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EX-31.2 - CERTIFICATION - New Leaf Brands, Inc.nlef_ex312.htm
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EX-32.1 - CERTIFICATION - New Leaf Brands, Inc.nlef_ex321.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

———————
FORM 10-Q
———————
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For The Quarter Ended: June 30, 2011
 
Or
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from: _____________ to _____________

Commission File Number: 000-22024
———————
NEW LEAF BRANDS, INC.
 (Exact name of registrant as specified in its charter)
———————

Nevada
 
77-0125664
(State or other jurisdiction
 
(I.R.S. Employer
of incorporation or organization)
 
Identification No.)

One De Wolf Road Suite 208, Old Tappan, New Jersey 07675
 (Address of principal executive offices) (Zip Code)

(201)784-2400
 (Registrant’s telephone number, including area code)

 (Former name, former address and former fiscal year, if changed since last report)
———————
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 þ     No o
 
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 (§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 ¨   No þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer 
o
Accelerated filer
o
       
Non-accelerated filer
o
Smaller reporting company
þ
(Do not check if a smaller reporting company)
     
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  ¨     No  þ
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
As of August 18, 2011, there were 143,229,126 shares of our common stock, $0.001 par value, outstanding.
 


 
 

 
 
NEW LEAF BRANDS, INC.

INDEX
 
   
Page
 
PART I – FINANCIAL INFORMATION
     
         
Item 1
Financial Statements
    3  
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
    20  
Item 3
Quantitative and Qualitative Disclosures About Market Risk
    24  
Item 4
Controls and Procedures
    24  
           
PART II – OTHER INFORMATION
       
           
Item 1
Legal Proceedings
    26  
Item 1A
Risk Factors
    26  
Item 4
Removed and Reserved
    27  
Item 5
Other Information
    27  
Item 6
Exhibits
    28  
 
 
2

 
 
PART I – FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
New Leaf Brands, Inc.
Condensed Consolidated Balance Sheet
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
(unaudited)
       
Assets
           
Current assets
           
Cash & cash equivalents
  $ 3,947     $ 13,024  
Accounts receivable, net of allowance of: $57,000 June 30, 2011 and $35,000 December 31, 2010
    313,980       148,833  
Inventories
    244,268       435,414  
Prepaid expenses and other assets
    258,749       67,780  
  Total current assets
    820,944       665,051  
                 
Property and equipment, net
    73,762       91,099  
Intangible assets, net
    3,474,576       4,040,824  
Total assets
  $ 4,369,282     $ 4,796,974  
                 
Liabilities and Stockholders' Deficit
               
Current Liabilities
               
Accounts payable
  $ 2,174,089     $ 2,670,993  
Accrued liabilities
    304,447       449,431  
Accrued liabilities related party
    469,951       750,103  
Interest payable
    138,103       118,784  
Short-term notes
    375,000       3,282,954  
Notes payable to related parties
    142,500       777,273  
Current portion of long-term debt
    837,930       838,741  
  Total current liabilities
    4,442,020       8,888,279  
                 
Long-term debt
    28,518       34,904  
Derivative liabilities
    223,084       594,271  
Total long-term liabilities
    251,602       629,175  
                 
  Total liabilities
    4,693,622       9,517,454  
                 
Commitment and contingencies (Note 12)
               
                 
Stockholders' deficit
               
Preferred stock, $0.001 par value, convertible 10,000,000 shares authorized
Series K 10% Convertible Preferred Stock, 1,000 cumulative shares designated;
30 issued and outstanding (liquidation preference $822,977 and $0, respectively)
    -       -  
Common Stock, $0.001 par value per share, 500,000,000 shares authorized;
issued and outstanding: 143,229,126 at June 30, 2011 and 75,761,856 at December 31, 2010
    143,229       75,762  
Shares issuable
    5,000          
Additional paid-in capital
    43,044,972       36,440,087  
Accumulated deficit
    (43,517,541 )     (41,236,329 )
                 
Total stockholders' deficit
    (324,340 )     (4,720,480 )
                 
Total liabilities and stockholders' deficit
  $ 4,369,282     $ 4,796,974  
 
See accompanying notes to the condensed consolidated financial statements

 
3

 
 
New Leaf Brands, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
 
     
Three Months Ended June 30,
   
Six Months Ended June 30,
 
     
2011
   
2010
   
2011
   
2010
 
                           
                           
Net Sales
    $ 658,527     $ 1,665,232     $ 1,346,113     $ 2,619,781  
Cost of goods sold
    496,144       1,087,103       1,053,262       1,766,802  
Gross profit
    162,383       578,129       292,851       852,979  
                                   
Operating expenses:
                               
 
Shipping & handling
    84,689       177,142       212,522       297,940  
 
Marketing
    547,367       1,527,939       1,165,364       2,714,828  
 
General and administrative
    455,824       542,437       1,025,653       2,081,982  
 
Depreciation & amortization
    129,293       129,103       258,585       258,459  
 
Total operating expenses
    1,217,173       2,376,621       2,662,124       5,353,209  
                                   
 
Loss from continuing operations
    (1,054,790 )     (1,798,492 )     (2,369,273 )     (4,500,230 )
                                   
Other income (expense):
                               
 
Miscellaneous income (expense), net
    (36,865 )             (36,884 )        
 
Interest expense, net
    (20,017 )     (69,764 )     (69,948 )     (142,349 )
 
Loss on settlement of accounts payable and extinguishment of long-term debt
    11,153       (1,552,788 )     (107,351 )     (1,628,166 )
 
Amortization of debt discount & deferred financing costs
            (155,843 )     (68,943 )     (230,273 )
 
Change in fair value of derivative liabilities
    435,456       636,150       371,187       933,541  
 
Total other income (expense)
    389,727       (1,142,245 )     88,061       (1,067,247 )
                                   
Loss from continuing operations before provision for income taxes
    (665,063 )     (2,940,737 )     (2,281,212 )     (5,567,477 )
Provision for income taxes
    -       -       -       -  
Loss from continuing operations
    (665,063 )     (2,940,737 )     (2,281,212 )     (5,567,477 )
                                   
Loss from discontinued operations, net
    -       (50,000 )     -       (50,000 )
Net loss
    $ (665,063 )   $ (2,990,737 )   $ (2,281,212 )   $ (5,617,477 )
Deemed dividends - Series K Preferred stock and warrants
    1,967,699       -       1,967,699       -  
Net loss attributable to common stockholders
  $ (2,632,762 )   $ (2,990,737 )   $ (4,248,911 )   $ (5,617,477 )
                                   
