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 as of September 30, 2017 and for the nine month periods ended September 30, 2017 and 2016 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. The Company’s products include 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 products also include bulk “Easy Pour” ready to blend frozen beverages, which are manufactured in gallon containers and contain a concentrated product formula that is mixed “one to one” with water. The Company has also recently launched a “no sugar added” version of the bulk Easy Pour format that is specifically targeted for the USDA national school meal programs, including the School Breakfast Program, the National School Lunch Program, and Smart Snacks in Schools Program.

Domestic and international patents and patents pending are owned by Barfresh, as well as related trademarks for all of the products. In November 2011, the Company acquired the patent rights in the United States and Canada. The Canadian patent has been granted and the United States patent was granted on August 16, 2016. On October 15, 2013, the Company acquired all of the related international patent rights, which were filed pursuant to the Patent Cooperation Treaty and have been granted in 13 jurisdictions. The patents are pending in the remainder of the jurisdictions that have signed the treaty. In addition, on October 15, 2013, the Company purchased all of the trademarks related to the patented products.

The Company has conducted sales through several channels: through National Accounts; through an exclusive nationwide distribution agreement with Sysco Corporation (“Sysco”), the U.S.’s largest broadline distributor, which was entered into during July 2014, and was recently extended for two years, and expanded to include bulk “Easy Pour” products; through a variety of national distributors that meet the exception to exclusivity in the Sysco contract, and through direct sales to customers (e.g., Penn State University).

The process of obtaining sales orders for National Accounts generally follows several steps, including product demonstration, product testing, and exclusive flavor development for the larger National Accounts. We are currently in various stages of product development and testing with a number of National Accounts and have launched in market tests with several major National Key accounts. The Company is focused on moving from in-market tests to national roll-out with those major National Key accounts.

In addition to the National Accounts, the Company sells to food distributors that supply products to the food services market place. The Company has an exclusive agreement with Sysco Merchandising and Supply Chain Services, Inc. for resale by Sysco to the foodservice industry of the Company’s ready-to-blend smoothies, shakes and frappes. 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 as to portion controlled products; 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 operators nominated distributor for our products. The agreement is not exclusive as to the bulk Easy Pour products.

The Company’s products have been included in Sysco’s “Cutting Edge Solutions” (“CES”) Platform since March of 2016, and are once again included in Sysco’s most recent CES Platform, announced during February of 2017. As part of this platform, our products receive national advertising and marketing, and will be considered a core product. All 72 of SYSCO’s Operating Companies (“OPCO”) will participate in the CES program, and will be evaluated on their success in moving the CES products.

On October 26, 2015, Barfresh signed an 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, which the Company expects to fast track our growth and expedite the test to market process. The agreement gives Barfresh access to PepsiCo’s one-thousand plus person foodservice sales team, with Barfresh products becoming part of PepsiCo’s customer presentations.

The Company has recently announced placement of the no sugar added version of its bulk Easy Pour product at 30 middle and high school cafeterias in Pasco County, Florida, representing a student body of over 40,000. Within the education channel, Barfresh is now being sold in a number of leading universities including Penn State University, Stanford, Colorado State, Florida State University and the University of Tennessee. The Company also recently announced that it had entered into a contract with one of Canada’s leading third party food service provider to provide its bulk, Easy Pour product to 22 dining locations.

Finally, the Company intends to monetize the international patents outside of the current area of operations, North America, by expanding contract manufacturing to other countries and selling either through selling agents or internal sales personnel. The Company will also consider entering into some form of license or royalty agreements with third parties.

Barfresh currently utilizes contract manufacturers to manufacture all of the products in the United States. Ice cream manufacturers are best suited to produce the products and one production line is currently operational in our Salt Lake City contract manufacturer location. This manufacturer is currently producing products sold to existing customers as well as producing exclusive test products. Currently annual production capacity with our Salt Lake City contract manufacturer is 14 million units per year. In February 2016, the Company signed an agreement with Yarnell Operations, LLC, a subsidiary of Schulze and Burch, securing additional production capacity ahead of expected sales growth. Barfresh now has the capacity to ramp up to an incremental production capacity of 100 million units through this agreement. The Yarnell Operations, LLC, subsidiary is strategically located in Arkansas. 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.

