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Barfresh Food Group Inc. – ‘10-Q’ for 9/30/19

On:  Thursday, 11/14/19, at 4:26pm ET   ·   For:  9/30/19   ·   Accession #:  1493152-19-17495   ·   File #:  0-55131

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

11/14/19  Barfresh Food Group Inc.          10-Q        9/30/19   65:3.9M                                   M2 Compliance/FA

Document/Exhibit                   Description                      Pages   Size 

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                (Parenthetical)                                                  
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                (Unaudited)                                                      
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                (Unaudited)                                                      
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                (Policies)                                                       
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ___________________

Commission File Number: 000-55131

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)

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 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.

[X] Yes [  ] No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

[X] 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 definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

If an emerging growth company, indicate by 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 [X] No

As of November 8, 2019, there were 130,341,737 outstanding shares of common stock of the registrant.

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

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Barfresh Food Group Inc.

Condensed Consolidated Balance Sheets

See the accompanying notes to the condensed consolidated financial statements

Barfresh Food Group Inc.

Condensed Consolidated Statements of Operations

For the three and nine months ended September 30, 2019 and 2018

See the accompanying notes to the condensed consolidated financial statements

Barfresh Food Group Inc.

Condensed Consolidated Statements of Cash Flows

For the nine months ended September 30, 2019 and 2018

See the accompanying notes to the condensed consolidated financial statements

Barfresh Food Group Inc.

Notes to Condensed Consolidated Financial Statements

September 30, 2019

(Unaudited)

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. We are engaged in the manufacturing and distribution of ready to blend beverages, particularly, smoothies, shakes and frappes.

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

Basis 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 September 30, 2019 and December 31, 2018. 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.

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.

Our financial instruments consist of cash, accounts receivable, accounts payable, derivative liabilities, and convertible notes. The carrying value of our financial instruments approximates their fair value, except for the derivative liability in which carrying value is fair value.

Accounts Receivable

Accounts receivable are typically unsecured. Our credit policy calls for payment generally within 30 days. The credit worthiness of a customer is evaluated prior to a sale. As of September 30, 2019 and December 31, 2018, the company’s allowance for doubtful accounts was $61,788 and $61,788, respectively. The allowance was estimated based on evaluation of collectability of outstanding accounts receivable.

Inventory

Inventory consists of finished goods and is carried at the lower of cost or 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. As of September 30, 2019 and December 31, 2018, the Company’s inventory reserve was $54,592 and $31,237, respectively.

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 have not recorded any significant impairment charges during the years presented.

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:

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 Company adopted this standard at the beginning of fiscal year 2018, with no significant impact to its financial position or results of operations, using the modified retrospective method. 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 general and administrative and are expensed as incurred. We incurred $127,123 and $150,299, in research and development expenses for the three-months ended September 30, 2019 and 2018, respectively. For the nine-month periods ended September 30, 2019 and 2018, research and development costs totaled $400,108 and $493,969, respectively.

Shipping and Handling Costs

Shipping and handling costs are included in general and administrative expenses. For the three-month periods ended September 30, 2019 and 2018, shipping and handling costs totaled $248,291 and $246,766, respectively. For the nine-month periods ended September 30, 2019 and 2018, shipping and handling costs totaled $501,685 and $681,188, respectively.

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 three-months and nine-months ended September 30, 2019 and 2018 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 asset (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.

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 September 30, 2019 and 2018 any equivalents would have been anti-dilutive as we had losses for the periods then ended.

Stock Based Compensation

We calculate 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 except for equity instruments held by employee stock ownership plans.

Reclassifications

Certain reclassifications of amounts previously reported have been made to the accompanying consolidated financial statements to maintain consistency between periods presented. The reclassifications had no impact on net loss or stockholder’s equity.

Recent pronouncements

From time to time, new accounting pronouncements are issued that we adopt as of the specified effective date. We believe that the impact of recently issued standards that are not yet effective may have an impact on our results of operations and financial position.