Net loss per share-basic and diluted
                               
Continuing operations
  $ (0.03 )   $ (0.04 )   $ (0.05 )   $ (0.09 )
Discontinued operations
  $ -     $ (0.00 )   $ -     $ (0.00 )
Net loss per share-basic and diluted
  $ (0.03 )   $ (0.04 )   $ (0.05 )   $ (0.09 )
                                   
Basic and diluted weighted average common shares outstanding
    98,768,289       67,194,272       85,706,996       64,944,025  
 
See accompanying notes to the condensed consolidated financial statements

 
4

 
 
 
New Leaf Brands, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
   
Six months ended June 30,
 
   
2011
   
2010
 
             
Operating Activities
           
Continuing operations:
           
Cash flows from operating activities:
           
Net loss
  $ (2,281,212 )   $ (5,567,477 )
Adjustments to reconcile net loss to net cash (used in) operating activities:
               
Depreciation & amortization
    258,585       258,459  
Loss on extinguishment of debt
    107,351       1,628,166  
Amortization of debt discount & deferred financing costs
    68,944       230,273  
Warrants issued for services
    10,398       54,913  
Stock based compensation
    90,879       107,486  
Common stock issued for services
    140,000       1,036,892  
Change in allowance for doubtful accounts
    22,000          
Loss on disposal of property and equipment
            4,249  
Change in fair value of derivative liabilities
    (371,187 )     (933,541 )
Changes in assets & liabilities:
               
Accounts receivable
    (187,147 )     (386,768 )
Inventories
    191,146       (492,378 )
Prepaid expenses and other assets
    (185,969 )     (37,920 )
Accounts payable
    (385,753 )     1,315,471  
Accrued liabilities
    (144,984 )     74,910  
Due to related parties
    44,848       (123,150 )
Interest payable
    19,319       5,880  
Net cash (used in) continuing operating activities
    (2,602,782 )     (2,824,535 )
Net loss from discontinued operations
            (50,000 )
Adjustments to reconcile net loss to net cash (used in) discontinued operating activities:
               
Write-off of escrow from sale of discontinued operations
            50,000  
Net cash provided by discontinued operating activities
    -       -  
Net cash (used in) operating activities
    (2,602,782 )     (2,824,535 )
                 
Cash flows from investing activities:
               
Purchase of property and equipment
    -       (16,945 )
Net cash (used in) investing activities
    -       (16,945 )
                 
Cash flows from financing activities
               
Proceeds from notes payable
    765,000       400,000  
Receipt of escrow from sale of discontinued operations
            200,000  
Net proceeds from sale of common stock
    425,000       974,998  
Net proceeds from sale of preferred stock and warrants
    1,068,401       -  
Proceeds from exercise of warrants
    500,000       -  
Principal payments on notes payable
    (164,696 )     (55,619 )
Net cash provided by financing activities
    2,593,705       1,519,379  
                 
Net decrease in cash for the period
    (9,077 )     (1,322,101 )
Cash - beginning of period
    13,024       1,547,924  
Cash - end of period
    3,947     $ 225,823  
                 
Cash paid during the period for:
               
Interest
  $ 69,250     $ 127,498  
                 
NONCASH INVESTING AND FINANCING ACTIVITIES:
               
Deemed dividend on Conversion of Series K Preferred and warrants
    1,967,699       -  
Settlement of accounts payable for common shares and warrants
    100,000       163,781  
Settlement of long-term debt for common stock
    4,129,172       212,500  
Conversion of debt obligations
    -       100,000  
Forgivenness of earn-out and reduction of intangibles
    325,000       -  
Fair value of shares issuable for future services
    5,000       -  
Issuance of warrants in connection with common stock and debt offering
    -       1,815,818  
Classification of derivative payable to additional paid-in capital upon exercise of warrants
    -       14,560  
 
See accompanying notes to the condensed consolidated financial statements

 
5

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

1.  Organization and Basis of Presentation

The condensed consolidated financial statements include NEW LEAF BRANDS, INC. (“the Company”) and its wholly-owned subsidiaries, Baywood New Leaf Acquisition, Inc. and Nutritional Specialties. Nutritional Specialties was acquired by the Company in March 2007 and sold in July 2009.

The Company develops, markets and distributes healthy and functional ready-to-drink (“RTD”) beverages. The Company distributes its products through independent distributors both internationally and domestically.
 
The Company was incorporated in Nevada on June 13, 1986 as Baywood Financial, Inc. In March 1992, the Company changed its name from Baywood Financial, Inc. to Baywood International, Inc. In March 2007, Baywood International, Inc. created the acquisition subsidiary Baywood Acquisition Inc. to acquire Nutritional Specialties. Baywood Acquisition Inc. changed its name to Nutritional Specialties Inc. In September 2008, Baywood International, Inc. created the acquisition subsidiary Baywood New Leaf Acquisition, Inc. to acquire Skae Beverage International. In October 2009, Baywood International, Inc. changed its name to New Leaf Brands, Inc.
 
The accompanying condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, considered necessary for a fair presentation of the results for the periods presented. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year.
 
2.  Going Concern

The Company has a history of recurring losses from continuing operations, deficiencies in working capital and limited cash on hand. As of June 30, 2011, it has also been unable to generate sustainable cash flows from operating activities. In addition, the Company has $1,825,381 in debt and related party obligations payable within the next twelve months including an obligation which is currently in default (see Note 8). For the three and six months ended June 30, 2011, the Company’s loss from continuing operations were $ 665,063 and $2,281,212, respectively. As of June 30, 2011, the Company’s cash and cash equivalents and working capital deficiency were $3,947 and $3,621,076, respectively. Collectively, these factors raise substantial doubt about the Company’s ability to continue as a going concern.

The Company is dependent upon its ability to obtain the necessary financing. The Company believes that its existing cash resources, combined with projected cash flows from operations, will not be sufficient to execute its business plan and continue operations for the next twelve months without additional funding. The Company intends to continue to explore various strategic alternatives, including asset sales and private placements of debt and equity securities to raise additional capital. In July 2011, the Company raised additional gross proceeds of $150,000 pursuant to Original Issue Discount notes (see Note 14). Management believes that its existing beverage business can eventually achieve profitability and positive cash flow. In addition to paying down and restructuring its debt, management is actively taking steps to reduce the Company’s future operating expenses and increase future sales. However, the Company cannot provide any assurance that operating results will generate sufficient cash flow to meet its working capital needs and service its existing debt or that it will be able to raise additional capital as needed.

