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.
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 June 30, 2014 accounts receivable balances included a concentration from one customer of an amount greater than 10% of the total net accounts receivable balance ($172,684 from Customer A). 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 in fiscal 2014, two customers accounted for sales in excess of 10% of the net sales for the three and six months ended June 30, 2014 ($1,226,320 and $1,506,880, respectively from Customer C) and $1,082,475 and $1,455,593 from Customer A) As to revenues in fiscal 2013, one customer accounted for sales in excess of 10% of the net sales for the three-month period ended June 30, 2013 ($695,197 to Customer A) . No customers accounted for revenues in excess of 10% of the net sales for the six-month period ended June 30, 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 June 30, 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 June 30, 2014 and 2013 was ($657,324) and $4,590, respectively. Income tax (benefit) expense for the six months ended June 30, 2014 and 2013 was ($1,409,724) and $9,180, respectively. The effective tax rate for the three and six months ended June 30, 2014 differs from the U.S. federal statutory rate of 34% primarily due to 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 June 30, 2014 the Company had federal and state net operating losses of $3,311,335 and $2,440,844, 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 (“FASB”) has issued Accounting Standards Update (“ASU”) No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial position and results of operations.
The
FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue
recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance
throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to which the company expects to be entitled in
exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each
prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at
the date of initial application. The Company is currently evaluating the potential impact, if any, the adoption of this
standard will have on the Company’s condensed consolidated financial position and
results of operations.
The FASB, the Emerging Issues Task Force and the SEC have issued other accounting standards, updates and regulations as of June 30, 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 and six months ended June 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.
|
ASSET PURCHASE AGREEMENT WITH INTERNATIONAL VAPOR GROUP, INC.
|
On May 14, 2014, the Company and the Buyer, entered into the Purchase Agreement with the Sellers and the Owners, pursuant to which the Buyer will purchase the Sellers’ Business (as defined below) in the Transaction. On July 25, 2014, the Company, the Buyer and the Owners entered into the First Amendment.
The Sellers are engaged in the business of (i) owning certain electronic cigarette and vaporizer brands, including South Beach Smoke® and EverSmoke® 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”).
The following is a summary of the Purchase Agreement, as amended by the First Amendment.
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) $1,700,000 in cash less any estimated net working capital shortfall of the Sellers and (ii) $19,100,000 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 $19,100,000 divided by $5.787 per share, which is 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, 453,430 shares of the Fixed Shares with a value of $2,624,000 will be deposited into escrow with a mutually acceptable escrow agent and will remain in escrow for a period of 27 months following
Closing
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, as defined in the Purchase Agreement. 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) full calendar months 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.
|
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, which is 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) (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.
In connection with the Purchase Agreement , the Company is required to enter into up to ten (10) real estate leases for new retail stores that the Sellers desire to add to their retail operations and fund up to $41,000 of the associated lease security deposits and expenses for the build out of each such retail store (as of August 6, 2014, the Company has entered into nine (9) of such real estate leases).
In addition, the Company may issue up to $250,000 in 43,200 shares of its common stock after the closing as reimbursement for certain of the Sellers’ inventory bearing the Vapor Zone
®
brand that is not part of the Transaction to the extent the Sellers are not able to sell such inventory within 120 days after the closing of the Transaction.
Closing of the Transaction is subject to the Company obtaining stockholder approval for issuance of the shares of its common stock that will be issued under the Purchase Agreement as well as additional customary closing conditions. The Company expects to close the Transaction as soon as possible but not later than September 30, 2014. The Purchase Agreement is terminable by either the Company or International Vapor if the Transaction is not consummated by September 30, 2014 due to no fault of the terminating party.
As of July 28, 2014, the Company has made a secured loan to International Vapor Group in the aggregate principal amount of $500,000.
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.
Note 4.
|
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 and six months ended June 30, 2014, the Company did not borrow under the Factoring Facility. At June 30, 2014 and December 31, 2013 the Company had no borrowings outstanding under the Factoring Facility.
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 June 30, 2014 and December 31, 2013 the Company had $109,617 and $478,847 of borrowings outstanding under the Term Loan, respectively. During the three and six months ended June 30, 2014, the Company recorded $30,000 and $59,077, respectively, in interest expense for the Term Loan and this amount is included in interest expense in the accompanying condensed consolidated statements of operations. During the three and six months ended June 30, 2013, the Company did not record any interest expense for the Term Loan because such periods precede the date the Company initially incurred the Term Loan.
