NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and notes of LifeVantage Corporation (the “Company”) as of and for the year ended
June 30, 2017
included in the annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on September 7, 2017.
Note 1 — Organization and Basis of Presentation
LifeVantage Corporation is a company focused on bio-hacking the aging code through nutrigenomics, the study of how nutrition and naturally occurring compounds affect our genes. The Company is dedicated to helping people achieve their health, wellness and financial independence goals. The Company provides quality, scientifically-validated products and a financially rewarding direct sales business opportunity to preferred customers, retail customers and independent distributors who seek a healthy lifestyle and financial freedom. The Company sells its products in the United States, Japan, Hong Kong, Australia, Canada, Mexico, Thailand, the United Kingdom, the Netherlands and Germany.
The Company engages in the identification, research, development and distribution of advanced nutraceutical dietary supplements and skin care products, including Protandim®, its line of scientifically-validated dietary supplements, TrueScience®, its line of anti-aging skin care products, Petandim™ for Dogs, its companion pet supplement formulated to combat oxidative stress in dogs, Axio®, its Smart Energy Drink mixes, and PhysIQ™, its Smart Weight Management System.
The condensed consolidated financial statements included herein have been prepared by the Company’s management, without audit, pursuant to the rules and regulations of the SEC. In the opinion of the Company’s management, these interim financial statements include all adjustments that are considered necessary for a fair presentation of its financial position as of
September 30, 2017
, and the results of operations for the
three months ended
September 30, 2017
and
2016
, and the cash flows for the
three months ended
September 30, 2017
and
2016
. Interim results are not necessarily indicative of results for a full year or for any future period. Certain amounts in the prior year financial statements have been reclassified for comparative purposes in order to conform with current year presentation.
The condensed consolidated financial statements and notes included herein are presented as required by Form 10-Q, and do not contain certain information included in the Company’s audited financial statements and notes for the fiscal year ended
June 30, 2017
pursuant to the rules and regulations of the SEC. For further information, refer to the financial statements and notes thereto as of and for the year ended
June 30, 2017
, and included in the annual report on Form 10-K on file with the SEC.
Note 2 — Summary of Significant Accounting Policies
Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation.
Use of Estimates
The Company prepares the condensed consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America (GAAP). In preparing these statements, the Company is required to use estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. On an ongoing basis, the Company reviews its estimates, including those related to inventory valuation and obsolescence, sales returns, income taxes and tax valuation reserves, share-based compensation and loss contingencies.
Foreign Currency Translation
A portion of the Company’s business operations occurs outside the United States. The local currency of each of the Company’s subsidiaries is generally its functional currency. All assets and liabilities are translated into U.S. dollars at exchange rates existing at the balance sheet dates, revenue and expenses are translated at weighted-average exchange rates and stockholders’ equity is recorded at historical exchange rates. The resulting foreign currency translation adjustments are recorded as a separate component of stockholders’ equity in the condensed consolidated balance sheets and as a component of comprehensive income. Transaction gains and losses are included in other income (expense), net in the condensed consolidated statements of operations and comprehensive income. For the
three months ended September 30, 2017
and
2016
, a net foreign
currency gain of
$0.1 million
and a net foreign currency loss of
$0.1 million
, respectively, are recorded in other income (expense), net.
Derivative Instruments and Hedging Activities
The Company's subsidiaries enter into transactions with each other which may not be denominated in the respective subsidiaries' functional currencies. The Company seeks to reduce its exposure to fluctuations in foreign exchange rates through the use of derivatives. The Company does not use such derivative financial instruments for trading or speculative purposes.
To hedge risks associated with the foreign-currency-denominated intercompany transactions, the Company entered into forward foreign exchange contracts which were settled in
September 2017
and were not designated for hedge accounting. For the
three months ended September 30, 2017
and
2016
, a realized gain of
$3,000
and a realized loss of
$0.1 million
, respectively, related to forward contracts, are recorded in other income (expense), net. The Company did not hold any derivative instruments at
September 30, 2017
.
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.
Concentration of Credit Risk
Accounting guidance for financial instruments requires disclosure of significant concentrations of credit risk regardless of the degree of such risk. Financial instruments with significant credit risk include cash and investments. At
September 30, 2017
, the Company had
$8.5 million
in cash accounts at one financial institution and
$3.8 million
in accounts at other financial institutions. As of
September 30, 2017
and
June 30, 2017
, and during the periods then ended, the Company’s cash balances exceeded federally insured limits.
Accounts Receivable
The Company’s accounts receivable as of
September 30, 2017
and
June 30, 2017
consist primarily of credit card receivables. Based on the Company’s verification process for customer credit cards and historical information available, management has determined that an allowance for doubtful accounts on credit card sales related to its customer sales as of
September 30, 2017
is not necessary.
No
bad debt expense has been recorded for the
three months ended September 30, 2017
and
2016
.
Inventory
As of
September 30, 2017
and
June 30, 2017
, inventory consisted of (in thousands):
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September 30,
2017
|
|
June 30,
2017
|
|
Finished goods
|
$
|
7,422
|
|
|
$
|
7,817
|
|
|
Raw materials
|
7,938
|
|
|
8,758
|
|
|
Total inventory
|
$
|
15,360
|
|
|
$
|
16,575
|
|
Inventories are carried and depicted above at the lower of cost or market, using the first-in, first-out method, which includes a reduction in inventory values of
$1.1 million
and
$0.9 million
at
September 30,
2017
and
June 30, 2017
, respectively, related to obsolete and slow-moving inventory.
Revenue Recognition
The Company ships the majority of its product directly to the consumer and receives substantially all payment for these sales in the form of credit card receipts. Revenue from direct product sales to customers is recognized upon shipment, which is when passage of title and risk of loss occurs. Estimated returns are recorded when product is shipped. Subject to some exceptions based on local regulations, the Company’s return policy is to provide a full refund for product returned within
30
days if the returned product is unopened or defective. After
30
days, the Company generally does not issue refunds to direct sales customers for returned product. The Company allows terminating distributors to return up to
30%
of unopened, unexpired product that they have purchased within the prior twelve months for a full refund, less a
10%
restocking fee. The Company establishes the returns reserve based on historical experience. The returns reserve is evaluated on a quarterly basis. As of
September 30, 2017
and
June 30, 2017
, the Company’s reserve balance for returns and allowances was
$0.3 million
and
$0.4 million
, respectively.
Shipping and Handling
Shipping and handling costs associated with inbound freight and freight out to customers, including independent distributors, are included in cost of sales. Shipping and handling fees charged to customers are included in sales.
Research and Development Costs
The Company expenses all costs related to research and development activities, as incurred. Research and development expenses for the
three months ended
September 30, 2017
and
2016
were
$0.3 million
and
$0.3 million
, respectively.
Stock-Based Compensation
The Company recognizes stock-based compensation by measuring the cost of services to be rendered based on the grant date fair value of the equity award. The Company recognizes stock-based compensation, net of any estimated forfeitures, over the period an employee is required to provide service in exchange for the award, generally referred to as the requisite service period. For awards with market-based performance conditions, the cost of the awards is recognized as the requisite service is rendered by employees, regardless of when, if ever, the market-based performance conditions are satisfied.
