BARFRESH FOOD GROUP INC. - Quarter Report: 2023 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2023

For the transition period from ________________ to ___________________

Commission File Number: 001-41228

BARFRESH FOOD GROUP INC.

(Exact name of registrant as specified in its charter)

310-598-7113

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by the check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 13,924,774 shares as of October 25, 2023.

TABLE OF CONTENTS

Item 1. Financial Statements.

Barfresh Food Group Inc.

Condensed Consolidated Balance Sheets

See the accompanying notes to the consolidated financial statements

Barfresh Food Group Inc.

Condensed Consolidated Statements of Operations

For the three and nine months ended September 30, 2023 and 2022

(Unaudited)

See the accompanying notes to the consolidated financial statements

Barfresh Food Group Inc.

Consolidated Statements of Cash Flows

For the nine months ended September 30, 2023 and 2022

See the accompanying notes to the consolidated financial statements

Barfresh Food Group Inc.

Notes to Condensed Consolidated Financial Statements

September 30, 2023

(Unaudited)

Note 1. Description of the Business, Basis of Presentation, and 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.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended December 31, 2022 included in the Company’s Annual Report on Form 10-K, as filed with the SEC on March 2, 2023. In management’s opinion, the unaudited interim condensed consolidated financial statements reflect all adjustments, which are of a normal and recurring nature, that are necessary for a fair presentation of financial results for the interim periods presented. Operating results for any quarter are not necessarily indicative of the results for the full fiscal year.

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.

Vendor Concentrations

The Company is exposed to supply risk as a result of concentrations in its vendor base resulting from the use of a limited number of contract manufacturers. Purchases from the Company’s significant contract manufacturers as a percentage of all finished goods purchased were as follows:

 Schedule of Company’s Contract Manufacturers of Finished Goods

Summary of Significant Accounting Policies

There have been no changes to our significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 2, 2023 that have had a material impact on our condensed consolidated financial statements and related notes.

Fair Value Measurement and Financial Instruments

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), requires the valuation of assets and liabilities permitted to be either recorded or disclosed at fair value based on a hierarchy of available inputs as follows:

Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 – Quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets and liabilities in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and

Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value and unobservable (i.e., supported by little or no market activity).

The Company’s financial instruments consist of cash, restricted cash, accounts receivable and accounts payable. The carrying value of the Company’s financial instruments approximates their fair value.

Restricted Cash

At December 31, 2022, the Company had approximately $211,000 in restricted cash related to a co-packing agreement. The restrictions were released in June 2023.

Accounts Receivable and Allowances

Accounts receivable are recorded and carried at the original invoiced amount less allowances for credits and for any potential uncollectible amounts due to credit losses. We make estimates of the expected credit and collectability trends for the allowance for credit losses based on our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from our customers. Expected credit losses are recorded as general and administrative expenses on our condensed consolidated statements of operations. As of September 30, 2023 and December 31, 2022, there was no allowance for expected credit losses.

Other Receivables

Other receivables consist of the Company’s 2021 Employer Retention Tax Credit claim, amounts due from vendors for materials acquired on their behalf for use in manufacturing the Company’s products, vendor rebates and freight claims.

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:

Storage and Shipping Costs

Storage and outbound freight costs are included in selling, marketing and distribution expense. For the three months ending September 30, 2023 and 2022, storage and outbound freight totaled approximately $370,000 and $273,000, respectively. For the nine months ending September 30, 2023 and 2022, storage and outbound freight totaled approximately $932,000 and $1,040,000, respectively.

Research and Development

Expenditures for research activities relating to product development and improvement are charged to expense as incurred. The Company incurred approximately $32,000 and $220,000, in research and development expense for the three months ending September 30, 2023 and 2022, respectively. For the nine months ending September 30, 2023 and 2022, the Company incurred approximately $88,000 and $347,000, respectively.

Loss Per Share

For the three and nine months ended September 30, 2023 and 2022 common stock equivalents have not been included in the calculation of net loss per share as their effect is anti-dilutive as a result of losses incurred.