The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.
 
 
6

 
 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

3.  Summary of significant accounting policies
 
The Company has identified the policies below as critical to its business operations and the understanding of the results of its operations. The impact and any of its associated risks related to these policies on the Company’s business operations are discussed throughout this section.
 
Inventories
 
Inventories, as estimated by management, consist primarily of finished goods, but at times will include certain raw materials and are recorded at the lower of cost (average cost basis) or market. The inventory is comprised of the following:
 
   
June 30,
2011
   
December 31,
2010
 
   
(Unaudited)
       
Finished goods
 
$
89,334
   
$
258,324
 
Raw materials
   
154,934
     
177,090
 
Total inventories
 
$
244,268
   
$
435,414
 

Property and Equipment
 
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of five years.  

Intangible assets

Intangible assets consist of brand value resulted from the September 9, 2008 acquisition of certain net assets from Skae Beverage International, LLC.  Intangible assets consisted of the following at June 30, 2011 and December 31, 2010:

   
Brand Value –
New Leaf Brands
 
Asset carrying value at December 31, 2010
 
$
5,085,824
 
Accumulated amortization as of December 31, 2010
   
(1,045,000
)
Net asset carrying value at December 31, 2010 
 
$
4,040,824
 
         
Asset carrying value at June 30, 2011
 
$
4,760,824
 
Accumulated amortization as of June 30, 2011
   
(1,286,248
)
Net asset carrying value at June 30, 2011
 
$
3,474,576
 

The Company evaluates intangible assets for potential impairment on an annual basis or whenever events or circumstances indicate that an impairment may have occurred using a two-step process. The first step of the impairment test, used to identify potential impairment, compares the estimated fair value of the reporting unit containing the amortizing intangible with the related carrying amount. If the estimated fair value of the reporting unit exceeds its carrying amount, the reporting unit’s amortizing intangible is not considered to be impaired and the second step is unnecessary. There has been no impairment of the intangible assets during the three and six months ended June 30, 2011.
 
The brand carrying values (including Trademarks and Trade Names) are being amortized over a ten-year period.  Amortization expense for the six months ended June 30, 2011 and 2010 was $241,248 and $241,251, respectively.  

Based on the Company's amortizable intangible assets as of June 30, 2011, amortization expense is expected to be approximately $241,252, for the remainder of 2011 and is $482,500, for each of the next five fiscal years.
 
 
7

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

Option -Warrants issued on debt and beneficial conversion
 
The Company estimates the fair value of each option and warrant grant on the date of grant using the Black-Scholes-Merton option-pricing model.  The option and warrant estimates are based on the following assumptions for the three and six months ended June 30, 2011 and 2010:
 
   
June 30,
2011
   
June 30,
2010
 
Dividend yield
           
Volatility
  81.47% to 98.07%     98.16% to 106.21%  
Risk free interest rate
  0.03% to 1.76%     0.32% to 1.79%  
Expected term
 
0.19 to 4.35 years
   
1.19 to 4.87 years
 
Forfeiture rate (options)
    8%       8%  

The Company accounts for the beneficial conversion feature of debt and preferred stock using intrinsic value method measure at the date of the note.

Derivatives

As part of certain note and warrant agreements, the Company has provided holders with the option to convert the note or exercise the warrant into the Company’s common stock at a specified strike price. In order to prevent dilution, if the new strike price may be lower than the original strike price on the day of conversion or exercise, the strike price would be lowered to the new conversion or exercise price.   The Company has determined that these types of down round protection terms are considered derivatives.

The Company originally estimated the fair value of these warrants using a Black-Scholes-Merton valuation model. The same valuation model approach is applied to the market price of the Company’s common stock at June 30, 2011 and 2010 to determine the amount of the derivative relative to the down round protection. The change in this derivative value is included in the consolidated statement of operations as a change in fair value of derivative liabilities. The Company considers these derivative instruments as used for the purpose of securing financing.
 
During December 2009, the Company commenced a private placement offering of common stock and warrants with certain accredited investors. On February 16, 2010, the company issued a side letter agreement to the shareholders of this offering which included down round protection through April 30, 2010 in which additional shares of common stock and/or warrants would be issued, subject to certain conditions in the side letter agreement. As of April 6, 2010, the Company initiated a new private placement offering where the terms are more favorable than the December 2009 private placement offering.  Shareholders who participated in the December 2009 offering received an aggregate of 1,499,407 additional warrants with an exercise price of $0.45 per warrant.

The fair value of the derivative payable associated with the private placement in the side letter as of the grant date of February 28, 2010 was $25,000. The fair value of the derivative liabilities at June 30, 2010 was $977,715. The decrease in fair value of the Company’s derivative payable resulted in a gain of $636,150 and $933,541 for the three and six months ended June 30, 2010 and is included in the change in fair value of the derivative liabilities. The gain includes a decrease in the derivative liabilities due to the passage of time.
 
 
8

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
The following table summarizes the fair value of warrants classified as liability instruments, recorded on the consolidated balance sheet as of June 30, 2011 (all of which are calculated using level 3 fair value measurements):
 
   
Total Fair Value
 
   
 of Derivative as of
 
Offering
 
June 30, 2011
 
2006 and 2008 Bridge Financing
 
$
518
 
Warrants issued to Series I and J Preferred Stock holders
   
372
 
October 2009 notes
   
7,287
 
February 2010 stock and warrant issuance
   
76,510
 
April 2010 stock and warrant issuance
   
53,749
 
September 2010 notes
   
84,648
 
         
   
$
223,084
 
 
The following table summarizes the changes in fair value of warrant liabilities (a level 3 fair value measurement) during the six months ended June 30, 2011:
 
Balance at December 31, 2010
 
$
594,271
 
         
Change in fair value of derivative instruments included in net loss for the six months ended June 30, 2011
   
     (371,187
         
Balance at June 30, 2011
 
$
223,084
 

Revenue Recognition
 
Revenue is recognized when the earnings process is complete and the risks and rewards of ownership have transferred to the customer, which is generally considered to have occurred upon the shipment of product to the customer. The earnings process is complete once the customer order has been placed and approved and the product shipped to the customer. Product is sold to customers on credit terms established on an individual basis. The credit factors used include historical performance, current economic conditions and the nature and volume of the product.
 
