Barfresh Food Group Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
Barfresh develops, manufactures through contract manufacturers, and distributes ready-to-blend frozen beverages, including smoothies, shakes, and frappes. Products are sold through national and regional accounts, broadline distributors, schools, military channels, and foodservice operators. The report covers the three and six months ended June 30, 2018; interim financial statements are unaudited.
Financial performance and condition
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Six months ended June 30, 2018 | Six months ended June 30, 2017 |
|---|---|---|---|---|
| Revenue | $1.086 million | $0.629 million | $1.709 million | $0.941 million |
| Gross profit | $0.566 million | $0.322 million | $0.911 million | $0.453 million |
| Gross margin | 52.2% | 51.2% | 53.3% | 48.1% |
| Operating loss | $(1.812) million | $(2.158) million | $(3.675) million | $(4.517) million |
| Net loss | $(1.815) million | $(2.158) million | $(4.153) million1 | $(4.517) million |
| Loss per share | $(0.02) | $(0.02) | $(0.03) | $(0.04) |
Cash flow and liquidity: Cash used in operating activities was $2.732 million in the first six months, compared with $3.293 million in the prior-year period. Investing cash use was $0.646 million, primarily for $0.678 million of equipment purchases. Financing activities generated $2.928 million, including $2.705 million of convertible-note proceeds and $0.250 million of short-term borrowings. Cash declined from $1.305 million at December 31, 2017 to $0.854 million at June 30, 2018.
Balance sheet and debt: Total assets were $5.573 million and total liabilities were $4.772 million at June 30, 2018. Stockholders’ equity declined to $0.801 million from $4.162 million at year-end 2017. Debt and related obligations included a $0.250 million short-term note, $0.591 million of related-party convertible debt, $1.262 million of other convertible debt, $0.079 million of accrued interest, and an $0.887 million derivative liability. The convertible notes generally bear 10% interest and mature in March 2020; the short-term note bears 12% interest and was subsequently extended to December 31, 2018.
Material changes versus the prior comparable period
- Quarterly revenue increased 73%; six-month revenue increased 82%, primarily due to growth in the bulk Easy Pour product, particularly in school and military channels.
- Quarterly gross margin improved to 52.2% from 51.2%; management attributed the improvement to production scale and product mix.
- Six-month gross margin improved to approximately 53% from 48%.
- Quarterly and six-month operating losses improved by 16% and 19%, respectively, due to higher gross profit and lower general and administrative expenses.
- General and administrative expense decreased 7% in the quarter and 11% year to date, primarily from lower personnel and stock-based compensation costs. Shipping and storage costs increased substantially with higher sales.
- The Company issued convertible notes and warrants during the first half of 2018, resulting in significant new debt, derivative liabilities, interest expense, and potential future equity dilution.
- Shares outstanding increased to 119.6 million at June 30, 2018 from 118.7 million at December 31, 2017. The filing reported 120,756,547 shares outstanding as of August 8, 2018.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected gross margin for the remainder of 2018 to be approximately 50% and anticipated lower shipping and storage costs as distribution became more efficient.
- Management reported contracts in education and military channels and expected increased revenue in subsequent quarters. The Company also began distributing products to approximately 1,000 foodservice locations under a new agreement.
- The Company reduced its workforce from 44 employees in 2016 to 28 at June 30, 2018, then eliminated three additional sales positions after quarter-end. Management estimated annualized savings of $2.2 million to $2.7 million, plus approximately $0.3 million from the additional reductions.
- The filing states that recurring losses and negative operating cash flow raise substantial doubt about the Company’s ability to meet obligations over the following twelve months. Management expected additional financing and further cost reductions to address the issue, but acknowledged that financing availability and the success of these plans are uncertain.
- Variable conversion terms on certain convertible notes resulted in an $0.887 million Level 3 derivative liability at June 30, 2018. Fair-value changes produced a quarterly gain of $0.197 million but a year-to-date loss of $0.248 million.
- After quarter-end, the Company received $0.550 million from warrant exercises, issued 1.1 million shares, used $0.050 million to repay the short-term note, and extended the note maturity to December 31, 2018.
- Disclosure controls and procedures were reported as ineffective because of inadequate segregation of duties resulting from limited personnel.
- Minimum remaining office lease commitments were reported at $0.130 million. No material pending legal proceedings or material off-balance-sheet arrangements were disclosed.
Important facts for investors to verify
- Whether the Company can obtain additional financing and avoid a liquidity shortfall despite only $0.854 million of cash and continued operating cash use.
- The terms, maturity, conversion mechanics, warrant coverage, and dilution potential of the convertible notes and outstanding warrants.
- The sustainability of revenue growth from Easy Pour, school, military, Sysco, and national-account channels.
- Whether gross margins remain near management’s approximately 50% expectation and whether shipping costs decline as projected.
- The remediation and ongoing impact of the material weakness in segregation of duties and ineffective disclosure controls.
- The precise six-month net loss: the condensed statements report $(4,152,924), while the MD&A text reports $(4,152,424).
1The condensed consolidated statement of operations reports a six-month net loss of $(4,152,924); the MD&A contains a conflicting figure of $(4,152,424).