N
ot
es to Condensed Consolidated Financial Statements
(Unaudited)
June 30, 2016
Note 1. Basis of Presentation and Description of Business
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations.
The statements presented as of June 30, 2016 and for the three and six months ended June 30, 2016 and 2015 are unaudited. In the opinion of management, these financial statements reflect all normal recurring and other adjustments necessary for a fair presentation, and to make the financial statements not misleading. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2015. The results for interim periods are not necessarily indicative of the results for the entire year.
Certain reclassifications have been made to conform to the current year presentations including the Company’s adoption of ASU 2015-03 and ASU 2015-15, pertaining to the presentation of debt issuance costs with retrospective application effective January 1, 2016. This resulted in a reclassification
from prepaid expenses and other assets to convertible notes payable, net of debt discount
. Refer below to “Recently Issued Accounting Pronouncements” of the notes to the condensed consolidated financial statements for further details. These reclassifications did not affect revenue, total costs and expenses, income (loss) from operations, or net income (loss).
The Company consolidates all majority owned subsidiaries, investments in entities in which we have controlling influence and variable interest entities where we have been determined to be the primary beneficiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
Nature of Business
Youngevity International, Inc. (the “Company”), founded in 1996, develops and distributes nutritional supplements, sports and energy drinks, health and wellness, weight loss, gourmet coffee, skincare and cosmetics, lifestyle services, digital products including scrap books and memory books, packaged foods, pharmacy discount cards, clothing and jewelry line products through its global independent direct selling network, also known as multi-level marketing, and sells coffee products to commercial customers. The Company operates in two business segments, its direct selling segment where products are offered through a global distribution network of preferred customers and distributors and its commercial coffee segment where products are sold directly to businesses. In the following text, the terms “we,” “our,” and “us” may refer, as the context requires, to the Company or collectively to the Company and its subsidiaries.
The Company operates through the following domestic wholly-owned subsidiaries: AL Global Corporation, which operates our direct selling networks, CLR Roasters, LLC (“CLR”), our commercial coffee business, Financial Destination, Inc., FDI Management, Inc., and MoneyTrax LLC (collectively referred to as “FDI”), 2400 Boswell LLC, MK Collaborative LLC, Youngevity Global LLC and the wholly-owned foreign subsidiaries Youngevity Australia Pty. Ltd., Youngevity NZ, Ltd., Siles Plantation Family Group S.A. located in Nicaragua, Youngevity Mexico S.A. de CV, Youngevity Israel, Ltd., Youngevity Russia LLC, Youngevity Colombia S.A.S., Youngevity International Singapore Pte. Ltd., and Mialisia Canada, Inc.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense for each reporting period. Estimates are used in accounting for, among other things, allowances for doubtful accounts, deferred taxes, and related valuation allowances, fair value of derivative liabilities, uncertain tax positions, loss contingencies, fair value of options granted under our stock based compensation plan, fair value of assets and liabilities acquired in business combinations, capital leases, asset impairments, estimates of future cash flows used to evaluate impairments, useful lives of property, equipment and intangible assets, value of contingent acquisition debt, inventory obsolescence, and sales returns.
Actual results may differ from previously estimated amounts and such differences may be material to the consolidated financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected prospectively in the period they occur.
Cash and Cash Equivalents
The Company considers only its monetary liquid assets with original maturities of three months or less as cash and cash equivalents.
Earnings Per Share
Basic earnings (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to common stockholders by the sum of the weighted-average number of common shares outstanding during the period and the weighted-average number of dilutive common share equivalents outstanding during the period, using the treasury stock method. Dilutive common share equivalents are comprised of in-the-money stock options, warrants and convertible preferred stock, based on the average stock price for each period using the treasury stock method.
The Company incurred a loss for the three months ended June 30, 2016, and therefore, 5,726,128 common share equivalents were not included in the weighted-average calculation since their effect would have been anti-dilutive. The incremental dilutive common share equivalents were 7,082,610 for the six months ended June 30, 2016.
The Company incurred a loss for the three and six months ended June 30, 2015, and therefore, 7,434,581 and 4,881,194 common share equivalents, respectively, were not included in the weighted-average calculation since their effect would have been anti-dilutive.
Stock Based Compensation
The Company accounts for stock based compensation in accordance with ASC Topic 718, “
Compensation – Stock Compensation,”
which establishes accounting for equity instruments exchanged for employee services. Under such provisions, stock based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense, under the straight-line method, over the vesting period of the equity grant.
The Company accounts for equity instruments issued to non-employees in accordance with authoritative guidance for equity based payments to non-employees. Stock options issued to non-employees are accounted for at their estimated fair value, determined using the Black-Scholes option-pricing model. The fair value of options granted to non-employees is re-measured as they vest, and the resulting increase in value, if any, is recognized as expense during the period the related services are rendered.
