THOE HEAL You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties, including those described in the section titled "Special Note Regarding Forward-Looking Statements." Our actual results and the timing of selected events could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those set forth under the section titled "Risk Factors."
Overview
We are a science-driven wellness company pioneering innovative solutions and personalized approaches to health and well-being. We are building a new health category to deliver better health outcomes through a proactive, empowered approach. Our unique, vertically integrated brands, Thorne and Onegevity, provide actionable insights and personalized data, products and services that help individuals take a proactive approach to improve and maintain their health over their lifetime. By combining our proprietary multi-omics database, artificial intelligence (AI) and digital health content with our science-backed nutritional supplements, we deliver a total system for wellness. We believe our integrated solution will redefine the expectations for good health, peak performance and healthy aging. Founded in 1984,Thorne Research was a small company dedicated to being a "thorn" in the side of the traditional supplement industry by making the purest and highest quality nutritional supplements to sell to health professionals. With a vision for an unparalleled health ecosystem fueled by innovation and technology, our current Chief Executive Officer,Paul Jacobson , and his management team, acquiredThorne Research in 2010 and co-founded Onegevity. We completed our acquisition of Onegevity and combined these two complementary companies in early 2021. During the past ten years, we have evolved to become a transformative consumer brand, trusted by more than 4,000,000 customers, 45,000 healthcare professionals, thousands of professional athletes, more than 100 professional sports teams and 11 U.S. Olympic teams.
Key milestones in our growth history include:
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2011: Strategic ingredient and botanical agreement with
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2014: Clinical Study Agreement with
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2017: Launch of NSF Certified for Sport product line;
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2018: Onegevity founded; we expanded capacity by moving to a new,
state-of-the-art 272,000 square foot facility in
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2019-2020: Sponsorships of the
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2020-2021:
Our revenue is generated primarily from the sale of our supplements and health tests. We have experienced significant sales growth of our supplements and health tests through the acquisition of new customers and strong customer retention.
For the years ended
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we generated net sales of
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we generated gross profit of
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we incurred a net loss of
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our Adjusted EBITDA was
OnApril 26, 2021 , we entered into a merger agreement (the Merger Agreement) withDrawbridge Health, Inc. (Drawbridge), to acquire the majority of the outstanding shares of Drawbridge, a healthcare technology company (the Drawbridge Transaction). OnSeptember 27, 2021 , we closed our initial public offering (IPO) of 7,000,000 shares of common stock. The public offering price of the shares sold in the offering was$10.00 per share. The total gross proceeds from the offering were$70.0 million . After deducting underwriting discounts and commissions of approximately$4.9 million and offering expenses paid or payable by us of approximately$5.1 million , the net proceeds from the offering were approximately$60.0 million . Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with generally accepted accounting principles inthe United States (GAAP). In this Annual Report, we have used certain non-GAAP financial measures, including Adjusted EBITDA, Adjusted EBITDA Margin and free cash flow. These measures are derived on the basis of methodologies other than in accordance with GAAP. Non-GAAP financial measures used by us may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies. We have provided a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure. These non-GAAP financial measures should be considered along with, but not as alternatives to, the operating performance measures as prescribed by GAAP.
Key Financial and Operating Data
Our financial profile is characterized by high growth, recurring revenue, improving gross margins, efficient customer acquisition, and free cash flow.
We measure our business using both financial and operational data and use the following metrics to assess the near-term and long-term performance of our brands and business. These metrics serve as guidance for identifying trends, formulating financial projections, making strategic decisions, assessing operational efficiencies, and monitoring our business.
We define net sales as sales of our goods and services and related shipping fees less discounts and returns following the accounting guidelines in accordance withFinancial Accounting Standards Board (FASB), Topic 606, "Revenue from Contracts with Customers," (ASC 606). Our net sales consist of sales of our nutritional supplements, health tests and sales associated with our services leveraging our AI and multi-omics databases, such as product development services. We recognize revenues when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled in exchange for those goods or services. We consider several factors in determining when control transfers to the customer upon shipment, or upon delivery for certain customers. These factors include when legal title transfers to the customer, if we have a present right to payment and whether the customer has assumed the risks and rewards of ownership at the time of shipment. Shipping and handling costs are considered a fulfillment activity and are expensed as incurred. We view net sales as a key indicator of demand for our products and services. Gross Profit We define gross profit as net sales less cost of sales. Cost of sales consists of depreciation and amortization, product and packaging costs, including manufacturing costs, inventory freight, testing costs of all raw materials and finished goods, inventory shrinkage costs and inventory valuation adjustments, offset by reductions for promotions and percentage or volume rebates offered by our vendors.
Adjusted EBITDA and Adjusted EBITDA Margin
We calculate Adjusted EBITDA as net income (loss) adjusted to exclude: interest
income (expense), net; guarantee fees; other income (expense), net; provision
for income taxes; depreciation and amortization expense; stock-based
compensation expense; change in fair value of warrant liability; write-off of
acquired Drawbridge in-process research and development; loss on the Drawbridge
Transaction; and income/loss from equity interest in unconsolidated affiliates.
Adjusted EBITDA Margin is calculated by dividing Adjusted EBITDA by total net
sales.
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We use Adjusted EBITDA and Adjusted EBITDA Margin as measures of operating
performance and the operating leverage in our business. We believe that these
non-GAAP financial measures are useful to investors for period-to-period
comparisons of our business and in understanding and evaluating our operating
results for the following reasons:
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Adjusted EBITDA and Adjusted EBITDA Margin are widely used by investors and securities analysts to measure a company's operating performance without regard to items such as stock-based compensation expense, depreciation and amortization expense, interest expense, net, other (income) expense, net, loss from non-controlling interest and provision for income taxes, each of which can vary substantially from company to company depending upon their financing, capital structures and the method by which assets are acquired;
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our management uses Adjusted EBITDA and Adjusted EBITDA Margin in conjunction with financial measures prepared in accordance with GAAP for planning purposes, including the preparation of our annual operating budget, as a measure of our core operating results and the effectiveness of our business strategy, and in evaluating our financial performance; and
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Adjusted EBITDA and Adjusted EBITDA Margin provide consistency and comparability with our past financial performance, facilitate period-to-period comparisons of our core operating results, and also facilitate comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. Our use of Adjusted EBITDA and Adjusted EBITDA Margin have limitations as analytical tools, and you should not consider these measures in isolation or as substitutes for analysis of our financial results as reported under GAAP. Some of these limitations are, or may in the future be, as follows:
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although depreciation and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA and Adjusted EBITDA Margin do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
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Adjusted EBITDA and Adjusted EBITDA Margin exclude stock-based compensation expense, which is a recurring expense for our business and an important part of our compensation strategy;
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Adjusted EBITDA and Adjusted EBITDA Margin do not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; (3) tax payments that may represent a reduction in cash available to us; or (4) the use of net operating loss (NOL) carryforwards and the full valuation reserve against deferred tax assets and liabilities are non-cash items that can have an impact on GAAP performance, but may not reflect the continuing operating results of our business; and
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the expenses and other items that we exclude in our calculation of Adjusted EBITDA and Adjusted EBITDA Margin may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA when they report their operating results and we may, in the future, exclude other significant, unusual or non-recurring expenses or other items from these financial measures.
