BARFRESH FOOD GROUP INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion should be read in conjunction with the financial information included elsewhere in this Quarterly Report on Form 10-Q (this “Report”), including our unaudited condensed consolidated financial statements and the related notes and with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 10, 2022, and other reports that we file with the SEC from time to time. References in this Quarterly Report on Form 10-Q to “us”, “we”, “our” and similar terms refer to Barfresh Food Group Inc. Cautionary Note Regarding Forward-Looking Statements This discussion includes forward-looking statements, as that term is defined in the federal securities laws, based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations, and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. Words such as “anticipate”, “estimate”, “plan”, “continuing”, “ongoing”, “expect”, “believe”, “intend”, “may”, “will”, “should”, “could” and similar expressions are used to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. 13 Critical Accounting Policies There have been no changes to our significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 10, 2022, that have a material impact on our condensed consolidated financial statements and related notes. Recent Accounting Pronouncements See Note 1 to the accompanying notes to unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for further details regarding this topic. Results of Operations Results of Operation for Three Months Ended September 30, 2022 as Compared to the Three Months Ended September 30, 2021 Revenue and cost of revenue Revenue increased by approximately $476,000 (25%) from approximately $1,930,000 in 2021 to approximately $2,406,000 in 2022. The overall revenue for the third quarter 2022 was higher due to growth in “Twist & Go”™ revenue and the gradual return of single serve demand. Revenue in the third quarter of 2022 was adversely impacted by a withdrawal of “Twist & Go”™ product manufactured by one of its co-manufacturers. The withdrawal resulted from quality complaints that are the subject of a legal dispute that is more fully described in the footnotes of the accompanying financial statements. As a result of the withdrawal, we recorded a reserve for anticipated sales claims and distributor administrative fees of $630,000. The Company anticipates that its revenues will be adversely impacted as a result of the dispute unless and until a suitable resolution is reached or new sources of reliable supply at sufficient volume can be identified and developed, the timing of which is uncertain. Cost of revenue for 2022 was approximately $3,129,000 as compared to approximately $1,209,000 in 2021. Cost of revenue in the third quarter of 2022 was adversely impacted by the anticipated disposal of withdrawn inventory, amounting to $932,000 including ancillary costs. Our gross profit was approximately ($723,000) (-30%) and $721,000 (37%) for 2022 and 2021, respectively. Excluding the impact of the product withdrawal on both revenue and cost of revenue, our gross profit in the third quarter was $839,000 (28%). The decrease in the third quarter is primarily due to product mix which includes a higher proportion of “Twist & Go”™ at slightly lower product margins. Selling, marketing and distribution expense Our operations were primarily directed towards increasing sales and expanding our distribution network. Three months ended September 30, Three months ended September 30, 2022 2021 Change Percent Sales and marketing $ 365,000 $ 164,000 $ 201,000 123 % Storage and outbound freight 450,000 316,000 134,000 42 % $ 815,000 $ 480,000 $ 335,000 70 % Sales and marketing expense increased approximately $201,000 (123%) from approximately $164,000 in 2021 to $365,000 in 2022. The increase in sales and marketing expense was primarily the result of the retention of new employees and outside service providers to assist with sales and initiatives, including, beginning in the third quarter of 2022, brokers specializing in the school market. Additionally, the Company increased its participation in education nutrition trade shows in 2022. 14 Storage and outbound freight expense increased approximately $134,000 (42%) from approximately $316,000 in 2021 to $450,000 in 2022. The increase was primarily a result of the 25% increase in revenue and the additional shipments that were ultimately not recognized as revenue due to the aforementioned product withdrawal. General and administrative expense Our general and administrative expense increased by 81%, or approximately $472,000, from approximately $586,000 in 2021 to approximately $1,058,000 in 2022, primarily driven by research and development, personnel, including non-cash stock-based compensation, and other general and administrative expense. The following is a breakdown of our general and administrative expense for the three months ended September 30, 2022, and 2021: Three months ended September 30, Three months ended September 30, 2022 2021 Change Percent Personnel costs $ 352,000 $ 244,000 $ 108,000 44 % Stock-based compensation 118,000 42,000 76,000 181 % Legal, professional and consulting fees 98,000 67,000 31,000 46 % Director fees 62,000 50,000 12,000 24 % Research