BARFRESH FOOD GROUP INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The information and financial data discussed below is derived from the audited financial statements of Barfresh for its fiscal years ended December 31, 2021 and 2020. The financial statements of Barfresh were prepared and presented in accordance with generally accepted accounting principles in the United States. The information and financial data discussed below is only a summary and should be read in conjunction with the historical financial statements and related notes of Barfresh contained elsewhere in this Annual Report. This discussion and analysis may contain forward-looking statements based on assumptions about our future business. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors. See “Cautionary Note Regarding Forward Looking Statements” above for a discussion of forward-looking statements and the significance of such statements in the context of this Annual Report. 15 Overview The Company’s products are packaged in four distinct formats. The Company’s ready-to-drink bottled smoothie, “Twist & Go”™, has initially been focused towards the USDA national school meal program, including the School Breakfast Program, the National School Lunch Program and Smart Snacks in Schools Program.. This sweet fruit and creamy yogurt smoothie contains four ounces of yogurt and a half-cup of fruit/fruit juice and comes in three different flavors: strawberry banana, peach and mango pineapple. “Twist & Go”™ contains no added sugars, preservatives, artificial flavors or colors. At only 125 -130 calories and with 5 grams of protein, it makes the perfect start to any day or on-the-go snack. The Company’s bulk “Easy Pour” format, which contains all the ingredients necessary to make the beverage, is packaged in gallon containers in a concentrated formula that is mixed 1:1 with water. The Company has a “no sugar added” version of the bulk “Easy Pour” format that is specifically targeted for the aforementioned USDA national school meal programs. In addition, the Company received approval from the United States Defense Logistics Agency (“DLA”) to sell its smoothie products into all branches of the U.S. Armed Forces, and is currently in contract with and selling its bulk Easy Pour products into over one hundred military bases in the United States and abroad. The Company’s WHIRLZ 100% Juice Concentrates are a perfect complement to the Company’s current existing 1:1 bulk Easy Pour products used in beverage dispensing equipment. The 100% juice concentrates offer a more affordably priced product that responds to the need of the schools to have a wider range of options at various price points. The products are USDA reimbursable, Smart Snack Compliant for schools in the United States, a good source of Vitamin C, contain no added sugars and come in fun, great-tasting flavors. The Company’s single serve format features portion controlled and ready-to-blend beverage ingredient packs or “beverage packs”. The beverage packs contain all the ingredients necessary to make the beverage, including the base (either sorbet, frozen yogurt, or ice cream), real fruit pieces, juices, and ice – five ounces of water are added before blending. Domestic and international patents and patents pending are owned by Barfresh, as well as related trademarks for all of the single serve products. Patent rights have been granted in 13 jurisdictions including the United States. In addition, the Company has purchased all of the trademarks related to the patented products. The Company conducts sales through several channels, including National Accounts, Regional Accounts, and Broadline Distributors. Barfresh’s primary broadline distribution arrangement is through a nationwide agreement with Sysco Corporation (“Sysco”), the U.S.’s largest broadline distributor. Pursuant to that agreement, all Barfresh products are included in Sysco’s national core selection of beverage items. On October 26, 2015, Barfresh signed a five-year agreement with PepsiCo North America Beverages, a division of PepsiCo, to become its exclusive sales representative within the food service channel to present the Barfresh line of ready-to-blend smoothies and frozen beverages throughout the United States and Canada. Through this agreement, Barfresh’ products are included as part of PepsiCo’s offerings to its significant customer base. The agreement facilitates access to potential National customer accounts, through introductions provided by PepsiCo’s one thousand plus person foodservice sales team. On May 30, 2019, the Company amended its agreement with Pepsi which included a reduction in the commission fee and a clause which allows either party the right to terminate the agreement upon 90 days written notice. Neither party has exercised its right to terminate the agreement. This agreement remains in effect. Barfresh utilizes contract manufacturers to manufacture all of the products in the United States. 16 Recent developments On June 1, 2021, the Company completed a private placement of 1,282,051 shares of its common stock at $4.68 per share, resulting in gross proceeds of $6,000,000. In addition, holders of debt converted a total of $399,000 in principal and $234,410 in interest into 133,991 shares of common stock, and debt in the amount of $840,000 was retired. Additionally, in 2021, two PPP loans amounting to $1,136,262 were forgiven as a result, the company has no debt outstanding. Currently we have 14 employees and 4 consultants. Critical Accounting Policies Our financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Revenue Recognition In accordance with ASC 606, “Revenue from Contracts with Customers”, revenue is recognized when a customer obtains ownership of promised goods. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods. The Company applies the following five steps: 1) Identify the contract with a customer A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable. For the Company, the contract is the approved sales order, which may also be supplemented by other agreements that formalize various terms and conditions with customers. 2) Identify the performance obligation in the contract Performance obligations promised in a contract are identified based on the goods or that will be transferred to the customer. For the Company, this consists of the delivery of frozen beverages, which provide immediate benefit to the customer. 3) Determine the transaction price The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods and is generally stated on the approved sales order. Variable consideration, which typically includes volume-based rebates or discounts, are estimated utilizing the most likely amount method. 4) Allocate the transaction price to performance obligations in the contract Since our contracts contain a single performance obligation, delivery of frozen beverages, the transaction price is allocated to that single performance obligation. 5) Recognize Revenue when or as the Company satisfies a performance obligation The Company recognizes revenue from the sale of frozen beverages when title and risk of loss passes and the customer accepts the goods, which generally occurs at the time of delivery to a customer warehouse. Customer sales incentives such as volume-based rebates or discounts are treated as a reduction of sales at the time the sale is recognized. Shipping and handling costs are treated as fulfillment costs and presented in distribution, selling and administrative costs. 17 Stock-based Compensation We account for share-based employee compensation plans under the fair value recognition and measurement provisions in accordance with applicable accounting standards, which require all share-based payments to employees, including grants of stock options and restricted stock units (RSUs), to be measured based on the grant date fair value of the awards, with the resulting expense generally recognized on a straight-line basis over the period during which the employee is required to perform service in exchange for the award. Derivative Liability The Company evaluates its convertible instruments, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under ASC Topic 815, “Derivatives and Hedging.” The result of this accounting treatment is that the fair value of any derivative is marked-to-market each balance sheet date and recorded as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the statement of operations as gain/loss from derivative liability. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. We analyzed the derivative financial instruments in accordance with ASC 815. The objective is to provide guidance for determining whether an equity-linked financial instrument is indexed to an entity’s own stock. This determination is needed for a scope exception which would enable a derivative instrument to be accounted for under the accrual method. The classification of a non-derivative instrument that falls within the scope of ASC 815-40-05 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” also hinges on whether the instrument is indexed to an entity’s own stock. A non-derivative instrument that is not indexed to an entity’s own stock cannot be classified as equity and must be accounted for as a liability. There is a two-step approach in determining whether an instrument or embedded feature is indexed to an entity’s own stock. First, the instrument’s contingent exercise provisions, if any, must be evaluated, followed by an evaluation of the instrument’s settlement provisions. The Company utilized the fair value standard set forth by the Financial Accounting Standards Board, defined as the amount at which the assets (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Results of Operations Revenue and cost of revenue Revenue increased $4,132,303, or 161%, from $2,567,547 in 2020 to $6,699,850 in 2021. The overall revenue for 2021 was significantly higher due to growing “Twist & Go”™ revenue and the gradual return of single serve and bulk demand. Cost of revenue for 2021 was $4,175,132 as compared to $1,784,537 in 2020. Our gross profit was $2,507,045 (37%) and $764,072 (30%) for 2021 and 2020, respectively. This improvement was mainly driven by improving Twist & Go ™ margins and having a greater mix of higher margin bulk and single serve revenue. Depreciation from manufacturing equipment was $17,673 and $18,938 for December 31, 2021 and 2020, respectively. 18 Operating expenses Our operations were primarily directed towards increasing sales and expanding our distribution network. Our general and administrative expenses decreased $400,274 (9%) from $4,379,976 in 2020 to $3,979,702 in 2021. Shipping and storage costs were significantly higher due to higher sales volume and due to unprecedented market prices and labor shortages, which offset lower research and development and personnel costs. The following is a breakdown of our general and administrative expenses for the years 2021 and 2020. Year ended December 31, Year ended December 31, 2021 2020 Change Percent Personnel costs 1,316,461 1,581,414 (264,953 ) -17 % Stock based compensation/options 91,959 276,641 (184,682 ) -67 % Legal and professional fees 196,238 300,047 (103,809 ) -35 % Travel 37,368 86,569 (49,201 ) -57 % Rent 79,267 82,194 (2,927 ) -4 % Marketing and selling 137,223 205,050 (67,827 ) -33 % Consulting fees 238,886 75,890 162,996 215 % Director fees 250,000 187,500 62,500 33 % Research and