Although there currently is not a contract in place with any suppliers for the raw materials needed to manufacture our products, there are a significant number of sources available and the company does not anticipate becoming dependent on any one supplier. As demand for the range of our products grows, we plan to contract a level of raw material requirements to ensure continuity of supply.

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 provides Barfresh with the necessary capital to drive revenue growth 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.

Currently we have 30 employees and 4 consultants. There are currently 19 employees and 1 consultant 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

We recognize revenue when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collection is reasonably assured. Revenue is recorded net of provisions for discounts, slotting fees, and promotion allowances. Our products are sold on various terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery. We recognize revenue upon receipt of our products by our distributors and retail accounts, in accordance with written sales terms, net of provisions for discounts or allowances. Allowances for returns and discounts are made on a case-by-case basis. Historically, neither returns nor discounts have been material.

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.

Results of Operations

Results of Operation for Three Months Ended September 30, 2017 as Compared to the Three Months Ended September 30, 2016

Revenue and cost of revenue

Revenue increased $201,272 (42%) from $478,680 in 2016 to $679,952 in 2017. The increase in revenue is primarily the result of the rollout of our new bulk Easy Pour product which began during the first quarter of 2017 and has continued to gain momentum during the balance of the year. 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 2017 was $334,376 as compared to $265,072 in 2016. Our gross profit was $345,576 (51%) and $213,408 (45%) for 2017 and 2016, respectively. We anticipate that our gross profit percentage for the remainder of 2017 will be approximately 50% .

Operating expenses

Our operations during 2017 and 2016 were primarily directed towards increasing sales and expanding our distribution network.

Our general and administrative expenses decreased $182,998 (7.3%) from $ 2,520,632 in 2016 to $ 2,337,634 in 2017, with the improvement primarily driven by lower personnel expenses resulting from the November 2016 realignment of our sales force. The following is a breakdown of our general and administrative expenses for the three months ended September 30, 2017 and 2016:

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 $387,255 (28%) from $1,386,141 to $998,886. During the fourth quarter of 2016, we affected a restructuring of our sales force, whereby we eliminated 13 full time sales positions, and replaced the associated sales territory coverage with brokerage arrangements. This change has allowed our remaining sales force to more effectively focus on pursuing larger accounts, while our expanded brokerage network will support and expand our “up and down the street” business. This restructuring is the primary driver for the reduction in personnel costs in the third quarter. In addition, after the end of the third quarter, we affected a further restructuring of our sales force, whereby we eliminated an additional 5 full time sales position. We expect this further restructuring to result in estimated additional annualized savings of $700,000, bringing the total annualized savings resulting from these two sales force restructurings to $2.2 to $2.7 million

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 compensation for the current quarter was in line with the prior quarter. The Company issues additional stock options to its employees from time to time under its Equity Compensation Plan.

Legal and professional fees decreased $25,617 (20%) from $129,346 in 2016 to $103,729 in 2017. The decrease was primarily due to a timing of legal services required. We anticipate legal fees related to our business and financing activities to increase as our business continues to grow.

Travel expenses decreased $73,052 (46%) from $157,746 in 2016 to $84,694 in 2017. 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 lower than the third quarter expenses, as a result of reduced travel costs associated with the additional employees terminated after the end of the third quarter.

Rent expense is primarily for our location in Beverly Hills, California. Rent expense for the Beverly Hills office is approximately $10,996 per month. We have entered into a new lease for office space at 8383 Wilshire Boulevard, Beverly Hills, California. The new lease commenced on November 1, 2016 and expires March 31, 2019.

Marketing and selling expenses increased $$79,872 (74%) from $108,166 in 2016 to $188,038 in 2017. Higher marketing and selling expenses were primarily due to higher sales commissions associated with higher sales during the quarter.

