NuZee, Inc. - Quarter Report: 2022 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2022

or

For the transition period from ________to________

Commission File No. 001-39338

NUZEE, INC.

(exact name of registrant as specified in its charter)

1401 Capital Avenue, Suite B, Plano, TX, 75074

(Address of principal executive offices) (zip code)

(760) 295-2408

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of August 11, 2022, the registrant had 23,668,017 shares of common stock outstanding.

Table of Contents

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This report includes “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Such forward-looking statements reflect the views of NuZee, Inc. (“NuZee” or the “Company”) with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. From time to time, our management or persons acting on our behalf may make forward-looking statements to inform existing and potential security holders about the Company. All statements other than statements of historical facts included in this report regarding our financial position, business strategy, plans and objectives of management for future operations, industry conditions, or any other matters, are forward-looking statements. When used in this report, forward-looking statements are generally accompanied by terms or phrases such as “estimate,” “expects”, “project,” “predict,” “believe,” “expect,” “anticipate,” “target,” “plan,” “intend,” “seek,” “goal,” “will,” “should,” “may” or other words and similar expressions that convey the uncertainty of future events or outcomes. Items contemplating or making assumptions about, actual or potential future sales, market size, collaborations, and trends or operating results also constitute such forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Forward-looking statements in this report may include, without limitation, statements regarding:

The forward-looking statements are not meant to predict or guarantee actual results, performance, events, or circumstances and may not be realized because they are based upon our current projections, plans, objectives, beliefs, expectations, estimates and assumptions and are subject to a number of risks and uncertainties and other influences, many of which we have no control over. Actual results and the timing of certain events and circumstances may differ materially from those described by the forward-looking statements as a result of these risks and uncertainties. Forward-looking statements speak only as of the date they are made. You should consider carefully the statements in the section of our Annual Report on Form 10-K filed with the SEC on December 22, 2021, titled “Risk Factors” and sections of this report that describe factors that could cause our actual results to differ from those set forth in the forward-looking statements.

Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We assume no obligation to update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, other than as may be required by applicable law or regulation. Readers are urged to carefully review and consider the various disclosures made by us in our reports filed with the Securities and Exchange Commission which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operation and cash flows. If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, our actual results may vary materially from those expected or projected.

Item 1. Financial Statements

NuZee, Inc.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

NuZee, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

NuZee, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

NuZee, Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

NuZee, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

NuZee, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2022

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited interim consolidated financial statements of NuZee, Inc. (together with its subsidiaries, referred to herein as the “Company”, “we” or “NuZee”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and rules of the Securities and Exchange Commission (the “SEC”), and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended September 30, 2021 as filed with the SEC on December 22, 2021. In the opinion of management, all adjustments, consisting of recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited financial statements as reported in the Annual Report on Form 10-K for the year ended September 30, 2021, have been omitted.

Reclassification

Certain amounts in the prior period financial statements have been reclassified to conform to the presentation of the current period financial statements. We reclassified lease expenses associated with subleased property from Operating expenses to Other expenses totaling $118,885 for the nine months ended June 30, 2021 and $40,712 for the three months ended June 30, 2021. We also reclassified $18,000 of capitalized software costs included in Property and Equipment, net at September 30, 2021 to Prepaid expenses and other current assets. These reclassifications had no effect on the previously reported net loss.

Principles of Consolidation

The Company prepares its financial statements on the accrual basis of accounting. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts, balances and transactions have been eliminated upon consolidation.

The Company has two wholly owned international subsidiaries in NuZee KOREA Ltd. (“NuZee KR”) and NuZee Investment Co., Ltd. (“NuZee INV”).

On February 25, 2022 (the “Closing Date”), the Company acquired substantially all the assets and certain specified liabilities (the “Acquisition”) of Dripkit, Inc., a Delaware corporation (“Dripkit”), pursuant to the Asset Purchase Agreement, dated as of February 21, 2022 (the “Asset Purchase Agreement”), by and among the Company, Dripkit, and Dripkit’s existing investors (the “Stock Recipients”) who executed joinders to the Asset Purchase Agreement as of the Closing Date. Pursuant to the terms of the Asset Purchase Agreement, the aggregate purchase price paid by the Company for the Acquisition was $860,000, plus the assumption of certain assumed liabilities, subject to certain adjustments and holdbacks as provided in the Asset Purchase Agreement. Dripkit is engaged in the business of manufacturing and sales of a single serve pour over coffee format that has a large-size single serve pour over pack that sits on top of the cup. Dripkit operates as a new Dripkit Coffee business division that is wholly owned by NuZee, Inc. The Company analyzed the Acquisition under ASC 805 and concluded that it should be accounted for as a business combination. The Acquisition has been included in the Company’s financial statements from the date of the Acquisition.

Earnings per Share

Basic earnings per common share is equal to net earnings or loss divided by the weighted average of shares outstanding during the reporting period. Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company. As of June 30, 2022, and June 30, 2021, the total number of common stock equivalents was 9,706,438 and 8,289,864, respectively, comprised of stock options and warrants as of June 30, 2022 and June 30, 2021. The Company incurred a net loss for the three and nine months ended June 30, 2022, and 2021, respectively, and therefore basic and diluted earnings per share for those periods are the same because all potential common equivalent shares would be antidilutive.

