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PART
I
Item
1. Business.
Corporate
History and Background
The
Company is engaged in the manufacturing and distribution of ready-to-drink and ready-to-blend frozen beverages, including smoothies,
shakes and frappes. The current operation was established following a 2012 reverse merger into an inactive Delaware corporation, formed
on February 25, 2010. We have two direct subsidiaries: Barfresh Corporation, Inc. (formerly known as Smoothie, Inc.) and Barfresh, Inc.
Our corporate office is located at 3600 Wilshire Boulevard Suite 1720, Los Angeles, 90010. Our telephone number is (310) 598-7113 and
our website is www.barfresh.com.
Business
Overview
Barfresh
is a leader in the creation, manufacturing and distribution of ready-to-drink and ready-to-blend frozen beverages. The current portfolio
of products includes smoothies, shakes and frappes.
Some
of the key benefits of the products for the end consumers that drink the products include:
|
● |
From
as little as 125-130 calories (per serving) |
|
|
|
|
● |
Real
fruit in every smoothie |
|
|
|
|
● |
Dairy
free options |
|
|
|
|
● |
Kosher
approved |
|
|
|
|
● |
Gluten
Free |
Products
Products
are packaged in three distinct formats.
The
Company’s ready-to-drink smoothie, “Twist & Go”™, has initially been focused towards the USDA national school
meal program, including the School Breakfast Program, the National School Lunch Program and Smart Snacks in Schools Program. This sweet
fruit and creamy yogurt smoothie contains four ounces of yogurt and a half-cup of fruit/fruit juice and comes in three different flavors:
strawberry banana, peach and mango pineapple. The product was originally launched in a bottled packaging format. The Company introduced
Twist & Go™ cartons in 2022. Twist & Go™ contains no added sugars, preservatives, artificial flavors or colors. At
only 125 -130 calories and with 5 grams of protein, it makes the perfect start to any day or on-the-go snack.
The
Company’s bulk “Easy Pour” format, which contains all the ingredients necessary to make the beverage, is packaged in
gallon containers in a concentrated formula that is mixed in beverage dispensing equipment 1:1 with water. The Company has a “no
sugar added” version of the bulk “Easy Pour” format, WHIRLZ 100% Juice Concentrate, that is specifically targeted for the aforementioned USDA national
school meal programs. In addition, the Company received approval from the United States Defense Logistics Agency (“DLA”)
to sell its smoothie products into all branches of the U.S. Armed Forces and is currently in contract with and selling its bulk Easy
Pour products into over one hundred military bases in the United States and abroad.
The
Company’s single serve format features portion controlled and ready-to-blend beverage ingredient packs or “beverage packs”.
The beverage packs contain all the ingredients necessary to make the beverage, including the base (either sorbet, frozen yogurt, or ice
cream), real fruit pieces, juices, and ice – five ounces of water are added before blending.
Distribution
The
Company conducts sales through several channels, including National Accounts, Regional Accounts, and Broadline Distributors.
On
October 26, 2015, Barfresh signed a five-year agreement with PepsiCo North America Beverages, a division of PepsiCo, to become its
exclusive sales representative within the food service channel to present Barfresh’s line of ready-to-blend smoothies and
frozen beverages throughout the United States and Canada. In February 2023, Barfresh
terminated the agreement. Such termination is not anticipated to have a significant impact on sales.
Manufacturing
Barfresh
utilizes contract manufacturers to manufacture all of its products in the United States.
Research
and Development
The
Company incurred approximately $382,000 and $245,000, in research and development expenses for the years ended December 31, 2022 and
2021, respectively. The increase in Research and Development expenses was primarily attributable to the launch of the Company’s
Twist & Go™ cartons, as well as costs incurred to investigate the quality issues experienced
with the Manufacturer, more fully described in Item 7,
Competition
There
is significant competition in the smoothie market at both the institutional and consumer purchasing level.
The
Company distributes products institutionally primarily through distributors to school districts. The Company has recently launched its
Twist & Go ready-to-drink smoothie as well as a “no sugar added” version of the bulk “Easy Pour” format,
WHIRLZ 100% Juice Concentrates, both of which are specifically targeted for the USDA national school meal program, including the School
Breakfast Program, the National School Lunch Program, and Smart Snacks in Schools Program. At the institutional level, the Company competes
with other food and beverage manufacturers, many of which have significantly greater financial resources and distribution reach.
The
competition at the consumer level is primarily between specialized juice bars (e.g. Jamba Juice) and major fast casual and fast food
restaurant chains (such as McDonalds). Barfresh does not compete specifically at this level but intends to supply its product to customers
that fall within these segments to enable them to compete for consumer demand. The Company believes that its single serve products afford
a very significant competitive advantage based on ease of use, portion control, premium quality, and minimal capital investment required
to enable a customer to begin to carry Barfresh beverage products. The Company also believes that its bulk “Easy Pour” product
represents an attractive alternative delivery method for customers that serve high volume locations, where speed of service over extended
periods is a critical requirement.
There
may also be new entrants to the smoothie market that may alter the current competitor landscape.
Intellectual
Property
Barfresh
owns the domestic and international property rights to its products’ sealed pack of ingredients used in its single serve products.
In
November 2011, the Company acquired patent applications filed in the United States (Patent Application number 11/660415) and Canada (Patent
Application number 2577163) from certain related parties. The United States patent was originally filed on December 4, 2007 and it was
granted during August of 2017. The Canadian patent was originally filed on August 16, 2005 and it was granted on May 27, 2014.
On
October 15, 2013, the Company acquired all of the related international patent rights, which were filed pursuant to the Patent Cooperation
Treaty, have been granted in 13 jurisdictions and are pending in the remainder of the jurisdictions that have signed the PCT. In addition,
the Company purchased all of the trademarks related to the patented products.
Governmental
Approval and Regulation
While
the Company is not aware of the need for any governmental approvals to manufacture or distribute its products, manufacturing products
which meet the criteria of the USDA’S national school meal program and USDLA is critical to the Company’s business plan.
The
Company utilizes contract manufacturers. Before entering into any manufacturing contracts, the Company determines that the manufacturer
meets all government requirements.
Environmental
Laws
The
Company does not believe that it is subject to any environmental laws, either state or federal. Compliance with any laws concerning manufacturing
is the responsibility of the contract manufacturer.
Employees
As
of March 1, 2023, the Company has 13 employees and 3 consultants.
Item
1A. Risk Factors
An
investment in the Company’s securities involves significant risks, including the risks described below. The risks included below
are not the only ones that the Company faces. Additional risks presently unknown to us or that we currently consider immaterial or unlikely
to occur could also impair our operations. If any of the risks or uncertainties described below or any such additional risks and uncertainties
actually occur, our business, prospects, financial condition or results of operations could be negatively affected.
The
impact of COVID-19 on the Company is constantly evolving. The direct impact to our operations had begun to take effect at the close of
the first quarter ended March 31, 2020. Specifically, our business was impacted by dining bans targeted at restaurants to reduce the
size of public gatherings. Such bans precluded our single serve products from being served at those establishments for a number of weeks,
and in some instances, resulted in abandoned product launches. Furthermore, many school districts closed regular attendance for a period
of time thereby disrupting sales of product into that channel. More recently, we have experienced a disruption in the supply chain for
manufacturing our products due to COVID-19. The developments surrounding COVID-19 remain fluid and dynamic, and consequently, will require
the Company to continue to monitor news headlines from government and health officials, as well as, the business community.
Risks
Related to Our Business
We
have a history of operating losses.
We
have a history of operating losses and may not achieve or sustain profitability. These operating losses have been generated while we
market to potential customers. We cannot guarantee that we will become profitable. Even if we achieve profitability, given the competitive
and evolving nature of the industry in which we operate, we may be unable to sustain or increase profitability and our failure to do
so would adversely affect the Company’s business, including our ability to raise additional funds.
If
we continue to suffer losses from operations, our working capital may be insufficient to support our ability to expand our business operations
as rapidly as we would deem necessary at any time, unless we are able to obtain additional financing. There can be no assurance that
we will be able to obtain such financing on acceptable terms, or at all. If adequate funds are not available or are not available on
acceptable terms, we may not be able to pursue our business objectives and would be required to reduce our level of operations, including
reducing infrastructure, promotions, sales and marketing programs, personnel and other operating expenses. These events could adversely
affect our business, results of operations and financial condition. If adequate funds are not available or if they are not available
on acceptable terms, our ability to fund the growth of our operations, take advantage of opportunities, develop products or services
or otherwise respond to competitive pressures, could be significantly limited.
Issues
with a manufacturer have resulted in a significant loss for 2022, as well as other negative impacts.
As
described more fully in Item 7, we experienced product quality issues with a contract manufacturer (the “Manufacturer”) that
provided approximately 52% and 42% of our products in the years ended December 31, 2022 and 2021. Complaints from customers led us to
withdraw product from the market and destroy existing inventory. The results for 2022 reflect the estimated accounting impact of these
actions, including $493,000 in refunds and administrative fees due to customers and $932,000 to dispose of unsaleable inventory.
In
addition to the accounting impact, we must obtain suitable replacement contract manufacturers and regain the confidence of our customers
and investing public, all while seeking a resolution with the Manufacturer. These tasks require substantial amounts of personnel and
capital resources. As of the filing of this report, we are unable to predict the impact on our results for the 2023 fiscal year.
We
may need additional financing in the future, which may not be available when needed or may be costly and dilutive.
We
may require additional financing to support our working capital needs in the future. The amount of additional capital we may require,
the timing of our capital needs and the availability of financing to fund those needs will depend on a number of factors, including our
strategic initiatives and operating plans, the performance of our business and the market conditions for debt or equity financing. Additionally,
the amount of capital required will depend on our ability to meet our case sales goals and otherwise successfully execute our operating
plan. We believe it is imperative to meet these sales objectives in order to lessen our reliance on external financing in the future.
Although we believe various debt and equity financing alternatives will be available to us to support our working capital needs, financing
arrangements on acceptable terms may not be available to us when needed. Additionally, these alternatives may require significant cash
payments for interest and other costs or could be highly dilutive to our existing shareholders. Any such financing alternatives may not
provide us with sufficient funds to meet our long-term capital requirements. If necessary, we may explore strategic transactions that
we consider to be in the best interest of the Company and our shareholders, which may include, without limitation, public or private
offerings of debt or equity securities, and other strategic alternatives; however, these options may not ultimately be available or feasible.