Consulting fees were $58,870 in 2017, as compared with $58,192 in 2016. 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 increased $75,000 from $25,000 in 2016 to $100,000 in 2017. The increase was due to both the addition of a director during the fourth quarter of 2016, and the timing of recording fees. Annual director fees are anticipated at $50,000 per non-employee director.

Research and development expenses increased $ 6,020 from $ 101,304 in 2016 to $ 107,324 in 2017. During the third quarter of 2016 we re-classified certain personnel expenses that had previously been included in Personnel Expense, to Research and Development. These expenses relate to the services performed by our Director of Manufacturing and Product Development, and consultants supporting that employee. The re-classification is shown in both the current period and the prior period.

Shipping and storage expense increased $ 122,009 (107%) from $ 113,674 in 2016 to $ 235,683 in 2017. Shipping and storage expense as a percentage of revenue increased from 24% in 2016 to 35% in 2017. The higher expense in 2017 is due to a number of factors, including the continued movement of inventory to new forward warehouses as the Company expanded its business into Canada, movement of sample inventory into position for trade shows and customer demonstrations, and special situation ordering of raw materials for production and R&D runs. 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 increases in certain of these expenses, as our business continues to grow.

We had operating losses of $2,086,033 and $2,358,669 for the three month periods ended September 30, 2017 and 2016, respectively.

Interest expense decreased from $7,677 in 2016 to zero in 2017. Interest primarily relates to convertible debt that was issued in November, 2015, and converted into stock during February, 2016, and short term notes that were issued in December 2013, all of which were repaid prior to the current quarter.

We had net losses of $2,086,033 and $2,366,346 in the three month periods ended September 30, 2017 and 2016, respectively.

Results of Operation for Nine Months Ended September 30, 2017 as Compared to the Nine Months Ended September 30, 2016

Revenue and cost of revenue

Revenue increased $307,941 (23%) from $ 1,313,178 in 2016 to $ 1,621,119 in 2017. The increase in revenue is primarily the result of the rollout of our new bulk Easy Pour product which began during the first quarter of 2017 and has gained momentum during the second and third quarter. 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 2017 was $ 822,902 as compared to $ 683,741 in 2016. Our gross profit was $ 798,217 (49%) and $ 629,437 (48%) for 2017 and 2016, respectively. We anticipate that our gross profit percentage for the remainder of 2017 will be approximately 50%.

Operating expenses

Our operations during 2017 and 2016 were primarily directed towards increasing sales and expanding our distribution network.

Our general and administrative expenses decreased $644,891 (8.25%) from $7,819,348 in 2016 to $7,174,457 in 2017, with the improvement primarily driven by lower personnel expenses resulting from the November 2016 realignment of our sales force. The following is a breakdown of our general and administrative expenses for the nine months ended September 30, 2017 and 2016:

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 $ 1,074,894 (25%) from $ 4,351,271 to $ 3,276,377. During the fourth quarter of 2016, we affected a restructuring of our sales force, whereby we eliminated 13 full time sales positions, and replaced the associated sales territory coverage with brokerage arrangements. This change has allowed our remaining sales force to more effectively focus on pursuing larger accounts, while our expanded brokerage network will support and expand our “up and down the street” business. This restructuring is the primary driver for the reduction in personnel costs in the first nine months of 2017. In addition, after the end of the third quarter of this year, we affected a further restructuring of our sales force, whereby we eliminated an additional 5 full time sales position. We expect this further restructuring to result in additional annualized savings of $700,000 bringing the total annualized savings resulting from these two sales force restructurings to $2.2 to $2.7 million

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 compensation for the first nine months of 2017 was $ 876,253, an increase of $ 91,990, or 12%, as compared with the first nine months of 2016, which was $784,263. The increase in stock based compensation expense was primarily due to additional stock option grants made to our employees during the fourth quarter of 2016. The Company issues additional stock options to its employees from time to time under its Equity Compensation Plan.

Legal and professional fees decreased $ 2,424 (1%) from $ 362,385 in 2016 to $359,961 in 2017. We anticipate that legal fees related to our business and financing activities will increase as our business continues to grow.