In February 2016, the FASB issued ASU No. 2016-02, “Leases”, to improve financial reporting about leasing transactions. This ASU will require organizations that lease assets (“lessees”) to recognize a lease liability and a right-of-use asset on its balance sheet for all leases with terms of more than twelve months. A lease liability is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset represents the lessee’s right to use, or control use of, a specified asset for the lease term. The amendments in this ASU leaves the accounting for the organization that own the assets leased to the lessee (“lessor”) largely unchanged except for targeted improvements to align it with the lessee accounting model and Topic 606, “Revenue from Contracts with Customers”.

The Company has evaluated the effect of the standard on our financial statements. Based on our evaluation, we have one material lease subject to adoption of this standard, effective January 1, 2019. As disclosed in Note 7, we entered into a new office space lease that took effect on April 1, 2019 and recorded a right-of-use asset and corresponding liability for amounts that approximate our future commitments of $241,555.

Note 2. Property Plant and Equipment

Major classes of property and equipment at September 30, 2019 and December 31, 2018:

We recorded depreciation expense related to these assets of $135,652 and $148,700 for the three-months ended September 30, 2019 and 2018, respectively and $460,898 and $378,985 for the nine months ended September 30, 2019 and 2018, respectively. Depreciation expense in Cost of Goods Sold was $29,905 and $18,175 for three-months ended September 30, 2019 and 2018 respectively and $61,385 and $48,511 for the nine months ended September 30, 2019 and 2018 respectively.

Note 3. Intangible Assets

As of September 30, 2019, intangible assets consist of patent costs of $764,891, trademarks of $104,194 and accumulated amortization of $378,118.

As of December 31, 2018, intangible assets consist of patent costs of $764,891, trademarks of $103,309 and accumulated amortization of $330,411.

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 patents, which is December 2025. The amount charged to amortization was $15,902 and $15,902 for the three-months ended September 30, 2019 and 2018, respectively and $47,707 and $47,707 for the nine months ended September 30, 2019 and 2018 respectively.

Estimated future amortization expense related to patents as of September 30, 2019, is as follows:

Note 4. Related Parties

As disclosed below in Note 5, members of management and directors invested in the company’s convertible notes; and in Note 8, members of management and directors have received shares of stock and options in exchange for services.

Note 5. Convertible Notes (Related and Unrelated Party)

In March 2018, we closed an offering of $2,527,500 in convertible notes, Series CN Note 1 of 2, of which, management, directors and significant shareholders have invested $840,000. The convertible notes bear 10% interest per annum and are due and payable on March 14, 2020. The notes are convertible at any time prior to the due date into our common stock at a conversion price of $0.88 per share or 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no event lower than $0.60 per share. In addition, the interest is convertible at any time prior to the due dates into our common stock at conversion price of 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no event lower than $0.60 per share. There were 1,331,583 warrants issued, in conjunction with the convertible note offering.

The fair value of the warrants, $0.17 per share ($220,548 in the aggregate), was calculated using the Black-Scholes option pricing model using the following assumptions:

The value of $220,548 was recorded as a debt discount related to the issuance of the warrants.

In April 2018, we offered investors in our March 2018 Convertible Note (“Series CN Notes”) the opportunity to accelerate the issuance of certain warrants associated with the CN Notes. Pursuant to the acceleration offer, Series CN Notes investors who invested an additional 10% to 20% of the Series CN Note amount, immediately received an additional 25% warrant coverage on their initial CN Note investment, which would otherwise have been issued after one year. During April 2018, we closed the CN Note acceleration offer in the amount of $177,300 in convertible notes, of which, management, directors and significant shareholders have invested $30,000. The CN Note acceleration offer convertible notes bear 10% interest per annum and are due and payable on March 14, 2020. The notes are convertible at any time prior to the due date into our common stock at conversion price of $0.88 per share or 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no events lower than $0.60 per share. In addition, the interest is convertible at any time prior to the due dates into our common stock at conversion price of 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no event lower than $0.60 per share. There were 937,373 warrants issued in conjunction with the Series CN Note acceleration offer convertible note offering.