Factoring Agreement
The
Company has a factoring agreement (“Factoring Agreement”) with Crestmark Bank (“Crestmark”) related to the Company’s accounts receivable resulting from sales of certain products within its commercial coffee segment. Effective May 1, 2016, the Company entered into a third amendment to the factoring agreement (“Agreement”). Under the terms of the Agreement, all new receivables assigned to Crestmark shall be “Client Risk Receivables” and no further credit approvals will be provided by Crestmark and there will be no new credit-approved receivables. The changes to the Agreement include expanding the factoring facility to include borrowings to be advanced against acceptable eligible inventory up to 50% of landed cost of finished goods inventory and meeting certain criteria, not to exceed the lesser of $1,000,000 or 85% of the value of the receivables already advanced with a maximum overall borrowing of $3,000,000. Interest accrues on the outstanding balance and a factoring commission is charged for each invoice factored which is calculated as the greater of $5.00 or 0.75% to 1.00% of the gross invoice amount and is recorded as interest expense. In addition Youngevity Inc. has entered into a Guaranty and Security Agreement with Crestmark Bank if in the event that CLR were to default. This Agreement shall continue in full force and is effective until February 1, 2019
.
The Company accounts for the sale of receivables under the Factoring Agreement as secured borrowings with a pledge of the subject inventories and receivables as well as all bank deposits as collateral, in accordance with the authoritative guidance for accounting for transfers and servicing of financial assets and extinguishments of liabilities. The caption “Accounts receivable, due from factoring company” on the accompanying condensed consolidated balance sheets in the amount of approximately $849,000 and $556,000 as of June 30, 2016 and December 31, 2015, respectively, reflects the related collateralized accounts.
The Company's outstanding liability related to the Factoring Agreement was approximately $1,288,000 and $457,000 as of June 30, 2016 and December 31, 2015, respectively, and is included in other current liabilities, net on the condensed consolidated balance sheets.
Plantation Costs
The Company’s commercial coffee segment CLR includes the results of the Siles Plantation Family Group (“Siles”), which is a 450 acre coffee plantation and a dry-processing facility located on 26 acres both located in Matagalpa, Nicaragua. Siles is a wholly-owned subsidiary of CLR, and the results of CLR include the depreciation and amortization of capitalized costs, development and maintenance and harvesting costs of Siles. In accordance with GAAP, plantation maintenance and harvesting costs for commercially producing coffee farms are charged against earnings when sold. Deferred harvest costs accumulate throughout the year, and are expensed over the remainder of the year as the coffee is sold. The difference between actual harvest costs incurred and the amount of harvest costs recognized as expense is recorded as either an increase or decrease in deferred harvest costs, which is reported as an asset and included with prepaid expenses and other current assets in the condensed consolidated balance sheets. Once the harvest is complete, the harvest cost is then recognized as the inventory value.
In April 2015, the Company completed the 2015 coffee harvest in Nicaragua and approximately $723,000 of deferred harvest costs were reclassified as inventory during the quarter ended June 30, 2015. The remaining inventory as of June 30, 2016 and December 31, 2015 is $144,000 and $192,000, respectively.
In May 2016, the Company completed the 2016 coffee harvest in Nicaragua and approximately $650,000 of deferred harvest costs were reclassified as inventory during the quarter ended June 30, 2016. The remaining inventory as of June 30, 2016 is $153,000.
Costs associated with the 2017 harvest as of June 30, 2016 total approximately $96,000 and are included in prepaid expenses and other current assets as deferred harvest costs on the Company’s condensed consolidated balance sheets.
Related Party Transactions
Our coffee segment CLR is associated with
Hernandez, Hernandez, Export Y Company
(“H&H”), a Nicaragua company through sourcing arrangements to procure Nicaraguan green coffee and in March 2014 as part of the Siles acquisition, CLR engaged H&H as employees to manage Siles. The Company made purchases of approximately $2,900,000 and $4,700,000 from this supplier for the three months and six months ended June 30, 2016, respectively. In addition, for the three months and six months ended June 30, 2016, CLR sold $1,500,000 and $2,200,000 respectively, in green coffee to H&H Coffee Group Export, a Florida Company which is affiliated with H&H.
Revenue Recognition
The Company recognizes revenue from product sales when the following four criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectability is reasonably assured. The Company ships the majority of its direct selling segment products directly to the distributors via UPS or USPS and receives substantially all payments for these sales in the form of credit card transactions. The Company regularly monitors its use of credit card or merchant services to ensure that its financial risk related to credit quality and credit concentrations is actively managed. Revenue is recognized upon passage of title and risk of loss to customers when product is shipped from the fulfillment facility. The Company ships the majority of its coffee segment products via common carrier and invoices its customer for the products. Revenue is recognized when the title and risk of loss is passed to the customer under the terms of the shipping arrangement, typically, FOB shipping point.
Sales revenue and a reserve for estimated returns are recorded net of sales tax when product is shipped.
Deferred Revenues and Costs
Deferred revenues relate primarily to the Heritage Makers product line and represent the Company’s obligation for points purchased by customers that have not yet been redeemed for product. Cash received for points sold is recorded as deferred revenue. Revenue is recognized when customers redeem the points and the product is shipped. As of June 30, 2016 and December 31, 2015, the balance in deferred revenues was approximately $2,115,000 and $2,580,000 respectively, of which the portion attributable to Heritage Makers was approximately $2,068,000 and $2,485,000, respectively. The remaining balance of approximately $47,000 and $95,000 as of June 30, 2016 and December 31, 2015, respectively, relates primarily to the Company’s 2016 conventions whereby attendees pre-enroll in the events and the Company does not recognize this revenue until the conventions occur.