A
worsening of economic conditions or a decrease in consumer spending may adversely impact our ability to implement our business strategy.
Our
success depends to a significant extent on discretionary consumer spending, which is influenced by general economic conditions and the
availability of discretionary income. There is no certainty regarding economic conditions in the United States, and credit and financial
markets and confidence in economic conditions could deteriorate at any time. Accordingly, we may experience declines in revenue during
economic turmoil or during periods of uncertainty. Any material decline in the amount of discretionary spending, leading cost-conscious
consumers to be more selective in restaurants visited, could have a material adverse effect on our revenue, results of operations, business
and financial condition.
The
challenges of competing with the many food services businesses may result in reductions in our revenue and operating margins.
We
compete with many well-established companies, food service and otherwise, on the basis of taste, quality and price of product offered,
customer service, atmosphere, location and overall guest experience. Our success depends, in part, upon the popularity of our products
and our ability to develop new menu items that appeal to consumers across all four day parts. Shifts in consumer preferences away from
our products, our inability to develop new menu items that appeal to consumers across all day parts, or changes in our menu that eliminate
items popular with some consumers could harm our business. We compete with other smoothie and juice bar retailers, specialty coffee retailers,
yogurt and ice cream shops, bagel shops, fast-food restaurants, delicatessens, cafés, take-out food service companies, supermarkets
and convenience stores. Our competitors change with each of the four day parts, ranging from coffee bars and bakery cafés to casual
dining chains. Many of our competitors or potential competitors have substantially greater financial and other resources than we do,
which may allow them to react to changes in the market quicker than we can. In addition, aggressive pricing by our competitors or the
entrance of new competitors into our markets, could reduce our revenue and operating margins. We also compete with other employers in
our markets for workers and may become subject to higher labor costs as a result of such competition.
The
recent global coronavirus outbreak could harm our business and results of operations.
In
March 2020 the World Health Organization declared coronavirus COVID-19 a global pandemic. This contagious disease outbreak, which has
continued to spread, and any related adverse public health developments, has adversely affected workforces, customers, economies, and
financial markets globally, potentially leading to an economic downturn. It has also disrupted the normal operations of many businesses,
including ours. This outbreak could decrease spending, adversely affect demand for our product and harm our business and results of operations.
It is not possible for us to predict the duration or magnitude of the adverse results of the outbreak and its effects on our business
or results of operations at this time.
Disruption
within our supply chain, contract manufacturing or distribution channels could have an adverse effect on our business, financial condition
and results of operations.
Our
ability, through our suppliers, business partners, contract manufacturers, independent distributors and retailers, to produce, transport,
distribute and sell products is critical to our success.
Damage
or disruption to our suppliers or to manufacturing or distribution capabilities due to weather, natural disaster, fire or explosion,
terrorism, pandemics such as COVD-19 and influenza, labor strikes or other reasons, could impair the manufacture, distribution and sale
of our products. Many of these events are outside of our control. Failure to take adequate steps to protect against or mitigate the likelihood
or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial
condition and results of operations.
Our
experience with the Manufacturer demonstrates how our reliance on a limited number of manufacturers and suppliers further increases this
risk. Most of our suppliers and manufacturers produce similar products for other companies, and our products may represent a small portion
of their businesses. Further, it takes a newly engaged manufacturer typically up to nine months of retrofitting/ preparation before it
can begin producing our products. We have contracts in place to produce sufficient units to meet projected demand; however, if one of
our manufacturers fails to perform, we would be faced with a significant interruption in our supply chain. If one of our manufacturers
or suppliers fails to perform or deliver products, for any reason, our sales and results of operations could be adversely affected. Furthermore,
if we are unable to meet our customers’ demands due to a disruption in our supply chain, we may lose that customer which could
adversely affect our business, financial condition and results of operations.
Our
dependence on independent contract manufacturers could make management of our manufacturing and distribution efforts inefficient or unprofitable.
We
are expected to arrange for our contract manufacturing needs sufficiently in advance of anticipated requirements, which is customary
in the contract manufacturing industry for comparably sized companies. Based on the cost structure and forecasted demand for the particular
geographic area where our contract manufacturers are located, we continually evaluate which of our contract manufacturers to use. To
the extent demand for our products exceeds available inventory or the production capacity of our contract manufacturing arrangements,
or orders are not submitted on a timely basis, we will be unable to fulfill distributor orders on demand. Conversely, we may produce
more product inventory than warranted by the actual demand for it, resulting in higher storage costs and the potential risk of inventory
spoilage. Our failure to accurately predict and manage our contract manufacturing requirements and our inventory levels may impair relationships
with our independent distributors and key accounts, which, in turn, would likely have a material adverse effect on our ability to maintain
effective relationships with those distributors and key accounts. At present, we must replace the Manufacturer with one or more new contract
manufacturers and/or arrange for increased production from our existing contract manufacturers, all of which require several months to
implement.
If
we do not adequately manage our inventory levels, our operating results could be adversely affected.
We
need to maintain adequate inventory levels to be able to deliver products to distributors on a timely basis. Our inventory supply depends
on our ability to correctly estimate demand for our products. Our ability to estimate demand for our products is imprecise, particularly
for new products, seasonal promotions and new markets. If we materially underestimate demand for our products or are unable to maintain
sufficient inventory of raw materials, we might not be able to satisfy demand on a short-term basis. If we overestimate distributor or
retailer demand for our products, we may end up with too much inventory, resulting in higher storage costs, increased trade spending
and the risk of inventory spoilage. If we fail to manage our inventory to meet demand, we could damage our relationships with our distributors
and retailers and could delay or lose sales opportunities, which would unfavorably impact our future sales and adversely affect our operating
results. In addition, if the inventory of our products held by our distributors and retailers is too high, they will not place orders
for additional products, which would also unfavorably impact our sales and adversely affect our operating results.
Increases
in costs of packaging, ingredients and contract manufacturing tolling fees may have an adverse impact on our gross margin.
Packaging
costs such as paper and aluminum cans have experienced industry wide price increases in the past and there is always the risk that the
Company’s contract manufacturers increase their toll rates based on increases in their fixed and variable costs. If the Company
is unable to pass on these costs, the gross margin will be significantly impacted.
Litigation
or legal proceedings could expose us to significant liabilities and damage our reputation.
We
may become party to litigation claims and legal proceedings. Litigation involves significant risks, uncertainties and costs, including
distraction of management attention away from our business operations. We evaluate litigation claims and legal proceedings to assess
the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates,
we establish reserves and disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates
are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes
or losses may differ materially from those envisioned by our current assessments and estimates. Our policies and procedures require strict
compliance by our employees and agents with all U.S. and local laws and regulations applicable to our business operations, including
those prohibiting improper payments to government officials. Nonetheless, our policies and procedures may not ensure full compliance
by our employees and agents with all applicable legal requirements. Improper conduct by our employees or agents could damage our reputation
or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines, as
well as disgorgement of profits.
While
the litigation with the Manufacturer has been voluntarily moved from the court system, there is no assurance that we will be able to
reach a suitable resolution with the Manufacturer and not be forced to refile our case with the court.
We
have identified a material weakness in our disclosure controls and procedures and internal control over financial reporting. If not remediated,
our failure to establish and maintain effective disclosure controls and procedures and internal control over financial reporting could
result in material misstatements in our financial statements and a failure to meet our reporting and financial obligations, each of which
could have a material adverse effect on our financial condition and the trading price of our common stock.
Maintaining
effective internal control over financial reporting and effective disclosure controls and procedures are necessary for us to produce
reliable financial statements. As discussed in Item 9A – “Controls and Procedures” of this Form 10-K, we have re-evaluated
our internal control over financial reporting and our disclosure controls and procedures and concluded that they were not effective as
of December 31, 2022.
A
material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that
there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or
detected on a timely basis. Management has concluded that there is a material weakness due to the control environment. The control environment
is impacted due to the Company’s inadequate segregation of duties.
The
Company is committed to remediating its material weaknesses as promptly as possible. Implementation of the Company’s
remediation plans has commenced , including adding appropriate staffing and implementing an improved information system. Remediation
is being overseen by the audit committee. However, there can be no assurance as to when these material weaknesses will be remediated
or that additional material weaknesses will not arise in the future. Even effective internal control can provide only reasonable
assurance with respect to the preparation and fair presentation of financial statements. Any failure to remediate the material
weaknesses or the development of new material weaknesses in our internal control over financial reporting, could result in material
misstatements in our financial statements, which in turn could have a material adverse effect
on our financial condition and the trading price of our common stock and we could fail to meet our financial reporting
obligations.
Fluctuations
in various food and supply costs, particularly fruit and dairy, could adversely affect our operating results.
Supplies
and prices of the various ingredients that we are going to use to can be affected by a variety of factors, such as weather, seasonal
fluctuations, demand, politics and economics in the producing countries.
These
factors subject us to shortages or interruptions in product supplies, which could adversely affect our revenue and profits. In addition,
the prices of fruit and dairy, which are the main ingredients in our products, can be highly volatile. The fruit of the quality we seek
tends to trade on a negotiated basis, depending on supply and demand at the time of the purchase. An increase in pricing of any fruit
that we are going to use in our products could have a significant adverse effect on our profitability. We cannot assure you that we will
be able to secure our fruit supply.
Our
business depends substantially on the continuing efforts of our senior management and other key personnel, and our business may be severely
disrupted if we lose their services.
Our
future success heavily depends on the continued service of our senior management and other key employees. If one or more of our senior
executives is unable or unwilling to continue to work for us in his or her present position, we may have to spend a considerable amount
of time and resources searching, recruiting, and integrating a replacement into our operations, which would substantially divert management’s
attention from our business and severely disrupt our business. This may also adversely affect our ability to execute our business strategy.
We
may be unable to attract and retain qualified, experienced, highly skilled personnel, which could adversely affect the implementation
of our business plan.
Our
success depends to a significant degree upon our ability to attract, retain and motivate skilled and qualified personnel. As we become
a more mature company in the future, we may find recruiting and retention efforts more challenging. If we do not succeed in attracting,
hiring and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. The
loss of any key employee, including members of our senior management team, and our inability to attract highly skilled personnel with
sufficient experience in our industries could harm our business.
Product
liability exposure may expose us to significant liability.
We
may face an inherent business risk of exposure to product liability and other claims and lawsuits in the event that the development or
use of our technology or prospective products is alleged to have resulted in adverse effects. We may not be able to avoid significant
liability exposure. Although we believe our insurance coverage to be adequate, we may not have sufficient insurance coverage, and we
may not be able to obtain sufficient coverage at a reasonable cost. An inability to obtain product liability insurance at acceptable
cost or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of our products.