and development 220,000 34,000 186,000 547 % Other general and administrative expenses 208,000 149,000 59,000 40 % $ 1,058,000 $ 586,000 $ 472,000 81 % Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes and continues to be our largest cost. Personnel cost increased by approximately $108,000 (44%) from approximately $244,000 to $352,000. The increase in personnel cost was partially offset by the decrease in consulting fees as we choose to hire permanent staff as the critical stages of the COVID-19 pandemic waned, rather than rely on consultants and temporary staff. Stock based compensation is used as an incentive to attract new employees and to compensate existing employees. Stock based compensation includes stock issued and restricted stock units and options granted to employees and non-employees. Stock based compensation for the three months ended September 30, 2022 was approximately $118,000 compared to $42,000 for the three months ended September 30, 2021 due to the aforementioned increase in staffing as well as the implementation of a performance-based stock compensation program. Research and development expense increased approximately $186,000 (547%) from approximately $34,000 in 2021 to $220,000 in 2022. The increase is primarily due to materials consumed in pre-production runs at a new co-manufacturer that will provide our Twist & Go™ product in carton format starting in the fourth quarter of 2022. Other expense increased approximately $59,000 (40%) from approximately $149,000 in 2021 to $208,000 in 2022, primarily related to an increase in maintenance costs on equipment loaned to our bulk product customers, costs related to our annual meeting, and approximately $8,000 in one-time costs related to the uplist of our common stock to the NASDAQ Stock Market. Operating loss and net loss We had operating and net losses of approximately $2,708,000 and $508,000 for the three-month periods ended September 30, 2022 and 2021, respectively. The increase of approximately $2,200,000 or 433%, was primarily due to $1,785,000 in charges related to the aforementioned product quality issue and withdrawal. 15 Results of Operation for Nine Months Ended September 30, 2022 as Compared to the Nine Months Ended September 30, 2021 Revenue and cost of revenue Revenue increased by approximately $3,485,000 (82%) from approximately $4,246,000 in 2021 to approximately $7,731,000 in 2022. The overall revenue for the nine months ended September 30, 2022 was higher due to growth in “Twist & Go”™ revenue and the gradual return of single serve demand. Revenue in the third quarter of 2022 was adversely impacted by a withdrawal of “Twist & Go”™ product manufactured by one of its co-manufacturers. The withdrawal resulted from quality complaints that are the subject of a legal dispute that is more fully described in the footnotes of the accompanying financial statements. As a result of the withdrawal, we recorded a reserve for anticipated sales claims and distributor administrative fees of $630,000. The Company anticipates that its revenues will be adversely impacted as a result of the dispute unless and until a suitable resolution is reached or new sources of reliable supply at sufficient volume can be identified and developed, the timing of which is uncertain. Cost of revenue for 2022 was approximately $6,807,000 as compared to approximately $2,614,000 in 2021. Cost of revenue in the third quarter of 2022 was adversely impacted by the anticipated disposal of withdrawn inventory, amounting to $932,000 including ancillary costs. Our gross profit was approximately $924,000 (12%) and $1,632,000 (38%) for 2022 and 2021, respectively. Excluding the impact of the product withdrawal on both revenue and cost of revenue, our gross profit in the nine months ended September 30, 2022 was $2,486,000 (30%). Gross margins decreased in the nine months ended September 30, 2022 primarily due to product mix which includes “Twist & Go”™ at slightly lower product margins. Selling, marketing and distribution expense Nine months ended September 30, Nine months ended September 30, 2022 2021 Change Percent Sales and marketing $ 929,000 $ 519,000 $ 410,000 79 % Storage and outbound freight 1,208,000 717,000 491,000 68 % $ 2,137,000 $ 1,236,000 $ 901,000 73 % Sales and marketing expense increased approximately $410,000 (79%) from approximately $519,000 in 2021 to $929,000 in 2022. The increase in sales and marketing expense was primarily the result of the retention of new employees and outside service providers to assist with sales and initiatives, including, beginning in the third quarter of 2022, brokers specializing in the school market. Additionally, the Company increased its participation in education nutrition trade shows in 2022. Storage and outbound freight expense increased approximately $491,000 (68%) from approximately $717,000 in 2021 to $1,208,000 in 2022. The increase was primarily a result of the 82% increase in revenue, tempered by logistics efficiencies from the increased volume in core markets served. 