RYTHM, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of our financial condition and results of our operations together with our consolidated financial statements and the notes thereto appearing elsewhere in this report. This discussion contains forward-looking statements reflecting our current expectations, whose actual outcomes involve risks and uncertainties. Actual results and the timing of events may differ materially from those stated in or implied by these forward-looking statements due to a number of factors, including those discussed in the sections entitled “Risk Factors,” “Cautionary Statement regarding Forward-Looking Statements” and elsewhere in this report. Overview We are a developer of highly advanced and proprietary precision hardware and software grow solutions for the indoor agriculture marketplace and provide equipment and solutions for extraction, post-processing, and testing for the cannabis and hemp industry. We believe we are the only company with an automated and fully integrated grow solution in the industry. We believe our Agrify “Precision Elevated™” cultivation solution is vastly differentiated from anything else on the market in that it combines our seamlessly integrated hardware and software offerings with a wide range of associated services such as consulting, engineering, and construction to form what we believe is the most complete solution available from a single provider. The totality of our product mix and service capabilities forms an unrivaled ecosystem in what has historically been an extremely fragmented market. As a result, we believe we are well situated to create a dominant market position in the indoor agriculture sector. Agrify Corporation was incorporated in the state of Nevada on June 6, 2016, originally incorporated as Agrinamics, Inc. (or Agrinamics). On September 16, 2019, Agrinamics amended its articles of incorporation to reflect a name change to Agrify Corporation. The Company’s corporate office is located in Billerica, Massachusetts. We also lease properties located within various geographic regions in which we conduct business, including Colorado, Georgia, Massachusetts, Michigan, and Oregon. Reverse Stock Split On January 12, 2021, the Company effected a 1-for-1.581804 reverse stock split. All share and per share information has been retroactively adjusted to give effect to the reverse stock split for all periods presented, unless otherwise indicated. 34 Fiscal 2021 Highlights Acquisition of Precision and Cascade On September 29, 2021 (the “Execution Date”), we entered into a Plan of Merger and Equity Purchase Agreement, as amended by an amendment dated as of October 1, 2021 (as amended, the “Purchase Agreement”), with Sinclair Scientific, LLC, a Delaware limited liability company (“Sinclair”), Mass2Media, LLC, d/b/a PX2 Holdings, LLC, d/b/a Precision Extraction Solutions, a Michigan limited liability company; and each of the equity holders of Sinclair named therein (collectively, the “Sinclair Members”). On October 1, 2021, we consummated the transactions contemplated by the Purchase Agreement. Subject to the terms and conditions set forth in the Purchase Agreement, (1) Sinclair transferred, to us, and we purchased (the “Interest Purchase”) from Sinclair, 100% of the equity interests of Cascade Sciences, LLC, a Delaware limited liability company, such that immediately after the consummation of such Interest Purchase, Cascade became a wholly owned subsidiary of us, and (2) Precision merged (the “Merger”) with and into a newly-formed wholly owned subsidiary of us, Precision Extraction NewCo, LLC. The aggregate consideration for the Interest Purchase and the Merger consisted of: (a) the sum of $30 million, plus consideration payable to holders of outstanding Sinclair equity awards, subject to certain adjustments for working capital, cash and indebtedness, payable in connection with the Interest Purchase; (b) the number of shares of our common stock, subject to adjustment, equal to the quotient of (i) $20 million divided by (ii) the volume-weighted average price per share of our common stock on The Nasdaq Capital Market for the 30 consecutive trading days ending on the Execution Date (the “VWAP Price”), issuable in connection with the Merger; and (c) the True-Up Buyer Shares, if any (as defined below), issuable in connection with the Merger. The Purchase Agreement includes customary post-closing adjustments, representations and warranties and covenants of the parties. The Sinclair Members may become entitled to additional shares of our common stock (the “True-Up Buyer Shares”) and cash (together with the True-Up Buyer Shares, the “Aggregate True-Up Payment”) based on the eligible net revenues (as defined in the Purchase Agreement) achieved by the Cascade and Precision businesses during the fiscal year ending December 31, 2021. However, in no event shall the aggregate purchase price paid by us pursuant to the terms of the Purchase Agreement, taking into account any Aggregate True-Up Payment in favor of the Sinclair Members, exceed $65 million. In connection with the Aggregate True Up Payment, Precision and Cascade earned additional purchase consideration of $5.4 million during fiscal year ending December 31, 2021. Of the $5.4 million of additional consideration, $1.4 million was recognized as change in contingent consideration in our consolidated statements of operations during the fourth quarter of 2021 due to the fact that the final revenue achievement exceeded our original fair value estimate at the time of the acquisition. Transaction and related costs, consisting primarily of professional fees, directly related to the acquisition, totaled $4.0 million for the year ended December 31, 2021. All transaction and related costs were expensed as incurred and are included in selling, general and administrative expenses. The purchase price allocation for the business combination has been prepared on a preliminary basis and changes to those allocations may occur as additional information becomes available during the respective measurement period (up to one year from the acquisition date). The estimated fair value at acquisition is $49.9 million and may be adjusted upon further review of the values assigned to identifiable intangible assets and goodwill. Our initial fair value estimates related to the various identified intangible assets were determined under various valuation approaches including the Income Approach, Relief-from-Royalty Method, and Discounted Cash Flow Method. These valuation methods require management to project revenues, operating expenses, working capital investment, capital spending and cash flows for the reporting unit over a multiyear period, as well as determine the weighted average cost of capital to be used as a discount rate. 35 We amortize our intangible assets assuming no residual value over periods in which the economic benefit of these assets is consumed. The amount of revenue of Precision and Cascade included in our consolidated statement of operations from the acquisition date of October 