Business Context and Reporting Period
Barfresh Food Group Inc. filed this unaudited Form 10-Q for the quarter and nine months ended December 31, 2013, its first fiscal year as an operating company after leaving the development stage. The company manufactures and distributes ready-to-blend smoothies, shakes and frappes using patented sealed ingredient packs.
During the period, Barfresh acquired international patent rights and related trademarks, expanded production in Salt Lake City, began shipping to one contracted customer and smaller customers, and continued testing and negotiations with potential QSR and food-service customers. Six employees were reported at December 31, 2013.
Financial Highlights
| Metric | Nine months ended December 31, 2013 | Comparable 2012 period |
|---|---|---|
| Revenue | $39,799 | $7,488 |
| Gross profit | $14,066; 35.3% margin | $1,373; 18.3% margin |
| Operating loss | $(1,407,494) | $(1,232,122) |
| Interest expense | $195,313 | $112,279 |
| Net loss | $(1,602,807); $(0.03) per share | $(1,344,401); $(0.03) per share |
| Cash used in operations | $(1,443,739) | $(541,246) |
For the quarter ended December 31, 2013, revenue was $7,541 versus $4,608, gross profit was $3,127 versus $749, operating loss was $(487,324) versus $(590,987), and net loss was $(530,608) versus $(675,196). Quarterly gross margin improved to 41.5% from 16.3%.
General and administrative expense was $1,365,431 for the nine-month period, up from $1,216,059. Personnel costs increased as the company shifted work from consultants to employees, while consulting expense and stock-based compensation declined. Research and development expense was $40,305, compared with $55,233.
Financial Position, Liquidity and Debt
- Cash was $664,484 at December 31, 2013, compared with $85,957 at March 31, 2013.
- Working capital was negative $76,954. Total current assets were $750,032 and current liabilities were $826,986.
- Total assets were $1,793,162, including $713,327 of net patent-related intangible assets. Total liabilities were $999,670, and stockholders’ equity was $793,492, versus a deficit of $91,331 at March 31, 2013.
- Financing activities provided $2,763,583, including $2,038,855 net from common-stock and warrant offerings and $775,000 of short-term notes. Investing activities used $741,317, including $697,157 for patents and trademarks and $44,160 for equipment.
- Short-term notes had $775,000 of principal, a 2% cash interest rate and a December 20, 2014 maturity, with a possible six-month extension. Warrants to purchase 1,291,667 shares at $0.45 per share were issued.
- Convertible notes had $420,000 of principal outstanding, with a December 31 carrying amount of $172,684 after discounts. Principal payments of $775,000 were scheduled for fiscal 2015 and $420,000 for fiscal 2016.
- The company had $66,650 of remaining minimum office-lease obligations as of December 31, 2013.
Material Changes, Outlook and Risks
- Revenue increased substantially from a small base as customers began testing products in multiple locations, but the company continued to generate limited revenue and significant operating losses.
- Management stated that the 35.3% nine-month gross margin was more indicative of expected future results than the prior-year margin, although no formal financial guidance was provided.
- Management expected continued spending on personnel, marketing, selling, research and development, investor relations and other operating activities. No specific revenue, earnings or cash-flow forecast was provided.
- The company planned to use contract manufacturers, expand internationally through sales agents or licensing arrangements, and evaluate ways to monetize its international patents. A first Australian order was shipped in January 2014.
- Customer agreements covering approximately 10,000 potential outlets were described as development and testing arrangements; the company cautioned that there was no assurance any major chain would ultimately purchase its products and that customer concentration could develop.
- The financial statements state that recurring losses, negative working capital and dependence on equity, debt and related-party financing raise substantial doubt about the company’s ability to continue as a going concern. Management indicated that additional financing would be required, with no assurance it would be available.
- Interest expense included $146,839 of non-cash debt-discount amortization for the nine months. The effective interest rate on the short-term notes was estimated at approximately 52%, compared with a 2% cash coupon; the convertible notes had an estimated effective rate of approximately 74% versus a 12% cash rate.
- Management reported effective disclosure controls but identified inadequate staffing and lack of segregation of duties as a material weakness in internal control over financial reporting.
- The registrant marked “No” for having filed all required reports during the preceding 12 months. No legal proceedings, defaults upon senior securities or material off-balance-sheet arrangements were reported.
Investor Verification Items
- Verify the company’s ability to raise additional capital and meet the $775,000 and $420,000 scheduled debt maturities.
- Assess whether customer testing and preliminary agreements convert into recurring commercial orders and whether the reported outlet opportunities generate material revenue.
- Review the valuation, enforceability and commercial monetization prospects of the $713,327 patent-related intangible asset.
- Monitor cash burn, working-capital deficits, gross-margin sustainability and the pace of operating-expense growth.
- Review dilution from outstanding warrants, including 14,372,232 placement warrants, 2,636,519 convertible-note warrants and 1,291,667 short-term-note warrants.
- Confirm remediation of the material weakness involving staffing and segregation of duties, as well as the company’s SEC filing compliance status.