Capital Resources

Since its inception, the Company has devoted substantially all its efforts to business planning, research and development, recruiting management and technical staff, acquiring operating assets, raising capital, and the commercialization and manufacture of its single serve coffee products. The Company has generated limited revenues from its principal operations, and there is no assurance of future revenues.

As of June 30, 2022, the Company had cash of $7,523,099. However, the Company has not attained profitable operations since inception.

Major Customers

In the nine months ended June 30, 2022 and 2021, revenue was primarily derived from major customers disclosed below.

 SCHEDULE OF REVENUE BY MAJOR CUSTOMERS 

Nine months ended June 30, 2022:

Nine months ended June 30, 2021:

Lease

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), to provide guidance on recognizing lease assets and lease liabilities on the consolidated balance sheet and disclosing key information about leasing arrangements, specifically differentiating between different types of leases. The Company implemented ASU No. 2016-02 on October 1, 2019.

The Company performs a quarterly analysis of leases to determine if there are any operating leases that require recognition under ASC 842. The Company has a long-term operating lease for office and manufacturing space in Plano, Texas. The leased property in Plano, Texas, has a remaining lease term through June 2024. The lease has an option to extend beyond the stated termination date, but exercise of this option is not probable. The Company did not apply the recognition requirements of ASC 842 to operating leases with a remaining lease term of 12 months or less.

During our analysis of leases in the nine months ended June 30, 2022, we determined to renew the office and manufacturing space in Vista, California which was scheduled to expire on January 31, 2023, through March 31, 2025. The lease has a monthly base rent of $8,451, plus common area expenses. Along with the extension, we leased an additional 1,796 square feet that has a monthly base rent of $2,514 through March 31, 2025. We extended our sub-leased property in Vista, California, through January 31, 2023. The lease has a monthly rent of $2,111 and has been calculated as a ROU Asset co-terminus with the direct-leased property. The Seoul, Korea office and manufacturing space lease was extended through June 2022 and there is an apartment leased through June 2022. Additionally, the Company leased a new larger office and manufacturing space in Seoul, Korea beginning November 15, 2021, through November 15, 2023. The lease has a monthly expense of $7,040. Accordingly, we have added ROU assets and lease liabilities related to those leases at June 30, 2022.

As of June 30, 2022, our operating leases had a weighted average remaining lease term of 1.6 years and a weighted-average discount rate of 5.5%. Other information related to our operating leases is as follows:

 SCHEDULE OF OTHER INFORMATION RELATED TO OPERATING LEASE

The table below reconciles the fixed component of the undiscounted cash flows for each of the first five years and the total remaining years to the lease liabilities recorded on the Consolidated Balance Sheet as of June 30, 2022:

Amounts due within twelve months of June 30,

 SCHEDULE OF FUTURE MINIMUM RENTAL PAYMENTS FOR OPERATING LEASES

On October 9, 2019, the Company entered into a lease agreement with Alliance Funding Group which provided for a sale lease back on certain packing equipment. The terms of this agreement require us to pay $2,987 per month through July 2024. As part of this agreement, Alliance Funding Group provided our equipment supplier with $124,500 for the purchase of this equipment. This transaction was accounted for as a finance lease. As of June 30, 2022, our finance lease had a remaining lease term of 1.9 years and a discount rate of 12.75%. The interest expense on finance lease liabilities for the nine months ended June 30, 2022 was $6,741.

During the year ended September 30, 2021, we recorded an impairment to fully write off the related equipment as it was deemed no longer useful for our operations.

The table below summarizes future minimum finance lease payments at June 30, 2022 for the twelve months ended June 30:

 SCHEDULE OF FUTURE MINIMUM LEASE PAYMENTS FOR FINANCE LEASES

Rent expense included in Operating expense for the nine months ended June 30, 2022 and 2021 was $221,972 and $132,279, respectively. Rent expense included in Other expense for the nine months ended June 30, 2022 and 2021 was $157,267 and $118,885, respectively.

Cash and non-cash activities associated with the leases for the nine months ended June 30, 2022 are as follows:

 SCHEDULE OF CASH AND NON-CASH ACTIVITIES OF LEASES

In September 2020, we subleased the space at 1700 Capital Avenue in Plano, Texas, effective October 1, 2020, under terms that are co-terminus with the original lease ending June 30, 2024. During the nine months ended June 30, 2022, we recognized sublease income of $140,753 pursuant to the sublease included in Other income on our financial statements. Future minimum lease payments to be received under that sublease as of June 30, 2022, for each of the twelve months ended June 30 are as follows:

 SCHEDULE OF FUTURE MINIMUM LEASE PAYMENTS OF SUBLEASE

Loans

On April 1, 2019, we purchased a delivery van from Ford Motor Credit for $41,627. The Company paid $3,500 as a down payment and financed $38,127 for 60 months at a rate of 2.9%. The loan is secured by the van. The outstanding balance on the loan at June 30, 2022 and September 30, 2021 amounted to $14,643 and $20,146, respectively.

The remaining loan payments are as follows:

 SCHEDULE OF LOAN PAYMENTS

On February 15, 2019, NuZee KR entered into equipment financing for production equipment with Shin Han Bank for $60,563. In June 2019, NuZee KR purchased additional equipment and increased the loan with Shin Han Bank by $86,518. The financing had a term of 36 months at a rate of 4.33%. Principal payments began in July 2019. The outstanding balance on this loan at June 30, 2022 and September 30, 2021 amounted to $0 and $35,898, respectively. This loan was paid in full in this reporting period.

