KSPN Kaspien Holdings Inc. - 10-K

Item 1A.

RISK FACTORS

The following is a discussion of certain factors, which could affect the financial results of the Company.

Risks Related to Our Business

If we cannot successfully implement our business strategy our growth and profitability could be adversely impacted.

Our future results will depend, among other things, on our success in implementing our business strategy. The ability of the Company to meet its liabilities and to continue as a going concern is dependent on improved profitability, the continued implementation of the strategic initiative to reposition Kaspien as a platform of software and services and the availability of future funding.

There can be no assurance that we will be successful in further implementing our business strategy or that the strategy, including the completed initiatives, will be successful in sustaining acceptable levels of sales growth and profitability. Based on recurring losses from operations, negative cash flows from operations, the expectation of continuing operating losses for the foreseeable future, and uncertainty with respect to any available future funding, the Company has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Continued increases in Amazon Marketplace fulfillment and storage fees   could have an adverse impact on our profit margin and results of operations.

The Company utilizes Amazon’s Freight by Amazon (“FBA”) platform to store their products at the Amazon fulfillment center and to pack and distribute these products to customers. If Amazon continues to increase its FBA fees, our profit margin could be adversely affected.

Our business depends on our ability to build and maintain strong product listings on e-commerce platforms. We may not be able to maintain and enhance our product listings if we receive unfavorable customer complaints, negative publicity, or otherwise fail to live up to consumers’ expectations, which could materially adversely affect our business, results of operations and growth prospects.

Maintaining and enhancing our product listings is critical in expanding and growing our business. However, a significant portion of our perceived performance to the customer depends on third parties outside of our control, including suppliers and third-party delivery agents as well as online retailers such as Amazon and Walmart. Because our agreements with our online retail partners are generally terminable at will, we may be unable to maintain these relationships, and our results of operations could fluctuate significantly from period to period. Because we rely on third parties to deliver our products, we are subject to shipping delays or disruptions caused by inclement weather, natural disasters, labor activism, health epidemics or bioterrorism. We may also experience shipping delays or disruptions due to other carrier-related issues relating to their own internal operational capabilities. Further, we rely on the business continuity plans of these third parties to operate during pandemics, like the COVID-19 pandemic, and we have limited ability to influence their plans, prevent delays, and/or cost increases due to reduced availability and capacity and increased required safety measures.

Customer complaints or negative publicity about our products, delivery times, or marketing strategies, even if not accurate, especially on blogs, social media websites and third-party market sites, could rapidly and severely diminish consumer view of our product listings and result in harm to our brands. Customers may also make safety-related claims regarding products sold through our online retail partners, such as Amazon, which may result in an online retail partner removing the product from its marketplace. We have from time to time experienced such removals and such removals may materially impact our financial results depending on the product that is removed and length of time that it is removed. We also use and rely on other services from third parties, such as our telecommunications services, and those services may be subject to outages and interruptions that are not within our control.

A change in one or more of the Company’s partners’ policies or the Company’s relationship with those partners could adversely affect the Company’s results of operations.

The Company is dependent on its partners to supply merchandise in a timely and efficient manner. If a partner fails to deliver on its commitments, whether due to financial difficulties or other reasons, the Company could experience merchandise shortages that could lead to lost sales.

Historically, the Company has not experienced difficulty in obtaining satisfactory sources of supply and management believes that it will continue to have access to adequate sources of supply. The Company had one partner that represented 20.4% of net revenue in fiscal 2022.

Our revenue is dependent upon maintaining our relationship with Amazon and failure to do so, or any restrictions on our ability to offer products on the Amazon Marketplace, could have an adverse impact on our business, financial condition and results of operations.

The Company generates substantially all of its revenue through the Amazon Marketplace. Therefore, we depend in large part on our relationship with Amazon for growth. In particular, we depend on our ability to offer products on the Amazon Marketplace. We also depend on Amazon for the timely delivery of products to customers. Any adverse change in our relationship with Amazon, including restrictions on the ability to offer products or termination of the relationship, could adversely affect our continued growth and financial condition and results of operations.

We have substantial indebtedness, which could adversely affect our business.

We have a significant amount of debt and we may continue to incur additional debt in the future.  As of January 28, 2023, the Company had borrowings of $8.8 million under our credit facility with Eclipse.   We also had borrowings of $5.3 million under our Subordinated Debt facility, with interest accruing at the rate of twelve percent (12%) per annum and compounded on the last day of each calendar quarter by becoming a part of the principal amount .  In addition, we have $4.5 million under our Subordinated Debt Facility, with interest accruing at the rate of fifteen percent (15%) per annum and compounded on the last day of each calendar quarter by becoming a part of the principal amount . Substantially all of our assets, including the capital stock of Kaspien is pledged to secure our indebtedness.  This leverage also exposes us to significant risk by limiting our flexibility in planning for, or reacting to, changes in our business (whether through competitive pressure or otherwise), our industry and the economy at large. In addition, our ability to make payments on, or repay or refinance, such debt, and to fund our operating and capital expenditures, depends largely upon our future operating performance. Our future operating performance, to a certain extent, is subject to general economic, financial, competitive, regulatory and other factors that are beyond our control.

The terms of our asset-based revolving credit agreement and subordinated debt agreement impose certain restrictions on us that may impair our ability to respond to changing business and economic conditions, which could have a significant adverse impact on our business.  Additionally, our business could suffer if our ability to acquire financing is reduced or eliminated.

On February 20, 2020, Kaspien entered into a Loan and Security Agreement (the “Loan Agreement”) with Eclipse, as administrative agent, under which the lenders committed to provide up to $25 million in loans under a four-year, secured revolving credit facility (the “Credit Facility”).  On March 30, 2020, we entered into a Subordinated Loan and Security Agreement (the “Subordinated Loan Agreement”) with the lenders party thereto from time to time (the “Lenders”) and TWEC Loan Collateral Agent, LLC (“Collateral Agent”), as collateral agent for the Lenders, pursuant to which the Lenders made a $5.2 million secured term loan (the “Subordinated Loan”) to Kaspien.  We subsequently amended the Subordinated Loan to add an additional $5.0 million secured term loan.

