BARFRESH FOOD GROUP INC

Barfresh food Group Inc.

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.

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, 2023 and 2022. 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:

Restricted Cash

At December 31, 2022, the Company had $211,000 in restricted cash related to a contract manufacturing agreement. The restricted cash was released in 2023.

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.

Financial Instruments

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 $821,000 and $126,000 as of December 31, 2023 and 2022, respectively. Allowances for credit losses are considered when an undisputed balance is greater than 90 days past due. There wasno allowance for credit losses as of December 31, 2023 and 2022. There wasno credit loss expense for the years ended December 31, 2023 and 2022.

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 350Intangibles – 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 2023.

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:

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:

Research and Development

Expenditures for research activities relating to product development and improvement are charged to expense as incurred. The Company incurred $115,000 and $382,000, in research and development expenses for the years ended December 31, 2023 and 2022, respectively.

Storage and Shipping Costs

Storage and outbound freight costs are included in selling, marketing and distribution expense. For the years ended December 31, 2023 and 2022, storage and outbound freight amounted to $1,278,000 and $1,467,000, 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 agreater 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, 2023 and 2022 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 Company determined that its convertible instruments issued in 2023 did not include any embedded derivatives that require bifurcation.

Loss 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, 2023 and 2022 any equivalents would have been anti-dilutive as we had losses for the years then ended.

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.

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. Restatement of Prior Financial Information

This Company’s previously filed audited balance sheet and statement of operations and cash flow statement 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 restatement reduced the accumulated deficit by $327,000 as of December 31, 2021. The effect of the correction of previously issued financial statements is summarized below:

Note 3. Inventory

Inventory consists of the following at December 31:

Note 4. Property Plant and Equipment

Major classes of property and equipment consist of the following at December 31:

We recorded depreciation expense related to these assets of $339,000 and $380,000 for the years ended December 31, 2023 and 2022, respectively. Depreciation expense in cost of revenue was $18,000 and $29,000 for the years ended December 31, 2023 and 2022 respectively.

Note 5. Intangible Assets

Intangible assets consist of the following at December 31:

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, 2023 and 2022, respectively.

Estimated future amortization expense related to patents as of December 31, 2023, is as follows:

Note 6. Convertible Notes

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.

On October 23, 2023, we drew down $1,390,000 in convertible debt and converted a total of $1,207,000 of principal into 820,160 shares of common stock. Additionally, on December 19, 2023, the Company drew down $470,000 in convertible debt and converted a total of $653,000 of principal and $4,000 of accrued interest into 495,331 shares of common stock, settling all debt. Debt drawdowns included the non-cash settlement of $30,000 in accounts payable.

Note 7. Commitments and Contingencies

Lease Commitments

The Company leases office space under a non-cancelable operating lease which expired on March 31, 2023 and has been extended multiple times, most recently through September 30, 2024. The Company incurred lease expense of $80,000 for the years ended December 31, 2023 and 2022, respectively. Due to the short-term nature of the extensions, there isno right of use asset or related liability as of December 31, 2023. As of December 31, 2022, the right of use asset and related liability were $18,000 and $20,000, respectively.

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 and continues to progress through the court system.

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 a material unfavorable outcome to be remote.

Note 8. Stockholders’ Equity

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.

In 2023, the Company issued 1,315,491 shares of common stock pursuant to the conversion of debt and accrued interest, as more fully described in Note 6.

In 2023, the Company issued 165,779 shares of common stock for equity-based compensation. Additionally,4,094 shares of common stock valued between $1.45 - $4.00 were issued for services.

Warrants

The following is a summary of changes in warrants outstanding for the years ended December 31, 2023 and 2022:

The following is a summary of all outstanding warrants as of December 31, 2023:

Equity Incentive Plan

Through 2022, the Company issued equity incentive 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.

Awards may be granted to employees, members of the Board of Directors and consultants, and 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, 2023, and issues new shares upon exercise of options or vesting of stock awards and stock units.