Deferred costs relate to Heritage Makers prepaid commissions that are recognized in expense at the time the related revenue is recognized. As of June 30, 2016 and December 31, 2015, the balance in deferred costs was approximately $684,000 and $967,000, respectively, and was included in prepaid expenses and current assets.
Recently Issued Accounting Pronouncements
In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02,
Leases (Topic 842).
The amendments in this ASU change the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. The guidance is effective for annual reporting periods beginning after December 15, 2018. The new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The Company is currently evaluating the impact of adopting the new leases standard on its consolidated financial statements.
In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-07,
Simplifying the Transition to the Equity Method of Accounting
(“ASU 2016-07”). ASU 2016-07 eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. ASU 2016-07 requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. ASU 2016-17 requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. ASU 2016-07 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2016, and must be applied prospectively. The Company does not believe that the adoption of this standard will have a material impact on the Company’s consolidated financial position or results of operations.
In March 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-09, “
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”
(“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for us beginning January 1, 2017. Early adoption is permitted. The Company is currently evaluating the impact adopting this guidance will have on its consolidated financial statements.
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In July 2015, the FASB approved a one-year deferral of the effective date of the new revenue recognition standard. The new standard will become effective for the Company on January 1, 2018 and the Company has the option to adopt it effective January 1, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue versus Net) (“ASU 2016-08”), which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. ASU 2016-08 clarifies how an entity should identify the unit of accounting (i.e., the specified good or service) for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements. In April 2016, the FASB issued Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing (“ASU 2016-10”), which amends certain aspects of the guidance on identifying performance obligations and the implementation guidance on licensing. The Company is evaluating the effect the ASUs will have on its consolidated financial statements and related disclosures. The Company has not yet selected an adoption date, a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
In April 2015, the FASB issued ASU No. 2015-03,
Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
to simplify the presentation of debt issuance costs. The amendments in the update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction of the carrying amount of
the debt. Recognition and measurement of debt issuance costs were not affected
by this amendment. In August 2015, FASB issued ASU 2015-15, “Presentation and
Subsequent Measurement of Debt Issuance Costs Associated With Line-of-Credit Arrangements-Amendments to SEC Paragraphs Pursuant to Staff Announcement at
June 18, 2015 EITF Meeting” which clarified that the SEC would not object to an
entity deferring and presenting debt issuance costs as an asset and subsequently
amortizing the deferred debt issuance costs ratably over the term of the
line-of-credit arrangement.
ASU 2015-03 represents a change in accounting principle and was effective on January 1, 2016 and was applied on a retrospective basis. The adoption of ASU 2015-03 resulted in a retrospective reclassification of our debt issuance costs as described above from prepaid expenses and other assets to convertible notes payable, net of debt discount on our December 31, 2015 balance sheet in the amount of $1,456,000.
Note 2.
Income Taxes
The Company accounts for income taxes in accordance with ASC Topic 740, “
Income Taxes,”
under the asset and liability method which includes the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the condensed consolidated financial statements. Under this approach, deferred taxes are recorded for the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial statement and tax basis of assets and liabilities, and are adjusted for changes in tax rates and tax laws when changes are enacted. The effects of future changes in income tax laws or rates are not anticipated.
Income taxes for the interim periods are computed using the effective tax rates estimated to be applicable for the full fiscal year, as adjusted for any discrete taxable events that occur during the period.
The Company files income tax returns in the United States (“U.S.”) on a federal basis and in many U.S. state and foreign jurisdictions. Certain tax years remain open to examination by the major taxing jurisdictions to which the Company is subject.
Note 3.
Inventory and Costs of Sales
Inventory is stated at the lower of cost or market value. Cost is determined using the first-in, first-out method. The Company records an inventory reserve for estimated excess and obsolete inventory based upon historical turnover, market conditions and assumptions about future demand for its products. When applicable, expiration dates of certain inventory items with a definite life are taken into consideration.
Inventories consist of the following (in thousands):
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As of
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June 30,
2016
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December 31,
2015
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Reserve for excess and obsolete
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Cost of revenues includes the cost of inventory, shipping and handling costs, royalties associated with certain products, transaction banking costs, warehouse labor costs and depreciation on certain assets.
Note 4. Acquisitions and Business Combinations
The Company accounts for business combinations under the acquisition method and allocates the total purchase price for acquired businesses to the tangible and identified intangible assets acquired and liabilities assumed, based on their estimated fair values. When a business combination includes the exchange of the Company’s common stock, the value of the common stock is determined using the closing market price as of the date such shares were tendered to the selling parties. The fair values assigned to tangible and identified intangible assets acquired and liabilities assumed are based on management or third-party estimates and assumptions that utilize established valuation techniques appropriate for the Company’s industry and each acquired business. Goodwill is recorded as the excess, if any, of the aggregate fair value of consideration exchanged for an acquired business over the fair value (measured as of the acquisition date) of total net tangible and identified intangible assets acquired. A liability for contingent consideration, if applicable, is recorded at fair value as of the acquisition date. In determining the fair value of such contingent consideration, management estimates the amount to be paid based on probable outcomes and expectations on financial performance of the related acquired business. The fair value of contingent consideration is reassessed quarterly, with any change in the estimated value charged to operations in the period of the change. Increases or decreases in the fair value of the contingent consideration obligations can result from changes in actual or estimated revenue streams, discount periods, discount rates and probabilities that contingencies will be met.
