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, 2022, as filed with the SEC on March 2, 2023, 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. Critical Accounting Policies Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). 16 Results of Operations Results of Operation for the Three Months Ended September 30, 2023 as Compared to the Three Months Ended September 30, 2022 Revenue and cost of revenue Revenue increased $197,000, or 8%, from $2,406,000 in 2022 to $2,603,000 in 2023. Revenue in 2022 was negatively impacted by the $630,000 claims estimate resulting from the market withdrawal of product purchased from the Manufacturer due to quality complaints. Excluding the refund claims estimate, revenue was $3,036,000 in 2022 and therefore decreased by $433,000 in 2023, or 14% based on product shipped. Our revenues have been adversely impacted as a result of lost customers and supply constraints resulting from the product issues and related dispute with the Manufacturer. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities. Cost of revenue for 2023 was $1,690,000 as compared to $3,129,000 in 2022. Cost of revenue in 2022 was negatively impacted by the $932,000 inventory write-off related to the product withdrawal. Excluding the inventory write-off, cost of revenue was $2,197,000 in 2022, and therefore decreased by $507,000 in 2023, or 23% based on product shipped. Excluding the impact of the product withdrawal, cost of revenue declined due to lower revenue, and lower product cost due to a shift in product mix resulting from the limited supply of smoothie bottles. Our gross profit was $913,000 (35%) and ($723,000) (-30%) for 2023 and 2022, respectively. Adjusted for the product withdrawal, our 2022 gross profit was $839,000 (28%). Adjusted comparative gross margin improvement is a result of favorable product mix, pricing actions, and a slight improvement in the cost of supply chain components. Selling, marketing and distribution expense Our operations were primarily directed towards increasing sales and expanding our distribution network. Three months ended September 30, 2023 Three months ended September 30, 2022 Change Percent Sales and marketing $ 327,000 $ 410,000 $ (83,000 ) -20 % Storage and outbound freight 370,000 450,000 (80,000 ) -18 % Sales, marketing and distribution expense $ 697,000 $ 860,000 $ (163,000 ) -19 % Selling, marketing and distribution expense decreased approximately $163,000 (-19%) from approximately $860,000 in 2022 to $697,000 in 2023. Sales and marketing expense decreased approximately $83,000 (-20%) from approximately $410,000 in 2022 to $327,000 in 2023. The decrease is a result of headcount reductions and lower broker commissions due to lower revenue and product mix. Storage and outbound freight expense decreased approximately $80,000 (-18%) from approximately $450,000 in 2022 to $370,000 in 2023, primarily as a result of the 14% decrease in product shipped as described in the discussion of revenue for the comparative quarters. The volume-related decrease in expense was enhanced by freight efficiencies compared to 2022. 17 General and administrative expense Three months ended September 30, 2023 Three months ended September 30, 2022 Change Percent Personnel costs $ 196,000 $ 336,000 $ (140,000 ) -42 % Stock-based compensation 240,000 156,000 84,000 54 % Legal, professional and consulting fees 61,000 98,000 (37,000 ) -38 % Director fees paid in cash (50,000 ) 25,000 (75,000 ) -300 % Research and development 32,000 220,000 (188,000 ) -85 % Other general and administrative expenses 99,000 178,000 (79,000 ) -44 % General and administrative expense $ 578,000 $ 1,013,000 $ (435,000 ) -43 % General and administrative expense decreased approximately $435,000 (-43%) from approximately $1,013,000 in 2022 to $578,000 in 2023. Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes. Personnel cost decreased by approximately $140,000 (-42%) from approximately $336,000 to $196,000 and stock-based compensation increased by approximately $84,000 (54%) from $156,000 to $240,000. The decrease in personnel cost resulted from a reduction in headcount and the decision to issue stock-based compensation in lieu of cash bonuses for a portion of the performance criteria in 2023, resulting in a year-to-date reduction of personnel costs of $87,000, including a $60,000 reclassification of expense incurred in the first two quarters of 2023. Additionally, unpaid directors’ fees for 2023 that were expected to be paid in cash were also converted to stock-based compensation, resulting in a year-to-date reduction in cash expense of $75,000, including a $50,000 reclassification of expense incurred in the first two quarters of 2023. Excluding the impact of the compensation modifications for employees and directors, stock-based