The fair value of the warrants, $0.25 per share ($235,519 in the aggregate), was calculated using the Black-Scholes option pricing model using the following assumptions:

The value of $105,199 was recorded as a debt discount related to the issuance of the warrants as using the fair value would cause the debt discount to exceed the gross proceeds received.

In November and December 2018, three investors elected to convert their convertible note issued on March 14, 2018 into stock. The total debt converted was $453,000 and $30,459 accrued interest into 804,396 shares of stock.

In March 2019, an investor elected to exercise I-Warrants by using part of the investor’s convertible note. The total debt settled was $350,634 of principal and $33,929 of accrued interest.

The convertible notes consist of the following components as of September 30, 2019 and December 31, 2018:

The total shown in the above table of $1,722,936 at September 30, 2019, ties to the total shown in the balance sheet of Current Liabilities: Convertible Note – related party net of discount, of $761,252, and Convertible Note – net of Discount of $961,684. The total in the above table of $1,741,107 at December 31, 2018, plus the total from the table below of $468,216 ($2,209,323) ties to the total shown in the balance sheet of Long Term Liabilities: Convertible note – related party, net of discount of $841,836, and Convertible Note, net of discount, of $1,367,487.

In December 2018, we closed an offering of $1,363,200 in convertible notes, Series CN 2 of 2, of which, management, directors and significant shareholders have invested $560,000. The convertible notes bear 10% interest per annum and are due and payable on November 30, 2020. The notes are convertible at any time prior to the due date into our common stock at conversion price of $0.88 per share or 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no event lower than $0.60 per share. In addition, the interest is convertible at any time prior to the due dates into our common stock at a conversion price of 85% of the average closing price of the common stock over the twenty consecutive trading days immediately preceding the date of note holders’ election; but in no event lower than $0.60 per share. There were 678,864 warrants issued, in conjunction with the convertible note offering.

The fair value of the warrants, $0.31 per share ($212,763 in the aggregate), was calculated using the Black-Scholes option pricing model using the following assumptions:

The value of $212,763 was recorded as a debt discount related to the issuance of the warrants.

The convertible notes consist of the following components as of September 30, 2019 and December 31, 2018:

The total shown in the above table of $816,197 at September 30, 2019, ties to the total shown in the balance sheet of Long-term Liabilities: Convertible Note – related party net of discount, of $335,292, and Convertible Note – net of Discount of $480,905. The total in the first table above of $1,741,107 at December 31, 2018, plus the total from the second table above of $468,216 ($2,209,323) ties to the total shown in the balance sheet of Long Term Liabilities: Convertible note – related party, net of discount of $841,836, and Convertible Note, net of discount, of $1,367,487.

As of September 30, 2019, the outstanding balances due of the Series CN Notes, net of all related debt discount, total $2,539,133. The related party convertible notes (net) and unrelated party convertible notes (net) represent $1,096,544 and $1,442,589, respectively as of September 30, 2019.

Future maturity of convertible notes at face value before effect of all discount, are as follow:

Note 6. Derivative Liabilities

As discussed in Note 5, Convertible Notes, the Company issued Series CN Note acceleration offer convertible notes payable that provide variable conversion provisions. The conversion terms of the convertible notes are variable based on certain factors, such as the future price of the Company’s common stock. The number of shares of common stock to be issued is based on the future price of the Company’s common stock, therefore the number of shares of common stock issuable upon conversion of the promissory note is indeterminate.

The fair values of the Company’s derivative liabilities are estimated at the issuance date and are revalued at each subsequent reporting date. The Company recognized a derivative liability and debt discount of $569,588 at March 14, 2018 related to the Series CN Convertible notes 1 of 2; $69,400 at April 11, 2018 related to the Series CN Notes Warrant Acceleration; and $697,186 at November 30, 2018 related to the Series CN Convertible note 2 of 2. The derivative liability was revalued at September 30, 2019 with a value of $228,121. The Company recorded a gain of $704,798 and a loss of ($5,911) for the three-months ended September 30, 2019 and 2018, respectively, and $1,097,532 and a loss of ($253,807) for the nine-months ended September 30, 2019 and 2018, respectively, related to the derivative liability.