Revenue Recognition

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (Topic 606) “Revenue from Contracts with Customers.” Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605). The new standard’s core principle is that an entity will recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer. The principles in the standard are applied in five steps: 1) Identify the contract(s) with a customer; 2) Identify the performance obligations in the contract; 3) Determine the transaction price; 4) Allocate the transaction price to the performance obligations in the contract; and 5) Recognize revenue when (or as) the entity satisfies a performance obligation. We adopted Topic 606 as of October 1, 2018, on a modified retrospective basis. The adoption of Topic 606 did not have a material impact on our consolidated financial statements, including the presentation of revenues in our Consolidated Statements of Operations.

Foreign Currency Translation

The financial position and results of operations of each of the Company’s foreign subsidiaries are measured using the foreign subsidiary’s local currency as the functional currency. Revenues and expenses of each such subsidiary have been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders’ equity unless there is a sale or complete liquidation of the underlying foreign investment. Foreign currency translation adjustments recorded to other comprehensive loss amounted to $(19,604) and $(2,374) for the nine months ended June 30, 2022 and 2021, respectively.

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

Prepaid expenses and other current assets

Prepaid expenses and other current assets at June 30, 2022 and September 30, 2021, were as follows:

SCHEDULE OF PREPAID EXPENSES AND OTHER CURRENT ASSETS

The prepaid expenses and other current assets balance of $1,174,297 as of June 30, 2022 primarily consists of deferred financing costs related to our ATM offering of $368,783 and our underwritten public offering completed in August 2022 of $273,762 (see Note 8—Subsequent Events), prepaid insurance and deposits, and the balance of $482,288 as of September 30, 2021 primarily consists of prepaid insurance and a customer deposit.

Inventories

Inventory, consisting principally of raw materials, work in process and finished goods held for production and sale, is stated at the lower of cost or net realizable value, cost being determined using the weighted average cost method. The Company reviews inventory levels at least quarterly and records a valuation allowance when appropriate. At June 30, 2022 and September 30, 2021, the carrying value of inventory was $682,580 and $573,464, respectively.

 SCHEDULE OF INVENTORY

Joint Venture

On January 9, 2020, a joint venture agreement was signed between Industrial Marino, S.A. de C.V. (50%) and the Company (50%) forming NuZee LATIN AMERICA (NLA), S.A. de C.V. NLA was formed pursuant to the laws of Mexico, with corporate domicile in Mazatlan, Mexico. As part of the capitalization of NLA, the Company contributed two co-packing machines to the joint venture. These machines had an aggregate carrying cost of $313,012. The Company received $110,000 in cash for this contribution and recorded an investment in NLA of $160,000 and a loss of $43,012 on the contribution of the machines to NLA.

The Company accounts for NLA using the equity method of accounting since the management of day-to-day operations at NLA ultimately lies with the Company’s joint venture partner as the operations of NLA are based in its partners facilities and our partner appoints the Chairman of the joint board of directors of NLA. As of June 30, 2022, the only activities in NLA were the contribution of two machines, as described above, and start up and initial marketing and sales activities. $4,215 and $4,077 of losses were recognized under the equity method of accounting during the nine months ended June 30, 2022 and June 30, 2021, respectively.

2. GEOGRAPHIC CONCENTRATION

The Company is organized based on fundamentally one business segment although it does sell its products on a world-wide basis. The Company is organized in three geographical segments. The Company co-packs product for customers and produces and sells its products directly in North America and Korea. The Company has a minimally staffed office in Japan that provides support for import and export of product and materials between the U.S. and Japan, as well as investor relations support to our shareholders based in Japan. Information about the Company’s geographic operations for the nine months ended June 30, 2022 and 2021 are as follows:

Geographic Concentration

 SCHEDULE OF GEOGRAPHIC OPERATIONS

3. RELATED PARTY TRANSACTIONS

For the nine months ended June 30, 2022 and June 30, 2021, respectively, the Company had sales of $0 and $28,299 of materials to NLA.

4. BUSINESS COMBINATIONS

As described in Note 1, on February 25, 2022, the Company acquired substantially all the assets and certain specified liabilities of Dripkit pursuant to the Asset Purchase Agreement, dated as of February 21, 2022, by and among the Company, Dripkit, and Dripkit’s existing investors who executed joinders to the Asset Purchase Agreement as of the Closing Date. Pursuant to the terms of the Asset Purchase Agreement, the aggregate purchase price paid by the Company for the Acquisition was $860,000, plus the assumption of certain assumed liabilities, including a $13,000 bridge loan and approximately $3,176 of payables, subject to certain adjustments and holdbacks as provided in the Asset Purchase Agreement resulting in an acquisition accounting purchase price of $876,176. The Company analyzed the Acquisition under ASC 805 and concluded that it should be accounted for as a business combination.

Pursuant to the terms of the Asset Purchase Agreement, on the Closing Date, the cash portion of the purchase price was reduced by the following amounts: (a) $22,000, in satisfaction of a bridge loan made from the Company to Dripkit in February 2022 to provide Dripkit with operational financing prior to the Closing Date, (b) $35,500, as an indemnity holdback for the purpose of satisfying any indemnification claims made by the Company pursuant to the Asset Purchase Agreement, and (c) $40,000, as a cash bulk sales holdback (the “Cash Bulk Sales Holdback Amount”). In addition, on the Closing Date, the Company held back $40,000 worth of stock consideration as the Stock Bulk Sales Holdback Amount (together with the Cash Bulk Sales Holdback Amount, the “Bulk Sales Holdback Amount”).

