Sow Good Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our financial statements and notes to those statements. In addition to historical information, the following discussion and other parts of this annual report contain forward-looking information that involves risks and uncertainties. Overview and Outlook Effective January 21, 2021, we changed our name from Black Ridge Oil & Gas, Inc. to Sow Good Inc. Our common stock is quoted on the OTCQB under the trading symbol “SOWG”. During 2021, the Company launched a line of freeze-dried snacks, smoothies, soups and granola. We are marketing our line of products via our direct-to-consumer focused website, as well as via the business-to-business sales channel. Our business operates under two distinct brands, Sow Good and Sustain Us. Our unique food products are target the large, and growing, freeze-dried food products market. The global freeze-dried food products market is estimated by Technavio to total nearly $60B in 2020, with the United States representing almost 30% of the total. Technavio further projects market growth to continue at over 8% per year through 2024. With the extensive freeze-dried manufacturing and food product-focused business development experience of our senior management team, including recent additions, we believe we are well positioned to lead the Company's growth and development in the freeze-dried food industry. 12 S-FDF Business Combination On October 1, 2020, the Company completed its acquisition of S-FDF, LLC (the "Seller"), a Texas limited liability company, pursuant to an Asset Purchase Agreement, between the Company and the Seller, dated June 9, 2020, as subsequently amended effective October 1, 2020. In connection with the closing of the Asset Purchase Agreement, the Company acquired approximately $2.2 million in cash and certain assets and agreements related to the Seller’s freeze-dried fruits and vegetables business for human consumption and entered into certain employment and registration rights agreements. The Company did not assume any liabilities of Seller or any liabilities, liens, or encumbrances pertaining to or encumbering the Purchased Assets, except for those related to agreements or arrangements specified in the Asset Purchase Agreement. The Seller transferred the Purchased Assets to the Company in exchange for the issuance of 1,120,000 shares of the Company’s common stock to the Seller. The number of shares to be issued to Seller was subject to adjustment, as specified in the Asset Purchase Agreement, as amended, based on the extent to which the amount of cash proceeds held by the Company, as derived from the sale of the Company’s holdings of AESE Shares, were less than $5 million or greater than $6 million on the date specified in the Asset Purchase Agreement, which resulted in the issuance of an additional 500,973 Seller Shares that were issued on January 4, 2021. The combined issuances represented approximately 46% of the Company’s issued and outstanding common stock, on a fully diluted basis. Black Ridge Oil & Gas, Inc. was determined to be the acquiror of the business combination. Pursuant to its obligations under the Asset Purchase Agreement, on the Closing Date the Company, (a) created three new seats on the Company’s Board of Directors and appointed the Seller’s principals, Ira Goldfarb and Claudia Goldfarb, and a third person designated by the Goldfarbs, Greg Creed, as directors, (b) entered into employment agreements with Ira Goldfarb and Claudia Goldfarb, (c) delivered a registration rights agreement with respect to the shares to be issued to Seller and any shares of common stock delivered as part of the employment compensation for Ira Goldfarb or Claudia Goldfarb, and (d) amended the Company’s 2020 Stock Incentive Plan to increase the number of shares of common stock reserved thereunder. At closing, the Company also assumed the Seller’s obligations under a real property lease for its facility in Irving, Texas under which an entity owned entirely by Ira Goldfarb is the landlord. Going Concern Uncertainty As of December 31, 2021, the Company had a cash balance of $3,345,928 and total working capital of $4,488,207. We are too early in our development stage to project revenue with a necessary level of certainty; therefore, we may not have sufficient funds to sustain our operations for the next twelve months and we may need to raise additional cash to fund our operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company has commenced sales and continues to develop its operations. In the event sales do not materialize at the expected rates, management would seek additional financing or would attempt to conserve cash by further reducing expenses. There can be no assurance that we will be successful in achieving these objectives. We continue to pursue sources of additional capital through various financing transactions or arrangements, including equity financing or other means. We may not be successful in identifying suitable funding transactions in a sufficient time period or at all, and we may not obtain the capital we require by other means. If we do not succeed in raising additional capital, our resources may not be sufficient to fund our business. Our ability to scale production and distribution capabilities and further increase the value of our brands, is largely dependent on our success in raising additional capital. The report of the Company’s independent registered public accounting firm that accompanies its audited financial statements in this Annual Report on Form 10-K contains an explanatory paragraph regarding the substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of the going concern uncertainty. 13 Overview of 2021 results Our 2021 results were largely dominated by the completion of our freeze drier and manufacturing facility, the commencement of product sales on our direct-to-consumer websites, and building the management capacity of the Company to support anticipated sales growth. We earned $88,440 of revenue in 2021 following the launch of our direct-to-consumer website for our Sow Good brand in the second quarter of the year. Our general and administrative expenses totaled $6,906,606 in 2021, with Salaries and Benefits expenses of $3,473,661 representing the majority. Salaries and Benefits expenses increased throughout the year as the Company added employees necessary to support growing the business beyond 2021, and a goodwill impairment loss of $1,524,030 on our prior year acquisition of S-FDF, LLC. Our stock-based compensation of $1,377,379 consisted of $814,047 of stock issued to officers and directors, $20,000 of stock issued to employees and consultants, and $543,332 of expense related to the amortization of stock options. Application of Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to impairment of property, plant and equipment, intangible assets, deferred tax assets and fair value computation using the Black Scholes option pricing model. We base our estimates on historical experience and on various other assumptions, such as the trading value of our common stock and estimated future undiscounted cash flows, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that our estimates, including those for the above-described items, are reasonable. Critical Accounting Policies The establishment and consistent application of accounting policies is a vital component of accurately and fairly presenting our financial statements in accordance with generally accepted accounting principles in the United States (GAAP), as well as ensuring compliance with applicable laws and regulations governing financial reporting. While there are rarely alternative methods or rules from which to select in establishing accounting and financial reporting policies, proper application often involves significant judgment regarding a given set of facts and circumstances and a complex series of decisions. Cash in Excess of FDIC Insured Limits The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. Accounts are guaranteed by the Federal Deposit Insurance Corporation (FDIC) and the Securities Investor Protection Corporation (SIPC) up to $250,000 and $500,000, respectively, under current regulations. The Company had approximately $2,813,000 and $1,311,000 in excess of FDIC and SIPC insured limits at December 31, 2021 and 2020, respectively. The Company has not experienced any losses in such accounts. 14 Property and Equipment Property and equipment are stated at the lower of cost or estimated net recoverable amount. The cost of property, plant and equipment is depreciated using the straight-line method based on the lesser of the estimated useful lives of the assets or the lease term based on the following life expectancy: Software 3 years, or over the life of the agreement Website 3 years Office equipment 5 years Furniture and fixtures 5 years Machinery and equipment 7-10 years Leasehold improvements Fully extended lease-term Repairs and maintenance expenditures are charged to operations as incurred. Major improvements and replacements, which extend the useful life of an asset, are capitalized and depreciated over the remaining estimated useful life of the asset. When assets are retired or sold, the cost and related accumulated depreciation and amortization are eliminated and any resulting gain or loss is reflected in operations. Depreciation expense was $208,448 and $3,642 for the years ended December 31, 2021 and 2020, respectively. Impairment of Long-Lived Assets Long-lived assets held and used by the Company are reviewed for possible impairment whenever events or circumstances indicate the carrying amount of an asset may not be recoverable or is impaired. Recoverability is assessed using undiscounted cash flows based upon historical results and current projections of earnings before interest and taxes. Impairment is measured using discounted cash flows of future operating results based upon a rate that corresponds to the cost of capital. Impairments are recognized in operating results to the extent that carrying value exceeds discounted cash flows of future operations. Our intellectual property is comprised of indefinite-lived brand names acquired and have been assigned an indefinite life as we currently anticipate that these brand names will contribute cash flows to the Company perpetually. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Inventory Inventory, consisting of raw materials, material overhead, labor, and manufacturing overhead, are stated at the average cost or net realizable value and consist of the following: December 31, December 31, 2021 2020 Finished goods $ 273,135 $ – Packaging materials 95,436 – Work in progress 613,063 – Raw materials 470,263 141,371 Total inventory $ 1,451,897 $ 141,371 No reserve for obsolete inventories has been recognized. We have not yet commenced significant production. 15 Goodwill The Company evaluates goodwill on an annual basis in the fourth quarter or more frequently if management believes indicators of impairment exist. Such indicators could include, but are not limited to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, management conducts a quantitative goodwill impairment test. The impairment test involves comparing the fair value of the applicable reporting unit with its carrying value. The Company estimates the fair values of its reporting units using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The Company’s evaluation of goodwill completed during the year resulted in an impairment loss of $1,524,030 for the year ended December 31, 2021. Revenue Recognition The Company recognizes revenue in accordance with ASC 606 — Revenue from Contracts with Customers (“ASC” 606”). Under ASC 606, the Company recognizes revenue from the sale of its freeze-dried food products, in accordance with a five-step model in which the Company evaluates the transfer of promised goods or services and recognizes revenue when customers obtain control of promised goods or services in an amount that reflects the consideration which the Company expects to be entitled to receive in exchange for those goods or services. To determine revenue recognition for the arrangements that the Company determines are within the scope of ASC 606, the Company performs the following five steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The Company has elected, as a practical expedient, to account for the shipping and handling as fulfillment costs, rather than as a separate performance obligation. Revenue is reported net of applicable provisions for discounts, returns and allowances. Methodologies for determining these provisions are dependent on customer pricing and promotional practices. The Company records reductions to revenue for estimated product returns and pricing adjustments in the same period that the related revenue is recorded. These estimates are based on industry-based historical data, historical sales returns, if any, analysis of credit memo data, and other factors known at the time. Stock-Based Compensation The Company accounts for equity instruments issued to employees in accordance with the provisions of ASC 718 Stock Compensation (ASC 718) and Equity-Based Payments to Non-employees pursuant to ASC 2018-07 (ASC 2018-07). All transactions in which the consideration provided in exchange for the purchase of goods or services consists of the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty’s performance is complete or the date at which a commitment for performance by the counterparty to earn the equity instruments is reached because of sufficiently large disincentives for nonperformance. Stock-based compensation was $1,377,379 and $726,656 for the years ended December 31, 2021 and 2020, respectively. Stock-based compensation consisted of $834,047 and $268,608 related to the issuance of shares of common stock for services for the years ended December 31, 2021 and 2020, respectively. Amortization of the fair values of stock options issued for services and compensation totaled $543,332 and $458,048 for the years ended December 31, 2021 and 2020, respectively. The fair values of stock options were determined using the Black-Scholes options pricing model and an effective term of 6 to 6.5 years based on the weighted average of the vesting periods and the stated term of the option grants and the discount rate on 5 to 7 year U.S. Treasury securities at the grant date and are being amortized over the related implied service term, or vesting period. In addition, $377,440 of expenses related to the amortization of warrants issued in consideration of personal guarantees provided for debt financing, using the Black-Scholes options pricing model and an effective term of 5 years based on the weighted average of the vesting periods and the stated term of the warrant grants and the discount rate on 5 year U.S. Treasury securities at the grant date were recognized as interest expense for the year ended December 31, 2020. 16 Results of Operations for the Years Ended December 31, 2021 and 2020. The following table summarizes selected items from the statement of operations for the years ended December 31, 2021 and 2020. Years Ended December 31, Increase/ 2021 2020 Decrease Revenues $ 88,440 $ – $ 88,440 Cost of goods sold 81,311 – 81,311 Gross Profit 7,129 – 7,129 Operating expenses: General and administrative: Salaries and benefits 3,473,661 2,203,780 1,269,881 Professional services 357,945 451,125 (93,180 ) Other general and administrative 1,550,970 350,875 1,200,095 Goodwill impairment 1,524,030 – 1,524,030 Total general and administrative 6,906,606 3,005,780 3,900,826 Depreciation and amortization 208,448 3,642 204,806 Total operating expenses: 7,115,054 3,009,422 4,105,632 Net operating loss (7,107,925 ) (3,009,422 ) 4,098,503 Other income: Interest expense (5,911 ) (386,164 ) (380,253 ) Other income – 5,045 (5,045 ) Loss on disposal of property and equipment (8,036 ) (5,369 ) 2,667 Gain on early extinguishment of debt 113,772 – 113,772 Gain (loss) on investment in Allied Esports Entertainment, Inc. 133,944 (1,925,029 ) 2,058,973 Total other income (expense) 233,769 (2,311,517 ) 2,545,286 Net loss $ (6,874,156 ) $ (5,320,939 ) $ 1,553,217 Revenues Revenues commenced during the year ended December 31, 2021, which were generated by online sales of our freeze-dried foods products. The revenues were $88,440 for the year ended December 31, 2021. The Company did not earn any revenues during the comparative year ended December 31, 2020. We anticipate increased revenues during 2022, although there can be no assurance regarding the amount of such increased revenues. 17 Cost of Goods Sold Cost of goods sold for the year ended December 31, 2021 were $81,311, primarily consisting of material costs and labor on the sales of freeze-dried food products, resulting in a gross profit of approximately 8% during the period. The Company did not have any cost of goods sold during the comparative year ended December 31, 2020. General and Administrative Expenses Salaries and Benefits Salaries and benefits for the year ended December 31, 2021 were $3,473,661, compared to $2,203,780 for the year ended December 31, 2020, an increase of $1,269,881, or 58%. Salaries and benefits included stock-based compensation expense of $1,377,379 for the year ended December 31, 2021, compared to $726,656 for the year ended December 31, 2020, an increase of $650,723, or 90%. Stock-based compensation consists of $543,332 and $458,048 of stock options expense incurred in the years ended December 31, 2021 and 2020, respectively, and $834,047 and $268,608 of expense related to shares of common stock issued to officers and consultants for services rendered in the years ended December 31, 2021 and 2020, respectively. The increase in salaries and benefits was primarily due to increased operations as we developed our freeze-dried food operations and stock-based compensation, as management accepted stock-based compensation in lieu of cash. Professional Services General and administrative expenses related to professional services were $357,945 for the 2021 period, compared to $451,125 for the 2020 period, a decrease of $93,180, or 21%. The decrease was primarily due to decreased legal costs that were not necessary in the current year, compared to those incurred on our asset purchase agreement with S-FDF, LLC in the prior year. Other General and Administrative Expenses Other general and administrative expenses for the year ended December 31, 2021 were $1,550,970, compared to $350,875 for the year ended December 31, 2020, an increase of $1,200,095, or 342%. The increase is primarily attributable to increased administrative infrastructure as we seek to scale the production and sales of our freeze-dried products. Goodwill Impairment Goodwill impairment expense for the year ended December 31, 2021 was $1,524,030, compared to $-0- for the year ended December 31, 2020. In 2021, the Company recognized a $1,524,030 loss on impairment of goodwill related to our prior year acquisition of S-FDF, LLC. Depreciation Depreciation expense for the year ended December 31, 2021 was $208,448, compared to $3,642 for year ended December 31, 2020. The increase is attributable to the significant increase in capital expenditures incurred as we developed our freeze-dried foods production facility and placed it into service. Other Income (Expense) In the year ended December 31, 2021, other income was $233,769, consisting of a gain on early extinguishment of debt of $113,772 related to forgiveness of our PPP loan and a net gain on investments in Allied Esports Entertainment, Inc. securities of $133,944, as offset by $5,911 of interest expense derived from operating loans, and a loss on the disposal of equipment of $8,036. In the year ended December 31, 2020, other expense was $2,311,517, consisting of $386,164 of interest expense derived from operating loans, including $377,440 of warrants issued as consideration to officers and directors in exchange for their personal guarantees, a loss on the disposal of equipment of $5,369, and a net loss on investments in Allied Esports Entertainment, Inc. securities of $1,925,029, as offset by a $5,000 grant from the Small Business Administration under their EIDL program and $45 of interest income. 18 Provision for Income Taxes The Company had no income tax expense in the 2021 or 2020 periods, as the Company continues to reserve against any deferred tax assets due to the uncertainty of realization of any benefit. Net Loss Net loss for the year ended December 31, 2021 was $6,874,156, compared to $5,320,939 during the year ended December 31, 2020, an increase of $1,553,217, or 29%. The increased net loss was primarily due to our loss on impairment of goodwill related to our prior year acquisition of S-FDF, LLC. Liquidity and Capital Resources The following table summarizes our total current assets, liabilities and working capital at December 31, 2021 and 2020. December 31, 2021 2020 Current Assets $ 4,891,264 $ 2,390,944 Current Liabilities $ 403,057 $ 622,791 Working Capital $ 4,488,207 $ 1,768,153 As of December 31, 2021, we had working capital of $4,488,207. The following table summarizes our cash flows during the years ended December 31, 2021 and 2020, respectively. Years Ended December 31, 2021 2020 Net cash used in operating activities $ (5,551,261 ) $ (1,743,409 ) Net cash provided by (used in) investing activities (653,051 ) 3,284,457 Net cash provided by financing activities 7,637,511 262,925 Net change in cash and cash equivalents $ 1,433,199 $ 1,803,973 Net cash used in operating activities was $5,551,261 and $1,743,409 for the years ended December 31, 2021 and 2020, respectively, a year over year increased use of $3,807,852. The increased use was primarily due to an increased net loss of $1,553,217. Changes in working capital from continuing operating activities resulted in a decrease in cash of $1,547,282 during the year ended December 31, 2021, as compared to an increase in cash of $340,735 for the same period in the previous year. 19 Net cash used in investing activities was $653,051 for the year ended December 31, 2021, compared to $3,284,457 of net cash provided by investing activities for the year ended December 31, 2020. During the year ended December 31, 2021, cash used in investing activities consisted of $982,818 paid for the purchase of property and equipment and $84,594 paid for the purchase of intangible assets, as offset by $414,361 of proceeds received from the sale of AESE securities. During the year ended December 31, 2020, cash provided by investing activities consisted of $1,154,459 of cash received pursuant to our business combination with S-FDF, LLC, and $3,181,735 of proceeds received from the sale of AESE securities, as offset by $257,626 of equipment purchases and $794,111 paid on construction projects still in progress. Net cash provided by financing activities was $7,637,511 and $262,925 for the years ended December 31, 2021 and 2020, respectively. Net cash provided by financing activities consisted of $2,075,000 of proceeds received from related party debt financing, and $5,562,511 we raised from the sale of an aggregate 631,250 shares of the Company’s common stock at $4.00 per share, and the sale of an aggregate 714,701 shares sold at $4.25 per share, during the year ended December 31, 2021. Net cash provided by financing activities consisted of $802,025 of proceeds received from debt financing, including $112,925 of proceeds received under the Paycheck Protection Program (“PPP”) that were forgiven in January of 2021, as offset by $539,100 of debt repayments for the year ended December 31, 2020. Satisfaction of our cash obligations for the next 12 months As of December 31, 2021, our balance of cash and cash equivalents was $3,345,928 and we had total working capital of $4,488,207. We are too early in our development stage to project revenue with a necessary level of certainty; therefore, we may not have sufficient funds to sustain our operations for the next twelve months and we may need to raise additional cash to fund our operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company has commenced sales and continues to develop its operations. In the event sales do not materialize at the expected rates, management would seek additional financing or would attempt to conserve cash by further reducing expenses. There can be no assurance that we will be successful in achieving these objectives. We continue to pursue sources of additional capital through various financing transactions or arrangements, equity or debt financing or other means. Our ability to scale production and distribution capabilities and further increase the value of our brands, is largely dependent on our success in raising additional capital. We may not be successful in identifying suitable funding transactions in a sufficient time period or at all, and we may not obtain the capital we require by other means. If we do not succeed in raising additional capital, our resources may not be sufficient to fund or expand our business. Effects of inflation and pricing We expect supplies and prices of the ingredients that we are going to use to be affected by a variety of factors, such as weather, seasonal fluctuations, demand, politics and economics in the producing countries. These factors subject us to shortages or interruptions in product supplies, which could adversely affect our revenue and profits. In addition, the price of fruit, which is currently our main ingredient in our products, can be highly volatile. The fruit of the quality we seek tends to trade on a negotiated basis, depending on supply and demand at the time of the purchase. An increase in pricing of any fruit that we are going to use in our products could have a significant adverse effect on our profitability. We cannot assure you that we will be able to secure our fruit supply. 20 Contractual obligations and commitments Upon closing of the Asset Purchase Agreement, the Company assumed the Seller’s obligations under a real property lease for its 20,945 square foot facility at 1440 N. Union Bower Rd. Irving, TX 75061, under which an entity owned entirely by Ira Goldfarb is the landlord. The lease term is through September 15, 2025, with two five-year options to extend, at a monthly lease term of $10,036, with approximately a 3% annual escalation of lease payments commencing September 15, 2021. Summary of product and research and development that we will perform for the term of our plan We anticipate performing product research and development as required for our products and distribution under our new plan of operation. The Company currently has one full-time employee dedicated to product research and development. The Company’s research and development activities primarily consist of product formulation, nutritional analysis, and taste analysis. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues, expenses, results of operations liquidity, capital expenditures or capital resources that are material to investors.