Among other things, the Loan Agreement and Subordinated Loan Agreement limit Kaspien’s ability to incur additional indebtedness, create liens, make investments, make restricted payments or specified payments and merge or acquire assets.  The Loan Agreement also requires Kaspien to comply with a financial maintenance covenant.

The Loan Agreement and Subordinated Loan Agreement contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other obligations, customary ERISA defaults, certain events of bankruptcy and insolvency, judgment defaults, the invalidity of liens on collateral, change in control, cessation of business or the liquidation of material assets of the borrowers and guarantors taken as a whole, the occurrence of an uninsured loss to a material portion of collateral and, in the case of the Credit Facility, failure of the obligations to constitute senior indebtedness under any applicable subordination or intercreditor agreements, including our Subordinated Debt.

Risks Related to Information Technology and Intellectual Property

Breach of data security could harm our business and standing with our customers.

The protection of our partner, employee and business data is critical to us. Our business, like that of most companies, involves confidential information about our employees, our suppliers and our Company. We rely on commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of all such data, including confidential information. Despite the security measures we have in place, our facilities and systems, and those of our third-party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors, or other similar events. Unauthorized parties may attempt to gain access to our systems or information through fraud or other means, including deceiving our employees or third-party service providers. The methods used to obtain unauthorized access, disable or degrade service, or sabotage systems are also constantly changing and evolving, and may be difficult to anticipate or detect. We have implemented and regularly review and update our control systems, processes and procedures to protect against unauthorized access to or use of secured data and to prevent data loss. However, the ever-evolving threats mean we must continually evaluate and adapt our systems and processes, and there is no guarantee that they will be adequate to safeguard against all data security breaches or misuses of data. Any security breach involving the misappropriation, loss or other unauthorized disclosure of customer payment card or personal information or employee personal or confidential information, whether by us or our vendors, could damage our reputation, expose us to risk of litigation and liability, disrupt our operations, harm our business and have an adverse impact upon our net sales and profitability. As the regulatory environment related to information security, data collection and use, and privacy becomes increasingly rigorous, with new and changing requirements applicable to our business, compliance with those requirements could also result in additional costs. Further, if we are unable to comply with the security standards established by banks and the credit card industry, we may be subject to fines, restrictions and expulsion from card acceptance programs, which could adversely affect our retail operations.

Our hardware and software systems are vulnerable to damage, theft or intrusion that could harm our business.

Any failure of our computer hardware or software systems that causes an interruption in our operations or a decrease in inventory tracking could result in reduced net sales and profitability. Additionally, if any data intrusion, security breach, misappropriation or theft were to occur, we could incur significant costs in responding to such event, including responding to any resulting claims, litigation or investigations, which could harm our operating results.

Our inability or failure to protect our intellectual property rights, or any claimed infringement by us of third-party intellectual rights, could have a negative impact on our operating results.

Our trademark, trade secrets and other intellectual property, including proprietary software, are valuable assets that are critical to our success. The unauthorized reproduction or other misappropriation of our intellectual property could cause a decline in our revenue. In addition, any infringement or other intellectual property claim made against us could be time-consuming to address, result in costly litigation, cause product delays, require us to enter into royalty or licensing agreements or result in our loss of ownership or use of the intellectual property.

Risks Related to Human Capital

Loss of key personnel or the inability to attract, train and retain qualified employees could adversely affect the Company’s results of operations.

The Company believes that its future prospects depend, to a significant extent, on the services of its executive officers. Our future success will also depend on our ability to attract and retain qualified key personnel. The loss of the services of certain of the Company’s executive officers and other key management personnel could adversely affect the Company’s results of operations.

In addition to our executive officers, the Company’s business is dependent on our ability to attract, train and retain qualified team members. Our ability to meet our labor needs while controlling our costs is subject to external factors such as unemployment levels, health care costs and changing demographics. If we are unable to attract and retain adequate numbers of qualified team members, our operations and support functions could suffer. Those factors, together with increased wage and benefit costs, could adversely affect our results of operations.

We may face difficulties in meeting our labor needs to effectively operate our business.

We are heavily dependent upon our labor workforce. Our compensation packages are designed to provide benefits commensurate with our level of expected service. However, we face the challenge of filling many positions at wage scales that are appropriate to the industry and competitive factors. We also face other risks in meeting our labor needs, including competition for qualified personnel and overall unemployment levels. Changes in any of these factors, including a shortage of available workforce, could interfere with our ability to adequately service our customers and could result in increasing labor costs.

Our business could be adversely affected by increased labor costs, including costs related to an increase in minimum wage and health care.

Labor is one of the primary components in the cost of operating our business.  Increased labor costs, whether due to competition, unionization, increased minimum wage, state unemployment rates, health care, or other employee benefits costs may adversely impact our operating expenses.  Additionally, there is no assurance that future health care legislation will not adversely impact our results or operations.

Risks Related to Ownership of Our Common Stock.

The ownership of our Common Stock is concentrated, and entities affiliated with members of our Board of Directors have influence over the outcome of any vote of the Company’s shareholders and may have competing interests.

The Robert J. Higgins TWMC Trust (the “Trust”) owns approximately 14.4% of the outstanding Common Stock and Neil Subin owns approximately 9.1% of the outstanding Common Stock, and as a result each can influence the outcome of most actions requiring shareholder approval.  In addition, entities affiliated with each of the Trust and Mr. Subin, as well as one of our directors, Mr. Simpson, and certain of his affiliated entities, collectively hold approximately 25.3% of the outstanding Common Stock, and as a result can influence the outcome of most actions requiring shareholder approval.

