NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Vapor Corp. (the “Company”) is the holding company for its wholly owned subsidiary Smoke Anywhere U.S.A., Inc. (“Smoke”).
The Company designs, markets and distributes electronic cigarettes, vaporizers, e-liquids and accessories under the Krave
®
, VaporX
®
,
Hookah Stix
®,
Alternacig
®
, Fifty-One
®
(also known as Smoke 51), EZ Smoker
®
, Green Puffer
®
, Americig
®
, Fumaré™ and Smoke Star
®
brands. “Electronic cigarettes” or “e-cigarettes,” designed to look like traditional cigarettes, are battery-powered products that enable users to inhale nicotine vapor
without smoke, tar, ash, or carbon monoxide.
Reincorporation
The Company reincorporated to the State of Delaware from the State of Nevada effective on December 31, 2013. The reincorporation was
effected in accordance with the Company’s obligation to reincorporate to the State of Delaware from the State of Nevada not later than December 31, 2013, in connection with the Company’s completion of a private placement of 3,333,338
shares of common stock at a per share price of $3.00 for gross proceeds of $10 million, which closed on October 29, 2013 (as described under “Private Placement of Common Stock” in Note 4 below).
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally
accepted in the United States of America (“GAAP”) for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, these condensed consolidated financial
statements do not include all of the information and footnotes required for audited annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the condensed
consolidated financial statements not misleading have been included. The condensed consolidated balance sheet at December 31, 2013 has been derived from the Company’s audited consolidated financial statements as of that date.
These unaudited condensed consolidated financial statements for the three months ended March 31, 2014 and 2013 should be read in
conjunction with the audited consolidated financial statements and related notes thereto as of and for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K for such year as filed with the SEC on
February 26, 2014. Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014.
6
Reverse Stock Split
Effective on December 27, 2013, the Company effected a reverse stock split of its common stock at a ratio of 1-for-5. As a result of the
reverse stock split, the Company’s share capital was reduced to 51,000,000 shares from 251,000,000 shares, of which 50,000,000 shares are common stock and 1,000,000 shares are “blank check” preferred stock. All references in these
notes and in the related condensed consolidated financial statements to number of shares, price per share and weighted average number of shares outstanding of common stock prior to the reverse stock split (including the share capital decrease) have
been adjusted to reflect the reverse stock split (including the share capital decrease) on a retroactive basis, unless otherwise noted.
Note 2. SUMMARY OF CERTAIN SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All
significant intercompany transactions and balances have been eliminated.
Use of estimates in the preparation of the financial
statements
The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of net revenue and
expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include allowances, reserves and write-downs of receivables and inventory, valuing equity securities, stock-based payment
arrangements, deferred taxes and valuation allowances. Certain of our estimates could be affected by external conditions, including those unique to our industry, and general economic conditions. It is possible that these external factors could have
an effect on our estimates that could cause actual results to differ from our estimates. The Company re-evaluates all of its accounting estimates at least quarterly based on these conditions and records adjustments when necessary.
Revenue recognition
The Company recognizes revenue from product sales or services rendered when the following four revenue recognition criteria are met: (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the selling price is fixed or determinable, and (iv) collectability is reasonably assured.
Product sales and shipping revenues, net of promotional discounts, rebates, and return allowances are recorded when the products are shipped,
title passes to customers and collection is reasonably assured. Retail sales to customers are made pursuant to a sales contract that provides for transfer of both title and risk of loss upon the Company’s delivery to the carrier. Retail sales
to customers are made pursuant to a sales contract that provides for transfer of both title and risk of loss upon the Company’s delivery to the carrier. Return allowances, which reduce product revenue, are estimated using historical experience.
Revenue from product sales and services rendered is recorded net of sales and consumption taxes.
The Company periodically provides
incentive offers to its customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, inducement offers, such as offers for future discounts subject to a minimum current purchase,
and other similar offers. Current discount offers, when accepted by the Company’s customers, are treated as a reduction to the purchase price of the related transaction, while inducement offers, when accepted by its customers, are treated as a
reduction to the purchase price of the related transaction based on estimated future redemption rates. Redemption rates are estimated using the Company’s historical experience for similar inducement offers. The Company reports sales net of
current discount offers and inducement offers, on its condensed consolidated statements of operations.
7
Accounts Receivable
Accounts receivable, net is stated at the amount the Company expects to collect. The Company provides a provision for allowances that includes
returns, allowances and doubtful accounts equal to the estimated uncollectible amounts. The Company estimates its provision for allowances based on historical collection experience and a review of the current status of trade accounts receivable. It
is reasonably possible that the Company’s estimate of the provision for allowances will change.
At March 31, 2014 accounts
receivable balances included a concentration from two customers of an amount greater than 10% of the total net accounts receivable balance ($280,560 from Customer A and $235,947 from Customer B). At December 31, 2013 accounts receivable
balances included a concentration from one customer of an amount greater than 10% of the total net accounts receivable balance ($286,768 from Customer B). As to revenues, no customers accounted for revenues in excess of 10% of the net sales for the
three-month periods ended March 31, 2014 and 2013.