On the Closing Date, after adjustments and holdbacks under the Asset Purchase Agreement, the Company paid the aggregate purchase price as follows: (i) cash paid by the Company to Dripkit was $257,000, and (ii) the Company issued to the Stock Recipients an aggregate of 178,681 shares of the Company’s common stock. The Company repaid the entire outstanding principal amount of Dripkit’s Small Business Association Economic Injury Disaster Loan in the amount of $78,656. In addition, the Company recorded a liability on its balance sheet in Accounts Payable of $115,500 related to potential future amounts due related to the Bulk Sales Holdback of $80,000 and the indemnity holdback of $35,500.

In the quarter ended June 30, 2022, pursuant to the terms of the Asset Purchase Agreement, the Bulk Sales Holdback Amount was used to satisfy sales and use taxes owed by Dripkit to the State of New York as of the Closing Date. Pursuant to the terms of the Asset Purchase Agreement, the amounts remaining after offsetting the cost of these sales and use taxes were distributed as follows in the quarter ended June 30, 2022: (i) $39,237 was distributed to Dripkit on May 9, 2022, in connection with the Cash Bulk Sales Holdback Amount, and (ii) 18,475 shares of common stock were issued to the Stock Recipients on April 25, 2022, in connection with the Stock Bulk Sales Holdback Amount.

Dripkit was acquired for purposes of supplementing our current product offerings. Dripkit operates as a new Dripkit Coffee business division that is wholly-owned by NuZee, Inc.

The following table presents the allocation of the aggregate purchase price paid by the Company for the Acquisition of $860,000, plus the assumption of certain assumed liabilities, including a $13,000 bridge loan and approximately $3,176 of payables, resulting in an acquisition accounting purchase price of $876,176, to the assets acquired for the acquisition of Dripkit:

 SCHEDULE OF ALLOCATION OF AGGREGATE PURCHASE PRICE

Identified Intangibles and Goodwill

The Company identified tradename and customer relationships intangible assets. The tradename and customer relationships intangible assets will be amortized on a straight-line basis over their respective estimated useful lives. The goodwill recognized results from such factors as an assembled workforce and management’s industry know-how. See Note 5—Goodwill and Intangible Assets for additional information on identified intangible assets and goodwill.

The nine months ended June 30, 2022 includes the operating results of Dripkit for the period from February 25, 2022, the date of acquisition, to June 30, 2022. The consolidated statement of operations for the three and nine months ended June 30, 2022 includes revenue of approximately $30,164 and $32,645, respectively, net loss of approximately $109,249 and $122,370, respectively, and amortization expense, of approximately $19,833 and $26,444, respectively, contributed by Dripkit.

During the nine months ended June 30, 2022, the Company incurred $270,478 of transaction costs related to the Acquisition which are included in Operating expenses.

Unaudited Pro forma Financial Information

The following unaudited proforma financial information presents the combined results of operations of the Company and gives effect to the Dripkit Acquisition for the three and nine months ended June 30, 2022 and 2021, as if the Acquisition had occurred as of the beginning of the first period presented instead of on February 25, 2022.

The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results of operations that would have been realized if the Acquisition had been completed on October 1, 2021, nor does it purport to project the results of operations of the combined company in future periods. The pro forma financial information does not give effect to any anticipated integration costs related to the acquired company.

The proforma financial information for the Company and Dripkit is as follows:

 SCHEDULE OF UNAUDITED PRO FORMA FINANCIAL INFORMATION

For purposes of the pro forma disclosures above, the primary adjustments for the three months and nine months ended June 30, 2022 include the elimination of transaction costs of approximately $8,917 and $270,478, respectively.

5. GOODWILL AND INTANGIBLE ASSETS

Changes in goodwill for the nine months ended June 30, 2022, consists of the following:

 SCHEDULE OF CHANGES IN GOODWILL

As of June 30, 2022, the Company’s intangible assets consisted of the following:

 SCHEDULE OF INTANGIBLE ASSETS

Amortization expense was $26,444 for the nine months ended June 30, 2022.

6. ISSUANCE OF EQUITY SECURITIES

Exercise of Warrants

In the nine months ended June 30, 2022, we issued 384,447 shares of common stock related to exercises of 2021 Warrants (as defined below), including 380,447 shares of common stock issued upon exercise of 380,447 Series A Warrants (as defined below) and 4,000 shares of common stock issued upon exercise of 8,000 Series B Warrants (as defined below). In connection with such exercises, in the nine months ended June 30, 2022, we received aggregate net proceeds of $1,702,596.

