TOFB Tofutti Brands Inc (QB)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying financial statements.

The discussion and analysis which follows in this Quarterly Report and in other reports and documents and in oral statements made on our behalf by our management and others may contain trend analysis and other forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 which reflect our current views with respect to future events and financial results. These include statements regarding our earnings, projected growth and forecasts, and similar matters which are not historical facts. We remind stockholders that forward-looking statements are merely predictions and therefore are inherently subject to uncertainties and other factors which could cause the actual future events or results to differ materially from those described in the forward-looking statements. These uncertainties and other factors include, among other things, business conditions in the food industry and general economic conditions, both domestic and international; lower than expected customer orders; competitive factors; changes in product mix or distribution channels; and resource constraints encountered in developing new products. The forward-looking statements contained in this Quarterly Report and made elsewhere by or on our behalf should be considered in light of these factors.

Critical Accounting Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The policies discussed below are considered by management to be critical to an understanding of our financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.

Revenue Recognition. We primarily sell vegan and dairy-free soy-based cheeses, frozen desserts and other food products. We recognize revenue when control over the products transfers to our customers, deemed to be the performance obligation, which generally occurs when the product is shipped or picked up from one of our distribution locations by the customer. We account for product shipping, handling and insurance as fulfillment activities with revenues for these activities recorded within net revenue and costs recorded within cost of sales. Revenues are recorded net of trade and sales incentives and estimated product returns. Known or expected pricing or revenue adjustments, such as trade discounts, rebates or returns, are estimated at the time of sale. We base these estimates of expected amounts principally on historical utilization and redemption rates. Estimates that affect revenue, such as trade incentives and product returns, are monitored and adjusted each period until the incentives or product returns are realized.

Key sales terms, such as pricing and quantities ordered, are established on a frequent basis such that most customer arrangements and related incentives have a one year or shorter duration. As such, we do not capitalize contract inception costs and we capitalize product fulfillment costs in accordance with U.S. GAAP and our inventory policies. We generally do not have any unbilled receivables at the end of a period.

Accounts Receivable. The majority of our accounts receivables are due from distributors (domestic and international) and retailers. Credit is extended based on evaluation of a customers’ financial condition and, generally, collateral is not required. Accounts receivable are most often due within 30 to 90 days and are stated at amounts due from customers net of an allowance for doubtful accounts and reserve for sales promotions. Accounts outstanding longer than the contractual payment terms are considered past due. We determine whether an allowance is necessary by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, the customer’s current ability to pay its obligation, and the condition of the general economy and the industry as a whole. We write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the bad debt expense account. We do not accrue interest on accounts receivable past due.

Inventory. Inventory is stated at lower of cost or net realizable value determined by first in first out (FIFO) method. Inventories in excess of future demand are written down and charged to the provision for inventories. At the point of which loss is recognized, a new, lower cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in the newly established cost basis.

Leases. Under Topic 842, operating lease expense is generally recognized evenly over the term of the lease. We have operating leases primarily consisting of facilities with remaining lease terms of approximately one to three years. Leases with an initial term of twelve months or less are not recorded on the balance sheet. For lease agreements entered into or reassessed after the adoption of Topic 842, we have combined the lease and non-lease components in determining the lease liabilities and right of use assets.

Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded if there is uncertainty as to the realization of deferred tax assets. We will recognize a tax benefit in the financial statements for an uncertain tax position only if management’s assessment is that the position is “more likely than not” (i.e., a likelihood greater than 50 percent) to be allowed by the tax jurisdiction based solely on the technical merits of the position. The term “tax position” refers to a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for financial reporting purposes.

Recent Developments

An outbreak of an infectious respiratory illness caused by a novel coronavirus known as COVID-19 was first detected in China in December 2019 and spread globally. This outbreak resulted in travel restrictions, closed international borders, enhanced health screenings at ports of entry and elsewhere, prolonged quarantines, order cancellations, supply chain disruptions, increased costs for raw materials, lower consumer demand, and other significant economic impacts, as well as general concern and uncertainty.