If all of the outstanding warrants described in “Related Party Transactions” were exercised, the Trust would own approximately 13.5% of the outstanding Common Stock and Neil Subin and his affiliated entities would own approximately 14.6% of the outstanding Common Stock, and as a result each can influence the outcome of most actions requiring shareholder approval.  If all of the outstanding warrants described in “Related Party Transactions” were exercised, entities affiliated with each of the Trust, Mr. Subin, as well as one of our directors, Mr. Simpson, and certain of his affiliated entities, would collectively hold approximately 29.8% of the outstanding Common Stock, and as a result can significantly influence the outcome of nearly all actions requiring shareholder approval,

These shareholders entered into a voting agreement (as described in “Related Party Transactions”) and agreed to how their respective shares of the Company’s Common Stock held by the parties will be voted with respect to the designation, election, removal, and replacement of members of the Board.  Pursuant to the voting agreement, Messrs. Marcus and Simpson were appointed as directors of the Company, and Mr. Reickert, a trustee of the Trust, remained as a director of the Company. Mr. Subin was also granted board observer rights.

Entities affiliated with the Trust and Messrs. Marcus and Simpson are also lenders under our subordinated loan and security agreement, have received warrants to purchase shares of the Company’s Common Stock and received contingent value rights (“CVRs”) representing the contractual right to receive cash payments from the Company in an amount equal, in the aggregate, to 19.9% of the proceeds received by the Company in respect of certain intercompany indebtedness owing to it by Kaspien and/or its equity interest in Kaspien, each as described in “Related Party Transactions”.  In addition, entities affiliated with Mr. Marcus received an additional CVR representing the contractual right to receive cash payments from the Company in an amount equal to 9.0% of the proceeds received by the Company in respect of certain distributions by the Company or Kaspien; recapitalizations or financings of the Company or Kaspien (with appropriate carve out for trade financing in the ordinary course); repayment of intercompany indebtedness owing to the Company by Kaspien; or sale or transfer of any stock of the Company or Kaspien, as described in “Related Party Transactions”.  As a result, there may be instances in which the interest of Mr. Reickert, the Trust and its affiliated entities, Messrs. Marcus and Subin and their respective affiliated entities, and Mr. Simpson and his affiliated entities may conflict or be perceived as being in conflict with the interest of a holder of our securities or the interest of the Company.

The holders of our common stock could suffer substantial dilution due to our corporate financing practices.

The holders of our common stock could suffer substantial dilution due to our corporate financing practices, which, in the past few years, have included a registered direct offering, the issuance of warrants and the issuance of contingent value rights.

If all of the outstanding warrants were exercised, an additional 2,782,286 shares of common stock would be issued and outstanding.  This additional issuance of shares of common stock would cause immediate and substantial dilution to our existing shareholders and could cause a significant reduction in the market price of our common stock.

Additionally, lenders under our subordinated loan and security agreement, have received contingent value rights (“CVRs”) representing the contractual right to receive cash payments from the Company in an amount equal, in the aggregate, to 19.9% of the proceeds received by the Company in respect of certain intercompany indebtedness owing to it by Kaspien and/or its equity interest in Kaspien, each as described in “Related Party Transactions”.  In addition, certain lenders received an additional CVR representing the contractual right to receive cash payments from the Company in an amount equal to 9.0% of the proceeds received by the Company in respect of certain distributions by the Company or Kaspien; recapitalizations or financings of the Company or Kaspien (with appropriate carve out for trade financing in the ordinary course); repayment of intercompany indebtedness owing to the Company by Kaspien; or sale or transfer of any stock of the Company or Kaspien, as described in “Related Party Transactions”.  If events triggering these payments occur, the amount of consideration received by the Company will be reduced, thereby reducing any amounts distributable or attributable to shareholders or their shares.

The issuance of any securities for acquisition or financing efforts, upon exercise of warrants, pursuant to our equity compensation plans, or otherwise may result in a reduction of the market price of the outstanding shares of our common stock. If we issue any such additional securities, such issuance will cause a reduction in the proportionate ownership and voting power of all current shareholders. Further, such issuance may result in a change in control of our Company.

The Company’s stock price has experienced and could continue to experience volatility and could decline, resulting in a substantial loss on your investment.

Our stock price has experienced, and could continue to experience in the future, substantial volatility as a result of many factors, including global economic conditions, broad market fluctuations and public perception of the prospects for the industries in which we operate and the value of our assets. We are reliant on the performance of Kaspien, and a failure to meet market expectations, particularly with respect to net revenues, operating margins and earnings per share, would likely result in a further decline in the market price of our stock.

We do not currently meet continued listing standards of the NASDAQ, and as a result our Common Stock could be delisted from trading, which could limit investors’ ability to make transactions in our Common Stock and subject us to additional trading restrictions.

Our common stock is listed on The NASDAQ Stock Market LLC (“the NASDAQ”), which imposes continued listing requirements with respect to listed shares. On December 14, 2022, we received written notice from the NASDAQ that the closing bid price for our common stock had been below $1.00 for the previous 30 consecutive business days, and that the Company therefore was not in compliance with the minimum bid price requirement for continued listing on The Nasdaq Capital Market under Nasdaq Listing Rule 5550(a)(2). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), the Company has been provided a period of 180 calendar days, or until June 12, 2023, to regain compliance. In order to regain compliance with the minimum closing bid price rule, the closing bid price of the Company’s common stock must be at least $1.00 for a minimum of ten consecutive business days during the compliance period. If the Company does not regain compliance during the initial compliance period, the Company may be eligible for additional time to regain compliance. If the Company is not eligible, the Company expects that at that time the NASDAQ will provide written notice to the Company that the Company’s common stock will be subject to delisting.