1, 2021 to December 31, 2021 was approximately $12.3 million. Acquisition of PurePressure On December 31, 2021, we entered into a Membership Interest Purchase Agreement (the “Pure Purchase Agreement”) with PurePressure, LLC, a Colorado Limited liability company and the members of PurePressure (collectively, the “Members”), Benjamin Britton as the Member Representative thereunder, and each of the Members. Concurrently with the execution of the Pure Purchase Agreement, we consummated the acquisition of all the outstanding equity interests of PurePressure, such that immediately after the consummation of such purchase, PurePressure became a wholly owned subsidiary of us (the “Acquisition”). The aggregate consideration for the Acquisition consisted of: (a) $4.0 million in cash, subject to certain adjustments for working capital, cash and indebtedness of PurePressure at closing; (b) 329,179 shares of our common stock (the “Buyer Shares”); and (c) the Earn-out Consideration (as defined below), to the extent earned. We withheld 88,878 of the Buyer Shares issuable to certain Members (the “Holdback Buyer Shares”) for the purpose of securing any post-closing adjustment owed to us and any claim for indemnification or payment of damages to which we may be entitled under the Pure Purchase Agreement. The Holdback Buyer Shares shall be released following the twelve (12) month anniversary of the Closing Date in accordance with and subject to the conditions of the Pure Purchase Agreement. The Pure Purchase Agreement includes customary post-closing adjustments, representations and warranties and covenants of the parties. The Members may become entitled to additional consideration with a value of up to $3.0 million based on the eligible net revenues achieved by the PurePressure business during the fiscal years ending December 31, 2022 and December 31, 2023, of which 40% will be payable in cash and the remaining 60% will be payable by issuing shares of our common stock (collectively, the “Earn-out Consideration”). The purchase price allocation for the business combination has been prepared on a preliminary basis and changes to those allocations may occur as additional information becomes available during the respective measurement period (up to one year from the acquisition date). The estimated fair value at acquisition is $7.9 million and may be adjusted upon further review of the values assigned to identifiable intangible assets and goodwill.   Our initial fair value estimates related to the various identified intangible assets were determined under various valuation approaches including the Income Approach, Relief-from-Royalty Method, and Discounted Cash Flow Method. These valuation methods require management to project revenues, operating expenses, working capital investment, capital spending and cash flows for the reporting unit over a multiyear period, as well as determine the weighted average cost of capital to be used as a discount rate. We amortize our intangible assets assuming no residual value over periods in which the economic benefit of these assets is consumed. No revenue from PurePressure was included in our consolidated statement of operations as the transaction occurred on December 31, 2021. 36 Impact of coronavirus pandemic (“COVID-19”) The extensive impact of the pandemic caused by COVID-19 has resulted and will likely continue to result in significant disruptions to the global economy, as well as businesses and capital markets around the world. In an effort to halt the outbreak of COVID-19, a number of countries, states, counties, and other jurisdictions have imposed, and may impose in the future, various measures, including but not limited to, voluntary and mandatory quarantines, stay-at-home orders, travel restrictions, limitations on gatherings of people, reduced operations, and extended closures of businesses. To date, although all of our operations are functioning, COVID-19 has continued to cause some disruptions to our business, such as some temporary delays in the delivery of our inventory. Although the ability of our suppliers to timely ship their goods has affected some of our deliveries, currently the difficulties experienced by our suppliers have not yet materially impacted our ability to deliver products to our customers. However, if this continues, it may negatively affect any inventory we may have and more significantly delay the delivery of merchandise to our customers, which in turn will adversely affect our revenues and results of operations. The extent to which COVID-19 and the related global economic crisis, affect our business, results of operations and financial condition, will depend on future developments that are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and any recovery period, future actions taken by governmental authorities, central banks and other third parties (including new financial regulation and other regulatory reform) in response to the pandemic, and the effects on our produce, clients, vendors and employees. We continue to service our customers amid uncertainty and disruption linked to COVID-19 and we are actively managing our business to respond to its impact. Convertible Promissory Notes On January 11, 2021, our Board of Directors and shareholders approved the amendment to the conversion formula of the Convertible Promissory Notes (the “Notes”) issued by us on dates between August 2020 and November 2020. Pursuant to the amendment, immediately prior to the consummation of a public transaction, the outstanding principal amount of the Notes, together with all accrued and unpaid interest, shall convert into a number of fully paid and non-assessable shares of common stock, at a conversion price of $7.72. While the original conversion feature was bifurcated from the host instrument, we determined that the amended conversion feature would not require bifurcation. Since the accounting for the conversion feature changed because of the amendment, we applied extinguishment accounting pursuant to its accounting policy. Accordingly, we recognized a gain on extinguishment of $2.7 million in connection with the derecognition of the net carrying amount of the extinguished debt of $19.7 million (inclusive of $13.1 million of principal, $7.1 million of derivative liabilities, less $587 thousand of debt discount) and the recognition of the $17.0 million fair value of the new convertible notes (including the same principal amount of $13.1 million, plus the $3.9 million fair value of the beneficial conversion feature). On February 1, 2021, in conjunction with the closing of our IPO, the Notes in the aggregate principal amount of $13.1 million were converted into 1,697,075 shares of common stock at the election of us at a conversion price of $7.72 per share. 