Inventories
Inventories are stated at the lower of cost (determined by the first-in, first-out method) or market. If the cost of the inventories exceeds
their market value, provisions are recorded to write down excess inventory to its net realizable value. The Company’s inventories consist primarily of merchandise available for resale.
Income Taxes
The
(benefit) provision for income taxes is based on (loss) income before income tax (benefit) expense reported for financial statement purposes after adjustments for transactions that do not have tax consequences. Deferred tax assets and liabilities
are realized according to the estimated future tax consequences attributable to differences between the carrying value of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the
enacted tax rates as of the date of the condensed consolidated balance sheets. The effect of a change in tax rates on deferred tax assets and liabilities is reflected in the period that includes the statutory enactment date. In assessing the
realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this
assessment. After consideration of all of the information available, management has determined that a valuation allowance is not required at March 31, 2014 and December 31, 2013, to reduce the deferred tax assets for the amounts that will
likely not be realized. Should the factors underlying management’s analysis change, future valuation adjustments to the Company’s net deferred tax assets may be necessary.
The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position in a previously filed tax
return or a position expected to be taken in a future tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company
may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the
tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income
taxes.
In order to determine the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate, which is
based on expected annual income and statutory tax rates. Certain significant or unusual items are separately recognized in the quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.
Income tax (benefit) expense for the three months ended March 31, 2014 and 2013 was ($752,400) and $4,590, respectively. The effective tax rate for the three months ended March 31, 2014 differs from the U.S. federal statutory rate of 34%
primarily due to
8
utilization of net operating losses and certain permanent differences between tax reporting purposes and financial reporting purposes. The Company files U.S. and state income tax returns in
jurisdictions with various statutes of limitations. At March 31, 2014 the Company had federal and state net operating losses of $1,841,082 and $1,632,554, respectively. These net operating losses expire in 2032. Utilization of the
Company’s net operating losses may be subject to annual limitation due to ownership change limitations that may have occurred or that could occur in the future with respect to the stock ownership of the Company, as required by section 382 of
the Internal Revenue Service Code of 1986, as amended, as well as similar state provisions. These ownership changes may limit the amount of net operating losses that can be utilized annually to offset future taxable income and tax respectively.
Fair value measurements
The Company applies the provisions of Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and
Disclosures,” (“ASC 820”). The Company’s short term financial instruments include cash, due from merchant credit card processors, accounts receivable, accounts payable and accrued expenses, each of which approximate their fair
values based upon their short term nature. The Company’s other financial instruments include notes payable obligations. The carrying value of these instruments approximate fair value, as they bear terms and conditions comparable to market, for
obligations with similar terms and maturities.
ASC 820 defines fair value as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy,
which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value: Level 1 – quoted prices in
active markets for identical assets or liabilities; Level 2 – quoted prices for similar assets and liabilities in active market or inputs that are observable; and Level 3 – inputs that are unobservable.
Stock-Based Compensation
The Company accounts for stock-based compensation under ASC Topic No. 718, “Compensation-Stock Compensation” (“ASC
718”). These standards define a fair value based method of accounting for stock-based compensation. In accordance with ASC 718, the cost of stock-based compensation is measured at the grant date based on the value of the award and is
recognized over the vesting period. The value of the stock-based award is determined using the Black-Scholes-Merton valuation model, whereby compensation cost is the fair value of the award as determined by the valuation model at the grant date or
other measurement date. The resulting amount is charged to expense on the straight-line basis over the period in which the Company expects to receive the benefit, which is generally the vesting period. The Company considers many factors when
estimating expected forfeitures, including types of awards, employee class, and historical experience.
Recent Accounting
Pronouncements
The Financial Accounting Standards Board, the Emerging Issues Task Force and the SEC have issued certain accounting
standards, updates and regulations as of March 31, 2014 that will become effective in subsequent periods; however, management of the Company does not believe that any of those standards, updates or regulations would have significantly affected
the Company’s financial accounting measures or disclosures had they been in effect during the three months ended March 30, 2014 or 2013, and it does not believe that any of them will have a significant impact on the Company’s
condensed consolidated financial statements at the time they become effective.
Note 3. FACTORING FACILITY AND TERM LOAN PAYABLE
Factoring Facility
On
August 8, 2013, the Company and Smoke entered into an accounts receivable factoring facility (the “Factoring Facility”) with Entrepreneur Growth Capital, LLC (the “Lender”) pursuant to an Invoice Purchase and Sale Agreement,
dated August 8, 2013, by and among them (the “Factoring Agreement”). During the three months ended March 31, 2014, the Company did not borrow under the Factoring Facility. At March 31, 2014 and December 31, 2013 the
Company had no borrowings outstanding under the Factoring Facility.
9
Term Loan
On August 16, 2013, the Company and Smoke entered into a $750,000 term loan (the “Term Loan”) with the Lender pursuant to a Credit Card
Receivables Advance Agreement, dated August 16, 2013, by and among them (the “Term Agreement”). The Term Loan matures on August 15, 2014 (or earlier generally upon termination of the Factoring Agreement), is payable from the
Company’s and Smoke’s current and future merchant credit card receivables at the annual rate of 16% subject to the Lender retaining a daily fixed amount of $3,346 from the daily collection of the merchant credit card receivables and is
secured by a security interest in substantially all of the Company’s assets. The Company used the proceeds of the Term Loan for general working capital purposes.