The notice has no immediate impact on the listing of the Company’s common stock, which will continue to trade on The Nasdaq Capital Market. The Company intends to monitor its closing bid price for its common stock between now and June 12, 2023 and will consider available options to resolve the Company’s noncompliance with the minimum bid price requirement, as may be necessary. There can be no assurance, however, that we will be able to regain compliance or that we will otherwise be in compliance with other NASDAQ listing criteria. If we fail to regain and maintain compliance with the minimum bid requirement or to meet the other applicable continued listing requirements in the future and NASDAQ determines to delist our common stock, the delisting could adversely affect the market price and liquidity of our common stock, and reduce our ability to raise additional capital.

The limited public float and trading volume for our Common Stock may have an adverse impact and cause significant fluctuation of market price.

Historically, ownership of a significant portion of our outstanding shares of Common Stock has been concentrated in a small number of shareholders. Consequently, our Common Stock has a relatively small float and low average daily trading volume, which could affect a shareholder’s ability to sell our stock or the price at which it can be sold. In addition, future sales of substantial amounts of our Common Stock in the public market by those larger shareholders, or the perception that these sales could occur, may adversely impact the market price of the stock and our stock could be difficult for a shareholder to liquidate.

Failure to remediate a material weakness related to our ability to perform adequate independent reviews and maintain effective controls related to account analyses, account summaries and account reconciliations , could result in material misstatements in our financial statements.

Our management has identified a material weakness related to our ability to perform adequate independent reviews and maintain effective controls related to account analyses, account summaries and account reconciliations and has concluded that, due to such material weakness, each of our disclosure controls and procedures and internal control over financial reporting were not effective as of January 28, 2023. While remediation is in process, our failure to establish and maintain effective disclosure controls and procedures and internal control over financial reporting could result in material misstatements in our financial statements, and a failure to meet our reporting and financial obligations, each of which could have a material adverse effect on our financial condition and the trading price of our common stock.

General Risk Factors

The Company’s business is influenced by general economic conditions.

The Company’s performance is subject to general economic conditions and their impact on levels of discretionary consumer spending. General economic conditions impacting discretionary consumer spending include, among others, wages and employment, consumer debt, reductions in net worth, residential real estate and mortgage markets, taxation, fuel and energy prices, interest rates, consumer confidence and other macroeconomic factors.

Consumer purchases of discretionary items generally decline during recessionary periods and other periods where disposable income is adversely affected. A downturn in the economy affects retailers disproportionately, as consumers may prioritize reductions in discretionary spending, which could have a direct impact on purchases of our products and services and adversely impact our results of operations. In addition, reduced consumer spending may drive us and our competitors to offer additional products at promotional prices, which would have a negative impact on gross profit.

Disruption of global capital and credit markets may have a material adverse effect on the Company’s liquidity and capital resources.

Distress in the financial markets has in the past and can in the future result in extreme volatility in security prices, diminished liquidity and credit availability. There can be no assurance that our liquidity will not be affected by changes in the financial markets and the global economy or that our capital resources will at all times be sufficient to satisfy our liquidity needs.

Because of our floating rate credit facility, we may be adversely affected by interest rate changes.

Our financial position may be affected by fluctuations in interest rates, as the Credit Facility is subject to floating interest rates. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. As we borrow against our credit facility, a significant increase in interest rates could have an adverse effect on our financial position and results of operations.

The Company is dependent upon access to capital, including bank credit facilities and short-term vendor financing, for its liquidity needs.

The Company must have sufficient sources of liquidity to fund its working capital requirements and indebtedness. The future availability of financing will depend on a variety of factors, such as economic and market conditions, permissibility under our existing financing arrangements, the availability of credit and the Company’s credit rating, as well as the Company’s reputation with potential lenders. These factors could materially adversely affect the Company’s ability to fund its working capital requirements, costs of borrowing, and the Company’s financial position and results of operations would be adversely impacted.

We may complete a future significant strategic transaction that may not achieve intended results or could increase the number of our outstanding shares or amount of outstanding debt or result in a change of control.

We will evaluate and may in the future enter into strategic transactions. Any such transaction could happen at any time following the closing of the merger, could be material to our business and could take any number of forms, including, for example, an acquisition, merger or a sale of all or substantially all of our assets.

Evaluating potential transactions and integrating completed ones may divert the attention of our management from ordinary operating matters. The success of these potential transactions will depend, in part, on our ability to realize the anticipated growth opportunities and cost synergies through the successful integration of the businesses we acquire with our existing business. Even if we are successful in integrating the acquired businesses, we cannot assure you that these integrations will result in the realization of the full benefit of any anticipated growth opportunities or cost synergies or that these benefits will be realized within the expected time frames. In addition, acquired businesses may have unanticipated liabilities or contingencies.

If we complete an acquisition, investment or other strategic transaction, we may require additional financing that could result in an increase in the number of our outstanding shares or the aggregate principal amount of our debt. A strategic transaction may result in a change in control of our company or otherwise materially and adversely affect our business.

Historically, we have experienced declines, and we may continue to experience fluctuation in our level of sales and results from operations.

A variety of factors has historically affected, and will continue to affect, our sales results and profit margins. These factors include general economic conditions; competition; actions taken by our competitors; consumer trends and preferences; access to third party marketplaces; and new product introductions and changes in our product mix.

There is no assurance that we will achieve positive levels of sales and earnings growth, and any decline in our future growth or performance could have a material adverse effect on our business and results of operations.

The ability of the Company to satisfy its liabilities and to continue as a going concern will continue to be dependent on the implementation of several items, the success of which is not certain.

The Company has suffered recurring losses from operations and the Company’s primary sources of liquidity are borrowing capacity under its revolving credit facility, available cash and cash equivalents, all of which are limited. Therefore, the ability of the Company to meet its liabilities and to continue as a going concern is dependent on, among other things, improved profitability, the continued implementation of the strategic initiative to reposition Kaspien as a platform of software and services, the availability of future funding, implementation of one or more corporate initiatives to reduce costs at the parent company level and other strategic alternatives, including selling all or part of the remaining business or assets of the Company.