ATM Offering

On December 28, 2021, we entered into an Equity Distribution Agreement (the “Equity Distribution Agreement”) with Maxim Group LLC, as agent (the “Agent”), pursuant to which we could offer and sell, from time to time, shares of our common stock through the Agent in “at-the-market-offerings”, as defined in Rule 415 under the Securities Act, having an aggregate offering price of up to $20,000,000, subject to any applicable limits when using Form S-3. Pursuant to the Equity Distribution Agreement, we paid the Agent a commission rate, in cash, equal to 3.0% of the aggregate gross proceeds from each sale of shares of our common stock under the Equity Distribution Agreement. The offer and sale of shares of our common stock were made pursuant to a shelf registration statement on Form S-3 and the related prospectus (File No. 333-248531) initially filed by us with the SEC on September 1, 2020, and declared effective by the SEC on October 2, 2020, under the Securities Act. We were not obligated to make any sales of shares of our common stock under the Equity Distribution Agreement. In the nine months ended June 30, 2022, we issued and sold 49,326 shares of our common stock under the Equity Distribution Agreement, raising net proceeds of $95,256. In connection with such sales, we paid compensation to the Agent in the amount of $3,003. As further described in Note 8 – Subsequent Events, we terminated the Equity Distribution Agreement on August 5, 2022.

Grant of Restricted Stock Awards to the Company’s Independent Board Members

On March 17, 2022, pursuant to the Company’s non-employee director compensation policy, the Compensation Committee (the “Committee”) of the Company’s Board of Directors (the “Board”) granted 23,584 restricted shares (the “Restricted Shares”) of the Company’s common stock to each of the Company’s five independent directors pursuant to the NuZee, Inc. 2013 Stock Incentive Plan, totaling 117,920 Restricted Shares. The Restricted Shares are scheduled to vest in full on the one-year anniversary of the grant date, subject to each independent director’s continued service as a director of the Company. The Company recognized common stock compensation expense of $71,916 for the nine months ended June 30, 2022 related to these Restricted Shares.

April 2022 Exempt Offering

On April 13, 2022, pursuant to Securities Act registration exemptions under Regulation S and/or Section 4(a)(2) of the Securities Act, the Company sold 884,778 units (the “2022 Units”), at a price of $2.00 per 2022 Unit for aggregate net proceeds of $1,649,736, with each 2022 Unit consisting of (a) one share of our common stock and (b) one warrant (each, a “2022 Warrant” and collectively, the “2022 Warrants”) to purchase one whole share of our common stock with an initial exercise price of $2.00 per share.

7. STOCK OPTIONS AND WARRANTS

Options

During the nine months ended June 30, 2022, the Company granted 100,000 new stock options, issued 14,000 shares upon the exercise of outstanding stock options, and had 223,500 stock options that were forfeited because of the termination of employment.

The fair value of each option award granted in the nine months ended June 30, 2022 was estimated on the date of grant using the Black-Scholes option valuation model using the assumptions noted as follows: expected volatility was based on the historical volatility of a peer group of companies. The expected term of options granted was determined using the simplified method under SAB 107 which represents the mid-point between the vesting term and the contractual term. The risk-free rate is calculated using the U.S. Treasury yield curve and is based on the expected term of the option.

The Black-Scholes option pricing model was used with the following weighted average assumptions for options granted during the nine months ended June 30, 2022:

 SCHEDULE OF WEIGHTED AVERAGE ASSUMPTIONS FOR FAIR VALUE MEASUREMENT OF OPTIONS GRANTED

The following table summarizes stock option activity for the nine months ended June 30, 2022:

 SUMMARY OF STOCK OPTION ACTIVITY

The Company is expensing these stock option awards on a straight-line basis over the requisite service period. The Company recognized stock option expense of $2,687,529 and $8,002,917 for the nine months ended June 30, 2022 and June 30, 2021, respectively. Unamortized option expense as of June 30, 2022, for all options outstanding amounted to $1,808,520. These costs are expected to be recognized over a weighted average period of 1.4 years.

A summary of the status of the Company’s nonvested options as of June 30, 2022, is presented below:

 SUMMARY OF UNVESTED SHARES

Nonvested options

Warrants

On June 23, 2020, as part of our agreement with Benchmark Company, LLC, the underwriter of the Company’s June 2020 registered public offering of common stock, we issued 40,250 warrants (the “2020 Warrants”) to purchase our common stock at an exercise price of $9.00 a share. The 2020 Warrants became exercisable on December 23, 2020 and expire on June 18, 2025.

On March 19, 2021, we entered into an underwriting agreement in connection with our registered public offering of (i) 2,777,777 units (the “2021 Units”), at a price to the public of $4.50 per 2021 Unit, with each 2021 Unit consisting of (a) one share of our common stock, (b) one Series A Warrant, and (c) one Series B Warrant (together with the Series A Warrants, the “2021 Warrants”), and (ii) 416,666 Series A Warrants and 416,666 Series B Warrants, each pursuant to the underwriter’s full exercise of their overallotment option with respect to such warrants.

Each Series A Warrant entitles the registered holder to purchase one share of our common stock at an exercise price of $4.50 per share. Each Series B Warrant entitles the registered holder thereof to purchase one-half of a share of our common stock at an exercise price of $5.85 per whole share. The 2021 Warrants have a term of 5 years.

The Series A and Series B Warrant holders are obligated to pay the exercise price in cash upon exercise of the 2021 Warrants unless we fail to maintain a current prospectus relating to the common stock issuable upon the exercise of the 2021 Warrants (in which case, the 2021 Warrants may only be exercised via a “cashless” exercise provision).

On April 13, 2022, pursuant to Securities Act registration exemptions under Regulation S and/or Section 4(a)(2) of the Securities Act, the Company sold 884,778 2022 Units, with each 2022 Unit consisting of (a) one share of our common stock and (b) one 2022 Warrant. Each 2022 Warrant entitles the holder to purchase one share of our common stock at an exercise price of $2.00 per share. The 2022 Warrants have a term of 5 years. Holders may exercise their 2022 Warrants on a “cashless” basis pursuant to a formula set forth in the form of 2022 Warrant.