Because of these limitations, Adjusted EBITDA and Adjusted EBITDA Margin should be considered along with other operating and financial performance measures presented in accordance with GAAP.
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The following table presents a reconciliation of Adjusted EBITDA to net loss,
the most directly comparable financial measure prepared in accordance with GAAP,
for each of the periods indicated:
Year Ended
December 31,
2020 2021
EBITDA Calculation and Reconciliation Net (loss) income$ (3,953,813 ) $ 6,844,798 Depreciation and amortization 4,295,840 4,453,057 Interest expense, net 1,125,472 449,908 Income tax expense 176,758 411,919 EBITDA$ 1,644,257 $ 12,159,682 EBITDA margin 1.2 % 6.6 % Adjustments Stock-based compensation 10,037,396 4,554,024 Change in fair value of warrant liability 1,912,487 (1,872,364 ) Write-off of acquired Drawbridge in-process research and development -
1,563,015
Loss on Drawbridge Transaction -
165,998
Guarantee fees 243,040
336,915
Loss from equity interest in unconsolidated affiliates 1,509,704 3,664,058 Adjusted EBITDA$ 15,346,884 $ 20,571,328 Adjusted EBITDA margin 11.1 % 11.1 % Free Cash Flow We define free cash flow as net cash provided by (used in) operating activities less capital expenditures, which consist of purchases of property and equipment as well as purchase of licensing agreements. Accordingly, we believe that free cash flow provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. Free cash flow may be affected in the near-to medium-term by the timing of capital investments, such as purchases of machinery, information technology and other equipment, the launch of new fulfillment centers, customer service centers and new products, fluctuations in our growth and the effect of such fluctuations on working capital and changes in our cash conversion cycle due to increases or decreases of customer and vendor payment terms as well as inventory turnover. We expect free cash flow to increase over the long term as investments made in prior years drive increased profitability. If we experience an unforeseen increase in demand, we may need to make additional capital investments in manufacturing facility expansion.
The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable financial measure prepared in accordance with GAAP, for each of the periods indicated:
Year Ended
December 31,
2020 2021
Free Cash flow Calculation
Net cash provided by operating activities
(1,193,642 ) (4,311,015 )
Purchase of licensing agreements (1,128,621 ) (750,457 )
Free cash flow $ 14,784,792 $ 4,022,814
Number of Subscriptions
We define subscriptions as orders resulting from direct-to-consumer (DTC) customers opting into automatic refills or orders that are recurring on Thorne.com and Amazon. Our subscription programs on both platforms offer automatic ordering, payment and delivery of our products to a customer's doorstep.
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--------------------------------------------------------------------------------Subscription Sales as a Percentage of Net DTC Sales
We define subscription sales as sales generated from retail subscription orders on Thorne.com and Amazon within a given period. Subscription sales are taken as a percentage of net sales from all DTC orders in that same period. We view subscription sales as a percentage of net DTC sales as a key indicator of our recurring sales and customer retention.
Annual LTV to CAC
We define annual life-time value (LTV) to customer acquisition costs (CAC) as LTV from a specific calendar year divided by the CAC of that same year. Annual LTV is defined as the average gross contribution per purchasing DTC customer within a particular calendar year divided by one less the customer retention rate (Churn Rate) during the same period. Average gross contribution is defined as the cumulative revenue from our DTC customers during a calendar year less the cost of goods divided by the number of purchasing DTC customers in the same period. To arrive at the annual LTV for a particular calendar year, we divide the average gross contribution by that year's Churn Rate. Annual CAC is defined as the total advertising and marketing expenses, less headcount expenses and associated benefit expenses, in a particular calendar year divided by the number of customerswho placed their first order during that same year. We view the annual LTV to CAC ratio as a key indicator for marketing efficiency.
Orders per Customer per Year
We define orders per customers per year as the total number of sales orders placed by our DTC customers in a given year divided by the total number of DTC customerswho purchased within that same period. We view orders per customer per year as a key indicator of our customers' purchasing patterns, including their initial and repeat purchase behavior, and as an indication of the desirability of our products to our customers. We expect orders per customer per year to remain steady or increase modestly over the long term as we continue to grow and acquire new customers and as our customers continue to demand our high-quality products.
Factors Affecting Our Performance
Ability to Increase Brand Awareness and Attract New Customers
Our long-term growth will depend on our continued ability to attract new customers. Our historical growth was largely driven by organic customer acquisition. We are still in the early stages of our growth and believe we can significantly expand our customer base as we increase brand awareness. Growing brand awareness through efficient, impactful communications and through building brand equity and loyalty is central to our marketing and growth strategy. We believe optimizing the message of our brand as one that defies expectations of good health differentiates us and is key to our ability to attract customers and retain them within our ecosystem. As our brand awareness grows, we intend to strengthen our reach across demographics and markets.
Growth in Our Subscriptions
We offer our customers the ability to opt into recurring automatic refills on both our website and Amazon. On both platforms, a customer can cancel or modify a subscription at any time at no cost to the customer. On our website, we allow customers to subscribe monthly, every 45 days, every two months, every three months, or every four months. For all these frequencies, we offer a 10% discount on retail refill orders. On Amazon, the discount ranges from 5% to 10% depending on the number of products to which a customer is subscribed, with an average discount of approximately 6%. We view our growing subscription business on Thorne.com and Amazon as a key driver of future sales growth. Our subscriptions grew from 155,305 as ofDecember 31, 2020 , to 257,070 as ofDecember 31, 2021 , representing 65.5% year-over-year growth. We expect subscription sales to continue to grow as we continue to invest in brand awareness, innovate new products and solutions, and market the convenience and savings of our nutritional supplements and tests.
Efficiency of Spending on Advertising and Marketing
We are disciplined in measuring and managing CAC and LTV of our customers. We are consistently looking for new ways to acquire customers more efficiently, grow revenue per customers, and retain our customers for longer periods of time. In 2021, we implemented a holistic, full funnel strategy that balanced long term brand objectives with performance marketing goals using a mix of paid, owned, and earned media. We take a data-driven approach to managing our marketing campaigns constantly optimizing and adjusting to improve performance. In the second half of 2021, we launched our Olympic "Better Health " brand campaign, which increased our brand marketing spend and included deploying campaign assets across connected TV, YouTube, influencers, out of home, Amazon, search, and social platforms. Despite the campaign's orientation toward longer-term brand 70 -------------------------------------------------------------------------------- objectives, the DTC sales acceleration was evident on our website with a 24.8% increase in average daily consumer sales and a 35.6% increase in new weekly DTC customers in the 20 weeks post-campaign, compared to the prior period.
We experience high retention, repeat purchases and low CAC, as seen by our 2020 and 2021 LTV to CAC ratios of 7.6x and 4.5x, respectively.
Ability to Engage and Retain Our Existing Customers
Our success is impacted not only by efficient and profitable customer acquisition, but also by our ability to retain customers and encourage repeat purchases. In 2021, 51.0% of our DTC sales were generated from new, first-time purchasers versus 49.0% from existing customers. We deepen our relationships with our customers and drive retention by engaging them with digital health content and educational resources. Out of our total 2021 DTC sales, nearly one-third were recurring subscription sales. We expect the growth in net sales each year to continue as we generate and grow sales from existing customers and from newly acquired customers.
