 30, 2024, Share-based compensation decreased $(0.4) million or (82)% to $0.1 million compared to $0.5 million for the three months ended September 30, 2023. During the nine months ended September 30, 2024, Share-based compensation decreased by $(0.8) million, or (53)%, to $0.8 million, as compared to share-based compensation of $1.6 million during the nine months ended September 30, 2023. The decrease is driven by January 2023 grants which became fully vested in January 2024, resulting in a decrease to share-based compensation, partially offset by common stock issued for board service.
• Freight, which is primarily related to the shipping of DTC orders to customers, decreased $(0.3) million or (96)% during the three months ended September 30, 2024 to $0.01 million compared to $0.3 million during the three months ended September 30, 2023. Freight decreased $(0.5) million or (51)% during the nine months ended September 30, 2024 to $0.5 million from $1.0 million during the nine months ended September 30, 2023. Freight costs have been generally decreasing due to lower DTC sales as described above. The DTC channel was shut down as of June 1, 2024, which contributed to the decrease in freight costs for the three and nine months ended September 30, 2024.
• Non-cash charges including depreciation, amortization, disposal or sale of assets and bad debt expense decreased by $(0.4) million or (89)% to $0.05 million during the three months ended September 30, 2024 from $0.4 million during the three months ended September 30, 2023. Non-cash charges were $0.2 million and $1.3 million during the nine months ended September 30, 2024 and September 30, 2023, respectively. The decrease was driven by the full impairment of intangible assets as of December 31, 2023.
• Other general and administrative costs for various general corporate expenses, including professional services, information technology, insurance, travel, costs related to merchant credit card fees, product development costs, rent, and certain tax costs. During the three months ended September 30, 2024, other general and administrative costs increased $0.4 million, or 24% to $1.9 million compared to $1.5 million during the three months ended September 30, 2023. During the nine months ended September 30, 2024, other general and administrative costs increased $0.5 million, or 11% to $4.5 million compared to $4.0 million during the nine months ended September 30, 2023. The increase for the three and nine months ended September 30, 2024 was driven by an increase in transaction-related and litigation-related legal fees.

Interest expense, net

During the three months ended September 30, 2024, interest expense decreased by $(0.4) million, or (102)% to $0.0 million from $(0.3) million for the three months ended September 30, 2023. During the nine months ended September 30, 2024, interest expense decreased by $(0.4) million, or (44)% to $(0.5) million from $(1.0) million for the nine months ended September 30, 2023. Interest expense for the nine months ended September 30, 2024 is comprised of interest on our Wintrust Receivables Credit Facility, Alphia Term Loan, the amortization of debt issuance costs, and interest accretion on the Alphia Term Loan. The decrease in interest expense for the three and nine months ended September 30, 2024 is related to the forgiveness of the Alphia Term Loan, as discussed in Note 8 - Debt.

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 they arise. During the three and nine months ended September 30, 2024, we recorded income tax expense of less than $0.01 million, which relates to the gain on extinguishment of debt. During the three and nine months ended September 30, 2023 we recorded income tax expense of less than $0.1 million, which related to indefinite-lived assets. The effective tax rate for the nine months ended September 30, 2024 was less than 1%, which differs from the U.S. Federal statutory rate of 21% primarily because our losses have been fully offset by a valuation allowance due to uncertainty of realizing the tax benefit of NOLs.

Liquidity and capital resources

Historically, we have financed our operations primarily through the sales of shares of our common stock, warrants, preferred stock, and loans. In connection with our July 2024 public offering, we issued and sold 739,000 shares of common stock at a public offering price of $3.00 per share and pre-funded warrants to issue 1,028,000 shares of Common Stock at a public offering price of $2.99 per Pre-Funded Warrant. On September 30, 2024 and December 31, 2023, we had cash and cash equivalents of $4.7 million and $4.5 million, respectively.

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 our products, the successful protection of our proprietary technologies, ability to grow into new markets, and compliance with government regulations. As of September 30, 2024, we have not experienced a significant adverse impact to our business, financial condition or cash flows resulting from geopolitical actions or threat of cyber-attacks. However, we have seen adverse impacts to our gross margin from time to time due to inflationary pressures in the current economic environment. Uncertainties regarding the continued economic impact of inflationary pressures, geopolitical actions and threat of cyber-attacks 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 expect to continue to generate operating losses and consume cash resources in the near term. These conditions raise substantial doubt about our ability to continue as a going concern for a period of twelve months from the date these interim condensed consolidated financial statements are issued, meaning that we may be unable to generate sufficient operating cash flows to pay our short-term obligations. We have implemented and continue to implement plans to achieve operating profitability, including various margin improvement initiatives, the consolidation of and introduction of new co-manufacturers, the optimization of our pricing strategy and ingredient profiles, and new product innovation.

Our ability to raise additional capital may be adversely impacted by the potential worsening of global economic conditions, including inflationary pressures, he recent disruptions to, and volatility in, the credit and financial markets in the United States and worldwide resulting from geopolitical tensions. 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.