The following table summarizes warrant activity for the nine months ended June 30, 2022:

 SCHEDULE OF WARRANT ACTIVITY

In the nine months ended June 30, 2022, we issued 384,447 shares of common stock related to exercises of 2021 Warrants, including 380,447 shares of common stock issued upon exercise of 380,447 Series A Warrants and 4,000 shares of common stock issued upon exercise of 8,000 Series B Warrants. In connection with such exercises, in the nine months ended June 30, 2022, we received aggregate net proceeds of $1,702,596.

8. SUBSEQUENT EVENTS

Termination of Equity Distribution Agreement

On August 5, 2022, we terminated our Equity Distribution Agreement with the Agent. See Note 6—Issuance of Equity Securities for additional information regarding the Equity Distribution Agreement. Prior to termination, we issued and sold 49,326 shares of our common stock under the Equity Distribution Agreement, raising net proceeds of $95,256.

August 2022 Underwritten Public Offering

On August 10, 2022, we completed an underwritten public offering (the “Offering”) of 4,200,000 shares of our common stock, pursuant to an Underwriting Agreement dated as of August 7, 2022 and a prospectus supplement to the Company’s effective shelf registration statement on Form S-3 (Registration No. 333-248531). The aggregate gross proceeds from the Offering were approximately $3.4 million. We received proceeds of approximately $3.2 million, after deducting underwriting discounts and before deducting Offering costs payable by us.

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

Overview

We are a specialty coffee company and, we believe, a leading co-packer of single serve pour over coffee in the United States, as well as a preeminent co-packer of coffee brew bags, which is also referred to as tea-bag style coffee. In addition to our portfolio of innovative single serve pour over and coffee brew bag coffee products, we have recently expanded our product portfolio to offer a third type of single serve coffee format, DRIPKIT pour over products, as a result of our acquisition of substantially all of the assets of Dripkit, Inc. (“Dripkit”) in February 2022, as further described below. Our new, premium DRIPKIT pour over format features a large-size single serve pour over pack that sits on top of the cup and delivers in our view a barista-quality coffee experience to coffee drinkers in the United States. Our mission is to leverage our position as a co-packer at the forefront of the North American single serve coffee market to revolutionize the way single serve coffee is enjoyed in the United States. While the United States is our core market, we also have manufacturing and sales operations in Korea and a joint venture in Latin America.

We believe we are the only commercial-scale producer that has the dual capacity to pack both single serve pour over coffee and coffee brew bag coffee within the North American market. We intend to leverage our position to become the commercial coffee manufacturer of choice and aim to become the preeminent leader for coffee companies seeking to enter into and grow within the single serve coffee market in North America. We are paid per-package based on the number of single serve coffee products produced by us. Accordingly, we consider our business model to be a form of tolling arrangement, as we receive a fee for almost every single serve coffee product our co-packing customers sell in the North American and Korean markets. While we financially benefit from the success of our co-packing customers through the sales of their respective single serve coffee products, we believe we are also able to avoid the risks associated with owning and managing the product and its related inventory.

We have also developed and sell NuZee branded single serve coffee products, including our flagship Coffee Blenders line of both single serve pour over coffee and coffee brew bag, or tea-bag style, coffee, which we believe offers consumers some of the best coffee available in a single serve application in the world. We offer DRIPKIT pour over packs direct to consumers through our website, wholesale business-to-business to hospitality customers, and co-pack for coffee roasters.

We may also consider co-packaging other products that are complementary to our current product offerings and provide us with a deeper access to our customers. In addition, we are continually exploring potential strategic partnerships, co-ventures, and mergers, acquisitions, or other transactions with existing and future business partners to generate additional business, drive growth, reduce manufacturing costs, expand our product portfolio, enter into new markets, and further penetrate the markets in which we currently operate. Our goal is to continue to expand our product portfolio to raise our visibility, consumer awareness and brand profile.

Since 2016, we have been primarily focused on single serve pour over coffee production. Over this time, we have developed expertise in the operation of our sophisticated packing equipment and the related production of our single serve pour over coffee products at our manufacturing facilities. We have also expanded our co-packing expertise to coffee brew bag coffee products, which we believe are gaining traction in the United States, as well as our DRIPKIT pour over products, which is our innovative new product offering that we believe has significant growth potential.

Operational Capacity and Recent Developments

We currently lease manufacturing facilities in Vista, California and Seoul, Korea to produce our single serve pour over or coffee brew bag coffee products. In November 2021, we entered into a new lease in Seoul, Korea for a larger office and manufacturing space. In addition, we have recently expanded our office and manufacturing space in Vista, California by approximately 2,000 square feet and also extended our current lease through March 2025 and our sub-leased property through January 2023.

As a result of our capital investments since 2015, including our acquisition of packing equipment from manufacturers whom we believe are the global leaders for supplying such machines, we presently have the annual capacity to produce up to 150 million single serve coffee products (pour over or coffee brew bags) at our two manufacturing facilities, which we believe is sufficient to meet our current and anticipated manufacturing requirements. In addition, in May 2022 we announced a new partnership pursuant to which a manufacturing partner in Knoxville, Tennessee has agreed to provide us with additional manufacturing, coffee roasting and co-packing capabilities, and facilitate distribution efforts to the Eastern United States. In connection with the foregoing operational developments and following our strategic analysis of our current and anticipated facility requirements, we have determined to transition our manufacturing operations away from the facility we previously operated in Plano, Texas. However, we intend to retain our executive office and administrative operations in Plano, Texas.