Health Professionals
Our network of 45,000 health professionals helps serve two key purposes. First, it allows us to distinguish our brand by offering both credibility and validation to patients at times when the industry has struggled with trust. Secondly, health professionals carry, promote and distribute our products to consumers. Based on a 2018 survey conducted with 1,188 consumers, primary care physicians were identified as the most common entry point for supplement category consumers with nearly 60% of patients looking to their primary care providers when considering which supplements to buy. Therefore, retention and expansion of our professional network is important to our strategy.
Ability to Invest
We expect to continue to make investments across our business to drive growth and therefore we expect expenses to increase. We plan to continue to invest in sales and marketing to drive demand for our products and services. We expect to continue to invest in research and development to enhance our platform, develop new nutritional supplements, expand our testing portfolio, grow our multi-omics database and AI capabilities and improve our brand ecosystem's infrastructure.
Ability to Grow in New Geographies
Entering new geographic markets requires us to invest in distribution and marketing, infrastructure and personnel. Our international growth will depend on our ability to sell in international markets. In 2021, we shipped to 32 countries. We believe capital investment coupled with our regulatory expertise will lead to promising results. However, international sales are dependent upon local regulations and custom practices, which both change continuously.
Components of our Operating Results
Our net sales consist of sales of our nutritional supplements, health tests and sales associated with our services leveraging our AI and multi-omics databases, such as product development services. We recognize net sales when control over the product has transferred to customers in accordance with our revenue recognition policy.
Cost of Sales
Cost of sales consists of depreciation and amortization, product and packaging
costs, including manufacturing costs, inventory freight, testing costs of all
raw materials and finished goods, inventory shrinkage costs and inventory
valuation adjustments, offset by reductions for promotions and percentage or
volume rebates offered by our vendors, which may depend on reaching minimum
purchase thresholds. We expect cost of sales to increase on an absolute dollar
basis and improve as a percentage of net sales over the long term.
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--------------------------------------------------------------------------------Operating Expenses
Operating expenses consist of:
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sales and marketing;
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research and development;
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payroll and related expenses for employees involved in general corporate functions, including accounting, finance, tax, legal and human resources;
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costs associated with use by these functions, such as depreciation expense and rent relating to facilities and equipment;
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professional fees and other general corporate costs;
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stock-based compensation; and
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fulfillment costs.
Marketing expenses consist of performance marketing media spend, asset creation, and other brand creation, as well as sales and marketing personnel-related expenses. We intend to continue to invest in our sales and marketing capabilities in the future and expect this increase in absolute dollars in future periods as we release new products and expand internationally. Sales and marketing expense as a percentage of net sales may fluctuate from period to period based on net sales and the timing of our investments in our sales and marketing functions as these investments may vary in scope and scale over future periods. Our research and development expenses support our efforts to add new features to our existing solutions and to ensure the reliability and scalability of our product development and testing. Research and development expenses consist of personnel expenses, including salaries, bonuses, stock-based compensation expense and benefits for employees and contractors for our engineering, product, and design teams and allocated overhead costs. We have expensed our research and development costs as they were incurred, except those costs that have been capitalized as software development costs. We plan to hire employees for our science and engineering team to support our research and development efforts. We expect that research and development expenses will increase on an absolute dollar basis in the foreseeable future as we continue to increase investments in our technology platform. However, our research and development expenses may fluctuate as a percentage of revenue from period to period due to the timing and amount of these expenses. Fulfillment costs represent costs incurred in operating, manufacturing, staffing order fulfillment and customer service teams, including costs attributable to buying, receiving, inspecting and warehousing inventories, picking, packaging and preparing customer orders for shipment, payment processing and related transaction costs and responding to inquiries from customers. Included within fulfillment costs are merchant processing fees charged by third parties that provide merchant processing services for credit cards. We expect to incur additional expenses as a result of operating as a public company, including expenses to comply with the rules and regulations applicable to companies listed on the Nasdaq, expenses related to compliance and reporting obligations pursuant to the rules and regulations of theSEC , as well as higher expenses for general and director and officer insurance, investor relations and professional services. We also anticipate that fulfillment costs will fluctuate as a percentage of net sales over the long term. Overall, as we continue to grow as a company, we expect that our selling, general and administrative costs will increase on an absolute dollar basis but decrease as a percentage of net sales over the long term. Interest expense, net
Interest expense, net consists primarily of interest earned on cash we hold, and interest incurred on borrowings.
Income Tax Provision
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 allowable
credits, deductions and uncertain tax positions. Because we have experienced net
losses we have fully
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--------------------------------------------------------------------------------reserved for all deferred tax assets and liabilities. Our income tax provision consists of cash taxes paid during the year in review.
Results of Operations
The following table summarizes our results of operations for each of the periods
indicated:
Years Ended December 31,
2020 2021
Net Sales $ 138,454,924 $ 185,246,025
Cost of sales 73,667,333 87,892,579
Gross profit 64,787,591 97,353,446
Gross margin 46.8 % 52.6 %
Operating expenses:
Research and development 4,224,891 5,935,514
Marketing 11,150,514 25,189,326
Selling, general and administrative 48,397,419 54,913,441
Write-off of acquired Drawbridge in-process research
and development - 1,563,015 Income from operations 1,014,767 9,752,150 Other expense (income): Interest expense, net 1,125,472 449,908 Guarantee fees 243,040 336,915 Change in fair value of warrant liability 1,912,487 (1,872,364 ) Loss on Drawbridge Transaction -
165,998
Other expense (income), net 1,119 (249,082 ) Total other expense (income), net 3,282,118 (1,168,625 ) (Loss) income before income taxes and loss from equity interest in unconsolidated affiliates (2,267,351 )
10,920,775
Income tax expense 176,758
411,919
Net (loss) income before loss from equity interest in unconsolidated affiliates
(2,444,109 ) 10,508,856
Loss from equity interest in unconsolidated affiliates (1,509,704 ) (3,664,058 ) Net (loss) income (3,953,813 )
6,844,798
Net income-non-controlling interest (596,067 )
(408,625 )
Net (loss) income attributable to
(3,357,746 ) 7,253,423
Undistributed earnings attributable to Series E convertible preferred stockholders - (3,507,892 ) Net (loss) income attributable to common stock-basic$ (3,357,746 ) $
3,745,531
Net (loss) income attributable to common stockholders-diluted$ (3,357,746 ) $ 3,349,308 Earnings (loss) per share: Basic$ (0.34 ) $ 0.14 Diluted$ (0.34 ) $ 0.10 Weighted average common shares outstanding: Basic 9,985,800 27,478,411 Diluted 9,985,800 32,328,565 Net sales Net sales for the year endedDecember 31, 2021 , increased by$46.8 million , or 33.8%, to$185.2 million , compared to$138.5 million in the year endedDecember 31, 2020 . This growth was largely driven by growth in our DTC customers. Our DTC sales were$73.9 million during the year endedDecember 31, 2021 , compared to$53.7 million for the year endedDecember 31, 2020 , which represents 37.7% year-over-year growth. The introduction of new innovative products along with an increase in demand for our immune supportive suite products helped drive sales and new customers, while the expansion of our health evaluations with quizzes and tests increased the conversion of those new customers. 73 --------------------------------------------------------------------------------
Cost of Sales and Gross Profit
The following table summarizes our cost of sales and gross profit for the
periods indicated:
Years Ended December 31,
Percent
2020 2021 Change Change
Net Sales $ 138,454,924 $ 185,246,025 $ 46,791,101 33.8 %
Cost of sales 73,667,333 87,892,579 14,225,246 19.3 %
Percent of net sales 53.2 % 47.4 % -580 bps (10.8 )%
Gross profit $ 64,787,591 $ 97,353,446 $ 32,565,855 50.3 %
Percent of net sales 46.8 % 52.6 % 580 bps 12.3 %
Cost of sales for the year ended December 31, 2021 , increased by $14.2 million ,
or 19.3%, to $87.9 million , compared to $73.7 million in the year ended December
31, 2020 . This increase in cost of sales was primarily due to a 33.8% increase
in net sales and associated product costs, partially offset by a reduction of
our product manufacturing costs. The increase in cost of sales was lower than
the increase in revenues on a percentage basis, primarily due to lower
production costs.