37 Use of Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include assumptions about collection of accounts and notes receivable, the valuation and recognition of stock- based compensation expense, valuation allowance for deferred tax assets and useful life of fixed assets and intangible assets. Financial Overview Critical Accounting Policies and Significant Judgments and Estimates Our management’s discussion and analysis of our financial position and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, we evaluate estimate, which include estimates related to accruals, stock-based compensation expense, and reported amounts of revenues and expenses during the reported period. We base our estimates on historical experience and other market-specific or other relevant assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from those estimates or assumptions. Revenue Recognition Overview We generate revenue from the following sources: (1) equipment sales, (2) services sales and (3) construction contracts. We recognize revenue from contracts with customers using a five-step model, which is described below: ● identify the customer contract; ● identify performance obligations that are distinct; ● determine the transaction price; ● allocate the transaction price to the distinct performance obligations; and ● recognize revenue as the performance obligations are satisfied. Identify the customer contract A customer contract is generally identified when there is approval and commitment from both use and its customer, the rights have been identified, payment terms are identified, the contract has commercial substance and collectability, and consideration is probable. Specifically, we obtain written/electronic signatures on contracts and a purchase order, if said purchase orders are issued in the normal course of business by the customer. Identify performance obligations that are distinct A performance obligation is a promise to provide a distinct good or service or a series of distinct goods or services. A good or service that is promised to a customer is distinct if the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and our promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. 38 Determine the transaction price The transaction price is the amount of consideration to which we expect to be entitled in exchange for transferring goods or services to a customer, excluding sales taxes that are collected on behalf of government agencies. Allocate the transaction price to distinct performance obligations The transaction price is allocated to each performance obligation based on the relative standalone selling prices (“SSP”) of the goods or services being provided to the customer. Our contracts typically contain multiple performance obligations, for which we account for individual performance obligations separately, if they are distinct. The standalone selling price reflects the price we would charge for a specific piece of equipment or service if it was sold separately in similar circumstances and to similar customers. Recognize revenue as the performance obligations are satisfied Revenue is recognized when, or as, performance obligations are satisfied by transferring control of a promised product or service to a customer. Significant Judgments We enter into contracts that can include various combinations of equipment, services and construction, which are generally capable of being distinct and accounted for as separate performance obligations. Contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Once we determine the performance obligations, it determines the transaction price, which includes estimating the amount of variable consideration to be included in the transaction price, if any. We then allocate the transaction price to each performance obligation in the contract based on the SSP. The corresponding revenue is recognized as the related performance obligations are satisfied. Judgment is required to determine the SSP for each distinct performance obligation. We determine SSP based on the price at which the performance obligation is sold separately and the methods of estimating SSP under the guidance of Accounting Standards Codification (“ASC”) 606-10-32-33. If the SSP is not observable through past transactions, we estimate the SSP, taking into account available information such as market conditions, expected margins, and internally approved pricing guidelines related to the performance obligations. We license our software as a SaaS type subscription license, whereby the customer only has a right to access the software over a specified time period. The full value of the contract is recognized ratably over the contractual term of the SaaS subscription, adjusted monthly if tiered pricing is relevant. We typically satisfy our performance obligations for equipment sales when equipment is made available for shipment to the customer; for services sales as services are rendered to the customer and for construction contracts both as services are rendered and when contract is completed. We utilize the cost-plus margin method to determine the SSP for equipment and buildout services. It is based on the cost of the services from third parties, plus a reasonable markup that we believe is reflective of a market-based reseller margin. The SSP for services in time and materials contracts is determined by observable prices in standalone services arrangements. Variable consideration in the form of royalties, revenue share, monthly fees, and service credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Variable consideration is typically not subject to constraint. Changes to variable consideration were not material for the periods presented. 39 If contracts have payment terms that differ from the timing of revenue recognition, we will assess whether the transaction price for those contracts include a significant financing component. We have elected the practical expedient that permits an entity to not adjust for the effects of a significant financing component if we expect that at the contract inception, the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service, will be one year or less. For those contracts in which the period exceeds the one-year threshold, this assessment, as well as the quantitative estimate of the financing component and its relative significance, requires judgment. Accordingly, we impute interest on such contracts at an agreed upon interest rate and will present the financing components separately as financial income. For the years ended December 31, 2021 and 2020, we did not have any such financial income. Payment terms with customers typically require payment 30 days from invoice date. Our agreements with customers do not provide for any refunds for services or products and therefore no specific reserve for such is maintained. In the infrequent instances where customers raise a concern over delivered products or services, we have endeavored to remedy the concern and all costs related to such matters have been insignificant in all periods presented. We have elected to treat shipping and handling activities after the customer obtains control of the goods as a fulfillment cost and not as a promised good or service. Accordingly, we will accrue all fulfillment costs related to the shipping and handling of consumer goods at the time of shipment. We have payment terms with its customers of one year or less and has elected the practical expedient applicable to such contracts not to consider the time value of money. Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. We receive payment from customers based on specified terms that are generally less than 30 days from the satisfaction of performance obligations. There are no contract assets related to performance under the contract. The difference in the opening and closing balances of our deferred revenue primarily results from the timing difference between our performance and the customer’s payment. We fulfil obligations under a contract with a customer by transferring products and services in exchange for consideration from the customer. Accounts receivables are recorded when the customer has been billed or the right to consideration is unconditional. We recognize deferred revenue when consideration has been received or an amount of consideration is due from the customer, and we have a future obligation to transfer certain proprietary products. In accordance with ASC 606-10-50-13, we are required to include disclosure on its remaining performance obligations as of the end of the current reporting period. Due to the nature of our contracts, these reporting requirements are not applicable. The majority of our remaining contracts meet certain exemptions as defined in ASC 606-10-50-14 through 606-10-50-14A, including (i) performance obligation is part of a contract that has an original expected duration of one year or less and (ii) the right to invoice practical expedient. We generally provide a one-year warranty on our products for materials and workmanship but may provide multiple year warranties as negotiated, and will pass on the warranties from its vendors, if any, which generally covers this one-year period. In accordance with ASC 450-20-25, we accrue for product warranties when the loss is probable and can be reasonably estimated. The reserve for warranty returns is included in accrued expenses and other current liabilities in our consolidated balance sheets. 40 Accounting for Business Combinations We allocated the purchase price of acquired companies to the tangible and intangible assets acquired, including in-process research and development assets, and liabilities assumed, based upon their estimated fair values at the acquisition date. These fair values are typically estimated with assistance from independent valuation specialists. The purchase price allocation process requires us to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets, contractual support obligations assumed, contingent consideration arrangements, and pre-acquisition contingencies. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: ● future expected cash flows from software license sales, support agreements, consulting contracts, other customer contracts, and acquired developed technologies; ● expected costs to develop in-process research and development into commercially viable products and estimated cash flows from the projects when completed; ● the acquired company’s brand and competitive position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; ● cost of capital and discount rates; and ● estimating the useful lives of acquired assets as well as the pattern or manner in which the assets will amortize. The fair value estimates related to the various identified intangible assets were determined under various valuation approaches including the Income Approach, Relief-from-Royalty Method, and Discounted Cash Flow Method. These valuation methods require management to project revenues, operating expenses, working capital investment, capital spending and cash flows for the reporting unit over a multiyear period, as well as determine the weighted average cost of capital to be used as a discount rate. Goodwill and Intangible Assets Amortization of acquired intangible assets is the result of the acquisition of TriGrow, which occurred in 2020, the acquisition of Sinclair which occurred in 2021, and the acquisition of PurePressure, which also occurred in 2021. As a result of these transactions, customer relationships, acquired technology, non-compete agreements and trade name were identified as intangible assets, and are amortized over their estimated useful lives. We recognize the excess of the purchase price over the fair value of identifiable net assets acquired as goodwill. Goodwill is not amortized but is tested for impairment annually on December 2 or more frequently if events or changes in circumstances indicate that the carrying amount of the goodwill may not be recoverable. The Company has determined it is a single reporting unit for the purpose of conducting the goodwill impairment assessment. A goodwill impairment charge is recorded if the amount by which the Company’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Factors that could lead to a future impairment include material uncertainties such as a significant reduction in projected revenues, a deterioration of projected financial performance, future acquisitions and/or mergers, and a decline in the Company’s market value as a result of a significant decline in the Company’s stock price. There have been no impairment charges recorded for fiscal 2020 and fiscal 2021. 41 Income Taxes We account for income taxes pursuant to the provisions of ASC Topic 740, “Income Taxes,” which requires, among other things, an asset and liability approach to calculating deferred income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. A valuation allowance is provided to offset any net deferred tax assets for which management believes it is more likely than not that the net deferred asset will not be realized. We follow the provisions of ASC 740-10-25-5, “Basic Recognition Threshold.” When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. In accordance with the guidance of ASC 740-10-25-6, the benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above should be reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. We believe our tax positions are all highly certain of being upheld upon examination. As such, we have not recorded a liability for unrecognized tax benefits. We recognize the benefit of a tax position when it is effectively settled. ASC 740-10-25-10, “Basic Recognition Threshold” provides guidance on how an entity should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. ASC 740-10-25-10 clarifies that a tax position can be effectively settled upon the completion of an examination by a taxing authority. For tax positions considered effectively settled, we recognize the full amount of the tax benefit. Accounting for Stock-Based Compensation We follow the provisions of ASC Topic 718, “Compensation — Stock Compensation.” ASC Topic 718 establishes standards surrounding the accounting for transactions in which an entity exchanges its equity instruments for goods or services. ASC Topic 718 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions, such as options issued under our Stock Option Plans. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. This model incorporates certain assumptions for inputs including a risk-free market interest rate, expected dividend yield of the underlying common stock, expected option life and expected volatility in the market value of the underlying common stock. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our stock options and warrants have characteristics different from those of our traded stock, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of such stock options. The risk-free interest rate is based upon quoted market yields for United States Treasury debt securities with a term similar to the expected term. The expected dividend yield is based upon our history of having never issued a dividend and management’s current expectation of future action surrounding dividends. We calculate the expected volatility of the stock price based on the corresponding volatility of our peer group stock price for a period consistent with the underlying instrument’s expected term. The expected lives for such grants were based on the simplified method for employees and directors. In arriving at stock-based compensation expense, we estimate the number of stock-based awards that will be forfeited due to employee turnover. Our forfeiture assumption is based primarily on its turn-over historical experience. If the actual forfeiture rate is higher than the estimated forfeiture rate, then an adjustment will be made to increase the estimated forfeiture rate, which will result in a decrease to the expense recognized in our financial statements. If the actual forfeiture rate is lower than the estimated forfeiture rate, then an adjustment will be made to lower the estimated forfeiture rate, which will result in an increase to expense recognized in our financial statements. The expense we recognize in future periods will be affected by changes in the estimated forfeiture rate and may differ significantly from amounts recognized in the current period. It is important that the discussion of our operating results that follows be read in conjunction with the critical accounting policies disclosed above. 42 Results of Operations Comparison of Years Ended December 31, 2021 and 2020 The following table summarizes our results of operations for the years ended December 31, 2021 and 2020: Years ended December 31, (Dollar amounts, excluding share and per share amounts, in thousands) 2021 2020 Revenue, net $ 59,859 $ 12,087 Cost of goods sold 54,625 11,517 Gross profit 5,234 570 Selling, general and administrative 34,970 9,832 Research and development 3,925 3,354 Change in contingent consideration 1,412 — Total operating expenses 40,307 13,186 Loss from operations (35,073 ) (12,616 ) Interest income (expense), net 74 (481 ) Other expenses (31 ) — Gain (loss) on extinguishment of notes payable 2,685 (5,618 ) Gain on forgiveness of PPP loan 45 — Change in fair value of derivative liabilities — (2,924 ) Other income (expense), net 2,773 (9,023 ) Net loss before income taxes (32,300 ) (21,639 ) Income tax provision 25 — Net loss (32,325 ) (21,639 ) Income (loss) attributable to non-controlling interest 140 (22 ) Net loss attributable to Agrify Corporation $ (32,465 ) $ (21,617 ) Net loss per share attributable to common stockholders – basic and diluted $ (1.69 ) $ (5.32 ) Weighted average common shares outstanding – basic and diluted 19,090,932 4,175,867 Revenues Our goal is to provide our customers with a variety of products to address their entire indoor agriculture needs. Our core product offering includes our Agrify Vertical Farming Units (or “VFUs”) and Agrify Integrated Grow Racks with our Agrify Insights software, which in 2020 and 2021 are supplemented with environmental control products, grow lights, facility build-out services and extraction equipment. We continue to monitor and address the COVID-19 pandemic impacts on our supply chain. Although the availability of various products is dependent on our suppliers, their locations, and the extent to which they are impacted by the COVID-19 pandemic, we are proactively working with manufacturers to meet the needs of our customers during the pandemic. Product shortages have generally led to fluctuations in prices globally, with corresponding impacts to sales and interim profits. We generate revenue from sales of cultivation solutions, including ancillary products and services, Agrify Insights software, facility build-outs and extraction equipment and solutions. We believe that our product mix form an integrated ecosystem which allows us to be engaged with our potential customers from early stages of the grow cycle — first during the facility build-out, to the choice of cultivation solutions, running the grow business with our Agrify Insights software and finally, our extraction, post -processing and testing services to transform harvest into a sellable product. We believe that delivery of each solution in the various stages in the process will generate sales of additional solutions and services. 43 The following table provides a breakdown of our revenue for the years ended December 31, 2021 and 2020: Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Cultivation solutions, including ancillary products and services $ 11,354 $ 4,883 $ 6,471 133 % Agrify Insights software 8 24 (16 ) (67 )% Facility build-outs 36,193 7,180 29,013 404 % Extraction solutions 12,304 — 12,304 100 % $ 59,859 $ 12,087 $ 47,772 395 % Revenues for the year ended December 31, 2021 and 2020 were $59.9 million and $12.1 million, respectively, representing a year over year increase of $47.8 million. The comparative increase in revenue was generated primarily from facility build-outs, driven in large part by the current year introduction of our TTK Solution, an increase in stand-alone VFU equipment sales and incremental revenue contribution associated with extraction-based equipment sales, resulting from our October 1, 2021 acquisition of Precision and Cascade. The Precision-Cascade Acquisition accounted for $12.3 million of our revenue increase in 2021. Cost of Goods Sold Cost of goods sold represents a combination of the following: construction-related costs associated with our facility buildouts, internal and outsourced labor and material costs associated with the assembly of both cultivation equipment (primarily VFUs) and extraction equipment, as well as labor and parts costs associated with the sale or provision of other products and services. The following table provides a breakdown of our cost of goods sold for the years ended December 31, 2021 and 2020: Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Cultivation solutions, including ancillary products and services $ 10,855 $ 4,562 $ 6,293 138 % Agrify Insights software — — — — % Facility build-outs 35,012 6,955 28,057 403 % Extraction solutions 8,758 — 8,758 100 % $ 54,625 $ 11,517 $ 43,108 374 % The year over year increase in cost of goods sold is primarily associated with an increase in subcontractor construction costs related to our facility buildouts in 2021, including construction costs associated