A product liability claim could hurt our financial performance. Even if we ultimately avoid financial liability for this type of exposure,
we may incur significant costs in defending ourselves that could hurt our financial performance and condition.
Our
inability to protect our intellectual property rights may force us to incur unanticipated costs.
Our
success will depend, in part, on our ability to obtain and maintain protection in the United States and internationally for certain intellectual
property incorporated into our products. Our intellectual property rights may be challenged, narrowed, invalidated or circumvented, which
could limit our ability to prevent competitors from marketing similar solutions that limit the effectiveness of our patent protection
and force us to incur unanticipated costs. In addition, existing laws of some countries in which we may provide services or solutions
may offer only limited protection of our intellectual property rights.
Our
products may infringe the intellectual property rights of third parties, and third parties may infringe our proprietary rights, either
of which may result in lawsuits, distraction of management and the impairment of our business.
As
the number of patents, copyrights, trademarks and other intellectual property rights in our industry increases, products based on our
technology may increasingly become the subject of infringement claims. Third parties could assert infringement claims against us in the
future. Infringement claims with or without merit could be time consuming, result in costly litigation, cause product shipment delays
or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, might not be available on
terms acceptable to us, or at all. We may initiate claims or litigation against third parties for infringement of our proprietary rights
or to establish the validity of our proprietary rights. Litigation to determine the validity of any claims, whether or not the litigation
is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel
from productive tasks. If there is an adverse ruling against us in any litigation, we may be required to pay substantial damages, discontinue
the use and sale of infringing products and expend significant resources to develop non-infringing technology or obtain licenses to infringing
technology. Our failure to develop or license a substitute technology could prevent us from selling our products.
We
will continue to incur increased costs as a result of operating as a public company, and our management will be required to devote substantial
time to compliance initiatives and corporate governance practices.
As
a public company, we will continue to incur significant legal, accounting and other expenses. The Sarbanes-Oxley Act of 2002, the Dodd-Frank
Wall Street Reform and Consumer Protection Act and other applicable securities rules and regulations impose various requirements on public
companies, including establishment and maintenance of effective disclosure and financial controls and corporate governance practices.
Our management and other personnel will need to continue to devote a substantial amount of time to these compliance initiatives. Moreover,
these rules and regulations will increase our legal and financial compliance costs and make some activities more time-consuming and costly.
We
cannot predict or estimate the amount of additional costs we may incur to continue to operate as a public company, nor can we predict
the timing of such costs. These rules and regulations are often subject to varying interpretations, in many cases due to their lack of
specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing
bodies which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to
disclosure and governance practices.
Failure
to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
As
a Delaware corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies
from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Some foreign
companies, including some that may compete with our Company, may not be subject to these prohibitions. Corruption, extortion, bribery,
pay-offs, theft and other fraudulent practices may occur from time-to-time in countries in which we conduct our business. However, our
employees or other agents may engage in conduct for which we might be held responsible. If our employees or other agents are found to
have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our
business, financial condition and results of operations.
It
is difficult to predict the timing and amount of our sales because our distributors and national accounts may not be required to place
minimum orders with us.
Our
distributors are not required to place minimum monthly or annual orders for our products. Accordingly, we cannot predict the timing or
quantity of purchases by any of our independent distributors or whether any of our distributors will continue to purchase products from
us in the same frequencies and volumes as they may have done in the past. Additionally, our larger distributors and partners may make
orders that are larger than we have historically been required to fill. Shortages in inventory levels, supply of raw materials or other
key supplies could negatively affect us.
Risks
Related to Ownership of Our Common Stock
If
we are unable to adequately fund our operations, we may be forced to voluntarily file for deregistration of our common stock with the
SEC.
Compliance
with the periodic reporting requirements required by the SEC consumes a considerable amount of both internal, as well external, resources
and represents a significant cost for us. If we are unable to continue to devote adequate funding and the resources needed to maintain
such compliance, while continuing our operations, we could be forced to deregister with the SEC. After the deregistration process, our
common stock would only be tradable on the “Pink Sheets” and could suffer a decrease in or absence of liquidity.
If
securities or industry analysts do not publish research, or publish inaccurate or unfavorable research, about our business, our share
price and trading volume could decline.
The
trading market for our common stock may be impacted, in part, by the research and reports that securities or industry analysts publish
about our business or us. There can be no assurance that analysts will cover us, continue to cover us or provide favorable coverage.
If one or more analysts downgrade our stock or change their opinion of our stock, our share price may decline. In addition, if one or
more analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets,
which could cause our share price or trading volume to decline.
Because
we became public by means of a “reverse merger”, we may not be able to attract the attention of major brokerage firms.
Additional
risks may exist since we became public through a “reverse merger”. Securities analysts of major brokerage firms may not provide
coverage of us since there is little incentive to brokerage firms to recommend the purchase of our common stock. We cannot assure you
that brokerage firms will want to conduct any secondary offerings on behalf of our Company in the future.
Future
sales of our common stock in the public market could lower the price of our common stock and impair our ability to raise funds in future
securities offerings.
Future
sales of a substantial number of shares of our common stock in the public market, or the perception that such sales may occur, could
adversely affect the then prevailing market price of our common stock and could make it more difficult for us to raise funds in the future
through a public offering of our securities.
Our
common stock is subject to price volatility unrelated to our operations.
The
market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability
to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock,
changes in general conditions in the economy and the financial markets or other developments affecting the Company’s competitors
or the Company itself.
Because
we do not intend to pay dividends, shareholders will benefit from an investment in our common stock only if it appreciates in value.
We
have never declared or paid any cash dividends on our preferred stock or common stock. For the foreseeable future, it is expected that
earnings, if any, generated from our operations will be used to finance the growth of our business, and that no dividends will be paid
to holders of the Company’s common stock. As a result, the success of an investment in our common stock will depend upon any future
appreciation in its value. There can be no guarantee that our common stock will appreciate in value.
The
price of our common stock may become volatile, which could lead to losses by investors and costly securities litigation.
The
trading price of our common stock is likely to be highly volatile and could fluctuate in response to factors such as:
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actual
or anticipated variations in our operating results; |
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announcements
of developments by us or our competitors; |
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announcements
by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; |
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adoption
of new accounting standards affecting our industry; |
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additions
or departures of key personnel; |
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introduction
of new products by us or our competitors; |
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sales
of our common stock or other securities in the open market; and |
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other
events or factors, many of which are beyond our control. |
The
stock market is subject to significant price and volume fluctuations. In the past, following periods of volatility in the market price
of a company’s securities, securities class action litigation has often been initiated against such a company. Litigation initiated
against us, whether or not successful, could result in substantial costs and diversion of our management’s attention and Company
resources, which could harm our business and financial condition.
Investors
may experience dilution of their ownership interests because of future issuances of additional shares of our common stock.
We
intend to continue to seek financing through the issuance of equity or convertible securities to fund our operations. In the future,
we may also issue additional equity securities resulting in the dilution of the ownership interests of our present shareholders. We may
also issue additional shares of our common stock or other securities that are convertible into or exercisable for our common stock in
connection with hiring or retaining employees, future acquisitions or for other business purposes. The future issuance of any such additional
shares of common stock will result in dilution to our shareholders and may create downward pressure on the trading price of our common
stock.
Provisions
in our Company charter documents and under Delaware law could make an acquisition of our company, which may be beneficial to our stockholders,
more difficult and may prevent attempts by our stockholders to replace or remove our current management.
Provisions
in our certificate of incorporation and our bylaws may discourage, delay or prevent a merger, acquisition or other change in control
of our Company that stockholders may consider favorable, including transactions in which they might otherwise receive a premium for their
shares. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock,
thereby depressing the market price of our common stock. In addition, because our board of directors is responsible for appointing the
members of our management team, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current
management by making it more difficult for stockholders to replace members of our board of directors. In addition, because we are incorporated
in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns
in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the
transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved
in a prescribed manner.
Our
board of directors controls the majority of the outstanding shares of voting stock.
At
present, members of our board of directors and/or their affiliated entities control over 60% of the outstanding shares of voting stock,
and therefore have the power to control all matters requiring the approval of our stockholders, including the election of directors and
the approval of mergers and other significant corporate transactions.
Item
1B. Unresolved Staff Comments.
Not
applicable.
Item
2. Properties.
Our
principal executive offices are located at 3600 Wilshire Boulevard Suite 1720, Los Angeles, 90010. Beginning in April 2019, we leased
this office space pursuant to a direct lease for approximately $80,000 annually through March 31, 2023. The Company extended its lease through June 2023 while management evaluates options for renewal or relocation.
Item
3. Legal Proceedings.
Other
than as disclosed below, neither the Company nor its subsidiaries are party to or have property that is the subject of any material pending
legal proceedings. We may be subject to ordinary legal proceedings incidental to our business from time to time that are not required
to be disclosed under this Item 3.
On
November 10, 2022, we filed a complaint in the United States District Court for the Central District of California, Western
Division, against Schreiber Foods, Inc. claiming a breach of the supply agreement and seeking economic damages. On
January 20, 2023, the Company filed a voluntary dismissal of the complaint which allows the parties to reach a potential resolution
outside of the court system. Further information is included in Item 7 and Notes 1 and 9 of
our financial statements.
Item
4. Mine Safety Disclosures.
Not
applicable.
PART
II
Item
5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market
Information
Our
common stock is currently traded on the Nasdaq’s Capital Market under the symbol “BRFH”. Our common stock had been
quoted on the Nasdaq’s Capital Market since January 20, 2022. Prior to January 20, 2022, our common stock was quoted on the OTCQB.
Effective December 29, 2021, we effected a 1-for-13 reverse stock split. The following table sets forth the range of high and low bid
quotations for the applicable periods, as adjusted for the reverse stock split. These quotations as reported by the Nasdaq Capital Market
reflect inter-dealer prices without retail mark-up, markdown or commissions and may not necessarily represent actual transactions.