During the six months ended June 30, 2016, the Company entered into one acquisition, which is described below. The acquisition was conducted in an effort to expand the Company’s distributor network, enhance and expand its product portfolio, and diversify its product mix. As such, the major purpose for the Company’s business combination was to increase revenue and profitability. The acquisition was structured as an asset purchase which resulted in the recognition of certain intangible assets.
South Hill Designs Inc.
In January 2016, the Company acquired certain assets of South Hill Designs Inc., (“South Hill”) a direct-sales and proprietary jewelry company that sells customized lockets and charms, which further expands the Company’s jewelry line that the Company’s distributors have access to offering more variety and appealing to a broader consumer base and the South Hill distributors and customers will gain access to products offered by the Company.
The contingent consideration’s estimated fair value at the date of acquisition was $2,650,000 as determined by management using a discounted cash flow methodology. The acquisition related costs, such as legal costs and other professional fees were minimal and expensed as incurred.
The Company has agreed to pay South Hill a monthly royalty payment on all gross sales revenue generated by the South Hill distributor organization in accordance with this agreement, regardless of products being sold and a monthly royalty payment on South Hill product revenue for seven (7) years from the closing date.
The assets acquired were recorded at estimated fair values as of the date of the acquisition. The fair values of the acquired assets have not been finalized pending further information that may impact the valuation of certain assets or liabilities. The preliminary purchase price allocation for South Hill is as follows (in thousands):
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Customer-related intangible
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Trademarks and trade name
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The preliminary fair value of intangible assets acquired was determined through the use of a discounted cash flow methodology. The trademarks and trade name, customer-related intangible and distributor organization intangible are being amortized over their estimated useful life of ten (10) years using the straight-line method which is believed to approximate the time-line within which the economic benefit of the underlying intangible asset will be realized.
The Company expects to finalize the valuation within one (1) year from the acquisition date.
Revenues related to the acquisition for the three and six months ended June 30, 2016 were $1,144,000 and $2,539,000, respectively.
The pro-forma effect assuming the business combination with South Hill discussed above had occurred at the beginning of the current period is not presented as the information was not available.
2015 Acquisition
Mialisia & Co., LLC
On June 1, 2015, the Company acquired certain assets of Mialisia & Co., LLC, (“Mialisia”) a direct-sales jewelry company that specializes in interchangeable jewelry. As a result of this business combination, the Company’s distributors and customers have access to the unique line of Mialisia’s patent-pending “VersaStyle™” jewelry and Mialisia’s distributors and customers have gained access to products offered by the Company. The purchase price consisted of a maximum aggregate purchase price of $1,900,000. The Company paid $118,988 for certain inventories, which payment was applied against the maximum aggregate purchase price.
The Company has agreed to pay Mialisia a monthly payment equal to seven (7%) of all gross sales revenue generated by the Mialisia distributor organization in accordance with the asset purchase agreement, regardless of products being sold and pay five (5%) royalty on Mialisia product revenue until the earlier of the date that is fifteen (15) years from the closing date or such time as the Company has paid aggregate cash payment equal to $1,781,012 provided, however, that in no event will the maximum aggregate purchase price be reduced below $1,650,000.
The contingent consideration’s estimated fair value at the date of acquisition was $700,000 as determined by management using a discounted cash flow methodology. The acquisition related costs, such as legal costs and other professional fees were minimal and expensed as incurred.
During the second quarter ended June 30, 2016 the purchase accounting was finalized and the Company determined that the initial purchase price should be reduced from $700,000, by approximately $108,000. The final purchase price allocation for Mialisia (in thousands) is as follows:
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Customer-related intangible
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Trademarks and trade name
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The fair value of intangible assets acquired was determined through the use of a discounted cash flow methodology. The trademarks and trade name, customer-related intangible and distributor organization intangible are being amortized over their estimated useful life of ten (10) years using the straight-line method which is believed to approximate the time-line within which the economic benefit of the underlying intangible asset will be realized.
Note 5. Intangible Assets and Goodwill
Intangible Assets
Intangible assets are comprised of distributor organizations, trademarks and tradenames, customer relationships and internally developed software. The Company's acquired intangible assets, which are subject to amortization over their estimated useful lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. An impairment loss is recognized when the carrying amount of an intangible asset exceeds its fair value.
Intangible assets consist of the following (in thousands):
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June 30, 2016
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December 31, 2015
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Cost
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Accumulated
Amortization
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Net
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Cost
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Accumulated
Amortization
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Net
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Distributor organizations
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Trademarks and trade names
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Internally developed software
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Amortization expense related to intangible assets was approximately $605,000 and $525,000 for the three months ended June 30, 2016 and 2015, respectively. Amortization expense related to intangible assets was approximately $1,209,000 and $1,038,000 for the six months ended June 30, 2016 and 2015, respectively.