Gross profit for the year ended December 31, 2021 , increased by $32.6 million ,
or 50.3%, to $97.4 million , compared to $64.8 million in the year ended December
31, 2020 . This increase was primarily due to the increase in net sales described
above and additional efficiencies in our manufacturing processes, including
increased capacity, increased batch sizes and improved fixed cost leverage.
Gross profit as a percentage of net sales for the year ended December 31, 2021 ,
increased by 580 basis points, or 12.3%, compared to the year ended December 31,
2020 .
Operating Expenses
The following table summarizes our operating expenses for periods indicated:
Years Ended December 31,
Percent
2020 2021 Change Change
Net sales $ 138,454,924 $ 185,246,025
Operating expenses:
Research and development 4,224,891 5,935,514 $ 1,710,623 40.5 %
Percent of net sales 3.1 % 3.2 % 20 bps 5.0 %
Marketing 11,150,514 25,189,326 $ 14,038,812 125.9 %
Percent of net sales 8.1 % 13.6 % 550 bps 68.8 %
Stock-based compensation 10,037,396 4,554,024 $ (5,483,372 ) (54.6 )%
Percent of net sales 7.2 % 2.5 % -480 bps (66.1 )%
Depreciation and amortization 4,295,840 4,453,057 $ 157,217 3.7 %
Percent of net sales 3.1 % 2.4 % -70 bps (22.5 )%
Other selling, general and
administrative expenses 34,064,183 45,906,360 $ 11,842,177 34.8 %
Percent of net sales 24.6 % 24.8 % 20 bps 0.7 %
Write-off of acquired Drawbridge
in-process research and development - 1,563,015 $ 1,563,015 100.0 %
Percent of net sales 0.0 % 0.8 % 80 bps 100.0 %
Total operating expenses for the year ended December 31, 2021 increased by $23.8
million , or 37.4%, to $87.6 million , compared to $63.8 million in the year ended
December 31, 2020 . This increase was primarily due to an increase in marketing
expenses and the write-off of acquired Drawbridge in-process research and
development of $1.6 million .
Research and development expense for the year ended December 31, 2021 , increased
by $1.7 million , or 40.5%, to $5.9 million , compared to $4.2 million in the year
ended December 31, 2020 . The increase was primarily due to achieving the
objective to increase research spending as a percent of sales to drive new
product development and clinical trial investments.
Marketing expenses for the year ended December 31, 2021 , increased by $14.0
million , or 125.9%, to $25.2 million , compared to $11.2 million for the year
ended December 31, 2020 . The increase was primarily due to our investment in
paid, working media. The increased investment in our paid media efforts is
attributable to the strategy of increasing brand awareness, and reaching and
acquiring more customers, particularly to the Thorne.com website.
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Other selling, general and administrative expenses for the year ended December
31, 2021 , increased $11.8 million , or 34.8%, to $45.9 million , compared to $34.1
million in the year ended December 31, 2020 . The increase was primarily due to
increased shipping costs of approximately $4.0 million related to the 33.8%
increase in net sales, along with an increase in payroll related costs of
approximately $4.8 million related to the merger with Onegevity and Drawbridge
and incremental public company costs of approximately $3.0 million .
Interest Expense, Net
The following table summarizes our interest expense, net for the periods
indicated:
Years Ended December 31,
Percent
2020 2021 Change Change
Interest expense, net $ 1,125,472 $ 449,908 $ (675,564 ) (60.0 )%
Percent of net sales 0.8 % 0.2 % -60 bps (70.1 )%
Interest expense, net for the year ended December 31, 2021 decreased by $0.7
million , or 60.0%, to $0.4 million , compared to $1.1 million for the year ended
December 31, 2020 . This decrease was primarily due to the lower interest rate
associated with the refinancing of the $20.0 million loan obtained in February
2020 and the subsequent repayment of the loan in October 2021 .
Liquidity and Capital Resources
Revolving Credit Line.
OnFebruary 14, 2020 , we entered into an Uncommitted and Revolving Credit Line Agreement, by and among us as the borrower andSumitomo Mitsui Banking Corporation (SMBC) as the lender (2020 Credit Agreement). Upon the closing of the 2020 Credit Agreement, we borrowed$20.0 million from the revolving line of credit and used the proceeds to repay the outstanding principal and accrued interest under the previous line of credit totaling approximately$13.6 million , as well as issued payment of the Series D dividend, including all accrued and unpaid dividends, totaling approximately$3.3 million , and repaid the outstanding related party note payable to Kirin Holdings Company, Limited (Kirin), including all accrued and unpaid interest, totaling approximately$3.1 million . Our obligations under the 2020 Credit Agreement were guaranteed by two significant shareholders, Kirin and Mitsui & Co., Ltd. (Mitsui). We paid each guarantor an annual fee equal to two percent of$10 million for such guarantees annually and upon the occurrence of any change of control in respect of our company. Under separate Fee Letters, datedFebruary 14, 2020 , between us and each of Mitsui (2020Mitsui Fee Letter ) and Kirin (2020Kirin Fee Letter ), we agreed to reimburse Mitsui and/or Kirin, in cash, for any amounts that Mitsui and/or Kirin paid under its respective guarantee of the 2020 Credit Agreement. However, if we were not able to reimburse such amounts, wholly or partially, to Mitsui and/or Kirin, then we and Mitsui and/or Kirin agreed to deem such unreimbursed amount to have been made for the benefit of our company in consideration for our debt or equity securities on terms reasonably satisfactory to Mitsui and/or Kirin, and us. Under the Fee Letter datedFebruary 14, 2020 between us and Kirin (2020Kirin Fee Letter ), we agreed to reimburse Kirin in cash for any amounts that Kirin paid under its guarantee of the 2020 Credit Agreement. If we were not able to wholly or partially reimburse such amounts to Kirin, however, then we and Kirin agreed to deem such unreimbursed amount to have been made for our benefit in consideration for our debt or equity securities on terms reasonably satisfactory to Kirin and us. InFebruary 2021 , we replaced and refinanced the 2020 Credit Agreement and all loans outstanding thereunder with a new uncommitted revolving credit line from SMBC having substantially similar terms, as further described below. OnFebruary 12, 2021 , we entered into an Uncommitted and Revolving Credit Line Agreement, by and among us as the borrower and SMBC as the lender (2021 Credit Agreement), to refinance and replace the 2020 Credit Agreement. The terms of the 2021 Credit Agreement are substantially similar to the terms of the 2020 Credit Agreement. Under the 2021 Credit Agreement, SMBC may in its sole discretion elect to make unsecured loans to us untilFebruary 11, 2022 , in an aggregate principal amount up to but not exceeding$20.0 million at any time. Each loan made under the 2021 Credit Agreement may have a maturity date that is not less than one day and not more than twelve months after the date that such loan is disbursed, as we and SMBC may mutually agree. SMBC may, in its sole discretion at any time, terminate in whole or partially reduce the unused portion of the credit line under the 2021 Credit Agreement. SMBC is not obligated to make any loan under the 2021 Credit Agreement.
