ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. 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 rapidly growing 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 portfolio of brands 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. Our executive team has a proven history of success in both pet and consumer-packaged goods, and has over 50 years of combined experience in the pet industry and over 100 years of combined experience in the consumer-packaged goods industry.
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, which includes Halo Holistic™, Halo Elevate® and the TruDog brand, which we anticipate will be rebranded under the Halo umbrella in 2022. 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 four distinct categories: E-Commerce, which includes the sale of product to online retailers such as Amazon and Chewy; Brick & Mortar, which primarily includes the sale of product to Pet Specialty retailers such as Petco, Pet Supplies Plus and neighborhood pet stores, as well as to select grocery chains; DTC, which includes the sale of product through our website halopets.com; and International, which includes the sale of product to foreign distribution partners and to select international retailers.
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 $39 billion of consumer sales in 2019, or 36% of the total U.S. pet care market, according to AlphaWise and Morgan Stanley Research. According to the American Pet Product Association, between 66% and 70% of all households in the U.S. own a pet, equating to a total pet population of more than 130 million companion animals and an average of 1.7 pets per household. Pet spending represents a significant portion of household spend on consumer products, as this translates to an average annual spend on pet care of more than $1,500 per pet owning household, with $460 of this spend attributed to pet food and treats.
Historically, consumer spending on pets grew at an approximately 3% CAGR in the decade leading up to the COVID-19 pandemic, driven by steady annual increases in household pet ownership of approximately 1%, the continued premiumization of the category and the humanization of pets. These industry tailwinds have been magnified in the post-COVID landscape, as stay-at-home orders have driven a more than tripling of annual pet ownership growth alongside fundamental changes in consumer purchasing behavior. This surge in pet acquisition has led to a dramatic increase in the forecasted growth of the pet care industry over the next ten years.
Beyond the estimated $3.9 billion permanent increase to annual spend on pet food and treats, this “Pet Boom” was driven by the acceleration of pet ownership by millennial and Gen-Z households. 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 and TruDog, 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. 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 recent 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 Euromontior, 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
•Strong Innovation Pipeline. We have a robust and growing pipeline of new products, and believe our size is an advantage as we are nimble enough to quickly bring new products to market, but large enough to benefit from strong existing customer relationships and established economies of scale with our co-manufacturers.
•Ability to Leverage Differentiated Omni-Channel Strategy for Growth. We believe that we can leverage our differentiated omni-channel strategy to design and sell products purpose-built for success in specific channels while maintaining our ability to leverage marketing and sales resources cross-channel. We believe that this strategy will allow us to deliver on core consumer needs, maximize gross margin and respond to changing channel dynamics that have accelerated because of the COVID-19 pandemic.
•Capitalize on Continuing Trends of Humanization of Pets. We believe our combination of innovative products designed specifically for certain channels can assist our growth to become a leader in the premium and super-premium categories across dog and cat food.
•Well Positioned to Capitalize On a Once-in-a-Generation Demographic Shift in Asia. We believe that Asia represents the largest macro-growth opportunity in the global pet food industry. In China, the number of households that own a pet has doubled in the last five years, with younger pet owners leading growth.
Results of Operations for the three months ended March 31, 2022 and 2021
The following table sets forth our consolidated results for the periods presented (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2022 | | 2021 | | Change | | % | | | | | | | | |
Net sales | $ | 17,014 | | | $ | 10,830 | | | $ | 6,184 | | | 57 | % | | | | | | | | |
Cost of goods sold | 12,307 | | | 6,554 | | | 5,753 | | | 88 | % | | | | | | | | |
Gross profit | 4,707 | | | 4,276 | | | 431 | | | 10 | % | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | | | |
Selling, general and administrative | 7,577 | | | 6,889 | | | 688 | | | 10 | % | | | | | | | | |
Share-based compensation | 1,091 | | | 2,525 | | | (1,434) | | | (57) | % | | | | | | | | |
Total operating expenses | 8,668 | | | 9,414 | | | (746) | | | (8) | % | | | | | | | | |
Loss from operations | (3,961) | | | (5,138) | | | 1,177 | | | 23 | % | | | | | | | | |
Other expense: | | | | | | | | | | | | | | | |
Interest expense, net | (76) | | | (835) | | | 759 | | | 91 | % | | | | | | | | |
Loss on extinguishment of debt | — | | | (394) | | | 394 | | | 100 | % | | | | | | | | |
Change in fair value of warrant liabilities | — | | | (6,483) | | | 6,483 | | | 100 | % | | | | | | | | |
Total other expense, net | (76) | | | (7,712) | | | 7,636 | | | 99 | % | | | | | | | | |
Net loss before income taxes | (4,037) | | | (12,850) | | | 8,813 | | | 69 | % | | | | | | | | |
Income tax expense | 3 | | | — | | | 3 | | | 100 | % | | | | | | | | |
| | | | | | | | | | | | | | | |
Net loss available to common stockholders | $ | (4,040) | | | $ | (12,850) | | | $ | 8,810 | | | 69 | % | | | | | | | | |