with design and build projects under our TTK Solutions. Additionally, an increase in equipment revenue in 2021, largely attributable to the fourth quarter of 2021 addition of extraction equipment (which was associated with the Precision and Cascade acquisition) served to increase the amount of internal and outsourced labor and materials costs recognized by the Company in 2021. Gross Profit Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Gross profit $ 5,234 $ 570 $ 4,664 818 % Gross profit totaled $5.2 million, or 8.7% of total revenue during the year ended December 31, 2021 compared to gross profit of $570 thousand, or 4.7% of total revenue during the year ended December 31, 2020. The comparative $4.7 million year over year improvement in gross profit, as well as the comparative improvement in gross profit margin, are primarily attributable to two specific fourth quarter of 2021 items. First, the Company completed a sale of older VFU equipment models to a customer, which resulted in a gross margin well above the Company's historical gross margin performance range as it relates to stand-alone VFU equipment sales. Second, was the positive lift in gross profit (and gross profit margin) associated with our extraction equipment revenue, which is expected to generate gross margin of approximately 30%, which is also well above the company's historical gross margin performance. On a forward-looking basis, with the full year benefit of anticipated margin contribution associated with the extraction-related revenue contributions, the Company anticipates that gross margin performance, aided by our extraction-related equipment sales, will be in a mid-teens range. We anticipate that we will be able to improve upon that expected gross profit margin performance once we are able to generate meaningful software and production fee revenues from our TTK Solutions, which we currently expect to begin in the late third or early fourth quarter of 2022. 44 Selling, General and Administrative Year ended December 31, (Dollar amounts in thousands ) 2021 2020 Change % Change Selling, general and administrative $ 34,970 $ 9,832 $ 25,138 256 % Selling, general and administrative expenses (“SG&A Expenses”) consist principally of salaries and related costs for personnel, including stock-based compensation and travel expenses, associated with selling, marketing, executive and other administrative functions. Other general and administrative expenses include, but are not limited to, professional fees for legal, consulting, depreciation and amortization and accounting services, as well as facility related costs. SG&A Expenses increased by $25.1 million, or 256%, for the year ended December 31, 2021, compared to the same period in 2020. The increase is attributable mainly to payroll and related expenses increases of $4.1 million, an increase in stock-based compensation of $3.6 million, an increase in investor relations and directors’ and officers’ insurance of $3.1 million, an increase in legal, accounting and other operating expenses of $2.3 million, an increase in account receivable reserve for bad debt of $1.2 million, an increase in depreciation and amortization of $903 thousand, which primarily reflects an increase in amortization associated with the identified intangible assets in the acquisition of Precision and Cascade. Additionally, the increase in SG&A Expense also includes a one-time investment banker termination fee of $2.4 million, direct acquisition costs of $4.6 million and approximately $2.8 million related to incremental SG&A Expense associated with our fourth quarter 2021 acquisition of Precision and Cascade, which amount excludes one-time expenses related to direct acquisition costs, depreciation and amortization. Research and Development Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Research and development $ 3,925 $ 3,354 $ 571 17 % Research and development expenses consisted primarily of costs incurred for the development of our Agrify Insights software and next generation VFUs, which includes: ● employee-related expenses, including salaries, benefits, and travel; ● expenses incurred by subcontractor under agreements to provide engineering work related to the development of our next generation VFUs; ● expenses related to our facilities, depreciation, and other expenses, which include direct and allocated expenses for rent and maintenance of facilities, insurance and other supplies. Research and development expense increased by $571 thousand, or 17%, for the year ended December 31, 2021 compared to the same period in 2020. The increase was due primarily attributable to payroll and other employee-related expenses of approximately $1.6 million and an increase in materials and other items of $74 thousand. These increases are partially offset by a decrease in consulting services of $1.1 million. We expect to continue to invest in future developments of our VFUs, Agrify Insights software and our extraction products. As a percentage of net revenue, research and development expenses were 6.6% of total revenue for the year ended December 31, 2021, compared to 27.7% for the year ended December 31, 2020. Although we continue to increase our investment in research and development activities, we expect the expense to decrease as a percentage of revenue due to our revenue growth. Change in contingent consideration Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Change in contingent consideration $ 1,412 $ — $ 1,412 100 % Change in contingent consideration increased by $1.4 million, or 100%, for the year ended December 31, 2021 compared to the same period in 2020. The change in contingent consideration expense, which was recognized by the Company during the fourth quarter of 2021, relates to a change in our originally estimated fair value of contingent consideration to be earned by the former members of Precision and Cascade. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805 (ASC 805), “Business Combinations” requires the Company to determine an initial estimate as to the amount of potential contingent consideration to be earned as part of an acquisition as of the date of the acquisition. In connection with our Acquisition of Precision and Cascade, the former members could have earned up to a capped amount of $15.0 million in additional consideration, based upon the achievement of certain revenue-based thresholds, ending December 31, 2021. 