At March 31, 2014 and December 31, 2013 the Company had $297,116 and $478,847 of borrowings outstanding under the Term Loan, respectively. During
the three months ended March 31, 2014 and 2013, the Company recorded $28,434 and $0 in interest expense for the Term Loan, respectively, and this amount is included in interest expense in the accompanying condensed consolidated statements of
operations.
Note 4. STOCKHOLDERS’ EQUITY
Issuance of Common Stock
On February 3, 2014, the Company entered into a consulting agreement (the “Consulting Agreement”) with Knight Global Services,
LLC (“Knight Global”) pursuant to which the Company retained Knight Global to assist the Company with increasing awareness of its electronic cigarette brands as well as assisting the Company to expand and diversify its relationships with
large retailers and national chains. Knight Global is a wholly owned subsidiary of Knight Global, LLC of which Ryan Kavanaugh is an investor and principal. Effective March 5, 2014, the Board of Directors of the Company elected Mr. Kavanaugh as
a member of the Board of Directors in accordance with the Consulting Agreement. Knight Global serves as the family office for Mr. Kavanaugh. Mr. Kavanaugh is the Founder and Chief Executive Officer of Relativity, a next-generation media company
engaged in multiple aspects of entertainment, including film production; financing and distribution; television; sports management; music publishing; and digital media.
Under the terms of the Consulting Agreement, the Company has issued to Mr. Kavanaugh 400,000 shares of its common stock, of which 50,000 shares
have vested immediately while the remaining 350,000 shares will vest in installments of 50,000 shares per quarterly period beginning on the 90th day following February 3, 2014 and each ensuing quarterly period thereafter so long as the
Consulting Agreement has not been terminated and during each quarterly period Knight Global has presented the Company with a minimum of six (6) bona fide opportunities for activities specified in the Consulting Agreement that are intended to
increase awareness of the Company’s electronic cigarettes. In addition, during the term of the Consulting Agreement, which is 2 years, and during an 18-month post-termination period, the Company has agreed to pay Knight Global commissions
payable in cash equal to 6% of “net sales” (as defined in the Consulting Agreement) of its products to retailers introduced by Knight Global and to retailers with which the Company has existing relationships and with which Knight Global is
able, based on its verifiable efforts, to increase net sales of the Company’s products.
10
The grant date fair value of the common shares issued on February 3, 2014 was $3,080,000
based on closing price per share of the Company’s common stock, as reported on the OTC Bulletin Board, on February 3, 2014. During the three months ended March 31, 2014 and 2013, the Company recognized stock-based compensation
expense, for the Consulting Agreement, in the amount of $592,300 and $0, which is included as part of selling, general and administrative expense in the accompanying condensed consolidated statements of operations.
The Consulting Agreement is terminable by the Company between 181 days and 364 days after February 3, 2014 if Knight Global is not
performing the consulting services in accordance with the terms of the Consulting Agreement subject to the Company providing Knight Global with written notice of non-performance and Knight Global having a 30-day cure period to cure such
non-performance. In the event of such termination, in addition to delivering previously vested shares and commission payments due and owing Knight Global, 50,000 of the unvested shares subject to quarterly vesting as described above shall
automatically vest and be delivered by the Company to Mr. Kavanaugh and Knight Global shall be entitled to commission payments during the 18-month post-termination period.
The Consulting Agreement is terminable by Knight Global, at any time, and the Company, after the termination period described in the preceding
paragraph, for a material uncured breach of the Consulting Agreement, provided that the terminating party has provided the other party with written notice of material breach and a 30-day cure period (or longer under certain circumstances if the
breach is not curable within such 30-day period and such party has initiated curative action within such 30-day period and thereafter diligently and continuously pursues such curative action until the breach has been cured). A breach by either party
is not deemed to be material unless it causes economic harm to the other party. If the terminating party desires to terminate the Consulting Agreement after the notice and cure period on the basis that the other party has not cured the breach then
the terminating party, within 30 days following expiration of the cure period, is required to initiate arbitration in the Delaware Court of Chancery to determine whether the other party has materially breached the Consulting Agreement.
Private Placement of Common Stock
On October 22, 2013, the Company entered into a purchase agreement (the “Purchase Agreement”) with various institutional and
individual accredited investors and certain of its officers and directors to raise gross proceeds of $10 million in a private placement of 3,333,338 shares of its common stock at a per share price of $3.00 (the “Private Placement”). On
October 29, 2013, the Company completed the Private Placement. The Company received net proceeds from the Private Placement of approximately $9.1 million, after paying placement agent fees and estimated offering expenses, which the Company will
use to fund its growth initiatives and for working capital purposes.