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Bid Quotation | |
Financial Quarter Ended | |
High ($) | | |
Low ($) | |
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December 31, 2022 | |
| 3.09 | | |
| 1.00 | |
September 30, 2022 | |
| 5.89 | | |
| 2.62 | |
June 30, 2022 | |
| 7.64 | | |
| 4.67 | |
March 31, 2022 | |
| 8.00 | | |
| 3.86 | |
December 31, 2021 | |
| 7.15 | | |
| 3.12 | |
September 30, 2021 | |
| 8.45 | | |
| 4.68 | |
June 30, 2021 | |
| 8.45 | | |
| 4.96 | |
March 31, 2021 | |
| 7.15 | | |
| 3.90 | |
Holders
On
February 24, 2023, there were 12,971,330 shares of our common stock outstanding. Our shares of common stock are held by 82
stockholders of record. The number of record holders was determined from the records of our transfer agent and does not include
beneficial owners of common stock whose shares are held in the names of various security brokers, dealers and registered clearing
agencies.
Recent
Sales of Unregistered Securities
During
the fourth quarter of 2022, there were no sales of unregistered securities.
Purchases
of Equity Securities by the Company
There
were no purchases of equity securities made by the Company in the period covered by this report.
Securities
Authorized for Issuance Under Equity Compensation Plans
For equity compensation plan information, refer to Item 12. Security Ownership
of Certain Beneficial Owners and Related Stockholder Matters of this Annual Report on Form 10-K.
Transfer
Agent
Our
transfer agent, Securities Transfer Corporation, is located at 2901 N. Dallas Parkway, Suite 380, Plano, Texas 75093, and its telephone
number is (469) 633-0101.
Item
6. [Reserved]
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The
information and financial data discussed below is derived from the audited financial statements of Barfresh for its fiscal years ended
December 31, 2022 and 2021. The financial statements of Barfresh were prepared and presented in accordance with generally accepted accounting
principles in the United States. The information and financial data discussed below is only a summary and should be read in conjunction
with the historical financial statements and related notes of Barfresh contained elsewhere in this Annual Report. This discussion and
analysis may contain forward-looking statements based on assumptions about our future business. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of certain factors. See “Cautionary Note Regarding Forward
Looking Statements” above for a discussion of forward-looking statements and the significance of such statements in the context
of this Annual Report.
Overview
The
Company’s products are packaged in three distinct formats.
The
Company’s ready-to-drink smoothie, Twist & Go™, has initially been focused towards the USDA national school meal program,
including the School Breakfast Program, the National School Lunch Program and Smart Snacks in Schools Program. This sweet fruit and creamy
yogurt smoothie contains four ounces of yogurt and a half-cup of fruit/fruit juice and comes in three different flavors: strawberry banana,
peach and mango pineapple. “Twist & Go”™ contains no added sugars, preservatives, artificial flavors or colors.
At only 125 -130 calories and with 5 grams of protein, it makes the perfect start to any day or on-the-go snack.
The
Company’s bulk “Easy Pour” format, which contains all the ingredients necessary to make the beverage, is packaged in
gallon containers in a concentrated formula that is mixed 1:1 with water. The Company has a “no sugar added” version of the
bulk “Easy Pour” format that is specifically targeted for the aforementioned USDA national school meal programs. In addition,
the Company received approval from the United States Defense Logistics Agency (“DLA”) to sell its smoothie products into
all branches of the U.S. Armed Forces and is currently in contract with and selling its bulk Easy Pour products into over one hundred
military bases in the United States and abroad.
The
Company’s single-serve format features portion controlled and ready-to-blend beverage ingredient packs or “beverage packs”.
The beverage packs contain all the ingredients necessary to make the beverage, including the base (either sorbet, frozen yogurt, or ice
cream), real fruit pieces, juices, and ice – five ounces of water are added before blending.
Domestic
and international patents and patents pending are owned by Barfresh, as well as related trademarks for all of the single serve products.
Patent rights have been granted in 13 jurisdictions including the United States. In addition, the Company has purchased all of the trademarks
related to the patented products.
The
Company conducts sales through several channels, including National Accounts, Regional Accounts, and Broadline Distributors.
On
October 26, 2015, Barfresh signed a five-year agreement with PepsiCo North America Beverages, a division of PepsiCo, to become its
exclusive sales representative within the food service channel to present the Barfresh line of ready-to-blend smoothies and frozen
beverages throughout the United States and Canada. In February 2023, Barfresh terminated the agreement. Such termination is not anticipated to have a significant impact on sales.
Currently
we have 13 employees and 3 consultants.
Barfresh
utilizes contract manufacturers to manufacture all of the products in the United States.
Recent
developments
Our
products are produced to specifications through several contract manufacturers. One of our contract manufacturers (the “Manufacturer”)
has provided approximately 52% and 42% of our products in the years ended December 31, 2022 and 2021, respectively, under a Supply Agreement
with an initial term through September 2025.
Over
the course of 2022, we experienced numerous quality issues with the case packaging utilized by the Manufacturer. In addition, in
July of 2022, we began receiving customer complaints about the texture of our smoothie products produced by the Manufacturer. In
response, we withdrew product from the market and destroyed on-hand inventory, withholding $499,000 in payments due to the
Manufacturer. The results reflect the estimated accounting impact of such actions, including an estimated product return allowance
of $330,000 and total product returns reducing revenue by $493,000 as of and for the year ended December 31, 2022, and $932,000 in
cost of revenue to dispose of unsaleable inventory.
We
attempted to resolve the issues based on the contractual procedures described in the Supply Agreement. However, on November 4, 2022,
in response to a formal proposal of alternate resolutions, we received notification from the Manufacturer that it denied any responsibility
for the defective manufacture of the product. In response, on November 10, 2022, we filed a complaint in the United States District Court
for the Central District of California, Western Division (the “Complaint”), claiming that the Manufacturer has not met its
obligations under the Supply Agreement, and seeking economic damages. In response, the Manufacturer terminated the Supply Agreement.
On January 20, 2023, we filed a voluntary dismissal of the Complaint which allows the parties to reach a potential resolution outside
of the court system. However, if the parties are once again unable to come to an agreement, we have the right to refile the Complaint
in California State Court.
Due
to the uncertainties surrounding the claim, we are not able to predict either the outcome or a range of reasonably possible recoveries
that could result from its actions against the Manufacturer, and no gain contingencies have been recorded. The disruption in supply resulting
from the dispute will adversely impact its results of operations and cash flow until a suitable resolution is reached or new sources
of reliable supply at sufficient volume can be identified and developed, the timing of which is uncertain.
Critical
Accounting Policies
Our
financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
Revenue
Recognition
In
accordance with ASC 606, “Revenue from Contracts with Customers”, revenue is recognized when a customer obtains ownership
of promised goods. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive
in exchange for these goods. The Company applies the following five steps:
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1) |
Identify
the contract with a customer |
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A
contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s
rights, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration
for goods or services that are transferred is probable. For the Company, the contract is the approved sales order, which may also
be supplemented by other agreements that formalize various terms and conditions with customers. |
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2) |
Identify
the performance obligation in the contract |
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Performance
obligations promised in a contract are identified based on the goods or that will be transferred to the customer. For the Company,
this consists of the delivery of frozen beverages, which provide immediate benefit to the customer. |
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3) |
Determine
the transaction price |
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The
transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods
and is generally stated on the approved sales order. Variable consideration, which typically includes rebates or discounts, are estimated
utilizing the most likely amount method. Provisions for refunds and other adjustments are generally provided for in the period the related sales are recorded,
based on management’s assessment of historical and projected trends. |
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4) |
Allocate
the transaction price to performance obligations in the contract
Since
our contracts contain a single performance obligation, delivery of frozen beverages, the transaction price is allocated to that single
performance obligation. |
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5) |
Recognize
Revenue when or as the Company satisfies a performance obligation |
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The
Company recognizes revenue from the sale of frozen beverages when title and risk of loss passes and the customer accepts the goods,
which generally occurs at the time of delivery to a customer warehouse. Customer sales incentives such as volume-based rebates or
discounts are treated as a reduction of sales at the time the sale is recognized. Shipping and handling costs are treated as fulfilment
costs and presented in distribution, selling and administrative costs. |
Stock-based
Compensation
We
account for share-based employee compensation plans under the fair value recognition and measurement provisions in accordance with applicable
accounting standards, which require all share-based payments to employees, including grants of stock options and restricted stock units
(RSUs) and performance stock units (PSUs), to be measured based on the grant date fair value of the awards, with the resulting expense
generally recognized on a straight-line basis over the period during which the employee is required to perform service in exchange for
the award. Expense for PSUs is recognized based on expected performance against targets.
Results
of Operations
Revenue
and cost of revenue
Revenue
increased $2,462,000, or 37%, from $6,700,000 in 2021 to $9,162,000 in 2022. The overall revenue for 2022 was significantly higher due
to growing Twist & Go™ revenue prior
to our product withdrawal resulting from the quality complaints with product purchased from the Manufacturer. As a result of the withdrawal,
we recorded a reserve for anticipated sales claims and administrative fees of $493,000. We anticipate that our revenues will be adversely
impacted as a result of the dispute unless and until new sources of reliable supply at sufficient volume can be identified and developed,
the timing of which is uncertain.
Cost
of revenue for 2022 was $7,722,000 as compared to $4,193,000 in 2021. Our gross profit was $1,440,000 (16%) and $2,507,000 (37%) for
2022 and 2021, respectively. Cost of revenue was adversely impacted by the completed and anticipated disposals of Twist
& Go™ product purchased from the Manufacturer, resulting in a charge of $932,000. Depreciation from manufacturing equipment
was $29,000 and $18,000 for December 31, 2022 and 2021, respectively.
Selling,
marketing and distribution expense
| |
Year ended
December 31, | | |
Year ended
December 31, | | |
| | |
| |
| |
2022 | | |
2021 | | |
Change | | |
Percent | |
Sales and marketing | |
$ | 1,394,000 | | |
$ | 756,000 | | |
$ | 638,000 | | |
| 84 | % |
Storage and outbound freight | |
| 1,467,000 | | |
| 1,054,000 | | |
| 413,000 | | |
| 39 | % |
| |
$ | 2,861,000 | | |
$ | 1,810,000 | | |
$ | 1,051,000 | | |
| 58 | % |
Sales,
marketing and distribution expense increased approximately $1,051,000 (58%) from approximately $1,810,000 in 2021 to $2,861,000 in 2022.
Sales
and marketing expense increased approximately $638,000 (84%) from approximately $756,000 in 2021 to $1,394,000 in 2022. The increase
in sales and marketing expense was primarily the result of the retention of new employees and outside service providers to assist with
sales and initiatives, including, beginning in the third quarter of 2022, brokers specializing in the school market. Additionally, the
Company increased its participation in education nutrition trade shows in 2022.