Dripkit Transaction

On February 25, 2022 (the “Closing Date”), the Company acquired substantially all of the assets and certain specified liabilities of Dripkit (the “Acquisition”) pursuant to the Asset Purchase Agreement, dated as of February 21, 2022 (the “Asset Purchase Agreement”), by and among the Company, Dripkit, and Dripkit’s existing investors (the “Stock Recipients”) who executed joinders to the Asset Purchase Agreement as of the Closing Date. Pursuant to the terms of the Asset Purchase Agreement, the aggregate purchase price paid by the Company for the Acquisition was $860,000, plus the assumption of certain assumed liabilities, subject to certain adjustments and holdbacks as provided in the Asset Purchase Agreement.

On the Closing Date, after adjustments and holdbacks under the Asset Purchase Agreement, the Company paid the aggregate purchase price as follows: (i) cash paid by the Company to Dripkit was $257,000, and (ii) the Company issued to the Stock Recipients an aggregate of 178,681 shares of the Company’s common stock. In addition, the Company repaid the entire outstanding principal amount of Dripkit’s Small Business Association Economic Injury Disaster Loan in the amount of $78,656.

On May 2, 2022, pursuant to the terms of the Asset Purchase Agreement, the Bulk Sales Holdback Amount was used to satisfy sales and use taxes owed by Dripkit to the State of New York as of the Closing Date. Pursuant to the terms of the Asset Purchase Agreement, the amounts remaining after offsetting the cost of these sales and use taxes were distributed as follows: (i) $39,237 was distributed to Dripkit on May 9, 2022, in connection with the Cash Bulk Sales Holdback Amount, and (ii) 18,475 shares of common stock were issued to the Stock Recipients on April 25, 2022, in connection with the Stock Bulk Sales Holdback Amount.

For additional information regarding the Acquisition and the Asset Purchase Agreement, see Note 4—Business Combinations to the Unaudited Consolidated Financial Statements.

Dripkit operates as a new Dripkit Coffee business division that is wholly owned by NuZee, Inc.

Impact of the COVID-19 Pandemic

The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets. In the nine months ended June 30, 2022, as a result of the COVID-19 pandemic and responses to the outbreak, certain of our customers slowed or delayed purchases of our co-packing services or single serve coffee products, and we also believe that potential sales of our single serve coffee products to new or potential customers in the hospitality industry were adversely impacted. We have also experienced delays in the submission and approval of custom artwork and packaging as well as the shipment to us of coffee for co-packing. In addition, we incurred lost production time due to employee absences. We do not believe, however, that these delays and disruptions had a significant effect on our business or results of operations to date, and in some cases, we have been able to mitigate these adverse effects in part by sourcing coffee and other supplies from alternative suppliers in the United States. The COVID-19 crisis may have an adverse impact on our business and financial results going forward that we are not currently able to fully determine or quantify. The COVID-19 crisis may adversely affect the ability of our customers to pay for goods delivered on a timely basis, or at all. Any increase in the amount or deterioration in the collectability of accounts receivable will adversely affect our cash flows and results of operations, requiring an increased level of working capital.

Geographic Concentration

Our operations are primarily split between two geographic areas: North America and Asia.

For the three months ended June 30, 2022, net revenues attributable to our operations in North America totaled $630,496 compared to $419,648 of net revenues attributable to our operations in North America for the three months ended June 30, 2021. For the nine months ended June 30, 2022, net revenues attributable to our operations in North America totaled $2,031,781 compared to $1,077,986 of net revenues attributable to our operations in North America for the nine months ended June 30, 2021. Additionally, as of June 30, 2022, $400,842 of our property and equipment, net was attributable to our North American operations, compared to $517,966 attributable to our North American operations as of September 30, 2021.

For the three months ended June 30, 2022, net revenues attributable to our operations in Asia totaled $143,523 compared to $90,383 of net revenues attributable to our operations in Asia during the three months ended June 30, 2021. For the nine months ended June 30, 2022, net revenues attributable to our operations in Asia totaled $476,564 compared to $364,097 of net revenues attributable to our operations in Asia during the nine months ended June 30, 2021. Additionally, as of June 30, 2022, $211,454 of our property and equipment, net was attributable to our Asian operations, compared to $156,058 attributable to our Asian operations as of September 30, 2021.

Results of Operations

Our results of operations for the three and nine months ended June 30, 2022 includes the operations of Dripkit for the period from February 25, 2022, the date of the Acquisition, to June 30, 2022. The Acquisition of Dripkit did not contribute to the periods prior to its acquisition in our financial statements, which therefore impacts comparisons to 2021 for our results of operations in the discussion that follows.

Comparison of three months ended June 30, 2022 and 2021:

Revenue

For the three months ended June 30, 2022, our revenue increased by $263,987, or approximately 52%, compared with the three months ended June 30, 2021. This increase was primarily related to increased co-packing revenue to existing and new customers. In the third and fourth quarters of fiscal year 2021, we expanded our U.S. sales and support operations, which resulted in increased orders and increased co-packing opportunities in the three months ended June 30, 2022.