We may prepay any outstanding loans under the 2021 Credit Agreement in whole or in part at any time without penalty,
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other than customary prepayment fees or additional costs as determined by SMBC.
On February 12, 2021 , we drew down the full $20.0 million under the 2021 Credit
Agreement to refinance our outstanding loans under the 2020 Credit Agreement.
A loan under the 2021 Credit Agreement bears interest at a per annum rate quoted
by SMBC and agreed to by us when such loan is made. Interest on a loan is
payable in arrears on the maturity date of such loan. Principal of a loan is due
on such loan's maturity date. We are also obligated to pay other expenses and
indemnities customary for a credit facility of this size and type.
Our obligations under the 2021 Credit Agreement continue to be guaranteed by
Kirin and Mitsui. We are required to pay each guarantor an annual fee equal to
1.20% of each of their $10-million guarantees annually and upon the occurrence
of any change of control in respect of our company. We recorded $203 thousand
and $352 thousand of related expense during the years ended December 31, 2021
and 2020, respectively. These amounts are included in guarantee fees in the
consolidated statements of operations. Under separate Fee Letters, dated
February 12, 2021 , between us and each of Mitsui (2021 Mitsui Fee Letter ) and
Kirin (2021 Kirin Fee Letter ), we also agree to reimburse Mitsui and/or Kirin,
in cash, for any amounts that Mitsui and/or Kirin pays under its respective
guarantee of the 2021 Credit Agreement. However, if we are not able to reimburse
such amounts, wholly or partially, to Mitsui and/or Kirin, then we and Mitsui
and/or Kirin may agree to deem such unreimbursed amount to be made for our
benefit in consideration for our debt or equity securities on terms reasonably
satisfactory to Mitsui and/or Kirin, and us.
The 2021 Credit Agreement contains customary affirmative covenants, including
covenants regarding the payment of taxes and other obligations, maintenance of
insurance, reporting requirements and compliance with applicable laws and
regulations, and customary negative covenants limiting our ability, among other
things, to merge or consolidate, dispose of all or substantially all of its
assets, liquidate or dissolve, and grant liens, subject to certain exceptions.
Upon the occurrence and during the continuance of an event of default, SMBC may
declare all outstanding principal of, and accrued and unpaid interest on, loans
made under the 2021 Credit Agreement immediately due and payable and may
exercise the other rights and remedies provided for under the 2021 Credit
Agreement and related loan documents. The events of default under the 2021
Credit Agreement include, subject to grace periods in certain instances, payment
defaults, cross defaults with certain other material indebtedness, certain
material judgments, breaches of covenants or representations and warranties,
change in control of our company, a material adverse change as defined in the
2021 Credit Agreement, and certain bankruptcy and insolvency events.
On October 4, 2021 , we fully repaid the $20.0 million of outstanding borrowings,
plus all accrued and unpaid interest 2021 Credit Agreement through the date of
repayment. We incurred incremental fees related to the payoff totaling $7
thousand . Upon repayment of the outstanding borrowings under the 2021 Credit
Agreement, the related Mitsui and Kirin guarantees were released and terminated.
Letter of Credit Reimbursement Agreement.
OnOctober 31, 2018 , we entered into a Reimbursement Agreement with SMBC (LC Reimbursement Agreement), under which we may request SMBC to issue up to$4.9 million in letters of credit in the aggregate and we agree to reimburse SMBC for any drawings under such letters of credit. Our obligations under the LC Reimbursement Agreement are guaranteed by Kirin and Mitsui. We pay each guarantor an annual fee equal to 12-month LIBOR, plus 3.0%, of$2,450,000 for such guarantees annually and upon the occurrence of any change of control in respect of our company. In consideration of the future cessation of LIBOR interest rates, we are discussing with Kirin and Mitsui shifting to a SOFR based rate on terms yet to be negotiated. The 12-month LIBOR rate was last set onFebruary 12, 2021 . Under the Fee Letter datedNovember 30, 2018 , between us and Mitsui (2018Mitsui Fee Letter ), amounts paid by Mitsui under its guarantee shall be deemed made for our benefit in consideration for our debt or equity securities on terms reasonably satisfactory to Mitsui and us. Under the Fee Letter datedNovember 30, 2018 between us and Kirin (2018Kirin Fee Letter ), amounts paid by Kirin under its guarantee shall be deemed made for our benefit in consideration for our debt or equity securities on terms reasonably satisfactory to Kirin and us. The LC Reimbursement Agreement contains customary affirmative covenants, including covenants regarding the payment of taxes and other obligations, reporting requirements and compliance with applicable laws and regulations, and customary negative covenants limiting our ability, among other things, to merge or consolidate, dispose of all or substantially all of its assets, liquidate or dissolve. Upon the occurrence and during the continuance of an event of default, SMBC may declare all outstanding obligations owing under the LC Reimbursement Agreement immediately due and payable and may exercise the other rights and remedies provided for under the LC Reimbursement Agreement and related documents. The events of default under the LC Reimbursement Agreement include, subject to grace periods in certain instances, payment defaults, cross defaults with other indebtedness, certain material judgments, breaches of covenants or representations and warranties, a material adverse effect as defined in the LC Reimbursement Agreement and certain bankruptcy and insolvency events. To support the obligation of our subsidiary,Thorne Research, Inc. , to make a security deposit under its facility lease inSummerville, South Carolina , SMBC has issued an irrevocable standby letter of credit pursuant to the LC Reimbursement Agreement 76 -------------------------------------------------------------------------------- in the amount of$4.9 million with an original expiration date ofDecember 3, 2019 and automatic renewals untilOctober 31, 2037 . This letter of credit has an annual fee of$19,946 . We incurred guarantee fees for this letter of credit under the 2018 Mitsui Fee Letter and the 2018 Kirin Fee Letter during the years endedDecember 31, 2021 and 2020 were$134 thousand and$237 thousand , respectively. These fees are included in guarantee fees in the consolidated statements of operations.
On
We are currently negotiating with ourSouth Carolina facility's landlord to remove the requirement for such letter of credit. If the negotiation of such removal is successful, then the related supporting letter of credit may also not be required and could be terminated. There is no guarantee, however, that the landlord will agree to remove or reduce the required security under the lease, or the letter of credit.
