Business Context and Reporting Period
Barfresh Food Group Inc. filed its Form 10-K for the fiscal year ended December 31, 2018. The company develops, manufactures through contract manufacturers, and distributes ready-to-blend frozen beverages, including smoothies, shakes, and frappes, in single-serve and bulk “Easy Pour” formats.
Distribution relationships include Sysco, PepsiCo’s foodservice sales organization, national foodservice operators, schools, and U.S. military bases. The company operated in one reportable segment and had 26 employees and three consultants at year-end.
Financial Performance and Position
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $4.235 million | $1.997 million | Up 112% |
| Gross profit | $2.145 million | $0.890 million | Gross margin 51% vs. 45% |
| Operating loss | $(6.180) million | $(8.912) million | Improved 31% |
| Net loss | $(7.323) million | $(8.912) million | Improved 18% |
| Basic and diluted loss per share | $(0.06) | $(0.08) | Improved |
| Cash from operations | $(4.128) million | $(7.334) million | Lower cash use |
| Capital expenditures and intangible purchases, net | $(1.083) million | $(0.564) million | Higher investment |
| Year-end cash | $1.042 million | $1.305 million | Down $0.263 million |
| Working capital surplus | $0.652 million | $1.775 million | Down $1.122 million |
General and administrative expense declined 18% to $7.813 million, primarily because of lower personnel and stock-based compensation costs. Research and development expense increased 17% to $674,224, reflecting development of flavors for potential national accounts. Shipping and storage expense rose 40% to $864,871 but declined as a percentage of revenue from 31% to 20%.
Interest expense was $764,813, including $519,707 of amortization of warrant-related debt discounts. Other unusual expenses included a $290,300 warrant-modification loss and an $87,630 loss from changes in the fair value of derivative liabilities.
At December 31, 2018, total assets were $5.762 million, total liabilities were $5.797 million, and stockholders’ equity was negative $35,048. Cash was $1.042 million, compared with current liabilities of $2.071 million. Convertible notes, net of discounts, totaled $2.209 million, and derivative liabilities totaled $1.326 million.
Material Changes Versus the Prior Comparable Period
- Revenue more than doubled, principally from continued adoption of the bulk Easy Pour product and expanded distribution beyond the Sysco network.
- Gross margin improved to 51% from 45%, attributed to production scale and product mix.
- Operating and net losses narrowed, although the company remained materially unprofitable.
- Operating cash usage improved by $3.206 million, but the company continued to consume cash.
- Capital expenditures increased, particularly for manufacturing and customer equipment.
- Current liabilities increased substantially, including accounts payable, accrued payroll, convertible debt-related obligations, and derivative liabilities.
- The company adopted ASC 606 revenue recognition in 2018 and reported no significant adoption impact.
- Management stated that the material weakness in internal control over financial reporting identified at December 31, 2017 had been remediated. Management concluded disclosure controls were effective at December 31, 2018; the auditor was not engaged to provide an opinion on internal control effectiveness.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management expected 2019 gross margin to be comparable to 2018 and anticipated continued reductions in shipping and storage expense as a percentage of sales. The filing does not provide formal revenue or earnings guidance.
Growth initiatives included contracts covering more than 300 schools, more than 100 military bases, a national restaurant chain with over 2,500 locations, and a supply agreement involving four single-serve stock-keeping units. The company’s Sysco agreement was extended for two years in 2017 and included bulk Easy Pour products on a non-exclusive basis.
The company disclosed substantial doubt about its ability to meet all obligations over the twelve months following the filing because of recurring losses, negative operating cash flow, and expected working-capital needs. Management believed the concern was alleviated by expense reductions and $4.3 million raised in the first quarter of 2019, but acknowledged that additional financing and liquidity outcomes were not assured.
First-quarter 2019 financing included $2.4 million from common stock issued at $0.60 per share, $1.7 million from warrant exercises, and $180,000 from a further warrant exercise. The company issued 7,141,454 shares in these transactions. It also settled $730,869 of executive deferred compensation, paying one-third in cash and settling the remainder with warrants.
Key risks include continued operating losses, dependence on additional financing, dilution from convertible notes and warrants, customer and distributor concentration, lack of minimum purchase commitments, competition, food and dairy cost volatility, reliance on contract manufacturers and key personnel, product liability, intellectual property disputes, and limited liquidity and volatility of the OTCQB-traded common stock.
The company had no material pending legal proceedings and no material off-balance-sheet arrangements. It entered into a new office lease beginning April 1, 2019, with aggregate minimum commitments disclosed at approximately $310,000.
Important Facts for Investors to Verify
- Whether revenue growth from Easy Pour, national accounts, schools, and military bases converts into sustainable positive operating cash flow.
- The maturity, conversion terms, interest burden, warrant coverage, and potential dilution associated with the $3.615 million face amount of convertible notes due in 2020.
- The continuing fair-value exposure from the $1.326 million derivative liability.
- Whether first-quarter 2019 financing provides sufficient liquidity or whether further equity or debt financing will be required.
- The impact of customer concentration, including customers representing 32.84% and 11.71% of 2018 revenue.
- The company’s ability to improve profitability despite a $7.323 million net loss and $4.128 million of operating cash consumption in 2018.
- Potential dilution from 7.428 million outstanding options and approximately 25.3 million outstanding warrants at December 31, 2018.
- The effectiveness and continued operation of the internal-control remediation measures reported by management.