The fair value of the derivative liability for CN Convertible Note 1 of 2 and CN Note Warrant Acceleration was calculated using the Black-Scholes model using the following assumptions.

The fair value of the derivative liability for CN Convertible Note 2 of 2 was calculated using the Black-Scholes model using the following assumptions.

Reconciliation of the derivative liability measured at fair value on a recurring basis with the use of significant unobservable inputs (level 3) from December 31, 2018 to September 30, 2019:

The following table presents the Company’s fair value hierarchy for applicable assets and liabilities measured at fair value as of December 31, 2019 and September 30, 2018.

Note 7. Commitments and Contingencies

We lease office space under non-cancelable operating lease which expires on March 31, 2023. Our periodic lease cost and operating cash flows was $46,614 and $19,610 for the three months ended September 30, 2018 and 2019, respectively and $147,197 and $70,422 for the nine months ended September 30, 2018 and 2019, respectively. As of September 30, 2019, our right of use asset and related liability was $216,273 and $228,777.

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 3.50 years.

The following table presents the future operating lease payment as of September 30, 2019.

Note 8. Stockholders’ Equity

During the nine-months ended September 30, 2019, we issued 995,210 options to purchase our common stock to employees. The exercise price of the options ranged from $0.45 to $0.73 per share, vest after 3 years, and are exercisable for a period of 8 years.

The fair value of the options issued ($337,474, in the aggregate) was calculated using the Black-Sholes option pricing model, based on the criteria shown below.

The shares of our common stock were valued at the trading price on the date of grant, $0.45 and $0.73 per share

During the same period, we cancelled 402,333 options to purchase our common stock.

The total amount of equity-based compensation included in additional paid in capital was $67,185 and $209,082 for the three-months ended September 30, 2019 and 2018, respectively, and was $338,683 and $686,027 for the nine-months ended September 30, 2019 and 2018 respectively.

The following is a summary of outstanding stock options issued to employees and directors as of September 30, 2019:

The following is Changes in Stockholders’ Equity as of September 30, 2018 and September 30, 2019:

Note 9. Outstanding Warrants

The following is a summary of all outstanding warrants as of September 30, 2019:

Note 10. 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. 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. Accordingly, at this time the Company has placed a valuation allowance on all tax assets. As of September 30, 2019, the estimated effective tax rate for the year will be zero.

There are open statutes of limitations for taxing authorities in federal and state jurisdictions to audit our tax returns from 2009 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. There have been no income tax related interest or penalties assessed or recorded.

ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This pronouncement also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

For the nine-month periods ended September 30, 2019 and 2018, we did not have any interest and penalties associated with tax positions. As of September 30, 2019, we did not have any significant unrecognized uncertain tax positions.

Note 11. Liquidity

During the nine months ended September 30, 2019, we used cash for operations of $3,191,642, and purchased equipment for $418,456. We raised cash from the issuance of stock in the amount of $2,400,000, and we received cash for the exercise of warrants in the amount of $1,500,309. During the nine months ended September 30, 2018, we used $3,536,246 of cash for operations, $912,102 for the purchase of equipment, received $37,968 from the sale of equipment, and used $6,322 for trademarks. We raised cash in the amount of $2,677,800 from the issuance of convertible notes, net of issuance costs, $250,000 from the issuance of short-term notes, and $550,000 from the exercise of warrants.

We have a history of operating losses and negative cash flow. As our operations grow, we expect to experience significant increases in our working capital requirements. These conditions raise substantial doubt over the Company’s ability to continue as a going concern within one year after the date the financial statements are issued. Management has evaluated these conditions, and concluded that the mitigating actions discussed in this footnote are probable of occurring and mitigating the substantial doubt raised by our historical operating results, and satisfying our liquidity needs twelve months from the issuance of the financial statements. However, the Company cannot predict, with certainty, the outcome of its actions to preserve liquidity, including the accuracy of its financial forecast, the ability to sustain the current trend of cost cutting, or the ability to extend the maturity date of the debt that is maturing in March of 2020.

