Business Context and Reporting Period
Barfresh Food Group Inc. manufactures and distributes ready-to-drink and ready-to-blend beverages, including smoothies, shakes and frappes. This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods.
The company relies on contract manufacturers; one manufacturer supplied approximately 58% of finished goods during the first nine months of 2022 under an agreement expiring in September 2025.
Financial Performance and Position
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $2.406 million | $1.930 million | $7.731 million | $4.246 million |
| Gross profit/(loss) | $(0.723) million | $0.721 million | $0.924 million | $1.632 million |
| Gross margin | (30%) | 37% | 12% | 38% |
| Operating loss | $(2.708) million | $(0.508) million | $(4.339) million | $(1.658) million |
| Net loss | $(2.708) million | $(0.508) million | $(4.339) million | $(1.396) million |
| Loss per share | $(0.21) | $(0.04) | $(0.34) | $(0.11) |
Revenue increased 25% year over year in the third quarter and 82% in the first nine months, driven by growth in Twist & Go and a gradual return of single-serve demand. Reported profitability was materially reduced by product withdrawal-related charges and unfavorable product mix.
- Q3 cost of revenue was $3.129 million, including approximately $932,000 for anticipated disposal of unsaleable inventory and ancillary costs.
- The company recorded approximately $630,000 for anticipated customer refunds, sales claims and distributor administrative fees.
- Excluding the withdrawal impacts, Q3 gross profit was approximately $839,000, or 28%; excluding those impacts for the first nine months, gross profit was approximately $2.486 million, or 30%.
- First-nine-month selling, marketing and distribution expense increased 73% to $2.137 million, while general and administrative expense increased 71% to $2.736 million.
At September 30, 2022, cash was $2.837 million and restricted cash was $211,000. Total current assets were $5.006 million, current liabilities were $2.387 million, and reported working capital was approximately $2.619 million. Total liabilities were $2.387 million, consisting primarily of accounts payable, accrued expenses, payroll accruals and lease liabilities; the filing does not report outstanding convertible or other interest-bearing debt at that date.
Cash used in operating activities was $2.619 million for the first nine months of 2022, compared with $1.146 million in 2021. Investing cash use was $13,000, financing provided $5,000 from warrant exercises, and cash plus restricted cash declined from $5.675 million at the beginning of the year to $3.048 million at September 30, 2022.
Material Changes Versus Prior Comparable Period
- Revenue growth did not translate into improved profitability: Q3 gross margin declined to negative 30% from 37%, and nine-month gross margin declined to 12% from 38%.
- Q3 and nine-month operating losses increased by $2.200 million and $2.681 million, respectively, primarily due to the product quality and withdrawal charges, higher operating expenses and product mix.
- Operating cash burn more than doubled year over year, while cash and restricted cash decreased by $2.627 million during the first nine months.
- Sales and marketing, staffing, research and development, stock-based compensation and other corporate costs increased. Nine-month research and development expense rose 101% to $347,000, primarily reflecting pre-production work for a new co-manufacturer and carton-format Twist & Go product.
- The company issued 9,842 shares for services during the quarter, valued at $50,000. Shares outstanding were 12,934,741 at September 30, 2022.
Outlook, Risks, Contingencies and Unusual Items
In July 2022, customers reported texture issues with smoothie products produced by a major co-manufacturer. After the reporting date, the company withdrew product from the market and destroyed on-hand inventory. The co-manufacturer denied responsibility, and Barfresh filed a lawsuit on November 10, 2022 seeking economic damages. The company recorded no gain contingency because the outcome and potential recovery cannot be estimated.
Management expects the supply disruption to adversely affect revenue, operating results and cash flow until a resolution is reached or replacement supply sources are developed. The timing of that outcome is uncertain. The company also faces concentration risk because one manufacturer supplied approximately 58% of products in the first nine months.
Management stated that the company has a history of operating losses and negative operating cash flow and may need additional equity or debt financing if cash generation does not improve. Management concluded that the identified liquidity indicators did not raise substantial doubt about going-concern status as of September 30, 2022, but acknowledged uncertainty regarding the availability and effectiveness of future financing or other liquidity actions.
The company reported no material changes to significant accounting policies and no material off-balance-sheet arrangements. The office lease expires March 31, 2023, with approximately $40,000 of remaining minimum payments at September 30, 2022.
Disclosure controls and procedures were not effective as of September 30, 2022 because of a material weakness in the control environment, including inadequate segregation of duties. Management is hiring personnel, reallocating control responsibilities and implementing a new enterprise resource planning system.
Facts Investors Should Verify
- Whether the product-quality dispute, inventory destruction and customer claims result in additional costs, refunds, lost sales or recoveries.
- Whether replacement co-manufacturing capacity can be secured at sufficient volume and acceptable margins.
- The pace of cash burn and the company’s ability to obtain additional financing without substantial dilution or unfavorable terms.
- Whether revenue growth can be converted into positive gross margins and operating cash flow after withdrawal-related effects subside.
- Progress in remediating the material weakness in internal controls and the effectiveness of the new ERP system.
- Changes in manufacturer concentration and supply-chain dependence under the existing agreement expiring in September 2025.