development 244,609 515,145 (270,536 ) -53 % Shipping and storage 1,054,182 488,465 565,717 116 % Other expenses 333,509 581,061 (247,552 ) -43 % 3,979,702 4,379,976 (400,274 ) -9 % Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes for the years 2021 and 2020 and continues to be our largest cost. Personnel cost decreased $264,953 (17%) from $1,581,414 to $1,316,461 as a result of staffing vacancies. Stock based compensation is used as an incentive to attract new employees and to compensate existing employees. Stock based compensation includes stock issued and options granted primarily to employees and members of our board of directors. Stock compensation for the year ended December 31, 2021 was $91,959, a decrease of $184,682, or 67%, from the year ended December 31, 2020 expense of $276,641. The decrease is primarily due to changes in our workforce and the timing of equity grants. The Company issues additional stock options to its employees from time to time under its Equity Compensation Plan. Legal and professional fees decreased 35%, or $103,809, from $300,047 in 2020 to $196,238 in 2021. The decrease was primarily due to reduced legal services required. We anticipate legal fees related to our business and financing activities to decrease as we have renegotiated arrangements with existing service providers. Travel expenses decreased $49,201 (57%) from $86,569 in 2020 to $37,368 in 2021. The decrease is primarily due to reduced travel associated with terminated employees and COVID restrictions. We anticipate that travel expenses for 2022 will increase compared to the current year as business resumes with COVID restrictions being lifted. 19 Marketing and selling expenses decreased $67,827 (33%) from $205,050 in 2020 to $137,223 in 2021. Lower marketing and selling expenses were primarily due to lower percentage commissions associated with renegotiated distribution agreements. Consulting fees increased $162,996 (215%), from $75,890 in 2020, to $238,886 in 2021. The increase was due primarily to services related to consulting to improve sales operations and temporary labor to bridge staffing vacancies. Our consulting fees vary based on needs. We engaged consultants in the areas of sales operations during both 2021 and 2020. The need for future consulting services will be variable. Director fees increased $62,500, or 33%, from $187,500 in 2020 to $250,000 in 2021 as we had more non-employee directors in 2021 who received compensation. Annual director fees are anticipated at $50,000 per non-employee director. Research and development expenses decreased $270,536 (53%) from $515,145 in 2020 to $244,609 in 2021 due to reduced product development activity with national accounts and fewer market tests. These expenses relate to the services performed by our Director of Manufacturing and Product Development, and consultants supporting that employee. These activities are primarily directed towards the development of new products. Shipping and storage expense increased $565,717 (116%) from $488,465 in 2020 to $1,054,182 in 2021. This is primarily due to higher sales volume, higher fuel costs, and from costs resulting from relocating materials from one location to another. We anticipate that shipping and storage expense as a percentage of sales will reduce during 2022, as the Company is able to take advantage of more efficient distribution arrangements as well as an increased volume per load due to higher sales volume in 2022. Other expenses consist of ordinary operating expenses such as investor relations, office, telephone, insurance, and stock related costs. Other expense decreased $247,552, from $581,061 in 2020 to $333,509 in 2021, driven mainly by equipment repair, recruiting, and insurance expense. Other (income)/expenses Interest expense decreased $349,376 (73%) from $479,144 in 2020 to $129,768 in 2021. This decrease is due to the conversion and repayment of convertible notes during 2020 and 2021. The change in fair value of the derivative liability resulted in gains of $16,305 and $156,540 for the years ended December 31, 2021 and 2020, respectively. The gain is a result of the change in components of the Black-Scholes model. Components include the Company’s stock price, conversion price, remaining term, volatility, and current discount rate. The derivative liability was settled upon conversion and repayment of the convertible notes in June 2021. We recorded a gain on extinguishment of PPP debt of $1,136,262 in 2021. We also recognized a loss of $193,562 on debt extinguishment in 2021, as compared to a gain of $379,200 in 2020, both resulting from differences between the reacquisition price and the carrying amount of debt extinguished. In 2020, we recognized a gain of $437,201 related to the portion of convertible notes that were converted to common stock on March 20, 2020, offset by a loss on extinguishment of debt of $58,001 related to the portion of convertible notes that were extended by either 24 months for Milestone I, or 12 months for Milestone II. We had net losses of $1,265,147 and $4,152,506 for the years 2021 and 2020, respectively. This reduction in net loss, in the amount of $2,887,359, or 56%, is primarily attributable to the same factors that drove the improvement in gross profit and operating expenses, as well as the gain from extinguishment of the PPP loans. Liquidity and Capital Resources As of December 31, 2021, we had a working capital surplus of $6,170,701 as compared with a working capital surplus of $1,196,742 at December 31, 2020. The increase in working capital surplus is primarily due to the completion of the private placement of our common stock which resulted in gross proceeds of $6,000,000, offset by the debt extinguishment of all convertible debt of which $840,000 of the principal debt was paid in cash. In each of the years ended December 31, 2021 and 2020, the Company was granted a $568,131 loan under the PPP administered by a Small Business Administration (SBA) approved partner. The loans were forgiven, and the Company recorded a gain of $1,136,262 upon being legally released from the loan obligations during the year ended December 31, 2021. 