As of September 30, 2019, we had $1,318,114 of cash on the balance sheet. We have continued to significantly reduce core operating expenses, reducing total General and Administrative Expense in the first nine months of 2019 by $1,012,467, or 16%, as compared with the first nine months of 2018. The Company’s forecast for the next twelve months reflects a continuation of the improvement in cash flow from operations as the Company continues to reduce operating expenses and increase contracts with school locations, and military bases, and anticipates the roll-out of a National Account with over 2,500 locations. The Company has implemented numerous cost reduction measures which will reduce cash expenses over the next twelve months, including relocation of its headquarters office, as well as entering into a new contract for personnel related services. These two measures alone will yield $200,000 per year in cash savings, and the Company continues to pursue additional measures to reduce cash expenses. In addition, the Company has implemented new logistics arrangements which have already yielded substantial savings in the first nine months of 2019, which is expected to continue and accelerate over the next twelve months.

The Company has $1.9 million of convertible short term debt coming due in March of 2020. Approximately half of this debt is held by insiders. The Company expects that if available cash upon maturity of this debt is not adequate to repay the convertible short term debt, it will be able to extend the maturity date of that debt, in particular the portion held by insiders.

Management has evaluated these conditions, and concluded that there is substantial doubt over the Company’s ability to continue as a going concern. The actions discussed in this footnote could mitigate the substantial doubt raised by our historical operating results, and satisfying our liquidity needs twelve months from the issuance of the financial statements. However, the Company cannot predict, with certainty, the outcome of its actions to preserve liquidity, including the accuracy of its financial forecast, the ability to sustain the current trend of cost cutting, or the ability to extend the maturity date of the debt that is maturing in March of 2020.

Note 12. Subsequent Events

Management has evaluated all activity and concluded that no subsequent events have occurred that would require recognition in the financial statements or disclosure in the notes to the financial statements.

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. References in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section to “us”, “we”, “our” and similar terms refer to Barfresh Food Group Inc. 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.

Barfresh is a leader in the creation, manufacturing and distribution of ready to blend frozen beverages. The current portfolio of products includes smoothies, shakes and frappes. Products are packaged in two distinct formats. The Company’s original single serve format features portion controlled and ready to blend beverage ingredient packs or “beverage packs”. The beverage packs contain all of the solid 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.

The Company’s bulk “Easy Pour” format also contains all of the solid ingredients necessary to make the beverage, packaged in gallon containers in a concentrated formula that is mixed “one to one” with water. The Company has recently launched a “no sugar added” version of the bulk “Easy Pour” format that is 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. The Company currently provides its products to over 400 school locations. In addition, the Company recently 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 has begun to sell its bulk Easy Pour product into a number of military bases in the United States. The Company currently provides its products to over 150 military base locations.

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. Barfresh’s primary broadline distribution arrangement is through an exclusive nationwide agreement with Sysco Corporation (“Sysco”), the U.S.’s largest broadline distributor, which was entered into during July 2014, and the exclusivity provisions of the contract were renewed for an additional two year term on October 2, 2017. On October 2, 2019, the exclusive distribution agreement with Sysco expired, opening the possibility to expand distribution with other distributors outside of the Sysco system.

During 2016 and 2017 the Company announced that it had signed supply agreements with several of the major global on-site foodservice operators. On March 8, 2018, the Company announced that it had signed a new supply agreement with one of the largest of these foodservice operators, for exclusive distribution of four of Barfresh’s single serve SKUs. On November 14, 2018, the Company announced that it had received approval for multiple products to be rolled out to a national restaurant chain with over 2,500 locations.