A summary of our cash flows is as follows (in thousands):

Cash flows from operating activities

Cash used in operating activities increased by $2.3 million, or 257%, during the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. The increase in cash used was primarily driven by the $6.2 million gain recognized on extinguishment of the Alphia term loan as well as significant fluctuations in our working capital, including a comparative decrease in accounts payable of $5.9 million. These increases in cash used were partially offset by a decrease in net loss of $9.4 million, or 117%, to net income of $1.3 million.

Cash flows from investing activities

Cash used in investing activities was $1.5 million during the nine months ended September 30, 2024. The cash used in investing activities related to the issuance of a $1.5 million note receivable, there were also capital expenditures of less than $0.1 million. Cash used in investing activities was less than $0.1 million during the nine months ended September 30, 2023. The cash used in investing activities is related to capital expenditures.

Cash flows from financing activities

Cash provided by financing activities was $5.0 million, during the nine months ended September 30, 2024 and cash used in financing activities was $(4.8) million during the nine months ended September 30, 2023. The cash provided by financing activities for the nine months ended September 30, 2024 was related to net proceeds from the Equity Offering of $4.8 million and proceeds from the Wintrust revolving line of credit of $9.0 million, offset by payments on the Wintrust revolving line of credit of $(8.8) million. The cash used in financing activities for the nine months ended September 30, 2023 was related to payment of the Wintrust revolving line of credit of $(16.3) million offset by proceeds from the Wintrust revolving line of credit of $6.8 million and $2.8 million from the Alphia facility and proceeds of $2.2 million from warrant liabilities.

Wintrust Receivables Credit Facility

On June 21, 2023, the Company entered into an account purchase agreement with Wintrust Receivables Finance, a division of Wintrust Bank N.A. (“Wintrust”) pursuant to which Wintrust will purchase, at its discretion, eligible customer invoices and advance up to 70% of the face amount of all purchased amounts up to $4,750,000. Each advance under the AP Agreement will bear interest at the U.S. prime rate, plus 2.5%. The AP Agreement has an initial term of two years and will automatically renew annually unless terminated by the Company on at least 60 days’ notice. The Wintrust Receivables Credit Facility is secured by a general security interest in the assets of the Company. The Wintrust Receivables Credit Facility is guaranteed secured by the Company pursuant to that certain Unlimited Continuing Guaranty Agreement dated as of June 21, 2023.

As of September 30, 2024, the balance outstanding on the Wintrust Receivables Credit Facility amounted to $1.9 million.

Alphia Term Loan

On June 21, 2023, the Company entered into a term loan credit agreement with Alphia Inc., a leading custom manufacturer of super-premium pet food in the U.S. Pursuant to the Term Loan Agreement, Alphia made a term loan to the Company in the original principal amount of $5,000,000 (the “Term Loan”). The Term Loan is also evidenced by that certain Term Note dated as of June 21, 2023 issued by the Company to Alphia (the “Term Note”). The proceeds of the Term Loan, together with a portion of the Company’s cash on hand, were used to retire all of the outstanding obligations of Halo, Purely for Pets, Inc. (“Halo”), a wholly-owned subsidiary of the Company, under Halo’s long-term credit facility with Old Plank Trail Community Bank, N.A., an affiliate of Wintrust Bank, N.A.

As described in Note 8 - Debt, on March 25, 2024, the Company initiated a legal action to enforce a right of first refusal option exercised by Alphia pursuant to the terms of a written agreement between Alphia and the Company whereby Alphia was to acquire the assets of Halo. On June 20, 2024, the Company agreed to settlement terms of the lawsuit. The agreement dismisses the Company’s ongoing litigation with Alphia and provides for the forgiveness of the Company’s term loan, including $5.0 million in principal and $0.5 million of payable-in-kind (“PIK”) accrued interest, the termination of 335,640 warrants with a strike price of $11.44 per share that were set to expire in 2028, and the forgiveness of up to $2.6 million in accounts payable due to Alphia, provided the remaining outstanding accounts payable balance is paid within 90 days of the settlement date.

As a result of the settlement terms described above, we are not indebted to Alphia as it relates to the Term Loan Facility as of September 30, 2024.

Contractual Commitments and Obligations

We are contractually obligated to make future cash payments for various items, including debt arrangements, certain purchase obligations, as well as the lease arrangement for our office. See “Note 8 - Debt” to our interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for more information about our debt obligations. Our purchase obligations include certain ongoing marketing projects, 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 Quarterly Report on Form 10-Q.

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 unaudited condensed consolidated financial statements and related disclosures requires us to make estimates, assumptions and judgements 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 in our Annual Report for the year ended December 31, 2023 have the greatest potential impact on our financial statements and, therefore, we consider these to be our critical accounting estimates. Accordingly, we evaluate our estimates and assumptions on an ongoing basis, especially in light of recent economic volatility, and may adjust projections if market conditions change. Our actual results may differ from these estimates under different assumptions and conditions. There have been no material changes to our critical accounting estimates compared to the descriptions in our Annual Report for the year ended December 31, 2023.