Net sales
We sell our products through online retailers, pet specialty retailers, our online portal directly to our consumers and internationally to foreign distribution partners (transacted in U.S. dollars). Generally, our sales transactions are single performance obligations that are recorded at the time the product is shipped from our distribution centers and when control transfers. 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 include 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):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | |
| | 2022 | | 2021 | | | | |
E-commerce | | $ | 3,824 | | | 22 | % | | $ | 4,010 | | | 37 | % | | | | | | | | |
Brick & Mortar | | 4,334 | | | 26 | % | | 1,894 | | | 18 | % | | | | | | | | |
DTC | | 1,933 | | | 11 | % | | 2,436 | | | 22 | % | | | | | | | | |
International | | 6,923 | | | 41 | % | | 2,490 | | | 23 | % | | | | | | | | |
Net Sales | | $ | 17,014 | | | 100 | % | | $ | 10,830 | | | 100 | % | | | | | | | | |
(1)The Company's E-Commerce channel includes one customer that amounted to greater than 10% of the Company's total net sales during the three months ended March 31, 2022 and two customers that amounted to greater than 10% of the Company's total net sales during the three months ended March 31, 2021. These customers had $2.2 million of net sales during the three months ended March 31, 2022 and $3.7 million of net sales for both customers during the three months ended March 31, 2021.
(2)The Company's Brick & Mortar channel includes $1.8 million of net sales from one customer that amounted to greater than 10% of the Company's total net sales during the three months ended March 31, 2022. None of the Company's Brick & Mortar customers represented greater than 10% of net sales during the three months ended March 31, 2021.
(3)The Company's International channel includes $5.8 million of net sales from one customer in China that amounted to greater than 10% of the Company's total net sales during the three months ended March 31, 2022. None of the Company's International customers represented greater than 10% of net sales during the three months ended March 31, 2021.
Net sales increased $6.2 million, or 57%, to $17.0 million for the three months ended March 31, 2022 compared to $10.8 million for the three months ended March 31, 2021. The increase was driven by growth in our Brick & Mortar channel driven by the launch of Halo Elevate® and growth in our International channel, partially offset by lower E-commerce sales driven by out of stocks primarily impacting our Halo Holistic™ canned wet portfolio and transportation delays, and lower DTC sales driven by preparation for the TruDog rebrand under the Halo umbrella. Our revenue growth has been negatively impacted by the supply chain issues being felt globally. We are navigating through short-term shortages in raw materials as well as production delays stemming from supply chain shortages and labor constraints.
Key factors that we expect to affect our future sales growth include new product innovation, our new product launch, 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 damages, 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 March 31, 2022, gross profit increased $0.4 million, or 10%, to $4.7 million compared to $4.3 million during the three months ended March 31, 2021. Gross profit margin decreased 11% to 28% for the three months ended March 31, 2022 compared to 39% for the three months ended March 31, 2021. The change was driven by cost increases from our primary suppliers as a result of broad-scale inflation in the industry. We are actively working with our co-manufacturer and freight partners as well as transitioning some of our primary suppliers to generate future cost savings. Additionally, we have taken price increases to our customers to help cover these cost increases beginning late in the third quarter of 2021 and additional price increases in the first quarter of 2022, which will become effective in the second quarter of 2022. 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. Although we expect to improve our gross profit margin in the future, if we fail to effectively optimize our pricing strategy or if significant inflationary pressures continue to intensify, it could have a material negative impact on our future profitability.
Operating expenses
Our SG&A expenses consist of the following:
•Sales and marketing costs, including 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 March 31, 2022, Sales and marketing costs increased approximately $0.9 million or 46%, to $2.9 million from $2.0 million during the three months ended March 31, 2021. The increase was driven primarily by increased promotional spend in our International sales channel, as well as advertising agency fees related to our new sales strategy that we are beginning to implement, partially offset by an intentional decrease in DTC marketing spend as we begin to shift the focus of our investments to our longer-term DTC strategy.
•Employee compensation and benefits decreased approximately $0.5 million or 18% during the three months ended March 31, 2022 to $2.0 million from $2.5 million during the three months ended March 31, 2021. The decrease was primarily related to higher severance costs during the three months ended March 31, 2021, partially offset by the addition of several key members to our management team during 2021 that have significant operating experience in the pet and consumer-packaged good sectors which we believe will enable us to successfully execute our growth strategy.
•Freight, which is primarily related to the shipping of DTC orders to customers, decreased approximately $0.1 million or 10% during the three months ended March 31, 2022 to $0.4 million from $0.5 million during the three months ended March 31, 2021. The decrease was driven by the decrease in DTC net sales as described above, partially offset by overall shipping industry inflation.
•Non-cash charges including depreciation, amortization, disposal or sale of assets and bad debt expense decreased $0.1 million or 12% during the three months ended March 31, 2022 to $0.4 million from $0.5 million for the three months ended March 31, 2021. The decrease was driven by disposals of certain assets during three months ended March 31, 2021.
•Other general and administrative costs for various general corporate expenses, including professional services, information technology, rent, travel, costs related to merchant credit card fees, insurance, product development costs, and warehousing costs. During the three months ended March 31, 2022, other general and administrative costs increased $0.3 million, or 22% to $1.8 million compared to $1.5 million for the three months ended March 31, 2021. The increase was driven by a non-cash reduction of our sales tax liability of $0.5 million during the three months ended March 31, 2021 with no similar reduction of expense during the three months ended March 31, 2022, as well as increased International consulting fees. This increase was partially offset by lower professional fees and a reduction in rent expense as a result of prior lease terminations.
Share-based compensation includes expenses related to equity awards issued to employees and non-employee directors. During the three months ended March 31, 2022, share-based compensation decreased $1.4 million, or 57%, to $1.1 million as compared to $2.5 million for the three months ended March 31, 2021. The decrease was driven by accelerated vesting on certain stock option grants during the three months ended March 31, 2021 with no similar expense during the three months ended March 31, 2022, partially offset by common stock issued for board service during the three months ended March 31, 2022.
Interest expense, net
During the three months ended March 31, 2022, interest expense decreased $0.7 million to $0.1 million from $0.8 million for the three months ended March 31, 2021. Interest expense for the three months ended March 31, 2022 is comprised of interest on our Wintrust Credit Facility and the amortization of debt issuance costs. Interest expense for the three months ended March 31, 2021 is comprised of interest on our debt, payable in-kind interest on our previous senior subordinated convertible notes, and the amortization of debt issuance costs and accretion of debt discounts.
Loss on extinguishment of debt
During the three months ended March 31, 2021, we incurred a loss on extinguishment of debt of $0.4 million, while there was no corresponding activity for the three months ended March 31, 2022. Loss on extinguishment of debt for the three months ended March 31, 2021 relates to extinguishment accounting applied in connection with us terminating our prior term loan and credit facility.
Change in fair value of warrant liabilities
Common stock warrants classified as liabilities are revalued at each balance sheet date subsequent to the initial issuance and changes in the fair value are reflected in the Condensed Consolidated Statements of Operations as change in fair value of warrant liability. The change in fair value for the three months ended March 31, 2021 relates to the increase in the fair value of the common stock warrants issued in connection with the Series F Private Placement; upon consummation of the Company's Initial Public Offering (the "IPO") on July 1, 2021, these warrants met the requirements to be considered equity were reclassified as such.
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 months ended March 31, 2022, we recorded income tax expense of less than $0.1 million. During the three months ended March 31, 2021, we did not record income tax expense due to the continued losses incurred by us. The effective tax rate is less than 1% and 0% for the three months ended March 31, 2022 and 2021, respectively, 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 our NOLs.
Liquidity and capital resources
In connection with our IPO, we issued and sold 8,000,000 shares of common stock at a price of $5.00 per share. On July 1, 2021, we received total net proceeds of approximately $36.1 million from the IPO, after deducting underwriting discounts and commissions of $2.8 million, and offering costs of approximately $1.1 million.
We have financed our operations primarily through the sales of shares of our common stock, warrants, preferred stock, and loans. On March 31, 2022 and December 31, 2021, we had cash and cash equivalents and restricted cash of $23.4 million and $28.9 million, respectively.
We have historically incurred losses and expect to continue to generate operating losses and consume significant cash resources for the foreseeable future; however, due to our high level of working capital and minimal debt after the IPO, we do not anticipate substantial doubt about our ability to continue as a going concern. We have implemented and continue to implement plans to achieve cost savings, including realized cost savings from the consolidation of our third-party logistics operations and reduction of certain overhead costs and we expect to achieve further cost savings from the consolidation of co-manufacturers and optimization of shipping costs. Additionally, we have implemented and continue to implement margin improvement initiatives, including the optimization of our pricing strategy and ingredient profiles, and new product innovation. The business is focused on growing the most profitable channels while reducing investments in areas that are expected to have lower long-term benefits.
We are subject to risks common in the pet wellness consumer market including, but not limited to, dependence on key personnel, competitive forces, successful marketing and sale of its products, the successful protection of its proprietary technologies, ability to grow into new markets, and compliance with government regulations. As of March 31, 2022, we have not experienced a significant adverse impact to our business, financial condition or cash flows resulting from the COVID-19 pandemic, geopolitical actions or threat of cyber attacks. However, uncertainties regarding the continued economic impact of the COVID-19 pandemic, 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.