Reclassifications

Certain reclassifications have been made to the 2022 financial statements to conform to the 2023 presentation, namely the presentation of selling, marketing and distribution expense apart from general and administrative expense in the consolidated statement of operations, the reclassification of materials shipping from selling, marketing and distribution to cost of revenue, and the presentation of the components of cash used in 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.

Note 2. Restatement of Prior Financial Information

This Company’s previously filed unaudited statement of operations and cash flow statement and audited balance sheets have been restated to correct errors in calculating depreciation. From a quantitative and qualitative perspective, the Company determined that correcting the previously filed financial statements would not require amendment to its previously filed reports on Form 10-Q and 10-K. The effect of the correction of previously issued financial statements is summarized below:

 Schedule of Prior Financial Information

Note 3. Inventory

Inventory consists of the following:

 Schedule of Inventory

Note 4. Property Plant and Equipment

Property and equipment, net consist of the following:

 Schedule of Property and Equipment, Net

Depreciation expense related to these assets was approximately $102,000 and $85,000 each of the three months ended September 30, 2023 and 2022, respectively, and $277,000 and $297,000, respectively, for the nine months ended September 30, 2023 and 2022. Depreciation expense in cost of revenue was $4,000 and $10,000 for the three months ended September 30, 2023 and 2022, respectively, and $13,000 and $19,000 for the nine months ended September 30, 2023 and 2022, respectively.

Note 5. Commitments and Contingencies

Lease Commitments

The Company leases office space under a non-cancellable operating lease which expired on March 31, 2023, and was extended in a series of amendments through March 31, 2024. The Company’s periodic lease cost was approximately $20,000 for each of the three months ended September 30, 2023 and 2022 and $60,000 for each of the nine months ended September 30, 2023 and 2022.

Legal Proceedings

Schreiber Dispute

The Company’s products are produced to its specifications through several contract manufacturers. One of the Company’s contract manufacturers (the “Manufacturer”) 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 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 had 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 allowed the parties to reach a potential resolution outside of the court system. However, as the parties were once again unable to come to an agreement, the Company re-filed the Complaint in California State Court in August 2023.

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 has and will continue to adversely impact the Company’s 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. The Company has mitigated the impact of the supply disruption with the introduction of its single-serve smoothie cartons; however the product format has not been accepted by some customers or as a substitute for the bottle product in all use cases.

Other legal matters

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 the probability of a material unfavorable outcome is remote.

Note 6. Convertible Debt Subscriptions

From July to October of 2023, the Company executed subscription agreements for $1,880,000 of a $2,000,000 privately placed convertible debt offering. The debt may be drawn in 25% increments, matures on the anniversary of the draw, bears interest at 10% per annum for the term, regardless of earlier payment or conversion, and is mandatorily convertible as to principal and interest into shares of the Company’s common stock at any time prior to maturity at the greater of $1.20 or 85% of the volume-weighted average price of the common stock for the ten trading days immediately preceding the written notice of the conversion (the “Conversion Price”). If the Company has not exercised the mandatory conversion, the holder of the debt has the option after six months and on up to four occasions to convert all or any portion of the principal and interest into shares of the Company’s common stock at the Conversion Price. The Company made its initial drawdown on the convertible debt on October 23, 2023, as described in Note 10.

Note 7. Stockholders’ Equity

The following are changes in stockholders’ equity for the nine months ended September 30, 2022 and 2023:

 Schedule of Changes in Stockholders' Equity

Warrants

During the nine months ended September 30, 2023, 936,375 warrants at a weighted average exercise price of $6.00 per share expired.

Equity Incentive Plan

Through 2022, the Company issued equity awards under the 2015 Equity Incentive Plan (the “2015 Plan”) and outside the Plan. In June 2023, the Company’s stockholders adopted the 2023 Equity Incentive Plan (the “2023 Plan”), reserving 650,000 shares for future issuance. The Board of Directors discontinued further grants under the 2015 Plan.