The Company offers its customers and consumers a variety of sales and incentive programs, including discounts, allowances, coupons, slotting fees, and co-op advertising; such amounts are estimated and recorded as a reduction in revenue. The Company sells its products to customers with a right of return and is obligated to accept returns.

Net Loss per Share of Common Stock
 
Net loss per share is calculated using the weighted average number of shares of common stock outstanding during the period.  The Company has adopted the Earnings Per Share Topic of the Codification (ASC Topic 260-10). Diluted earnings, or loss, per share is computed similar to basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.  Diluted earnings (loss) per share may not been presented if the effect of the assumed exercise of options and warrants to purchase common shares would have an anti-dilutive effect.
 
 
9

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

Income Taxes

The Company accounts for income taxes under the liability method. Deferred taxes arise from temporary differences, due to differences between accounting methods for tax and financial statement purposes. The Company establishes a valuation allowance for the uncertainty related to its ability to generate sufficient future taxable income to utilize the net operating loss carryforwards and other deferred items.

The Company recognizes interest and penalties related to uncertain tax positions in interest and general and administrative expense. As of June 30, 2011, the Company has no unrecognized uncertain tax positions, including interest and penalties.

The tax years 2007-2010 are open to examination by the major tax jurisdictions in which the Company operates.

Comprehensive Income (Loss)

Other comprehensive income (loss) consists of charges or credits to stockholders’ equity, other than contributions from or distributions to stockholders, excluded from the determination of net income (loss). There were no other components of comprehensive income (loss) other than the net loss for the three and six months ended June 30, 2011 and 2010, respectively.
 
Fair Value Measurements

The Company applies recurring fair value measurements to its derivative liabilities.  In determining fair value, the Company uses a market approach and incorporates assumptions that market participants would use in pricing the liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation techniques.  These inputs can be readily observable, market corroborated, or generally unobservable internally-developed inputs.  Based upon the observation of the inputs used in these valuation techniques, the Company's derivative liabilities are classified as follows:

Level 1:  The fair value of derivative liabilities classified as Level 1 is determined by unadjusted quoted market prices in active markets for identical liabilities that are accessible at the measurement date.  The Level 1 inputs used in calculating the fair value of derivative liabilities include traded market values and volatilities calculated thereon.
 
Level 2:  The fair value of derivative liabilities classified as Level 2 is determined by quoted market prices for similar assets or liabilities in active markets, quoted market prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data.  The Level 2 inputs used in calculating the fair value of derivative liabilities include current published yields on United States Treasury securities.
 
Level 3:  The fair value of derivative liabilities classified as Level 3 is determined by internally-developed models and methodologies utilizing significant inputs that are generally less readily observable from objective sources.  The Level 3 inputs used in calculating the fair value of derivative liabilities include the remaining terms of the warrants and effective exercise prices.
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management 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 expenses during the reporting period. Actual results could differ from those estimates.
 
Recently Issued Accounting Pronouncements
 
There have been no significant developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s consolidated financial statements from those disclosed in our 2010 Annual Report on Form 10-K.
 
 
10

 

New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

4.  Geographic area information
 
The Company generates its revenues from numerous customers, primarily in the United States. The following table outlines the breakdown of sales to unaffiliated customers domestically and internationally for the six months ended June 30:
 
   
2011
   
2010
 
   United States
 
$
1,331,028
   
$
2,564,614
 
   Other International
   
15,085
     
55,167
 
      Totals
 
$
1,346,113
   
$
2,619,781
 

The Company holds all its assets in the United States.

5.  Concentration of Credit Risk
 
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents and trade receivables. The Company maintains the majority of its cash and cash equivalents in the form of demand deposits with financial institutions that management believes are creditworthy. At June 30, 2011, the cash balances in these institutions were insured in full by the Federal Deposit Insurance Corporation. Concentrations of credit risk relative to trade receivables are limited due to our diverse client base. The Company does have one customer that accounted for approximately 17.9% of sales during the six months ended June 30, 2011. The aggregate accounts receivable from this customer amounted to approximately 26.1% of the accounts receivable balance outstanding at June 30, 2011.

The Company does have two vendors that accounted for approximately 86.9% of purchases during the six months ended June 30, 2011. The aggregate accounts payable due to these vendors amounted to approximately 7.2% of the accounts payable balance outstanding at June 30, 2011.
 
A slowdown or loss of these customers or vendors could materially adversely affect the results of operations and the Company’s ability to generate significant cash flow.
 
6.  Notes payable to related parties
 
Notes payable to related party at June 30, 2011 and December 31, 2010 consisted of the following:

   
June 30,
   
December 31,
 
Description
 
2011
   
2010
 
             
Unsecured note payable to an officer with a original face amount of $20,000 bearing no interest and payable on demand (D)
  $
12,500
   
-
 
Unsecured note payable to an officer with a face amount of $20,000 bearing interest at 6% per annum and payable on demand (D)
   
20,000
   
-
 
Unsecured note payable to a director with a face amount of $75,000 bearing interest at 12% per annum and payable on demand (D)
   
75,000
   
-
 
Unsecured note payable to a director with a face amount of $10,000 bearing interest at 10% per annum and payable on demand (E)
   
10,000
   
-
 
Secured factoring loan agreement with a face amount of $26,668 bearing OID interest and payable on demand (F)
   
25,000
     
-
 
Unsecured note payable to a director with a face amount of $50,000 bearing interest, which is payable at maturity, at 10% per annum.  The note was originally payable on demand  but was amended to be payable on demand after December 31, 2010 (A) (B)
   
-
    $
50,000
 
Unsecured non-interest bearing note payable to an officer with a face amount of $50,000 which was originally payable on demand, but was amended to be payable on demand after December 31, 2010 (B)
   
-
     
50,000
 
Unsecured note payable to a director with a face amount of $150,000 bearing interest, which is payable at maturity, at 10% per annum.  The note was originally scheduled to mature in June 2010, but was extended to January 12, 2011  (A)
   
-
     
150,000
 
Unsecured note payable to a director with a face amount of $300,000 bearing interest, which is payable maturity, at 15% per annum. The note was originally scheduled to mature in July 2010, but was extended to December 31, 2010 (A)
   
-
     
300,000
 
Unsecured non-interest bearing note payable to a director which was issued at an original issuance discount of $27,273. The note matures on the three month anniversary of its issuance date on December 21, 2010 but was later extended to January 21, 2011 (C)
   
