RYTHM, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The information contained in this Quarterly Report on Form 10-Q is intended to update the information contained in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission on March 31, 2022 (the “Form 10-K”) and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other information contained in such Form 10-K. The following discussion and analysis also should be read together with our financial statements and the notes to the financial statements included elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains certain statements that may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements appear in a number of places in this Report, including, without limitation, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements are not guarantees of future performance and involve risks, uncertainties and requirements that are difficult to predict or are beyond our control. Forward-looking statements speak only as of the date of this quarterly report. You should not put undue reliance on any forward-looking statements. We strongly encourage investors to carefully read the factors described in our Annual Report on Form 10-K in the section entitled “Risk Factors” in the Annual Report on Form 10-K for a description of certain risks that could, among other things, cause actual results to differ from these forward-looking statements. We assume no responsibility to update the forward-looking statements contained in this Quarterly Report on Form 10-Q. The following should also be read in conjunction with the unaudited financial statements and notes thereto that appear elsewhere in this report. Except as otherwise indicated herein or as the context otherwise requires, references in this quarterly report to “we,” “us,” “our,” “Company,” and “Agrify” refer to Agrify Corporation, a Nevada corporation. Overview We are one of the most innovative providers of advanced cultivation and extraction solutions for the cannabis industry, bringing data, science, and technology to the forefront of the market. Our proprietary micro-environment-controlled Agrify Vertical Farming Units (or “VFUs”) enable cultivators to produce the highest quality products with what we believe to be an unmatched consistency, yield, and Return on Investment at scale. Our comprehensive extraction product line, which includes hydrocarbon, ethanol, solventless, post-processing, and lab equipment, empowers producers to maximize the quantity and quality of extract required for premium concentrates. We believe we are the only company with an automated and fully integrated grow solution in the industry. Our cultivation and extraction solutions seamlessly combine our integrated hardware and software offerings with a broad range of associated services including consulting, engineering, and construction and are designed to deliver the most complete commercial indoor farming solution available from a single provider. The totality of our product offerings and service capabilities forms an unrivaled ecosystem in what has historically been a highly 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. Our corporate headquarters are located in Billerica, Massachusetts. We also lease properties located within various geographic regions in which we conduct business, including Colorado, Georgia, Massachusetts, and Michigan. 49 Reverse Stock Split On January 12, 2021, we effected a 1-for-1.581804 reverse stock split on our Common Stock. 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. On October 18, 2022, we effected a 1-for-10 reverse stock split on our Common Stock. 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. Recent Business Developments Private Placement On January 25, 2022, we entered into a Securities Purchase Agreement (the “Securities Agreement”) with an institutional investor and other accredited investors for the sale by us of (i) 245,035 shares (the “SA Shares”) of the our Common Stock, (ii) pre-funded warrants (the “Pre-Funded Warrants”) to purchase up to an aggregate of 157,064 shares of Common Stock and (iii) warrants to purchase up to an aggregate of 301,575 shares of Common Stock (the “Common Warrants” and, collectively with the Pre-Funded Warrants, the “SA Warrants”), in a private placement offering. The combined purchase price for one share of Common Stock (or one Pre-Funded Warrant) and the accompanying fraction of a Common Warrant was $68.00 per share. Subject to certain ownership limitations, the SA Warrants are exercisable six months from issuance. Each Pre-Funded Warrant is exercisable into one share of Common Stock at a price per share of $0.001 (as adjusted from time to time in accordance with the terms thereof). Each Common Warrant is exercisable into one share of Common Stock at a price per share of $74.80 (as adjusted from time to time in accordance with the terms thereof) and will expire on the fifth anniversary of the initial exercise date. The institutional investor that received the Pre-Funded Warrants fully exercised such warrants in March 2022. Raymond Chang, our Chairman and Chief Executive Officer, and Stuart Wilcox, who is currently our Chief Operating Officer, and at the time was a member of our Board of Directors, participated in the private placement on essentially the same terms as other investors, except for having a combined purchase price of $69.00 per share. The gross proceeds to us from the private placement were approximately $27.3 million, before deducting the placement agent’s fees and other offering expenses, and excluding the proceeds, if any, from the exercise of the SA Warrants. Acquisition of Lab Society On February 1, 2022, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with LS Holdings Corp. (“Lab Society”), Lab Society NewCo, LLC, a newly-formed wholly-owned subsidiary of us (“Merger Sub”), Michael S. Maibach Jr. as the Owner Representative thereunder, and each of the shareholders of Lab Society (collectively, the “Owners”), pursuant to which we agreed to acquire Lab Society. Concurrently with the execution of the Merger Agreement, we consummated the merger of Lab Society with and into Merger Sub, with Merger Sub surviving such merger as a wholly-owned subsidiary of us (the “Lab Society Acquisition”). The aggregate consideration for the Lab Society Acquisition consisted of: $4.0 million in cash, subject to certain adjustments for working capital, cash and indebtedness of Lab Society at closing; 42,561 shares of Common Stock (the “Buyer Shares”); and the Earn-out Consideration (as defined below), to the extent earned. We withheld 12,768 of the Buyer Shares issuable to the Owners (the “Holdback Lab 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 Merger Agreement. During the third quarter of 2022, 2,785 of the Holdback Lab Buyer Shares were forfeited after the finalization of the net working capital settlement. The remaining 9,983 Holdback Lab Buyer Shares will be released following the twelve-month anniversary of the Closing Date in accordance with and subject to the conditions of the Merger Agreement. Additional information regarding our contingent consideration arrangements may be found in Note 4 – Fair Value Measures, included elsewhere in the notes to the consolidated financial statements. 