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 13 - Share-based compensation” of the Company’s Annual Form 10-K. 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 13 - Share-based compensation” of the Company’s Annual Form 10-K. 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.

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

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of management, including our Chief Executive Officer (our Principal Executive Officer or “PEO”) and our Chief Financial Officer (our Principal Financial Officer or “PFO”), we evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, because of the material weaknesses in our internal control over financial reporting described in our Annual Report on Form 10-K for the year ended December 31, 2023, our disclosure controls and procedures were not effective as of September 30, 2024. We are actively remediating these weaknesses, with ongoing improvements being made to the design and operating effectiveness of our internal controls.

Notwithstanding the material weaknesses in our internal control over financial reporting, we have concluded that the condensed consolidated financial statements included in this Form 10-Q, when read with the notes thereto, present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America.

Material Weaknesses

We previously reported three material weaknesses in the design and operation of our internal control over financial reporting that were identified in connection with the audit of our fiscal year 2023 consolidated financial statements. A “material weakness” is defined under SEC rules as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis by the Company’s internal controls. The material weaknesses relate to (i) failure to maintain controls over the operating effectiveness of cybersecurity and IT general controls; (ii) insufficient policies and procedures to review, analyze, account for and disclose complex transactions; (iii) failure to design and maintain controls over the operating effectiveness of revenue recognition controls.

Remediation of Prior Year Material Weaknesses

Cybersecurity and IT General Controls

To remediate the material weakness associated with failure to maintain controls over the operating effectiveness of cybersecurity and IT general controls, we have (i) fully transitioned to a new managed IT service provider with an appropriate level of knowledge and technical experience to design and maintain cybersecurity and IT general controls; (ii) established policies and procedures for the design and operation of IT generals controls and manual controls to prevent cybersecurity breaches, such as multi-factor authentication implemented and enforced, anti-virus and anti-malware software suites installed, a cybersecurity training platform for all employees through the industry leading KnowBe4 platform, and the dual approval of vendor payments and wiring instructions; (iii) sustained operation of our controls over a period that is appropriate in order to conclude that the controls are operating effectively.

Accounting for Complex Transactions

To remediate the material weakness associated with accounting for complex transactions, we have implemented sufficient policies and procedures to review, analyze, account for and disclose the following complex transactions in 2024: (i) Acquisition of Aimia (Note 9 - Business Combinations), (ii) extinguishment of the Alphia Term Loan (Note 8 - Debt), (iii) the July 2024 public offering (Note 1 - Nature of business and summary of significant accounting policies) which included issuance of warrants (Note 12 - Warrants), and (iv) the issuance of convertible notes (Note 4 – Note receivable). To address the material weakness in internal controls related to the accounting for complex accounting transactions, we have (i) added resources responsible for the execution and oversight of accounting and financial reporting operations; (ii) expanded the use of specialist involvement in highly complex and technical areas of accounting and valuation; and (iii) sustained operation of the implemented controls over a period of time that is appropriate in order to conclude that controls related to complex transactions are operating effectively.

Remediation Plan

Revenue Recognition

To address the material weakness in internal controls related to the revenue recognition, we continue to evaluate the design and operating effectiveness controls supporting revenue recognition and are in the process of enhancing certain controls over revenue, including adding resources and training programs addressing the design, implementation, and documentary evidence requirement of control procedures over revenue recognition for appropriate personnel.

Although we implemented measures and plan to implement additional measures to remedy our internal control deficiencies, there can be no assurance that our efforts will be successful. In addition, until the remediation steps have been completed and operated for a sufficient period of time, and subsequent evaluation of their effectiveness is completed, the material weaknesses identified and described above will continue to exist.

Changes in Internal Control Over Financial Reporting

We completed one acquisition for an aggregate purchase price of $0.4 million during the nine months ended September 30, 2024. The Company continues to evaluate the internal control environment of the acquired entity and has not yet concluded on the integration and effectiveness of internal controls. Our assessment is ongoing to ensure that all controls are appropriately aligned and integrated with our existing framework. The acquisition represents less than 1% of our consolidated total assets and has no revenues as of and for the nine months ended September 30, 2024, respectively.

Our remediation efforts were ongoing during the quarter ended September 30, 2024. Except for our ongoing remediation efforts of the material weaknesses described above, and the remediation of our material weaknesses related to cybersecurity and IT general controls and accounting for complex transactions, there were no changes in our internal control over financial reporting that occurred during the quarter-ended September 30, 2024 that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors described under the heading “Risk Factors” in our Annual Report filed on March 28, 2023. While we believe there have been no material changes from the risk factors previously disclosed, you should carefully consider, in addition to the other information set forth in this report, the risk factors discussed in our Annual Report that could materially affect our business, financial condition or future results. The risks described in our Annual Report are not the only risks facing our Company. In addition to risks and uncertainties inherent in forward-looking statements contained in this Quarterly Report, additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.