Cost of sales and gross margin

For the three months ended June 30, 2022, we generated a total gross loss of ($83,653) from sales of our products and co-packing services, compared to a total gross profit of $96,586 for the three months ended June 30, 2021. The gross margin rate was (11%) for the three months ended June 30, 2022, and 19% for the three months ended June 30, 2021. This decrease in gross profit was driven primarily by increased materials and labor costs as compared to the same period in the prior year.

Operating Expenses

For the three months ended June 30, 2022, the Company’s operating expenses totaled $2,546,608 compared to $3,165,840 for the three months ended June 30, 2021, representing a 20% decrease. This decrease is primarily attributable to a decrease in stock-based compensation expense, offset by an increase in operating expenses associated with greater staffing levels, marketing activities, and administrative costs.

Net Loss

For the three months ended June 30, 2022, we generated a net loss of $2,633,892 versus $3,067,042 for the three months ended June 30, 2021. This decrease in net loss is primarily attributable to lower stock-based compensation expense, offset by an increase in cost of sales, and an increase in operating expenses associated with greater staffing levels, marketing activities, and administrative costs.

Comparison of nine months ended June 30, 2022 and 2021:

Revenue

For the nine months ended June 30, 2022, our revenue increased by $1,066,262, or approximately 74% compared with the nine months ended June 30, 2021. This increase was primarily related to increased co-packing revenue to existing and new customers. In the third and fourth quarters of fiscal year 2021, we expanded our U.S. sales and support operations, which resulted in increased orders and increased co-packing opportunities in the nine months ended June 30, 2022.

Cost of sales and gross margin

For the nine months ended June 30, 2022, we generated a total gross loss of ($67,301), from sales of our products and co-packing services, compared to a total gross profit of $89,240 for the nine months ended June 30, 2021. The gross margin rate was (3%) for the nine months ended June 30, 2022, and 6% for the nine months ended June 30, 2021. This decrease in gross profit was driven primarily by increased materials and labor costs as compared to the same period in the prior year.

Operating Expenses

For the nine months ended June 30, 2022, the Company’s operating expenses totaled $8,554,276 compared to $15,103,252 for the nine months ended June 30, 2021, representing a 43% decrease. This decrease is primarily attributable to a decrease in stock-based compensation expense and professional services costs, offset by an increase in operating expenses associated with greater staffing levels, marketing activities and administrative costs.

Net Loss

For the nine months ended June 30, 2022, we generated a net loss of $8,661,792 versus $15,048,722 for the nine months ended June 30, 2021. This decrease in net loss is primarily attributable to lower stock-based compensation expense, impairment charges and professional services costs, offset by an increase in operating expenses associated with greater staffing levels, marketing activities and administrative costs.

Liquidity and Capital Resources

Since our inception in 2011, we have incurred significant losses, and as of June 30, 2022, we had an accumulated deficit of approximately $61.5 million. We have not yet achieved profitability and anticipate that we will continue to incur significant sales and marketing expenses prior to recording sufficient revenue from our operations to offset these expenses. In the United States, we expect to incur additional losses because of the costs associated with operating as an exchange-listed public company. We are unable to predict the extent of any future losses or when we will become profitable, if at all.

To date, we have funded our operations primarily with proceeds from registered public offerings and private placements of shares of our common stock. Our principal use of cash is to fund our operations, which includes the commercialization of our single serve coffee products, the continuation of efforts to improve our products, administrative support of our operations and other working capital requirements.

As of June 30, 2022, we had a cash balance of $7,523,099. We believe that our cash and cash equivalents will be sufficient to fund our planned operations and capital expenditure requirements for at least twelve months from August 11, 2022. This evaluation is based on relevant conditions and events that are currently known or reasonably knowable. As a result, we could deplete our available capital resources sooner than we currently expect, and a reduction in consumer demand for, or revenues from the sale of, our single serve coffee products could further constrain our cash resources. We have based these estimates on assumptions that may prove to be wrong, and our operating projections, including our projected revenues from sales of our single serve coffee products, may change as a result of many factors currently unknown to us.

On April 13, 2022, pursuant to Securities Act registration exemptions under Regulation S and/or Section 4(a)(2) of the Securities Act, we sold 884,778 units (the “2022 Units”), at a price of $2.00 per 2022 Unit for aggregate net proceeds of approximately $1.65 million, with each 2022 Unit consisting of (a) one share of our common stock and (b) one warrant (each, a “2022 Warrant” and collectively, the “2022 Warrants”) to purchase one whole share of our common stock with an initial exercise price of $2.00 per share. For additional information regarding the 2022 Warrants, see Note 7— Stock Options and Warrants to the Unaudited Consolidated Financial Statements.

On August 5, 2022, we terminated our Equity Distribution Agreement, dated December 28, 2021 (the “Equity Distribution Agreement”), with Maxim Group LLC, as agent (the “Agent”), pursuant to which we could from time to time offer and sell up to an aggregate of $20.0 million of shares of our common stock, subject to any applicable limits when using Form S-3, through the Agent in “at-the-market-offerings” (the “ATM Program”), as defined in Rule 415 under the Securities Act. Prior to termination, we issued and sold 49,326 shares of our common stock under the Equity Distribution Agreement, raising net proceeds of $95,256. We terminated the Equity Distribution Agreement because we do not intend to raise additional capital through the ATM Program.