45 Based on fourth quarter of 2021 revenue performance, the former members of Precision and Cascade earned additional contingent consideration of approximately $5.4 million. This amount exceeded the Company's initial fair value estimates by approximately $1.4 million. As per the guidelines of ASC 805, the Company is required to record this increase as an operating expense in the period of change and not as an increase to goodwill. As of December 31, 2021, there is no additional contingent consideration that can be earned by the former members of Precision and Cascade. Similarly, the Company's December 31, 2021, acquisition of PurePressure contains two consecutive twelve-month earnouts. The potential additional contingent consideration that can be earned under each of the two earnout periods is capped at $1.5 million per period. The Company has made an initial estimate with respect to the probability of achievement of the additional contingent consideration and recorded it as part of our initial purchase price accounting. We will continue to evaluate PurePressure's future performance against our initial assumptions and projections on a quarterly basis. Any identified changes to our original assumptions that result in a change in our overall expected earnout achievements will result in either an increase or reduction in our future periodic operating expenses. Other Income (Expense), Net Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Interest income (expense), net $ 74 $ (481 ) $ 555 115 % Other expenses (31 ) — (31 ) (100 )% Gain (loss) on extinguishment of notes payable 2,685 (5,618 ) 8,303 148 % Gain on forgiveness of PPP loan 45 — 45 100 % Change in fair value of derivative liabilities — (2,924 ) 2,924 100 % $ 2,773 $ (9,023 ) $ 11,796 131 % Interest income (expense), net increased by $555 thousand, or 115%, for the year ended December 31, 2021 compared to the same period in 2020. The increase was due to the amortization of debt discount related to the issuance of convertible promissory notes of $419 thousand for the year ended December 31, 2020, while no amortization of debt discount occurred for the year ended December 31, 2021. Other expenses decreased by $31 thousand, or 100%, for the year ended December 31, 2021 compared to the same period in 2020. Gain (loss) on extinguishment of notes payable increased by $8.3 million, or 148%, for the year ended December 31, 2021 compared to the same period in 2020. See Note 15 - Convertible Promissory Notes included elsewhere in the notes to the consolidated financial statements. Gain on forgiveness of PPP loan increased by $45 thousand, or 100%, for the year ended December 31, 2021 compared to the same period in 2020. In September 2021, the loan for $44 thousand was 100% forgiven by the SBA. As a result, we recorded a gain of $45 thousand on the forgiveness on the loan and the associated accrued interest. Change in fair value of derivative liabilities increased by $2.9 million, or 100%, for the year ended December 31, 2021 compared to the same period in 2020. The fair value of the variable-share settlement features was computed to be $7.1 million, which resulted with a loss of $2.9 million for the year ended December 31, 2020. For the year ended December 31, 2021, no derivatives were outstanding. Income Tax Provision Year ended December 31, (Dollar amounts in thousands) 2021 2020 Change % Change Income tax provision $ 25 $ — $ 25 100 % We recorded an income tax provision of $25 thousand in the year ended December 31, 2021 compared to no provision or benefit for income taxes in the year ago period. The Company has historically generated losses from operations and is currently in a cumulative loss position. Accordingly, the Company has established a full valuation allowance against the carrying value of its deferred tax assets. 46 Income (Loss) Attributable to Non-Controlling Interest We consolidate the results of operations of two less than wholly owned entities into our consolidated results of operations. On December 8, 2019, we formed Agrify Valiant LLC, a joint-venture limited liability company in which we are 60% majority owner and Valiant-America, LLC owns 40%. Agrify Valiant LLC started its operations during the second quarter of 2020. On January 22, 2020, as part of the acquisition of TriGrow, we received TriGrow’s 75% interest in Agrify Brands, LLC (formerly TriGrow Brands, LLC), a licensor of an established portfolio of consumer brands that utilize our grow technology. The license of these brands is ancillary to the sale of our VFUs and provides a means to differentiate customers’ products in the marketplace. It is not a material aspect of our business and we have not realized any royalty income. Accordingly, we are currently evaluating whether to continue this legacy business from an operational standpoint, as well as from a legal and regulatory perspective. Loss attributable to non-controlling interest represents the portion of profit (or loss) that are attributable to non-controlling interest calculated as a product of the net income of the entity multiplied by the percentage of ownership held by the non-controlling interest. Liquidity and Capital Resources As of December 31, 2021, our principal sources of liquidity were cash and cash equivalents and marketable securities totaling $56.5 million. We believe such amount, together with the proceeds from the Private Placement that closed on January 28, 2022 and the senior secured debt facility that closed on March 14, 2022, will be sufficient to support our planned operations for at least the next 12 months. Our current working capital needs are to support accounts receivable growth, to fund construction and equipment financing commitments associated with our TTK Solutions, manage inventory to meet demand forecasts and support operational growth. Our long-term financial needs primarily include working capital requirements and capital expenditures. We anticipate that we will allocate a significant portion of our current balance of working capital to satisfy the financing requirements of our current and future TTK arrangements. These arrangements require a significant amount of upfront capital necessary to fund construction, associated with facility build outs, and equipment. There are many factors that may negatively impact our available sources of funds in the future, including the ability to generate cash from operations, raise debt capital and raise cash from the issuance of our securities. The amount of cash generated from operations is dependent upon factors such as the successful execution of our business strategy and general economic conditions. We may opportunistically raise debt capital, subject to market and other conditions. Additionally, as part of our growth strategies, we may also raise debt capital for strategic alternatives and general corporate purposes. If additional financing is required from outside sources, we may not be able to raise such capital on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected. Indebtedness We entered into two Loan Agreements and Promissory Notes (collectively the “PPP Loan”) with Bank of America pursuant to the Paycheck Protection Program (the “PPP”) under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. We received total proceeds of approximately $823 thousand from the unsecured PPP Loans which are scheduled to mature during 2022 and 2025. Subject to certain conditions, the PPP Loan may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. In September 2021, the loan for $44 thousand was 100% forgiven by the SBA. As a result, we recorded a gain of $45 thousand on the forgiveness on the loan and the associated accrued interest. If the remaining principal