50 The Merger Agreement includes customary post-closing adjustments, representations and warranties and covenants of the parties. The Owners may become entitled to additional consideration with a value of up to $3.5 million based on the eligible net revenues achieved by the Lab Society business during the fiscal years ending December 31, 2022, and December 31, 2023, of which 50% will be payable in cash and the remaining 50% will be payable by issuing shares of Common Stock. Based upon the combined first and second-quarter actual revenue performance, Lab Society’s revenue trend is significantly below the originally estimated revenue trends incorporated into our original fair value estimates at the time of the acquisition. We have concluded Lab Society will not achieve any contingent earn-out consideration in connection with its first earn-out period. Accordingly, we reversed the current accrued contingent consideration liability associated with Lab Society’s first earn-out period as of September 30, 2022. The reversal of this liability of approximately $1.0 million, as required by ASC Topic 805 Business Combination (“ASC805”), was recorded as a reduction in operating expenses during the second quarter of 2022. 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. During the three-month period ended June 30, 2022, we identified an impairment-triggering event associated with both a sustained decline in our stock price and associated market capitalization, as well as a second-quarter slowdown in the cannabis industry as a whole. Due to these factors, we deemed that there was an impairment to the carrying value of its long-lived assets and accordingly performed interim testing as of June 30, 2022. Based on its interim testing, we noted that the entire carrying value of its goodwill and intangible assets should be impaired. Additional information regarding our interim testing on goodwill and intangible assets may be found in Note 7 – Goodwill and Intangible Assets, Net, included elsewhere in the notes to the consolidated financial statements. Securities Purchase Agreement On March 14, 2022, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with an accredited investor (the “Investor”), we agreed to issue and sell to the Investor, in a private placement transaction, in exchange for the payment by the Investor of $65 million, less applicable expenses as set forth in the Securities Purchase Agreement, a senior secured promissory note in an aggregate principal amount of $65 million (the “SPA Note”), and a warrant (the “SPA Warrant”) to purchase up to an aggregate of 688,111 shares of Common Stock. Securities Exchange Agreement On August 18, 2022, we reached an agreement with its Investor to amend its existing SPA Note and entered into a Securities Exchange Agreement (the “Exchange Agreement”). Pursuant to the Exchange Agreement, we partially paid $35.2 million under the SPA Note and exchanged the remaining balance of the SPA Note for a new senior secured note (the “Exchange Note”) with an aggregate original principal amount of $35.0 million and a new warrant to purchase 1,422,764 shares of Common Stock (the “Note Exchange Warrant”). Additionally, we exchanged the SPA Warrant for a new warrant for the same number of underlying shares but with a reduced exercise price (the “Modified Warrant” and, collectively with the Note Exchange Warrant, the “Warrant Liabilities”). Additional information regarding our Warrant Liabilities may be found in Note 1 – Overview, Basis of Presentation and Significant Accounting Policies and Note 4 – Fair Value Measures, included elsewhere in the notes to the condensed consolidated financial statements. 51 The Exchange Note is a senior secured obligation of us and ranks senior to all indebtedness of us. The Exchange Note will mature on the three-year anniversary of its issuance (the “Maturity Date”) and contains a 9.0% annualized interest rate, with interest to be paid monthly, in cash, beginning September 1, 2022. The principal amount of the Exchange Note will be payable on the Maturity Date, provided that the Investor will be entitled to a cash sweep of 20% of the proceeds received by us in connection with any equity financing, which will reduce the outstanding principal amount under the Exchange Note. At any time, we may prepay all of the Exchange Note by redemption at a price equal to 102.5% of the then-outstanding principal amount under the Note plus accrued but unpaid interest. The Investor will also have the option of requiring us to redeem the Exchange Note on the one-year or two-year anniversaries of issuance at a price equal to the then-outstanding principal amount under the Exchange Note plus accrued but unpaid interest, or if we undergo a fundamental change at a price equal to 102.5% of the then-outstanding principal amount under the Exchange Note plus accrued but unpaid interest. The Exchange Note imposes certain customary affirmative and negative covenants upon us, as well as covenants that restrict us and our subsidiaries from incurring any additional indebtedness or suffering any liens, subject to specified exceptions, restrict the ability of us and our subsidiaries from making certain investments, subject to specified exceptions, restrict the declaration of any dividends or other distributions, subject to specified exceptions, requires us not to exceed maximum levels of allowable cash spend while the Exchange Note is outstanding, and requires us to maintain minimum amounts of cash on hand. If an event of default under the Exchange Note occurs, the Investor can elect to redeem the Exchange Note for cash equal to 115% of the then-outstanding principal amount of the Note (or such lesser principal amount accelerated by the Investor), plus accrued and unpaid interest, including default interest, which accrues at a rate per year equal to 15% from the date of a default or event of default. As of September 30, 2022, we are in compliance with the financial debt covenants associated with our Exchange Note. Until the date the Exchange Note is fully repaid, the Investor has, subject to certain exceptions, the right to participate for up to 30% of any offering of debt, equity (other than an offering of solely Common Stock), or equity-linked securities, including without limitation any debt, preferred stock or other instrument or security, of us or our subsidiaries. The Modified Warrant has an exercise price of $21.50 per share, subject to adjustment for stock splits, reverse stock splits, stock dividends and similar transactions, will be exercisable on and after the six-month anniversary of issuance, has a term of five and one-half years from the date of issuance and will be exercisable on a cash basis, unless there is not an effective registration statement covering the resale of the shares issuable upon exercise of the Modified Warrant (the “Modified Warrant Shares”), in which case the Modified Warrant will also be exercisable on a cashless exercise basis at the Investor’s election. The Note Exchange Warrant has an exercise price of $12.30 per share, subject to adjustment for stock splits, reverse stock splits, stock dividends and similar transactions, was exercisable upon issuance, and has a term of five and one-half years from the date of issuance and is exercisable on a cash basis, unless there is not an effective registration statement covering the resale of the shares issuable upon exercise of the Warrant (the “Note Exchange Warrant Shares” and, together with the Modified Warrant Shares, the “Exchange Warrant Shares”), in which case the Note Exchange Warrant will also be exercisable on a cashless exercise basis at the Investor’s election. Until we complete a qualified equity financing of at least $15.0 million, which requirement was satisfied with sales under the ATM Program, the Note Exchange Warrant’s exercise price would have been reduced to the extent we issue securities for a lower purchase price. The Note Exchange Warrant also prohibited us, until following the completion of such qualified equity financing, from issuing warrants with more favorable or preferential terms and/or provisions. The Warrant Liabilities will each provide that in no event will the number of shares of Common Stock issued upon exercise of such warrant result in the Investor’s beneficial ownership exceeding 4.99% of our shares of Common Stock outstanding at the time of exercise (which percentage may be decreased or increased by the Investor, but to no greater than 9.99%, and provided that any increase above 4.99% will not be effective until the sixty-first day after notice of such request by the Investor to increase its beneficial ownership limit has been delivered to us). Additionally, the Warrant Liabilities could not be exercised for more than an aggregate of 530,858 shares of Common Stock unless and until shareholder approval is obtained, which approval was obtained on October 14, 2022. 