There can be no assurance that we will be successful in further implementing our business strategy or that the strategy, including the completed initiatives, will be successful in sustaining acceptable levels of sales growth and profitability. Based on recurring losses from operations, negative cash flows from operations, the expectation of continuing operating losses for the foreseeable future, and uncertainty with respect to any available future funding, the Company has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Parties with whom the Company does business may be subject to insolvency risks or may otherwise become unable or unwilling to perform their obligations to the Company.

The Company is a party to contracts, transactions and business relationships with various third parties, including partners, vendors, suppliers, service providers and lenders, pursuant to which such third parties have performance, payment and other obligations to the Company. In some cases, the Company depends upon such third parties to provide essential products, services or other benefits, including with respect to merchandise, advertising, software development and support, logistics, other agreements for goods and services in order to operate the Company’s business in the ordinary course, extensions of credit, credit card accounts and related receivables, and other vital matters. Economic, industry and market conditions could result in increased risks to the Company associated with the potential financial distress or insolvency of such third parties. If any of third parties were to become subject to bankruptcy, receivership or similar proceedings, the rights and benefits of the Company in relation to its contracts, transactions and business relationships with such third parties could be terminated, modified in a manner adverse to the Company, or otherwise impaired. The Company cannot make any assurances that it would be able to arrange for alternate or replacement contracts, transactions or business relationships on terms as favorable as the Company’s existing contracts, transactions or business relationships, if at all. Any inability on the part of the Company to do so could negatively affect the Company’s cash flows, financial condition and results of operations.

Failure to comply with legal and regulatory requirements could adversely affect the Company’s results of operations.

The Company’s business is subject to a wide array of laws and regulations. Significant legislative changes that impact our relationship with our workforce (none of which is represented by unions) could increase our expenses and adversely affect our operations. Examples of possible legislative changes impacting our relationship with our workforce include changes to an employer’s obligation to recognize collective bargaining units, the process by which collective bargaining units are negotiated or imposed, minimum wage requirements, health care mandates, and changes in overtime regulations.

Our policies, procedures and internal controls are designed to comply with all applicable laws and regulations, including those imposed by the Securities and Exchange Commission and the NASDAQ Capital Market, as well as applicable employment laws. Additional legal and regulatory requirements increase the complexity of the regulatory environment in which we operate and the related cost of compliance. Failure to comply with such laws and regulations may result in damage to our reputation, financial condition and market price of our stock.

Litigation may adversely affect our business, financial condition and results of operations.

Our business is subject to the risk of litigation by employees, consumers, partners, suppliers, competitors, stockholders, government agencies or others through private actions, class actions, administrative proceedings, regulatory actions or other litigation. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. We may incur losses relating to these claims, and in addition, these proceedings could cause us to incur costs and may require us to devote resources to defend against these claims that could adversely affect our results of operations. For a description of current legal proceedings, see “Part I, Item 3, Legal Proceedings.”

The effects of natural disasters, terrorism, acts of war, and public health issues may adversely affect our business.

Natural disasters, including earthquakes, hurricanes, floods, and tornadoes may affect store and distribution center operations. In addition, acts of terrorism, acts of war, and military action both in the United States and abroad can have a significant effect on economic conditions and may negatively affect our ability to purchase merchandise from suppliers for sale to our customers. Public health issues, such as flu or other pandemics, whether occurring in the United States or abroad, could disrupt our operations and result in a significant part of our workforce being unable to operate or maintain our infrastructure or perform other tasks necessary to conduct our business. Additionally, public health issues may disrupt, or have an adverse effect on, our suppliers’ operations, our operations, our customers, or customer demand. Our ability to mitigate the adverse effect of these events depends, in part, upon the effectiveness of our disaster preparedness and response planning as well as business continuity planning. However, we cannot be certain that our plans will be adequate or implemented properly in the event of an actual disaster. We may be required to suspend operations in some or all our locations, which could have a material adverse effect on our business, financial condition, and results of operations. Any significant declines in public safety or uncertainties regarding future economic prospects that affect customer spending habits could have a material adverse effect on customer purchases of our products.

A pandemic, epidemic or outbreak of an infectious disease, such as COVID-19, may materially and adversely affect our business.

Our business, results of operations, and financial condition may be materially adversely impacted if a public health outbreak, including the recent COVID-19 pandemic, interferes with our ability, or the ability of our employees, contractors, suppliers, and other business partners to perform our and their respective responsibilities and obligations relative to the conduct of our business.

Item 1B.

UNRESOLVED SEC COMMENTS

None.

Item 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Management’s Discussion and Analysis of Financial Condition and Results of Operations provide information that the Company’s management believes necessary to achieve an understanding of its financial condition and results of operations.  To the extent that such analysis contains statements which are not of a historical nature, such statements are forward-looking statements, which involve risks and uncertainties.  These risks include, but are not limited to, changes in the competitive environment for the Company’s products and services; general economic factors in markets where the Company’s products and services are sold; and other factors including, but not limited to: cost of goods, consumer disposable income, consumer debt levels and buying patterns, consumer credit availability, interest rates, customer preferences, unemployment, labor costs, inflation, fuel and energy prices, weather patterns, climate change, catastrophic events, competitive pressures and insurance costs discussed in the Company’s filings with the Securities and Exchange Commission.

Key Performance Indicators

Management monitors a number of key performance indicators to evaluate its performance, including:

Net Revenue: The Company measures total year over year sales growth. Net sales performance is measured through several key performance indicators including number of partners and active product listings and sales per listing.