20 On June 1, 2021, the Company completed a private placement of 1,282,051 shares of its common stock at $4.68 per share, resulting in gross proceeds of $6,000,000. In addition, holders of debt converted a total of $399,000 in principal and $234,410 in interest into 133,991 shares of common stock and debt in the amount of $840,000 was retired, leaving the Company with no debt. During the year ended December 31, 2021, we used cash of $1,861,633 in operations, $150,545 for the purchase of equipment, and $840,000 for the repayment of debt. The Company received $6,000,000 in cash for issuance of stock, and $568,131 for an SBA PPP loan. During the year ended December 31, 2020, the Company completed a funding, including a Private Placement Offering for common shares priced at $6.50 per share (subject to adjustment) in the amount of $3,825,000 and the issuance of 588,462 shares. The investors of this Private Placement Offering were granted 294,231 O warrants, exercisable for a period of 3 years at an exercise price of $7.80 per share (subject to adjustment). If the volume-weighted average trading price for the 20 consecutive trading days that conclude upon 6 months after the initial closing (the “Six Month Price”) exceeds or equals $6.50 per share (the “Target Price”), the per share purchase price will not be adjusted. If the Six Month Price is less than the Target Price, the per share purchase price will be automatically reduced to the Six Month Price, but in no event less than $4.55 per share, in which case the Company shall issue to each investor, pro-rata based on such investor’s investment: (a) shares in a quantity that equals the difference between the number of shares issued to such purchaser at closing and the number of shares that would have been issued to such purchaser at closing at the Six Month Price; and (b) a warrant for 0.50 shares for each additional share issued, with an exercise price equal to the sum of $1.30 per share and the Six Month Price, but in no event less than $5.85 per share. On September 28, 2020, the Company issued 409,451 additional shares in accordance with provisions of the Private Placement Offering and an additional 204,726 warrants exercisable at $5.85 per share. In addition, the Company obtained a 24-month extension on $1,071,000 in principal, and conversion of $720,000 of principal of the Milestone I Convertible Notes at a conversion price of $6.50 per share. The remaining $110,166 was extended for thirty days. The interest rate on the principal balance of the extended Milestone I Convertible Notes was amended to 15%. Furthermore, the Company obtained a 12 month extension on $168,000 in principal, and conversion of $1,128,000 in principal of the Milestone II Convertible Notes. The Convertible Noteholders of the Milestone I and II Convertible Notes were granted additional interest depending upon their election to convert or extend their Convertible Notes. Our liquidity needs will depend on how quickly we are able to profitably ramp up sales, as well as our ability to control and reduce variable operating expenses, and to continue to control and reduce fixed overhead expense. The impact of COVID-19 on the Company is constantly evolving. The direct impact to our operations had begun to take effect at the close of the first quarter ended March 31, 2020. Specifically, our business was impacted by dining bans targeted at restaurants to reduce the size of public gatherings. Such bans precluded our single serve products from being served at those establishments for a number of weeks, and in some instances, resulted in abandoned product launches. Furthermore, many school districts closed regular attendance for a period of time thereby disrupting sales of product into that channel. More recently, we have experienced a disruption in the supply chain for manufacturing our products due to COVID-19. The developments surrounding COVID-19 remain fluid and dynamic, and consequently, will require the Company to continue to monitor news headlines from government and health officials, as well as, the business community. Our operations to date have been financed by the sale of securities, the issuance of convertible debt and the issuance of short-term debt, including related party advances. If we are unable to generate sufficient cash flow from operations with the capital raised we will be required to raise additional funds either in the form of equity or in the form of debt. There are no assurances that we will be able to generate the necessary capital to carry out our current plan of operations. We have entered into a direct lease for new premises covering the period April 1, 2019 to March 31, 2023. The aggregate minimum requirements under the non-cancellable direct lease as of December 31, 2021 is approximately $101,000. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to stockholders. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Not applicable because we are a smaller reporting company. Item 8. Financial Statements and Supplementary Data. Our consolidated financial statements are included beginning immediately following the signature page to this report. See Item 15 for a list of the consolidated financial statements included herein. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. 21