Sources and Uses of Our Cash and Cash Equivalents
Operating Activities
Cash provided by operating activities consisted of net income (loss), adjusted for non-cash items, including depreciation and amortization, stock-based compensation, change in fair value of warrant liability and certain other non-cash items, as well as the effect of changes in working capital and other activities. Net cash provided by operating activities was$9.1 million for the year endedDecember 31, 2021 , primarily consisting of net income of$6.8 million , plus depreciation and amortization expense of$4.5 million ,$4.6 million of stock-based compensation expense, non-cash expenses of$1.7 million associated with the Drawbridge Transaction, the loss from equity interest in unconsolidated affiliates of$3.8 million , non-cash lease expense of$6.0 million , the change in fair value of warrant liability of$1.9 million , as well as a$16.4 million decrease in cash due to changes in working capital amounts, primarily related to an increase in inventories of$12.9 million to support continued sales growth Net cash provided by operating activities was$17.1 million for 2020, primarily consisting of$4.0 million of net loss adjusted for certain non-cash items, which primarily included depreciation and amortization expense of$4.3 million and$10.0 million of stock-based compensation expense, the loss from equity interest in unconsolidated affiliates of$1.5 million , non-cash lease expense of$5.3 million , change in fair value of warrant liability of$1.9 million , as well as a$2.0 million decrease in cash provided by a reduction in working capital primarily driven by a decrease in our operating lease liabilities and accounts receivable and increase in accounts payable.
Investing Activities
Our primary investing activities consisted of purchases of property and equipment, mainly to increase our manufacturing and fulfillment capabilities to support our growth, as well as leasehold improvements. Use of cash for investing activities also includes payments to support agreements with non-consolidated subsidiaries and the purchase and use of certain license and research agreements. Net cash used in investing activities was$7.2 million for the year endedDecember 31, 2021 , primarily consisting of capital spending of$4.3 million to support our continued growth, investing in the acquisition of Drawbridge of$1.4 million , investment in an equity-method investee of$0.7 million , and the entry into certain licensing and research agreements withMayo Clinic of$0.8 million .
Net cash used in investing activities was
Financing Activities Net cash provided by financing activities was$38.8 million for the year endedDecember 31, 2021 , primarily consisting of gross proceeds from our IPO of$70.0 million , reduced by the payment of related offering costs of$10.0 million , as well as the repayment of$20.0 million against our outstanding revolving line of credit, and payments for finance leases of$1.2 million . Net cash provided by financing activities was$1.4 million for 2020, primarily consisting of a$20.0 million revolving line of credit from SMBC and the exercise of certain warrants by our stockholders, offset by$11.2 million of principal repayments to 77 --------------------------------------------------------------------------------SunTrust Bank , the exercise of certain stock options that were set to expire, the repurchase of common stock from management, payment of a one-time deal flow dividend of$3.3 million to Mitsui, and a one-time loan from Kirin during plant construction of$3.0 million , both of which are current stockholders.
Contractual Obligations and Commitments
We have contractual obligations in the form of noncancelable leases and equipment loans. Future minimum payments due in the next 12 months under our leases and outstanding equipment loans are$3.0 million and$0.5 million , respectively. With the completion of our IPO inSeptember 2021 , we raised$60.0 million of net proceeds. As ofDecember 31, 2021 , we had$51.1 million of unrestricted cash and generated free cash flow of$4.0 million during the year endedDecember 31, 2021 . Considering recent market conditions and the ongoing COVID-19 pandemic, we have reevaluated our operating cash flows and cash requirements and continue to believe that current cash and future cash flows from operating activities will be sufficient to meet our anticipated cash needs, including working capital needs, capital expenditures, and contractual obligations for at least 12 months from the issuance date of the consolidated financial statements included herein. Our future capital requirements will depend on many factors, including our revenue growth rate, our working capital needs primarily for inventory build, our global footprint, the expansion of our marketing activities, the timing and extent of spending to support product development efforts, the introduction of new and enhanced products and the continued market consumption of our products. We may seek additional equity or debt financing in the future in order to acquire or invest in complementary businesses, products and/or new supportive infrastructures. In the event that we require additional financing, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital or general cash flows necessary to expand our operations and invest in continued product innovation, we may not be able to compete successfully, which would harm our business, operations, and financial condition.
Off Balance Sheet Arrangements
We currently do not have, and did not have during the periods presented, any off-balance sheet arrangements.
Critical Accounting Policies, Significant Judgments and Use of Estimates
Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with generally accepted accounting principles inthe United States (GAAP). The preparation of our consolidated financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, costs and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events, and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in the notes to our consolidated financial statements, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Under ASC 606, we account for revenue using the following steps:
•
identify the contract, or contracts, with a customer;
•
identify the performance obligations in the contract;
•
determine the transaction price
•
allocate the transaction price to the identified performance obligations; and
•
recognize revenue when, or as, we satisfy the performance obligations.
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We recognize revenues when control of the promised goods or services is
transferred to its customers in an amount that reflects the consideration we
expect to be entitled in exchange for those goods or services. We consider
several factors in determining that control transfers to the customer upon
shipment. These factors include that legal title transfers to the customer, we
have a present right to payment, and the customer has assumed the risks and
rewards of ownership at the time of shipment. Shipping and handling costs are
considered a fulfillment activity and are expensed as incurred. Our standard
business practice is to collect upfront payment for its products for
direct-to-consumer sales and to recognize a receivable for sales to distributors
when the performance obligation is satisfied.
Certain distributors resell our products in online marketplaces, however no
inventories are held on consignment; revenue is recognized when control of the
goods is transferred to these distributors, whom are ultimately our customers,
which is typically at the time of shipment. The terms of payment over the
recognized receivables from distributors are less than one year and therefore
these sales do not have any significant financing components. We use standard
business practices and standard price lists in determining the transaction
price. Any discounts stated or implied are allocated entirely to the sole
performance obligation. We primarily sell to customers throughout the United
States but also sell to international markets. Regardless of customer location,
all customer payments are required to be made in U.S. dollars. Given the
inherent nature of selling to international markets, there is a risk of higher
volatility pertaining to collecting payment on account; however, we review each
customer account for collectability and provides for probable uncollectible
amounts through a charge to earnings and a credit to a valuation allowance based
on its assessment. This process of assessing for collectability is performed for
all on account customers, both international and domestic.
We have elected to exclude sales tax for non-exempt customers from the
transaction price and is therefore excluded from revenue. For certain sales, we
incur incremental costs of obtaining the contract through the form of sales
commissions. The sales commissions incurred are directly correlated to the sales
generated and are therefore expensed as incurred as the amortization period of
the asset that otherwise would have been recognized is one year or less.
We also have a variable consideration element related to most of our contracts
in the form of product return rights. If a customer is not satisfied for any
reason with a product purchased, the customer can return it to the place of
purchase to receive a refund, a credit or a replacement product. If the customer
purchased the product on Amazon, the product must be returned to Amazon and if
purchased through our website, returned to us. The request must be submitted
within 60 days of the date of purchase. We analyze all returns and, as of the
balance sheet date, and record a sales return accrual within accrued liabilities
for the amount we expect to credit back to our customers based on our analysis.