Cost of Sales and Gross Profit:   Gross profit is calculated based on the cost of product in relation to its retail selling value. Changes in gross profit are impacted primarily by net sales levels, mix of products sold, obsolescence and distribution costs.  Distribution expenses include those costs associated with receiving, inspecting & warehousing merchandise, Amazon fulfillment fees, and costs associated with product returns to vendors.

Selling, General and Administrative (“SG&A”) Expenses: Included in SG&A expenses are payroll and related costs, general operating and overhead expenses and depreciation charges.  SG&A expenses also include miscellaneous income and expense items, other than interest.

Balance Sheet and Ratios:   The Company views cash, merchandise inventory, accounts payable leverage, and working capital as key indicators of its financial position.  See “Liquidity and Capital Resources” for further discussion of these items .

Gross Merchandise Value (“GMV”): The total value of merchandise sold over a given time period through a customer-to-customer exchange site. It is the measurement of merchandise value sold across all channels and partners within our platform.

Fiscal Year Ended January 28, 2023 (“fiscal 2022”)

Compared to Fiscal Year Ended January 29, 2022 (“fiscal 2021”)

The Company’s fiscal year is a 52 or 53-week period ending the Saturday nearest to January 31.  Fiscal 2022 and fiscal 2021 ended January 28, 2023 and January 29, 2022, respectively. Both fiscal 2022 and fiscal 2021 had 52 weeks.

Net Revenue. Net revenue decreased 10.8% to $128.2 million compared to $143.7 million in fiscal 2021. The primary source of revenue is the Retail as a Service (“RaaS”) model, which represented 98.7% of net revenue. Net revenue from Walmart, Target and Other Marketplaces decreased to 1.3% in fiscal 2022 from 1.5% in fiscal 2021. Subscriptions and Other share of net revenue increased to 1.4% of net revenue from 1.3% of net revenue in the comparable period from the prior year The following table sets forth net revenue by marketplace as a percentage of total net revenue:

January 28,

Total

January 29,

Total

Change

Amazon US

Amazon International

Walmart, Target & Other Marketplaces

Subtotal Retail

Subscriptions & Other

Total

The Company generates revenue across a broad array of product lines primarily through the Amazon Marketplace. Categories include apparel, baby, beauty, electronics, health & personal care, home/kitchen/grocery, pets, sporting goods, toys & art.

Annual platform GMV for fiscal year 2022 was $271.0 million, the same level as fiscal 2021. Retail GMV decreased 9.2% to $137.1 million or 50.6% of total GMV, compared to $151.0 million or 55.7% of total GMV in fiscal 2021. Subscription GMV increased 15.7% to $133.9 million  or 49.4% of total GMV, compared to $120.0 million or 44.3% of total GMV in fiscal 2021.

Gross Profit.    Gross profit as a percentage of revenue was 19.0% in fiscal 2022 as compared to 22.8% in fiscal 2021. The decrease in the gross profit rate was primarily due to a decrease in merchandise margin to 41.2% in fiscal 2022 as compared to 44.8% in fiscal 2021 and a $0.6 million increase in warehousing and freight expenses. The following table sets forth a year-over-year comparison of the Company’s gross profit:

Change

(amounts in thousands)

January 28,

January 29,

Merchandise margin

% of net revenue

Fulfillment fees

Warehousing and freight

Gross profit

% of net revenue

S elling, General and Administrative Expenses. The following table sets forth a year-over-year comparison of the Company’s SG&A expenses:

Change

(amounts in thousands)

January 28,

January 29,

Selling expenses

General and administrative expenses

Depreciation and amortization expenses

Total SG&A expenses

As a % of total revenue

SG&A expenses decreased $2.6 million, or 6.1%, primarily due to an 11.3% reduction in in Selling expenses. The decline in Selling expenses was attributable to the decline in Net revenue. General and administrative expenses increased $0.7 million.

SG&A expenses as a percentage of net revenue increased to 30.4% as compared to 29.5% in fiscal 2021. The increase in the rate as a percentage of net revenue was primarily due to lost leverage on the general and administrative expenses.

Depreciation and amortization expense. Consolidated depreciation and amortization expense for fiscal 2022 was $1.2 million as compared to $2.1 million in fiscal 2021.

Interest Expense.   Interest expense in fiscal 2022 was $3.6 million, compared to interest expense of $1.9 million in fiscal 2021.  The increase in interest expense was attributable to higher average borrowings on the Credit Facility and the Additional Subordinated Debt.

Income Tax Expense.    The following table sets forth a year-over-year comparison of the Company’s income tax expense:

(amounts in thousands)

Change

January 28,

January 29,

Income tax expense

Effective tax rate

The fiscal 2022 and fiscal 2021 income tax expense includes state taxes.

Net Loss.    The following table sets forth a year-over-year comparison of the Company’s net loss:

(amounts in thousands)

Change

January 28,

January 29,

Net loss

Net loss as a percentage of Net revenue

Net loss was $19.0 million for fiscal 2022, compared to $8.0 million for fiscal 2021. The increase in net loss was primarily due to lower net revenue and a lower gross margin rate.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Cash Flows:

The consolidated financial statements for the year ended January 28, 2023 were prepared on the basis of a going concern which contemplates that the Company will be able to realize assets and satisfy liabilities and commitments in the normal course of business. The ability of the Company to meet its liabilities and to continue as a going concern is dependent on improved profitability, the continued implementation of the strategic initiative to reposition the Company as a platform of software and services and the availability of future funding.

The audited consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

The Company incurred net losses of $19.0 million and $8.0 million for the fiscal 2022 and fiscal 2021, respectively, and has an accumulated deficit of $139.9 million as of January 28, 2023.  In addition, net cash used in operating activities during fiscal 2022 was $11.3 million. Net cash used in operating activities during fiscal 2021 was $14.5 million.