16 General and administrative expense Our general and administrative expense increased by 71%, or approximately $1,138,000, from approximately $1,598,000 in 2021 to approximately $2,736,000 in 2022, primarily driven by personnel, including non-cash stock-based compensation, other general and administrative expense, and research and development. The following is a breakdown of our general and administrative expense for the nine months ended September 30, 2022, and 2021: Nine months ended September 30, Nine months ended September 30, 2022 2021 Change Percent Personnel costs $ 1,036,000 $ 637,000 $ 399,000 63 % Stock-based compensation 211,000 52,000 159,000 306 % Legal, professional and consulting fees 342,000 244,000 98,000 40 % Director fees 187,000 200,000 (13,000 ) -7 % Research and development 347,000 173,000 174,000 101 % Other general and administrative expenses 613,000 292,000 321,000 110 % $ 2,736,000 $ 1,598,000 $ 1,138,000 71 % Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes and continues to be our largest cost. Personnel cost increased by approximately $399,000 (63%) from approximately $637,000 to $1,036,000. The increase in personnel cost was partially offset by the decrease in consulting fees as we choose to hire permanent staff as the critical stages of the COVID-19 pandemic waned, rather than rely on consultants and temporary staff. 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 to employees and non-employees. Stock based compensation for the nine months ended September 30, 2022 was approximately $211,000 compared to $52,000 for the nine months ended September 30, 2021 due to the aforementioned increase in staffing, and the institution of our performance-based stock compensation program in the third quarter of 2022. Stock-based compensation in 2021 benefited from forfeiture credits due to the departure of two key employees. Legal, professional, and consulting fees increased approximately $98,000 (40%) from approximately $244,000 in 2021 to $342,000 in 2022. The increase was primarily due to corporate development activities. Research and development expense increased approximately $174,000 (101%) from approximately $173,000 in 2021 to $347,000 in 2022. The increase is primarily due to materials consumed in pre-production runs at a new co-manufacturer that will provide our Twist & Go™ product in carton format starting in the fourth quarter of 2022 . Other expense increased approximately $321,000 (110%) from approximately $292,000 in 2021 to $613,000 in 2022. In 2022, we incurred approximately $175,000 in one-time costs related to the uplist of our common stock to the NASDAQ Stock Market. Additionally, we experienced maintenance cost increases related to equipment loaned to our bulk product customers, and an increase in annual meeting costs. Operating loss We had operating losses of approximately $4,339,000 and $1,658,000 for the nine-month periods ended September 30, 2022 and 2021, respectively. The increase of approximately $2,681,000 or 162%, was primarily due to $1,785,000 in charges related to the aforementioned product quality issue and withdrawal and increases in operating expense. Other income and expense The change in the value of the derivative liability is based upon the Black-Scholes model from one period to another. The gain of approximately $16,000 for the nine months ended September 30, 2021 was a result of the change in components of the Black-Scholes model. The derivative liability was settled upon conversion and repayment of the convertible notes in the second quarter of 2021, which resulted in an extinguishment loss of $194,000. We recorded a gain on extinguishment of covid-19 related Paycheck Protection Program (“PPP”) loan of $568,000 in the nine months ended September 30, 2021. 17 Interest expense was approximately $128,000 for the nine months ended September 30, 2021. Interest related to convertible debt that was converted and repaid in 2021. We did not incur any interest expense for the nine months ended September 30, 2022. Net loss We had net losses of approximately $4,339,000 and $1,396,000 in the nine-month periods ended September 30, 2022 and 2021, respectively, with the primary change due to the $568,000 gain on forgiveness of the PPP loan in 2021. Liquidity and Capital Resources As of September 30, 2022, we had working capital of approximately $2,619,000 as compared with approximately $6,172,000 at December 31, 2021. The decrease in working capital surplus is primarily due to operating loss for the nine months ended September 30, 2022. During the nine months ended September 30, 2022, we used cash of approximately $2,619,000 in operations, and $13,000 for the purchase of equipment, partially offset by $5,000 from the issuance of stock pursuant to an outstanding warrant. 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 expense, and to continue to control fixed overhead expense. 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 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 premises covering the period April 1, 2019 to March 31, 2023. The aggregate minimum lease payments under the non-cancellable direct lease as of September 30, 2022 are approximately $40,000. 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 expense, results of operations, liquidity, capital expenditures or capital resources that are material to stockholders. Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not required because we are a smaller reporting company.