compensation decreased by $26,000 due to headcount reductions and the non-recurrence of a one-time grant in 2022. Legal, professional and consulting fees decreased by $37,000 (-38%) as a result of a reduction in outside services in an effort to conserve working capital. Research and development expense decreased approximately $188,000 (-85%) from approximately $220,000 in 2022 to $32,000 in 2023. Expense was elevated in 2022 as we incurred pre-production expense related to the launch of our carton format, while 2023 expense was limited as activities were minimized to conserve working capital. Other general and administrative expenses decreased by approximately $79,000 (-44%) due to a reduction in local non-income based taxes and the timing of the Company’s annual meeting. Net loss We had net losses of approximately $476,000 and $2,687,000 for the three-month periods ended September 30, 2023 and 2022, respectively. The decrease in net loss of approximately $2,211,000, was the result of the non-recurrence of the estimated refund claims and inventory disposal costs associated with the product withdrawal, improved margins, and a reduction of approximately $575,000 in operating expenses due to cost saving measures and to a lesser extent, reduced volume of product shipped. Results of Operation for the Nine Months Ended September 30, 2023 as Compared to the Nine Months Ended September 30, 2022 Revenue and cost of revenue Revenue was $6,205,000 in 2023 compared to $7,731,000 in 2022, a decrease of $1,526,000, or 20%. Revenue in 2022 was negatively impacted by the $630,000 claims estimate resulting from the market withdrawal of product purchased from the Manufacturer. Excluding the refund claims estimate, revenue was $8,361,000 in 2022 and therefore decreased by $2,156,000 in 2023, or 26% based on product shipped. Our revenues have been adversely impacted as a result of lost customers and supply constraints resulting from the product issues and related dispute with the Manufacturer. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities. 18 Cost of revenue was $3,963,000 in 2023 compared to $6,807,000 in 2022, a decrease of $2,844,000, or 42%. Cost of revenue in 2022 was negatively impacted by the $932,000 inventory write-off related to the product withdrawal. Excluding the inventory write-off, cost of revenue was $5,875,000 in 2022, and therefore decreased by $1,912,000 in 2023, or 33% based on product shipped. Excluding the impact of the product withdrawal, cost of revenue declined due to lower revenue, and lower product cost due to a shift in product mix resulting from the limited supply of smoothie bottles. Our gross profit was $2,242,000 (36%) and $924,000 (12%) for 2023 and 2022, respectively. Adjusted for the product withdrawal, our 2022 gross profit was $2,486,000 (30%). Adjusted comparative gross margin improvement is a result of favorable product mix, pricing actions, and a slight improvement in the cost of supply chain components. Selling, marketing and distribution expense Our operations were primarily directed towards increasing sales and expanding our distribution network. Nine months ended September 30, Nine months ended September 30, 2023 2022 Change Percent Sales and marketing $ 1,058,000 $ 1,019,000 $ 39,000 4 % Storage and outbound freight 932,000 1,217,000 (285,000 ) -23 % Sales, marketing and distribution expense $ 1,990,000 $ 2,236,000 $ (246,000 ) -11 % Selling, marketing and distribution expense decreased approximately $246,000 (-11%) from approximately $2,236,000 in 2022 to $1,990,000 in 2023. Sales and marketing expense increased approximately $39,000 (4%) from approximately $1,019,000 in 2022 to $1,058,000 in 2023. We incurred additional expense for product sampling of smoothie carton products, equipment maintenance incurred to relaunch bulk product sales in locations that had been non-operational as a result of COVID shutdowns and subsequent labor shortages, and broker commissions as we engaged numerous regional K-12 specialists to expand our geographic reach in the third quarter of 2022. These increases were partially offset by a reduction in personnel costs. Storage and outbound freight expense decreased approximately $285,000 (-23%) from approximately $1,217,000 in 2022 to $932,000 in 2023 primarily as a result of the 26% decrease in product shipped as described in the discussion of revenue for the comparative year-to-date periods. The volume-related decrease in expense was partially offset by higher costs resulting from product mix and inefficiencies due to production transitions. General and administrative expense Nine months ended September 30, 2023 Nine months ended September 30, 2022 Change Percent Personnel costs $ 929,000 $ 1,006,000 $ (77,000 ) -8 % Stock based compensation 431,000 355,000 76,000 21 % Legal, professional and consulting fees 236,000 311,000 (75,000 ) -24 % Director fees paid in cash - 75,000 (75,000 ) -100 % Research and development 88,000 347,000 (259,000 ) -75 % Other general and administrative expenses 381,000 543,000 (162,000 ) -30 % General and administrative expense $ 2,065,000 $ 2,637,000 $ (572,000 ) -22 % 19 General and administrative expense decreased approximately $572,000 (-22%) from approximately $2,637,000 in 2022 to $2,065,000 in 2023. Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes and continues to be our largest cost. Personnel cost decreased by approximately $77,000 (-8%) from approximately $1,006,000 to $929,000. The decrease in personnel cost resulted primarily from the confirmation and recognition of our 2021 COVID-related tax credit, partially offset by bonus expense from the 2023 decision to cash settle a portion of the 2022 performance stock units. Stock-based compensation increased by approximately $76,000 (21%) from $355,000 to $431,000 because 2023 directors’ fees that were expected to be paid in cash were converted to stock-based compensation. Legal, professional and consulting fees decreased by $75,000 (-24%). We reduced outside services in an effort to conserve working capital. Research and development expense decreased approximately $259,000 (-75%) from approximately $347,000 in 2022 to $88,000 in 2023. Expense was elevated in 2022 as we incurred pre-production expense related to the launch of our carton format, while 2023 expense was limited as activities were minimized to conserve working capital. Other general and administrative expenses decreased approximately $162,000 (-30%) from approximately $543,000 in 2022 to $381,000 in 2023 primarily as a result of non-recurring costs related to our uplisting to the NASDAQ stock exchange in 2022, partially offset by legal costs related by our dispute with the Manufacturer. Net loss We had net losses of approximately $2,123,000 and $4,276,000 for the nine-month periods ended September 30, 2023 and 2022, respectively. The decrease in net loss of approximately $2,153,000, was the result of the non-recurrence of the estimated refund claims and inventory disposal costs associated with the product withdrawal, improved margins, and a reduction of approximately $835,000 in operating expenses due to cost saving measures, reduced volume of product shipped, and the recognition of our COVID-related tax credit. Liquidity and Capital Resources As of September 30, 2023, we had working capital of $541,000 compared with $1,801,000 at December 31, 2022. The decrease in working capital is primarily due to the operating loss for the nine months ended September 30, 2023 as adjusted for non-cash depreciation, amortization and stock-based compensation. During the nine months ended September 30, 2023, we used $2,008,000 in operations. 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. While further developments surrounding COVID-19 may arise, the business climate appears to have stabilized in 2023. 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 $234,000 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. From July to October 2023, the Company executed subscription agreements for $1,880,000 of a $2,000,000 privately placed convertible debt offering. The debt may be drawn in 25% increments, matures on the anniversary of the draw, bears interest at 10% per annum for the term, regardless of earlier payment or conversion, and is mandatorily convertible as to principal and interest into shares of the Company’s common stock at any time prior to maturity at the greater of $1.20 or 85% of the volume-weighted average price of the common stock for the ten trading days immediately preceding the written notice of the conversion (the “Conversion Price”). If the Company has not exercised the mandatory conversion, the holder of the debt has the option after six months and on up to four occasions to convert all or any portion of the principal and interest into shares of the Company’s common stock at the Conversion Price. On October 23, 2023, the Company issued $1,390,000 of convertible notes pursuant to the subscription agreements, and immediately converted $1,207,000 of principal and interest into approximately 820,000 shares of common stock. 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. Our current dispute with the Manufacturer and the resulting loss of product supply and legal expense continue to negatively impact our financial position, results of operations and cash flow. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities. 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. 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. 21 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not required because we are a smaller reporting company.