Note 5.
|
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 vested immediately upon execution of the Consulting Agreement, 50,000 shares vested on May 3, 2014 and the remaining 300,000 shares will vest in installments of 50,000 shares each quarterly period beginning on the 90th day following May 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.
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. The Company has determined that
the achievement of the performance conditions defined in the Consulting Agreement is probable and as a result, during the
three and six months ended June 30, 2014, the Company recognized stock-based compensation expense relating to the Consulting
Agreement, in the amount of $336,875 and $929,183, respectively, which is included as part of selling, general and
administrative expense in the accompanying condensed consolidated statements of operations. During the three and six months
ended June 30, 2013, the Company did not recognize any stock-based compensation expense for the Consulting Agreement because
such periods precede the date of the parties’ entry into the Consulting Agreement.
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. On June 20, 2014, the Company filed a second post-effective amendment to the initial registration statement. The second post-effective amendment to the initial registration statement was declared effective by the SEC on June 27, 2014. If the second post-effective amendment to the initial registration statement after being declared effective by the SEC 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 $81,489 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.
|
|
●
|
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 (as described in Note 1 above).
|
|
●
|
Reincorporated to the State of Delaware effective on December 31, 2013 (as described in Note 1 above).
|
|
●
|
Reconstituted its board of directors effective April 25, 2014 so that 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 in Note 1 above); and
|
|
●
|
Listed its common stock on The NASDAQ Capital Market effective May 30, 2014 (as describe in Note 1 above).
|
Warrants
A summary of warrant activity for the six months ended June 30, 2014 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Warrants
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Contractual Term
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding at January 1, 2014
|
|
|
215,880
|
|
|
$
|
3.23
|
|
|
—
|
|
|
$
|
—
|
|
|
Warrants granted
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Warrants exercised
|
|
|
(192,970
|
)
|
|
|
3.30
|
|
|
—
|
|
|
—
|
|
|
Warrants forfeited or expired
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Outstanding at June 30, 2014
|
|
|
22,910
|
|
|
$
|
2.63
|
|
|
|
5.0
|
|
|
$
|
53,090
|
|
|
Exercisable at June 30, 2014
|
|
|
22,910
|
|
|
$
|
2.63
|
|
|
|
5.0
|
|
|
$
|
53,090
|
|
On May 8, 2014, 192,970 warrants were exercised on a cashless basis into 142,383 shares of common stock.
Stock-based Compensation
On March 6, 2014, the Board granted to Ryan Kavanaugh a non-qualified Director’s 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 $8.30 (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).On April 25, 2014, the Board granted to each of the three (3) other New Directors 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 the New Director’s stock options expire on the fifth anniversary of the grant date, vest 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. The weighted average grant date fair value of the March 6 and April 25, 2014 awards were $149,160 and $315,720, respectively.
In addition, during the six months ended June 30, 2014, the Company issued non-qualified stock option awards under the Company’s Equity Incentive Plan to purchase up to 12,000 shares of the Company’s common stock at an exercise price equal to $8.30 (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). The options vest in 3 annual installments and had an aggregate grant date fair value of $29,882.
The fair value of employee stock options was estimated using the following weighted-average assumptions:
|
|
|
|
|
For Six Months Ended
June 30, 2014
|
Expected term
|
|
5 - 7 years
|
|
|
|
Risk Free interest rate
|
|
1.57% - 1.72%
|
|
|
|
Dividend yield
|
|
0.0%
|
|
|
|
Volatility
|
|
27% - 31%
|
No employee stock options were granted during the first six months of 2013.
Stock option activity
Options outstanding at June 30, 2014 under the various plans are as follows (in thousands):
|
Plan
|
|
Total
Number of
Options
Outstanding
under Plans
|
|
|
|
|
|
|
|
|
Equity compensation plans not approved by security holders
|
|
|
900
|
|
|
|
|
|
|
|
|
Equity Incentive Plan
|
|
|
455
|
|
|
|
|
|
|
|
|
|
|
|
1,355
|
|
A summary of activity under all option Plans at June 30, 2014 and changes during the six months ended June 30, 2014 (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
252
|
|
|
|
7.00
|
|
|
5.24
|
|
|
-
|
|
|
Options exercised
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
Options forfeited or expired
|
|
|
16
|
|
|
|
1.47
|
|
|
10.00
|
|
|
-
|
|
|
Outstanding at June 30, 2014
|
|
|
1,355
|
|
|
$
|
3.08
|
|
|
|
6.54
|
|
|
$
|
2,539
|
|
|
Exercisable at June 30, 2014
|
|
|
993
|
|
|
$
|
2.16
|
|
|
|
6.38
|
|
|
$
|
2,772
|
|
|
Options available for grant at June 30, 2014
|
|
|
1,302
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the three months ended June 30, 2014 and 2013, the Company recognized stock-based compensation expense in connection with the amortization of stock options expense of $36,820 and $10,688, respectively. During the six months ended June 30, 2014 and 2013, the Company recognized stock-based compensation expense in connection with the amortization of stock option expense of $54,926 and $21,377, respectively. Stock-based compensation expense is included as part of selling, general and administrative expense in the accompanying condensed consolidated statements of operations.