52 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. Nasdaq Deficiency Notice On October 4, 2022, we received a deficiency letter (the “Notice”) from the Listing Qualifications Department (the “Staff”) of The Nasdaq Stock Market, LLC (“Nasdaq”) notifying us that, for the last 30 consecutive business days, the bid price for our Common Stock had closed below $1.00 per share, which is the minimum closing price required to maintain continued listing on The Nasdaq Capital Market under Nasdaq Listing Rule 5550(a)(2) (the “Minimum Bid Requirement”). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we had 180 calendar days to regain compliance with the Minimum Bid Requirement. To regain compliance with the Minimum Bid Requirement, the closing bid price of our Common Stock must be at least $1.00 per share for a minimum of 10 consecutive trading days during this 180-day compliance period, unless the Staff exercises its discretion to extend the minimum trading day period pursuant to Nasdaq Listing Rule 5810(c)(3)(G). On October 28, 2022, the Staff notified us that the closing bid price of our Common Stock was more than $1.00 for 10 consecutive trading days, and that we therefore regained compliance with the Minimum Bid Requirement. 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 the 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 (“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) providing services and (3) construction contracts. 53 In accordance with ASC 606 “Revenue Recognition”, 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 us 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 by us 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. 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 may 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. 54 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, considering 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 build-out services. This method 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. We determine the SSP for services in time and materials contracts by observable prices in standalone services arrangements. We estimate 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. If a contract has payment terms that differ from the timing of revenue recognition, we will assess whether the transaction price for those contracts includes 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 three and nine months ended September 30, 2022 and 2021, we did not have any such financial income. Payment terms with customers typically require payment 30 days from the 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 fulfill 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. 55 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. 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 Systems, LLC (“TriGrow”), which occurred in 2020, the acquisition of Precision Extraction NewCo, LLC (“Precision”) and Cascade Sciences, LLC (“Cascade”) which occurred in 2021, the acquisition of PurePressure, LLC (“PurePressure”), which also occurred in 2021, and the acquisition of Lab Society, which occurred in 2022. As a result of these transactions, customer relationships, acquired developed technology, non-compete agreements and trade names were identified as intangible assets, and are amortized over their estimated useful lives. 56 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. We have 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 our 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 our market value as a result of a significant decline in our stock price. During the three-month period ended June 30, 2022, we identified an impairment-triggering event associated with both a sustained decline in our stock price and associated market capitalization, as well as a second-quarter slowdown in the cannabis industry as a whole. Due to these factors, we deemed that there was an impairment to the carrying value of its long-lived assets and accordingly performed interim testing as of June 30, 2022. Based on its interim testing, we noted that the entire carrying value of its goodwill and intangible assets should be impaired. Additional information regarding our interim testing on goodwill and intangible assets may be found in Note 7 – Goodwill and Intangible Assets, Net, included elsewhere in the notes to the consolidated financial statements. Capitalization of Internal Software Development Costs We capitalize on certain software engineering efforts related to the continued development of Agrify Insights™ cultivation software under ASC 985-20. Costs incurred during the application development phase are only capitalized once technical feasibility has been established and the work performed will result in new or additional functionality. The types of costs capitalized during the application development phase include employee compensation, as well as consulting fees for third-party software developers working on these projects. Costs related to the research and development are expensed as incurred until technical feasibility is established as well as post-implementation activities. Internal-use software is amortized on a straight-line basis over the estimated useful life of the asset, which ranges from two to five years. 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. 57 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. Results of Operations We have incurred recurring losses to date. Our financial statements have been prepared assuming that we will continue as a going concern and, accordingly, do not include adjustments relating to the recoverability and realization of assets and classification of liabilities that might be necessary should we be unable to continue in operation. We expect we will require additional capital to meet our long-term operating requirements. We expect to raise additional capital through, among other things, the sale of equity or debt securities. Comparison of the Three and Nine Months Ended September 30, 2022 and 2021 The following table summarizes our results of operations for the three and nine months ended September 30, 2022 and September 30, 2021: Three Months Ended September 30, Nine Months Ended September 30, (In thousands, except share and per share data) 2022 2021 2022 2021 Revenue $ 7,019 $ 15,751 $ 52,369 $ 34,584 Cost of goods sold 11,135 16,131 50,703 34,977 Gross (loss) profit (4,116 ) (380 ) 1,666 (393 ) General and administrative 24,126 7,705 53,263 16,562 Selling and marketing 2,160 890 6,582 2,288 Research and development 1,747 827 6,269 2,483 Change in contingent consideration (602 ) — (1,509 ) — Impairment of goodwill and intangible assets — — 69,904 — Total operating expenses 27,431 9,422 134,509 21,333 Loss from operations (31,547 ) (9,802 ) (132,843 ) (21,726 ) Interest (expense) income, net (3,979 ) 45 (5,224 ) 68 Other income (expense) 1,506 (15 ) 1,506 (78 ) Change in fair value of warrant liability 5,686 — 5,686 — (Loss) gain on extinguishment of notes payable (17,933 ) — (17,933 ) 2,685 Other (expense) income, net (14,720 ) 30 (15,965 ) 2,675 Net loss before income taxes (46,267 ) (9,772 ) (148,808 ) (19,051 ) Income tax benefit — — (262 ) — Net loss (46,267 ) (9,772 ) (148,546 ) (19,051 ) Income (loss) attributable to non-controlling interests 1 (14 ) 5 153 Net loss attributable to Agrify Corporation $ (46,268 ) $ (9,758 ) $ (148,551 ) $ (19,204 ) 58 Revenue 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 VFUs and Agrify Integrated Grow Racks with our Agrify Insights™ cultivation software, which 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 increases in prices globally, with significant impacts to sales and interim profits. We generate revenue from sales of cultivation solutions, including ancillary products and services, Agrify Insights™ cultivation software, facility build-outs and extraction equipment and solutions. We believe that our product mix forms an integrated ecosystem that allows us to be engaged with our potential customers from the 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™ cultivation software and finally, our extraction, post-processing and testing services to transform harvest into a sellable product. We believe that the delivery of each solution in the various stages of the process will generate sales of additional solutions and services. The following table provides a breakdown of our revenue for the three and nine months ended September 30, 2022 and 2021: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change Cultivation solutions, including ancillary products and services $ 4 $ 2,756 $ (2,752 ) (100 )% $ 707 $ 4,110 $ (3,403 ) (83 )% Agrify Insights™ cultivation software 1 — 1 100 % 46 8 38 475 % Facility build-outs 1,334 12,995 (11,661 ) (90 )% 23,551 30,466 (6,915 ) (23 )% Extraction solutions 5,680 — 5,680 100 % 28,065 — 28,065 100 % Total revenue $ 7,019 $ 15,751 $ (8,732 ) (55 )% $ 52,369 $ 34,584 $ 17,785 51 % Revenues decreased by $8.7 million, or 55.4% for the three months ended September 30, 2022, as compared to the same period in 2021. The comparative decrease in revenue was primarily related to a reduction in facility build-outs of $11.7 million and a reduction in our cultivation solution sales of $2.8 million, partially offset by the sale of extraction solutions equipment and services from our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021, which contributed $5.7 million in revenue for the three months ended September 30, 2022. The $11.7 million decrease in facility build-out revenue was the result of the completed build-out of two facilities under our TTK Solutions, the deferral of $5.3 million of revenue for the Bud & Mary’s Cultivation, Inc. (“Bud & Mary’s”) project due to pending litigation and a decrease in cultivation products and service sales of $2.8 million primarily due to migrating to a VFU leasing model. Additional information regarding Bud & Mary’s pending litigation may be found in Note 5 – Loan Receivable and Note 19 – Subsequent Events, included elsewhere in the notes to the consolidated financial statements. Revenues increased by $17.8 million, or 51.4% for the nine months ended September 30, 2022, as compared to the same period in 2021. The comparative increase in revenue was generated primarily from extraction solutions sales of equipment and services from our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021, which contributed $28.1 million in revenue for the nine months ended September 30, 2022. This was partially offset by a reduction of $6.9 million in facility build-out revenue resulting from the completed build-out of two facilities under our TTK Solutions which includes the deferral of $5.3 million of revenue resulting from Bud & Mary’s pending litigation and a decrease in cultivation products and service sales of $3.4 million primarily due to migrating to a VFU leasing model. Cost of Goods Sold Cost of goods sold represents a combination of the following: construction-related costs associated with our facility build-outs, 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. 59 The following table provides a breakdown of our cost of goods sold for the three and nine months ended September 30, 2022 and 2021: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change Cultivation solutions, including ancillary products and services $ 572 $ 3,570 $ (2,998 ) (84 )% $ 2,312 $ 5,456 $ (3,144 ) (58 )% Agrify Insights™ cultivation software — — — — % — — — — % Facility build-outs 6,429 12,561 (6,132 ) (49 )% 28,217 29,521 (1,304 ) (4 )% Extraction solutions 4,134 — 4,134 100 % 20,174 — 20,174 100 % Total cost of goods sold $ 11,135 $ 16,131 $ (4,996 ) (31 )% $ 50,703 $ 34,977 $ 15,726 45 % Cost of goods sold decreased by $5.0 million, or 31%, for the three months ended September 30, 2022 as compared to the same period in 2021. The comparative quarterly decrease in the cost of goods sold is related to a decrease of $6.1 million related to costs for facility build-outs and a decrease of $3.0 million of costs for cultivation product and service sales. This was partially offset by an increase of $4.1 million in expenses associated with the sales of our extraction-related equipment, for which there was no associated revenue or expense in the prior year quarterly period. The cost of goods sold related to facility build-outs decreased disproportionately as compared to revenue in the period as we have included $5.1 million of facility build-out expenses related to the Bud & Mary’s project for which revenue has been deferred in the period. Cost of goods sold increased by $15.7 million, or 45%, for the nine months ended September 30, 2022 compared to the same period in 2021. The comparative quarterly increase in the cost of goods sold is associated with the introduction of our extraction-related equipment sales in the year-to-date 2022 fiscal period. Costs associated with extraction equipment-related equipment sales accounted for $20.2 million of the comparative year-to-date fiscal 2022 increase in the cost of goods sold. This increase was partially offset by a decrease of $1.3 million in facility build-outs and a decrease of $3.1 million in cultivation product and service sales. The cost of goods sold related to facility build-outs decreased disproportionately as compared to revenue in the period as we have included $5.1 million of facility build-out expenses related to the Bud & Mary’s project for which revenue has been deferred in the period. Gross (Loss) Profit Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change Gross (loss) profit $ (4,116 ) $ (380 ) $ (3,736 ) (983 )% $ 1,666 $ (393 ) $ 2,059 524 % Gross loss totaled $(4.1) million, or (58.6) % of total revenue during the three months ended September 30, 2022 compared to a gross loss of $(380) thousand, or ( 2.4)% of total revenue during the three months ended September 30, 2021. During the three months ended September 30, 2022, we realized a gross profit margin of 27% associated with our extraction solutions revenue. The negative gross margin on the cultivation-related revenue is primarily related to $5.1 million of facility build-out costs recognized for the Bud & Mary’s project for which $5.3 million of revenue has been deferred due to pending litigation and $568 thousand of overhead expenses for cultivation solutions expenses. This was partially offset by $1.5 million of contribution related to extraction solutions equipment and service sales from our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021. 