Pursuant to the Purchase Agreement, concomitantly with completion of
the Private Placement, the Company entered into a registration rights agreement with the investors (other than its participating officers and directors), pursuant to which the Company filed with the SEC an initial registration statement to register
for resale the 3,216,171 shares of the Company’s common stock purchased by the investors (other than the Company’s participating officers and directors). The initial registration statement was declared effective by the SEC on
January 27, 2014. On March 5, 2014, the Company filed a post-effective amendment to the initial registration statement. The post-effective amendment to the initial registration statement was declared effective by the SEC on March 11,
2014. The post-effective amendment does not include 1,035,732 shares of the Company’s common stock that were previously sold under the initial registration statement. If the post-effective amendment to the initial registration statement is not
effective for resales for more than 20 consecutive days or more than 45 days in any 12 month period during the registration period (i.e., the earlier of the date on which the shares have been sold or are eligible for sale under SEC Rule 144 without
restriction), the Company is required to pay the investors (other than the Company’s participating officers and directors) liquidated damages in cash equal to 1.5% of the aggregate purchase price paid by the investors (other than the
Company’s participating officers and directors) for the shares for every 30 days or portion thereof until the default is cured. These cash payments could be as much as $98,120 for every 30 days.
Under the terms of the Purchase Agreement, the Company:
|
|
•
|
|
Amended its existing equity incentive plan on November 20, 2013 to reduce the number of shares of its common stock reserved and available for issuance under the plan to 1.8 million from 8 million.
|
11
|
|
•
|
|
Effectuated a reverse stock split of its common stock at a ratio of 1-for-5, which became effective in the marketplace at the opening of business December 27, 2013.
|
|
|
•
|
|
Reincorporated to the State of Delaware effective on December 31, 2013.
|
|
|
•
|
|
Reconstituted its board of directors effective April 25, 2014 so that as so reconstituted, the board of directors consists of five members, a majority of whom each qualify as an “independent director” as
defined in NASDAQ Marketplace Rule 5605(a)(2) and the related NASDAQ interpretative guidance (as described under “Reconstitution of the Board” in Note 6 below); and
|
|
|
•
|
|
Is required no later than July 29, 2014 to list its common stock on The NASDAQ Capital Market and up until such time as the listing is accomplished the Company is required to comply with all NASDAQ rules (other
than NASDAQ’s board composition, board committee, minimum bid price and similar listing requirements), such as holding annual meetings and the timely filing of proxy statements.
|
Warrants
A
summary of warrant activity for the three months ended March 31, 2014 is presented below:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Warrants
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Contractual Term
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding at January 1, 2014
|
|
|
215,880
|
|
|
|
3.23
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|
|
|
|
|
|
|
|
|
|
Warrants granted
|
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|
—
|
|
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|
—
|
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|
|
|
|
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|
|
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|
Warrants exercised
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|
—
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|
|
—
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|
|
|
|
|
|
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|
Warrants forfeited or expired
|
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|
—
|
|
|
|
—
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|
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|
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|
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|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Outstanding at March 31, 2014
|
|
|
215,880
|
|
|
$
|
3.23
|
|
|
|
5.0
|
|
|
$
|
727,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Exercisable at March 31, 2014
|
|
|
215,880
|
|
|
$
|
3.23
|
|
|
|
5.0
|
|
|
$
|
727,516
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
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Stock-based Compensation
During the three months ended March 31, 2014 and 2013, the Company recognized stock-based compensation expense in connection with the
amortization of stock option expense of $18,106 and $10,688, respectively, which is included as part of selling, general and administrative expense in the accompanying condensed consolidated statements of operations. The amounts relate to the
previously granted options and the granting of options during the first quarter of 2014 to a Director and to an employee to purchase 72,000 shares of the Company’s common stock with an exercise price of $8.30 per share which vest in 3 annual
installments valued at $178,992.
The fair value of employee stock options was estimated using the following weighted-average assumptions:
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For Three Months Ended
March 31, 2014
|
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|
Expected term
|
|
|
5 -7 years
|
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|
Risk Free interest rate
|
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|
1.57
|
%
|
|
Dividend yield
|
|
|
0.0
|
%
|
|
Volatility
|
|
|
31
|
%
|
12
No employee stock options were granted during the first quarter of 2013.
Stock option activity
Options outstanding at March 31, 2014 under the various plans are as follows (in thousands):
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Plan
|
|
Total
Number of
Options
Outstanding
under Plans
|
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|
Equity compensation plans not approved by security holders
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|
900
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|
Equity Incentive Plan
|
|
|
275
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|
|
|
|
|
|
|
|
|
|
|
1,175
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|
|
|
|
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|
A summary of activity under all option Plans at March 31, 2014 and changes during the three months ended
March 31, 2014 (in thousands, except per share data):
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|
|
|
|
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|
Number of
Shares
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Contractual Term
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding at January 1, 2014
|
|
|
1,119
|
|
|
$
|
2.17
|
|
|
|
6.89
|
|
|
$
|
7,815
|
|
|
Options granted
|
|
|
72
|
|
|
|
8.30
|
|
|
|
5.83
|
|
|
|
—
|
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Options forfeited or expired
|
|
|
16
|
|
|
|
1.47
|
|
|
|
10.00
|
|
|
|
—
|
|
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|
|
|
|
|
|
|
|
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|
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|
|
|
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|
Outstanding at March 31, 2014
|
|
|
1,175
|
|
|
$
|
2.55
|
|
|
|
6.78
|
|
|
$
|
4,753
|
|
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|
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|
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Exercisable at March 31, 2014
|
|
|
989
|
|
|
$
|
2.167
|
|
|
|
6.36
|
|
|
$
|
4,384
|
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|
|
|
|
|
|
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Options available for grant at March 31, 2014
|
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1,482
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|
|
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At March 31, 2014 the amount of unamortized stock-based compensation expense on unvested stock options
granted to employees and consultants was $307,076.