There can be no assurance that we will be successful in further implementing our business strategy or that the strategy, including the completed initiatives, will be successful in sustaining acceptable levels of sales growth and profitability.  Based on recurring losses from operations, negative cash flows from operations, the expectation of continuing operating losses for the foreseeable future, and uncertainty with respect to any available future funding, the Company has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company’s primary sources of liquidity are its borrowing capacity under its Credit Facility, available cash and cash equivalents, and to a lesser extent, cash generated from operations. Our cash requirements relate primarily to working capital needed to operate Kaspien, including funding operating expenses, the purchase of inventory and capital expenditures. Our ability to achieve profitability and meet future liquidity needs and capital requirements will depend upon numerous factors, including the timing and amount of our revenue; the timing and amount of our operating expenses; the timing and costs of working capital needs; and successful implementation of our strategy and planned activities.

On March 18, 2021, the Company closed an underwritten offering of 416,600 shares of common stock of the Company, at a price to the public of $32.50 per share. The gross proceeds of the offering were approximately $13.5 million, prior to deducting underwriting discounts and commissions and estimated offering expenses. The Company used the net proceeds from the offering for general corporate purposes, including working capital to implement its strategic plans focused on brand acquisition, investments in technology to enhance its scalable platform and its core retail business.

On March 2, 2022, the Company amended its subordinated loan pursuant to which the lenders made an additional $5.0 million secured term loan with a scheduled maturity date of March 31, 2024, which is the same maturity date as the existing loans under the Subordinated Loan Agreement.

On July 12, 2022, the Company entered into a Securities Purchase Agreement (the “PIPE Purchase Agreement”) with a single institutional investor for a private placement offering (“Private Placement”) of the Company’s common stock (the “Common Stock”) or pre-funded warrants, with each pre-funded warrant exercisable for one share of Common Stock (the “Pre-Funded Warrants”) and warrants exercisable for one share of Common Stock (the “Investor Warrants”). Pursuant to the PIPE Purchase Agreement, the Company issued and sold 1,818,182 shares (the “Shares”) of its Common Stock or Pre-Funded Warrants in lieu thereof together with Investor Warrants to purchase up to 2,457,160 shares of Common Stock. Each share of Common Stock and accompanying Investor Warrant were sold together at a combined offering price of $3.30 per share.

The Pre-Funded Warrants have been exercised in full, at a nominal exercise price of $0.001.

The Investor Warrants have an exercise price of $3.13 per share (subject to adjustment as set forth in the warrant), are exercisable upon issuance and will expire five years from the date of issuance. The Investor Warrants contain standard adjustments to the exercise price including for stock splits, stock dividend, rights offerings and pro rata distributions.

The Private Placement closed on July 14, 2022. The Company received approximately $6 million in gross proceeds from the Private Placement, before deducting discounts and commissions and estimated offering expenses. The Company used the net proceeds from the private placement for working capital and other general corporate purposes.

On July 12, 2022, the Company also entered into a Securities Purchase Agreement (the “Registered Purchase Agreement”) with a single institutional investor, pursuant to which the Company agreed to issue and sell 638,978 shares (the “Registered Shares”) of its Common Stock or Pre-Funded Warrants in lieu thereof, with each Pre-Funded Warrant exercisable for one share of Common Stock (the “Offering”). The Company received approximately $2 million in gross proceeds from the Offering, before deducting discounts and commissions and estimated offering expenses. The Company used the net proceeds from the private placement for working capital and other general corporate purposes.

In addition to the aforementioned current sources of existing working capital, the Company is continuing its efforts to generate additional sales and increase margins. There can be no assurance that any of the initiatives or strategic alternatives will be implemented, successful or consummated.

The following table sets forth a two-year summary of key components of cash flow and working capital:

(amounts in thousands)

Operating Cash Flows

Investing Cash Flows

Financing Cash Flows

Capital Expenditures

End of Period Balances:

Cash, Cash Equivalents, and Restricted Cash

Merchandise Inventory

Working Capital

Cash and cash equivalents per Consolidated Balance Sheets

Add: Restricted cash

Cash, cash equivalents, and restricted cash

During fiscal 2022, cash used in operations was $11.3 million compared to $14.5 million in fiscal 2021.  During 2022, cash used in operations consisted primarily of a net loss of $18.8 million, partially offset by a $2.6 million reduction in inventory and a $0.8 million increase in accounts payable.  During 2021, cash used in operations consisted primarily of a net loss of $8.0 million, an increase of $4.8 million in inventory and the payment of $2.6 million in accounts payable.  See the Consolidated Statement of Cash Flows for further detail.

The Company monitors various statistics to measure its management of inventory, including inventory turnover (annual cost of sales divided by average merchandise inventory balances), and accounts payable leverage (accounts payable divided by merchandise inventory).   Inventory turnover measures the Company’s ability to sell merchandise and how many times it is replaced in a year. This ratio is important in determining the need for markdowns and planning future inventory levels and assessing customer response to our merchandise.  Inventory turnover in fiscal 2022 and in fiscal 2021 was 3.7 and 4.0, respectively.  Accounts payable leverage measures the percentage of inventory being funded by the Company’s product vendors.  The percentage is important in determining the Company’s ability to fund its business.  Accounts payable leverage on inventory for Kaspien was 26.4% as of January 28, 2023 compared with 20.7% as of January 29, 2022.

Cash used in investing activities was $0.9 million in fiscal 2022, compared to $1.4 million in fiscal 2021. During fiscal 2022 and fiscal 2021, cash used in investing activities consisted entirely of capital expenditures.

The Company has historically financed its capital expenditures through borrowings under its revolving credit facility and cash flow from operations.  The Company anticipates capital spending of approximately $1.0 million in fiscal 2023.