60 Gross profit totaled $1.7 million, or 3.2 % of total revenue during the nine months ended September 30, 2022 compared to a gross loss of $(393) thousand, or (1.1)% of total revenue during the nine months ended September 30, 2021. The comparative $2.1 million year-over-year improvement in gross profit, as well as the comparative improvement in gross profit margin, is primarily attributable to the introduction of our extraction solutions revenue during the first nine months of 2022. No extraction solutions-related revenues were recognized during the first nine months of 2021. Extraction solutions revenue contributes a higher gross profit and gross profit margins than those realized on our cultivation-related revenue, which includes our TTK Solutions build-out revenue. During the first nine months of 2022, we realized a gross profit margin of 28% associated with our extraction solutions revenue, while we realized a gross loss of approximately (26)% on our cultivation-related revenues. The negative gross margin on the cultivation-related revenue is primarily related to $5.1 million of facility build-out costs recognized for the Bud & Mary’s project for which $5.3 million of revenue has been deferred due to pending litigation. Operating Expenses Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change General and administrative $ 24,126 $ 7,705 $ 16,421 213 % $ 53,263 $ 16,562 $ 36,701 222 % Selling and marketing 2,160 890 1,270 143 % 6,582 2,288 4,294 188 % Research and development 1,747 827 920 111 % 6,269 2,483 3,786 152 % Change in contingent consideration (602 ) — (602 ) (100 )% (1,509 ) — (1,509 ) (100 )% Impairment of goodwill and intangible assets — — — — % 69,904 — 69,904 100 % Total operating expenses $ 27,431 $ 9,422 $ 18,009 191 % $ 134,509 $ 21,333 $ 113,176 531 % General and administrative General and administrative (“G&A”) expenses consist principally of salaries and related costs for personnel, including stock-based compensation and travel expenses, associated with executive and other administrative functions. Other G&A expenses include, but are not limited to, professional fees for legal, consulting, depreciation and amortization and accounting services, as well as facility-related costs. G&A expense increased by $16.4 million, or 213%, for the three months ended September 30, 2022, compared to the same period in 2021. The primary drivers of the increase in comparative G&A expense in the third quarter of 2022 is largely the result of a $14.7 million increase in loan receivable allowances recorded during the quarter, a $1.4 million increase in payroll and employee-related expenses, a $597 thousand increase in subscription, facilities and other expenses, an increase of $151 thousand of investor related and compliance expenses and an additional $1.9 million of G&A expenses related to our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021. These expenses were partially offset by a decrease of $2.4 million in consulting expenses that were related to a one-time financing arrangement cancellation fee in September 2021. During the third quarter of 2022, we increased our loans receivable reserve by approximately $14.7 million. We deemed it necessary to fully reserve Bud & Mary’s loan receivable balance due to the current litigation and the uncertainty of the customer’s ability to repay the outstanding balance. We believe the litigation is without merit and will continue to vigorously defend ourselves. G&A expense increased by $36.7 million, or 222%, for the nine months ended September 30, 2022, compared to the same period in 2021. The primary drivers of the year-over-year increase in the comparative nine-month period of G&A expenses are largely attributable to an increase in trade and loan receivable allowances of $23.7 million and $8.8 million of incremental G&A expenses related to our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021. Other drivers of the comparative year-over-year increase in G&A expense included $1.3 million related to legal and accounting services associated with our acquisition of Lab Society in 2022 and acquisitions of Precision, Cascade and PurePressure in 2021, $1.8 million in employee-related expenses, $1.1 million of severance expenses, $800 thousand legal settlement and $389 thousand of other operating expenses. 61 During the second and third quarter of 2022, we increased our loan receivable reserve by approximately $7.1 million and $14.7 million, respectively. The $7.1 million increase during the second quarter of 2022, is specifically related to Greenstone Holdings (“Greenstone”). We specifically established the loan reserve related to Greenstone based on our review of Greenstone’s financial stability, which would impact collectability and is primarily the result of unfavorable market conditions within the Colorado market. We will continue to monitor the operations of Greenstone in an effort to collect all outstanding receivables but due to the uncertain nature of Greenstone’s business at this time we have made the decision to place a reserve against the loan receivable amounts. Additional information regarding recent developments with Greenstone may be found in Note 5 – Loan Receivable, included elsewhere in the notes to the consolidated financial statements. The $14.7 million increase during the third quarter of 2022, specifically related to Bud & Mary’s. We deemed it necessary to fully reserve Bud & Mary’s loan receivable balance due to the current litigation and the uncertainty of the customer’s ability to repay the outstanding balance. We believe the litigation is without merit and will continue to vigorously defend ourselves. Selling and marketing Selling and marketing expenses consist primarily of salaries and related costs of personnel, travel expenses, trade shows and advertising expenses. Selling and marketing expenses increased by $1.3 million, or 143%, for the three months ended September 30, 2022, compared to the same period in 2021. The increase is attributable to our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021, which contributed $972 thousand, an increase in payroll and employee-related expenses of $163 thousand and an increase in advertising and trade show expenses of $147 thousand. Selling and marketing expenses increased by $4.3 million, or 188%, for the nine months ended September 30, 2022, compared to the same period in 2021. The increase is primarily related to our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade, and PurePressure in 2021, which attributed $3.2 million, an increase in payroll, severance, and related expenses of $540 thousand and an increase in advertising, trade shows and other expenses of $539 thousand. Research and development Research and development (“R&D”) expense consisted primarily of costs incurred for the development of our Agrify Insights™ cultivation software and next-generation generation VFUs, which includes: ● employee-related expenses, including salaries, benefits, and travel; ● expenses incurred by the 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. R&D expense increased by $920 thousand, or 111%, for the three months ended September 30, 2022, compared to the same period in 2021. The increase is primarily related to an increase in materials and other costs of $565 thousand and our acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade, and PurePressure in 2021, which contributed $470 thousand. These increases were partially offset by a decrease of $116 thousand in payroll and employee-related expenses. As a percentage of net revenue, R&D expenses were 24.9% of total revenue for the three months ended September 30, 2022, compared to 5.3% for the three months ended September 30, 2021. 