-
     
227,273
 
                 
Total notes payable to related parties
  $
142,500
    $
777,273
 
 
 
11

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

A) In connection with the issuance of the $300,000 unsecured note payable to a director, the Company agreed to amend the terms of the two previous outstanding notes payable to the director to provide the director with the option to convert the outstanding note balance to common stock at $0.35 per share, subject to a reset provision which contingently adjusts the conversion price in certain circumstances through July 19, 2010. The Company concluded that the addition of the embedded conversion option to the two previous outstanding notes qualified as modification resulted in extinguishment of the notes and the resulted loss was de minimis. The Company also determined that the embedded conversion option did not need to be bifurcated as a derivative instrument. However, since the embedded conversion option contained a beneficial conversion feature of $57,143 in intrinsic value, and the notes were either payable on demand or in default, the Company immediately recognized the intrinsic value in amortization of debt discount and deferred financing costs. This note was converted into Series K Preferred stock in January 2011.

In June 2010, the Company entered into a transaction which triggered the reset provision contained in the amended note terms resulting in a reduction of the conversion price to $0.30 per share. The $42,857 in incremental intrinsic value created by the reduction of the conversion price was immediately recognized in amortization of debt discount and deferred financing costs.
 
On January 21, 2011, $500,000 of these notes were converted into 20 units of Series K Preferred Shares and 1,666,667 warrants, which are described in Notes 7 and 9. At June 30, 2011, accrued interest of $57,500 was not converted in the January 21, 2011 transaction, and is included in accrued liabilities related party.

B) In August 2010, these notes were amended to be payable on demand after December 31, 2010. The holder did not receive any additional consideration for amending the note. The Company concluded that the modification of the note did not result in an extinguishment of debt and therefore did not record any gain (loss) on the modification of the note. This note was converted on January 21, 2011 into 2 units of Series K Preferred Stock and 166,667 Series Y warrants which are discussed in Note 9.

C) The note was issued in connection with the Company’s private placement of promissory notes and warrants in September 2010. The note was extended to January 21, 2011, as part of this extension the company issued 45,455 Common shares and reflected a charge of $7,500 as extinguishment of debt for the period ended March 31, 2011. On January 21, 2011, $235,294 of these notes were converted into 9.41 units of Series K Preferred shares and 3,137,255 warrants, which are described in Notes 7 and 9.

D) These notes were issued during the six months ended June 30, 2011 to provide short-term financing.

E) On June 30, 2011, the Company issued a $10,000 Demand 10% Promissory Note to O. Lee Tawes, a director of the Company. The note required a $5,000 repayment on July 7, 2011 which the holder converted to due on demand on the same day at no additional cost to the Company.

F) On June 15, 2011, the Company entered into a Secured Factoring Loan with a principal amount of $426,680 with lenders, a Director is a participant in this agreement. The total amount received on the Original Issue Discount Notes was $400,000 of which $25,000 was purchased by a director of the Company. These notes matured on August 20, 2011 and are secured by all of the Company assets, subject to subordinations of certain assets to present and future factoring facilities.

Interest expense in the six months ended June 30, 2011 and 2010 amounted to $11,847 and $7,500, respectively. The weighted average interest rate for all short term borrowings, excluding the amortization of debt discount was 5.2% for six months ended 2011 and 12% in 2010.

The following is a schedule of principal maturities for the next five years and the total amount thereafter on these related party notes as of June 30, 2011:

Year Ending December 31,
 
Principal
Maturities
 
2011
 
$
142,500
 
2012
   
-
 
2013
   
-
 
2014
   
-
 
2015
   
-
 
Total
 
$
142,500
 
 
 
12

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

7.  Short-term notes
 
Short-term notes at June 30, 2011 and December 31, 2010 consisted of the following:
                
   
June 30,
   
December 31,
 
Description
 
2011
   
2010
 
Secured factoring loan agreement with a face amount of $375,000 bearing OID interest and payable on demand (C)
 
 $
375,000
     
 -
 
Secured notes payable with an aggregate original face amount of $1,500,000 bearing interest, which is payable at maturity, at 10% per annum. The notes were originally scheduled to mature in May 24, 2010, but were extended to January 21, 2011.  The notes are secured by the Company’s accounts receivable and inventory. (A)
   
-
   
$
1,500,000
 
Unsecured non-interest bearing notes payable which were issued at an original issuance discount of $213,954. The notes mature on the three month anniversary of their issuance date in December 2010. (B)
   
-
     
1,782,954 
 
                 
Total short-term notes
 
 $
375,000
     
3,282,954
 

(A). On January 21, 2011, these notes were converted into 60 units of Preferred stock as part of the Series K Preferred share offering and the note holders also received 5,000,000 warrants series Y which are discussed below. At June 30, 2011, accrued interest of $70,211 was not converted in the January 21, 2011 transaction and is included in the accrued expenses.
 
(B). The payment term on these notes were extended to January 21, 2011, as part of this extension, the company issued 356,596 common shares and reflected a charge of $58,838 as extinguishment of debt for the six months ended June 30, 2011.
 
On January 21, 2011, these notes were converted 73.76 units of Preferred stock as part of the Series K Preferred share offering and also received 24,585,026 warrants series X, Y and Z which are discussed below. The Company determined that the fair value of the Series K Preferred Stock and Common Stock warrants Series X, Y and Z collectively,  were $4,129,171 and $2,284,829, respectively, at the date of the conversion. The $2,050,000 of note payable to Related Parties and $2,079,171 of Short-term notes were converted in accordance with the original terms of the debt agreements whereby if, at any time prior to or on the Maturity Date, the Company consummates a Qualified Offering, all of the outstanding Face Amount of these Notes shall, without further act at the closing of such Qualified Offering, convert into securities identical to those being sold in the Qualified Offering, at a conversion price equal to the price of the securities sold in the Qualified Offering.  A “Qualified Offering” is defined as proceeds of at least $1,200,000 and consummated by January 21, 2011. Under the terms of the Qualified Offering which closed on January 21, 2011, the outstanding debt described above was converted into the respective preferred shares and common stock warrants following the terms specified in the debt agreements and therefore, no gain or loss was recorded in the accompanying financial statements.
 