Cash provided by financing activities was $11.0 million in fiscal 2022, compared to $14.2 million in fiscal 2021. In fiscal 2022, the primary source of cash was $5.0 million raised from the issuance of subordinated debt and $7.1 million from the Private Placement and Registered Shares offerings partially offset by the payment of short-term borrowings of $1.2 million. In fiscal 2021, the primary source of cash was $12.2 million raised from the underwritten offering of common stock of the Company. Additional sources of cash included the $10.0 million in proceeds from short term borrowings. The Company used $6.3 million of the proceeds to pay down its Credit Facility.

Related Party Transactions.

Directors Jonathan Marcus, Thomas Simpson, and Michael Reickert are the chief executive officer of Alimco Re Ltd. (“Alimco”), the managing member of Kick-Start III, LLC and Kick-Start IV, LLC (“Kick-Start”), and a trustee of the Robert J. Higgins TWMC Trust (the “Trust”), an affiliate of RJHDC, LLC (“RJHDC” and together with Alimco and Kick-Start, “Related Party Entities”), respectively.  The Related Party Entities are parties to the following agreements with the Company entered into on March 30, 2020:

Subordinated Loan and Security Agreement (as amended), pursuant to which the Related Party Entities made a $5.2 million secured term loan ($2.7 million from Alimco, $0.5 million from Kick-Start, and $2.0 million from RJHDC) to Kaspien with a scheduled maturity date of March 31, 2024, interest accruing at the rate of twelve percent (12%) per annum and compounded on the last day of each calendar quarter by becoming a part of the principal amount, and secured by a second priority security interest in substantially all of the assets of the Company and Kaspien;

Common Stock Purchase Warrants (“Warrants”), pursuant to which the Company issued warrants to purchase up to 244,532 shares of Common Stock to the Related Party Entities (127,208 shares for Alimco, 23,401 shares for Kick-Start, and 93,923 shares for RJHDC), subject to adjustment in accordance with the terms of the Warrants, at an exercise price of $0.01 per share.  As of April 28, 2023, 236,993 of the Warrants had been exercised by the Related Party Entities and 5,126 warrants remained outstanding;

Contingent Value Rights Agreement (the “CVR Agreement”), pursuant to which the Related Party Entities received contingent value rights (“CVRs”) representing the contractual right to receive cash payments from the Company in an amount equal, in the aggregate, to 19.9% of the proceeds (10.35% for Alimco, 1.90% for Kick-Start, and 7.64% for RJHDC) received by the Company in respect of certain intercompany indebtedness owing to it by Kaspien and/or its equity interest in Kaspien; and

Voting Agreement (the “Voting Agreement”), pursuant to which the Related Party Entities, the Trust, Mr. Simpson and their respective related entities agreed to how their respective shares of the Company’s capital stock held by the parties will be voted with respect to the designation, election, removal, and replacement of members of the Board of Directors of the Company. On August 2, 2022, the parties entered into Amendment No. 1 to the Voting Agreement setting forth their agreements and understandings with respect to how shares of the Company’s capital stock held by the parties thereto will be voted with respect to (i) amending the Certificate of Incorporation of the Company to set the size of the Board of Directors of the Company at four directors and (ii) the designation, election, removal, and replacement of members of the Board.

On March 2, 2022, the Company entered into the following agreements with certain of the Related Parties:

An amendment to the Subordinated Loan and Security Agreement, pursuant to which Alimco made an additional $5,000,000.00 secured term loan (the “Additional Subordinated Loan”) with a scheduled maturity date of March 31, 2024, interest accruing at the rate fifteen percent (15.0%) per annum, compounded on the last day of each calendar quarter by becoming a part of the principal amount of the Additional Subordinated Loan, and secured by a second priority security interest in substantially all of the assets of the Company and Kaspien;

Common Stock Purchase Warrant (“Alimco Warrant”), pursuant to which the Company issued warrants to purchase up to 320,000 shares of Common Stock to Alimco, subject to adjustment in accordance with the terms of the Alimco Warrant, at an exercise price of $0.01 per share. All such warrants were outstanding as of April 28, 2023;

Registration Rights Agreement, pursuant to which Alimco has been granted customary demand and piggyback registration rights with respect to the Warrant Shares issued upon exercise of the Alimco Warrant; and

Contingent Value Rights Agreement (the “Second CVR Agreement”) pursuant to which Alimco received additional contingent value rights (“Additional CVRs”) representing the contractual right to receive cash payments from the Company in an amount equal, in the aggregate, to 9.0% of the proceeds received by the Company in respect of certain distributions by the Company or Kaspien; recapitalizations or financings of the Company or Kaspien (with appropriate carve out for trade financing in the ordinary course); repayment of intercompany indebtedness owing to the Company by Kaspien; or sale or transfer of any stock of the Company or Kaspien.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires that management apply accounting policies and make estimates and assumptions that affect results of operations and the reported amounts of assets and liabilities in the financial statements.  Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.  Note 1 of the Notes to the Consolidated Financial Statements in this report includes a summary of the significant accounting policies and methods used by the Company in the preparation of its consolidated financial statements. Management believes that of the Company’s significant accounting policies and estimates, the following involve a higher degree of judgment or complexity:

Merchandise Inventory and Return Costs . Merchandise inventory is stated at the lower of cost or net realizable value under the average cost method. Inventory valuation requires significant judgment and estimates, including obsolescence and any adjustments to net realizable value, if net realizable value is lower than cost.  For all merchandise categories, the Company records obsolescence and any adjustments to net realizable value (if lower than cost) based on current and anticipated demand, customer preferences, and market conditions.

Long-Lived Assets other than Goodwill: Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset over its remaining useful life.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the assets exceeds the fair value of the assets.  Fair value is generally measured based on discounted estimated future cash flows. Assets to be disposed of would be separately presented in the Consolidated Balance Sheets and reported at the lower of the carrying amount or fair value less disposition costs. As of January 28, 2023, for the purposes of the asset impairment test, the Company has one asset grouping.

Recently Issued Accounting Pronouncements.

The information set forth above may be found under Notes to Consolidated Statements, Note 2.