Storage
and outbound freight expense increased approximately $413,000 (39%) from approximately $1,054,000 in 2021 to $1,467,000 in 2022. The
increase was primarily a result of the 37% increase in revenue.
General
and administrative expense
| |
Year ended
December 31, | | |
Year ended
December 31, | | |
| | |
| |
| |
2022 | | |
2021 | | |
Change | | |
Percent | |
Personnel costs | |
$ | 1,340,000 | | |
$ | 830,000 | | |
$ | 510,000 | | |
| 61 | % |
Stock-based compensation and payment for outside services | |
| 559,000 | | |
| 281,000 | | |
| 278,000 | | |
| 99 | % |
Legal, professional and consulting fees | |
| 499,000 | | |
| 396,000 | | |
| 103,000 | | |
| 26 | % |
Director fees paid in cash | |
| 100,000 | | |
| 100,000 | | |
| - | | |
| 0 | % |
Research and development | |
| 382,000 | | |
| 245,000 | | |
| 137,000 | | |
| 56 | % |
Other general and administrative expenses | |
| 669,000 | | |
| 318,000 | | |
| 351,000 | | |
| 110 | % |
| |
$ | 3,549,000 | | |
$ | 2,170,000 | | |
$ | 1,379,000 | | |
| 64 | % |
General
and administrative expense increased approximately $1,379,000 (64%) from approximately $2,170,000 in 2021 to $3,549,000 in 2022.
Personnel
cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes and continues to be our largest
cost. Personnel cost increased by approximately $510,000 (61%) from approximately $830,000 to $1,340,000. The increase in personnel cost
was partially offset by the decrease in consulting fees as we choose to hire permanent staff as the critical stages of the COVID-19 pandemic
waned, rather than rely on consultants and temporary staff.
Stock-based
compensation is used as an incentive to attract and compensate employees and other service providers. Stock-based compensation includes
stock issued and options granted to employees and non-employees. Stock-based compensation for the year ended December 31, 2022 was approximately
$559,000 compared to $281,000 for the year ended December 31, 2021 due to the aforementioned increase in staffing, and the institution
of our performance-based stock compensation program in the third quarter of 2022. Stock-based compensation in 2021 benefited from forfeiture
credits due to the departure of two key employees.
Legal,
professional, and consulting fees increased approximately $103,000 (26%) from approximately $396,000 in 2021 to $499,000 in 2022. The
increase was primarily due to the dispute and litigation with the Manufacturer and corporate development activities.
Research
and development expense increased approximately $137,000 (56%) from approximately $245,000 in 2021 to $382,000 in 2022. The increase
is primarily due to materials consumed in pre-production runs at a new contract manufacturer that provided our Twist
& Go™ product in carton format starting in the fourth quarter of 2022. Additionally, we incurred costs investigating the quality issue that occurred with the Manufacturer.
Other
expense increased approximately $351,000 (110%) from approximately $318,000 in 2021 to $669,000 in 2022. In 2022, we incurred approximately
$175,000 in one-time costs related to the uplist of our common stock to the NASDAQ Stock Market. Additionally, we experienced maintenance
cost increases related to equipment loaned to our bulk product customers, and an increase in annual meeting costs.
Asset
Impairment
We
evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances
indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable
cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a
comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates
that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced
to fair value. We recorded impairment charges of $746,000 related to idle equipment resulting from overcapacity for single-serve products
and equipment that is held at the Manufacturer.
Operating
loss
We
had operating losses of approximately $6,219,000 and $2,095,000 for the years ended December 31, 2022 and 2021, respectively. The increase
of approximately $4,124,000 or 196%, was primarily due to $1,425,000 in charges related to the aforementioned product quality issue and
withdrawal, the asset impairment of $746,000 and other increases in operating expense.
Other
income and expense
The
change in the value of the derivative liability is based upon the Black-Scholes model from one period to another. The gain of approximately
$16,000 for the year ended December 31, 2021 was a result of the change in components of the Black-Scholes model. The derivative liability
was settled upon conversion and repayment of the convertible notes in the second quarter of 2021, which resulted in an extinguishment
loss of $194,000.
We
recorded a gain on extinguishment of Covid-19 related Paycheck Protection Program (“PPP”) loan of $1,136,000 in the year
ended December 31, 2021.
Interest
expense was approximately $128,000 for the year ended December 31, 2021. Interest related to convertible debt that was converted and
repaid in 2021. We did not incur any interest expense for the year ended December 31, 2022.
Net
loss
We
had net losses of approximately $6,219,000 and $1,265,000 in the years ended December 31, 2022 and 2021, respectively, an increase of
$4,954,000 due primarily to the $1,425,000 charges related to the product withdrawal and the asset impairment of $746,000 in 2022, increases
in operating expense and the $1,136,000 gain on forgiveness of the PPP loan in 2021.
Liquidity
and Capital Resources
As
of December 31, 2022, we had working capital of $1,801,000 compared with $6,172,000 at December 31, 2021. The decrease in working capital
is primarily due to the operating loss of $6,219,000, partially offset by non-cash expenses of $1,834,000.
During
the year ended December 31, 2022, we used $2,648,000 in operations and $13,000 for the purchase of equipment.
The
impact of COVID-19 on the Company is constantly evolving. The direct impact to our operations had begun to take effect at the close of
the first quarter ended March 31, 2020. Specifically, our business was impacted by dining bans targeted at restaurants to reduce the
size of public gatherings. Such bans precluded our single serve products from being served at those establishments for a number of weeks,
and in some instances, resulted in abandoned product launches. Furthermore, many school districts closed regular attendance for a period
of time thereby disrupting sales of product into that channel. More recently, we have experienced a disruption in the supply chain for
manufacturing our products due to COVID-19. The developments surrounding COVID-19 remain fluid and dynamic, and consequently, will require
the Company to continue to monitor news headlines from government and health officials, as well as the business community.
In
each of the years ended December 31, 2021 and 2020, the Company was granted a $568,000 loan under the PPP administered by a Small Business
Administration (SBA) approved partner. The loans were forgiven, and the Company recorded a gain of $1,136,000 upon being legally released
from the loan obligations during the year ended December 31, 2021.
On
June 1, 2021, the Company completed a private placement of 1,282,051 shares of its common stock at $4.68 per share, resulting in gross
proceeds of $6,000,000. In addition, holders of debt converted a total of $399,000 in principal and $234,000 in interest into 133,991
shares of common stock and debt in the amount of $840,000 was retired, leaving the Company with no debt.
We
have entered into a direct lease covering the period April 1, 2019 to March 31, 2023. The aggregate minimum requirements under the
non-cancellable direct lease as of December 31, 2022 is approximately $20,000. The Company extended its lease through June 2023
while management evaluates options for renewal or relocation.
Our
liquidity needs will depend on how quickly we are able to profitably ramp up sales, as well as our ability to control and reduce variable
operating expenses, and to continue to control and reduce fixed overhead expense. Our recent business developments with the Manufacturer
impact our supply chain and will result in increased legal cost and are expected to have a negative impact on our financial position,
results of operations and cash flow.
Our
operations to date have been financed by the sale of securities, the issuance of convertible debt and the issuance of short-term debt,
including related party advances. If we are unable to generate sufficient cash flow from operations with the capital raised we will be
required to raise additional funds either in the form of equity or in the form of debt. There are no assurances that we will be able
to generate the necessary capital to carry out our current plan of operations.
Off-Balance
Sheet Arrangements
We
have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition,
changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that
are material to stockholders.
Item
7A. Quantitative and Qualitative Disclosures About Market Risk.
Not
applicable because we are a smaller reporting company.
Item
8. Financial Statements and Supplementary Data.
Our
consolidated financial statements are included beginning immediately following the signature page to this report. See Item 15 for a list
of the consolidated financial statements included herein.
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item
9A. Controls and Procedures.
Management’s
Annual Report on Internal Control over Financial Reporting
Disclosure
Controls and Procedures
Under
the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer,
we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Securities and Exchange Act of 1934
Rule 13a-15(e). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s
disclosure controls and procedures were not effective as of December 31, 2022, due to inadequate segregation of duties.
Management’s
Annual Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined
in Rule 13a-15(f) under the Exchange Act, for the Company.
Internal
control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that our receipts and expenditures are being made only in accordance with authorizations of its management and directors; and (3)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.
Our
management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2022. The framework
used by management in making that assessment was the criteria set forth in the document entitled “Internal Control – Integrated
Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013.
Under
the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer,
we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Securities and Exchange Act of 1934
Rule 13a-15(e). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s
disclosure controls and procedures were not effective as of December 31, 2022.
Management
has identified the following material weakness in our internal control over financial reporting:
Management
has concluded that there is a material weakness due to the control environment. The control environment is impacted due to the Company’s
inadequate segregation of duties, including information technology control activities.
Since
the assessment of the effectiveness of our internal control over financial reporting did identify material weaknesses, management considers
its internal control over financial reporting to be ineffective.
Management
recognizes that there are inherent limitations in the effectiveness of any system of internal control, and accordingly, even effective
internal control can provide only reasonable assurance with respect to financial statement preparation and may not prevent or detect
material misstatements. In addition, effective internal control at a point in time may become ineffective in future periods because of
changes in conditions or due to deterioration in the degree of compliance with our established policies and procedures.
In
an effort to remediate the identified material weakness and enhance our internal control over financial reporting, we have hired additional
financial personnel to help ensure that we are able to properly implement internal control procedures.
This
report shall not be deemed to be filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that
section, and is not incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless
of any general incorporation language in such filing.
Changes
in Internal Control over Financial Reporting
None
Item
9B. Other Information.
None
Item
9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.
None
Notes
to Consolidated Financial Statements
Note
1. Summary of Significant Accounting Policies
Barfresh
Food Group Inc., (“we,” “us,” “our,” and the “Company”) was incorporated on February
25, 2010 in the State of Delaware. The Company is engaged in the manufacturing and distribution of ready-to-drink and ready-to-blend
beverages, particularly, smoothies, shakes and frappes.
Recent
Business Developments
The
Company’s products are produced to its specifications through several contract manufacturers. One of the Company’s contract
manufacturers (the “Manufacturer”) has provided approximately 52% and 42% of the Company’s products in the years ended
December 31, 2022 and 2021, respectively, under a Supply Agreement with an initial term through September 2025.