The severity of the pandemic and the future uncertainty regarding the length of its effects could have negative consequences for our company. To date, the effects of the pandemic have negatively affected certain aspects of our operations. All of our co-packing facilities are currently operating normally, and the pandemic has not constrained any of our production requirements. The cost of certain key ingredients and packaging has increased substantially due to short-term supply issues related to COVID-19. Additionally, we are currently experiencing longer lead times in receiving certain ingredients and packaging. We anticipate that these longer lead times will persist for the balance of 2022. We continue to be able to schedule trucks for delivery and a large majority of our customers are still operating and ordering our products as before. However, our freight costs have increased substantially due to a driver shortage caused by COVID-19 and a significant increase in fuel costs. Fuel costs have continued to increase substantially due to record high petroleum costs caused by the current unsettled world political situation. In response to these cost increases and the potential for additional cost increases affecting various aspects of our operations, we initiated a series of sales price increases commencing in the fourth quarter of 2021 and continuing into the first quarter of 2022 to help offset these cost increases. As these costs have either continued to increase, or have remained at their high historic levels, we have been forced to implement further price increases which will become effective during the fourth quarter of the current year.

Our ability to handle customer and consumer communications, schedule production, and order ingredients necessary for our production has not been materially impacted. Nor have we experienced a significant change in the timeliness of payments of our invoices. Our cash position is $1,365,000 as of November 8, 2022 as compared to our fiscal year end January 1, 2022 balance of $1,698,000

Results of Operations

Thirteen Weeks Ended October 1, 2022 Compared with Thirteen Weeks Ended October 2, 2021

Net sales for the thirteen weeks ended October 1, 2022 decreased by $460,000, or 14%, to $2,896,000, from net sales of $3,356,000 for the thirteen weeks ended October 2, 2021. Sales of our vegan cheese products decreased to $2,334,000 in the thirteen weeks ended October 1, 2022 from $2,816,000 in the thirteen weeks ended October 2, 2021, due to the timing of cheese promotions that occurred last year. Sales of our frozen dessert and frozen food products, which consist primarily of frozen dessert products, increased slightly to $562,000 in the thirteen weeks ended October 1, 2022 from $540,000 for the thirteen weeks ended October 2, 2021.

Our gross profit decreased significantly to $427,000 for the thirteen weeks ended October 1, 2022 from $818,000 for the thirteen weeks ended October 2, 2021, due partially to the reduction in sales. Our gross profit percentage was 15% for the thirteen weeks ending October 1, 2022 compared to 24% for the thirteen weeks ending October 2, 2021. The decrease in both our gross profit and gross profit percentage were primarily caused by the substantial increases in the costs for certain ingredients, especially soybean oil. These substantial cost increases were due primarily to the lingering supply chain issues caused by the Covid-19 pandemic and the record high cost of petroleum. The high cost of petroleum has also directly impacted the costs of certain ingredients and packaging such as the plastic packaging we use for our spreadable cheese products. While the costs of some of these key ingredients have recently started to decline, we anticipate that our gross margin and gross margin percentage will continue to be negatively impacted into fiscal year 2023.

Freight out expense, a significant part of our cost of sales, decreased by $59,000, or 20%, to $218,000 for the thirteen weeks ended October 1, 2022 compared with $277,000 for the thirteen weeks October 2, 2021. Freight out expense was 8% of sales for the thirteen weeks ended October 1, 2022 compared to 8% of sales for the thirteen weeks ended October 2, 2021. While actual freight expense declined for the current quarter, it was due to more customers picking up their orders due to the additional pickup allowances we offer. The availability of trucks is still limited and the actual cost of shipping is still at the same high cost from the first half of 2022.

Selling expenses decreased by $21,000, or 7%, to $261,000 for the thirteen weeks ended October 1, 2022 from $282,000 for the thirteen weeks ended October 2, 2021. The decrease was due to decreases in outside warehouse rental expense of $40,000 and commission expense of $13,000, which were partially offset by increases in meeting and convention expense of $22,000 and messenger expense of $5,000.