Earnings (loss) per share
Basic earnings and loss per share are computed by dividing the net income or loss available to common stockholders by the weighted average
number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist
of the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s convertible debt and warrants (using the if-converted method). Diluted loss per share excludes
the shares issuable upon the exercise of stock options from the calculation of net loss per share, as their effect is antidilutive.
13
The following table reconciles the numerator and denominator for the calculation:
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|
For the Three Months Ended
March 31,
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|
|
2014
|
|
|
2013
|
|
|
Net (loss) income—basic
|
|
$
|
(1,452,759
|
)
|
|
$
|
123,544
|
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|
|
|
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Denominator – basic:
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|
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Weighted average number of common shares outstanding
|
|
|
16,463,417
|
|
|
|
12,038,847
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|
|
|
|
|
|
|
|
|
|
|
|
Basic (loss) earnings per common share
|
|
$
|
(0.09
|
)
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income—diluted
|
|
$
|
(1,452,759
|
)
|
|
$
|
123,544
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator – diluted:
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
16,463,417
|
|
|
|
12,038,847
|
|
|
Weighted average effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
Common share equivalents of outstanding stock options
|
|
|
—
|
|
|
|
224,816
|
|
|
Common share equivalents of outstanding convertible debt
|
|
|
—
|
|
|
|
—
|
|
|
Common share equivalents of outstanding warrants
|
|
|
—
|
|
|
|
7,005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
16,463,419
|
|
|
|
12,070,668
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted (loss) earnings per common share
|
|
$
|
(0.09
|
)
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities excluded from the weighted outstanding because their inclusion would have been antidilutive:
|
|
|
|
|
|
|
|
|
|
Convertible debt
|
|
|
—
|
|
|
|
665,419
|
|
|
Stock options
|
|
|
1,174,500
|
|
|
|
—
|
|
|
Warrants
|
|
|
215,880
|
|
|
|
8,142
|
|
Note 5. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases its Florida office and warehouse facilities under a twenty-four month lease agreement with an initial term through
April 30, 2013 that the Company extended in March 2013 and 2014 when it exercised the first and second of three successive one-year renewal options. The lease provides for annual rental payments of $144,000 per annum (including 45 days of total
rent abatement) during the initial twenty-four month term and annual rental payments of $151,200, $158,760 and $174,636 during each of the three one-year renewal options. In October 2013, the Company amended the master lease to include an additional
approximately 2,200 square feet for an additional annual rental payment of $18,000 subject to the same renewal options and other terms and conditions set forth in the master lease.
The remaining minimum annual rents for the years ending December 31 are:
|
|
|
|
|
|
|
2014
|
|
$
|
131,940
|
|
|
2015
|
|
|
58,920
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
190,860
|
|
|
|
|
|
|
|
Rent expense for the three months ended March 31, 2014 and 2013 was $44,838 and $38,160, respectively,
and is included in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations.
14
Legal Proceedings
From time to time the Company may be involved in various claims and legal actions arising in the ordinary course of our business. There were no
pending material claims or legal matters as of the date of this report other than two of the three following matters.
On May 15,
2011, the Company became aware that Ruyan Investment (Holdings) Limited (“Ruyan”) had named the Company, along with three other sellers of electronic cigarettes in a lawsuit filed in the U.S. District Court for the Central District of
California alleging infringement of U.S. Patent No. 7,832,410, entitled “Electronic Atomization Cigarette.” against the Company’s Fifty-One Trio products. In that lawsuit, which was initially filed on January 12, 2011, Ruyan
was unsuccessful in bringing suit against the Company due to procedural rules of the court. Subsequent thereto, on July 29, 2011, Ruyan filed a new lawsuit in which it named the Company, along with seven other sellers of electronic cigarettes,
alleging infringement of the same patent. On March 1, 2013, the Company and Ruyan settled this multi-defendant federal patent infringement lawsuit as to them pursuant to a settlement agreement by and between them. Under the terms of the
settlement agreement:
|
|
•
|
|
The Company acknowledged the validity of Ruyan’s U.S. Patent No. 7,832,410 for “Electronic Atomization Cigarette” (the “410 Patent”), which had been the subject of Ruyan’s patent
infringement claim against the Company;
|
|
|
•
|
|
The Company paid Ruyan a lump sum payment of $12,000 for the Company’s previous sales of electronic cigarettes based on the 410 Patent; and
|
|
|
•
|
|
On March 1, 2013, in conjunction with releasing one another (including their respective predecessors, successors, officers, directors and employees, among others) from claims related to the 410 Patent, the Company
and Ruyan filed a Stipulated Judgment and Permanent Injunction with the above Court dismissing with prejudice all claims which have been or could have been asserted by them in the lawsuit.
|
On June 22, 2012, Ruyan filed a second lawsuit against the Company alleging infringement of U.S. Patent No. 8,156,944 (the ‘944
Patent). Ruyan also filed separate cases for patent infringement against nine other defendants asserting infringement of the 944 Patent. Ruyan’s second lawsuit against the Company known as
Ruyan Investment (Holdings) Limited vs. Vapor Corp.
CV-12-5466
is pending in the United States District Court for the Central District of California. All of these lawsuits have been consolidated for discovery and pre-trial purposes. The Company intends to vigorously defend against this lawsuit.
On February 25, 2013, Ruyan’s second patent infringement lawsuit against the Company as well as all of the other consolidated
lawsuits were stayed as a result of the Court granting a stay in one of the consolidated lawsuits. The Court granted the motion to stay Ruyan’s separate lawsuits against the Company and the other defendants based on the filing of a request for
inter partes reexamination of the ‘944 Patent at the United States Patent and Trademark Office.
As a result of the stay, all of the
consolidated lawsuits involving the ‘944 Patent have been stayed until the reexamination is completed. As a condition to granting the stay of all the lawsuits, the Court required any other defendant who desires to seek reexamination of the 944
Patent and potentially seek another stay (or an extension of the existing stay) based on any such reexamination to seek such reexamination no later than July 1, 2013. Two other defendants sought reexamination of the 944 Patent before expiration
of such Court-imposed deadline of July 1, 2013. All reexamination proceedings of the ‘944 Patent have been stayed by the United States Patent and Trademark Office Patent Trial and Appeal Board pending its approval of one or more of them.
On March 5, 2014, Fontem Ventures, B.V. and Fontem Holdings 1 B.V. (the successors to Ruyan) filed a complaint against the Company
alleging infringement of U.S. Patent No. 8,365,742, entitled “Aerosol Electronic Cigarette”, U.S. Patent No. 8,375,957, entitled “Electronic Cigarette”, U.S. Patent No. 8,393,331, entitled “Aerosol Electronic
Cigarette” and U.S. Patent No. 8,490,628, entitled “Electronic Atomization Cigarette. On April 8, 2014, plaintiffs amended their complaint to add U.S. Patent No. 8,689,805, entitled “Electronic Cigarette.” The
products accused of infringement by the plaintiff are various Krave, Fifty-one and Hookah Stix products and parts. Eight other companies were also sued in separate lawsuits alleging infringement of one or more of the patents listed above. The
Company filed its Answer and Counterclaims on May 1, 2014. The Company intends to vigorously defend against this lawsuit.
15
Related Party Transactions
During the three months ended March 31, 2014 and 2013, the Company paid aggregate interest of $0 and $29,589, respectively to Ralph Frija,
the father of the Company’s former Chief Executive Officer Kevin Frija and a less than 5% stockholder, pursuant to a previously outstanding senior note. During the three months ended March 31, 2014 and 2013, the Company paid aggregate
interest of $0 and $5,658, respectively to Kevin Frija, a greater than 5% stockholder, pursuant to a previously outstanding senior convertible note. During the three months ended March 31, 2014 and 2013, the Company paid interest of $0 and
$4,438, respectively to Doron Ziv, a greater than 5% stockholder, and to Harlan Press, the Company’s Chief Financial Officer, pursuant to previously outstanding senior convertible notes.
Purchase Commitments
At March 31, 2014 and December 31, 2013, the Company has vendor deposits of $690,715 and $782,363, respectively, and vendor deposits
are included as a component of prepaid expenses and vendor deposits on the condensed consolidated balance sheets included herewith.
NOTE 6. SUBSEQUENT EVENTS
The Company evaluates events that have occurred after the balance sheet date but before the condensed consolidated financial
statements are issued. Based upon the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the accompanying condensed consolidated financial statements other
than those set forth below.
Reconstitution of the Board of Directors
Effective April 25, 2014, the Board of Directors (the “Board”) of the Company reconstituted itself to consist of five
(5) members, a majority of whom each qualify as an “independent director” as defined in NASDAQ Marketplace Rule 5605(a)(2) and the related NASDAQ interpretative guidance.
Specifically, the Board’s reconstitution consisted of the following:
|
|
•
|
|
the Board elected each of Robert J Barrett III, Angela Courtin, Frank E. Jaumot as a member of the Board to serve until his/her successor is duly elected or until his/her earlier resignation or removal from office.
Mr. Barrett, Ms. Courtin and Mr. Jaumot each qualify as an “independent director” as defined by NASDAQ Marketplace Rule 5605(a)(2) and the related NASDAQ interpretative guidance;
|
|
|
•
|
|
Kevin Frija, and Doron Ziv, incumbent members of the Board, resigned;
|
|
|
•
|
|
The Board elected Jeffrey Holman, President and an incumbent member of the Board, as Chairman of the Board; and
|
|
|
•
|
|
the size of the Board was increased to and fixed at five (5) members from four (4) members.
|
After reconstituting the Board, the five (5) members of the Board are Jeffrey Holman, Robert J Barrett III, Angela Courtin, Frank E.
Jaumot and Ryan Kavanaugh.
In addition, the Board granted to each of Mr. Barrett, Ms. Courtin and Mr. Jaumot effective
April 25, 2014 a non-qualified stock option award under the Company’s Equity Incentive Plan to purchase up to 60,000 shares of the Company’s common stock at an exercise price per share equal to $6.48 (the closing share price of the
Company’s common stock as reported on the OTC Bulletin Board at the close of trading on the grant date). Each of Mr. Barrett’s, Ms. Courtin’s and Mr. Jaumot’s stock options expires on the fifth anniversary of the
grant date, vests in equal annual installments over a three-year period from the grant date subject to he/she serving as a member of the Board on each such vesting date and is to be evidenced by a non-qualified stock option agreement customarily
utilized under the Equity Incentive Plan.
There are no arrangements or understandings between any of Mr. Barrett, Ms. Courtin
and Mr. Jaumot and any other person pursuant to which he/she was selected as a director.
16
None of Mr. Barrett, Ms. Courtin and Mr. Jaumot have a direct or indirect material
interest in any transaction with the Company involving an amount exceeding the lesser of $120,000 or one percent of the average of the Company’s total assets at year end for the last two completed fiscal years.
Mr. Ziv, a founder of the Company, will continue to serve as an employee of the Company and as a director of the Company’s subsidiary
Smoke Anywhere USA, Inc. and is a greater than 5% stockholder of the Company.
Resignation of Chief Executive Officer and
Appointment of New Chief Executive Officer
Effective April 25, 2014, Mr. Frija resigned as the Company’s Chief
Executive Officer and the Board appointed the Company’s President and incumbent member of the Board, Jeffrey Holman, as the Company’s new Chief Executive Officer.
In connection with Mr. Frija’s resignation as Chief Executive Officer, the Board approved severance payments to Mr. Frija in an
aggregate amount equal to one year of base salary at the rate of $159,000 per annum payable in installments in accordance with the Company’s normal payroll schedule conditioned upon his execution and delivery of a general release to the
Company, which has become irrevocable in accordance with its terms and applicable law, and his compliance with the non-solicitation, confidentiality and non-competition covenants of his Employment Agreement dated February 27, 2012 with the
Company until April 24, 2015 in certain respects and indefinitely in other respects. During the three months ended March 31, 2014 the Company accrued severance expense in the amount of $167,003, which is included as part of the selling,
general and administrative expenses in accompanying condensed consolidated statements of operations in connection with Mr. Frija’s resignation.
In addition to serving as a member of the Board, Chairman of the Board and Chief Executive Officer, Mr. Holman, a founder of the Company,
will continue to serve as the Company’s President, and as a director of the Company’s subsidiary Smoke Anywhere USA, Inc. and is a greater than 5% stockholder of the Company.
Entry into a material definitive agreement
On May 14, 2014, the Company and its newly formed wholly-owned subsidiary IVGI Acquisition, Inc., a Delaware corporation (the
“Buyer”), entered into an Asset Purchase Agreement (the “Purchase Agreement”) with International Vapor Group, Inc., a Delaware corporation (“International Vapor”), certain of International Vapor’s subsidiaries
(together with International Vapor, the “Sellers”) and the owners of International Vapor (the “Owners”), pursuant to which the Buyer will purchase the Sellers’ Business (as defined below) by acquiring substantially all of
the Sellers’ assets and assuming certain of the Sellers’ liabilities in an asset purchase transaction (the “Transaction”).
17
The Sellers are engaged in the business of (i) owning certain electronic cigarette and vaporizer
brands, including South Beach Smoke
®
, EverSmoke
®
and Vapor Zone
®
and related
products and accessories, as well as any other electronic cigarette and vaporizer brands and related products and accessories commercially available and under development by the Sellers (collectively, the “E-Cig Products”), (ii) online
sales of the E-Cig Products (the “Online Operations”), (iii) wholesale distribution of the E-Cig Products (the “Wholesale Operations”) and (iv) retail sales of the E-Cig Products (the “Retail Operations” and together
with the E-Cig Products, the Online Operations and the Wholesale Operations, the “Business”).
Under the terms of the Purchase
Agreement, the “Purchase Price” will be the sum of (x) $20,800,000 (the “Fixed Purchase Price”) plus (y) an earn-out aggregating up to a maximum of $29,200,000 (the “Earn-Out”).
Upon consummation of the Transaction (the “Closing”), the Company will, through the Buyer, pay the Fixed Purchase Price as follows:
(i) $1.7 million in cash less any estimated net working capital shortfall of the Sellers and (ii) $19.1 million in 3,300,501 newly issued unregistered shares of the Company’s common stock (the “Fixed Shares”, which number of shares
represents the quotient of the $19.1 million divided by $5.787 per share (the 30-trading day weighted average closing price per share of the Company’s common stock, as reported on the OTC Bulletin Board preceding May 14, 2014, the date of the
Purchase Agreement)).