Over
the course of 2022, the Company experienced numerous quality issues with the case packaging utilized by the Manufacturer. In
addition, in July of 2022, the Company began receiving customer complaints about the texture of the Company’s smoothie
products produced by the Manufacturer. In response, the Company withdrew product from the market and destroyed on-hand inventory,
withholding $499,000
in payments due to the Manufacturer. The results reflect the estimated accounting impact of such actions, including an estimated
product return allowance of $330,000
and total product returns reducing revenue by $493,000
as of and for the year ended December 31, 2022, and $932,000
in cost of revenue to dispose of unsaleable inventory.
The
Company attempted to resolve the issues based on the contractual procedures described in the Supply Agreement. However, on November 4,
2022, in response to a formal proposal of alternate resolutions, the Company received notification from the Manufacturer that it was
denying any responsibility for the defective manufacture of the product. In response, on November 10, 2022, the Company filed a complaint
in the United States District Court for the Central District of California, Western Division (the “Complaint”), claiming
that the Manufacturer has not met its obligations under the Supply Agreement, and seeking economic damages. In response, the Manufacturer
terminated the Supply Agreement. On January 20, 2023, the Company filed a voluntary dismissal of the Complaint which allows the parties
to reach a potential resolution outside of the court system. However, if the parties are once again unable to come to an agreement, the
Company has the right to refile the Complaint in California State Court.
Due
to the uncertainties surrounding the claim, the Company is not able to predict either the outcome or a range of reasonably possible recoveries
that could result from its actions against the Manufacturer, and no gain contingencies have been recorded. The disruption in its supply
resulting from the dispute will adversely impact its results of operations and cash flow until a suitable resolution is reached or new
sources of reliable supply at sufficient volume can be identified and developed, the timing of which is uncertain.
Basis
of Presentation
The
accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the
United States of America (“GAAP”).
Principles
of Consolidation
The
consolidated financial statements include the financial statements of the Company and our wholly owned subsidiaries, Barfresh Inc. and
Barfresh Corporation Inc. (formerly known as Smoothie, Inc.). All inter-company balances and transactions among the companies have been
eliminated upon consolidation.
Use
of Estimates
The
preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities in the balance sheets and revenues and expenses during the years reported. Actual results may differ
from these estimates.
Concentration
of Credit Risk
The
amount of cash on deposit with financial institutions exceeds the $250,000 federally insured limit at December 31, 2022 and 2021. However,
we believe that cash on deposit that exceeds $250,000 in the financial institutions is financially sound and the risk of loss is minimal.
The
following customers accounted for 10% or more of the Company’s accounts receivable balance at December 31:
Schedule
of Concentration of Credit Risk for Accounts Receivable
| |
2022 | | |
2021 | |
Customer A | |
| 31 | % | |
| 36 | % |
Customer B | |
| 24 | % | |
| 11 | % |
Customer C | |
| 23 | % | |
| 5 | % |
Customer D | |
| 3 | % | |
| 11 | % |
Restricted
Cash
At
December 31, 2022 and 2021, the Company had $211,000 and $142,000, respectively, in restricted cash related to a contract manufacturing
agreement.
Fair
Value Measurement
Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements
and Disclosures (“ASC 820”), provides a comprehensive framework for measuring fair value and expands disclosures which
are required about fair value measurements. Specifically, ASC 820 sets forth a definition of fair value and establishes a hierarchy prioritizing
the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities
and the lowest priority to unobservable value inputs. ASC 820 defines the hierarchy as follows:
Level
1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date. The types of assets
and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices, such as equities listed on
the New York Stock Exchange.
Level
2 – Pricing inputs are other than quoted prices in active markets but are either directly or indirectly observable as of the reported
date. The types of assets and liabilities in Level 2 are typically either comparable to actively traded securities or contracts or priced
with models using highly observable inputs.
Level
3 – Significant inputs to pricing that are unobservable as of the reporting date. The types of assets and liabilities included
in Level 3 are those with inputs requiring significant management judgment or estimation, such as complex and subjective models and forecasts
used to determine the fair value of financial transmission rights.
Our
financial instruments consist of cash, restricted cash, accounts receivable and accounts payable. The carrying value of our financial
instruments approximates their fair value.
Accounts
Receivable
Accounts
receivable from customers are typically unsecured. The Company’s credit policy calls for payment generally within 30 days. The
credit worthiness of a customer is evaluated prior to a sale. Accounts receivable totaled $126,000, $1,223,000 and $425,000 as of
December 31, 2022, 2021 and 2020, respectively. There was no
allowance for doubtful accounts as of December 31, 2022. As of December 31, 2021, the Company’s allowance for doubtful
accounts was $121,000.
There was no bad debt
expense for the year ended December 31, 2022, and ($7,000)
of bad debt recoveries recorded for the year ended December 31, 2021. The allowance was applied to certain receivable accounts which
are over 95 days.
Inventory
Inventory
consists of finished goods and is carried at the lower of cost or net realizable value on a first in first out basis. The Company monitors
the remaining useful life of its inventory and establishes a reserve of obsolescence where appropriate.
Intangible
Assets
Intangible
assets are comprised of patents, net of amortization and trademarks. The patent costs are being amortized over the life of the patent,
which is twenty years from the date of filing the patent application. In accordance with ASC Topic 350 Intangibles – Goodwill
and Other (“ASC 350”), the costs of internally developing other intangible assets, such as patents, are expensed as incurred.
However, as allowed by ASC 350, costs associated with the acquisition of patents from third parties, legal fees and similar costs relating
to patents have been capitalized.
In
accordance with ASC 350 legal costs related to trademarks have been capitalized. We have determined that trademarks have an indeterminable
life and therefore are not being amortized.
Long-Lived
Assets and Other Acquired Intangible Assets
We
evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances
indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable
cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a
comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates
that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced
to fair value. We recorded impairment charges of $746,000 related to idle equipment resulting from overcapacity for single-serve products
and equipment that is held at the Manufacturer in 2022. There was no impairment in 2021.
Property,
Plant, and Equipment
Property,
plant, and equipment is stated at cost less accumulated depreciation and accumulated impairment loss, if any. Depreciation is calculated
on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are being amortized over the shorter of
the useful life of the asset or the lease term that includes any expected renewal periods that are deemed to be reasonably assured. The
estimated useful lives used for financial statement purposes are:
Summary of Estimated Useful Lives of Assets
Furniture
and fixtures |
5
years |
Manufacturing
equipment and customer equipment |
3
years to 7 years |
Vehicles |
5
years |
Revenue
Recognition
In
accordance with ASC 606, Revenue from Contracts with Customers, revenue is recognized when a customer obtains ownership of promised goods.
The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these
goods. The Company applies the following five steps:
|
1) |
Identify
the contract with a customer |
|
|
|
|
|
A
contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s
rights, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration
for goods or services that are transferred is probable. For the Company, the contract is the approved sales order, which may also
be supplemented by other agreements that formalize various terms and conditions with customers. |
|
2) |
Identify
the performance obligation in the contract |
|
|
|
|
|
Performance
obligations promised in a contract are identified based on the goods or services that will be transferred to the customer. For the
Company, this consists of the delivery of frozen beverages, which provide immediate benefit to the customer. |
|
|
|
|
3) |
Determine
the transaction price |
|
|
|
|
|
The
transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods
and is generally stated on the approved sales order. Variable consideration, which typically includes rebates or discounts, are estimated
utilizing the most likely amount method. Provisions for refunds are generally provided for in the period the related sales are recorded, based on management’s
assessment of historical and projected trends. |
|
|
|
|
4) |
Allocate
the transaction price to performance obligations in the contract
Since
the Company’s contracts contain a single performance obligation, delivery of frozen beverages, the transaction price is allocated
to that single performance obligation. |
|
|
|
|
5) |
Recognize
revenue when or as the Company satisfies a performance obligation |
|
|
|
|
|
The
Company recognizes revenue from the sale of frozen beverages when title and risk of loss passes and the customer accepts the goods,
which generally occurs at the time of delivery to a customer warehouse. Customer sales incentives such as volume-based rebates or
discounts are treated as a reduction of sales at the time the sale is recognized. Shipping and handling costs are treated as fulfilment
costs and presented in distribution, selling and administrative costs.
Payments
that are received before performance obligations are recorded are shown as current liabilities. |
|
|
|
|
|
The
Company evaluated the requirement to disaggregate revenue and concluded that substantially all of its revenue comes from a single
product, frozen beverages. |
Research
and Development
Expenditures
for research activities relating to product development and improvement are charged to expense as incurred. The Company incurred $382,000
and $245,000, in research and development expenses for the years ended December 31, 2022 and 2021, respectively.
Storage
and Shipping Costs
Storage
and outbound freight costs are included in selling, marketing and distribution expense. For the years ended December 31, 2022 and 2021,
storage and outbound freight amounted to $1,467,000 and $1,054,000, respectively.
Leases
We
determine if an arrangement is a lease upon inception. A contract is or contains a lease if the contract conveys the right to control
the use of an identified asset for a period of time in exchange for consideration. The right to control the use of an asset includes
the right to obtain substantially all of the economic benefits of the underlying asset and the right to direct how and for what purpose
the asset is used. Operating lease right-of-use assets and liabilities are recognized
at commencement date based on the present value of lease payments over the lease term. Lease expense is recognized on a straight-line
basis over the lease term. As a lessee, the Company leases office space.
Income
Taxes
The
provision for income taxes is determined in accordance with the provisions of ASC Topic 740, Accounting for Income Taxes (“ASC
740”). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets
and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
ASC
740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements,
uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the
financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax
positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of
being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.
ASC
740 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of evidence, it is more than likely
than not that some portion or all of the deferred tax assets will not be recognized.
For
the years ended December 31, 2022 and 2021 we did not have any interest and penalties or any significant unrecognized uncertain tax positions.
Derivative
Liability
The
Company evaluates its convertible instruments, options, warrants or other contracts to determine if those contracts or embedded components
of those contracts qualify as derivatives to be separately accounted for under ASC Topic 815, “Derivatives and Hedging.”