With regard to our subscription offering, we offer our customers the ability to
opt into recurring automatic refills on both Thorne.com and Amazon.com. We
recognize revenue under our subscription program when product is shipped to the
consumer. No funds are collected at the time a consumer signs up for a
subscription and the customer can cancel or modify a subscription at any time
and no cost. The discount offered under the subscription plan reduces revenue at
the time the product ships to the customer. On our website, we allow customers
to subscribe monthly, every 45 days, every two months, every three months, or
every four months. For all these frequencies, we offer a 10% discount on retail
refill orders. On Amazon, the discount ranges from 5% to 10% depending on the
number of products to which a customer is subscribed; the average discount on
Amazon for our subscriptions is approximately 8%.
There are no material differences in our revenue recognition policy between the DTC subscription program and the DTC transaction program.
Stock-Based Compensation
We account for stock-based compensation by measuring and recognizing compensation expense for all share-based awards made to employees and non-employees based on estimated grant-date fair values. We use the straight-line method to allocate compensation cost to reporting periods over the requisite service period, which is generally the vesting period. We recognize actual forfeitures by reducing the stock-based compensation in the same period as the forfeitures occur. We estimate the fair value of share-based awards to employees and non-employees using the Black-Scholes option-pricing valuation model. The Black-Scholes model requires the input of subjective assumptions, including fair value of common stock, expected term, expected volatility, risk-free interest rate, and expected dividend yield, which are described in greater detail below. Estimating the fair value of equity-settled awards as of the grant date using the Black-Scholes option pricing model is affected by assumptions regarding a number of complex variables. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation is recognized. These inputs are subjective and generally require significant analysis and judgment to develop. These inputs are as follows:
•
Fair value of common stock - Prior to our IPO, there was no public market for our common stock. As such, the
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estimated fair value of our common stock and underlying stock options has been
determined at each grant date by our board of directors, with input from
management, based on the information known to us on the grant date and upon a
review of any recent events and their potential impact on the estimated per
share fair value of our common stock. As part of these fair value
determinations, our board of directors obtained and considered valuation reports
prepared by a third-party valuation firm in accordance with the guidance
outlined in the American Institute of Certified Public Accountants Technical
Practice Aid , Valuation of Privately-Held-Company Equity Securities Issued as
Compensation. For valuations after the completion of our initial public
offering, the fair value of each share of underlying common stock is based on
the closing price of our common stock as reported on the date of grant.
•
Expected term - The expected term for options granted to employees and directors represents the average period that our options granted are expected to be outstanding and is determined using the simplified method (based on the mid-point between the weighted-average vesting date and the end of the contractual term). We have very limited historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior for our stock option grants. The expected term for options granted to non-employees is the contractual term.
•
Expected volatility - As we had no publicly available stock price information prior to our IPO and limited publicly available stock price information subsequent to our IPO, the expected volatility was estimated based on the historical average volatility for comparable publicly traded life sciences technology companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their similar size, life cycle stage, or area of specialty. We will continue to apply this process until enough historical information regarding the volatility of our own stock price becomes available.
•
Risk-free interest rate - The risk-free interest rate is based on the
•
Expected dividend yield - We have never paid dividends on our common stock and have no plans to pay dividends on our common stock. Therefore, we used an expected dividend yield of zero.
We will continue to use judgment in evaluating the expected volatility, expected terms, and interest rates utilized for our stock-based compensation calculations on a prospective basis. Assumptions we used in applying the Black-Scholes option-pricing model to determine the estimated fair value of our stock options granted involve inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our equity-based compensation could be materially different.
Warrant Liability
We determine the accounting classification of a warrant, as either liability or
equity, by first assessing whether the warrant meets liability classification in
accordance with ASC 480, Distinguishing Liabilities from Equity (ASC 480), and
then in accordance with ASC 815-40, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock (ASC
815-40). If the warrant does not meet liability classification under ASC 480, we
assess the requirements under ASC 815-40, including whether the warrant is
indexed to our common stock and whether the warrant meets the other requirements
to be classified as equity under ASC 815-40. After all relevant assessments are
made, we conclude whether the warrant should be classified as liability or
equity.
We have warrants that are classified as a liability on our consolidated balance
sheet. The warrants classified as a liability are measured at fair value using
the Black-Scholes pricing model which takes into account, as of the valuation
date, factors including the current exercise price, the contractual life of the
warrant, the current fair value of the underlying stock, its expected
volatility, and the risk-free interest rate for the term of the warrant. The
warrant liability is revalued at each reporting period and changes in fair value
are recognized in the consolidated statements of operations. The selection of
the appropriate valuation model and the inputs and assumptions that are required
to determine the valuation requires significant judgment and requires management
to make estimates and assumptions that affect the reported amount of the related
liability and reported amounts of the change in fair value. Actual results could
differ from those estimates, and changes in these estimates are recorded when
known. As the warrant liability is required to be measured at fair value at each
reporting date, it is reasonably possible that these estimates and assumptions
could change in the near term.
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The fair value of our equity instruments has historically been determined based on information available at the time of granting. Given the absence of a public trading market for our equity, and in accordance with theAmerican Institute of Certified Public Accountants Practice Aid , Valuation of Privately Held Company Equity Securities Issued as Compensation, our management has exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of the fair value of our equity instruments at each grant date. These factors included: •
our operating and financial performance;
•
current business conditions and projections;
•
the lack of marketability of our shares;
•
using third-party experts to support the valuation of the shares; and
•
the market performance of comparable publicly-traded companies.
