Form 10-K for TRUE DRINKS HOLDINGS, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with our financial statements, including the notes thereto contained in this Annual Report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of certain factors, including those set forth under "Risk Factors Associated with Our Business" and elsewhere in this Annual Report.
Critical Accounting Polices and Estimates
Discussion and analysis of our financial condition and results of operations are based upon financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates; including those related to collection of receivables, inventory obsolescence, sales returns and non-monetary transactions such as stock and stock options issued for services. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
In accordance with ASC Topic 605 (Staff Accounting Bulletin 104 "Revenue Recognition in Financial Statements"), revenue is recognized at the point of shipment, at which time title is passed. Net sales include sales of products, sales of marketing tools to independent distributors and freight and handling charges. With the exception of retail customers, we receive the net sales price from all of our orders in the form of cash or credit card payment prior to shipment. Retail customers with approved credit have been extended payment terms of net 30 days, with a few exceptions.
Allowance for Doubtful Accounts
We estimate losses on receivables based on known troubled accounts and historical experience of losses incurred. Based on our estimations, we recorded an allowance for doubtful accounts of approximately $110,000 as of December 31, 2015.
Inventories are stated at the lower of cost or market on a first-in first-out basis. Inventory is periodically reviewed and obsolete inventories are written off. No inventory was written off as obsolete for the period ended December 31, 2015. Prior to inventory becoming obsolete, inventory which is close to expiration is donated to charitable organizations.
Stock Based Compensation
The Company recognizes the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards in accordance with ASC Topic 718, which requires compensation costs related to share-based transactions, including employee stock options, to be recognized in the financial statements based on fair value, and the SEC's Staff Accounting Bulletin No. 107 ("SAB 107") interpreting ASC Topic 718 and the valuation of share-based payments for public companies. The Company records compensation expense on a straight-line basis. The fair value of options granted are estimated at the date of grant using a Black-Scholes option pricing model with assumptions for the risk-free interest rate, expected life, volatility, dividend yield and forfeiture rate.
Intangible assets consists of the direct costs incurred for application fees and legal expenses associated with trademarks on the Company's products, customer first, and the estimated value of GT Beverage Company, LLC's interlocking spherical bottle patent acquired on March 31, 2012. The Company's intangible assets, are amortized over their estimated useful remaining lives. The Company evaluates the useful lives of its intangible assets annually and adjusts the lives according to the expected useful life. No impairment was deemed necessary as of December 31, 2015.
Goodwill represents the future economic benefits arising from other assets acquired that are individually identified and separately recognized. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but are tested for impairment at least annually.
A derivative is an instrument whose value is "derived" from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts ("embedded derivatives") and for hedging activities. As a matter of policy, the Company does not invest in financial derivatives or engage in hedging transactions. However, the Company has entered into complex financing transactions that involve financial instruments containing certain features that have resulted in the instruments being deemed derivatives or containing embedded derivatives. The Company may engage in other similar complex debt transactions in the future, but not with the intention to enter into derivative instruments. Derivatives and embedded derivatives, if applicable, are measured at fair value using the binomial lattice- ("Binomial Lattice") pricing model and marked to market and reflected on our consolidated statement of operations as other (income) expense at each reporting period. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions, which may impact the level of precision in the financial statements. Furthermore, depending on the terms of a derivative or embedded derivative, the valuation of derivatives may be removed from the financial statements upon conversion of the underlying instrument into some other security.
Results of Operations – Fiscal Years Ended December 31, 2015 and 2014
Net sales for the year ended December 31, 2015 was $6,121,097 compared to $4,693,414 during the same period in 2014, an increase of 30%. This increase in net sales is attributable to the continued expansion of retail accounts for AquaBall� Naturally Flavored Water, including entrance into the club channel with significant sales at Sam's Club, the commencement of sales to Target, and a growing base of direct-store-distributors in the second and fourth quarters of 2015.
Gross Profit (Loss) and Gross Margin
Gross loss for the year ended December 31, 2015 was $160,990 as compared to gross profit of $291,712 for the year ended December 31, 2014. Gross loss as a percentage of revenue (gross margin) during the year ended December 31, 2015 was 3%. This figure was affected by negative gross profit experienced in the second and fourth quarters due to a high mix of club packs for Sam's Club.
Gross margin will likely remain at current or below current levels through the second quarter of 2016, during the transition from our current bottling facilities to Niagara. We anticipate an increase in gross margin as early as the third quarter of 2016 as a result of decreased manufacturing costs once Niagara becomes the sole manufacturer of AquaBall�. At that time, Niagara will provide finished goods to the Company, and bill the Company for the product as it is shipped to customers.
Sales, General and Administrative Expense
Selling and marketing expenses were $5,073,211, or 83% of net sales, for the year ended December 31, 2015, as compared to $4,388,108, or 93% of net sales for the year ended December 31, 2014. This increase is due to higher marketing expense and marginal sales expense increases as a result of increased sales, including freight for shipping orders to customers and license fees.
General and administrative expenses were $5,475,673, or 89% of net sales, for the year ended December 31, 2015, as compared to $4,450,101, or 95% of net sales, for the year ended December 31, 2014. This increase is due to an increase in salaries of approximately $480,000 and a $500,000 write off of deposits with co-packers related to equipment purchases in connection with to our transition to Niagara Bottling as our co-packer.
We expect sales, general and administrative expense to continue to increase in the first quarter of 2016, due primarily to the cost associated with transitioning manufacturing of AquaBall� to Niagara, as well as increased marketing efforts associated with promoting the preservative free formulation of AquaBall�.
Interest expense for the year ended December 31, 2015 was $257,389 as compared to $202,773 for the year ended December 31, 2014. Interest expense for the 2015 period consists of interest and fees due on promissory notes generated in late 2014 and in the third quarter of 2015, most of which were all either repaid or converted into shares of Series C Preferred in connection with the March Note Exchange in the first quarter of 2015 and the January Note Exchange during the first quarter of 2016.
Other expense for the year ended December 31, 2015 was $2,285,629, as compared to other income of $11,508 for the year ended December 31, 2014. The increase in other expense is primarily due to the issuance of the Personal Guaranty Warrant for 17,500,000 shares of Common Stock valued at $2,263,783, issued for the execution of a personal guaranty of True Drinks' obligations under the Niagara Agreement.
Our net loss for the year ended December 31, 2015 was $11,990,563 as compared to a net loss of $8,116,603 for the year ended December 31, 2014. On a per share basis, our loss, after dividends on outstanding shares of Series B Preferred, was $0.16 and $0.23 per share for the years ended December 31, 2015 and December 31, 2014, respectively.
Although we experienced an increase in net sales during the year ended December 31, 2015 as compared to the same period in 2014, the increased period over period losses are primarily the result of the decrease in gross margins on sales as AquaBall� Naturally Flavored Water entered the club channel, and the increase in sales and marketing expenses during the 2015 period. We expect to continue to incur a net loss in subsequent periods, and plan to fund our operations using proceeds received from capital raising activities until our operations become profitable. Although we anticipate a growth in sales and gross margins as a result of the Niagara Agreement and the introduction of our new, preservative free formulation of AquaBall�, these increases may not occur, may take longer than anticipated, or may not be sufficient to produce net income in any subsequent quarters.
Liquidity and Capital Resources
Our auditors have included a paragraph in their report on our consolidated financial statements, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, indicating that there is substantial doubt as to the ability of the Company to continue as a going concern. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. For the year ended December 31, 2015, the Company incurred a net loss of $11,990,563. At December 31, 2015, the Company had negative working capital of $5,303,989 and an accumulated deficit of $30,348,644. The Company had negative cash flow from operations of $10,433,069 and $6,649,706 during the year ended December 31, 2015 and 2014, respectively. Although the Company raised approximately $13 million from the sale of shares of Series C Preferred and certain promissory notes during the year ended December 31, 2015, additional capital will be necessary to advance the marketability of the Company's products to the point at which the Company can sustain operations. Management's plans are to continue to contain expenses, expand distribution and sales of its AquaBall� Naturally Flavored Water as rapidly as economically possible, and raise capital through equity and debt offerings to execute the Company's business plan and achieve profitability from continuing operations. The accompanying consolidated financial statements do not include any adjustments that might result in the event the Company is unsuccessful in its plans.
The Company has financed its operations through sales of equity and, to a lesser degree, cash flow provided by sales of AquaBall�. Despite recent sales of preferred stock as described below, funds generated from sales of shares of our preferred stock or other equity or debt securities, and cash flow provided by AquaBall� sales may be insufficient to fund our operating requirements for the next twelve months. As a result, we may require additional capital to continue operating as a going concern. No assurances can be given that we will be successful.