Trade names, which do not have legal, regulatory, contractual, competitive, economic, or other factors that limit the useful lives are considered indefinite lived assets and are not amortized but are tested for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Approximately $2,267,000 in trademarks from business combinations have been identified as having indefinite lives.
Goodwill
Goodwill is recorded as the excess, if any, of the aggregate fair value of consideration exchanged for an acquired business over the fair value (measured as of the acquisition date) of total net tangible and identified intangible assets acquired. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350,
“Intangibles — Goodwill and Other”,
goodwill and other intangible assets with indefinite lives are not amortized but are tested for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company conducts annual reviews for goodwill and indefinite-lived intangible assets in the fourth quarter or whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable.
The Company first assesses qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that goodwill is impaired. After considering the totality of events and circumstances, the Company determines whether it is more likely than not that goodwill is not impaired. If impairment is indicated, then the Company conducts the two-step impairment testing process. The first step compares the Company’s fair value to its net book value. If the fair value is less than the net book value, the second step of the test compares the implied fair value of the Company’s goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, the Company would recognize an impairment loss equal to that excess amount. The testing is generally performed at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (referred to as a component) if discrete financial information is prepared and regularly reviewed by management at the component level. The Company has determined that its reporting units for goodwill impairment testing are the Company’s reportable segments. As such, the Company analyzed its goodwill balances separately for the commercial coffee reporting unit and the direct selling reporting unit. The goodwill balance as of June 30, 2016 and December 31, 2015 was $6,323,000. There were no triggering events indicating impairment of goodwill or intangible assets during the three and six months ended June 30, 2016 and 2015.
Note 6. Debt
Our total convertible notes payable, net of debt discount outstanding consisted of the amount set forth in the following table (in thousands):
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June 30,
2016
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December 31,
2015
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8% Convertible Notes due July and August 2019 (July 2014 Private Placement) (1)
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8% Convertible Notes due October and November 2018 (November 2015 Private Placement) (2)
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Net debt issuance costs (3)
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Total convertible notes payable, net of debt discount (4)
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(1) Amounts are net of unamortized debt discounts of $2,929,000 as of June 30, 2016 and $3,404,000 as of December 31, 2015.
(2) Amounts are net of unamortized debt discounts of $240,000 as of June 30, 2016 and $292,000 as of December 31, 2015.
(3) As of January 1, 2016, we adopted ASU 2015-03 with retrospective application. This resulted in a $1,456,000 reclassification from prepaid expenses and other current assets to convertible notes payable, net of debt discount, for unamortized debt issuance costs.
(4) Amounts are net of unamortized discounts and issuance costs of $4,381,000 as of June 30, 2016 and $5,152,000 as of December 31, 2015.
Convertible Notes Payable
November 2015 Private Placement
Between October 13, 2015 and November 25, 2015 the Company entered into Note Purchase Agreements (the “Note” or “Notes”) related to its private placement offering (“November 2015 Private Placement”) with three (3) accredited investors pursuant to which the Company raised cash proceeds of $3,187,500 in the offering and converted $4,000,000 of debt from the January 2015 Private Placement to this offering in consideration of the sale of aggregate units consisting of three (3) year senior secured convertible Notes in the aggregate principal amount of $7,187,500, convertible into 20,535,714 shares of common stock, par value $0.001 per share, at a conversion price of $0.35 per share, subject to adjustment as provided therein; and five (5) year Warrants exercisable to purchase 9,583,333 shares of the Company’s common stock at a price per share of $0.45. The Notes bear interest at a rate of eight percent (8%) per annum and interest is paid quarterly in arrears with all principal and unpaid interest due at maturity on October 12, 2018. As of June 30, 2016 and December 31, 2015 the principal amount of $7,187,500 remains outstanding.
July 2014 Private Placement
Between July 31, 2014 and September 10, 2014 the Company entered into Note Purchase Agreements (the “Note” or “Notes”) related to its private placement offering (“2014 Private Placement”) with seven accredited investors pursuant to which the Company raised aggregate gross proceeds of $4,750,000 and sold units consisting of five (5) year senior secured convertible Notes in the aggregate principal amount of $4,750,000, that are convertible into 13,571,429 shares of our common stock, at a conversion price of $0.35 per share, and warrants to purchase 18,586,956 shares of common stock at an exercise price of $0.23 per share. The Notes bear interest at a rate of eight percent (8%) per annum and interest is paid quarterly in arrears with all principal and unpaid interest due between July and September 2019. As of June 30, 2016 and December 31, 2015 the principal amount of $4,750,000 remains outstanding.
Notes Payable
January 2015 Private Placement
In January 2015, the Company entered into Note Purchase Agreements (the “Note” or “Notes”) related to its private placement offering (“January 2015 Private Placement”) with three (3) accredited investors pursuant to which the Company sold units consisting of one (1) year senior secured notes in the aggregate principal amount of $5,250,000. One holder of a January 2015 Note in the principal amount of $5,000,000 was prepaid on October 26, 2015 through a cash payment from us to the investor of $1,000,000 and the remaining $4,000,000 owed was applied to the investor’s purchase of a $4,000,000 November 2015 Note in the November 2015 Private Placement and a November 2015 Warrant exercisable to purchase 5,333,333 shares of Common Stock. The Notes bore interest at a rate of eight percent (8%) per annum and interest was paid quarterly in 2015. The remaining balance of the January 2015 Notes as of December 31, 2015 was $250,000 and was paid in January 2016.