The Company also sells to broadline distributors that supply products to the food services market place. Effective July 2, 2014, the Company entered into an exclusive agreement with Sysco Merchandising and Supply Chain Services, Inc. for resale by the Sysco Corporation (“Sysco”) to the foodservice industry of the Company’s ready-to-blend smoothies, shakes and frappes. Pursuant to that agreement, all Barfresh products are included in Sysco’s national core selection of beverage items, making Barfresh its exclusive single-serve, pre-portioned beverage provider. The agreement is mutually exclusive; however, Barfresh may also sell the products to other foodservice distributors, but only to the extent required for such foodservice distributors to service multi-unit chain operators with at least 20 units and where Sysco is not such multi- unit chain operator’s nominated distributor for our products. On October 2, 2017, the exclusivity provisions of the Sysco agreement were extended for an additional two year period, and expanded to cover bulk easy pour products, on a non-exclusive basis. On October 2, 2019, the exclusive distribution agreement with Sysco expired, opening the possibility to expand distribution with other distributors outside of the Sysco system.

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. Through this agreement, Barfresh’ products are included as part of PepsiCo’s offerings to its significant customer base. The agreement facilitates access to potential National customer accounts, through introductions provided by PepsiCo’s one-thousand plus person foodservice sales team. Barfresh products have become part of PepsiCo’s customer presentations at national trade shows and similar venues.

Barfresh utilizes contract manufacturers to manufacture all of the products in the United States. Production lines are currently operational at two locations. The first location is in Salt Lake City, which currently produces bulk easy pour products. The second location is with Yarnell Operations, LLC., a subsidiary of Shulze and Burch, located in Arkansas. The Yarnell’s agreement, which was signed during February, 2016, secures the capacity to ramp up to an incremental production capacity of 100 million units. Yarnell’s location enhances the company’s ability to efficiently move product throughout the supply chain to destinations in the eastern United States, home to many of the country’s large foodservice outlets.

During November 2016, the Company received an equity investment from Unibel, the majority shareholder of the Bel Group (“Unibel”). The Bel Group is headquartered in Paris, France, with global operations in 33 countries, 30 production sites on 4 continents and nearly 12,000 employees. Its many branded products, including The Laughing Cow®, Mini Babybel® and Boursin®, are sold in over 130 countries around the world. Pursuant to the securities purchase agreement, Unibel purchased 15,625,000 shares of common stock at $0.64 per share (“Shares”) and warrants to purchase 7,812,500 shares of common stock (“Warrants”) for aggregate gross proceeds to Barfresh of $10 million. The Warrants are exercisable for a term of five years at a per share price of $.88 for cash. Pursuant to the Investor Rights agreement, Barfresh has registered the Shares and the Warrants, and Unibel was granted a seat on the Barfresh Board. This strategic investment provided Barfresh with necessary capital while leveraging Unibel’s more than 150 years of industrial expertise, innovative capabilities, world-class marketing and branding expertise to accelerate our growth in new and existing markets and product channels.

On February 14, 2018, we announced the private placement of convertible notes with gross proceeds of $4.1 million The closing shall be no later than five (5) business days after receipt of notice from the Company that it has achieved certain milestones establishing significant sales to national accounts. One milestone is that the Company shall have entered into a material agreement or series of related agreements with a national account for the sale of its products into approximately 1,000 new locations. The first milestone was achieved on March 8, 2018, and according to the terms of the note the Company has received 60% of the principal amount. The remaining 40% of the principal amount was received upon achieving a second milestone on November 30, 2018.

The convertible notes are unsecured and have (i) a two-year term, (ii) a 10% annual coupon to be paid in cash or stock at the Company’s discretion at a conversion price equal to 85% of the average closing bid prices of the Common Stock over the twenty (20) consecutive trading day period immediately preceding the payment date, but in no event lower than sixty cents ($0.60) per share of Common Stock. The investor’s may elect to convert their principal into common stock at a conversion price equal to the lower of: (i) $0.88 per share of Common Stock, or (ii) 85% of the average closing bid prices of the Common Stock over the twenty (20) consecutive trading day period immediately preceding the date of investor’s election to convert; but in no event lower than $0.60 per share of Common Stock. Investors also received warrant coverage of 25% of the number of shares that would be issuable upon a full conversion of the principal amount at an average of the twenty consecutive trading day period immediately preceding the applicable closing date. If any principal amount remains outstanding after the one-year anniversary of the closing, investors will be granted an additional warrant with identical terms. The warrants are exercisable for a period of three years for cash at the greater of 120% of the closing price or $0.70 per share of common stock. After the initial private placement, investors were offered the opportunity to accelerate the issuance of the additional warrant by increasing their convertible note investment by 10% to 20%. After the close of the first quarter, a number of investors took advantage of this acceleration opportunity, resulting in an increase in the amount of the total convertible note by $177,300 and the issuance of 930,332 additional warrants.