In valuing our equity instruments, we determined the equity value of our business using a weighted blend of the income and market approaches. The income approach estimates the fair value of a company based on the present value of such company's future estimated cash flows and the residual value of such company beyond the forecast period. These future values are discounted to their present values to reflect the risks inherent in such company achieving these estimated cash flows. Significant inputs of the income approach, in addition to our estimated future cash flows themselves, include the long-term growth rate assumed in the residual value, discount rate and normalized long-term operating margin. The terminal value was calculated to estimate our value beyond the forecast period by applying valuation metrics to the final year of our forecasted net sales and discounting that value to the present value using the same weighted average cost of capital applied to the forecasted periods. Application of these approaches involves the use of estimates, judgment and assumptions that are highly complex and subjective, such as those regarding our expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies and the probability of possible future events. Changes in any or all of these estimates and assumptions or the relationships between those assumptions impact our valuations as of each valuation date and may have a material impact on the valuation of our common stock. Income Taxes Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some portion or all of the net deferred tax assets will not be realized. We recognize the tax benefit from uncertain tax positions if it is more likely than not the tax positions will be sustained on examination by the tax authorities, based on the technical merits of the position. The tax benefit is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We recognize interest and penalties related to income tax matters in income tax expense.Health Elements, LLC made a previous election to be taxed as a Subchapter C corporation. As such, a provision for income taxes has been made for our investment in this entity and is included in the accompanying consolidated financial statements. As ofDecember 31, 2021 , we hadU.S. federal net operating loss carryforwards (NOLs) and state NOLs of approximately$70.2 million and$69.7 million , respectively, due to prior period losses. If not utilized the federal operating loss carryforwards incurred beforeJanuary 1, 2020 , will begin to expire in 2030. The federal operating losses incurred in 2018 and beyond do not expire. The state operating loss carryforwards do not expire. Realization of these NOLs depends on future income, and there is a risk that our existing NOLs could expire unused and be unavailable to offset future income tax liabilities, which could adversely affect our operating results. 81 -------------------------------------------------------------------------------- In general, under Section 382 of the Internal Revenue Code of 1986, as amended (the Code), a corporation that undergoes a defined "ownership change" is subject to limitations on its ability to utilize its NOLs carryforwards to offset future taxable income. The annual limitation is based on the Company's stock value prior to the ownership change, multiplied by the applicable federal long-term, tax-exempt interest rate. During 2021, we completed a Section 382 study and concluded that while there were no deemed changes in ownership related to the prior equity transactions of Thorne that may limit our NOLs as ofDecember 31, 2021 , the merger withDrawbridge Health during 2021 did constitute a deemed change in ownership under Section 382, resulting in a Section 382 limitation that applies to all Drawbridge Health NOLs generated prior to the merger, or deemed ownership change date. As a result of the identified ownership change related toDrawbridge Health at the time of the merger, the portion of NOL carryforwards attributable to the pre-ownership change periods are subject to a substantial limitation under Section 382. The Company has adjusted its NOL carryforwards to address the impact of the Section 382 ownership changes. This resulted in a reduction of available federal and state NOLs of$8.1 million and$8.1 million , respectively. All of the remaining federal and state NOLs are subject to a full valuation allowance atDecember 31, 2021 . Future changes in our stock ownership, the causes of which may be outside of our control, could result in ownership change under Section 382 of the Code. If we undergo a deemed ownership change in the future, our NOLs arising before such an ownership change may be subject to one or more Section 382 limitations that materially limit the use of such NOLs to offset our taxable income. Our ability to utilize NOLs of companies that we have acquired or may acquire in the future may also be subject to limitations. Further, our NOLs may be impaired under state laws. In addition, under the 2017 Tax Cuts and Jobs Act (Tax Act), as modified by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), NOLs arising in taxable years beginning afterDecember 31, 2020 may not be carried back, and NOLs generated in taxable years beginning afterDecember 31, 2017 may be carried forward indefinitely, but the deductibility of such NOLs generally will be limited in taxable years beginning afterDecember 31, 2020 to 80% of the current year taxable income. This change may require us to pay federal income taxes in future years even if our NOLs were otherwise sufficient to offset our federal taxable income in such years. There is also a risk that due to regulatory changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. For these reasons, we may not be able to realize, in whole or in part, a tax benefit from the use of our NOLs, whether or not we attain profitability.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements included elsewhere in this Annual Report for more information about recent accounting pronouncements, the timing of their adoption, and our assessment, to the extent we have made one yet, of their potential impact on our financial condition of results of operations.
COVID-19 Pandemic
OnJanuary 30, 2020 , theWorld Health Organization (WHO ) announced a global health emergency because of a new strain of coronavirus (COVID-19) and the risks to the international community as the virus spreads globally. InMarch 2020 , theWHO classified the COVID-19 outbreak as a pandemic. We are a manufacturer of nutritional supplement products, a category of food that is regulated by theU.S. Food and Drug Administration . Based on guidance issued by theU.S. Department of Homeland Security and theCybersecurity and Infrastructure Security Agency , and in particular, specific guidance therein regarding the food and agriculture industries, our manufacturing facility has been designated as "Essential Critical Infrastructure Workers " and would therefore be exempt from any "shelter in place" restrictions that might be imposed by theState of South Carolina . The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the impact this pandemic on the Company's financial condition. Management is actively monitoring the impact of this virus on its financial condition, liquidity, operations, suppliers, customers and workforce. Our consolidated financial statements presented herein reflect the latest estimates and assumptions made by management that affect the reported amounts of assets and liabilities and related disclosures as of the date of the consolidated financial statements and reported amounts of revenue and expenses during the reporting periods presented.
Emerging Growth Company Status
We are an emerging growth company, as defined in the JOBS Act. Under the JOBS
Act, emerging growth companies can delay adopting new or revised accounting
standards issued subsequent to the enactment of the JOBS Act until such time as
those
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standards apply to private companies. Other exemptions and reduced reporting
requirements under the JOBS Act for emerging growth companies include
presentation of only two years audited financial statements in a registration
statement for an initial public offering, an exemption from the requirement to
provide an auditor's report on internal controls over financial reporting
pursuant to the Sarbanes-Oxley Act, an exemption from any requirement that may
be adopted by the Public Company Accounting Oversight Board regarding mandatory
audit firm rotation, and less extensive disclosure about our executive
compensation arrangements. We have elected to use the extended transition period
for complying with new or revised accounting standards that have different
effective dates for public and private companies until the earlier of the date
that (i) we are no longer an emerging growth company or (ii) we affirmatively
and irrevocably opt out of the extended transition period provided in the JOBS
Act. As a result, our consolidated financial statements may not be comparable to
companies that comply with the new or revised accounting pronouncements as of
public company effective dates.
We will remain an emerging growth company under the JOBS Act until the earliest
of (i) the last day of our first fiscal year in which we have total annual gross
revenue of $1.07 billion or more, (ii) the date on which we have issued more
than $1.0 billion of non-convertible debt instruments during the previous three
fiscal years or (iii) the date on which we are deemed a "large accelerated
filer" under the rules of the SEC with at least $700.0 million of outstanding
equity securities held by non-affiliates, or (iv) the last day of the fiscal
year following the fifth anniversary of completion of our initial public
offering.
Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. As a result of becoming a public company, we will be required, pursuant to Section 404 of the Sarbanes-Oxley Act, as amended, to furnish a report by our management on, among other things, the effectiveness of our internal control over financial reporting for the first fiscal year beginning after our IPO. This assessment will need to include disclosures of any material weaknesses identified by our management in our internal control over financial reporting.
In connection with the audits of our financial statements, we identified material weaknesses related to:
•
an ineffective design of certain management review controls and insufficient controls to validate the completeness and accuracy of underlying data;
•
insufficient controls related to the accounting for complex, non-routine and significant and unusual transactions; and
•
insufficient design of information technology general controls ("ITGCs") in the
areas of logical security access and change management in certain financially
relevant systems, including adequate segregation of duties, and appropriate
journal entry review.
Under standards established by the Public Company Accounting Oversight Board , a
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of our annual or interim financial statements will
not be prevented or detected and corrected on a timely basis.
We are working to remediate the material weaknesses and are taking steps to
strengthen our internal control over financial reporting through the hiring of
additional finance and accounting personnel. With the additional personnel, we
intend to take appropriate and reasonable steps to remediate these material
weaknesses through the implementation of appropriate segregation of duties,
formalization of accounting policies and controls and retention of appropriate
expertise for complex accounting transactions. However, we cannot assure you
that these measures will significantly improve or remediate the material
weaknesses described above. As of December 31, 2021 , the material weaknesses
have not been remediated.
The actions that we are taking are subject to ongoing executive management review, and will also be subject to audit committee oversight. If we are unable to successfully remediate the material weakness, or if in the future, we identify further material weaknesses in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated.
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