Travel expenses decreased $ 134,689 (30%) from $ 447,733 in 2016 to $313,094 in 2017. 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 continue to decline due the same factors impacting the first nine months of this year. .

Rent expense is primarily for our location in Beverly Hills, California. Rent expense for the Beverly Hills office is approximately $10,996 per month. We have entered into a new lease for office space at 8383 Wilshire Boulevard, Beverly Hills, California. The new lease commenced on November 1, 2016 and expires March 31, 2019.

Marketing and selling expenses increased $ 19,417 (4.5%) from $ 433,863 in 2016 to $ 453,280 in 2017. Higher marketing and selling expenses were primarily due to higher sales commissions associated with higher sales revenue.

Consulting fees decreased $36,504 (19%) from $ 191,875 in 2016 to $155,371 in 2017. Our consulting fees vary based on needs. We engage consultants in the areas of sales, operations and accounting. The need for future consulting services will be variable

Director fees increased $81,296 from $75,000 in 2016 to $156,296 in 2017. The increase in director fees is due to an increase in the number of non-employee directors. Annual director fees are anticipated at $50,000 per non-employee director.

Research and development expenses increased $191,053 (74%) from $256,874 in 2016 to $447,927 in 2017. During the third quarter of 2016 we re-classified certain personnel expenses that had previously been included in Personnel Expense, to Research and Development. These expenses relate to the services performed by our Director of Manufacturing and Product Development, and consultants supporting that employee. The re-classification is shown in both the current period and the prior period. The increase in Research and Development Expense is being driven by an increased need for research and development services, as we continue to expand product offerings, both for our standard SKU’s, and for National Accounts, and experience increased commissioning costs at our third party production facility in Searcy, Arkansas.

Shipping and storage expense increased $149,427 (47%) from $319,525 in 2016 to $468,952 in 2017. Shipping and storage expense as a percentage of revenue was 29% for 2017, and 24% for 2016 The higher expense in 2017 is due to a number of factors, including movement of inventory to new forward warehouses as the Company expanded its business into Canada, movement of sample inventory into position for trade shows and customer demonstrations, and special situation ordering of raw materials for production and R&D runs. 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 increases in certain of these expenses, as our business continues to grow.

We had operating losses of $6,602,816 and $7,340,363 for the nine month periods ended 2017 and 2016, respectively.

Interest expense decreased from $243,150 in 2016 to zero in 2017. Interest primarily relates to convertible debt that was issued in November, 2015, and converted into stock during February, 2016, and short term notes that were issued in December 2013, all of which were repaid prior to the end of 2016.

We had net losses of $6,602,816and $7,583,513 in the nine month periods ended 2017 and 2016, respectively.

Liquidity and Capital Resources

During the nine months ended September 30, 2017 we used cash for operations of $ 5,224,812 , purchased equipment for $412,865, and incurred spending for trademarks in the amount $27,684.

During the nine months ended September 30, 2016 we used $5,590,671 of cash for operations, and used $985,315 for the purchase of equipment.

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 meet all of its obligations over the twelve months following the filing of this Form 10-Q. Management has evaluated these conditions, and concluded that current plans will alleviate this concern. We currently have no debt. In addition, we have significantly reduced core operating costs beginning in 2016, including reducing the number of our employees from 44 to 30 over this time period. In addition, we plan to address this concern by raising additional capital through a loan or loans, and by continuing to reduce core operating expenses as required. While these plans have not yet been implemented, management has concluded that it is probable that they will be implemented within one year of the issuance of the financial statements, and that they will mitigate the substantial doubt of our ability to continue as a going concern. However, the Company cannot predict, with certainty, the outcome of its action to generate liquidity, including the availability of additional financing, or whether such actions would generate the expect liquidity as planned.

We lease office space under a non-cancelable operating lease, which expires March 31, 2019.

The aggregate minimum requirements under non-cancelable leases as of September 30, 2017 is $248,537.

Off-Balance Sheet Arrangements

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