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. 11 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”. The Company produces 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. We have also recently launched a freeze-dried candy product offering that we expect will be a major driver of our growth going forward. In 2022, we commenced the construction of our second and third freeze driers in anticipation of the increased production demands for our products and freeze-drying expertise. We expect to place these additional freeze driers in service during the second quarter of 2023. 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. 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. 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. 12 Going Concern Uncertainty As of December 31, 2022, the Company had a cash balance of $276,464 and total working capital of $1,687,880. 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. Overview of 2022 results We earned $428,132 of revenue in 2022, as we began to ramp up our direct-to-consumer website for our Sow Good brand and began to provide products to big box retailers. Our general and administrative expenses totaled $10,731,281 in 2022, including salaries and benefits expenses of $3,662,313 and goodwill and intangible asset impairment losses of $5,197,470, including $4,887,297 of losses on our 2020 acquisition of S-FDF, LLC. Salaries and benefits and other general expenses increased slightly throughout the year due to inflationary pressures. Our stock-based compensation of $862,079 consisted of $49,998 of stock issued to officers and directors, $30,000 of stock issued to employees and consultants, and $782,081 of expense related to the amortization of stock options for the year ended December 31, 2022. 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. 13 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 didn’t have any cash in excess of FDIC and SIPC insured limits at December 31, 2022. The Company had approximately $2,813,000 in excess of FDIC and SIPC insured limits at December 31, 2021. The Company has not experienced any losses in such accounts. 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 $299,553, including $25,500 capitalized as inventory overhead and expensed to cost of goods sold, and $208,448 for the years ended December 31, 2022 and 2021, 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. Impairment analysis on intangible assets resulted in a loss of $310,173 f or the year ended December 31, 2022. 14 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, 2022 2021 Finished goods $ 384,241 $ 273,135 Packaging materials 416,663 95,436 Work in progress 864,460 613,063 Raw materials 307,515 470,263 Total inventory $ 1,972,879 $ 1,451,897 No reserve for obsolete inventories has been recognized. We have not yet commenced significant production. 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 at year-end resulted in an impairment loss of $4,887,297 and $1,524,030 for the years ended December 31, 2022 and 2021, respectively. 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. 15 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 $862,079 and $1,377,379 for the years ended December 31, 2022 and 2021, respectively. Stock-based compensation consisted of $79,998 and $834,047 related to the issuance of shares of common stock for services for the years ended December 31, 2022 and 2021, respectively. Amortization of the fair values of stock options issued for services and compensation totaled $782,081 and $543,332 for the years ended December 31, 2022 and 2021, 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, $925,839 of expenses related to the amortization of warrants issued in consideration 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, 2022. Results of Operations for the Years Ended December 31, 2022 and 2021. The following table summarizes selected items from the statement of operations for the years ended December 31, 2022 and 2021. Years Ended December 31, Increase/ 2022 2021 Decrease Revenues $ 428,132 $ 88,440 $ 339,692 Cost of goods sold 308,293 81,311 226,982 Gross Profit 119,839 7,129 112,710 Operating expenses: General and administrative: Salaries and benefits 3,662,313 3,473,661 188,652 Professional services 245,546 357,945 (112,399 ) Other general and administrative 1,625,952 1,550,970 74,982 Intangible asset impairment 310,173 – 310,173 Goodwill impairment 4,887,297 1,524,030 3,363,267 Total general and administrative 10,731,281 6,906,606 3,824,675 Depreciation and amortization 274,053 208,448 65,605 Total operating expenses: 11,005,334 7,115,054 3,890,280 Net operating loss (10,885,495 ) (7,107,925 ) 3,777,570 Other income (expense): Interest expense (1,277,965 ) (5,911 ) 1,272,054 Gain (loss) on disposal of property and equipment 36,392 (8,036 ) 44,428 Gain on early extinguishment of debt – 113,772 (113,772 ) Gain (loss) on investment in Allied Esports Entertainment, Inc. – 133,944 (133,944 ) Total other income (expense) (1,241,573 ) 233,769 1,475,342 Net loss $ (12,127,068 ) $ (6,874,156 ) $ 5,252,912 16 Revenues Revenues for the year ended December 31, 2022 were $428,132, compared to $88,440 for the year ended December 31, 2021, an increase of $339,692, or 384%. Revenues increased as we ramped up sales on our product lines and expanded our business-to-business sales during 2022, compared to the same period in the prior year. We had minimal revenues during the comparative period, as we had commenced sales midway through 2021. Cost of Goods Sold Cost of goods sold for the year ended December 31, 2022 were $308,293, compared to $81,311 for the year ended December 31, 2021, an increase of $226,982, or 279%. Cost of goods sold, primarily consisted of material costs and labor on the sales of freeze-dried food products, resulted in a gross profit of approximately 28% and 8% during the year ended December 31, 2022, compared to the year ended December 31, 2021. Cost of goods sold and our gross profit increased as we began to realize economies of scale pursuant to our increased sales. General and Administrative Expenses Salaries and Benefits Salaries and benefits for the year ended December 31, 2022 were $3,662,313, compared to $3,473,661 for the year ended December 31, 2021, an increase of $188,652, or 5%. Salaries and benefits included stock-based compensation expense of $862,079 for the year ended December 31, 2022, compared to $1,377,379 for the year ended December 31, 2021, a decrease of $515,300, or 37%. Stock-based compensation consists of $782,081 and $543,332 of stock options expense incurred in the years ended December 31, 2022 and 2021, respectively, and $79,998 and $834,047 of expense related to shares of common stock issued to officers and consultants for services rendered in the years ended December 31, 2022 and 2021, respectively. The increase in salaries and benefits was primarily due to inflationary pressures, as diminished by decreased stock-based compensation awards. Professional Services General and administrative expenses related to professional services were $245,546 for the 2022 period, compared to $357,945 for the 2021 period, a decrease of $112,399, or 31%. The decrease was primarily due to decreased legal fees incurred in connection with creating our brand in the comparative period that were not necessary in the current period. Other General and Administrative Expenses Other general and administrative expenses for the year ended December 31, 2022 were $1,625,952, compared to $1,550,970 for the year ended December 31, 2021, an increase of $74,982, or 5%. The increase is primarily attributable to increased administrative infrastructure as we seek to scale the production and sales of our freeze-dried products. Intangible Asset Impairment Intangible asset impairment losses of $310,173, for the year ended December 31, 2022, related to impairment of our licensing and trademark assets, as our sales have not ramped up quickly enough to support the carrying value. 17 Goodwill Impairment Goodwill impairment losses related to our 2020 acquisition of S-FDF, LLC was $4,887,297 and $1,524,030 for the years ended December 31, 2022 and 2021. Depreciation Depreciation expense for the year ended December 31, 2022 was $274,053, compared to $208,448 for year ended December 31, 2021, an increase of $65,605 or 31%. 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, 2022, other expense was $1,241,573, consisting of $1,277,965 of interest expense derived from operating loans, as offset by a gain on the disposal of equipment of $36,392. 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. Provision for Income Taxes The Company had no income tax expense in the 2022 or 2021 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, 2022 was $12,127,068, compared to $6,874,156 during the year ended December 31, 2021, an increase of $5,252,912, or 76%. The increased net loss was primarily due to our loss on impairment of intangible assets and goodwill related to our 2022 acquisition of S-FDF, LLC. Liquidity and Capital Resources The following table summarizes our total current assets, liabilities and working capital at December 31, 2022 and 2021. December 31, 2022 2021 Current Assets $ 2,578,057 $ 4,891,264 Current Liabilities $ 890,177 $ 403,057 Working Capital $ 1,687,880 $ 4,488,207 18 As of December 31, 2022, we had working capital of $1,687,880. The following table summarizes our cash flows during the years ended December 31, 2022 and 2021, respectively. Years Ended December 31, 2022 2021 Net cash used in operating activities $ (5,146,635 ) $ (5,551,261 ) Net cash provided by (used in) investing activities (2,622,829 ) (653,051 ) Net cash provided by financing activities 4,700,000 7,637,511 Net change in cash and cash equivalents $ (3,069,464 ) $ 1,433,199 Net cash used in operating activities was $5,146,635 and $5,551,261 for the years ended December 31, 2022 and 2021, respectively, a year over year decreased use of $404,626. The decreased use was primarily due to increased revenues. Changes in working capital from continuing operating activities resulted in a decrease in cash of $2,800,327 during the year ended December 31, 2022, as compared to $1,547,282 for the same period in the previous year. Net cash used in investing activities was $2,622,829 for the year ended December 31, 2022, compared to $653,051 for the year ended December 31, 2021, a year over year increased use of $1,969,778. During the year ended December 31, 2022, cash used in investing activities consisted of $193,184 paid for the purchase of property and equipment, $2,487,673 of payments for the construction of the Company’s second and third freeze dryers and expansion of its operations facility, as well as, $5,929 paid for the purchase of intangible assets, as offset by $63,957 of proceeds received from the disposal of property and equipment. 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. Net cash provided by financing activities was $4,700,000 and $7,637,511 for the years ended December 31, 2022 and 2021, respectively. Net cash provided by financing activities the year ended December 31, 2022 consisted of $4,700,000 of proceeds received from debt financing, including $4,120,000 received from related parties. 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. Satisfaction of our cash obligations for the next 12 months As of December 31, 2022, our balance of cash and cash equivalents was $276,464 and we had total working capital of $1,687,880. 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. 19 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. In addition, we may face limits on the ability to source some of the candy for our freeze-dried candy products. 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. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Commodity Price Risk We do not expect any significant effects from commodity price risk outside of inherent inflationary risks. Interest Rate Risk We do not anticipate entering into any transactions that would expose us to any direct interest rate risk. 20