Marketing expenses increased by $65,000, or 171%, to $103,000 for the thirteen weeks ended October 1, 2022 from $38,000 for the thirteen weeks ended October 2, 2021. The increase was primarily due to increases in point of sale materials expense of $24,000 and advertising expenses of $12,000, and an increase in promotion expenses of $21,000. We anticipate that our marketing expenses for the balance of the year will be higher that the corresponding period in fiscal year 2021.

Product development costs, which consist principally of salary expenses and laboratory costs, increased slightly by $2,000, or 8%, to $26,000 for the thirteen weeks ended October 1, 2022 from $24,000 for the thirteen weeks ended October 2, 2021. We anticipate our product development costs for the balance of the year will continue at a similar level as those for the 2021 period.

General and administrative expenses decreased by $33,000, or 9%, to $298,000 for the thirteen weeks ended October 1, 2022 from $331,000 for the thirteen weeks ended October 2, 2021, primarily due to a decrease in professional fees and outside services expense of $33,000, a decrease in loss incurred on the sale of assets of $36,000, and a decrease on franchise tax expenses of $7,000, which were partially offset by increases in payroll expense of $24,000, and general insurance expense of $15,000. We anticipate our general and administrative expense for the remaining period in 2022 will approximate the same level as in the corresponding 2021 period.

Income tax benefit was $69,000 for the thirteen weeks ended October 1, 2022 and income tax expense was $16,000 for the thirteen weeks ended October 2, 2021. The income tax benefit resulted from the lower taxable income during the thirteen weeks ended October 1, 2022 compared to the thirteen weeks ended October 2, 2021.

Thirty-Nine Weeks Ended October 1, 2022 Compared with Thirty-Nine Weeks Ended October 2, 2021

Net sales for the thirty-nine weeks ended October 1, 2022 decreased by $195,000, or 2%, to $9,338,000, from net sales of $9,533,000 for the thirty-nine weeks ended October 2, 2021. Sales of our vegan cheese products decreased by $257,000 to $7,776,000 in the thirty-nine weeks ended October 1, 2022 from $8,033,000 in the thirty-nine weeks ended October 2, 2021. Sales of our frozen dessert and frozen food products, which consist primarily of frozen dessert products, increased to $1,562,000 in the thirty-nine weeks ended October 1, 2022 from $1,500,000 for the thirty-nine weeks ended October 2, 2021.

Our gross profit decreased to $1,812,000 in the thirty-nine weeks ended October 1, 2022 from $2,577,000 in the thirty-nine weeks ended October 2, 2021. Our gross profit percentage was 19% for the thirty-nine weeks ending October 1, 2022 compared to 27% for the thirty-nine weeks ending October 2, 2021. The decrease in both our gross profit and gross profit percentage were caused by the substantial increases in certain ingredients and freight expenses. These substantial cost increases were due primarily to the lingering supply chain issues caused by the Covid-19 pandemic and the record high cost of petroleum. Besides causing substantial increases in our freight expenses, the high cost of petroleum has also directly impacted the costs of certain ingredients and packaging such as the plastic packaging we use for our spreadable cheese products.

Freight out expense, a significant part of our cost of sales, increased by $86,000, or 11%, to $861,000 for the thirty-nine weeks ended October 1, 2022 compared with $775,000 for the thirty-nine weeks October 2, 2021. Freight out expense was 9% of sales for the thirty-nine weeks ended October 1, 2022 compared to 8% of sales for the thirty-nine weeks ended October 2, 2021. The increase in freight out expenses was due to the increases in shipping costs due to the large increase in the cost of fuel and the unavailability of trucks.

Selling expenses decreased by $75,000, or 8%, to $834,000 for the thirty-nine weeks ended October 1, 2022 from $909,000 for the thirty-nine weeks ended October 2, 2021. This decrease was primarily attributable to decreases in payroll expense of $22,000, outside warehouse rental expense of $98,000, and commission expense of $15,000, which were offset by increases in meetings and convention expenses of $42,000 and travel, entertainment, and auto expenses of $20,000.