As of September 30, 2023, the Company has $153,000 of total unrecognized share-based compensation expense relative to unvested options, stock awards and stock units, which is expected to be recognized over the remaining weighted average period of 1.5 years.

Stock Options

The following is a summary of stock option activity for the nine months ended September 30, 2023:

 Summary of Stock Options Activity

The fair value of the options issued was calculated using the Black-Scholes option pricing model, based on the following:

 Summary of Fair Value of Options Using Black-Sholes Option Pricing Model

Restricted Stock

The following is a summary of restricted stock award and restricted stock unit activity for the nine months ended September 30, 2023:

 Summary of Restricted Stock Award and Restricted Stock Unit Activity

Performance Share Units

During 2022 and 2023, the Company issued performance share units (“PSUs”) that represented shares potentially issuable based upon Company and individual performance in the years of issuance.

The following table summarizes the activity for the Company’s unvested PSUs for the nine months ended September 30, 2023:

 Summary of Performance Stock Unit Activity

In February 2023, the unvested awards issued for individual performance and outstanding at January 1, 2023 were modified to cash-settle the original grant-date fair value of approximately $80,000, resulting in incremental compensation of $56,000 after considering the $24,000 fair value of the vested shares at the date of the modification. Additionally, the Company performance targets were modified to allow approximately 71,000 PSUs to vest, with an additional time-based vesting requirement for approximately 26,000 of the PSUs. Because the awards did not vest based on the original terms, the modification was considered a new grant, resulting in $64,000 in compensation expense in the nine-months ended September 30, 2023.

The Company adopted a 2023 PSU program in April 2023, granting approximately 211,000 PSUs at target performance against company-wide metrics. An additional 76,000 PSUs were granted in September 2023 for performance against individual goals, replacing the Company’s cash bonus program. The results for the three and nine months ended September 30, 2023 include $84,000 in expense for the 2023 PSU program. Estimates of expense associated with 2023 performance will be reassessed each quarter through the performance period.

Note 8. Income Taxes

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 the deferred tax assets will not be recognized. Accordingly, at this time the Company has placed a valuation allowance on all tax assets. As of September 30, 2023, the estimated effective tax rate for 2023 was zero.

There are open statutes of limitations for taxing authorities in federal and state jurisdictions to audit our tax returns from 2018 through the current period. Our policy is to account for income tax related interest and penalties in income tax expense in the statement of operations.

For the three and nine months ended September 30, 2023 and 2022, the Company did not incur any interest and penalties associated with tax positions. As of September 30, 2023, the Company did not have any significant unrecognized uncertain tax positions.

Note 9. Liquidity

During the nine months ended September 30, 2023, the Company used cash for operations of $2,008,000. 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 5, the dispute and subsequent contract termination with the Manufacturer has resulted in limitations in our ability to procure certain products, which has and may continue to inhibit our ability to achieve positive cash flow until we are able to expand our manufacturing capacity. Additionally, management has considered that dispute resolution, including litigation, is costly and will require the outlay of cash.

However, as of September 30, 2023, the Company has $1,011,000 of cash and funding commitments of approximately $1,880,000, as more fully described in Note 6. As such, even though management has identified certain indicators, these indicators do not raise substantial doubt regarding the Company’s ability to continue as a going concern. However, management 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.

Note 10. Subsequent Event – Nasdaq Compliance

On May 5, 2023, the Company received a notice letter from the Listing Qualifications Staff of The Nasdaq Stock Market, LLC (“Nasdaq”) notifying the Company that it was not in compliance with the Listing Rule 5550(b) (the “Rule”), which requires listed companies to maintain a minimum $2,500,000 stockholders’ equity, $35,000,000 market value of listed securities, or $500,000 net income from continuing operations. In its quarterly report for the period ended March 31, 2023, the Company reported stockholders’ equity of $1,845,000, and as a result, did not satisfy the Rule. On June 14, 2023, the Company received a letter from Nasdaq granting the Company an extension through October 30, 2023 to regain compliance with the Rule.