At Closing, 345,602 shares of the Fixed Shares with a value of $2 million will be deposited into escrow with a
mutually acceptable escrow agent and will remain in escrow for a period of 27 months following as a non-exclusive source to secure the Sellers’ and the Owners’ indemnification obligations under the Purchase Agreement.
Payments of the Earn-Out are contingent and based upon the post-Closing performance of the Wholesale Operations, the Online Operations and the
Retail Operations. Earn-Out payments are limited to $29,200,000 in the aggregate and will be determined as follows:
|
|
•
|
|
Wholesale Operations. An amount equal to 200% of the audited revenues generated from the Wholesale Operations for the twelve (12) beginning on the first day of the month following the month in which the Closing Date
occurs (the “Earn-Out Start Date”);
|
|
|
•
|
|
Online Operations. An amount equal to 100% of the amount by which the aggregate audited revenues generated from the Online Operations and the online sales of the Company and its Affiliates (other than the Online
Operations for the twelve (12) full calendar month period beginning on the Earn-Out Start Date) exceed the aggregate audited revenues generated by the Online Operations and the online sales of the Company for the calendar year ended December 31,
2013 subject to certain exclusions; and
|
|
|
•
|
|
Retail Operations. $50,000 for each Retail Store that is opened by the Company or any of its Affiliates directly, or by franchisees of any of the foregoing, during the twenty four (24) months following the Earn-Out
Start Date (the “Measurement Period”) so long as at least 75% of such Retail Stores that are opened during the Measurement Period generate positive cash flow for any three (3) months within any consecutive six (6) month period after being
opened during the later of the Measurement Period or the twelve (12) full calendar months after expiration of the Measurement Period subject to certain exclusions.
|
18
Payments of the Earn-Out if and when earned will be paid by the Company, through the Buyer, with
newly issued unregistered shares of the Company’s common stock (the number of which will be equal to the quotient of an Earn-Out payment divided by $5.787 per share) (the “Earn-Out Shares”).
The Buyer and the principal Owners Nicolas Molina and David Epstein have entered into Employment Agreements which will become effective at
Closing, pursuant to which Messrs. Molina and Epstein will continue to be involved in the Business as conducted by the Buyer. Pursuant to their respective Employment Agreements, Mr. Molina will serve as Senior Vice President of Retail &
eCommerce and Mr. Epstein will serve as Vice President of Wholesale.
The Purchase Agreement generally contains customary representations,
warranties, covenants and agreements of the parties. The Company’s and Buyer’s obligations and the Sellers’ and Owners’ obligations to consummate the Transaction are subject to certain conditions, including (i) the accuracy of
the representations and warranties of the other parties; (ii) performance in all material respects by the other parties of their pre-Closing covenants and agreements; and (iii) that there has been no “Buyer/Parent Material Adverse Effect”
or “Seller/Owner Material Adverse Effect” (as such terms are defined in the Purchase Agreement), as applicable, of the other parties.
In addition, consummation of the Transaction is conditioned upon the Company obtaining stockholder approval for issuance of the Fixed Shares
and the Earn-Out Shares.
The Company expects to consummate the Transaction as soon as possible but not later than July 31, 2014.
Each of the Company and the Buyer and International Vapor and the Owners (severally, but not jointly, and ratably) have post-Closing indemnity
obligations under the Purchase Agreement for breaches of their representations and warranties as well as their pre- and post-Closing covenants and agreements which are subject to specified caps, baskets, limits and survival periods depending on the
nature of the indemnity claim. These indemnity obligations are the sole and exclusive remedy and recourse of the parties subject to limited exceptions for fraud and specific performance.
The Purchase Agreement is terminable by either the Company or International Vapor if the Transaction is not consummated by July 31, 2014 due to
no fault of the terminating party.
If the Purchase Agreement is terminated by International Vapor because the Company has willfully and
intentionally breached the Purchase Agreement, which includes the failure of the Company’s stockholders to approve the issuance of the Fixed Shares and the Earn-Out Shares, then the Company is required to pay International Vapor a $500,000
break-up fee in cash within two (2) business days following the date of termination of the Purchase Agreement. International Vapor is equally required to pay the Company a $500,000 break-up fee in cash if the Company terminates the Purchase
Agreement because the Sellers or the Owners have willfully and intentionally breached the Purchase Agreement.
If the Purchase Agreement is
terminated by either International Vapor or the Company because the non-terminating party breached the Purchase Agreement and such breach was unintentional then the non-terminating party is required to reimburse the terminating party for all
out-of-pocket fees and expenses incurred by the terminating party up to a maximum of $300,000.
At the Closing, the Company is required to
enter into a Registration Rights Agreement with International Vapor and the Owners, pursuant to which the Company will be required to file one or more shelf registration statements with the Securities and Exchange Commission registering for resale
by International Vapor and the Owners the Fixed Shares and the Earn-Out Shares.
19