Marketing expenses increased by $197,000, or 114%, to $370,000 for the thirty-nine weeks ended October 1, 2022 from $173,000 for the thirty-nine weeks ended October 2, 2021. The increase was primarily due to increases in promotions expense of $59,000, artwork and plate expenses of $73,000, advertising expenses of $32,000, and point of sales material expense of $30,000. In 2022, we completed the rebranding of our product line and introduced new packaging for our products.

Product development costs increased by $9,000, or 9%, to $108,000 for the thirty-nine weeks ended October 1, 2022 from $99,000 for the thirty-nine weeks ended October 2, 2021, primarily due to the increase in professional fees and outside services of $28,000 which was partially offset by a decrease in lab costs and supplies of $9,000.

General and administrative expenses decreased by $110,000, or 10%, to $987,000 for the thirty-nine weeks ended October 1, 2022 from $1,097,000 for the thirty-nine weeks ended October 2, 2021, primarily due to decreases in payroll expense of $32,000, professional fees and outside services expense of $48,000, loss on the sale of asset of $36,000, equipment rental expense of $19,000, and travel, auto and entertainment expenses of $14,000, which were partially offset by an increase in public relations expense of $50,000 and an increase in general insurance expense of $9,000. The decrease in payroll expense was due to no salary being paid to Mr. Mintz this period compared to the same period in the prior year.

Income tax benefit was $127,000 for the thirty-nine weeks ended October 1, 2022 and income tax expense was $52,000 for the thirty-nine weeks ended October 2, 2021 resulting from the lower taxable income during the thirty-nine weeks ended October 1, 2022 compared to the thirty-nine weeks ended October 2, 2021.

Liquidity and Capital Resources

As of October 1, 2022, we had approximately $965,000 in cash and our working capital was approximately $3,994,000, compared with approximately $1,698,000 in cash and working capital of $4,326,000 at January 1, 2022. The decrease in cash is primarily due to the use of funds to purchase ingredients during the period, due to management’s decision to purchase certain key ingredients in advance of production needs to ensure an adequate supply and to prevent future production disruptions.

The following table summarizes our cash flows for the periods presented:

Net cash used in operating activities for the thirteen weeks ended October 1, 2022 was $733,000 compared to $1,500,000 provided by operating activities for the thirteen weeks ended October 2, 2021. Net cash used in operating activities for the thirty-nine weeks ended October 1, 2022 was primarily a result of a net loss of $195,000, SBA loan forgiveness of $165,000, an increase in inventories of $820,000, deferred taxes of $133,000 and a non-cash lease expense of $6,000, offset by a decrease in accounts receivable of $146,000, an increase in accounts payable and accrued expenses of $385,000, and a decrease in prepaid expenses and other current assets of $42,000. The significant increase in inventories during the period is due to management’s decision to purchase certain key ingredients in advance of production needs to ensure an adequate supply and to prevent future production disruptions.

We believe our existing cash on hand at October 1, 2022, existing working capital and the cash flows expected from operations, will be sufficient to support our operating and capital requirements during the next twelve months.

Inflation and Seasonality

We do not believe that our operating results have been materially affected by inflation during 2020 and 2021.However, beginning in 2022, due to substantial increases in ingredient, packaging, freight, and co-packing expenses, we are now experiencing negative effects on our operations from inflation. While we do believe that certain of these costs and expenses will return to their previous lower levels, there is no assurance that they will do so. Our business is subject to minimal seasonal variations with slightly increased sales historically in the second and third quarters of the fiscal year.

Off-balance Sheet Arrangements

None.

Contractual Obligations

We had no material contractual obligations as of October 1, 2022.

Recently Issued Accounting Standards

See Note 2 to the unaudited condensed financial statements included in Part I, Item 1, Financial Statements, of this Quarterly Report on Form 10-Q.