62 R&D expense increased by $3.8 million, or 152%, for the nine months ended September 30, 2022, compared to the same period in 2021. The comparative periodic increase in R&D expense is attributable to third-party consulting services of $1.4 million, $1.2 million of incremental R&D expense related to the acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021, increases in wages and benefits-related expenses of $684 thousand and an increase in materials, supplies and other expenses of $450 thousand. As a percentage of net revenue, R&D expenses were 12.0% of total revenue for the nine months ended September 30, 2022, compared to 7.1% for the nine months ended September 30, 2021. We expect to continue to invest in future developments of our VFUs, Agrify Insights™ cultivation software and our extraction products. Although we continue to increase our investment in R&D activities, we expect R&D expenses to decrease as a percentage of revenue due to our revenue growth. Change in contingent consideration Change in contingent consideration resulted in a gain of $602 thousand, or 100%, for the three months ended September 30, 2022, compared to the same periods in 2021. The change in contingent consideration, which was recognized by us during the third quarter of 2022, primarily relates to the reduction in the projected earn-out achievement associated with PurePressure’s first twelve-month earn-out period, for which current revenue projections are trending below our original earn-out achievement fair value estimates. During the third quarter of 2022, we reduced the current fair value estimate of contingent consideration to be earned by the former members of PurePressure by approximately $602 thousand. As per the guidelines of ASC805, we are required to record subsequent changes to our original fair value estimates related to contingent consideration as an operating expense in the period of change and not as an increase to goodwill. Change in contingent consideration resulted in a gain of $1.5 million, or 100%, for the nine months ended September 30, 2022, compared to the same periods in 2021. The change in contingent consideration, which was recognized by us during the second and third quarter of 2022, primarily relates to the reduction in the projected earn-out achievement associated with Lab Society’s and PurePressure’s first twelve-month earn-out period, for which current revenue projections are trending below our original earn-out achievement fair value estimates. During the second quarter of 2022, we reduced the current fair value estimate of contingent consideration to be earned by the former members of Lab Society by approximately $1.0 million. During the third quarter of 2022, we reduced the current fair value estimate of contingent consideration to be earned by the former members of PurePressure by approximately $602 thousand. This was partially offset by an increase of $121 thousand to the final contingent consideration amount earned by the former members of Precision and Cascade. As per the guidelines of ASC805, we are required to record subsequent changes to our original fair value estimates related to contingent consideration as an operating expense in the period of change and not as an increase to goodwill. Impairment of goodwill and intangible assets During the three months period ended June 30, 2022, we identified an impairment-triggering event associated with both a sustained decline in our stock price and associated market capitalization, as well as a second-quarter slowdown in the cannabis industry as a whole. Due to these factors, we deemed that there was an impairment to the carrying value of its long-lived assets and accordingly performed interim testing as of June 30, 2022. Based on its interim testing, we noted that the current carrying value of equity significantly exceeded the calculated fair value equity, by an amount greater than the aggregate value of our goodwill and intangible assets. Accordingly, we concluded that the entire carrying value of its goodwill and intangible assets should be impaired, resulting in a second-quarter impairment charge of $69.9 million. Additional information regarding our interim testing on goodwill may be found in Note 7 – Goodwill and Intangible Assets, Net, included elsewhere in the notes to the consolidated financial statements. 63 Other Income (Expense), Net Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change Interest (expense) income, net $ (3,979 ) $ 45 $ (4,024 ) (8,943 )% $ (5,224 ) $ 68 $ (5,292 ) (7,782 )% Other income (expense) 1,506 (15 ) 1,521 10,140 % 1,506 (78 ) 1,584 2,031 % Change in fair value of warrant liability 5,686 — 5,686 100 % 5,686 — 5,686 100 % (Loss) gain on extinguishment of notes payable (17,933 ) — (17,933 ) (100 )% (17,933 ) 2,685 (20,618 ) (768 )% Total other (expense) income, net $ (14,720 ) $ 30 $ (14,750 ) (49,165 )% $ (15,964 ) $ 2,675 $ (18,639 ) (697 )% Interest (expense) income, net Interest expense increased by $4.0 million, or 8,943%, for the three months ended September 30, 2022 compared to the same period in 2021. The increase in interest expense primarily is attributable to an increase in interest expense, including the amortization of debt discount costs associated with the outstanding principal balance of our existing debt facility, plus incremental pre-payment penalty interest incurred in connection with the modification of our debt facility, of $4.1 million related to our SPA Note and Exchange Note. This was partially offset by interest income of approximately $100 thousand from our TTK Solutions. Interest expense increased by $5.3 million, or 7,782%, for the nine months ended September 30, 2022 compared to the same period in 2021. The increase in interest expense primarily is attributable to an increase in interest expense, including the amortization of debt discount costs associated with the outstanding principal balance of our existing debt facility, plus incremental pre-payment penalty interest incurred in connection with the modification of our debt facility, of $6.9 million related to our SPA Note and Exchange Note. This was partially offset by interest income of approximately $1.2 million from our TTK Solutions. Other income (expense) Other income increased by $1.5 million, or 10,140%, for the three months ended September 30, 2022 compared to the same period in 2021. The increase in other income primarily is attributable to the finalization and favorable true-up of previously estimated acquisition-related net working capital amounts related to the acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021 of $1.5 million. This partially was offset by other expense-related items. Other expenses increased by $1.6 million, or 2,031%, for the nine months ended September 30, 2022 compared to the same period in 2021. The increase in other income primarily is attributable to the finalization and favorable true-up of previously estimated acquisition-related net working capital amounts related to the acquisition of Lab Society in 2022 and the acquisitions of Precision, Cascade and PurePressure in 2021 of $1.5 million. This partially was offset by other expense-related related items. Change in fair value of warrant liability Change in fair value of warrant liability increased by $5.7 million, or 100% for the three and nine months ended September 30, 2022, compared to $0 for the three and nine months ended September 30, 2021. During the three months period ended September 30, 2022, we recorded a non-cash gain of $5.7 million related to changes in the valuation of our liability-classified warrants issued through a private placement associated with Warrant Liabilities , which was primarily driven by movements in our stock price. Additional information regarding the fair value of our liability-classified warrants issued through a private placement using a Black - Scholes option- pricing model that makes certain assumptions may be found in Note 4 – Fair Value Measures, included elsewhere in the notes to the consolidated financial statements. 