Business Context and Reporting Period
Barfresh Food Group Inc. manufactures and distributes ready-to-blend frozen beverages, including smoothies, shakes and frappes. Its products are sold through national accounts, regional accounts, broadline distributors, schools and U.S. military locations. This Form 10-Q covers the three and six months ended June 30, 2019; the financial statements are unaudited. The company is a smaller reporting company and identified itself as a shell company.
As of August 12, 2019, 130,287,011 common shares were outstanding. The company reported distribution through all 72 U.S. mainland Sysco distribution centers, products at more than 400 school locations and more than 150 military base locations, and anticipated a national-account rollout covering more than 2,500 locations.
Financial Highlights
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Revenue | $1,382,665 | $1,086,166 | $2,217,199 | $1,709,237 |
| Gross profit | $851,046 | $547,726 | $1,285,750 | $880,747 |
| Gross margin | 61.6% | 50.4% | 58.0% | 51.5% |
| Operating loss | $(1,089,848) | $(1,812,407) | $(2,860,565) | $(3,674,932) |
| Net loss | $(573,916) | $(1,814,786) | $(3,421,178) | $(4,152,924) |
| Net loss per share | $0.00 | $(0.02) | $(0.03) | $(0.03) |
| Cash used in operating activities | Not provided for the quarter | Not provided for the quarter | $(2,354,225) | $(2,732,466) |
At June 30, 2019, cash was $2,268,315, compared with $1,041,569 at December 31, 2018. Accounts receivable were $822,384, inventory was $907,366 and total current assets were $4,038,063. Total liabilities were $4,941,675, including $2,337,704 of convertible notes outstanding net of discounts and $932,919 of derivative liabilities. Stockholders’ equity was $2,347,447, compared with a deficit of $35,048 at year-end 2018.
Six-month investing cash outflows were $319,339, principally for property and equipment. Financing provided $3,900,310, consisting of $2,400,000 from stock issuance and $1,500,310 from warrant exercises. Cash increased by $1,226,746 during the six months.
Material Changes Versus the Prior Comparable Period
- Revenue increased 27% in the second quarter and 30% for the first six months, driven primarily by increased demand for the bulk Easy Pour product, particularly in school and military channels.
- Gross margin improved to 61.6% in the quarter and 58.0% year to date, reflecting greater production scale and a favorable product mix. Management expected approximately 58% gross margin for the remainder of 2019.
- General and administrative expense declined 20% in the quarter and 12.4% year to date. Reductions reflected lower personnel, marketing, rent, research and development, and shipping costs.
- Shipping expense declined to 11% of quarterly revenue and 11.4% of year-to-date revenue, compared with 26% and 25.4%, respectively, in the prior-year periods, following distribution-system changes. Storage expense increased as the company phased out its forward-warehouse program.
- The operating loss improved by 40% in the quarter and 22.2% for the six-month period, but the company remained unprofitable.
- Net loss improved substantially in the quarter, partly because of a $798,746 gain from revaluation of derivative liabilities. For the six months, the company recorded a $392,734 derivative gain versus a $247,896 derivative loss in the prior-year period. These noncash gains are dependent on changes in the company’s stock price and derivative valuation assumptions.
- Interest expense increased to $645,887 for the six months from $230,096, partly because of convertible debt and amortization of warrant-related debt discounts.
- Shares outstanding increased from 122,770,960 at December 31, 2018 to 130,085,820 at June 30, 2019, primarily through warrant exercises and a $2.4 million equity financing.
Guidance, Outlook, Risks and Unusual Items
Management forecast continued improvement in operating cash flow from cost reductions, increased school and military contracts, and the anticipated rollout of a national account with more than 2,500 locations. Management stated that headquarters relocation and a new personnel-services contract were expected to generate approximately $200,000 of annual cash savings. New logistics arrangements were also expected to produce additional savings.
The filing states that historical operating losses and negative operating cash flow raise substantial doubt about the company’s ability to continue as a going concern for at least one year after issuance of the financial statements. Management expected approximately $1.8 million of convertible short-term debt to mature in March 2020 and indicated that, if cash is insufficient, it may seek maturity extensions, particularly for insider-held debt. The company acknowledged that it cannot predict the success of its forecasts, cost-cutting program, or debt-extension efforts.
The convertible notes generally bear 10% interest, contain variable conversion provisions and mature in 2020. Their variable conversion terms result in derivative-liability accounting and potentially significant earnings volatility. The company also had approximately $241,368 of operating lease liability at June 30, 2019, under a lease expiring March 31, 2023.
The company reported no material pending legal proceedings, no material off-balance-sheet arrangements and no subsequent events requiring recognition or disclosure. Management concluded that disclosure controls and procedures were effective as of June 30, 2019.
Important Facts for Investors to Verify
- Whether revenue growth in school, military and national-account channels can continue and whether the anticipated 2,500-location rollout occurs as planned.
- Whether the reported gross-margin improvement toward approximately 58% is sustainable as product mix, production volume and logistics arrangements change.
- The company’s ability to reduce cash burn and achieve the forecast savings, given $2.35 million of operating cash use during the first six months.
- How the company will repay or refinance the approximately $1.8 million of convertible debt due in March 2020 and the effect of any insider-held debt extensions.
- The going-concern uncertainty and the company’s potential need for additional equity or debt financing.
- The effect of derivative-liability revaluations, variable conversion terms, warrants, options and future equity issuance on reported earnings and shareholder dilution.
- The accuracy and comparability of cost-of-revenue disclosures: the financial statements separately report cost of revenue and manufacturing-equipment depreciation, while MD&A discusses combined amounts.