On October 23, 2023, the Company issued convertible notes in the amount of $1,390,000 pursuant to the subscription agreements described in Note 6. Note balances of $1,207,000 were immediately converted into approximately 820,000 shares of common stock. A pro-forma balance sheet giving effect to the transactions is presented below:

 Schedule of Pro-forma Balance Sheet

Management believes that taking into consideration the October 23, 2023 note issuance and conversion, the Company satisfies the stockholders’ equity requirement on a pro-forma basis as of September 30, 2023 and as of October 26, 2023. Nasdaq will continue to monitor the Company’s ongoing compliance with the Rule and, if at the time of its next periodic report the Company does not evidence compliance, it may be subject to delisting.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the financial information included elsewhere in this Quarterly Report on Form 10-Q (this “Report”), including our unaudited condensed consolidated financial statements and the related notes and with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 2, 2023, and other reports that we file with the SEC from time to time.

References in this Quarterly Report on Form 10-Q to “us”, “we”, “our” and similar terms refer to Barfresh Food Group Inc.

Cautionary Note Regarding Forward-Looking Statements

This discussion includes forward-looking statements, as that term is defined in the federal securities laws, based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations, and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. Words such as “anticipate”, “estimate”, “plan”, “continuing”, “ongoing”, “expect”, “believe”, “intend”, “may”, “will”, “should”, “could” and similar expressions are used to identify forward-looking statements.

We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.

Critical Accounting Policies

Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

Results of Operations

Results of Operation for the Three Months Ended September 30, 2023 as Compared to the Three Months Ended September 30, 2022

Revenue and cost of revenue

Revenue increased $197,000, or 8%, from $2,406,000 in 2022 to $2,603,000 in 2023. Revenue in 2022 was negatively impacted by the $630,000 claims estimate resulting from the market withdrawal of product purchased from the Manufacturer due to quality complaints. Excluding the refund claims estimate, revenue was $3,036,000 in 2022 and therefore decreased by $433,000 in 2023, or 14% based on product shipped. Our revenues have been adversely impacted as a result of lost customers and supply constraints resulting from the product issues and related dispute with the Manufacturer. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities.

Cost of revenue for 2023 was $1,690,000 as compared to $3,129,000 in 2022. Cost of revenue in 2022 was negatively impacted by the $932,000 inventory write-off related to the product withdrawal. Excluding the inventory write-off, cost of revenue was $2,197,000 in 2022, and therefore decreased by $507,000 in 2023, or 23% based on product shipped. Excluding the impact of the product withdrawal, cost of revenue declined due to lower revenue, and lower product cost due to a shift in product mix resulting from the limited supply of smoothie bottles.

Our gross profit was $913,000 (35%) and ($723,000) (-30%) for 2023 and 2022, respectively. Adjusted for the product withdrawal, our 2022 gross profit was $839,000 (28%). Adjusted comparative gross margin improvement is a result of favorable product mix, pricing actions, and a slight improvement in the cost of supply chain components.

Selling, marketing and distribution expense

Our operations were primarily directed towards increasing sales and expanding our distribution network.

Selling, marketing and distribution expense decreased approximately $163,000 (-19%) from approximately $860,000 in 2022 to $697,000 in 2023.

Sales and marketing expense decreased approximately $83,000 (-20%) from approximately $410,000 in 2022 to $327,000 in 2023. The decrease is a result of headcount reductions and lower broker commissions due to lower revenue and product mix.

Storage and outbound freight expense decreased approximately $80,000 (-18%) from approximately $450,000 in 2022 to $370,000 in 2023, primarily as a result of the 14% decrease in product shipped as described in the discussion of revenue for the comparative quarters. The volume-related decrease in expense was enhanced by freight efficiencies compared to 2022.

General and administrative expense

General and administrative expense decreased approximately $435,000 (-43%) from approximately $1,013,000 in 2022 to $578,000 in 2023.

Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes. Personnel cost decreased by approximately $140,000 (-42%) from approximately $336,000 to $196,000 and stock-based compensation increased by approximately $84,000 (54%) from $156,000 to $240,000. The decrease in personnel cost resulted from a reduction in headcount and the decision to issue stock-based compensation in lieu of cash bonuses for a portion of the performance criteria in 2023, resulting in a year-to-date reduction of personnel costs of $87,000, including a $60,000 reclassification of expense incurred in the first two quarters of 2023. Additionally, unpaid directors’ fees for 2023 that were expected to be paid in cash were also converted to stock-based compensation, resulting in a year-to-date reduction in cash expense of $75,000, including a $50,000 reclassification of expense incurred in the first two quarters of 2023. Excluding the impact of the compensation modifications for employees and directors, stock-based compensation decreased by $26,000 due to headcount reductions and the non-recurrence of a one-time grant in 2022.

Legal, professional and consulting fees decreased by $37,000 (-38%) as a result of a reduction in outside services in an effort to conserve working capital.

Research and development expense decreased approximately $188,000 (-85%) from approximately $220,000 in 2022 to $32,000 in 2023. Expense was elevated in 2022 as we incurred pre-production expense related to the launch of our carton format, while 2023 expense was limited as activities were minimized to conserve working capital.

Other general and administrative expenses decreased by approximately $79,000 (-44%) due to a reduction in local non-income based taxes and the timing of the Company’s annual meeting.

Net loss

We had net losses of approximately $476,000 and $2,687,000 for the three-month periods ended September 30, 2023 and 2022, respectively. The decrease in net loss of approximately $2,211,000, was the result of the non-recurrence of the estimated refund claims and inventory disposal costs associated with the product withdrawal, improved margins, and a reduction of approximately $575,000 in operating expenses due to cost saving measures and to a lesser extent, reduced volume of product shipped.

Results of Operation for the Nine Months Ended September 30, 2023 as Compared to the Nine Months Ended September 30, 2022

Revenue and cost of revenue

Revenue was $6,205,000 in 2023 compared to $7,731,000 in 2022, a decrease of $1,526,000, or 20%. Revenue in 2022 was negatively impacted by the $630,000 claims estimate resulting from the market withdrawal of product purchased from the Manufacturer. Excluding the refund claims estimate, revenue was $8,361,000 in 2022 and therefore decreased by $2,156,000 in 2023, or 26% based on product shipped. Our revenues have been adversely impacted as a result of lost customers and supply constraints resulting from the product issues and related dispute with the Manufacturer. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities.

Cost of revenue was $3,963,000 in 2023 compared to $6,807,000 in 2022, a decrease of $2,844,000, or 42%. Cost of revenue in 2022 was negatively impacted by the $932,000 inventory write-off related to the product withdrawal. Excluding the inventory write-off, cost of revenue was $5,875,000 in 2022, and therefore decreased by $1,912,000 in 2023, or 33% based on product shipped. Excluding the impact of the product withdrawal, cost of revenue declined due to lower revenue, and lower product cost due to a shift in product mix resulting from the limited supply of smoothie bottles.

Our gross profit was $2,242,000 (36%) and $924,000 (12%) for 2023 and 2022, respectively. Adjusted for the product withdrawal, our 2022 gross profit was $2,486,000 (30%). Adjusted comparative gross margin improvement is a result of favorable product mix, pricing actions, and a slight improvement in the cost of supply chain components.

Selling, marketing and distribution expense

Our operations were primarily directed towards increasing sales and expanding our distribution network.

Selling, marketing and distribution expense decreased approximately $246,000 (-11%) from approximately $2,236,000 in 2022 to $1,990,000 in 2023.

Sales and marketing expense increased approximately $39,000 (4%) from approximately $1,019,000 in 2022 to $1,058,000 in 2023. We incurred additional expense for product sampling of smoothie carton products, equipment maintenance incurred to relaunch bulk product sales in locations that had been non-operational as a result of COVID shutdowns and subsequent labor shortages, and broker commissions as we engaged numerous regional K-12 specialists to expand our geographic reach in the third quarter of 2022. These increases were partially offset by a reduction in personnel costs.