Note 7. Derivative Liability
The Company accounted for the warrants issued in conjunction with our November 2015 and July 2014 Private Placement’s in accordance with the accounting guidance for derivatives ASC Topic 815. The accounting guidance sets forth a two-step model to be applied in determining whether a financial instrument is indexed to an entity’s own stock, which would qualify such financial instruments for a scope exception. This scope exception specifies that a contract that would otherwise meet the definition of a derivative financial instrument would not be considered as such if the contract is both (i) indexed to the entity’s own stock and (ii) classified in the stockholders’ equity section of the entity’s balance sheet. The Company determined the warrants related to Notes are ineligible for equity classification due to anti-dilution provisions set forth therein.
The Company revalued the warrants as of the end of each reporting period, and the estimated fair value of the outstanding warrant liabilities was $4,550,000 and $4,716,000 as of June 30, 2016 and December 31, 2015, respectively.
Increases or decreases in fair value of the derivative liability are included as a component of total other expense in the accompanying condensed consolidated statements of operations for the respective period. The changes to the derivative liability for warrants resulted in an increase of approximately $484,000 and an increase of approximately $2,209,000 for the three months ended June 30, 2016 and 2015, respectively, and a decrease of approximately $166,000 and an increase of approximately $2,301,000 for the six months ended June 30, 2016 and 2015, respectively.
Various factors are considered in the pricing models we use to value the warrants, including our current stock price, the remaining life of the warrants, the volatility of our stock price, and the risk free interest rate. Future changes in these factors may have a significant impact on the computed fair value of the warrant liability. As such, we expect future changes in the fair value of the warrants to continue and may vary significantly from period to period. The warrant liability and revaluations have not had a cash impact on our working capital, liquidity or business operations.
Warrants classified as derivative liabilities are recorded at their estimated fair value (see Note 8, below) at the issuance date and are revalued at each subsequent reporting date. We will continue to revalue the derivative liability on each subsequent balance sheet date until the securities to which the derivative liabilities relate are exercised or expire.
The estimated fair value of the warrants were computed as of June 30, 2016 and as of December 31, 2015 using Black-Scholes and Monte Carlo option pricing models, using the following assumptions:
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June 30,
2016
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December 31, 2015
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In addition, Management assessed the probabilities of future financing assumptions in the valuation models.
Note 8. Fair Value of Financial Instruments
Fair value measurements are performed in accordance with the guidance provided by ASC Topic 820,
“Fair Value Measurements and Disclosures.”
ASC Topic 820 defines fair value as the price that would be received from selling an asset, or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or parameters are not available, valuation models are applied.
ASC Topic 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Assets and liabilities recorded at fair value in the financial statements are categorized based upon the hierarchy of levels of judgment associated with the inputs used to measure their fair value. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
Level 1 – Quoted prices in active markets for identical assets or liabilities that an entity has the ability to access.
Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – Unobservable inputs that are supportable by little or no market activity and that are significant to the fair value of the asset or liability.
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, capital lease obligations and deferred revenue approximate their fair values based on their short-term nature. The carrying amount of the Company’s long term notes payable approximates its fair value based on interest rates available to the Company for similar debt instruments and similar remaining maturities.
The estimated fair value of the contingent consideration related to the Company's business combinations is recorded using significant unobservable measures and other fair value inputs and is therefore classified as a Level 3 financial instrument.
In connection with the 2015 and 2014 Private Placements, we issued warrants to purchase shares of our common stock which are accounted for as derivative liabilities (see Note 7 above.) The estimated fair value of the warrants is recorded using significant unobservable measures and other fair value inputs and is therefore classified as a Level 3 financial instrument.
We used Level 3 inputs for the valuation methodology of the derivative liabilities. Our derivative liabilities are adjusted to reflect estimated fair value at each period end, with any decrease or increase in the estimated fair value being recorded in other income or expense accordingly, as adjustments to the fair value of the derivative liabilities.
The following table details the fair value measurement within the three levels of the value hierarchy of the Company’s financial instruments, which includes the Level 3 liabilities (in thousands):
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Fair Value at June 30, 2016
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Total
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Level 1
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Level 2
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Level 3
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Liabilities:
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Contingent acquisition debt, current portion
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Contingent acquisition debt, less current portion
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Warrant derivative liability
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Fair Value at December 31, 2015
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Total
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Level 1
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Level 2
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Level 3
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Liabilities:
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Contingent acquisition debt, current portion
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Contingent acquisition debt, less current portion
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Warrant derivative liability
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The fair value of the contingent acquisition liabilities are evaluated each reporting period using projected revenues, discount rates, and projected timing of revenues. Projected contingent payment amounts are discounted back to the current period using a discount rate. Projected revenues are based on the Company’s most recent internal operational budgets and long-range strategic plans. In some cases, there is no maximum amount of contingent consideration that can be earned by the sellers. Increases in projected revenues will result in higher fair value measurements. Increases in discount rates and the time to payment will result in lower fair value measurements. Increases (decreases) in any of those inputs in isolation may result in a significantly lower (higher) fair value measurement. During the three and six months ended June 30, 2016 the net adjustment to the fair value of the contingent acquisition debt was a decrease of $480,000 and a decrease of $871,000, respectively. There were no adjustments to the fair value of the contingent acquisition debt during the three and six months ended June 30, 2015.
Note 9. Stockholders’ Equity
The Company’s Articles of Incorporation, as amended, authorize the issuance of two classes of stock to be designated “Common Stock” and “Preferred Stock”.
Convertible Preferred Stock
The Company had 161,135 shares of Series A Convertible Preferred Stock ("Series A Preferred") outstanding as of June 30, 2016 and December 31, 2015, and accrued dividends of approximately $105,000 and $98,000, respectively. The holders of the Series A Preferred Stock are entitled to receive a cumulative dividend at a rate of 8.0% per year, payable annually either in cash or shares of the Company's Common Stock at the Company's election. Shares of Common Stock paid as accrued dividends are valued at $0.50 per share. Each share of Series A Preferred is convertible into two shares of the Company's Common Stock. The holders of Series A Preferred are entitled to receive payments upon liquidation, dissolution or winding up of the Company before any amount is paid to the holders of Common Stock. The holders of Series A Preferred have no voting rights, except as required by law.
Common Stock
The Company had 392,683,365 common shares outstanding as of June 30, 2016. The holders of Common Stock are entitled to one vote per share on matters brought before the shareholders.
Repurchase of Common Stock
On December 11, 2012, the Company authorized a share repurchase program to repurchase up to 15 million of the Company's issued and outstanding common shares from time to time on the open market or via private transactions through block trades. Under this program, for the six months ended June 30, 2016, the Company repurchased a total of 71,400 shares at a weighted-average cost of $0.28. A total of 3,877,572 shares have been repurchased to-date at a weighted-average cost of $0.26. The remaining number of shares authorized for repurchase under the plan as of June 30, 2016 is 11,122,428.
Warrants to Purchase Preferred Stock and Common Stock
As of June 30, 2016, warrants to purchase 41,604,796 shares of the Company's common stock at prices ranging from $0.10 to $0.50 were outstanding. All warrants are exercisable as of June 30, 2016 and expire at various dates through November 2020 and have a weighted average remaining term of approximately 2.98 years as of June 30, 2016.
A summary of the warrant activity for the six months ended June 30, 2016 is presented in the following table:
Balance at December 31, 2015
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Advisory Agreements
PCG Advisory Group.
On September 1, 2015, the Company entered into an agreement with PCG Advisory Group (“PCG”), pursuant to which PCG agreed to provide investor relations services for six (6) months in exchange for fees paid in cash of $6,000 per month and 100,000 shares of restricted common stock to be issued in accordance with the agreement upon successfully meeting certain criteria in accordance with the agreement. In connection with this agreement, the Company accrued for the estimated per share value on the agreement date at $0.32 per share, the price of Company’s common stock at September 1, 2015 for a total of $32,000 due to PCG. The fair values of the shares was recorded as prepaid advisory fees and were included in prepaid expenses and other current assets on the Company’s balance sheets and were amortized on a pro-rata basis over the term of the contract. On June 28, 2016 the Company issued PCG 100,000 restricted shares of our common stock in accordance with the performance of the agreement as previously accrued. These shares were valued at $0.30 per share, based on the price per share of the Company’s common stock on June 28, 2016. During the three and six months ended June 30, 2016, the Company recorded expense of approximately $10,000 and $9,000, respectively, in connection with the stock issuance.
On March 1, 2016, the Company signed a renewal contract with PCG, pursuant to which PCG agreed to provide investor relations services for six (6) months in exchange for fees paid in cash of $6,000 per month and 100,000 shares of restricted common stock to be issued in accordance with the agreement upon successfully meeting certain criteria in accordance with the agreement. In connection with this agreement, the Company has accrued for the estimated per share value on the agreement date at $0.30 per share, the price of Company’s common stock at March 1, 2016 for a total of $30,000 due to PCG. The fair values of the shares was recorded as prepaid advisory fees and are included in prepaid expenses and other current assets on the Company’s balance sheets and will be amortized on a pro-rata basis over the term of the contract. During the three and six months ended June 30, 2016, the Company recorded expense of approximately $15,000 and $20,000, respectively, in connection with amortization of the stock issuance. As of June 30, 2016, the total remaining balance of the prepaid investor relation services is approximately $10,000.
Stock Options
On May 16, 2012, the Company established the 2012 Stock Option Plan (“Plan”) authorizing the granting of options for up to 40,000,000 shares of Common Stock. The purpose of the Plan is to promote the long-term growth and profitability of the Company by (i) providing key people and consultants with incentives to improve stockholder value and to contribute to the growth and financial success of the Company and (ii) enabling the Company to attract, retain and reward the best available persons for positions of substantial responsibility. The Plan permits the granting of stock options, including non-qualified stock options and incentive stock options qualifying under Section 422 of the Code, in any combination (collectively, “Options”). At June 30, 2016, the Company had 18,269,625 shares of Common Stock available for issuance under the Plan.
A summary of the Plan Options for the six months ended June 30, 2016 is presented in the following table:
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Number of
Shares
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Weighted
Average
Exercise Price
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Aggregate
Intrinsic
Value
(in thousands)
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Outstanding December 31, 2015
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Outstanding June 30, 2016
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Exercisable June 30, 2016
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The weighted-average fair value per share of the granted options for the six months ended June 30, 2016 and 2015 was approximately $0.11 and $0.15, respectively.
Stock based compensation expense included in the condensed consolidated statements of operations was $56,000 and $131,000 for the three months ended June 30, 2016 and 2015, respectively, and $126,000 and $275,000 for the six months ended June 30, 2016 and 2015, respectively.
As of June 30, 2016, there was approximately $533,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Plan. The expense is expected to be recognized over a weighted-average period of 3.05 years.
The Company uses the Black-Scholes option-pricing model (“Black-Scholes model”) to estimate the fair value of stock option grants. The use of a valuation model requires the Company to make certain assumptions with respect to selected model inputs. Expected volatility is calculated based on the historical volatility of the Company’s stock price over the expected term of the option. The expected life is based on the contractual life of the option and expected employee exercise and post-vesting employment termination behavior. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of the grant.
Note 10. Segment and Geographical Information
The Company offers a wide variety of products to support a healthy lifestyle including; Nutritional Supplements, Sports and Energy Drinks, Health and Wellness, Weight Loss, Gourmet Coffee, Skincare and Cosmetics, Lifestyle Services, Digital products including Scrap books and Memory books, Packaged Foods, Pharmacy Discount Cards, and Clothing and Jewelry line. The Company’s business is classified by management into two reportable segments: direct selling and commercial coffee.
The Company’s segments reflect the manner in which the business is managed and how the Company allocates resources and assesses performance. The Company’s chief operating decision maker is the Chief Executive Officer. The Company’s chief operating decision maker evaluates segment performance primarily based on revenue and segment operating income. The principal measures and factors the Company considered in determining the number of reportable segments were revenue, gross margin percentage, sales channel, customer type and competitive risks. In addition, each reporting segment has similar products and customers, similar methods of marketing and distribution and a similar regulatory environment.
The accounting policies of the segments are consistent with those described in the summary of significant accounting policies. Segment revenue excludes intercompany revenue eliminated in the consolidation. The following tables present certain financial information for each segment (in thousands):
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Three months ended
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Six months ended
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June 30,
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June 30,
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2016
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2015
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2016
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2015
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Revenues
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Total capital expenditures
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As of
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June 30,
2016
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December 31,
2015
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Total assets
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Total assets located outside the United States are approximately $5.3 million as of June 30, 2016. For the year ended December 31, 2015, total assets located outside the United States were approximately $5.2 million.
The Company conducts its operations primarily in the United States. The Company also sells its products in 70 different countries. The following table displays revenues attributable to the geographic location of the customer (in thousands):
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Three months ended
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Six months ended
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June 30,
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June 30,
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2016
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2015
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2016
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2015
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Revenues
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Note 11. Subsequent Events
Nature’s Pearl Corporation
On
August 1, 2016, the Company entered into an agreement to acquire certain assets of Nature’s Pearl Corporation, (“Nature’s Pearl”) with an effective date of September 1, 2016. Nature’s Pearl is a direct-sales company that produces nutritional supplements and skin and personal care products using the muscadine grape grown in the southeastern region of the United States that are deemed to be rich in antioxidants. As a result of this acquisition, the Company’s distributors and customers have access to the unique line of Nature’s Pearl products and Nature’s Pearl distributors and customers will gain access to products offered by the Company. The Company is obligated to make monthly payments based on a percentage of Nature’s Pearl distributor revenue derived from sales of the Company’s products and a percentage of royalty revenue derived from sales of Nature’s Pearl products until the earlier of the date that is ten (10) years from the closing date or such time as the Company has paid to Nature’s Pearl aggregate cash payments of Nature’s Pearl distributor revenue and royalty revenue equal to a predetermined maximum aggregate purchase price. The preliminary purchase price allocation has not been determined as of the filing of this report
.
Renew Interest, LLC (SOZO Global, Inc.)
On July 29, 2016, the Company acquired certain assets of Renew Interest, LLC (“Renew”) formerly owned by SOZO Global, Inc. (“SOZO”), a direct-sales company that produces nutritional supplements, skin and personal care products, weight loss products and coffee products. The SOZO® brand of products contain the benefits of CoffeeBerry® a fruit extract known for its high abundance of antioxidant properties. As a result of this business combination, the Company’s distributors and customers have access to the unique line of the Renew products and Renew distributors and customers will gain access to products offered by the Company. The Company is obligated to make monthly payments based on a percentage of Renew distributor revenue derived from sales of the Company’s products and a percentage of royalty revenue until the earlier of the date that is twelve (12) years from the closing date or such time as the Company has paid to Renew, aggregate cash payments of Renew distributor revenue and royalty revenue equal to a predetermined maximum aggregate purchase price. The preliminary purchase price allocation has not been determined as of the filing of this report.