Currently we have 22 employees, 1 part-time employee, and 2 consultants. There are currently 13 employees selling our products.

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 Company adopted this standard at the beginning of fiscal year 2018, with no significant impact to its financial position or results of operations, using the modified retrospective method. 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:

Impairments

We periodically evaluate whether the carrying value of long-lived assets has been impaired when circumstances indicate the carrying value of those assets may not be recoverable. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying value is not recoverable, the impairment loss is measured as the excess of the asset’s carrying value over its fair value.

Share-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), 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.

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.

Leases

The Company adopted ASC Topic 842, effective January 1, 2019, which modifies the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less are accounted for in the same manner as operating leases under ASC Topic 840.

The Company determines whether a contract is or contains a lease at inception of the contract based on whether an identified asset exists and whether the Company has the right to obtain substantially all of the benefit of the assets and to control its use over the full term of the agreement. When available, the Company uses the rate implicit in the lease to discount lease payments to present value. However, none of our leases provide a readily determinable implicit rate. Therefore, the Company estimated its incremental borrowing rate considering both the revolving credit rates and a credit notching approach to discount the lease payments based on information available at lease commencement. There are no material residual value guarantees and no restrictions or covenants included in the Company’s lease agreements. Certain of the Company’s leases include provisions for variable payments. These variable payments are typically determined based on a measure of throughput or actual days or another measure of usage and are not included in the calculation of lease liabilities and right-of-use assets.

Results of Operations

Results of Operation for Three Months Ended September 30, 2019 as Compared to the Three Months Ended September 30, 2018

Revenue and cost of revenue

Revenue decreased $55,038 (3%) from $1,620,214 in 2018 to $1,565,176 in 2019. The overall revenue of the third quarter 2019 was comparable to third quarter in 2018. Our product continues to be distributed through all 72 of Sysco’s U.S. mainland distribution centers, as well as through new customers beyond the Sysco distribution network.

Cost of revenue for 2019 was $684,064 as compared to $723,719 in 2018. Our gross profit was $851,207 (54.4%) and $878,320 (54.2%) for 2019 and 2018, respectively. We anticipate that our gross profit percentage for the remainder of 2019 will be consistent with the most recent quarter.

Operating expenses

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

Our general and administrative expenses decreased $477,806 (22%) from $2,139,064 in 2018 to $1,661,258 in 2019, with the improvement primarily driven by marketing and selling expenses resulting from the renegotiation of our arrangement to certain sales commission agreements. The following is a breakdown of our general and administrative expenses for the three months ended September 30, 2019 and 2018:

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 $84,546 (12%) from $724,101 to $639,555. We had 24 full time employees and 3 consultants at the end of the third quarter of 2018, and we currently have 22 full time employees, 1 part time employee and 2 consultants.

Stock based compensation is used as an incentive to attract new employees and to compensate existing employees. Stock based compensation includes stock issued and options granted to employees and non-employees. Stock based compensation for the current quarter was $67,135, a decrease of $66,947, or 50%, from the year ago quarter expense of $134,082. The decrease is primarily due to the termination of employees. The Company issues additional stock options to its employees from time to time under its Equity Compensation Plan.

Legal and professional fees decreased $25,529 (29%) from $87,170 in 2018 to $61,641 in 2019. The decrease was primarily due to reduced legal services required. We anticipate legal fees related to our business and financing activities to decrease as we have renegotiated arrangements with existing service providers.

Travel expenses decreased $35,256 (33%) from $107,223 in 2018 to $71,967 in 2019. The decrease is primarily due to reduction in travel costs associated with terminated employees. We anticipate that travel expenses for the balance of this year will be comparable to the current quarter.