The result of this accounting treatment is that the fair value of any derivative is marked-to-market each balance sheet date and recorded
as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the statement of
operations as gain/loss from derivative liability. Upon conversion or exercise of a derivative instrument, the instrument is marked to
fair value at the conversion date and then that fair value is reclassified to equity. We analyzed the derivative financial instruments
in accordance with ASC 815. The objective is to provide guidance for determining whether an equity-linked financial instrument is indexed
to an entity’s own stock. This determination is needed for a scope exception which would enable a derivative instrument to be accounted
for under the accrual method. The classification of a non-derivative instrument that falls within the scope of ASC 815-40-05 “Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” also hinges on whether
the instrument is indexed to an entity’s own stock. A non-derivative instrument that is not indexed to an entity’s own stock
cannot be classified as equity and must be accounted for as a liability. There is a two-step approach in determining whether an instrument
or embedded feature is indexed to an entity’s own stock. First, the instrument’s contingent exercise provisions, if any,
must be evaluated, followed by an evaluation of the instrument’s settlement provisions. The Company utilized the fair value standard
set forth by the Financial Accounting Standards Board, defined as the amount at which the assets (or liability) could be bought (or incurred)
or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.
The Company’s derivative instruments were settled in 2021, and there
were no outstanding derivatives as of December 31, 2021 or 2022.
Earnings
per Share
We
calculate net loss per share in accordance with ASC Topic 260, Earnings per Share. Basic net loss per share is computed by dividing
net loss by the weighted average number of shares of common stock outstanding for the period, and diluted earnings per share is computed
by including common stock equivalents outstanding for the period in the denominator. At December 31, 2022 and 2021 any equivalents would
have been anti-dilutive as we had losses for the years then ended.
Debt
Extinguishment
The
Company evaluates its convertible instruments in accordance with ASC 470-50, “Debt Modifications and Extinguishments.” For
all extinguishments of debt, ASC 470-50 requires the difference between the reacquisition price (including any premium) and the net carrying
amount of the debt being extinguished (including any deferred debt issuance costs) to be recognized as a gain or loss when the debt is
extinguished. Accordingly, the Company recorded a net loss of $194,000 on extinguishment of debt in its statement of operations for the
year ended December 31, 2021. There were no debt extinguishments in the year ended December 31, 2022.
Stock
Based Compensation
The
Company calculates stock compensation in accordance with ASC Topic 718, Compensation-Stock Based Compensation (“ASC 718”).
ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements and establishes
fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based
measurement method in accounting for share-based payment transactions with employees.
Reclassifications
Certain
reclassifications have been made to the 2021 financial statements to conform to the 2022 presentation, namely the presentation of selling
and marketing expense apart from general and administrative expense in the consolidated statement of operations.
Recent
pronouncements
From
time to time, new accounting pronouncements are issued that we adopt as of the specified effective date. We have not determined if the
impact of recently issued standards that are not yet effective will have an impact on our results of operations and financial position.
Subsequent
events
None.
Note
2. Inventory
Inventory
consists of the following at December 31:
Schedule
of Inventory
| |
2022 | | |
2021 | |
Raw materials | |
$ | 65,000 | | |
$ | 105,000 | |
Finished goods | |
| 983,000 | | |
| 600,000 | |
Inventory, net | |
$ | 1,048,000 | | |
$ | 705,000 | |
Note
3. Property Plant and Equipment
Major
classes of property and equipment consist of the following at December 31:
Schedule
of Major Classes of Property and Equipment
| |
2022 | | |
2021 | |
Manufacturing and customer equipment | |
$ | 3,637,000 | | |
$ | 3,800,000 | |
Other property | |
| 69,000 | | |
| 36,000 | |
Property and equipment, gross | |
| 3,706,000 | | |
| 3,836,000 | |
Less: accumulated depreciation | |
| (3,317,000 | ) | |
| (2,894,000 | ) |
Property and equipment | |
| 389,000 | | |
| 942,000 | |
Equipment not yet placed in service | |
| - | | |
| 646,000 | |
Property and equipment, net of depreciation | |
$ | 389,000 | | |
$ | 1,588,000 | |
We
recorded depreciation expense related to these assets of $467,000
and $557,000
for the years ended December 31, 2022 and 2021, respectively. Depreciation expense in cost of revenue was $29,000
and $18,000
for the years ended December 31, 2022 and 2021 respectively.
Note
4. Intangible Assets
Intangible
assets consist of the following at December 31:
Schedule of Intangible Assets
| |
2022 | | |
2021 | |
Patent costs, subject to amortization | |
$ | 768,000 | | |
$ | 768,000 | |
Less: accumulated amortization | |
| (586,000 | ) | |
| (522,000 | ) |
Patent costs, net | |
| 182,000 | | |
| 246,000 | |
Trademarks, not subject to amortization | |
| 124,000 | | |
| 124,000 | |
Total | |
$ | 306,000 | | |
$ | 370,000 | |
The
amounts carried on the balance sheet represent cost to acquire, legal fees and similar costs relating to the patents incurred by the
Company. Amortization is calculated through the expiration date of the patent. The amount charged to expenses for amortization of the
patent costs was $64,000 for each of the years ended December 31, 2022 and 2021, respectively.
Estimated
future amortization expense related to patents as of December 31, 2022, is as follows:
Schedule
of Estimated Future Amortization Expense Related to Intangible Property
| | |
Total
Amortization | |
Years ending December 31, | | |
| | |
2023 | | |
$ | 64,000 | |
2024 | | |
| 64,000 | |
2025 | | |
| 49,000 | |
2026 | | |
| 5,000 | |
Intangible asset, net of amortization | | |
$ | 182,000 | |
Note
5. Related Parties
Members
of management and directors invested in the Company’s convertible notes (Note 7).
Note
6. Paycheck Protection Program (PPP) Loan
The
PPP was established to provide federally guaranteed, uncollateralized loans to assist businesses during the Covid-10 pandemic. PPP loans
are administered by a Small Business Administration (SBA) approved partners.
On
May 7, 2020 the Company was granted a $568,000 loan which was to mature in two years. On January 27, 2021, the Company was granted a
second $568,000 loan which was to mature in five years. The Company was eligible for loan forgiveness of up to 100% of the loans, upon
meeting certain requirements.
On
May 20, 2021 and December 22, 2021, respectively, the loans were legally released and forgiven by the SBA. Loan forgiveness income of
$1,136,000 has been recorded for the year ended December 31, 2021.
Note
7. Convertible Notes (Related and Unrelated Party)
In
2018, the Company issued Milestone I and Milestone II Convertible Notes.
During
the year ended December 31, 2021, the Company settled all remaining Milestone I Convertible Notes by issuing 89,173 shares of common
stock in exchange for $231,000 ($30,000 related party) and $193,000 ($38,000 related party) in principal and interest, respectively,
and repaying $840,000 ($180,000 related party) in cash. Additionally, the Company settled all remaining amounts due under Milestone II
Convertible Notes by issuing 44,818 shares of common stock in exchange for $168,000 and $42,000 of principal and interest, respectively.
In accordance with ASC 470-50, the Company recorded a loss of $194,000 upon extinguishment of the Milestone I and Milestone II Convertible
Notes.
Note
8. Derivative Liabilities
Milestone
II Convertible Notes (Note 7) contained variable conversion provisions based on the future price of the Company’s common stock,
resulting in the potential issuance of an indeterminate number of shares of common stock upon conversion. The Company measured the fair
value of the derivative resulting from the variable conversion provisions each reporting period. The change in fair value was recorded
in the accompanying consolidated statements of operations.
On
May 26, 2021, the Milestone II Convertible Notes were settled. Upon extinguishment, the derivative liability was revalued to $25,000,
which resulted in a gain of $16,000 for the year ended December 31, 2021.
The
fair value of the derivative liabilities for Milestone II Convertible Notes was calculated using the Black-Scholes model using the following
assumptions:
Schedule
of Fair Value of Derivative Liability
| |
26-May-21 | | |
31-Dec-20 | |
Expected life | |
| 0.46 | | |
| 0.92 | |
Volatility (based on comparable company) | |
| 101.32 | % | |
| 120.38 | % |
Risk free interest rate | |
| 0.04 | % | |
| 0.1 | % |
Dividend yield | |
| - | | |
| - | |
The
following table provides a reconciliation of the beginning and ending balances for the Company’s derivative liabilities measured
at fair value on a recurring basis using Level 3 inputs:
Schedule
of Derivative Liability Measured at Fair Value on a Recurring Basis
Fair value, December 31, 2020 | |
$ | 41,000 | |
Extinguishment of derivative upon debt settlement | |
| (25,000 | ) |
Net gain from change in fair value | |
| (16,000 | ) |
Fair value, December 31, 2021 | |
$ | - | |
Note
9. Commitments and Contingencies
Lease
Commitments
The
Company leases office space under a non-cancelable operating lease which expires on March 31, 2023. The Company incurred lease expense
of $80,000 for the years ended December 31, 2022 and 2021, respectively. As of December 31, 2022, the right of use asset and related
liability were $18,000 and $20,000, respectively.
In
determining the present value of our operating lease right-of-use asset and liability, we used a 10% discount rate (which approximates
our borrowing rate). The remaining term on the lease is 0.25 years. The Company expects to extend the lease on a short-term basis.
Legal
Proceedings
As
described in Note 1, the Company has an on-going dispute with the Manufacturer, the outcome of which cannot be predicted at this time.
From
time to time, various lawsuits and legal proceedings may arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties and an adverse result in these or other matters may arise from time to time that may harm our business. We are
currently the defendant in one legal proceeding for an amount less than $100,000. Our legal counsel and management believe a material
unfavorable outcome to be remote.
Note
10. Stockholders’ Equity
On
June 1, 2021, the Company completed a private placement of 1,282,051 shares of its common stock at $4.68 per share, resulting in gross
proceeds of $6,000,000.
In
2021, holders of debt converted a total of $399,000 in principal and $234,410 in interest into 133,991 shares of common stock, and debt
in the amount of $840,000 was retired (Note 7).
In
2021, the Company issued 17,273 shares of common stock, valued between $4.94 - $10.15 per share, for services rendered.
In
2021, the Company issued a warrant to purchase 10,550 shares of common stock at exercise prices ranging from $3.25 - $5.46 (weighted
average $4.15) in exchange for services rendered.
In
2022, the Company issued 23,643 shares of common stock, valued between $5.00 - $5.16 per share, for services rendered. Additionally,
5,000 fully vested shares of common stock were granted and issued for equity-based compensation at a value of $4.50 per share.
In
2022, the Company issued 986
shares of common stock due to the exercise of a warrant at an exercise price of $5.07.
Warrants
The
following is a summary of changes in warrants outstanding for the years ended December 31, 2022 and 2021:
Summary
of Changes in Warrants Outstanding
| |
Number of
warrants | |
Outstanding at December 31,2020 | |
| 2,204,303 | |
Issued | |
| 10,550 | |
Expired | |
| (927,449 | ) |
Outstanding at December 31, 2021 | |
| 1,287,404 | |
Exercised | |
| (986 | ) |
Expired | |
| (106,228 | ) |
Outstanding at December 31, 2022 | |
| 1,180,190 | |
The
following is a summary of all outstanding warrants as of December 31, 2022:
Summary
of Outstanding Warrants
Warrant issuance event | |
Number of warrants | | |
Weighted
average
exercise
price | | |
Exercise price
per share | | |
Remaining
term in
years | | |
Intrinsic
value at
date of
grant | |
| |
| | |
| | |
| | |
| | |
| |
Private placements of common stock | |
| 818,683 | | |
$ | 6.03 | | |
$ | 5.85 – 6.89 | | |
| 0.28 | | |
$ | - | |
Private placement of notes | |
| 117,692 | | |
$ | 5.85 | | |
$ | 5.85 | | |
| 0.22 | | |
$ | - | |
Settlement of deferred compensation | |
| 243,815 | | |
$ | 6.32 | | |
$ | 3.51 - 9.10 | | |
| 1.74 | | |
$ | - | |
| |
| 1,180,190 | | |
$ | 6.07 | | |
$ | 3.51 - 9.10 | | |
| 0.58 | | |
$ | - | |
Equity
Incentive Plan
Under
the 2015 Equity Incentive Plan (the “2015 Plan”), the Company has reserved 1,153,846 shares for equity incentive awards for
issuance to employees, members of the board of directors and other service providers. Awards may take the form of options, restricted
stock, restricted stock units, performance shares and stock appreciation rights. The Company has issued options with no intrinsic value,
stock awards and stock units through December 31, 2022, and issues new shares upon exercise of options or vesting of stock awards and
stock units. As of December 31, 2022, there were 354,000 shares available for the issuance of awards under the 2015 Plan. The Company
has reserved approximately 30,000 shares for equity awards issued outside of the 2015 Plan.
Stock-Based
Compensation
The
total amount of equity-based compensation included in general and administrative expense in the accompanying consolidated statements
of operations was $386,000 and $92,000 for the years ended December 31, 2022 and 2021.
As
of December 31, 2022, the Company has $281,000 of total unrecognized share-based compensation expense related to unvested options, stock
awards and stock units, which is expected to be amortized over the remaining weighted average period of 1.9 years.
Stock
Options
The
following is a summary of stock option activity:
Summary of Stock Options Activity
| |
Number of
Options | | |
Weighted
average
exercise price
per share | | |
Remaining
term in years | |
| |
| | |
| | |
| |
Outstanding on December 31, 2020 | |
| 614,271 | | |
$ | 7.61 | | |
| 3.8 | |
Issued | |
| 65,805 | | |
$ | 5.63 | | |
| | |
Cancelled/expired | |
| (44,187 | ) | |
$ | 5.08 | | |
| | |
Outstanding on December 31, 2021 | |
| 635,889 | | |
$ | 7.41 | | |
| 3.8 | |
Issued | |
| 64,672 | | |
$ | 5.72 | | |
| | |
Cancelled/expired | |
| (17,622 | ) | |
$ | 5.08 | | |
| | |
Outstanding on December 31, 2022 | |
| 682,939 | | |
$ | 7.30 | | |
| 3.2 | |
| |
| | | |
| | | |
| | |
Exercisable, December 31, 2022 | |
| 595,829 | | |
$ | 7.54 | | |
| 2.7 | |
The
fair value of the options issued was calculated using the Black-Sholes option pricing model, based on the criteria shown below:
Summary of Fair Value of Options Using Black-Sholes Option Pricing Model
| |
2022 | | |
2021 | |
Expected term (in years) | |
| 5.5 - 8 | | |
| 5.5
- 8 | |
Expected volatility | |
| 82.8%
- 85.7 | % | |
| 85.0% - 89.4 | % |
Risk-free interest rate | |
| 1.5% - 3.9 | % | |
| 0.7% - 1.3 | % |
Expected dividends | |
$ | - | | |
$ | - | |
Weighted average grant date fair value per share | |
$ | 4.53 | | |
$ | 4.04 | |
Restricted
Stock
The
following is a summary of restricted stock award and restricted stock unit activity:
Summary
of Restricted Stock Award and Restricted Stock Unit Activity
| |
Number of
shares | | |
Weighted
average grant
date fair value | |
Unvested at January 1, 2021 | |
| - | | |
$ | - | |
Unvested at January 1, 2022 | |
| - | | |
$ | - | |
Granted | |
| 46,554 | | |
$ | 4.96 | |
Forfeited | |
| (4,631 | ) | |
$ | 5.38 | |
Unvested at December 31, 2022 | |
| 41,923 | | |
$ | 4.91 | |
Performance
Stock Units
During
2022, the Company issued performance share units (“PSUs”) that represent shares potentially issuable based upon achievement
of Company and individual performance targets in 2022. The grantees have the ability to earn 0% - 200% of the PSU target award. The awards
also included a time-based service requirement through March 2023.
The
following is a summary of PSU activity:
Summary
of Performance Stock Unit Activity
| |
Number of
shares | | |
Weighted
average grant
date fair value | |
Unvested at January 1, 2022 | |
| - | | |
$ | - | |
Granted | |
| 123,512 | | |
$ | 4.50 | |
Forfeited | |
| (105,834 | ) | |
$ | 4.50 | |
Unvested at December 31, 2022 | |
| 17,678 | | |
$ | 4.50 | |
In
February 2023, the awards were modified to pay the original grant-date fair value of the shares expected to vest in cash.
Additionally, the Company performance targets were modified to allow approximately 77,000
shares to vest that would have otherwise been forfeited. As a result of the modifications, the Company expects to record an
additional $218,000
in compensation expense, primarily in 2023.
Note
11. Income Taxes
Income
tax provision (benefit) for the years ended December 31, 2022 and 2021 is summarized below:
Summary
of Income Tax Provision (Benefit)
| |
2022 | | |
2021 | |
Current: | |
| | | |
| | |
Federal | |
$ | - | | |
$ | - | |
State | |
| - | | |
| - | |
Total | |
| - | | |
| - | |
Deferred: | |
| | | |
| | |
Federal | |
| (956,000 | ) | |
| (1,002,000 | ) |
State | |
| (323,000 | ) | |
| (322,000 | ) |
Change in valuation allowance | |
| 1,279,000 | | |
| 1,324,000 | |
Total | |
| - | | |
| - | |
Provision for income taxes | |
$ | - | | |
$ | - | |
The
provision for income taxes differs from the amount computed by applying the statutory federal income tax rate before provision for income
taxes. The sources and tax effect of the differences are as follows:
Summary
of Statutory Federal Income Tax Rate Before Provision for Income Taxes
| |
2022 | | |
2021 | |
Statutory federal income tax rate | |
| 21 | % | |
| 21 | % |
State tax | |
| 7 | | |
| 7 | |
Permanent differences | |
| - | | |
| (15 | ) |
Change in valuation allowance | |
| (28 | ) | |
| (13 | ) |
Total Income tax | |
| - | % | |
| - | % |
Components
of the net deferred income tax assets at December 31, 2022 and 2021 were as follows:
Schedule
of Components of Net Deferred Income Tax Assets
| |
2022 | | |
2021 | |
Net operating loss carryover | |
$ | 13,948,000 | | |
$ | 12,669,000 | |
Valuation allowance | |
| (13,948,000 | ) | |
| (12,669,000 | ) |
Deferred tax assets,
net | |
$ | - | | |
$ | - | |
ASC
740 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of evidence, it is more than likely
than not that some portion or all of the deferred tax assets will not be recognized. After consideration of all the evidence, both positive
and negative, management has determined that a $13,948,000 and $12,669,000 allowance at December
31, 2022 and 2021, respectively, is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized.
The increase in the valuation allowance for the current period is $1,279,000 resulting for current year tax losses.
As
of December 31, 2022, the Company has a net operating loss carry forward to offset future taxable income of approximately $49,843,000,
$28,482,000 of which begins to expire in 2033. Net operating loss carry forwards of $21,361,000 may be carried forward indefinitely.
The Company may have experienced an ownership change that could limit its ability to utilize its operating loss carryforward to offset
taxable income in future years. An analysis will be required to determine whether such change has occurred, the outcome of which could
impact the Company’s operating results and cash flow if and when it achieves profitability in taxable jurisdictions.
Note
12. Business Segments and Customer Concentrations
The
Company operates in one business segment. Sales to the following customers represented more than 10% of total sales for the years ended
December 31, 2022 and 2021:
Schedule
of Revenue by Major Customers by Reporting Segments
| |
2022 | | |
2021 | |
Customer A | |
| 20 | % | |
| 21 | % |
Customer B | |
| 20 | % | |
| 9 | % |
Customer C | |
| 16 | % | |
| 20 | % |
Note
13. Supplemental Cash Flow Information
Supplemental
cash flow information is as follows:
Schedule
of Cash Flow Supplemental Information
| |
2022 | | |
2021 | |
| |
| | |
| |
Cash paid during the year for: | |
| | | |
| | |
Amounts included in the measurement of lease liabilities | |
$ | 78,000 | | |
$ | 78,000 | |
| |
| | | |
| | |
Non-cash financing and investing activities: | |
| | | |
| | |
Net carrying value of convertible notes and accrued interest extinguished through issuance of stock | |
$ | - | | |
$ | 467,000 | |
Accrued interest paid in stock | |
$ | - | | |
$ | 151,000 | |
Equipment included in accounts payable and accrued liability | |
$ | - | | |
$ | 90,000 | |
Extinguishment of derivative liability | |
$ | - | | |
$ | 25,000 | |
Note
14. Liquidity
During
the years ended December 31, 2022 and 2021, the Company used cash for operations of $2,648,000 and $1,861,000, respectively. The Company
has a history of operating losses and negative cash flow, which were expected to improve with growth, offset by working capital required
to achieve such growth. As described more fully in Note 1, the litigation against the Manufacturer has resulted in uncertainty around
our ability to procure product, which in turn may inhibit our ability to achieve positive cash flow. Additionally, management has considered
that dispute resolution, including litigation, is costly and will require the outlay of cash.
However,
as of December 31, 2022, we have $3,019,000 of cash and restricted cash and even though we have identified certain indicators, these
indicators do not raise substantial doubt regarding the Company’s ability to continue as a going concern. However, we cannot predict,
with certainty, the outcome of its potential actions to generate liquidity, including the availability of additional financing, or whether
such actions would generate the expected liquidity as planned.