64 (Loss) gain on extinguishment of notes payable Loss on extinguishment of notes payable increased by $17.9 million, or 100%, for the three months ended September 30, 2022 compared to the same period in 2021. The loss on extinguishment of notes payable, which was recognized by us during the third quarter of 2022, relates to the extinguishment of the SPA Note dated March 14, 2022. We recognized a loss on extinguishment of $17.9 million (inclusive of $12.4 million of unamortized warrants, $3.0 million default penalty on the principal amount, $2.3 million of unamortized issuance costs and $1.2 million of the incremental fair value of warrants modified in exchange of debt). Additional information relating to our SPA Note may be found in Note 9 – Debt, included elsewhere in the notes to the consolidated financial statements. Loss on extinguishment of notes payable increased by $20.7 million, or 768%, for the nine months ended September 30, 2022 compared to the same period in 2021. The loss on extinguishment of notes payable, which was recognized by us during the third quarter of 2022, relates to the extinguishment of the SPA Note. We recognized a loss on extinguishment of $17.9 million (inclusive of $12.4 million of unamortized warrants, $3.0 million default penalty on the principal amount, $2.3 million of unamortized issuance costs and $1.2 million of the incremental fair value of warrants modified in exchange of debt). This is compared to a gain on extinguishment of $2.7 million in connection with the derecognition of the net carrying amount of the extinguished debt of $19.6 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 $16.9 million fair value of the new convertible notes (including the same principal amount of $13.1 million plus the $3.8 million fair value of the beneficial conversion feature) in the nine months ended September 30, 2021. Additional information relating to our gain on extinguishment of notes payable may be found in Note 11 – Convertible Promissory Notes, included elsewhere in the notes to the consolidated financial statements. Income Tax Benefit Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 Change % Change 2022 2021 Change % Change Income tax benefit $ — $ — $ — — % $ (262 ) $ — $ (262 ) 100 % Effective tax rate 0.0 % 0.0 % 0.2 % 0.0 % 65 The effective income tax rate was 0.0% for both the three months ended September 30, 2022 and 2021. The income tax benefit was $0 for both the three months ended September 30, 2022 and 2021. The change in the income tax benefit for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 was primarily due to a discrete income tax benefit of approximately $200 thousand recorded during the first quarter of 2022, which is attributable to a non-recurring partial release of our U.S. valuation allowance as a result of the Lab Society acquisition. Additionally, as a result of the goodwill impairment charge recorded during the second quarter of 2022, we recognized a small benefit of approximately $62 thousand related to the reversal of our opening deferred tax liability on indefinite-lived assets. Income (Loss) Attributable to Non-Controlling Interest We consolidate the results of operations of two less than wholly-owned entities into our consolidated statements of operations. On December 8, 2019, we formed Agrify-Valiant, LLC (“Agrify-Valiant”), a joint-venture limited liability company in which we are 60% majority owner and Valiant-America, LLC owns 40%. Agrify-Valiant started its operations during the second quarter of 2020. On October 27, 2022, we provided notice to Valiant-America, LLC of our intention to begin winding up of Agrify Valiant, LLC. 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. Income (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 Operating Capital Requirements We have incurred operating losses since our inception and have negative cash flows from operations. We have an accumulated deficit of $207.5 million as of September 30, 2022. Our primary sources of liquidity are cash and cash equivalents, with additional liquidity accessible, subject to market conditions and other factors, including limitations that may apply to us under applicable Securities Exchange Commission (“SEC”) regulations, from the capital markets, including under its (“ATM” or ATM Program”). As of September 30, 2022, we had $12.5 million of cash, cash equivalents, marketable securities and restricted cash. Our restricted cash of $10.0 million is associated with the Exchange Note as of September 30, 2022. Current liabilities were $41.5 million as of September 30, 2022. In October 2022, we entered into the ATM Program with Canaccord Genuity LLC (the “Agent”) pursuant to which we may issue and sell, from time to time, shares of our Common Stock having an aggregate offering price of up to $50 million, depending on market demand, with the Agent acting as an agent for sales. The ATM Program allows us to sell shares of Common Stock pursuant to specific parameters defined by us as well as those defined by the SEC and the ATM Program agreement. Subsequent to the quarter ended September 30, 2022, as of November 7, 2022, we sold 6,132,565 shares of Common Stock, under the ATM at an average price of $2.54 per share, resulting in gross proceeds to us of $15.6 million, and net proceeds of $15.1 million after commissions and fees to the Agent totaling $468 thousand. $3.1 million of the proceeds under the ATM Program were used to repay amounts due to the Investor under the Exchange Note. The ATM allows for quick and agile sales of Common Stock to interested investors and provides an opportunity to raise additional capital for working capital requirements or to fund strategic opportunities that may present themselves from time to time. We have used, and intend to continue to use, the net proceeds generated from the ATM Program for working capital and general corporate purposes, including repayment of indebtedness, funding its transformation initiatives and product category expansion efforts and capital expenditures. As of November 7, 2022, we had $34.4 million of remaining availability for future issuances of Common Stock under the ATM Program. We believe we have sufficient cash on hand to continue operations for the next six months. Our current working capital needs are to support revenue growth, 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. 66 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. These financial statements have been prepared on a going concern basis, which implies we believe these conditions raise substantial doubt about our ability to continue as a going concern within the next twelve months from the date these financial statements are available to be issued. Our continuation as a going concern is dependent upon its ability to obtain the necessary debt or equity financing to continue operations until we begin generating sufficient cash flows from operations to meet its obligations. There is no assurance that we will ever be profitable. The financial statements do not include any adjustments to reflect the potential future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result should we be unable to continue as a going concern. Indebtedness We entered into one Loan Agreement and Promissory Note 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 $779 thousand from the unsecured PPP Loan which was originally scheduled to mature in May 2022. We applied for forgiveness on the $779 thousand of our PPP Loan however was denied by the SBA. On June 23, 2022, we received a letter from Bank of America agreeing to extend the maturity date to May 7, 2025 and bears interest at a rate of 1.00% per year. The PPP loan is payable in 34 equal combined monthly principal and interest payments of approximately $24 thousand that commenced on August 7, 2022. On March 14, 2022, we entered into a Securities Purchase Agreement with an institutional investor. The Purchase Agreement provides for the issuance of a senior secured note (the “SPA Note”) in the aggregate amount of $65 million and a warrant (the “SPA Warrant”) to purchase up to an aggregate of 688,111 shares of Common Stock, with the potential for two potential subsequent closings for notes with an original principal amount of $35 million each. On August 18, 2022, we entered into a Securities Exchange Agreement. Pursuant to the Exchange Agreement, we have paid $35.2 million under the SPA Note and exchanged the remaining balance of the SPA Note for a new senior secured note (the “Exchange Note”) with an aggregate original principal amount of $35 million and a new warrant to purchase 1,422,764 shares of Common Stock (the “Note Exchange Warrant”). Additionally, we exchanged the SPA Warrant for a new warrant for the same number of underlying shares but with a reduced exercise price (the “Modified Warrant”). The Exchange Note is a senior secured obligation of us and ranks senior to all indebtedness of us. The Exchange Note will mature on the three-year anniversary of its issuance (the “Maturity Date”) and contains a 9.0% annualized interest rate, with interest to be paid monthly, in cash, beginning September 1, 2022. The principal amount of the Exchange Note will be payable on the Maturity Date, provided that the Investor will be entitled to a cash sweep of 20% of the proceeds received by us in connection with any equity financing, which will reduce the outstanding principal amount under the Exchange Note. At any time, we may prepay all of the Exchange Note by redemption at a price equal to 102.5% of the then-outstanding principal amount under the Note plus accrued but unpaid interest. The Investor will also have the option of requiring us to redeem the Exchange Note on the one-year or two-year anniversaries of issuance at a price equal to the then-outstanding principal amount under the Exchange Note plus accrued but unpaid interest, or if we undergo a fundamental change at a price equal to 102.5% of the then-outstanding principal amount under the Exchange Note plus accrued but unpaid interest. 67 Summary Statement of Cash Flows The following table presents the major components of net cash flows from and used in operating, investing, and financing activities for the nine months ended September 30, 2022, and 2021: (In thousands) September 30, 2022 September 30, 2021 Net cash (used in) provided by: Operating activities $ (66,115 ) $ (17,557 ) Investing activities (4,135 ) (84,683 ) Financing activities 60,387 138,875 Net increase in cash and cash equivalents $ (9,863 ) $ 36,635 Cash Flow from Operating Activities Cash used in operating activities consists of net income adjusted for non-cash benefits and expenses, and changes in operating assets and liabilities. Our primary source of cash provided by operating activities is cash collections from our customers related to the sale of cultivation and extraction solutions. Our primary uses of cash from our operating activities include payments for employee-related expenditures, payments for inventory due to increased demand forecasts, construction costs related to TTK Solutions, acquisition-related costs and the payment of other operating expenses incurred in the ordinary course of business. Net cash used in operating activities increased from the nine months ended September 30, 2022 to the nine months ended September 30, 2021 primarily due to higher inventory purchases to meet demand, increased construction costs related to TTK Solutions, payments for employee-related expenditures and other working capital needs. Cash Flow from Investing Activities Cash provided by investing activities consists primarily of maturities and sales of investments in marketable securities. Cash used in investing activities consists primarily of purchases of marketable securities, cash paid associated with our 2022 acquisition of Lab Society, the issuance of loans receivable in connection with our financing of construction and equipment under its TTK Solutions offering and purchases of property and equipment expenditures. 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. Net cash used in investing activities decreased from the nine months ended September 30, 2022 to the nine months ended September 30, 2021 primarily due to a net decrease in cash used for purchases, sales and maturities of marketable securities, partially offset by an increase in purchases of property and equipment, issuance of TTK-related loans and cash paid in connection with our 2022 acquisitions of Lab Society. Cash Flow from Financing Activities Cash provided by financing activities consists primarily of proceeds from the issuance of Common Stock, debt, and warrants in private placements and proceeds from the initial and secondary public offerings. Cash used in financing activities consists primarily of repayment of debt. Net cash provided by financing activities decreased from the nine months ended September 30, 2022 to the nine months ended September 30, 2021 primarily due to an increase in repayment of debt. 68 Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are therefore not exposed to the financing, liquidity, market, or credit risk that could arise if we had engaged in those types of relationships. Critical Accounting Policies and Estimates Part I, Item, 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” discusses our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. These estimates are based on our knowledge and understanding of current conditions and actions that we may take in the future. Changes in these estimates will occur as a result of the passage of time and the occurrence of future events. Subsequent changes in these estimates may have a significant impact on our financial condition and results of operations and are recorded in the period in which they become known. We have identified the following estimates that, in our opinion, are subjective in nature, require the exercise of judgment and involve complex analysis: the fair value of derivative assets and liabilities, goodwill impairment assessment, revenue recognition and cost of goods sold. The significant accounting policies and estimates that have been adopted and followed in the preparation of our consolidated financial statements are detailed in Note 2 - Summary of Significant Accounting Policies included in our 2021 Annual Report and Note 1 - Overview, Basis of Presentation and Significant Accounting Policies to our consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. There have been no changes in these policies and estimates that had a significant impact on the financial condition and results of operations for the periods covered in this Quarterly Report. Recently Issued Accounting Pronouncements Adopted For more information on recently issued accounting pronouncements are included within Note 1 - Overview, Basis of Presentation and Significant Accounting Policies, included elsewhere in the notes to consolidated financial statements covered under Part I, Item 1 of this Quarterly Report on Form 10-Q. New Accounting Pronouncements Not Yet Adopted For more information on new accounting pronouncements not yet adopted are included within Note 1 - Overview, Basis of Presentation and Significant Accounting Policies, included elsewhere in the notes to consolidated financial statements covered under Part I, Item 1 of this Quarterly Report on Form 10-Q. 69 Item 3. 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.