At June 30, 2014 the amount of unamortized stock-based compensation expense on unvested stock options granted to employees, directors and consultants was $585,976 and will be amortized over 2.25 years.
(Loss) earnings 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.
The following table reconciles the numerator and denominator for the calculation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the six months ended June 30,
|
|
|
For the three months ended June 30,
|
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income - basic
|
|
$
|
(2,503,923
|
)
|
|
$
|
68,894
|
|
|
$
|
(1,051,164
|
)
|
|
$
|
(54,650
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator – basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
16,312,563
|
|
|
|
12,046,259
|
|
|
|
16,377,674
|
|
|
|
12,053,591
|
|
|
Basic (loss) earnings per common share
|
|
$
|
(0.15
|
)
|
|
$
|
0.01
|
|
|
$
|
(0.06
|
)
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income - diluted
|
|
$
|
(2,503,923
|
)
|
|
$
|
68,894
|
|
|
$
|
(1,051,164
|
)
|
|
$
|
(54,650
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator – diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
16,312,563
|
|
|
|
12,046,259
|
|
|
|
16,377,674
|
|
|
|
12,053,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common share equivalents of outstanding stock options
|
|
|
-
|
|
|
|
220,556
|
|
|
|
-
|
|
|
|
-
|
|
|
Common share equivalents of outstanding warrants
|
|
|
-
|
|
|
|
70,212
|
|
|
|
-
|
|
|
|
-
|
|
|
Weighted average number of common shares outstanding
|
|
|
16,312,563
|
|
|
|
12,337,027
|
|
|
|
16,377,674
|
|
|
|
12,053,591
|
|
|
Diluted (loss) earnings per common share
|
|
$
|
(0.15
|
)
|
|
$
|
0.01
|
|
|
$
|
(0.06
|
)
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities excluded from the weighted outstanding because their inclusion would have been antidilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible debt
|
|
|
-
|
|
|
|
665,420
|
|
|
|
-
|
|
|
|
665,420
|
|
|
Stock options
|
|
|
1,211,879
|
|
|
|
-
|
|
|
|
1,305,300
|
|
|
|
1,104,200
|
|
|
Warrants
|
|
|
22,910
|
|
|
|
8,142
|
|
|
|
22,910
|
|
|
|
18,818
|
|
|
Restricted common stock
|
|
|
300,000
|
|
|
|
-
|
|
|
|
300,000
|
|
|
|
-
|
|
Note 6.
|
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
|
|
$
|
88,380
|
|
2015
|
|
|
58,920
|
|
Total
|
|
$
|
147,300
|
|
Rent expense for the three months ended June 30, 2014 and 2013 was $46,174 and $39,432, respectively. Rent expense for the six months ended June 30, 2014 and 2013 was $91,012 and $77,592, respectively. Rent expense is included in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations.
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 and believes the claims are without merit. The Company has not accrued a loss for this matter and intends to vigorously defend against this lawsuit.
Related Party Transactions
During the three and six months ended June 30, 2013, the Company paid aggregate interest of $29,349 and $58,938, 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 and six months ended June 30, 2013, the Company paid aggregate interest of $6,732 and $13,389, respectively to Kevin Frija, a greater than 5% stockholder, pursuant to a previously outstanding senior convertible note.
During the three and six months ended June 30, 2013, the Company paid interest of $4,438 and $8,926, 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. No interest was paid during the three and six months ended June 30, 2014 to these related parties.
Purchase Commitments
At June 30, 2014 and December 31, 2013, the Company has vendor deposits of $541,540 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 7.
|
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.
Subsequent to June 30, 2014 but before these condensed consolidated
financial statements were issued, an additional 50,000 shares of common stock vested in connection with the Consulting Agreement
with Knight Global.