Storage and outbound freight expense decreased approximately $285,000 (-23%) from approximately $1,217,000 in 2022 to $932,000 in 2023 primarily as a result of the 26% decrease in product shipped as described in the discussion of revenue for the comparative year-to-date periods. The volume-related decrease in expense was partially offset by higher costs resulting from product mix and inefficiencies due to production transitions.

General and administrative expense

General and administrative expense decreased approximately $572,000 (-22%) from approximately $2,637,000 in 2022 to $2,065,000 in 2023.

Personnel cost represents the cost of employees including salaries, bonuses, employee benefits and employment taxes and continues to be our largest cost. Personnel cost decreased by approximately $77,000 (-8%) from approximately $1,006,000 to $929,000. The decrease in personnel cost resulted primarily from the confirmation and recognition of our 2021 COVID-related tax credit, partially offset by bonus expense from the 2023 decision to cash settle a portion of the 2022 performance stock units.

Stock-based compensation increased by approximately $76,000 (21%) from $355,000 to $431,000 because 2023 directors’ fees that were expected to be paid in cash were converted to stock-based compensation.

Legal, professional and consulting fees decreased by $75,000 (-24%). We reduced outside services in an effort to conserve working capital.

Research and development expense decreased approximately $259,000 (-75%) from approximately $347,000 in 2022 to $88,000 in 2023. Expense was elevated in 2022 as we incurred pre-production expense related to the launch of our carton format, while 2023 expense was limited as activities were minimized to conserve working capital.

Other general and administrative expenses decreased approximately $162,000 (-30%) from approximately $543,000 in 2022 to $381,000 in 2023 primarily as a result of non-recurring costs related to our uplisting to the NASDAQ stock exchange in 2022, partially offset by legal costs related by our dispute with the Manufacturer.

Net loss

We had net losses of approximately $2,123,000 and $4,276,000 for the nine-month periods ended September 30, 2023 and 2022, respectively. The decrease in net loss of approximately $2,153,000, was the result of the non-recurrence of the estimated refund claims and inventory disposal costs associated with the product withdrawal, improved margins, and a reduction of approximately $835,000 in operating expenses due to cost saving measures, reduced volume of product shipped, and the recognition of our COVID-related tax credit.

Liquidity and Capital Resources

As of September 30, 2023, we had working capital of $541,000 compared with $1,801,000 at December 31, 2022. The decrease in working capital is primarily due to the operating loss for the nine months ended September 30, 2023 as adjusted for non-cash depreciation, amortization and stock-based compensation.

During the nine months ended September 30, 2023, we used $2,008,000 in operations.

The impact of COVID-19 on the Company is constantly evolving. The direct impact to our operations had begun to take effect at the close of the first quarter ended March 31, 2020. Specifically, our business was impacted by dining bans targeted at restaurants to reduce the size of public gatherings. Such bans precluded our single serve products from being served at those establishments for a number of weeks, and in some instances, resulted in abandoned product launches. Furthermore, many school districts closed regular attendance for a period of time thereby disrupting sales of product into that channel. More recently, we have experienced a disruption in the supply chain for manufacturing our products due to COVID-19. While further developments surrounding COVID-19 may arise, the business climate appears to have stabilized in 2023.

On June 1, 2021, the Company completed a private placement of 1,282,051 shares of its common stock at $4.68 per share, resulting in gross proceeds of $6,000,000. In addition, holders of debt converted a total of $399,000 in principal and $234,000 in interest into 133,991 shares of common stock and debt in the amount of $840,000 was retired, leaving the Company with no debt.

From July to October 2023, the Company executed subscription agreements for $1,880,000 of a $2,000,000 privately placed convertible debt offering. The debt may be drawn in 25% increments, matures on the anniversary of the draw, bears interest at 10% per annum for the term, regardless of earlier payment or conversion, and is mandatorily convertible as to principal and interest into shares of the Company’s common stock at any time prior to maturity at the greater of $1.20 or 85% of the volume-weighted average price of the common stock for the ten trading days immediately preceding the written notice of the conversion (the “Conversion Price”). If the Company has not exercised the mandatory conversion, the holder of the debt has the option after six months and on up to four occasions to convert all or any portion of the principal and interest into shares of the Company’s common stock at the Conversion Price. On October 23, 2023, the Company issued $1,390,000 of convertible notes pursuant to the subscription agreements, and immediately converted $1,207,000 of principal and interest into approximately 820,000 shares of common stock.

Our liquidity needs will depend on how quickly we are able to profitably ramp up sales, as well as our ability to control and reduce variable operating expenses, and to continue to control and reduce fixed overhead expense. Our current dispute with the Manufacturer and the resulting loss of product supply and legal expense continue to negatively impact our financial position, results of operations and cash flow. While the introduction of our carton packaging format has mitigated the loss of supply, the product offering has not been accepted by some customers or as a substitute for the bottle product in all use cases. We have identified and are actively working to develop additional smoothie bottle manufacturing capacity. We expect expanded capacity to become available in early 2024, subject to the risks and uncertainties associated with contracting and pre-production activities.

Our operations to date have been financed by the sale of securities, the issuance of convertible debt and the issuance of short-term debt, including related party advances. If we are unable to generate sufficient cash flow from operations with the capital raised we will be required to raise additional funds either in the form of equity or in the form of debt. There are no assurances that we will be able to generate the necessary capital to carry out our current plan of operations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expense, results of operations, liquidity, capital expenditures or capital resources that are material to stockholders.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not required because we are a smaller reporting company.

Item 4. Controls and Procedures.

Evaluation of 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 13(a)-15(e). Disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Exchange Act has been appropriately recorded, processed, summarized and reported on a timely basis and are effective in ensuring that such information is accumulated and communicated to the Company’s management, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of September 30, 2023, our disclosure controls and procedures are not effective.

Management has identified the following material weaknesses in our internal control over financial reporting:

Management has concluded that there is a material weakness due to the control environment which led to a restatement in the second quarter of 2022. 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.

In an effort to remediate the identified material weakness and enhance our internal control over financial reporting, we have hired additional personnel to help ensure that we are able to properly implement internal control procedures.

Management believes that the material weakness set forth above did not have an effect on our financial results.

Changes in Internal Control over Financial Reporting

None

PART II- OTHER INFORMATION

Item 1. Legal Proceedings.

As described in Note 5, 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.

Item 1A. Risk Factors.

Not required because we are a smaller reporting company.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the quarter ended September 30, 2023, the Company issued 102,011 shares of common stock for services valued at $178,000. The Company relied upon the exemption from registration contained in Rule 506(b) and Section 4(a)(2) of the Securities Act, and corresponding provisions of state securities laws, on the basis that (i) offers were made to a limited number of persons, (ii) each offer was made through direct communication with the offerees by the Company, (iii) each of the offerees, which included an officer and two directors of the Company, had the requisite sophistication and financial ability to bear risks of investing in the Company’s common stock, (iv) the Company provided disclosure to the offerees, and (v) there was no general solicitation and no commission or remuneration was paid in connection with the offers.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

From July to October 2023, the Company executed subscription agreements for $1,880,000 of a $2,000,000 privately placed convertible debt offering. The debt may be drawn in 25% increments, matures on the anniversary of the draw, bears interest at 10% per annum for the term, regardless of earlier payment or conversion, and is mandatorily convertible as to principal and interest into shares of the Company’s common stock at any time prior to maturity at the greater of $1.20 or 85% of the volume-weighted average price of the common stock for the ten trading days immediately preceding the written notice of the conversion (the “Conversion Price”). If the Company has not exercised the mandatory conversion, the holder of the debt has the option after six months and on up to four occasions to convert all or any portion of the principal and interest into shares of the Company’s common stock at the Conversion Price. On October 23, 2023, the Company issued $1,390,000 of convertible notes pursuant to the subscription agreements, and immediately converted $1,207,000 of principal and interest into approximately 820,000 shares of common stock.

Item 6. Exhibits.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.