SRX Global Inc. quarterly report, Q3 FY2019

Business context and reporting period

Better Choice Company Inc. filed this Form 10-Q for the quarter ended September 30, 2019; it was signed January 31, 2020. The company sells pet food, treats, supplements and related products, including hemp-derived CBD products. On May 6, 2019, it completed acquisitions of TruPet and Bona Vida. TruPet is the accounting acquirer, so 2019 results include TruPet from January and Better Choice and Bona Vida only after May 6; the comparable 2018 results are TruPet alone and are not directly comparable.

Financial performance and position

Amounts below are in millions of dollars except per-share data and percentages.

• Nine-month net loss includes a $147.4 million acquisition loss, largely noncash, and $6.7 million of share-based compensation. Third-quarter results include a $1.1 million gain from a change in warrant derivative fair value and a $2.6 million acquisition-related income adjustment.
• Cash used in operations was $13.2 million for the nine months, versus $3.1 million in 2018. Investing activities provided $0.4 million, including cash acquired in the transactions; financing activities provided $17.9 million. Cash, cash equivalents and restricted cash rose $5.1 million to $9.0 million.
• At September 30, cash and cash equivalents were $2.8 million and restricted cash was $6.2 million. Current assets were $13.6 million and current liabilities $13.8 million, a working-capital deficit of approximately $0.3 million. Total assets were $17.2 million and total liabilities $14.5 million. Redeemable Series E preferred stock was $13.0 million, presented outside stockholders’ deficit.
• The company reported a $6.2 million revolving credit balance, secured by an equal restricted-cash deposit, bearing 3.7% interest and maturing May 6, 2020. The arrangement also grants the lender a security interest in company assets. The company said it was in covenant compliance at quarter-end.

Material changes versus the prior comparable period

• Nine-month sales grew 5%, while third-quarter sales declined 1%. Management cited greater acquisition and media spending, a shift toward higher-priced food and topper products, and stronger repeat purchasing; it also reported a more competitive and costly customer-acquisition environment in the quarter.
• Gross margin fell substantially: to 38% for the nine months and 21% for the quarter. Management attributed pressure to product mix, discounting discontinued products, a $0.6 million Houndog royalty expense, and a larger inventory reserve. The inventory reserve was $0.4 million at September 30 versus $0.1 million at year-end 2018.
• Operating expenses rose sharply, including general and administrative expense of $12.0 million for nine months and sales and marketing expense of $8.5 million. The company cited public-company infrastructure and professional fees, expanded customer acquisition efforts, and share-based compensation.
• Acquisitions and equity financing substantially changed the capital structure. The company issued 32.3 million shares in the May acquisitions and raised $15.8 million net through a private placement. Common shares outstanding were 45.4 million at September 30 and 48.0 million at January 31, 2020.

Outlook, risks, contingencies and unusual items

• Management stated that operating losses create substantial doubt about the company’s ability to continue as a going concern. It believes available cash, future capital raises and borrowing capacity can fund planned operations for the next 12 months, but cautioned that failure to raise funds, achieve savings or meet strategic objectives could threaten continued operations.
• No specific numeric revenue or earnings guidance was provided. Management expected general and administrative and selling expenses to rise as the business expanded. It was evaluating customer-acquisition economics and expected to continue research and development spending.
• Concentration risk is notable: one vendor supplied approximately 85% of inventory purchases in the first nine months of 2019. The largest customer accounted for 4% of sales and 38% of receivables at quarter-end.
• The company recorded an estimated $1.2 million sales-tax liability at September 30 and disclosed possible additional state assessments. It identified prior-period sales-tax accrual errors of $0.7 million at December 31, 2018 and $0.8 million at June 30, 2019, which it corrected and deemed not material to the presented periods.
• Management reported ineffective disclosure controls and material weaknesses in financial reporting, including insufficiently designed controls, an ineffective close and consolidation process, and inadequate sales-tax controls. A Controller was hired in September 2019; management did not assure timely or successful remediation.
• Subsequent events included the December 2019 acquisition of Halo for approximately $45 million, subject to final valuation and customary adjustments, financed with cash, shares and seller notes. A separate December loan facility provided up to $20.5 million of term debt and $7.5 million of demand revolver borrowing, at a floating rate set by Bank of Montreal plus 8.05%, secured by substantially all domestic assets and guaranteed by subsidiaries and three directors. The company also issued $2.75 million of subordinated convertible notes in November.
• In January 2020, the company terminated the Houndog license, agreeing to cash payments, stock, a subordinated note and warrants. The filing also describes additional warrant issuance and repricing obligations triggered by later share issuances. These post-quarter developments may affect liquidity and dilution.

Important facts for investors to verify

1. Assess near-term liquidity using unrestricted cash, the maturity and terms of debt, subsequent Halo-related financing, and the going-concern warning.
2. Review acquisition accounting, the unusually large noncash acquisition loss, and the limited comparability of reported periods.
3. Verify gross-margin recovery, inventory reserves, customer-acquisition returns, and dependence on a single supplier.
4. Track remediation of material weaknesses and the accuracy and payment status of sales-tax obligations.
5. Evaluate potential dilution from preferred stock, options, warrants, convertible notes, acquisition consideration and anti-dilution provisions.