amount is not forgiven in full, we would be obligated to repay any principal amount not forgiven and interest accrued thereon. On March 14, 2022, we entered into a Securities Purchase Agreement with an institutional investor. The Purchase Agreement provides for of the issuance of a senior secured note (the “Note”) in the aggregate amount of $65 million and a warrant exercisable 6,881,108 shares of the Company’s common stock, with the potential for two potential subsequent closings for notes with an original principal amount of $35 million each. The initial closing pursuant to this debt facility occurred on March 14, 2022. The Note is a senior secured obligation and ranks senior to all other indebtedness. We will be required to make amortization payments equal to 4.0% of the original principal amount of the Note on the first day of each calendar month starting on February 1, 2023 and extending through the maturity date of March 1, 2026 (the “Maturity Date”), at which time all remaining outstanding principal and accrued but unpaid interest will be due. The Note will have a stated interest rate of 6.75% per annum, and we will be required to pay interest on March 1, June 1, September 1 and December 1 of each calendar year through and including the Maturity Date. Following the one-year anniversary of the Note’s issuance, we may, in lieu of paying interest in cash, pay such interest in kind, in which case interest on the Note will be calculated at the rate of 8.75% per annum and will be added to the principal amount of the Note. At any time following the one-year anniversary of the Note’s issuance, we may prepay all (but not less than all) of the Note by redemption at a price equal to 106.75% of the then-outstanding principal amount under the Note plus accrued but unpaid interest. The noteholder will also have the option of requiring us to redeem the Note if we undergo a fundamental change at a price equal to 107% of the then-outstanding principal amount under the Note plus any accrued interest thereon. 47 Cash Flows The following table presents the major components of net cash flows from and used in operating, investing and financing activities for the years ended December 31, 2021, and 2020: (Dollar amounts in Thousands) December 31, 2021 December 31, 2020 Net cash (used in) provided by: Operating activities $ (30,149 ) $ (14,782 ) Investing activities (104,740 ) (1,228 ) Financing activities 138,792 23,915 Net increase in cash and cash equivalents $ 3,903 $ 7,905 Cash Flow from Operating Activities For the year ended December 31, 2021, we incurred a net loss of $32.5 million, which included non-cash expenses of $1.3 million related to depreciation and amortization, $5.6 million in connection with the issuance and acceleration of stock options, stock-based payment of $176 thousand related to the HMH acquisition, provision of $1.2 million for doubtful accounts, provision of inventory obsolescence of $942 thousand and $1.4 million resulting from the change in fair value of contingent consideration associated with the acquisition of Precision and Cascade. These items were partially offset by a gain attributed to non-controlling interest in the amount of $140 thousand, a gain on forgiveness of PPP loan of $45 thousand and a gain of $2.7 million related to extinguishment of notes payable. Net cash was reduced by a $3.4 million increase in accounts receivable, a $6.6 million increase in prepaid inventory due to demand forecast, a $3.3 million increase in deferred revenue, a $1.7 million increase in prepaid expenses and other receivables, partially offset by an $8.3 million increase in accrued expenses and a $1.1 million increase in accounts payable. For the year ended December 31, 2020, we incurred a net loss of $21.6 million, which includes non-cash expenses of $5.6 million related to extinguishment of notes payable, $2.9 million due to change in fair value of derivative liabilities, $407 thousand related to depreciation and amortization, $1.9 million in connection with the issuance of stock options, non-cash interest expenses of $447 thousand related to the issuance of notes payable, a provision of $54 thousand for doubtful accounts and $120 thousand from the disposal of fixed assets, partially offset by loss attributed to non-controlling interest in the amount of $22 thousand. Net cash was reduced by a $3.7 million increase in accounts receivable, a $2.9 million increase in prepaid inventory due to demand forecast, a $2.2 million decrease in deferred revenue, partially offset by a $4.8 million increase in accrued expenses, a $12 thousand decrease in prepaid expenses, and a $527 thousand decrease in accounts payable. Cash Flow from Investing Activities Net cash used in investing activities primarily relates net purchases of held to maturity marketable securities, cash paid associated with the Company’s 2021 acquisitions, the issuance of loans receivable in connection with the Company’s financing of construction and equipment under its TTK Solutions offering, and for purchases of property and equipment, expenditures and purchase of held to maturity marketable securities. The capital expenditures support growth and investment in property and equipment, to expand research, development, and testing capabilities and, to a lesser extent, the replacement of existing equipment. For the year ended December 31, 2021, net cash used in investing activities was $104.7 million, which included cash outflows of $44.5 million in net purchases of held to maturity marketable securities, $35.9 million paid in connection with our 2021 acquisitions of Precision and Cascade and PurePressure, $22.1 million related to the issuance of TTK-related loans receivable, and $2.2 million of expenditures of property and equipment. For the year ended December 31, 2020, net cash used in investing activities was $1.2 million, which includes $1.1 million paid in connection with the acquisition of TriGrow and $136 thousand of purchases of property and equipment. 48 Cash Flow from Financing Activities For the year ended December 31, 2021, net cash provided by financing activities was $138.8 million. Net cash provided by financing activities was primarily driven by the Company’s February 2021 public offering and a follow-on secondary public offering. The Company received $57.0 million in net proceeds from our initial public offering and $79.8 million in net proceeds from our secondary public offering. Additionally, the Company received $2.1 million in proceeds from the exercise of stock options and warrants. Each of the above inflows of cash were offset by $148 thousand in payments of financing leases. For the year ended December 31, 2020, net cash provided by financing activities was $23.9 million. Sources of cash provided by financing activities were attributable to $13.1 million in proceeds from the issuance of notes payable, $10.0 million in proceeds from the issuance of Series A Preferred Stock, and the receipt of $823 thousand in PPP Loans under the CARES Act. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.