The Company has reserved approximately 493,000 and 43,000 respectively for awards outstanding under the 2015 Plan and 2023 Plan, and 162,000 shares for equity awards issued outside either of the Company’s equity incentive plans. As of December 31, 2023,607,000 shares remain available for the issuance of awards under the 2023 Plan. Total shares reserved for awards that are outstanding and expected to vest or available for issuance is 1,305,000 as of December 31, 2023.

Stock-Based Compensation

The total amount of equity-based compensation included in general and administrative expense in the accompanying consolidated statements of operations was $290,000 and $386,000 for the years ended December 31, 2023 and 2022.

As of December 31, 2023, the Company has $93,000 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 1.3 years.

Stock Options

The following is a summary of stock option activity:

The fair value of the options issued was calculated using the Black-Sholes option pricing model, based on the criteria shown below:

Restricted Stock

The following is a summary of restricted stock award and restricted stock unit activity:

Performance Stock Units

During 2023 and 2022, the Company issued performance share units (“PSUs”) that represent shares potentially issuable based upon achievement of Company and individual performance targets. The grantees have the ability to earn 0% and, in some cases, up to 200% of the PSU target award. The awards also included various time-based service requirements.

The following is a summary of PSU activity:

In February 2023, the awards granted for 2022 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, and were not included in the total unvested at December 31, 2022. As a result of the modifications, the Company recorded an additional $218,000 in compensation expense in 2023.

Note 9. Income Taxes

Income tax provision (benefit) for the years ended December 31, 2023 and 2022 is summarized below:

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:

Components of the net deferred income tax assets at December 31, 2023 and 2022 were as follows:

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 hasdetermined that a $14,567,000 and $13,948,000 allowance at December 31, 2023 and 2022, 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 $619,000 resulting from current year tax losses net of adjustments to finalize the 2022 tax loss upon filing the tax returns.

As of December 31, 2023, the Company has a net operating loss carry forward to offset future taxable income of approximately $52,056,000, $28,482,000 of which begins to expire in 2033. Net operating loss carry forwards of $23,574,000 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.

CARES Act

On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) to provide certain relief as a result of the COVID-19 pandemic. The CARES Act provides tax relief, along with other stimulus measures, including a provision for an Employee Retention Credit (“ERC”), which allows for employers to claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages paid to employees from the start of the COVID-19 pandemic through September 30, 2021. The ERC was designed to encourage businesses to keep employees on the payroll during the COVID-19 pandemic.

As there is no authoritative guidance under U.S. GAAP on accounting for government assistance to for-profit business entities, the Company accounts for the ERC by analogy to International Accounting Standard (“IAS”) 20, Accounting for Government Grants and Disclosure of Government Assistance. In accordance with IAS 20, management determined based upon receipt of confirmation of the claim made by its co-employment partner and review of the calculations provided that it has reasonable assurance for receipt of the ERC and recorded the ERC benefit of $92,000 within general and administrative expenses in the accompanying consolidated statement of operations for the year ended December 31, 2023. The Company recorded a corresponding receivable for the benefit expected to be received within other receivables on the consolidated balance sheet as of December 31, 2023. The Company received the refund in March 2024.

ERC claims can be made in a variety of circumstances with varying degrees of subjectivity and clear authoritative guidance. Paid claims are subject to IRS inspection which may occur prior to expiration of the statute of limitations. The Company’s ERC claim was based on objectively calculated declines in revenue using methods that are clearly defined in the CARES Act and various regulations and interpretations thereof.

Note 10. 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, 2023 and 2022:

Note 11. Supplemental Cash Flow Information

Supplemental cash flow information is as follows:

Note 12. Liquidity

During the years ended December 31, 2023 and 2022, the Company used cash for operations of $2,958,000 and $2,648,000, 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 7, 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, 2023, we have $1,891,000 of 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.