C) On June 15, 2011, the Company entered into a Secured Factoring Loan with a principal amount of $426,680 with lenders receiving the amount of $400,000, of which $25,000 is from a related party (note 6). These notes matured on August 20, 2011 and are secured by all of the Company assets, subject to subordinations of certain assets to present and future financing facilities.

8.  Long-term debt

Long-term debt at June 30, 2011 and December 31, 2010 consisted of the following:
 
Description
 
June 30,
2011
   
December 31,
2010
 
             
Note payable to a trust, bearing interest at 5% per annum, unsecured, matures in May 2013(A)
 
$
    822,920
     
822,920
 
Equipment loan bearing interest at 11% per annum, mature in November 2013 (B)
   
43,528
     
50,725
 
Total long-term debt
   
866,448
     
873,645
 
Less current maturities
   
837,930
     
838,741
 
Long-term debt
 
 $
28,518
   
$
34,904
 
 
Interest expense for the six months ended June 30, 2011 and 2010 amounted to $34,023 and $32,154, respectively.  The weighted average interest rate for all long-term borrowings was 3.5% for 2011 and 6.4% for 2010.
 
(A) The Company is in negotiation with certain former shareholders of Nutritional Specialties, Inc. The Company stopped making principal and interest payments on these notes in September 2009 and the notes were considered to be in default. (See Note 12)

(B) On December 3, 2008, the Company completed the purchase of a new ERP system and financed that purchase through a third-party equipment financing arrangement having an interest rate of 11% and requiring payments of monthly interest and principal of $1,719 which matures by December 2013.
 
 
13

 

New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
The following is a schedule of principal maturities for the next five years and the total amount thereafter on these notes as of June 30 2011:

Year Ending December 31,
 
Principal
Maturities
 
2011
 
$
837,930
 
2012
   
18,511
 
2013
   
10,007
 
2014
       
2015
       
Total
 
$
866,448
 
 
9.  Stockholders’ deficit

During the six months ended June 30, 2011, the Company converted $100,000 of accrued expense into 4 Series K Preferred shares at the Series K Preferred share offering rate of $25,000 per shares and issued 333,333 Series X and Y warrants and 666,666 Series Z warrants. The Company determined that the issuance of the Series K Preferred and the warrants on the conversion of the accrued expense was more than the carrying value of the obligation on the date of the conversion and recorded a loss on extinguishment of debt of $52,166. In February 2011, the Company issued 1,000,000 common shares for Marketing services at stated market value on the date of the agreement of $0.14 per share. In June 2011 issued 80,000 shares for Marketing services at stated market value on the date of the agreement of $0.0625 per share.

On January 12, 2011, the Company’s OID noteholders agreed to extend the maturity of their notes to January 17, 2011. In granting the extensions to January 17, 2011, the OID note holders received 402,045 Common Shares in the Company. As this exchange was to extend the term of the debt the Company accounted for the extension as a material modification and recognized a loss on extinguishment of debt of $66,338 in January 2011.

On January 21, 2011, the Company completed a unit offering of an aggregate of $1,215,000 of its Series K 10% Convertible Preferred Stock (“Series K Preferred Stock”) and three series (Series X, Y and Z) of common stock purchase warrants (“Warrants”) to eleven accredited investors. Each unit sold consisted of one share of $25,000 stated value (and liquidation preference) of Series K Preferred Stock and Warrants to purchase up to an  aggregate of 333,333 shares of common stock at $0.15 per share, subject to adjustment. A total of 48.6 units were sold. The Series X Warrants are five-year warrants, exercisable immediately to purchase an aggregate of 4,049,999 shares of common stock. The Series Y Warrants are exercisable until 45 days after the effectiveness of a certain registration statement and are exercisable to purchase an aggregate of 4,049,999 shares of common stock.   The Series Z Warrants are five-year warrants whose effectiveness is conditional upon the exercise of the holder’s Y warrants and are exercisable to purchase an aggregate of 8,100,001 shares of common stock. Pursuant to a Registration Rights Agreement described below, Investors also received the right to demand that the Company file one or more registration statements covering the securities into which the Series K Preferred Stock is convertible and as to which the Warrants are exercisable.  As a condition to consummation of the offering, certain individuals converted outstanding debt in the original principal amount of $2,050,000 into 82 shares of the Company’s Series K Preferred Stock and 6,833,334 Series Y warrants. Additionally, all subscribers to the Company’s 12% Original Issue Discount Notes sold in September and October 2010, whose then current balances on such Notes aggregated $2,079,171, were automatically converted into 83.16 units of the Company’s Series K Preferred Stock and were issued X,Y and Z warrants pari passu  to the current unit investors (an aggregate of 6,930,571 Series X warrants, 6,930,571 Series Y warrants and 13,861,139 Series Z warrants).

In connection with the transaction, the Company entered into a Securities Purchase Agreement, dated January 20, 2011, with eleven investors (“SPA”).  In addition to providing for the purchase of the Series K Preferred Stock and warrants by such investors as above, the SPA also provided for the Company to amend  its earn-out arrangement with Eric Skae, its Chief Executive Officer, as set forth in a certain Amendment to Asset Purchase Agreement; placed certain restrictions on the Company in connection with additional equity offerings by it for a period of 12 months; caused each executive officer and director to enter into a “lock-up” agreement valid until 90 days after the effectiveness of one or more registration statements to be filed to be filed pursuant to the Registration Rights Agreement described below; and caused the conversion to equity of certain outstanding debt of the Company as set forth in the last two sentences of the preceding paragraph.
 
The Company also entered into a Registration Rights Agreement, dated January 20, 2011 with each unit subscriber pursuant to which the Company agreed, at its expense, to file and gain effectiveness for one or more registration statements covering the Company common stock issuable pursuant to exercise of the Warrants and conversion of the Series K Preferred Stock.  The Company further agreed to file such registration statement within 60 days of the closing of the offering and to obtain its effectiveness within 90 days of such closing (or 120 days if such registration statement is subject to full Securities and Exchange Commission  review), failing which monetary penalties are imposed. The registration statement(s) is (are) to be maintained effective until all securities registered for sale thereunder have been sold.
 
