Business Context and Reporting Period
Barfresh Food Group Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company develops and distributes ready-to-blend frozen smoothies, shakes and frappes through national accounts and foodservice distributors, principally Sysco. Products were available through all 72 mainland U.S. Sysco operating companies during the period.
The company reported 99,797,554 common shares outstanding at September 30, 2016 and 100,891,304 shares outstanding as of November 11, 2016. It is classified as a smaller reporting company.
Financial Highlights
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $478,680, versus $168,099 | $1,313,178, versus $447,859 |
| Gross profit | $213,608, versus $77,897 | $629,437, versus $209,080 |
| Gross margin | 45%, versus 46% | 48%, versus 47% |
| Operating loss | $(2,358,669), versus $(2,074,442) | $(7,340,363), versus $(4,824,271) |
| Net loss | $(2,366,346), versus $(2,136,949) | $(7,583,513), versus $(5,172,255) |
| Net loss per share | $(0.02), versus $(0.03) | $(0.08), versus $(0.07) |
Revenue increased 185% in the quarter and 193% for the nine-month period, primarily from the Sysco rollout. Gross margin remained broadly stable. Despite higher gross profit, operating expenses exceeded gross profit by a substantial amount; nine-month general and administrative expense rose 59% to $7,819,348, including increased personnel, travel, research and development, shipping and storage, and stock-based compensation costs.
Cash Flow, Liquidity and Capitalization
- Cash was $1,487,349 at September 30, 2016, compared with $1,986,004 at December 31, 2015.
- Cash used in operations was $5,590,671 for the first nine months, compared with $4,356,965 in the prior-year period.
- Investing cash use was $1,014,969, including $985,315 for equipment and $56,028 for trademark investment.
- Financing activities provided $6,106,985, primarily from issuing common stock and warrants for cash of $5,686,992, warrant exercises of $414,997 and option exercises of $25,500.
- Total liabilities were $1,309,636 at September 30, 2016, including $92,300 of convertible notes and $39,527 of long-term vehicle debt. Current liabilities were $1,281,499.
- Stockholders’ equity was $2,918,633, while accumulated deficit was $22,312,246.
- Management stated that existing cash and working capital may not be sufficient to fund projected needs and that additional equity or debt financing may be required. The filing provides no assurance that the required capital will be available.
Material Changes Versus the Prior Comparable Period
- Revenue increased from $168,099 to $478,680 for the quarter and from $447,859 to $1,313,178 for the nine months.
- Gross profit increased substantially, but operating and net losses widened because operating expenses grew faster than gross profit.
- Nine-month personnel costs increased 123% to $4,351,271, partly reflecting expansion of the sales organization and accruals under annual incentive plans.
- Nine-month shipping and storage expense increased 148% to $319,525 as the company positioned inventory for the Sysco rollout, although the expense ratio improved to approximately 24% from 28%.
- Interest expense declined 30% for the nine months to $243,150, largely because convertible debt was converted into equity during February 2016.
- The company raised $5,305,757 in gross proceeds from equity financings during the nine months, issued 11,558,579 shares and issued warrants to purchase additional shares. It also converted approximately $2.63 million of convertible note principal and interest into equity.
- During the quarter, $100,000 of short-term notes, including $50,000 owed to a related party, plus accrued interest, was converted into stock at $0.64 per share with 50% warrant coverage at $0.75 per share.
Outlook, Commentary, Risks and Unusual Items
- Management expected gross margin for the remainder of 2016 to be comparable to the reported period and anticipated further improvement in shipping and storage efficiency.
- Management reported product testing and development with national accounts representing more than 37,000 restaurant locations. A frozen-yogurt chain approved expansion to 60 southeastern U.S. units, Wegmans began offering products in its Pub concept, and a global foodservice operator agreement covered more than 2,000 potential accounts.
- The company introduced its Triple Berry flavor and received a U.S. patent on August 16, 2016. It reported patents granted in 16 countries.
- After quarter-end, the company restructured its sales force, eliminating approximately 12 to 13 sales positions and replacing coverage with commission-based brokers. Management estimated annualized net overhead savings of $1 million to $1.5 million.
- The company raised $2.3 million in a September private placement and an additional $700,000 after quarter-end, on terms of $0.64 per share with warrants exercisable at $0.75 per share.
- Management disclosed that disclosure controls and procedures were not effective as of September 30, 2016. Material weaknesses included inadequate segregation of duties, lack of a majority of independent directors and ineffective audit committee oversight.
- The company relies on contract manufacturers and has no contracts with raw-material suppliers, although management stated that multiple sources are available. Production capacity was expanded through a second contract manufacturer.
- The filing states that there were no material pending legal proceedings and no material off-balance-sheet arrangements. It also warns that forward-looking statements are subject to substantial business, financing and execution risks.
Important Facts for Investors to Verify
- Whether Sysco distribution and national-account tests convert into sustained, profitable recurring sales.
- The company’s ability to fund continuing operating cash losses and capital expenditures without additional financing.
- The terms, timing and dilution effects of subsequent equity issuances, note conversions, options and warrants.
- Whether the sales-force restructuring produces the projected $1 million to $1.5 million annualized cost reduction without impairing revenue growth.
- Progress in remediating the disclosed material weaknesses in internal control over financial reporting.
- Actual utilization of expanded manufacturing capacity and the company’s ability to secure sufficient raw materials and maintain product margins.