The Black-Scholes option pricing model is used to estimate the fair value of stock options. The determination of the fair value of stock options is affected by the Company's stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. The Company uses historical volatility as the expected volatility assumption required in the Black-Scholes model. The Company utilizes a simplified method for estimating the expected life of the options. The Company uses this method because it believes that it provides a better estimate than the Company’s historical data as post vesting exercises have been limited. The risk-free interest rate assumption is based on observed interest rates appropriate for the expected terms of the stock options.
The fair value of restricted stock grants is based on the closing market price of the Company's stock on the date of grant less the Company's expected dividend yield. The fair value of performance restricted stock units that include market-based performance conditions is based on the closing market price of the Company's stock on the date of grant less the Company's expected dividend yield, with further adjustments made to reflect the market conditions that must be satisfied in order for the units to vest by using a Monte-Carlo simulation model. Key assumptions for the Monte-Carlo simulation model include the risk-free rate, expected volatility, expected dividends and the correlation coefficient. The fair value of cash-settled performance-based awards, accounted for as liabilities, is remeasured at the end of each reporting period and is based on the closing market price of the Company’s stock on the last day of the reporting period. The Company recognizes compensation costs for awards with performance conditions when it concludes it is probable that the performance conditions will be achieved. The Company reassesses the probability of vesting at each balance sheet date and adjusts compensation costs accordingly.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the effective date of the change. The Company recognizes tax liabilities or benefits from an uncertain position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue. The amount recognized would be the largest liability or benefit that the Company believes has greater than a 50% likelihood of being realized upon settlement.
For the
three months ended
September 30, 2017
and
2016
, the Company recognized income tax expense of
$0.4 million
and
$0.5 million
, respectively, which is reflective of the Company’s current estimated federal, state and foreign effective tax rate. Realization of deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. The Company continues to evaluate the realizability of the deferred tax asset based upon achieved and estimated future results. The difference between the
three months ended
September 30, 2017
effective rate of
35.1%
and the Federal statutory rate of
35.0%
is due primarily to the effect of discrete items, return to provision adjustments, permanent items and benefits from the permanent reinvestment assertion.
Income Per Share
Basic income per common share is computed by dividing the net income by the weighted-average number of common shares outstanding during the period, less unvested restricted stock awards. Diluted income per common share is computed by dividing net income by the weighted-average common shares and potentially dilutive common share equivalents using the treasury stock method.
The effects of approximately
0.2 million
and
46,000
common shares issuable upon exercise of options and non-vested shares of restricted stock outstanding as of
September 30, 2017
and
2016
, respectively, are not included in computations as their effect was anti-dilutive.
The following is a reconciliation of net income per share and the weighted-average common shares outstanding for purposes of computing basic and diluted net income per share (in thousands except per share amounts):
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Three Months Ended September 30,
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2017
|
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2016
|
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Numerator:
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Net income
|
$
|
817
|
|
|
$
|
1,180
|
|
|
Denominator:
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|
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Basic weighted-average common shares outstanding
|
13,963
|
|
|
13,820
|
|
|
Effect of dilutive securities:
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|
|
Stock awards and options
|
117
|
|
|
601
|
|
|
Warrants
|
—
|
|
|
45
|
|
|
Diluted weighted-average common shares outstanding
|
14,080
|
|
|
14,466
|
|
|
Net income per share, basic
|
$
|
0.06
|
|
|
$
|
0.09
|
|
|
Net income per share, diluted
|
$
|
0.06
|
|
|
$
|
0.08
|
|
Segment Information
The Company operates in a single operating segment by selling products to an international network of independent distributors that operates in an integrated manner from market to market. Commissions and incentives expenses are the Company’s largest expense comprised of the commissions paid to its independent distributors. The Company manages its business primarily by managing its international network of independent distributors. The Company does not use profitability reports on a regional or divisional basis for making business decisions. However, the Company does report revenue in
two
geographic regions: the Americas region and the Asia/Pacific & Europe region. Revenues by geographic region are as follows (in thousands):
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Three Months Ended September 30,
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2017
|
|
2016
|
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Americas
|
$
|
36,163
|
|
|
$
|
40,135
|
|
|
Asia/Pacific & Europe
|
12,964
|
|
|
14,759
|
|
|
Total revenues
|
$
|
49,127
|
|
|
$
|
54,894
|
|
Additional information as to the Company’s revenue from operations in the most significant geographical areas is set forth below (in thousands):
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Three Months Ended September 30,
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2017
|
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2016
|
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United States
|
$
|
34,115
|
|
|
$
|
38,618
|
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|
Japan
|
$
|
10,856
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|
|
$
|
10,607
|
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As of
September 30, 2017
, long-lived assets were
$8.3 million
in the United States and
$0.9 million
in Japan. As of
June 30, 2017
, long-lived assets were
$6.2 million
in the United States and
$0.9 million
in Japan.
Effect of New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09,
Revenue from Contracts with Customers (Topic 606)
, and has subsequently issued ASU 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
, ASU 2016-08,
Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
, ASU 2016-10,
Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
, ASU 2016-11,
Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)
, ASU 2016-12,
Revenue from Contracts with Customers
(Topic 606): Narrow-Scope Improvements and Practical Expedients
and ASU 2016-20,
Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers
(collectively, Topic 606).
Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the new guidance is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration it expects to receive in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. This guidance is effective for the Company beginning on July 1, 2018 with the option to adopt using either a full retrospective or a modified retrospective approach. The Company expects to adopt Topic 606 using the modified retrospective approach, under which the cumulative effect of initially applying Topic 606 is recognized as an adjustment to the opening balance of retained earnings in the first quarter of fiscal 2019.
The Company is concluding the assessment phase of implementing this guidance. The Company has evaluated each of its revenue streams and has identified similar performance obligations under Topic 606 as compared to current revenue recognition guidance. As a result, the Company expects that the timing of the recognition of revenue will remain materially unchanged compared to the current guidance.
There are also considerations related to internal control over financial reporting associated with implementing Topic 606. The Company is currently evaluating its control framework for revenue recognition and identifying any changes that may need to be made in response to the new guidance. Disclosure requirements under Topic 606 have been expanded compared to the disclosure requirements under the current guidance. The Company is currently in the process of designing and implementing the appropriate controls over gathering and reporting the information required under Topic 606.
In February 2016, FASB issued ASU No. 2016-02,
Leases (Topic 841)
. For lessees, the amendments in this update require that for all leases not considered to be short term, a company recognize both a lease liability and right-of-use asset on its balance sheet, representing the obligation to make payments and the right to use or control the use of a specified asset for the lease term. The amendments in this update are effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods. The Company is currently evaluating the impact that this amendment will have on its consolidated financial statements.
In May 2017, FASB issued ASU No. 2017-09,
Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting
. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all the following are met: (1) The fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified, (2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified, (3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this update. The amendments in this update are effective for all annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The amendments in this update should be applied prospectively to an award modified on or after the adoption date. The Company will apply this amendment to any award modifications made on or after the adoption date.
Note 3 — Long-Term Debt
On
March 30, 2016
, the Company entered into a loan agreement (the “March 2016 Loan Agreement”) to refinance its then outstanding debt. In connection with the March 2016 Loan Agreement and on the same date, the Company entered into a security agreement (the “Security Agreement”). The March 2016 Loan Agreement provides for a term loan in an aggregate principal amount of
$10.0 million
(the “March 2016 Term Loan") and a revolving loan facility in an aggregate principal amount not to exceed
$2.0 million
(the “March 2016 Revolving Loan,” and collectively with the March 2016 Term Loan, the March 2016 Loan Agreement and the Security Agreement, the “March 2016 Credit Facility”).
The principal amount of the March 2016 Term Loan is payable in consecutive
quarterly
installments in the amount of
$0.5 million
plus accrued interest beginning with the fiscal quarter ended
June 30, 2016
and maturing on
March 30, 2019
(the “Maturity Date”). The March 2016 Term Loan bears interest at a fixed rate of
4.93%
. If the Company borrows under the March 2016 Revolving Loan, interest will be payable quarterly in arrears on the last day of each fiscal quarter at a variable rate equal to the 30 day LIBOR Rate plus
3.50%
.
The Company’s obligations under the March 2016 Credit Facility are secured by a security interest in substantially all of the Company’s assets. Loans outstanding under the March 2016 Credit Facility may be prepaid in whole or in part at any time
without premium or penalty. In addition, if, at any time, the aggregate principal amount outstanding under the March 2016 Revolving Loan exceeds
$2.0 million
, the Company must prepay an amount equal to such excess. Any principal amount of the March 2016 Term Loan which is prepaid or repaid may not be re-borrowed.
The March 2016 Credit Facility contains customary covenants, including affirmative and negative covenants that, among other things, restrict the Company’s ability to create certain types of liens, incur additional indebtedness, declare or pay dividends on or redeem capital stock, make other payments to holders of equity interests in the Company, make certain investments, purchase or otherwise acquire all or substantially all the assets or equity interests of other companies, sell assets or enter into consolidations, mergers or transfers of all or any substantial part of the Company’s assets. The March 2016 Credit Facility also contains various financial covenants that require the Company to maintain a certain consolidated minimum tangible net worth, minimum working capital amounts, and debt to EBITDA and fixed charge coverage ratios. Additionally, the March 2016 Credit Facility contains cross-default provisions, whereby a default under the terms of certain indebtedness or an uncured default of a payment or other material obligation of the Company under a material contract of the Company will cause a default on the remaining indebtedness under the March 2016 Credit Facility. As of
September 30, 2017
, the Company was in compliance with all applicable covenants under the March 2016 Credit Facility.
The Company’s book value for the March 2016 Credit Facility approximates the fair value. Aggregate future principal payments required in accordance with the terms of the March 2016 Credit Facility are as follows (in thousands):
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Fiscal Year Ending June 30,
|
|
Amount
|
|
2018 (remaining nine months ending June 30, 2018)
|
|
$
|
1,500
|
|
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2019
|
|
5,500
|
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|
|
|
$
|
7,000
|
|
Note 4 — Stockholders’ Equity
During the
three months ended
September 30, 2017
, the Company did
not
issue shares of restricted stock or shares of common stock upon the exercise of warrants and options. During the
three months ended
September 30, 2017
,
4,000
shares of restricted stock were canceled or surrendered as payment of tax withholding upon vesting.
The Company’s Articles of Incorporation authorize the issuance of preferred shares. However, as of
September 30, 2017
, none have been issued and no rights or preferences have been assigned to the preferred shares by the Company’s board of directors.
Note 5 — Stock-Based Compensation
Long-Term Incentive Plans
The Company adopted and the shareholders approved the 2007 Long-Term Incentive Plan (the “2007 Plan”), effective November 21, 2006, to provide incentives to eligible employees, directors and consultants. A maximum of
1.4 million
shares of the Company's common stock can be issued under the 2007 Plan in connection with the grant of awards. Awards to purchase common stock have been granted pursuant to the 2007 Plan and are outstanding to various employees, officers, directors, Scientific Advisory Board members and independent distributors at prices between
$1.47
and
$10.50
per share, with initial vesting periods of
one
to
three
years. Awards expire in accordance with the terms of each award and the shares subject to the award are added back to the 2007 Plan upon expiration of the award. The contractual term of stock options granted is generally
ten
years. Effective November 21, 2016, no new awards can be granted under the 2007 Plan.
The Company adopted and the shareholders approved the 2010 Long-Term Incentive Plan (the “2010 Plan”), effective September 27, 2010, as amended on August 21, 2014, to provide incentives to certain employees, directors and consultants. A maximum of
1.1 million
shares of the Company's common stock can be issued under the 2010 Plan in connection with the grant of awards. Awards to purchase common stock have been granted pursuant to the 2010 Plan and are outstanding to various employees, officers and directors. Outstanding stock options awarded under the 2010 Plan have exercise prices between
$5.60
and
$20.09
per share, and vest over
one
to
four
year vesting periods. Awards expire in accordance with the terms of each award and, upon expiration of the award, the shares subject to the award will be added to the 2017 Plan pool as described below. The contractual term of stock options granted is generally
ten
years. No new awards will be granted under the 2010 Plan and forfeited or terminated shares will be added to the 2017 Plan pool as described below.
The Company adopted a performance incentive plan effective July 1, 2015 (the "Fiscal 2016 Performance Plan"). The Fiscal 2016 Performance Plan is intended to provide selected employees an opportunity to earn performance-based cash bonuses whose value is based upon the Company’s stock value and to encourage such employees to provide services to the
Company and to attract new individuals with outstanding qualifications. The Fiscal 2016 Performance Plan seeks to achieve this purpose by providing for awards in the form of performance share units (the “Units”). No shares will be issued under the Fiscal 2016 Performance Plan. Awards may be settled only with cash and will be paid subsequent to award vesting. The fair value of share-based compensation awards, that include performance shares, are accounted for as liabilities. Vesting for the Units is subject to achievement of both service-based and performance-based vesting requirements. Performance-based vesting occurs in
three
installments if the Company meets certain performance criteria generally set for each year of a
three
-year performance period. The service-based vesting criteria occurs in a single installment at the end of the third fiscal year after the awards are granted if the participant has continuously remained in service from the date of award through the end of the third fiscal year. The fair value of these awards is based on the trading price of the Company's common stock and is remeasured at each reporting period date until settlement. The Company adopted separate performance incentive plans effective July 1, 2016 (the "Fiscal 2017 Performance Plan") and July 1, 2017 (the "Fiscal 2018 Performance Plan"). The Fiscal 2017 Performance Plan and Fiscal 2018 Performance Plan include performance-based and service-based vesting requirements and payment terms that are substantially the same as described above the Fiscal 2016 Performance Plan.
The Company adopted and the shareholders approved the 2017 Long-Term Incentive Plan (the “2017 Plan”), effective February 16, 2017, to provide incentives to eligible employees, directors and consultants. The maximum number of shares that can be issued under the 2017 Plan is not to exceed
1,125,000
shares, calculated as the sum of (i)
650,000
shares and (ii) up to
475,000
shares previously reserved for issuance under the 2010 Plan, including shares returned upon cancellation, termination or forfeiture of awards that were previously granted under that plan. As of
September 30, 2017
, a maximum of
1.0 million
shares of the Company's common stock can be issued under the 2017 Plan in connection with the grant of awards. Awards expire in accordance with the terms of each award and the shares subject to the award are added back to the 2017 Plan upon expiration of the award.
Stock-Based Compensation
In accordance with accounting guidance for stock-based compensation, payments in equity instruments for goods or services are accounted for by the fair value method. For the
three months ended
September 30, 2017
, stock-based compensation of
$0.4 million
was reflected as an increase to additional paid-in capital and an increase of
$0.2 million
was included in other accrued expenses, all of which was employee related. For the
three months ended
September 30, 2016
, stock-based compensation of
$0.7 million
was reflected as an increase to additional paid-in capital and an increase of
$0.2 million
was included in other accrued expenses, all of which was employee related.
On
January 4, 2016
, the Company awarded performance restricted stock units under the 2010 Long-Term Incentive Plan to its executive officers (the "Recipients") and, in
March 2016
, the Company and each Recipient entered into an amended and restated stock unit agreement (the "Restated Stock Unit Agreement") amending the terms of the January 2016 awards. Under the Restated Stock Unit Agreements, vesting for the performance restricted stock units occurs at the end of a
three
-year performance period beginning
January 1, 2016
(the "Performance Period") and is subject to achievement of both service-based and market-based performance vesting requirements. Subject generally to the Recipient's continued service with the Company (the service-based requirement) and limitations otherwise set forth in the 2010 Long-Term Incentive Plan, each performance restricted stock unit represents a contingent right for the Recipient to receive, within
thirty
days after the end of the performance period, a distribution of shares of common stock of the Company equal to
0%
to
200%
of the target number of performance restricted stock units subject to the award. The actual number of shares distributed will be based on the Company's total stockholder return ("TSR") performance during the Performance Period, subject to acceleration upon a change in control of the Company. The vesting for
50%
of the performance restricted stock units is based upon the Company's absolute TSR for the performance period compared to a matrix of fixed numeric values and the vesting for the other
50%
of the performance restricted stock units is based upon the relative comparison of the Company's TSR to the Vanguard Russell 2000 exchange traded fund TSR. The fair value of the performance restricted stock units will be recognized on a straight-line basis over the requisite service period of the awards, regardless of when, if ever, the market-based performance conditions are satisfied. On
March 28, 2017
, the Company awarded new performance restricted stock units under the 2017 Long-Term Incentive Plan to its executive officers. These awards have a
three
-year performance period beginning on
January 1, 2017
and otherwise include the same performance-based and service-based vesting requirements as the previous awards.
Note 6 — Commitments and Contingencies
Contingencies
The Company accounts for contingent liabilities in accordance with Accounting Standards Codification ("ASC") Topic 450,
Contingencies
. This guidance requires management to assess potential contingent liabilities that may exist as of the date of the financial statements to determine the probability and amount of loss that may have occurred, which inherently involves an exercise of judgment. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial
statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, and an estimate of the range of possible losses, if determinable and material, would be disclosed. For loss contingencies considered remote, no accrual or disclosures are generally made. Management has assessed potential contingent liabilities as of
September 30, 2017
, and based on the assessment, there are no probable loss contingencies requiring accrual or disclosures within its financial statements.
Legal Accruals
In addition to commitments and obligations in the ordinary course of business, from time to time, the Company is subject to various claims, pending and potential legal actions, investigations relating to governmental laws and regulations and other matters arising out of the normal conduct of its business. Management assesses contingencies to determine the degree of probability and range of possible loss for potential accrual in the consolidated financial statements. An estimated loss contingency is accrued in the consolidated financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because evaluating legal claims and litigation results are inherently unpredictable and unfavorable results could occur, assessing contingencies is highly subjective and requires judgments about future events. When evaluating contingencies, management may be unable to provide a meaningful estimate due to a number of factors, including the procedural status of the matter in question, the presence of complex or novel legal theories, and/or the ongoing discovery and development of information important to the matters. In addition, damage amounts claimed or asserted against the Company may be unsupported, exaggerated or unrelated to possible outcomes, and as such are not meaningful indicators of a potential liability. Management regularly reviews contingencies to determine the adequacy of financial statement accruals and related disclosures. The amount of ultimate loss may differ from these estimates. It is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies. Whether any losses finally determined in any claim, action, investigation or proceeding could reasonably have a material effect on the Company's business, financial condition, results of operations or cash flows will depend on a number of variables, including: the timing and amount of such losses; the structure and type of any remedies; the significance of the impact any such losses, damages or remedies may have on the consolidated financial statements; and the unique facts and circumstances of the particular matter that may give rise to additional factors.
Class Action Lawsuit:
On September 15, 2016, a purported securities class action was filed in the United States District Court for the District of Utah, entitled
Zhang v. LifeVantage Corp
., Case No. 2:16-cv-00965-BCW (D. Utah filed Sept. 15, 2016). In this action (later recaptioned as
In re LifeVantage Corp. Securities Litigation
), plaintiff alleged that the Company, its Chief Executive Officer and former Chief Financial Officer violated Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by making false or misleading statements or omissions in public filings with the Securities and Exchange Commission regarding the Company's internal controls and financial results for the first, second and third quarters of fiscal year 2016. The initial complaint sought unspecified damages against the defendants on behalf of a class of purchasers of the Company’s stock between November 4, 2015 and September 13, 2016. On December 13, 2016, the Court appointed Dale Blanch and Yvonne Cohen as lead plaintiffs and approved their selection of lead plaintiffs’ counsel. On January 27, 2017, lead plaintiffs filed an amended complaint largely reiterating the claims asserted in the original initial complaint and expanding the putative class period. On June 15, 2017, the Court granted defendants’ motion to dismiss the amended complaint, without prejudice, and permitted lead plaintiffs to file a motion for leave to file a second amended complaint. On July 6, 2017, lead plaintiffs filed a motion for leave to amend. On September 18, 2017, the Court denied lead plaintiffs’ motion for leave to amend and entered final judgment in favor of defendants and dismissed the case with prejudice. On October 17, 2017, the parties executed a stipulation whereby lead plaintiffs agreed not to take an appeal from the final judgment of dismissal in favor of defendants in exchange for mutual releases, without payment of any consideration by defendants. This case is now concluded.
Derivative Action Lawsuits:
On October 11, 2016,
two
purported shareholder derivative actions were filed in the Third District Court of the State of Utah, Salt Lake County, entitled Johnson v. Jensen, Case No. 160906320 MI (Utah Dist. filed Oct. 11, 2016), and Rupp v. Jensen, Case No. 160906321 MI (Utah Dist. filed Oct. 11, 2016). In these actions (which are substantively identical), plaintiffs, purportedly on behalf of the Company, allege that the Company's Chief Executive Officer, former Chief Financial Officer and members of the board of directors breached their fiduciary duties owed to the Company by, among other things, causing or permitting the Company to issue false and misleading statements or omissions in public filings with the Securities and Exchange Commission, as alleged in the class action lawsuit noted above. On October 19, 2016, the Court entered an order consolidating the two actions under the Johnson case number, with the new caption In re LifeVantage Corp. Derivative Litigation, providing that defendants and nominal defendant need not respond to the initial complaints and directing the parties to meet and confer within thirty days on a schedule for further proceedings in this action. On November 21, 2016, the Court approved a stipulation between the parties providing that (a) defendants and nominal defendant need not respond to the initial complaints and (b) within thirty days from the earlier of (i) the Company’s filing of its Form 10-K for fiscal year 2016 and (ii) plaintiffs’ filing of a consolidated amended complaint, the parties will meet and confer on a schedule regarding further proceedings in this action. On January 10, 2017, the Court approved a stipulation between the parties
providing that this action would be deferred (i.e., stayed) pending a ruling on defendants’ then-anticipated motion to dismiss the amended complaint in the Class Action Lawsuit. On March 13, 2017, plaintiffs filed a consolidated amended complaint. On July 14, 2017, the parties agree to continue the deferral (stay) of this action pending a ruling denying lead plaintiffs’ motion for leave to amend or on defendants’ anticipated motion to dismiss the amended complaint in the Class Action Lawsuit.
On January 30, 2017, another purported shareholder derivative action was filed in the United States District Court for the District of Utah, entitled
Hansen v. Jensen
, Case No. 2:17-cv-00075-DN (D. Utah filed Jan. 30, 2017). In this action, plaintiff, purportedly on behalf of the Company, alleges that the Company’s Chief Executive Officer, former Chief Financial Officer and members of the board of directors violated Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a), and breached their fiduciary duties owed to the Company by, among other things, causing or permitting the Company to issue false and misleading statements or omissions in public filings with the SEC, as alleged in the class action lawsuit noted above. On March 30, 2017, the parties entered into a stipulation providing that this action would be stayed pending a ruling on defendants’ motion to dismiss the amended complaint in the Class Action Lawsuit. On February 27, 2017, another purported shareholder derivative action was filed in the United States District Court for the District of Utah, entitled
Baker v. Jensen
, Case No. 2:17-cv-00141-PMW (D. Utah filed Feb. 27, 2017). Also, on April 24, 2017, another purported shareholder derivative action was filed in the United States District Court for the District of Utah, entitled
Inforzato v. Jensen
, Case No. 2:17-cv-00317-JNP (D. Utah filed Apr. 24, 2017). In these actions, plaintiffs, also purportedly on behalf of the Company, make similar allegations as the plaintiff in
Hansen v. Jensen
, described above. The parties in
Baker
and
Inforzato
similarly have agreed to stays of those actions pending a ruling on defendants’ motion to dismiss in the Class Action Lawsuit. All Derivative Action Lawsuits remain stayed.
The Company notes that although the plaintiffs in the Derivative Action Lawsuits purport to seek unspecified damages against the individual defendants on behalf of the Company, the Company owes certain indemnification obligations to these individual defendants under Colorado law and existing indemnification agreements. The Company has not established a loss contingency accrual for this lawsuit as it believes liability is not probable or estimable, and the defendants plan to vigorously defend against this lawsuit. Nonetheless, an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations or financial condition.
Other Matters.
In addition to the matters described above, the Company also may become involved in other litigation and regulatory matters incidental to its business and the matters disclosed in this quarterly report on Form 10-Q, including, but not limited to, product liability claims, regulatory actions, employment matters and commercial disputes. The Company intends to defend itself in any such matters and does not currently believe that the outcome of any such matters will have a material adverse effect on the Company's business, financial condition, results of operations and cash flows.
Note 7 — Related Party Transactions
Effective January 2014, the Company commenced a partnership with Real Salt Lake of Major League Soccer, which includes the placement of the Company's logo on the front of the team’s jersey as well as strategic placement of the Company's logo around the stadium and on televised broadcasts of the games. In July 2015, Dell Loy Hansen, the sole owner of Real Salt Lake and Real Monarchs SLC, became a major stockholder of the Company. During the
three months ended September 30, 2017
, the Company paid
$1.0 million
to Real Salt Lake pursuant to the terms of this partnership, and other various amounts for the endorsement of Real Monarchs SLC and product marketing expenses. During fiscal year
2018
, the Company will additionally pay approximately
$3.0 million
to Real Salt Lake pursuant to the terms of this partnership. During the
three months ended
September 30, 2016
,
no
amounts were paid by the Company.
During the
three months ended September 30, 2017
, Gig Economy Group ("GEG") provided outsourced software application development services to the Company pursuant to an agreement entered into between the Company and GEG in the amount of
$0.9 million
. During the
three months ended
September 30, 2016
, GEG did
not
provide services to the Company. David Toole, a member of the Company's board of directors, is a majority owner and an officer of GEG.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a company focused on bio-hacking the aging code through nutrigenomics, the study of how nutrition and naturally occurring compounds affect human genes. We are dedicated to helping people achieve their health, wellness and financial independence goals. We provide quality, scientifically-validated products and a financially rewarding direct sales business opportunity to preferred customers, retail customers and independent distributors who seek a healthy lifestyle and financial freedom. We engage in the identification, research, development and distribution of advanced nutraceutical dietary supplements and skin care products. We currently sell our products to preferred customers, retail customers and independent distributors in two geographic regions that we have classified as the Americas region and the Asia/Pacific & Europe region.
Our revenue depends on the number and productivity of our independent distributors and the number of our retail and preferred customers. When we are successful in attracting and retaining independent distributors and preferred customers, it is largely because of:
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•
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Our scientifically-validated products, including our Protandim® product line, TrueScience® anti-aging skin care line, Petandim™ for Dogs, Axio® Smart Energy Drink mixes and PhysIQ™ Smart Weight Management System;
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•
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Our compensation plan and other sales initiatives; and
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•
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Our delivery of superior customer service.
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As a result, it is vital to our success that we leverage our product development resources to develop and introduce compelling and innovative products and provide opportunities for our independent distributors to sell these products in a variety of markets.
We have begun selling our products and attracting new independent distributors and preferred customers in several new markets since the beginning of our direct selling activities in 2009, including Japan, Hong Kong, Australia, Canada, Mexico, Thailand, the United Kingdom, the Netherlands and Germany. In addition, we expect to expand into China in the near term through a new e-commerce business model. Entering a new market requires a considerable amount of time, resources and continued support. If we are unable to properly support an existing or new market, our revenue growth may be negatively impacted.
Our Products
Our products are the Protandim
®
product line, the TrueScience
®
anti-aging skin care line, Axio
®
Smart Energy Drink mixes, PhysIQ
™
Smart Weight Management System and Petandim™ for Dogs. The Protandim
®
product line includes Protandim
®
NRF1 and Nrf2 Synergizers™. The Protandim
®
NRF1 Synergizer is formulated to increase cellular energy and performance by boosting mitochondria production to improve cellular repair and slow cellular aging. The Protandim
®
Nrf2 Synergizer™ contains a proprietary blend of ingredients and has been shown to combat oxidative stress and enhance energy production by increasing the body’s natural antioxidant protection at the genetic level, inducing the production of naturally-occurring protective antioxidant enzymes including superoxide dismutase, catalase and glutathione synthase. Our TrueScience
®
anti-aging skin care line includes TrueScience
®
Facial Cleanser, TrueScience
®
Perfecting Lotion, TrueScience
®
Eye Serum, TrueScience
®
Anti-Aging Cream and TrueScience
®
Micro-Lift Serum. Axio
®
is our line of Smart Energy Drink mixes formulated to promote alertness and support mental performance. PhysIQ
™
is our Smart Weight Management System which includes PhysIQ
™
Fat Burn, PhysIQ
™
ProBio, PhysIQ
™
Cleanse and PhysIQ
™
Protein Shake mix, all formulated to aid in weight management. Petandim™ for Dogs is a supplement specially formulated to combat oxidative stress in dogs through Nrf2 activation.
We currently have additional products in development. Any delays or difficulties in introducing compelling products or attractive initiatives or tools into our markets may have a negative impact on our revenue and our ability to attract new independent distributors, preferred customers and retail customers.
Customers
Because we utilize a direct selling model for the distribution of our products, the success and growth of our business is primarily based on the effectiveness of our independent distributors in selling our products and on our ability to attract new and retain existing independent distributors. Changes in our product sales are typically the result of variations in product sales volume relating to fluctuations in the number of active independent distributors and preferred customers purchasing our products. The number of active independent distributors and preferred customers is, therefore, used by management as a key non-financial measure.
The following tables summarize the changes in our active customer base by geographic region. These numbers have been rounded to the nearest thousand as of the dates indicated. For purposes of this report, we only count as active customers those independent distributors and preferred customers who have purchased from us at any time during the most recent three-month period, either for personal use or for resale.
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Active Preferred Customers By Region
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As of September 30,
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2017
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|
2016
|
|
Change from Prior Year
|
|
Percent Change
|
|
Americas
|
87,000
|
|
|
79.8
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%
|
|
91,000
|
|
|
79.8
|
%
|
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(4,000
|
)
|
|
(4.4
|
)%
|
|
Asia/Pacific & Europe
|
22,000
|
|
|
20.2
|
%
|
|
23,000
|
|
|
20.2
|
%
|
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(1,000
|
)
|
|
(4.3
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)%
|
|
|
109,000
|
|
|
100.0
|
%
|
|
114,000
|
|
|
100.0
|
%
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(5,000
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)
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(4.4
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)%
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Active Independent Distributors By Region
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|
As of September 30,
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|
|
|
|
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|
2017
|
|
2016
|
|
Change from Prior Year
|
|
Percent Change
|
|
Americas
|
45,000
|
|
|
71.4
|
%
|
|
48,000
|
|
|
70.6
|
%
|
|
(3,000
|
)
|
|
(6.3
|
)%
|
|
Asia/Pacific & Europe
|
18,000
|
|
|
28.6
|
%
|
|
20,000
|
|
|
29.4
|
%
|
|
(2,000
|
)
|
|
(10.0
|
)%
|
|
|
63,000
|
|
|
100.0
|
%
|
|
68,000
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|
|
100.0
|
%
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(5,000
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)
|
|
(7.4
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)%
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Results of Operations
Three Months Ended
September 30, 2017
compared to the
Three Months Ended
September 30, 2016
Revenue.
We generated net revenue of
$49.1 million
and
$54.9 million
during the three months ended
September 30, 2017
and
2016
, respectively. Foreign currency fluctuations negatively impacted our revenue
$0.7 million
or
1.4%
during the
three months ended
September 30, 2017
. During the
three months ended
September 30, 2017
, revenues in our United States and Hong Kong markets decreased as compared to the prior year period as we took steps, following the completion of the independent review conducted by the audit committee of our board of directors, to help ensure that our products are not distributed or sold into countries without complying with applicable customs, tax and other regulatory requirements and to appropriately verify the residency of individuals who want to become our independent distributors.
Americas
. The following table sets forth revenue for the
three months ended
September 30, 2017
and
2016
for the Americas region (in thousands):
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|
Three Months Ended September 30,
|
|
|
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|
2017
|
|
2016
|
|
% Change
|
|
United States
|
$
|
34,115
|
|
|
$
|
38,618
|
|
|
(11.7
|
)%
|
|
Other
|
2,048
|
|
|
1,517
|
|
|
35.0
|
%
|
|
Americas Total
|
$
|
36,163
|
|
|
$
|
40,135
|
|
|
(9.9
|
)%
|
Revenue in the Americas region for the
three months ended
September 30, 2017
decreased
$4.0 million
or
9.9%
from the prior year same period. The policies that we implemented in connection with the audit committee review as discussed above were the primary factor for the decline in revenue for the
three months ended
September 30, 2017
, along with an overall decrease in the number of active preferred customers and active independent distributors.
Asia/Pacific & Europe
. The following table sets forth revenue for the
three months ended
September 30, 2017
and
2016
for the Asia/Pacific & Europe region and its principal markets (in thousands):
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|
Three Months Ended September 30,
|
|
|
|
|
2017
|
|
2016
|
|
% Change
|
|
Japan
|
$
|
10,856
|
|
|
$
|
10,607
|
|
|
2.3
|
%
|
|
Hong Kong
|
247
|
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|
2,623
|
|
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(90.6
|
)%
|
|
Other
|
1,861
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|
|
1,529
|
|
|
21.7
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%
|
|
Asia/Pacific & Europe Total
|
$
|
12,964
|
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|
$
|
14,759
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|
(12.2
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)%
|
Revenue in the Asia/Pacific & Europe region was negatively impacted approximately
$0.8 million
or
5.6%
during the
three months ended
September 30, 2017
, as compared to the prior year period, by foreign currency exchange rate fluctuations. The negative impact for the region was primarily due to the weakening of the Japanese yen against the U.S. dollar, as compared to the prior year period, negatively impacting our revenue in Japan by
$0.9 million
or
8.5%
. On a constant currency basis, revenue in Japan increased
10.9%
primarily due to a successful elite academy event held in Japan in September 2017. The policies that we implemented in connection with the audit committee review as disclosed previously contributed to the decline in revenue in Hong Kong.
We continue to focus on strengthening our core business, including the expansion of our product offering and expanding our global footprint. These efforts include the development and enhancement of distributor tools, training aids and technology, the scientific research and development of new products, and entrance into new markets. During the three months ended September 30, 2017, we launched business operations in Germany and held events for our independent distributors in the US, Canada and Japan. We are investing in both internal and external technology tools that we expect will help our independent distributors grow their business and help us better operate our business. We remain committed to pursuing growth in each of our markets and operating our business in accordance with our strengthened business practices.
Gross Margin.
Our gross profit percentage for the three months ended
September 30, 2017
and
2016
was
82.2%
and
83.9%
, respectively.
As a percentage of total revenues, cost of sales for the three months ended
September 30, 2017
increased to
17.8%
compared to
16.1%
for the three months ended
September 30, 2016
. The increase in cost of sales as a percentage of revenue for the
three months ended
September 30, 2017
, as compared to the prior year same period, is due primarily to increased costs associated with product and geographic sales mix.
Operating Expenses.
Total operating expenses during the
three months ended September 30, 2017
decreased to
$39.0 million
or
79.4%
of revenues as compared to operating expenses of
$44.1 million
or
80.3%
of revenues during the three months ended
September 30, 2016
. Operating expenses consist of commission and incentives expenses and selling, general and administrative expenses.
Commissions and Incentives.
Commissions and incentives expenses during the three months ended
September 30, 2017
were
$23.4 million
or
47.6%
of revenues as compared to commissions and incentives expenses of
$26.3 million
or
47.9%
of revenues for the three months ended
September 30, 2016
.
The overall decrease in commissions and incentives expenses for the three months ended
September 30, 2017
as compared to the prior year period is due to the overall decrease in revenue and refinements to our commission and incentive programs.
We expect commissions and incentives expenses to remain relatively stable as a percentage of net sales during the remainder of fiscal
2018
, with some fluctuations caused by changes to compensation and incentive programs and initiatives.
Selling, General and Administrative.
Selling, general and administrative expenses during the
three months ended September 30, 2017
were
$15.6 million
as compared to selling, general and administrative expenses of
$17.8 million
for the three months ended
September 30, 2016
.
The decrease in selling, general and administrative expenses during the
three months ended September 30, 2017
compared to the prior year same period was primarily due to decreased legal and accounting expenses associated with the independent review conducted by the audit committee of our board of directors, which was completed December 2016. Additionally, expenses associated with stock compensation, employee salaries and benefits and recruiting decreased due to changes to our management team as well as decreases in bank fees realized during the current period as a result of the decrease in revenues.
We expect selling, general and administrative expenses, as a percent of revenue, to remain relatively consistent as we execute on our strategic initiatives.
Total Other Expense.
During the
three months ended
September 30, 2017
, we recognized net other expenses of
$0.1 million
, as compared to net other expenses of
$0.3 million
for the
three months ended
September 30, 2016
. Total other expense for the
three months ended
September 30, 2017
consisted primarily of interest expense and net currency gains.
The following table sets forth interest expense for the
three months ended
September 30, 2017
and
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
Contractual interest expense:
|
|
|
|
|
2016 Term Loan
|
$
|
95
|
|
|
$
|
120
|
|
|
Amortization of deferred financing fees:
|
|
|
|
|
2016 Term Loan
|
3
|
|
|
3
|
|
|
Amortization of debt discount:
|
|
|
|
|
2016 Term Loan
|
5
|
|
|
5
|
|
|
Other
|
59
|
|
|
9
|
|
|
Total interest expense
|
$
|
162
|
|
|
$
|
137
|
|
Income Tax Expense
. We recognized income tax expense of
$0.4 million
for the
three months ended
September 30, 2017
, as compared to income tax expense of
$0.5 million
for the
three months ended
September 30, 2016
.
The effective tax rate was
35.1%
of pre-tax income during the
three months ended
September 30, 2017
, compared to
29.7%
for the same prior year period. The increase in the effective tax rate for the
three months ended
September 30, 2017
compared to the prior year period is due to changes in current income projections and the impact of certain discrete and permanent items and return to provision adjustments.
Liquidity and Capital Resources
Liquidity
Our primary liquidity and capital resource requirements are to service our debt and finance the cost of our planned operating expenses and working capital (principally inventory purchases), as well as capital expenditures. We have generally relied on cash flow from operations to fund operating activities and we have, at times, incurred long-term debt in order to fund stock repurchases and strategic transactions.
As of
September 30, 2017
, our available liquidity was
$12.3 million
, which consisted of available cash and cash equivalents. This represents an increase of
$0.8 million
from the
$11.5 million
in cash and cash equivalents as of
June 30, 2017
.
During the
three months ended
September 30, 2017
, our net cash provided by operating activities was
$2.5 million
as compared to net cash provided by operating activities of
$2.9 million
during the
three months ended
September 30, 2016
.
During the
three months ended
September 30, 2017
, our net cash used in investing activities was
$1.2 million
, as a result of our investment in new technology assets and the purchase of fixed assets. During the
three months ended
September 30, 2016
, our net cash used in investing activities was
$0.1 million
, as a result of the purchase of fixed assets.
Cash used in financing activities during the
three months ended
September 30, 2017
and
2016
was
$0.5 million
and
$0.5 million
, respectively, as a result of our quarterly principal payments on the March 2016 Term Loan.
At
September 30, 2017
and
June 30, 2017
, the total amount of our foreign subsidiary cash was
$7.1 million
and
$6.6 million
, respectively. For earnings considered to be indefinitely reinvested, we have not accrued taxes. If we were to remit the cash and cash equivalents from our foreign subsidiaries to our U.S. consolidated group for the purpose of repatriation of undistributed earnings, we would need to accrue and pay taxes. As of
September 30, 2017
, our U.S. consolidated group had approximately
$2.7 million
of permanently reinvested unremitted earnings from our subsidiaries. We do not have any plans to repatriate these unremitted earnings to our parent; therefore, we do not have any liquidity concerns relating to these unremitted earnings and related cash and cash equivalents.
At
September 30, 2017
, we had working capital (current assets minus current liabilities) of
$11.9 million
, compared to working capital of
$12.2 million
at
June 30, 2017
. We believe that our cash and cash equivalents balances and our ongoing cash
flow from operations will be sufficient to satisfy our cash requirements for at least the next 12 months. The majority of our historical expenses have been variable in nature and as such, a potential reduction in the level of revenue would reduce our cash flow needs. In the event that our current cash balances and future cash flow from operations are not sufficient to meet our obligations or strategic needs, we would consider raising additional funds, which may not be available on terms that are acceptable to us, or at all. Our credit facility, however, contains covenants that restrict our ability to raise additional funds in the debt markets and repurchase our equity securities without prior approval from the lender. Additionally, we would consider realigning our strategic plans including a reduction in capital spending and expenses.
Capital Resources
On
March 30, 2016
, we entered into a Loan Agreement (the “March 2016 Loan Agreement”) to refinance our outstanding debt. In connection with the March 2016 Loan Agreement and on the same date, we entered into a security agreement (the “Security Agreement”). The March 2016 Loan Agreement provides for a term loan in an aggregate principal amount of
$10.0 million
(the “March 2016 Term Loan") and a revolving loan facility in an aggregate principal amount not to exceed
$2.0 million
(the “March 2016 Revolving Loan,” and collectively with the March 2016 Term Loan, the March 2016 Loan Agreement and the Security Agreement, the “March 2016 Credit Facility”).
The principal amount of the March 2016 Term Loan is payable in consecutive quarterly installments in the amount of
$0.5 million
plus accrued interest beginning with the fiscal quarter ended
June 30, 2016
and maturing on
March 30, 2019
(the “Maturity Date”). The March 2016 Term Loan bears interest at a fixed rate of
4.93%
. If we borrow under the March 2016 Revolving Loan, interest will be payable quarterly in arrears on the last day of each fiscal quarter at a variable rate equal to the 30 day LIBOR Rate plus
3.50%
.
The March 2016 Credit Facility contains customary covenants, including affirmative and negative covenants that, among other things, restrict our ability to create certain types of liens, incur additional indebtedness, declare or pay dividends on or redeem capital stock, make other payments to holders of our equity interests, make certain investments, purchase or otherwise acquire all or substantially all the assets or equity interests of other companies, sell assets or enter into consolidations, mergers or transfers of all or any substantial part of our assets. As of
September 30, 2017
, we were in compliance with all applicable non-financial and restrictive covenants under the March 2016 Credit Facility.
The March 2016 Credit Facility also contains various financial covenants that require us to maintain certain consolidated minimum tangible net worth, minimum consolidated working capital amounts, and certain consolidated debt to EBITDA and fixed charge coverage ratios. Specifically, we must:
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Maintain a minimum fixed charge coverage ratio (as defined in the March 2016 Loan Agreement) of at least
1.50
to
1.00
at the end of each fiscal quarter, measured on a trailing twelve month basis;
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•
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Maintain minimum consolidated working capital (as defined in the March 2016 Loan Agreement) at the end of each fiscal quarter of at least
$5.0 million
;
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•
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Maintain a ratio of funded debt to EBITDA (as defined in the March 2016 Loan Agreement) of not greater than
2.00
to
1.00
at the end of each quarter, measured on a trailing twelve month basis; and
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•
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Have a tangible net worth (as defined in the March 2016 Loan Agreement) of at least
$4.0 million
by the end of our 2016 fiscal year and maintain that minimum tangible net worth thereafter, measured annually at fiscal year-end.
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As of
September 30, 2017
, we were in compliance with all applicable financial covenants under the March 2016 Credit Facility. Additionally, management anticipates that in the normal course of operations we will be in compliance with the financial covenants during the ensuing year.
Commitments and Obligations
The following table summarizes our contractual payment obligations and commitments as of
September 30, 2017
(in thousands):
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Payments due by period
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Contractual Obligations
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Total
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Less than
1 year
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1-3 years
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3-5 years
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Thereafter
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Long-term debt obligations
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$
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7,000
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$
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2,000
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$
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5,000
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$
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—
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$
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—
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Interest on long-term debt obligations
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431
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312
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|
119
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—
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—
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Operating lease obligations
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12,290
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2,557
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6,303
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3,430
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—
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Other operating obligations
(1)
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9,106
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9,106
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—
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—
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—
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Total
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$
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28,827
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$
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13,975
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$
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11,422
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$
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3,430
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$
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—
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(1) Other operating obligations represent non-cancelable contractual obligations primarily related to marketing and sponsorship commitments, as well as purchases of inventory.
Off-Balance Sheet Arrangements
As of
September 30, 2017
, we did not have any off-balance sheet arrangements.
Critical Accounting Policies
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ from these estimates. Our significant accounting policies are described in Note 2 to our financial statements. Certain of these significant accounting policies require us to make difficult, subjective, or complex judgments or estimates. We consider an accounting estimate to be critical if (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations.
There are other items within our financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could have a material impact on our financial statements. Management has discussed the development and selection of these critical accounting estimates with our board of directors, and the audit committee has reviewed the disclosures noted below.
Allowances for Product Returns
We record allowances for product returns at the time we ship the product based on estimated return rates. Subject to some exceptions based on local regulations, customers may return unopened product to us within 30 days of purchase for a refund of the purchase price less shipping and handling. As of
September 30, 2017
, our shipments of products sold totaling approximately
$15.6 million
were subject to the return policy. In addition, we allow terminating distributors to return up to
30%
of unopened, unexpired product they purchased within the prior twelve months.
We monitor our product returns estimate on an ongoing basis and revise the allowances to reflect our experience. Our allowance for product returns was
$0.3 million
at
September 30, 2017
, compared with
$0.4 million
at
June 30, 2017
. To date, product expiration dates have not played any role in product returns, and we do not expect that they will in the future as it is unlikely that we will ship product with an expiration date earlier than the latest allowable product return date.
Inventory Valuation
We value our inventory at the lower of cost or net realizable value on a first-in first-out basis. Accordingly, we reduce our inventories for the diminution of value resulting from product obsolescence, damage or other issues affecting marketability equal to the difference between the cost of the inventory and its estimated market value. Factors utilized in the determination of estimated market value include (i) current sales data and historical return rates, (ii) estimates of future demand, (iii) competitive pricing pressures, (iv) new production introductions, (v) product expiration dates, and (vi) component and packaging obsolescence.
During the three months ended
September 30, 2017
and
2016
, we recognized expenses of
$0.3 million
and
$0.6 million
, respectively, related to obsolete and slow-moving inventory.
Revenue Recognition
We ship the majority of our product directly to the consumer and receive substantially all payment for these sales in the form of credit card receipts. Revenue from direct product sales to customers is recognized upon shipment, which is when passage of title and risk of loss occurs.
Stock-Based Compensation
We use the fair value approach to account for stock-based compensation in accordance with current accounting guidance. We recognize compensation costs for awards with performance conditions when we conclude it is probable that the performance conditions will be achieved. We reassess the probability of vesting at each balance sheet date and adjust compensation costs based on our probability assessment. For awards with market-based performance conditions, the cost of the awards is recognized as the requisite service is rendered by the employees, regardless of when, if ever, the market-based performance conditions are satisfied.
Research and Development Costs
We expense all of our payments related to research and development activities as incurred.
Legal Accruals
We are occasionally involved in lawsuits and disputes arising in the normal course of business. Management regularly reviews all pending litigation matters in which we are involved and establishes accruals as we deem appropriate for these litigation matters when a probable loss estimate can be made. Estimated accruals require management judgment about future events. The results of lawsuits are inherently unpredictable and unfavorable resolutions could occur. As such, the amount of loss may differ from management estimates.
Recently Issued Accounting Standards
See Note 2 to our unaudited condensed consolidated financial statements for a discussion of recently issued accounting standards.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We conduct business in several countries and intend to continue to grow our international operations. Net revenue, operating income and net income are affected by fluctuations in currency exchange rates and other uncertainties in doing business and selling products in more than one currency. In addition, our operations are exposed to risks associated with changes in social, political and economic conditions inherent in international operations, including changes in the laws and policies that govern international investment in countries where we have operations, as well as, to a lesser extent, changes in U.S. laws and regulations relating to international trade and investment.
Foreign Currency Risk
During the
three months ended
September 30, 2017
, approximately
30.6%
of our net revenue was realized outside of the United States. The local currency of each international subsidiary is generally the functional currency. All revenues and expenses are translated at weighted-average exchange rates for the periods reported. Therefore, our reported revenue and earnings will be positively impacted by a weakening of the U.S. dollar and will be negatively impacted by a strengthening of the U.S. dollar. Currency fluctuations, however, have the opposite effect on our expenses incurred outside the United States. Given the large portion of our business derived from Japan, any weakening of the Japanese yen will negatively impact our reported revenue and profits, whereas a strengthening of the Japanese yen will positively impact our reported revenue and profits. Because of the uncertainty of exchange rate fluctuations, it is difficult to predict the effect of these fluctuations on our future business, product pricing and results of operations or financial condition. Changes in various currency exchange rates affect the relative prices at which we sell our products. We regularly monitor our foreign currency risks and periodically take measures to reduce the risk of foreign exchange rate fluctuations on our operating results. Additionally, we may seek to reduce our exposure to fluctuations in foreign currency exchange rates through the use of foreign currency exchange contracts. We do not use derivative financial instruments for trading or speculative purposes. At
September 30, 2017
, we did not have any derivative instruments. A 10% strengthening of the U.S. dollar compared to all of the foreign currencies in which we transact business would have resulted in a
2.8%
decrease of our
three months ended
September 30, 2017
revenue, in the amount of
$1.3 million
.