The Company also filed a Certificate of Designation of its Certificate of Incorporation which created a class of 1,000 shares of Series K 10% Convertible Preferred Stock, par value $.001 per share. The Series K Preferred Stock ranks senior to the common stock, carries a 10% cumulative rate of interest, has a liquidation preference and is convertible into shares of the Company’s common stock at $.15 per share, subject to adjustment and anti-dilution protection. The Series K Stock is callable and redeemable by the Company under certain circumstances. The Series K Stock may be converted by the Company into shares of its common stock if the market price of the common stock is at least 300% of the conversion price for a period of 30 days and at least 200,000 shares have traded each day during such 30 day period. The Series K Preferred Stock has voting rights, voting with the Company’s common stock on an assumed-converted basis. The Certificate of Designation contains additional restrictions on the Company’s operations, including a restriction prohibiting the payment of any dividends on the Company’s common stock without the affirmative consent of the holders of the Stock.
 
 
14

 

New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
The Warrants are represented by warrant certificates and are exercisable at $.15 per share. They are exercisable in whole or in part and the Series X and Z (but not Y) warrants may be exercised on a cashless basis.

The placement agent for the offering received $72,435 in cash fees and 361,000 warrants valued at $18,804 using the Black-Scholes-Merton model described above, to purchase common stock which have terms similar to the Series X warrants.
 
On February 22, 2010, the Company closed a private placement of common stock and warrants with certain accredited investors.  Pursuant to the private placement, the Company agreed to issue an aggregate of 1,988,889 shares of common stock, plus warrants to purchase 1,057,727 shares of common stock at an exercise price of $0.55 per share, subject to adjustment.  Gross proceeds from the private placement were approximately $895,000.  The Warrants will expire on or about five years from the date of issuance and have anti-dilution provisions, including that through the period ended April 30, 2010, if the Company issues any common stock or securities that can be converted or exercised for common stock at an effective price that is less than the unit price, then the purchasers would receive additional common stock and/or warrants. As of April 6, 2010, the Company initiated a new private placement offering where the terms are more favorable than the December 2009 private placement offering.  Shareholders who participated in the December 2009 offering will receive an aggregate of 568,253 additional shares of common stock and 1,499,407 additional warrants with an exercise price of $0.45 per warrant and a term of three years.

During April 2010, the Company commenced a private placement offering of common stock and warrants with certain accredited investors. The offering was for the sale of up to 40 Units at a price of $25,000 per Unit, each Unit consisting of 71,428 shares of its common stock and warrants to purchase 71,428 shares of its common stock at an exercise price of $0.45 per share.  The warrants expire on or about three years from the date of issuance and have anti-dilution provisions during that period.

On April 29, 2011 the Company and certain Series K Preferred shareholders agreed to convert 187.6 preferred shares for 31,268,984 common shares. As an inducement to convert the Series K Preferred stock into common shares, the Company issued 21,262,909 additional common shares and recorded a deemed dividend of $1,701,032.

On April 29, 2011 the Company and certain Series K Preferred shareholders agreed to exercise their warrants to acquire 6,666,665 shares of common stock for $500,000 at an exercise price of $0.075 per share, which was $0.075 per share less than the original exercise price. The Company determined that the inducement to reduce the conversion price resulted in a deemed dividend to the preferred stock warrant holders of $266,667.

On April 29, 2011 the Company entered into a private placement arrangement with qualified investors who acquired 5,666,667 shares of Common stock for $425,000 an exercise price of $0.075 per share.
 
On February 24, 2011, the Company received proceeds of $60,000 and $30,000 of unsecured notes from investors and a director, respectively. On April 29, 2011, these unsecured notes were converted into 800,000 and 400,000 common shares respectively.
 
10.  Stock options and warrants

Options
 
The Company did not grant any stock options to directors or employees during the six months ended June 30, 2011. The Company granted 1,390,000 options to purchase common stock to an officer during the six months ended June 30, 2010.  Compensation cost recognized in general and administrative expenses during the six months ended June 30, 2011 and 2010 related to stock-based awards was $90,879 and $107,486, respectively. Options are usually issued at an exercise price equal to or above the fair value at the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model.
 
The summary of activity for the Company's stock options is presented below:
 
   
June 30,
2011
   
Weighted Average
Exercise Price
 
             
Options outstanding at December 31, 2010
   
3,538,750
   
$
0.65
 
Granted for the period
   
-
         
Exercised for the period
   
-
         
Terminated/Expired
   
(703,000
)
   
0.50
 
Options outstanding at June 30, 2011
   
2,835,750
   
$
0.69
 
Options exercisable at June 30, 2011
   
1,578,214
   
$
0.71
 
Options available for grant at June 30, 2011
   
3,226,948
         
                 
Exercise price per share of options outstanding
 
$
0.40 to 1.60
         
                 
Weighted average remaining contractual lives
 
7.4 years
         
                 
Sum of  fair value of options granted during the quarter
 
$
-
         
 
 
15

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
The common stock options expire as follows:
 
Year
 
Number of
options
 
2011
    -  
2012
    10,000  
2013
    -  
2014
    -  
2015 - 2019
    2,825,750  
Total
    2,835,750  
 
The aggregate intrinsic value of the options outstanding at June 30, 2011 was $0 with a weighted average remaining contract term of 7.4 years.
 
Unrecognized compensation costs related to non-vested share-based compensation for the above options amounted to $666,028 as of June 30, 2011.
 
 Warrants
 
Set forth below is a description of the Company’s warrants outstanding as of June 30, 2011
 
Designation / Reason Granted
 
 
Original issue date
 
 
Shares of Common Stock Upon Exercise
 
 
Exercise Price / Share
 
 
Expiration Date
                 
Bridge Warrants / Bridge financing (1)
 
September-06
   
21,429
 
$
1.00
 
September-11
Marketing Program Development
 
October-07
   
250,000
 
$
1.00
 
October-12
Investor Warrants / 2007 Private Placement (1)
 
March-07
   
58,749
 
$
0.40
 
March-12
Placement Agent Warrants
 
March-07
   
155,000
 
$
0.80
 
March-12
12% Bridge Note Warrants (1)
 
March-07
   
35,000
 
$
1.00
 
March-12
Ancillary Warrants
 
June-07
   
5,000
 
$
0.40
 
June-12
April 2008 Bridge Notes Warrants (1)
 
April-08
   
15,625
 
$
0.80
 
April-13
September 2008 Bridge Note Warrants (1)
 
September-08
   
25,884
 
$
0.85
 
September-13
Series J Warrants (1)
 
December-08
   
14,368
 
$
0.87
 
December-13
October 2009 Note Warrants (1)
 
October-09
   
310,000
 
$
0.25
 
October-14
Investor Warrants 2009 Private Placement (1)
 