Recent Capital Raising Activity
February 2015 Series C Offering, Note Payment and Note Exchange. On February 20, 2015, the Company and certain accredited investors entered into securities purchase agreements, pursuant to which the investors purchased 43,000 shares of Series C Preferred for $100 per share over the course of three separate closings. As additional consideration, each investor received five-year warrants, exercisable for $0.15 per share.
On March 27, 2015, the Company and certain accredited investors entered into an amendment to the February 2015 securities purchase agreements pursuant to which the Company sold to one investor 27,000 additional shares of Series C Preferred for gross proceeds of $2.7 million, which the Company subsequently used to satisfy approximately $2.7 million of the Company's $3.8 million in outstanding promissory notes (the "Note Payments"). As additional consideration for the purchase of these additional shares of Series C Preferred, the investor received warrants to purchase shares of the Company's Common Stock on terms substantially similar to the warrants issued in connection with the offering of shares of Series C Preferred in February 2015.
Following the Note Payments, the Company and each of the holders of promissory notes remaining after the Note Payments entered into Exchange Agreements, wherein the holders agreed to exchange all remaining principal and accrued interest of the remaining promissory notes into shares of Series C Preferred on substantially similar terms to those offered in the offering of shares of Series C Preferred in February 2015 (the "Note Exchange"). As a result of the execution of these Exchange Agreements and the consummation of the Note Exchange, the Company issued to the Holders an aggregate total of 12,148 shares of Series C Preferred and warrants to purchase approximately 2.8 million shares of Common Stock for $0.15 per share.
August 2015 Series C Offering. On August 13, 2015, the Company and Red Beard Holdings, LLC ("Red Beard") entered into a securities purchase agreement, pursuant to which Red Beard purchased 17,648 shares of Series C Preferred for $113.33 per share over the course of three separate closings. As additional consideration for participating in this offering, Red Beard received warrants to purchase a total of 3,633,411 shares of Common Stock, exercisable for $0.17 per share. On October 16, 2015, the Company and Red Beard amended the securities purchase agreement in order to issue an additional 8,823 shares of Series C Preferred to Red Beard for gross proceeds to the Company of approximately $1.0 million. In connection with this amendment, Red Beard also received warrants to purchase approximately 1.81 million shares of Common Stock.
September 2015 Note Offering. On September 9, 2015, the Company began a private offering, to certain accredited investors of: (i) senior subordinated secured promissory notes ("Secured Notes") in the aggregate principal amount of up to $2.5 million; and (ii) and warrants to purchase that number of shares equal to 15% of the principal amount of the Secured Note purchased by each investor, divided by the ten-day average closing price of the Company's Common Stock. Each Secured Note accrues interest at a rate of 12% per annum, and will mature one year from the date of issuance. To date, the Company has issued an aggregate total of $855,000 Secured Notes and warrants to purchase an aggregate total of 280,265 shares of Common Stock.
November 2015 Series C Offering. On November 25, 2015, the Company Red Beard entered into a securities purchase agreement, pursuant to which Red Beard agreed to purchase up to 30,000 shares of Series C Preferred for $100 per share over the course of three separate closings between November 2015 and January 2016. As additional consideration for the purchase of the shares of Series C Preferred, Red Beard received five-year warrants, exercisable for $0.15 per share, to purchase that number of shares of the Company's Common Stock equal to 35% of the shares of Common Stock issuable upon conversion of the shares of Series C Preferred purchased.
January 2016 Note Exchange. On January 20, 2016, the Company and holders of Secured Notes in the principal amount of $500,000 entered into Note Exchange Agreements pursuant to which the holders agreed to convert the outstanding principal balance of their Secured Notes into an aggregate total of 4,413 shares of Series C Preferred and warrants to purchase up to an agate total of 1,029,413 shares of Common Stock for $0.17 per share. Neither holder received warrants to purchase shares of the Company's Common Stock in connection with their respective Secured Notes, and agreed to waive any unpaid interest accrued under the Secured Notes prior to the execution of the Note Exchange Agreement.
Off-Balance Sheet Items
We had no off-balance sheet items as of December 31, 2015.
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