Rent expense decreased 58%, from $46,614 in the three months ended September 30, 2018, to $19,609 in the three months ended September 30, 2019. Rent expense is primarily for our location in Los Angeles, California. Rent expense for the Los Angeles office is approximately $6,500 per month. We lease office space at 3600 Wilshire Boulevard, Los Angeles, California pursuant to a new lease that commenced on April 1, 2019 and expires March 31, 2023.

Marketing and selling expenses decreased $321,185 (84%) from $382,587 in 2018 to $61,402 in 2019. Lower marketing and selling expenses were primarily due to changes that were made to certain sales commission agreement.

Consulting fees were $53,207 in 2019, as compared with $17,450 in 2018. Our consulting fees vary based on needs. We engaged consultants in the areas of sales and operations during the quarter. The need for future consulting services will be variable.

Director fees decreased $23,725 from $75,000 in 2018 to $51,275 in 2019. Annual director fees are anticipated at $50,000 per non-employee director.

Research and development expenses decreased $23,176, (15%) from $150,299 in 2018 to $127,123 in 2019. These expenses relate to the services performed by our Director of Manufacturing and Product Development, and consultants supporting that employee. The decrease in research and development expense was primarily driven by the reduction in labor hours.

Shipping and storage expense increased $15,424 (6%) from $259,164 in 2018 to $274,588 in 2019. Shipping and storage expense as a percentage of revenue increased from 16% in 2018 to 20% in 2019. The higher expense in 2019 is due to increased freight movement related to the consolidation of forward warehouses. We anticipate that shipping and storage expense as a percentage of sales will reduce during the balance of the year, as the Company is able to take advantage of more efficient distribution arrangements.

Other expenses consist of ordinary operating expenses such as investor relations, office, telephone, insurance, and stock related costs. We anticipate these expenses to be comparable for the balance of the year.

We had operating losses of $949,789 and $1,407,171 for the three month periods ended September 30, 2019 and 2018, respectively. The improvement of $457,382, or 33%, was primarily due to lower G&A expenses.

The change in fair value of the derivative liability was a gain of $704,798 for the three months ended September 30 2019, as compared to a loss of $5,911 for the three months ended of September 30, 2018. The increase in the gain was due to the change in the Company’s stock price.

Interest expense in the third quarter of 2019 is $283,709. Interest relates to convertible debt in the amount of $2,527,500 that was issued on March 14, 2018, and in the amount of $1,363,200 that was issued on November 30, 2018, each of which bears interest at 10%. Interest expense includes amortization of $201,429 of the value of warrants issued with the convertible debt.

We had net losses of $528,700 and $1,899,583 in the three month periods ended September 30, 2019 and 2018.

Results of Operation for Nine Months Ended September 30, 2019 as Compared to the Nine Months Ended September 30, 2018

Revenue and cost of revenue

Revenue increased $452,924 (14%) from $3,329,451 in 2018 to $3,782,375 in 2019. The increase in revenue is primarily the result of our new bulk Easy Pour product continued to gain momentum during the second and third quarter of 2019. Our product continues to be distributed through all 72 of Sysco’s U.S. mainland distribution centers, as well as the addition of new customers beyond the Sysco distribution network.

Cost of revenue for 2019 was $1,584,033 as compared to $1,521,873 in 2018. Our gross profit was $2,136,957 (57%) and $1,759,067 (53%) for 2019 and 2018, respectively. The improvement in gross margin was related to product mix. We anticipate that our gross profit percentage for the remainder of 2019 will be consistent with the most recent quarter.

Operating expenses

Our operations during 2019 and 2018 were primarily directed towards increasing sales and expanding our distribution network.

Our general and administrative expenses decreased $1,012,467 (16%) from $6,462,989 in 2018 to $5,450,522 in 2019, with the improvement primarily driven by lower marketing, selling and personnel expenses resulting from the realignment of our sales force. The following is a breakdown of our general and administrative expenses for the nine months ended September 30, 2019 and 2018: