Youngevity International, Inc. - Quarter Report: 2017 June (Form 10-Q)

 

UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X]

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2017

 

[   ]

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 000-54900

 

YOUNGEVITY INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware		90-0890517
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
2400 Boswell Road, Chula Vista, CA		91914
(Address of Principal Executive Offices)		(Zip Code)

 

Registrant’s Telephone Number, including area code:  (619) 934-3980

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec.232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]  No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	[  ]	Accelerated filer	[  ]
Non-accelerated filer	[  ]	Smaller reporting company	[X]
(Do not check if a smaller reporting company)		Emerging growth company	[X]

If an emerging growth company indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ] 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [  ]  No [X]

 

As of August 10, 2017, the issuer had 19,678,166 shares of its Common Stock, par value $0.001 per share, issued and outstanding.

 

 

 

YOUNGEVITY INTERNATIONAL, INC.

TABLE OF CONTENTS

 

		Page
	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of June 30, 2017 (unaudited) and December 31, 2016	1
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2017 & 2016 (unaudited)	2
	Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2017 & 2016 (unaudited)	3
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2017 & 2016 (restated) (unaudited)	4
	Notes to Condensed Consolidated Financial Statements (unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	27
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Mine Safety Disclosures	29
Item 5.	Other Information	29
Item 6.	Exhibits	30
Signatures		31

 

 

 

 PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

Youngevity International, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(In thousands, except share amounts)
	As of
	June 30, 2017	December 31, 2016
ASSETS	(Unaudited)
Current Assets
Cash and cash equivalents	$903	$869
Accounts receivable, due from factoring company	2,743	1,078
Trade accounts receivable, net	843	1,071
Income tax receivable	1,784	311
Inventory	20,674	21,492
Prepaid expenses and other current assets	2,910	3,087
Total current assets	29,857	27,908
Property and equipment, net	13,997	14,006
Deferred tax assets	2,857	2,857
Intangible assets, net	16,249	14,914
Goodwill	6,323	6,323
Total assets	$69,283	$66,008
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable	$9,493	$8,174
Accrued distributor compensation	4,832	4,163
Accrued expenses	5,210	3,701
Deferred revenues	1,848	1,870
Other current liabilities	3,739	2,389
Capital lease payable	891	821
Notes payable	203	219
Warrant derivative liability	4,076	3,345
Contingent acquisition debt	359	628
Total current liabilities	30,651	25,310
Capital lease payable, net of current portion	1,210	1,569
Notes payable, net of current portion	4,393	4,431
Convertible notes payable, net of debt discount	9,098	8,327
Contingent acquisition debt, net of current portion	9,058	7,373
Total liabilities	54,410	47,010
Commitments and contingencies, Note 1
Stockholders’ Equity
Convertible Preferred Stock, $0.001 par value: 5,000,000 shares authorized; 161,135 shares issued and outstanding at June 30, 2017 and December 31, 2016	-	-
Common Stock, $0.001 par value: 50,000,000 shares authorized; 19,668,166 and 19,634,345 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively (1)	20	20
Additional paid-in capital	170,862	170,212
Accumulated deficit	(155,805)	(151,016)
Accumulated other comprehensive loss	(204)	(218)
Total stockholders’ equity	14,873	18,998
Total Liabilities and Stockholders’ Equity	$69,283	$66,008

See accompanying notes to condensed consolidated financial statements.

 

 

Youngevity International, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

 

	Three Months Ended June 30,		Six Months Ended June 30,
	2017	2016	2017	2016
Revenues	$41,527	$42,500	$80,260	$80,702
Cost of revenues	17,425	17,069	34,292	31,908
Gross profit	24,102	25,431	45,968	48,794
Operating expenses
Distributor compensation	16,686	16,796	32,105	32,770
Sales and marketing	2,901	2,637	6,576	4,438
General and administrative	5,191	4,474	10,363	8,899
Total operating expenses	24,778	23,907	49,044	46,107
Operating (loss) income	(676)	1,524	(3,076)	2,687
Interest expense, net	(1,258)	(1,089)	(2,455)	(2,193)
Change in fair value of warrant derivative liability	(1,341)	(484)	(731)	166
Total other expense	(2,599)	(1,573)	(3,186)	(2,027)
(Loss) income before income taxes	(3,275)	(49)	(6,262)	660
Income tax (benefit) provision	(545)	60	(1,473)	618
Net (loss) income	(2,730)	(109)	(4,789)	42
Preferred stock dividends	(3)	(3)	(6)	(6)
Net (loss) income attributable to common stockholders	$(2,733)	$(112)	$(4,795)	$36
Net (loss) income per share, basic (1)	$(0.14)	$(0.01)	$(0.24)	$0.00
Net (loss) income per share, diluted (1)	$(0.14)	$(0.01)	$(0.24)	$0.00
Weighted average shares outstanding, basic (1)	19,651,705	19,630,030	19,643,486	19,629,913
Weighted average shares outstanding, diluted (1)	19,651,705	19,630,030	19,643,486	19,984,044

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

Youngevity International, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

	Three Months Ended June 30,		Six Months Ended June 30,
	2017	2016	2017	2016
Net (loss) income	$(2,730)	$(109)	$(4,789)	$42
Foreign currency translation	(67)	(37)	(14)	(146)
Total other comprehensive loss	(67)	(37)	(14)	(146)
Comprehensive loss	$(2,797)	$(146)	$(4,803)	$(104)

 

See accompanying notes to condensed consolidated financial statements.

 

 

Youngevity International, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

 (In thousands)

(Unaudited)

 

	Six Months Ended June 30,
	2017	2016
Cash Flows from Operating Activities:		(As Restated)
Net (loss) income	$(4,789)	$42
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Depreciation and amortization	2,099	1,987
Stock based compensation expense	485	126
Amortization of deferred financing costs	180	180
Amortization of prepaid advisory fees	28	31
Stock issuance for services	150	30
Change in fair value of warrant derivative liability	731	(166)
Amortization of debt discount	527	527
Amortization of warrant issuance costs	64	64
Expenses allocated in profit sharing agreement	(420)	(382)
Change in fair value of contingent acquisition debt	(680)	(871)
Changes in operating assets and liabilities, net of effect from business combinations:
Accounts receivable	(1,437)	(391)
Inventory	818	(2,301)
Income taxes receivable	(1,473)	173
Prepaid expenses and other current assets	149	(67)
Accounts payable	1,319	458
Accrued distributor compensation	669	738
Deferred revenues	(22)	(465)
Accrued expenses and other liabilities	1,426	(1,027)
Net Cash Used In Operating Activities	(176)	(1,314)
Cash Flows from Investing Activities:
Acquisitions, net	(175)	-
Purchases of property and equipment	(499)	(461)
Net Cash Used in Investing Activities	(674)	(461)
Cash Flows from Financing Activities:
Proceeds from the exercise of stock options and warrants, net	21	12
Proceeds from factoring company	1,652	831
Payments of notes payable, net	(104)	(358)
Payments of contingent acquisition debt	(204)	(462)
Payments of capital leases	(495)	(132)
Repurchase of common stock	-	(20)
Net Cash Provided by (Used in) Financing Activities	870	(129)
Foreign Currency Effect on Cash	14	(146)
Net increase (decrease) in cash and cash equivalents	34	(2,050)
Cash and Cash Equivalents, Beginning of Period	869	3,875
Cash and Cash Equivalents, End of Period	$903	$1,825
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest	$1,730	$1,425
Income taxes	$31	$145
Supplemental Disclosures of Noncash Investing and Financing Activities
Purchases of property and equipment funded by capital leases	$256	1,046
Acquisitions of net assets in exchange for contingent acquisition debt (see Note 4)	$2,670	$2,650

 

See accompanying notes to condensed consolidated financial statements.

 

 

Youngevity International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

June 30, 2017

 

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, 2017 and for the three and six months ended June 30, 2017 and 2016 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, 2016. The results for interim periods are not necessarily indicative of the results for the entire year.

 

Youngevity International, Inc. (the “Company”) consolidates all wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Certain reclassifications have been made to conform to the current year presentations including the Company’s adoption of Accounting Standards Update (“ASU”) 2015-17 pertaining to the presentation of deferred tax assets and liabilities as noncurrent with retrospective application effective January 1, 2017. This resulted in a reclassification from deferred tax assets, net current to deferred tax assets, net long-term. These reclassifications did not affect revenue, total costs and expenses, income (loss) from operations, or net income (loss). The adoption of ASU No. 2015-17 resulted in a reclassification of deferred tax assets, net current of $565,000 to deferred tax assets, net long-term on the Company’s consolidated financial statements as of December 31, 2016.

 

As previously reported on the Annual Report on Form 10-K/A for the year ended December 31, 2016 filed with the Securities and Exchange Commission on August 14, 2017, the Company restated the interim Consolidated Statement of Cash Flows for the quarter ended June 30, 2016 previously filed by the Company in its quarterly report on Form 10-Q for the same period. This was due to an error in the presentation of cash flow activity under the Company’s factoring facility. The current report for the quarter ended June 30, 2017 reflects the restated numbers for the six months ended June 30, 2016.

Nature of Business

 

The Company, founded in 1996, develops and distributes health and nutrition related 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, 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. (“Siles”), 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., Mialisia Canada, Inc., Legacy for Life Limited (Hong Kong), BellaVita Group LLC; Taiwan, Hong Kong, Singapore, Indonesia, Malaysia and Japan.

 

The Company also operates subsidiary branches of Youngevity Global LLC in the Philippines and Taiwan.

 

Reverse Stock Split

 

On June 5, 2017, the Company filed a certificate to amend its Articles of Incorporation to effect a reverse split on a one-for-twenty basis (the “Reverse Split”), whereby, every twenty shares of the Company’s common stock, par value $0.001 per share (the “Common Stock or “common stock”), were exchanged for one share of its common stock. The Reverse Split became effective on June 7, 2017. All common stock share and per share amounts have been adjusted to reflect retrospective application of the Reverse Split, unless otherwise indicated. The Common Stock began trading on a reverse split basis at the market opening on June 8, 2017.

 

NASDAQ Listing

 

Effective June 21, 2017, the Common Stock began trading on the NASDAQ Stock Market LLC’s NASDAQ Capital Market, under the symbol “YGYI”. Prior to the Company’s uplisting to NASDAQ the Company’s common stock had been traded on the OTCQX market.

 

 

 

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 condensed consolidated financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected prospectively in the period they occur.

 

Liquidity

 

We believe that current cash balances, future cash provided by operations, and available amounts under our accounts receivable factoring agreement will be sufficient to cover our operating and capital needs in the ordinary course of business for at least the next twelve months as of August 14, 2017.

 

Though our operations are currently meeting our working capital requirements, if we experience an adverse operating environment or unusual capital expenditure requirements, or if we continue our expansion internationally or through acquisitions, additional financing may be required. No assurance can be given, however, that additional financing, if required, would be available on favorable terms. We might also require or seek additional financing for the purpose of expanding into new markets, growing our existing markets, or for other reasons. Such financing may include the use of additional debt or the sale of additional equity securities. Any financing which involves the sale of equity securities or instruments that are convertible into equity securities could result in immediate and possibly significant dilution to our existing shareholders.

 

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 and Common Stock associated with the Company's convertible notes based on the average stock price for each period using the treasury stock method.

 

Since the Company incurred a loss for the three and six months ended June 30, 2017, 5,282,208 common share equivalents were not included in the weighted-average calculations since their effect would have been anti-dilutive.

 

The Company incurred a loss for the three months ended June 30, 2016, and therefore, 4,866,703 common share equivalents including potential convertible shares of Common Stock associated with the Company's convertible notes were not included in the weighted-average calculation since their effect would have been anti-dilutive. The incremental dilutive common share equivalents were 1,380,915 for the six months ended June 30, 2016.

 

Income and loss per share amounts and weighted average shares outstanding for all periods have been retroactively adjusted to reflect the Company’s 1-for-20 Reverse Split, which was effective June 7, 2017.

 

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. Additionally, the Agreement expands the factoring facility to include advanced borrowings against eligible inventory up to 50% of landed cost of finished goods inventory that meet certain criteria, not to exceed the lesser of $1,000,000 or 85% of the value of the accounts 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 0.875% of the gross invoice amount and is recorded as interest expense. In addition, the Company and the Company’s CEO, Mr. Wallach have entered into a Guaranty and Security Agreement with Crestmark Bank guaranteeing payments in the event that CLR were to default. This Agreement 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 $2,743,000 and $1,078,000 as of June 30, 2017 and December 31, 2016, respectively, reflects the related collateralized accounts.

 

The Company's outstanding liability related to the Factoring Agreement was approximately $2,942,000 and $1,290,000 as of June 30, 2017 and December 31, 2016, respectively, and is included in other current liabilities 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 500 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 US generally accepted accounting principles (“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.

 

As of December 31, 2016, the inventory related to the 2016 harvest was $112,000. As of June 30, 2017, all previously harvested coffee from the 2016 harvest had been sold.

 

In April 2017, the Company completed the 2017 harvest in Nicaragua and approximately $552,000 of deferred harvest costs were reclassified as inventory during the quarter ended June 30, 2017. The remaining inventory as of June 30, 2017 is $391,000.

 

Costs associated with the 2018 harvest as of June 30, 2017 total approximately $100,000 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

  

Richard Renton

 

Richard Renton is a member of the Board of Directors and owns and operates with his wife Roxanna Renton, Northwest Nutraceuticals, Inc., a supplier of certain inventory items sold by the Company. The Company made purchases of approximately $59,000 and $16,000 from Northwest Nutraceuticals Inc., for the three months ended June 30, 2017 and 2016, respectively, and $81,000 and $50,000 for the six months ended June 30, 2017 and 2016, respectively. In addition, Mr. Renton and his wife are distributors of the Company and can earn commissions on product sales.

 

 

 

Other Relationships

 

Hernandez, Hernandez, Export Y Company

 

The Company’s coffee segment, CLR, is associated with Hernandez, Hernandez, Export Y Company (“H&H”), a Nicaragua company, through sourcing arrangements to procure Nicaraguan green coffee beans and in March 2014 as part of the Siles acquisition, CLR engaged the owners of H&H as employees to manage Siles. The Company made purchases of approximately $912,000 and $2,900,000 from this supplier for the three months ended June 30, 2017 and 2016, respectively and $1,327,000 and $4,700,000 for the six months ended June 30, 2017 and 2016, respectively.

 

In addition, CLR sold approximately $1,056,000 and $1,500,000 for the three months ended June 30, 2017 and 2016, respectively and $1,547,000 and $2,200,000 for the six months ended June 30, 2017 and 2016, respectively, of green coffee beans to H&H Coffee Group Export, a Florida based company which is affiliated with H&H.

 

In March 2017, the Company entered a settlement agreement and release with H&H Coffee Group Export pursuant to which it was agreed that $150,000 owed to H&H Coffee Group Export for services that had been rendered would be settled by the issuance of Common Stock. During the three months ended June 30, 2017, the Company issued to H&H Coffee Group Export 27,500 shares of Common Stock in accordance with this agreement.

 

In May 2017, the Company entered a settlement agreement with Alain Piedra Hernandez, one of the owners of H&H and the operating manager of Siles, who was issued a non-qualified stock option for the purchase of 75,000 shares of the Company’s Common Stock at a price of $2.00 with an expiration date of three years, in lieu of an obligation due from the Company to H&H as relates to a Sourcing and Supply Agreement 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 primarily via UPS, USPS or FedEx 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, 2017 and December 31, 2016, the balance in deferred revenues was approximately $1,848,000 and $1,870,000 respectively, of which the portion attributable to Heritage Makers was approximately $1,623,000 and $1,662,000, respectively. The remaining balance of approximately $225,000 and $208,000 as of June 30, 2017 and December 31, 2016, related primarily to the Company’s 2017 conventions, respectively, 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, 2017 and December 31, 2016, the balance in deferred costs was approximately $377,000 and $415,000 respectively, and was included in prepaid expenses and current assets.

 

Commitments and Contingencies

 

We are, from time to time, the subject of claims and suits arising out of matters occurring during the operation of our business. We are not presently party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, current legal proceedings are having an adverse impact on us because of litigation costs, diversion of management resources and other factors.

 

Recently Issued Accounting Pronouncements

 

In October 2016, the FASB issued Accounting Standard Update ("ASU") 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. This standard amends the guidance issued with ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis in order to make it less likely that a single decision maker would individually meet the characteristics to be the primary beneficiary of a Variable Interest Entity ("VIE"). When a decision maker or service provider considers indirect interests held through related parties under common control, they perform two steps. The second step was amended with this ASU to say that the decision maker should consider interests held by these related parties on a proportionate basis when determining the primary beneficiary of the VIE rather than in their entirety as was called for in the previous guidance. This ASU was effective for fiscal years beginning after December 15, 2016, and early adoption was not permitted. The Company adopted ASU 2016-17 effective the quarter ended March 31, 2017. The adoption of ASU 2016-17 did not have a significant impact on its consolidated financial statements.

 

 

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize lease assets and lease liabilities on the balance sheet and requires expanded disclosures about leasing arrangements. The Company expects to adopt the standard no later than January 1, 2019. The Company is currently assessing the impact that the new standard will have on the Company’s consolidated financial statements, which will consist primarily of a balance sheet gross up of our operating leases. The Company has not evaluated the impact this new standard will have on its consolidated financial statements; however it is expected to gross-up the consolidated balance sheet as a result of recognizing a lease asset along with a similar lease liability.

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This guidance requires that entities with a classified statement of financial position present all deferred tax assets and liabilities as noncurrent. This update is effective for annual and interim periods for fiscal years beginning after December 15, 2016, which required the Company to adopt the new guidance in the first quarter of fiscal 2017. Early adoption was permitted for financial statements that have not been previously issued and may be applied on either a prospective or retrospective basis. The Company adopted ASU 2015-17 effective the quarter ended March 31, 2017. The adoption of ASU 2015-17 did not have a significant impact on its consolidated financial statements other than the netting of current and long-term deferred tax assets and liabilities in the non-current section of the balance sheet and footnote disclosures.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, requiring 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. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of the new revenue standard for periods beginning after December 15, 2016 to December 15, 2017, with early adoption permitted but not earlier than the original effective date. Accordingly, the updated standard is effective for the Company in the first quarter of fiscal 2018 and we do not plan to early adopt. The Company has not yet selected a transition method and the Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.

 

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 Revenues

 

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):

 

	As of
	June 30, 2017	December 31, 2016
Finished goods	$10,962	$11,550
Raw materials	10,776	11,006
	21,738	22,556
Reserve for excess and obsolete	(1,064)	(1,064)
Inventory, net	$20,674	$21,492

 

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, 2017, the Company entered into two acquisitions, which are detailed below. The acquisitions were 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 all of the business combinations was to increase revenue and profitability. The acquisitions were structured as asset purchases which resulted in the recognition of certain intangible assets.

 

BellaVita Group, LLC

 

Effective March 1, 2017, the Company acquired certain assets of BellaVita Group, LLC “BellaVita” a direct sales company and producer of health and beauty products with locations and customers primarily in the Asian market.

 

The contingent consideration’s estimated fair value at the date of acquisition was $1,750,000 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. In addition, the Company has assumed certain liabilities in accordance with the agreement.

 

The Company is obligated to make monthly payments based on a percentage of the BellaVita distributor revenue derived from sales of the Company’s products and a percentage of royalty revenue derived from sales of BellaVita products until the earlier of the date that is twelve (12) years from the closing date or such time as the Company has paid to BellaVita aggregate cash payments of the BellaVita distributor revenue and royalty revenue equal to a predetermined maximum aggregate purchase price.

 

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 is as follows (in thousands):

 

Distributor organization	$825
Customer-related intangible	525
Trademarks and trade name	400
Total purchase price	$1,750

 

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 valuations within one (1) year from the acquisition date.

 

The revenue impact from the BellaVita acquisition, included in the condensed consolidated statements of operations for the three and six months ended June 30, 2017 was approximately $620,000 and $872,000, respectively.

 

The pro-forma effect assuming the business combination with BellaVita discussed above had occurred at the beginning of the year is not presented as the information was not available.

 

 

 

Ricolife, LLC

 

Effective March 1, 2017, the Company acquired certain assets of Ricolife, LLC “Ricolife” a direct sales company and producer of teas with health benefits contained within its tea formulas.

 

The contingent consideration’s estimated fair value at the date of acquisition was $920,000 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. In addition, the Company has assumed certain liabilities in accordance with the agreement.

 

The Company is obligated to make monthly payments based on a percentage of the Ricolife distributor revenue derived from sales of the Company’s products and a percentage of royalty revenue derived from sales of Ricolife products until the earlier of the date that is twelve (12) years from the closing date or such time as the Company has paid to Ricolife aggregate cash payments of the Ricolife distributor revenue and royalty revenue equal to a predetermined maximum aggregate purchase price.

 

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 is as follows (in thousands):

 

Distributor organization	$440
Customer-related intangible	280
Trademarks and trade name	200
Total purchase price	$920

 

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 valuations within one (1) year from the acquisition date.

 

The revenue impact from the Ricolife acquisition, included in the condensed consolidated statements of operations for the three and six months ended June 30, 2017 was approximately $351,000 and $415,000, respectively.

 

The pro-forma effect assuming the business combination with Ricolife discussed above had occurred at the beginning of the year is not presented as the information was not available.

 

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):

 

	June 30, 2017			December 31, 2016
	Cost	Accumulated Amortization	Net	Cost	Accumulated Amortization	Net
Distributor organizations	$14,195	$7,779	$6,416	$12,930	$7,162	$5,768
Trademarks and trade names	5,994	988	5,006	5,394	815	4,579
Customer relationships	8,651	4,136	4,515	7,846	3,642	4,204
Internally developed software	720	408	312	720	357	363
Intangible assets	$29,560	$13,311	$16,249	$26,890	$11,976	$14,914

 

Amortization expense related to intangible assets was approximately $690,000 and $605,000 for the three months ended June 30, 2017 and 2016, respectively. Amortization expense related to intangible assets was approximately $1,335,000 and $1,209,000 for the six months ended June 30, 2017 and 2016, 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”) 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, 2017 and December 31, 2016 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, 2017 and 2016.

 

Goodwill intangible assets consist of the following (in thousands):

 

	June 30, 2017	December 31, 2016
Goodwill, commercial coffee	$3,314	$3,314
Goodwill, direct selling	3,009	3,009
Total goodwill	$6,323	$6,323

 

Note 6. Debt

 

Convertible Notes Payable

 

Our total convertible notes payable as of June 30, 2017, net of debt discount outstanding consisted of the amount set forth in the following table (in thousands):

 

	June 30, 2017	December 31, 2016
8% Convertible Notes due July and August 2019 (July 2014 Private Placement) (1)	$2,771	$2,296
8% Convertible Notes due October and November 2018 (November 2015 Private Placement) (2)	7,051	6,999
Net debt issuance costs	(724)	(968)
Total convertible notes payable, net of debt discount (3)	$9,098	$8,327

 

 

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 678,568 shares of our Common Stock, at a conversion price of $7.00 per share, and warrants to purchase 929,346 shares of Common Stock at an exercise price of $4.60 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, 2017 and December 31, 2016 the principal amount of $4,750,000 remains outstanding.

 

 

The Company recorded debt discounts of $4,750,000 related to the beneficial conversion feature of $1,053,000 and a debt discount of $3,697,000 related to the detachable warrants discount. The beneficial conversion feature discount and the detachable warrants discount are amortized to interest expense over the life of the Notes. As of June 30, 2017 and December 31, 2016 the remaining balances of the debt discounts is approximately $1,979,000 and $2,454,000, respectively. The quarterly amortization of the issuance costs is approximately $238,000 and is recorded as interest expense.

 

With respect to the aggregate offering, the Company paid $490,000 in expenses including placement agent fees. The issuance costs are amortized to interest expense over the term of the Notes. As of June 30, 2017 and December 31, 2016 the remaining balances of the issuance cost is approximately $204,000 and $253,000, respectively. The quarterly amortization of the issuance costs is approximately $25,000 and is recorded as interest expense.

 

Unamortized debt discounts and issuance costs are included with convertible notes payable, net of debt discount on the condensed consolidated balance sheets.

 

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-year senior secured convertible Notes in the aggregate principal amount of $7,187,500, convertible into 1,026,784 shares of Common Stock, at a conversion price of $7.00 per share, subject to adjustment as provided therein; and five-year Warrants exercisable to purchase 479,166 shares of the Company’s common stock at a price per share of $9.00. 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, 2017 and December 31, 2016 the principal amount of $7,187,500 remains outstanding. (See Note 11 Subsequent Events, “July 2017 Private Placement” below.)

 

The Company recorded debt discounts of $309,000 related to the beneficial conversion feature of $15,000 and a debt discount of $294,000 related to the detachable warrants discount. The beneficial conversion feature discount and the detachable warrants discount are amortized to interest expense over the life of the Notes. As of June 30, 2017 and December 31, 2016 the remaining balances of the debt discounts is approximately $137,000 and $189,000 respectively. The quarterly amortization of the issuance costs is approximately $26,000 and is recorded as interest expense.

 

With respect to the aggregate offering, the Company paid $786,000 in expenses including placement agent fees. The issuance costs are amortized to interest expense over the term of the Notes. As of June 30, 2017 and December 31, 2016 the remaining balances of the issuance cost is approximately $349,000 and $480,000, respectively. The quarterly amortization of the issuance costs is approximately $65,000 and is recorded as interest expense.

 

In addition the Company issued warrants to the placement agent in connection with the Notes which were valued at approximately $384,000. These warrants were not protected against down-round financing and accordingly, were classified as equity instruments and corresponding deferred issuance costs are amortized over the term of the Notes. As of June 30, 2017 and December 31, 2016, the remaining balance of the warrant issuance costs is approximately $171,000 and $235,000, respectively. The quarterly amortization of the warrant issuance costs is approximately $32,000 and is recorded as interest expense.

 

Unamortized debt discounts and issuance costs are included with convertible notes payable, net of debt discount on the condensed consolidated balance sheets.

 

Note 7. Derivative Liability

 

The Company accounted for the warrants issued in conjunction with our November 2015 and July 2014 Private Placements 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 issued to the investors that relate to Notes are ineligible for equity classification due to anti-dilution provisions set forth therein.

 

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. The Company 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 outstanding warrant liabilities was $4,076,000 and $3,345,000 as of June 30, 2017 and December 31, 2016, 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 to the liability of approximately $1,341,000 for the three months ended June 30, 2017 compared to an increase to the liability of approximately $484,000 for the three months ended June 30, 2016. For the six months ended June 30, 2017 the liability increased by approximately $731,000 compared to a decrease of approximately $166,000 for the six months ended June 30, 2016.

 

Various factors are considered in the pricing models the Company uses to value the warrants, including its current stock price, the remaining life of the warrants, the volatility of its 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, the Company expects 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.

 

The estimated fair value of the warrants were computed as of June 30, 2017 and as of December 31, 2016 using Black-Scholes and Monte Carlo option pricing models, using the following assumptions:

 

	June 30, 2017	December 31, 2016
Stock price volatility	60% - 65%	60% - 65%
Risk-free interest rates	1.38%-1.55%	1.34%-1.70%
Annual dividend yield	0	0
Expected life	2.0-3.3 years	2.6-3.9 years

 

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, the Company issued warrants to purchase shares of its 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.

 

 

 

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):

 

	Fair Value at June 30, 2017
	Total	Level 1	Level 2	Level 3
Liabilities:
Contingent acquisition debt, current portion	$359	$-	$-	$359
Contingent acquisition debt, less current portion	9,058	-	-	9,058
Warrant derivative liability	4,076	-	-	4,076
Total liabilities	$13,493	$-	$-	$13,493

 

	Fair Value at December 31, 2016
	Total	Level 1	Level 2	Level 3
Liabilities:
Contingent acquisition debt, current portion	$628	$-	$-	$628
Contingent acquisition debt, less current portion	7,373	-	-	7,373
Warrant derivative liability	3,345	-	-	3,345
Total liabilities	$11,346	$-	$-	$11,346

  

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. 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, 2017 the net adjustment to the fair value of the contingent acquisition debt was a decrease of $680,000. 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.

 

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”.

 

Common Stock

 

On May 31, 2017, the Board of Directors of the Company authorized a reverse stock split in order to meet certain criteria in preparation for the Company’s uplisting on the NASDAQ Capital Market.

 

On June 5, 2017, the Company filed a certificate of amendment to the Company’s Articles of Incorporation with the Secretary of State of the State of Delaware to effect a one-for-twenty reverse stock split of the Company’s issued and outstanding common stock. As a result of the Reverse Split, every twenty shares of the Company issued and outstanding common stock were automatically combined and reclassified into one share of the Company’s common stock. The Reverse Split affected all issued and outstanding shares of common stock, as well as common stock underlying stock options, warrants outstanding, including common stock equivalents issuable under convertible notes and preferred shares. No fractional shares were issued in connection with the Reverse Split. Stockholders who would otherwise hold a fractional share of common stock will receive cash payment for the fractional share.

 

The Reverse Split became effective on June 7, 2017. All disclosures of shares and per share data in these condensed consolidated financial statements and related notes have been retroactively adjusted to reflect the Reverse Split for all periods presented.

 

The total number of authorized shares of common stock was reduced from 600,000,000 to 50,000,000. The total number of shares of stock which the Corporation shall have authority to issue is 50,000,000 shares of common stock, par value $.001 per share and 5,000,000 shares of preferred stock, par value $.001 per share, of which 161,135 shares have been designated as Series A convertible preferred stock, par value $.001 per share (“Series A Convertible Preferred”).

 

As of June 30, 2017, the total number of authorized shares of common stock was is 50,000,000.

 

As of June 30, 2017, and December 31, 2016 there were 19,668,166 and 19,634,345 shares of common stock outstanding, respectively. The holders of the Common Stock are entitled to one vote for each share held at all meetings of stockholders (and written actions in lieu of meetings).  

 

 

 

Convertible Preferred Stock

 

The Company had 161,135 shares of Series A Convertible Preferred Stock outstanding as of June 30, 2017 and December 31, 2016, and accrued dividends of approximately $118,000 and $112,000, respectively. The holders of the Series A Convertible 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 $10.00 per share.  Each share of Series A Convertible Preferred is convertible into two shares of the Company's Common Stock. The holders of Series A Convertible 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 Convertible Preferred have no voting rights, except as required by law.  

 

Repurchase of Common Stock

 

On December 11, 2012, the Company authorized a share repurchase program to repurchase up to 750,000 of the Company's issued and outstanding shares of Common Stock from time to time on the open market or via private transactions through block trades.  A total of 196,594 shares have been repurchased to-date as of June 30, 2017 at a weighted-average cost of $5.30. There were no repurchases during the six months ended June 30, 2017. The remaining number of shares authorized for repurchase under the plan as of June 30, 2017 is 553,406.

 

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 5,000 shares of restricted common stock to be issued upon successfully meeting certain criteria in accordance with the agreement. Subsequent to September 1, 2015 this agreement has been extended under the same terms with the monthly cash payment remaining at $6,000 per month and 5,000 shares of restricted common stock for every six (6) months of service performed.

 

As of June 30, 2017, the Company has issued 5,000 shares of restricted common stock in connection with this agreement and accrued for the estimated per share value on each subsequent six (6) month periods based on the price of Company’s common stock at each respective date. As of June 30, 2017, the Company has accrued for 10,000 shares of restricted stock that have been earned. The fair value of the shares to be issued are recorded as prepaid advisory fees and are included in prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets and is amortized on a pro-rata basis over the term of the respective periods. During the three months ended June 30, 2017 and 2016, the Company recorded expense of approximately $14,000 and $15,000, respectively and $28,000 and $31,000, during the six months ended June 30, 2017 and 2016, respectively, in connection with amortization of the stock issuance.

 

Warrants to Purchase Preferred Stock and Common Stock

 

As of June 30, 2017, warrants to purchase 1,883,885 shares of the Company's common stock at prices ranging from $4.60 to $10.00 were outstanding. All warrants are exercisable as of June 30, 2017 and expire at various dates through November 2020 and have a weighted average remaining term of approximately 2.27 years and are included in the table below as of June 30, 2017.

A summary of the warrant activity for the six months ended June 30, 2017 is presented in the following table:

 

Balance at December 31, 2016	1,899,385
Issued	-
Expired / cancelled	(15,500)
Exercised	-
Balance at June 30, 2017	1,883,885

 

Stock Options

 

On May 16, 2012, the Company established the 2012 Stock Option Plan (“Plan”) authorizing the granting of options for up to 2,000,000 shares of Common Stock. On February 23, 2017, the Company’s board of directors received the approval of our stockholders, to amend the 2012 Stock Option Plan (“Plan”) to increase the number of shares of common stock available for grant and to expand the types of awards available for grant under the Plan. The amendment of the Plan increased the number of authorized shares of the Company’s common stock that may be delivered pursuant to awards granted during the life of the plan from 2,000,000 to 4,000,000 shares.

 

 

 

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 allows for the grant of: (a) incentive stock options; (b) nonqualified stock options; (c) stock appreciation rights; (d) restricted stock; and (e) other stock-based and cash-based awards to eligible individuals qualifying under Section 422 of the Internal Revenue Code, in any combination (collectively, “Options”). At June 30, 2017, the Company had 2,294,018 shares of Common Stock available for issuance under the Plan. 

 

A summary of the Plan Options for the six months ended June 30, 2017 is presented in the following table: 

 

	Number of Shares	Weighted Average Exercise Price	Aggregate Intrinsic Value (in thousands)
Outstanding December 31, 2016	1,660,964	$4.74	$1,346
Issued	76,547	2.07
Canceled / expired	(54,332)	4.28
Exercised	(6,321)	4.19	-
Outstanding June 30, 2017	1,676,858	$4.63	$3,145
Exercisable June 30, 2017	959,533	$4.35	$2,079

 

The weighted-average fair value per share of the granted options for the six months ended June 30, 2017 and 2016 was approximately $3.08 and $2.93, respectively.

 

Stock based compensation expense included in the condensed consolidated statements of operations was $358,000 and $56,000 for the three months ended June 30, 2017 and 2016, respectively, and $485,000 and $126,000 for the six months ended June 30, 2017 and 2016, respectively.

 

As of June 30, 2017, there was approximately $1,828,000 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 3.93 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

 

We are a leading omni-direct lifestyle company offering a hybrid of the direct selling business model that also offers e-commerce and the power of social selling. Assembling a virtual Main Street of products and services under one corporate entity, Youngevity offers products from top selling retail categories: health/nutrition, home/family, food/beverage (including coffee), spa/beauty, apparel/jewelry, as well as innovative services. We operate in two segments: the direct selling segment where products are offered through a global distribution network of preferred customers and distributors and the commercial coffee segment where roasted and green coffee bean products are sold directly to businesses.

 

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):

 

 

	Three months ended		Six months ended
	June 30,		June 30,
	2017	2016	2017	2016
Revenues
Direct selling	$35,538	$37,019	$68,780	$71,817
Commercial coffee	5,989	5,481	11,480	8,885
Total revenues	$41,527	$42,500	$80,260	$80,702
Gross profit
Direct selling	$24,195	$24,967	$46,050	$48,457
Commercial coffee	(93)	464	(82)	337
Total gross profit	$24,102	$25,431	$45,968	$48,794
Operating income (loss)
Direct selling	$595	$1,708	$(1,159)	$3,732
Commercial coffee	(1,271)	(184)	(1,917)	(1,045)
Total operating income	$(676)	$1,524	$(3,076)	$2,687
Net (loss) income
Direct selling	$(135)	$416	$(1,647)	$1,090
Commercial coffee	(2,595)	(525)	(3,142)	(1,048)
Total net (loss) income	$(2,730)	$(109)	$(4,789)	$42
Capital expenditures
Direct selling	$346	$398	$474	$749
Commercial coffee	101	299	281	718
Total capital expenditures	$447	$697	$755	$1,467

 

	As of
	June 30, 2017	December 31, 2016
Total assets
Direct selling	$42,821	$40,127
Commercial coffee	26,462	25,881
Total assets	$69,283	$66,008

 

Total tangible assets, net located outside the United States were approximately $5.3 million and $5.4 million as of June 30, 2017 and December 31, 2016, respectively.

 

The Company conducts its operations primarily in the United States. For the three months ended June 30, 2017 and 2016 approximately 10% and 9%, respectively, of the Company’s sales were derived from sales outside the United States. For the six months ended June 30, 2017 and 2016 approximately 10% and 9%, respectively, of the Company’s sales were derived from sales outside the United States.

 

The following table displays revenues attributable to the geographic location of the customer (in thousands):

 

	Three months ended		Six months ended
	June 30,		June 30,
	2017	2016	2017	2016
Revenues
United States	$37,378	$38,739	$72,212	$73,702
International	4,149	3,761	8,048	7,000
Total revenues	$41,527	$42,500	$80,260	$80,702

 

 

 

 

Note 11.  Subsequent Events

 

July 2017 Private Placement

 

On July 28, 2017, the Company, closed the first tranche of its July 2017 Private Placement offering (the “Offering”) pursuant to which the Company offered for sale a minimum of $100,000 of units up to a maximum of $10,000,000 of units, with each unit (a “Unit”) consisting of: (i) a three (3) year convertible note in the principal amount of $25,000 (the “Note or Notes”) initially convertible into shares of the Company’s Common Stock, at $4.60 per share (subject to adjustment); and (ii) Series D Warrant (the “Class D Warrant” or “Warrant(s)”), exercisable to purchase 50% of the number of shares issuable upon conversion of the Note at an exercise price equal to $5.56. On July 28, 2017, the Company entered into a Note Purchase Agreement with eight (8) accredited investors pursuant to which the Company raised gross cash proceeds of $2,100,000 in the Offering and sold Notes in the aggregate principal amount of $2,100,000, convertible into 456,522 shares of the Company’s Common Stock, at a conversion price of $4.60 per share, subject to adjustment as provided therein; and Warrants to purchase 228,261 shares of Common Stock at an exercise price of $5.56. In addition, as part of the Offering, three (3) investors in the Company’s November 2015 Private Placement (the “Prior Investors”), converted their 8% Series C Convertible Notes in the aggregate principal amount of $4,200,349 together with accrued interest thereon into new convertible notes for an equal principal amount, convertible into 913,119 shares of Common Stock and class D warrants to purchase an aggregate of 456,560 shares of Common Stock. The new note will carry the same interest rate as the prior note. The Prior Investors also agreed to exchange their Series A Warrants dated October 26, 2015 to purchase an aggregate of 279,166 shares of Common Stock for a new warrant to purchase an aggregate of 182,065 shares of Common Stock (see Note 6 above “November 2015 Private Placement”). The Offering was extended an additional thirty (30) days from the initial closing date of July 31, 2017. The Company intends to use the proceeds for working capital purposes.  For twelve (12) months following the closing, the investors have the right to participate in any future equity financings by the Company up to their pro rata share of the maximum offering amount in the aggregate.

 

The Notes bear interest at a rate of eight percent (8%) per annum. The Company has the right to prepay the Notes at any time after the one year anniversary date of the issuance of the Notes at a rate equal to 110% of the then outstanding principal balance and accrued interest. The Notes automatically convert to Common Stock if prior to the maturity date the Company sells Common Stock, preferred stock or other equity-linked securities with aggregate gross proceeds of no less than $3,000,000 for the purpose of raising capital. The Notes provide for full ratchet price protection for a period of nine months after their issuance and thereafter weighted average price adjustment. 

 

In connection with the Offering, the Company also entered into a registration rights agreement with the investors in the Offering (the “Registration Rights Agreement”). The Registration Rights Agreement requires that the Company file a registration statement (the “Initial Registration Statement”) with the SEC within ninety (90) days of the final closing date of the Offering (the “Filing Date”) for the resale by the investors of all of the Common Shares underlying the Notes and the Warrants and all shares of Common Stock issuable upon any stock split, dividend or other distribution, recapitalization or similar event with respect thereto (the “Registrable Securities”).  The Initial Registration Statement must be declared effective by the SEC on the later of 180 days of the final closing date of the Offering or, if the registration statement receives a full review by the SEC, 210 days of the final closing date (the “Effectiveness Date”) subject to certain adjustments. Upon the occurrence of certain events (each an “Event”), including, but not limited to, that the Initial Registration Statement is not filed prior to the Filing Date or declared effective by the Effectiveness Date, the Company will be required to pay to the investors liquidated damages of 1.0% of their respective aggregate purchase price upon the date of the Event and then monthly thereafter until the Event is cured. In no event may the aggregate amount of liquidated damages payable to each of the Purchasers exceed in the aggregate 10% of the aggregate purchase price paid by such Purchaser for the Registrable Securities.

 

The Company paid a placement fee of $262,008, excluding legal expenses, and has agreed to issue to the Placement Agent three-year warrants to purchase 159,817 shares of Common Stock at an exercise price of $5.56 per share and the Company has agreed to issue the Placement Agent 22,680 shares of the Company’s Common Stock.

 

Acquisition Sorvana International, LLC

 

Effective July 1, 2017, the Company acquired certain assets and assumed certain liabilities of Sorvana International “Sorvana”. Sorvana was the result of the unification of the two companies FreeLife International, Inc. “FreeLife”, and L’dara. Sorvana offers a variety of products with the addition of the FreeLife and L’dara product lines. Sorvana offers an extensive line of health and wellness product solutions including healthy weight loss supplements, energy and performance products and skin care product lines as well as organic product options. As a result of this business combination, the Company’s distributors and customers will have access to Sorvana’s unique line of products and Sorvana’s distributors and clients will gain access to products offered by the Company. The maximum consideration payable by the Company shall be $14,000,000, subject to adjustments. The Company will make monthly payments based on a percentage of Sorvana’s distributor revenue and 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 Sorvana’s aggregate cash payments of Sorvana’s distributor revenue and royalty revenue equal to the maximum aggregate purchase price. The final purchase price allocation has not been determined as of the filing of this report. 

 

Grant of Restricted Stock Units and Stock Options

 

On August 9, 2017, the Company granted an aggregate of 500,000 restricted stock units, each unit representing a contingent right to receive one share of Common Stock vesting as follows: (i) Year 3 - 50,000 shares; (ii) Year 4 – 75,000 shares; (iii) Year 5 - 250,000 shares; and (iv) Year 6 – 125,000 shares; provided that the grantee continues to serve as an executive officer, employee or consultant, as applicable or otherwise is not terminated for cause prior to such dates. Included in the grants was a grant to  Mr. Briskie of  250,000 restricted stock units. The Company also granted ten year options to purchase an aggregate of 20,000 shares of Common Stock to  Messrs. Renton, Sallwasser, Allodi and Thompson (a grant of an option to purchase 5,000 shares of Common Stock to each), having an exercise price of $4.53 vesting immediately.

 

 

 

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD LOOKING STATEMENTS

 

This quarterly report on Form 10-Q contains forward-looking statements. The words “expects,” “anticipates,” “believes,” “intends,” “plans” and similar expressions identify forward-looking statements. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this Form 10-Q with the Securities and Exchange Commission. These forward-looking statements are subject to risks and uncertainties, including, without limitation, those risks and uncertainties discussed in Part I, Item 1A, “Risk Factors” and in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2017 and herein and as reported under Part II Other Information, Item 1A. Risk Factors. In addition, new risks emerge from time to time and it is not possible for management to predict all such risk factors or to assess the impact of such risk factors on our business. Accordingly, our future results may differ materially from historical results or from those discussed or implied by these forward-looking statements. Given these risks and uncertainties, the reader should not place undue reliance on these forward-looking statements.

 

Overview

 

We operate in two segments: the direct selling segment where products are offered through a global distribution network of preferred customers and distributors and the commercial coffee segment where products are sold directly to businesses.

 

Segment revenue as a percentage of total revenue is as follows (in thousands):

 

	Three months ended		Six months ended
	June 30,		June 30,
	2017	2016	2017	2016
Revenues
Direct selling	$35,538	$37,019	$68,780	$71,817
As a % of Revenue	86%	87%	86%	89%
Commercial coffee	5,989	5,481	11,480	8,885
As a % of Revenue	14%	13%	14%	11%
Total revenues	$41,527	$42,500	$80,260	$80,702

 

In the direct selling segment we sell health and wellness products on a global basis and offer a wide range of products through an international direct selling network of independent distributors. Our multiple independent selling forces sell a variety of products through friend-to-friend marketing and social networking.  

 

We also engage in the commercial sale of coffee.  We own a traditional coffee roasting business, CLR that sells roasted and unroasted coffee and produces coffee under its own Café La Rica brand, Josie’s Java House brand and Javalution brands. CLR produces coffee under a variety of private labels through major national sales outlets and major customers including cruise lines and office coffee service operators. During fiscal 2014 CLR acquired the Siles Plantation Family Group, a coffee plantation and dry-processing facility located in Matagalpa, Nicaragua, an ideal coffee growing region that is historically known for high quality coffee production. The dry-processing facility is approximately 26 acres and the plantation is approximately 500 acres and produces 100 percent Arabica coffee beans that are shade grown, Rainforest Alliance Certified™ and Fair Trade Certified™. The plantation, dry-processing facility and existing U.S. based coffee roaster facilities allows CLR to control the coffee production process from field to cup.

 

The Company conducts its operations primarily in the United States. For the three months ended June 30, 2017 and 2016 approximately 10% and 9%, respectively, of the Company’s sales were derived from sales outside the United States. For the six months ended June 30, 2017 and 2016 approximately 10% and 9%, respectively, of the Company’s sales were derived from sales outside the United States.

 

Results of Operations

 

The comparative financials discussed below show the condensed consolidated financial statements of Youngevity International, Inc. as of and for the three and six months ended June 30, 2017 and 2016.

 

 

 

Three months ended June 30, 2017 compared to three months ended June 30, 2016

 

Revenues

 

For the three months ended June 30, 2017, our revenue decreased 2.3% to $41,527,000 as compared to $42,500,000 for the three months ended June 30, 2016. During the three months ended June 30, 2017, we derived approximately 86% of our revenue from our direct sales and approximately 14% of our revenue from our commercial coffee sales. Direct selling segment revenues decreased by $1,481,000 or 4.0% to $35,538,000 as compared to $37,019,000 for the three months ended June 30, 2016. This decrease was primarily attributed to a decrease of $4,218,000 in revenues from existing business offset by additional revenues of $2,737,000 derived from the Company’s 2016 and 2017 acquisitions compared to the prior period. The decrease in existing business was partially due to reduction in revenues related to certain distributors moving their business to another direct selling company. For the three months ended June 30, 2017, commercial coffee segment revenues increased by $508,000 or 9.3% to $5,989,000 as compared to $5,481,000 for the three months ended June 30, 2016. This increase was primarily attributed to increased revenues in our coffee roasting and green coffee customers. The increase in green coffee business was primarily from a new contract with one of CLR’s major customers.

 

The following table summarizes our revenue in thousands by segment:

 

	For the three months ended June 30,		Percentage
Segment Revenues	2017	2016	change
Direct selling	$35,538	$37,019	(4.0)%
Commercial coffee	5,989	5,481	9.3%
Total	$41,527	$42,500	(2.3)%

 

Cost of Revenues

 

For the three months ended June 30, 2017, overall cost of revenues increased approximately 2.1% to $17,425,000 as compared to $17,069,000 for the three months ended June 30, 2016. The direct selling segment cost of revenues decreased 5.9% when compared to the same period last year as a result of product mix and lower shipping costs. The commercial coffee segment cost of revenues increased 21.2% when compared to the same period last year. This was primarily attributable to increases in revenues related to the green coffee business, and additional costs incurred due to increased labors costs, repairs and maintenance and inventory adjustments.

 

Cost of revenues includes the cost of inventory including green coffee, shipping and handling costs incurred in connection with shipments to customers, direct labor and benefits costs, royalties associated with certain products, transaction merchant fees and depreciation on certain assets.

 

Gross Profit

 

For the three months ended June 30, 2017, gross profit decreased approximately 5.2% to $24,102,000 as compared to $25,431,000 for the three months ended June 30, 2016. Overall gross profit as a percentage of revenues decreased to 58.0%, compared to 59.8% in the same period last year.

 

Gross profit in the direct selling segment decreased by 3.1% to $24,195,000 from $24,967,000 in the prior period as a result of the changes in revenues and costs discussed above. Gross profit as a percentage of revenues in the direct selling segment increased by approximately 0.7% to 68.1% for the three months ended June 30, 2017, compared to 67.4% in the same period last year.

 

Gross profit in the commercial coffee segment decreased to a loss of $93,000 compared to $464,000 in the prior period. The decrease in gross profit in the commercial coffee segment was primarily due to the increase in costs discussed above. Gross profit as a percentage of revenues in the commercial coffee segment decreased by 10.1% to a negative 1.6% for the period ended June 30, 2017, compared to 8.5% in the same period last year.

 

Below is a table of gross profit by segment (in thousands) and gross profit as a percentage of segment revenues:

 

	For the three months ended June 30,		Percentage
Segment Gross Profit	2017	2016	change
Direct selling	$24,195	$24,967	(3.1)%
Gross Profit % of Revenues	68.1%	67.4%	0.7%
Commercial coffee	(93)	464	(120.0)%
Gross Profit % of Revenues	(1.6)%	8.5%	(10.1)%
Total	$24,102	$25,431	(5.2)%
Gross Profit % of Revenues	58.0%	59.8%	(1.8)%

 

 

 

Operating Expenses

 

For the three months ended June 30, 2017, our operating expenses increased approximately 3.6% to $24,778,000 as compared to $23,907,000 for the three months ended June 30, 2016. Included in operating expense is distributor compensation paid to our independent distributors in the direct selling segment. For the three months ended June 30, 2017, distributor compensation decreased 0.7% to $16,686,000 from $16,796,000 for the three months ended June 30, 2016. This decrease was primarily attributable to the decrease in revenues. Distributor compensation as a percentage of direct selling revenues increased to 47.0% for the three months ended June 30, 2017 as compared to 45.4% for the three months ended June 30, 2016. This increase was primarily attributable to an increase in incentive payouts.

 

For the three months ended June 30, 2017, the sales and marketing expense increased 10.0% to $2,901,000 from $2,637,000 for the three months ended June 30, 2016 primarily due to increases in wages and related benefits, increases in distributor rewards not related to distributor compensation and an increase in marketing and consulting costs as the Company is revamping its marketing content. The increase in sales and marketing was offset by a decrease in distributor events, as sales and marketing expenses for the second quarter of 2016 included expenses for our 2016 annual convention.

 

For the three months ended June 30, 2017, the general and administrative expense increased 16.0% to $5,191,000 from $4,474,000 for the three months ended June 30, 2016 primarily due to increases in costs related to the international expansion, consulting fees, legal fees, investor relations, wages and related benefits, amortization and stock based compensation costs, computer and internet related costs and travel costs. In addition, the contingent liability revaluation resulted in a benefit of $680,000 for the three months ended June 30, 2017 compared to a benefit of $480,000 for the three months ended June 30, 2016.

 

Operating (Loss) Income

 

For the three months ended June 30, 2017, operating (loss) income decreased to a loss of $676,000 as compared to income of $1,524,000 for the three months ended June 30, 2016. This was primarily due to the lower gross profit and the increase in operating expenses discussed above. 

 

Total Other Expense

 

For the three months ended June 30, 2017, total other expense increased by $1,026,000 to $2,599,000 as compared to $1,573,000 for the three months ended June 30, 2016. Total other expense is net interest expense of $1,258,000 and the change in the fair value of warrant derivative of $1,341,000.

 

Net interest expense increased by $169,000 for the three months ended June 30, 2017 to $1,258,000 as compared to $1,089,000 for the three months ended June 30, 2016. Interest expense includes interest payments related to acquisitions and other operating debt, interest payments to investors associated with the 2014 and 2015 Private Placement transactions and related non-cash amortization costs of $385,000 and other non-cash costs of $7,000.

  

Change in Fair Value of Warrant Derivative Liability. 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 year to year (see Note 7, to the condensed consolidated financial statements.)

 

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 has determined through consideration of all positive and negative evidence that the US deferred tax assets are more likely than not to be realized. The Company does not have a valuation allowance in the US Federal tax jurisdiction. A valuation allowance remains on the state and foreign tax attributes that are likely to expire before realization. We have recognized an income tax benefit of $545,000, which is our estimated federal, state and foreign income tax benefit for the three months ended June 30, 2017. For the three months ended June 30, 2017, the current effective tax rate is 16.6% compared to the Federal statutory tax rate of 35%. 

 

Net Income (Loss)

 

For the three months ended June 30, 2017, the Company reported a net loss of $2,730,000 as compared to a net loss of $109,000 for the three months ended June 30, 2016. The primary reason for the increase in net loss when compared to the prior period was due to a net loss before income taxes of $3,275,000 in 2017 compared to a net loss before income taxes in 2016 of $49,000 offset by a tax benefit of $545,000 in 2017 when compared to a $60,000 tax provision in 2016.

 

 

 

Six months ended June 30, 2017 compared to six months ended June 30, 2016

 

Revenues

 

For the six months ended June 30, 2017, our revenue decreased 0.6% to $80,260,000 as compared to $80,702,000 for the six months ended June 30, 2016. During the six months ended June 30, 2017, we derived approximately 86% of our revenue from our direct sales and approximately 14% of our revenue from our commercial coffee sales. Direct selling segment revenues decreased by $3,037,000 or 4.2% to $68,780,000 as compared to $71,817,000 for the six months ended June 30, 2016. This decrease was primarily attributed to a decrease of $7,876,000 in revenues from existing business offset by additional revenues of $4,839,000 derived from the Company’s 2016 and 2017 acquisitions compared to the prior period. The decrease in existing business was partially due to reduction in revenues related to certain distributors moving their business to another direct selling company and general weakness during January and February of 2017. For the six months ended June 30, 2017, commercial coffee segment revenues increased by $2,595,000 or 29.2% to $11,480,000 as compared to $8,885,000 for the six months ended June 30, 2016. This increase was primarily attributed to increased revenues in our coffee roasting business and green coffee business. The increase in green coffee business was primarily from a new contract with one of CLR’s major customers.

 

The following table summarizes our revenue in thousands by segment:

 

	For the six months ended June 30,		Percentage
Segment Revenues	2017	2016	change
Direct selling	$68,780	$71,817	(4.2)%
Commercial coffee	11,480	8,885	29.2%
Total	$80,260	$80,702	(0.6)%

 

Cost of Revenues

 

For the six months ended June 30, 2017, overall cost of revenues increased approximately 7.5% to $34,292,000 as compared to $31,908,000 for the six months ended June 30, 2016. The direct selling segment cost of revenues decreased 2.7% when compared to the same period last year, primarily as a result of lower revenues during the six months ended June 30, 2017. The commercial coffee segment cost of revenues increased 35.3% when compared to the same period last year. This was primarily attributable to increases in revenues related to the green coffee and roasting business, and additional costs incurred due to increased direct labor costs, repairs and maintenance and inventory adjustments.

 

Cost of revenues includes the cost of inventory including green coffee, shipping and handling costs incurred in connection with shipments to customers, direct labor and benefits costs, royalties associated with certain products, transaction merchant fees and depreciation on certain assets.

 

Gross Profit

 

For the six months ended June 30, 2017, gross profit decreased approximately 5.8% to $45,968,000 as compared to $48,794,000 for the six months ended June 30, 2016. Overall gross profit as a percentage of revenues decreased to 57.3%, compared to 60.5% in the same period last year.

 

Gross profit in the direct selling segment decreased by 5.0% to $46,050,000 from $48,457,000 in the prior period as a result of the changes in revenues and costs discussed above. Gross profit as a percentage of revenues in the direct selling segment decreased by approximately 0.5% to 67.0% for the six months ended June 30, 2017, compared to 67.5% in the same period last year.

 

Gross profit in the commercial coffee segment decreased to a loss of $82,000 compared to $337,000 in the prior period. The decrease in gross profit in the commercial coffee segment was primarily due to an increase in costs discussed above. Gross profit as a percentage of revenues in the commercial coffee segment decreased by 4.5% to a negative 0.7% for the period ended June 30, 2017, compared to 3.8% in the same period last year.

 

Below is a table of gross profit by segment (in thousands) and gross profit as a percentage of segment revenues:

 

	For the six months ended June 30,		Percentage
Segment Gross Profit	2017	2016	change
Direct selling	$46,050	$48,457	(5.0)%
Gross Profit % of Revenues	67.0%	67.5%	(0.5)%
Commercial coffee	(82)	337	(124.3)%
Gross Profit % of Revenues	(0.7)%	3.8%	(4.5)%
Total	$45,968	$48,794	(5.8)%
Gross Profit % of Revenues	57.3%	60.5%	(3.2)%

 

 

 

Operating Expenses

 

For the six months ended June 30, 2017, our operating expenses increased approximately 6.4% to $49,044,000 as compared to $46,107,000 for the six months ended June 30, 2016. Included in operating expense is distributor compensation paid to our independent distributors in the direct selling segment. For the six months ended June 30, 2017, distributor compensation decreased 2.0% to $32,105,000 from $32,770,000 for the six months ended June 30, 2016. This decrease was primarily attributable to the decrease in revenues. Distributor compensation as a percentage of direct selling revenues increased to 46.7% for the six months ended June 30, 2017 as compared to 45.6% for the six months ended June 30, 2016. This increase was primarily attributable to an increase in incentive payouts.

 

For the six months ended June 30, 2017, the sales and marketing expense increased 48.2% to $6,576,000 from $4,438,000 for the six months ended June 30, 2016 primarily due to increases in wages and related benefits, increases in distributor rewards not related to distributor compensation and an increase in marketing and consulting costs as the Company is revamping its marketing content. Other increases included an increase in distributor events including our international distributor events.  

 

For the six months ended June 30, 2017, the general and administrative expense increased 16.5% to $10,363,000 from $8,899,000 for the six months ended June 30, 2016 primarily due to increases in costs related to the international expansion, consulting fees, legal fees, investor relations, wages and related benefits, amortization and stock based compensation costs, computer and internet related costs and travel costs. In addition, the contingent liability revaluation resulted in a benefit of $680,000 for the six months ended June 30, 2017 compared to a benefit of $871,000 for the six months ended June 30, 2016.

 

Operating (Loss) Income

 

For the six months ended June 30, 2017, operating (loss) income decreased to a loss of $3,076,000 as compared to income of $2,687,000 for the six months ended June 30, 2016. This was primarily due to the lower gross profit and the increase in operating expenses discussed above. 

 

Total Other Expense

 

For the six months ended June 30, 2017, total other expense increased by $1,159,000 to $3,186,000 as compared to $2,027,000 for the six months ended June 30, 2016. Total other expense is net interest expense of $2,455,000 and the change in the fair value of warrant derivative of $731,000.

 

Net interest expense increased by $262,000 for the six months ended June 30, 2017 to $2,455,000 as compared to $2,193,000 in 2016. Interest expense includes interest payments related to acquisitions and other operating debt, interest payments to investors associated with the 2014 and 2015 Private Placement transactions and related non-cash amortization costs of $771,000 and other non-cash costs of $14,000.

  

Change in Fair Value of Warrant Derivative Liability. 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 year to year (see Note 7, to the condensed consolidated financial statements).

 

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 has determined through consideration of all positive and negative evidence that the US deferred tax assets are more likely than not to be realized. The Company does not have a valuation allowance in the US Federal tax jurisdiction. A valuation allowance remains on the state and foreign tax attributes that are likely to expire before realization. We have recognized an income tax benefit of $1,473,000, which is our estimated federal, state and foreign income tax benefit for the six months ended June 30, 2017. For the six months ended June 30, 2017, the current effective tax rate is 23.5% compared to the Federal statutory tax rate of 35%. 

 

Net Income (Loss)

 

For the six months ended June 30, 2017, the Company reported a net loss of $4,789,000 as compared to net income of $42,000 for the six months ended June 30, 2016. The primary reason for the decrease in net income to a loss when compared to the prior period was due to a net loss before income taxes of $6,262,000 in 2017 compared to net income before income taxes in 2016 of $660,000 offset by a tax benefit of $1,473,000 in 2017 when compared to a tax provision of $618,000 in 2016.

 

 

 

Adjusted EBITDA

 

EBITDA (earnings before interest, income taxes, depreciation and amortization) as adjusted to remove the effect of stock based compensation expense and the change in the fair value of the warrant derivative or "Adjusted EBITDA," decreased to $745,000 for the three months ended June 30, 2017 compared to $2,564,000 in 2016 and decreased to a negative $492,000 for the six months ended June 30, 2017 compared to $4,800,000 in 2016, respectively.

 

Management believes that Adjusted EBITDA, when viewed with our results under GAAP and the accompanying reconciliations, provides useful information about our period-over-period growth. Adjusted EBITDA is presented because management believes it provides additional information with respect to the performance of our fundamental business activities and is also frequently used by securities analysts, investors and other interested parties in the evaluation of comparable companies. We also rely on Adjusted EBITDA as a primary measure to review and assess the operating performance of our company and our management team.

 

Adjusted EBITDA is a non-GAAP financial measure. We calculate adjusted EBITDA by taking net income, and adding back the expenses related to interest, income taxes, depreciation, amortization, stock based compensation expense and the change in the fair value of the warrant derivative, as each of those elements are calculated in accordance with GAAP.  Adjusted EBITDA should not be construed as a substitute for net income (loss) (as determined in accordance with GAAP) for the purpose of analyzing our operating performance or financial position, as Adjusted EBITDA is not defined by GAAP.

 

A reconciliation of our adjusted EBITDA to net income (loss) for the three and six months ended June 30, 2017 and 2016 is included in the table below (in thousands):

 

	Three months ended		Six months ended
	June 30,		June 30,
	2017	2016	2017	2016
Net (loss) income	$(2,730)	$(109)	$(4,789)	$42
Add/Subtract:
Interest, net	1,258	1,089	2,455	2,193
Income taxes (benefit) provision	(545)	60	(1,473)	618
Depreciation	373	379	764	778
Amortization	690	605	1,335	1,209
EBITDA	(954)	2,024	(1,708)	4,840
Add/Subtract:
Stock based compensation	358	56	485	126
Change in the fair value of warrant derivative	1,341	484	731	(166)
Adjusted EBITDA	$745	$2,564	$(492)	$4,800