December-09
   
649,999
 
$
0.55
 
December-14
Investor Warrants 2009 Private Placement (1)
 
February-10
   
407,727
 
$
0.55
 
February-15
Marketing Program Development
 
March-10
   
150,000
 
$
0.49
 
March-15
Investor warrants 2009 Private Placement (1)(2)
 
May-10
   
1,499,410
 
$
0.25
 
May-15
Investor Warrants 2010 Private Placement (1)
 
June-10
   
1,821,414
 
$
0.45
 
June-15
Investor Warrants 2010 Original Issue Discount Private Placement (1)
 
September/October 2010
   
2,412,273
 
$
0.25
 
September, October 2015
Placement agent Warrants (1)
 
October-10
   
266,760
 
$
0.25
 
October-15
Investor X Warrants 2011 Series K Preferred stock
 
January 2011
   
8,647,238
 
$
0.15
 
January-16
Investor Y Warrants 2011 Series K Preferred stock
 
January 2011
   
        9,313,905
 
$
0.15
 
45 days after registration statement
Investor Z Warrants 2011 Series K Preferred stock
 
January 2011
   
17,294,492
 
$
0.15
 
January-16
Placement agent X Warrants
 
January 2011
   
             361,000
 
$
0.15
 
January-16
Debt conversion Y Warrants
 
January 2011
   
          2,766,666
 
$
0.15
 
45 days after registration statement
Accounts payable conversion X Warrants
 
January 2011
   
             333,333
 
$
0.15
 
January-16
Accounts payable conversion Y Warrants
 
January 2011
   
             333,333
 
$
0.15
 
45 days after registration statement
Accounts payable conversion Z Warrants
 
January 2011
   
             666,667
 
$
0.15
 
January-16
Marketing Program Development
 
2/1/2011
   
             100,000
 
$
0.15
 
February-16

 
16

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
-1
 
The exercise price of the warrants and the number of warrant shares subject thereto shall be subject to adjustment in the event of stock splits, stock dividends, reverse stock splits, and similar events. Further, in the event that the Company should issue shares of its Common Stock at an effective price per share less than the then effective exercise price of the warrants, the exercise price and the number of warrant shares subject to such warrants shall be adjusted on a weighted average basis to reflect the dilution represented by the issuance of such shares of Common Stock and such lower effective price on a non-fully-diluted basis, subject to similar exceptions to those described for such adjustments above with respect to the Convertible Preferred Stock. The impact of this provision would be to reduce the exercise price. The warrants contain standard reorganization provisions. Therefore, these warrants are qualified as liability instruments upon issuance.
 
 
-2
 
In February 2010, the Company issued a side letter to investors in the private placements which closed in December 2009 and February 2010 which effectively amended the terms of the private placements to contain a price protection clause through April 30, 2010. The price protection clause required the Company to issue additional warrants to these investors, based upon a formula contained in the side letter, in the event that common stock was issued during the price protection period at an effective price less than the purchase price paid by such investors, subject to certain exceptions.
 
 
During the six months ended June 30, 2011, the Company issued 100,000 warrants for marketing services at an exercise price of $0.15 per share, 43,922,280 warrants were issued in conjunction with the issuance of Series K Preferred shares, 361,000 warrants were issued to the placement agent of the Series K Preferred shares, 6,833,333 warrants were issued for the conversion of certain notes payable into Series K Preferred shares, and 1,000,000 warrants were issued in conjunction with the conversion of vendor payables. In April 2011, the Company made an offer to the series X, Y and Z warrant holders to exercise their warrants at an exercise price of $0.075 per warrant share; certain warrant holders accepted the Company’s offer and exercised 6,666,665 warrants for $500,000. In addition a series K Preferred shareholder forfeited 666,667 series X warrants and 1,333,313 series Y warrants and a warrant holder who, as previously described, received warrants as part of the conversion certain notes payable agreed to forfeit 4,066,667 series X warrants.
 
            The following table reflects a summary of common stock warrants outstanding and warrant activity during the six months ended June 30, 2010:
 
   
Number of warrants
   
Weighted
Average Exercise
Price
   
Weighted
Average Term
(Years)
 
Warrants outstanding at December 31, 2010
   
8,098,638
   
$
0.42
     
3.85
 
   Granted during the period
   
52,549,946
     
0.15
     
4.55
 
   Exercised during period
   
(6,666,665 
   
0.15 
     
4.55 
 
   Forfeited during the period
   
(6,066,647 
)
   
0.15 
     
4.55 
 
Warrants outstanding at June 30, 2011
   
47,915,272
   
$
0.20
     
3.96
 

The common stock warrants expire in the years ended December 31 as follows:

Year
 
Amount
 
2011
   
21,429
 
2012
   
503,749
 
2013
   
55,877
 
2014
   
959,999
 
2015
   
6,557,584
 
2016
   
39,816,634
 
         
Total
   
47,915,272
 
 
 
17

 

New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements

11.  Related party transactions
 
From time to time, certain officers and directors loan the Company money as well as defer payment of salaries in order to assist the Company in its cash flow needs.

The table below sets forth the amounts of notes payable and accrued salaries of the Company’s officers and directors as of June 30, 2011:
 
Officer/Director
Notes Payable
     
Accrued Salaries &
 
 
Amount
 
Accrued Interest
 
Earn-out Amount
 
Bonus Amount
 
                 
Eric Skae, C.E.O. & President
 
$
12,500
         
$
260,000
   
$
145,500
 
David Tsiang, Chief Financial Officer
   
20,000
     
180
                 
O. Lee Tawes III, Director
   
110,000
     
64,263
     
-
     
-
 
                   Total
 
$
142,500
   
$
64,443
   
$
260,000
   
$
145,500
 
 
On January 12, 2011, O. Lee Tawes, a director of the Company, lent the Company an aggregate of $75,000 for which he received a demand promissory note bearing interest at the rate of 12% per annum. Mr. Tawes lent the Company an additional $30,000 on February 24, 2011 for which he received a promissory note bearing interest at the rate of 0% per annum. This note was converted into 400,000 shares of common stock on April 29, 2011 at $0.075 per share. On June 30, 2011, O. Lee Tawes  lent the Company an additional $10,000 for which he received a promissory note bearing interest at the rate of 10% per annum.

On January 12, 2011, Eric Skae, the Company's CEO and a director, lent the Company an aggregate of $20,000 for which he received a demand promissory note bearing interest a the rate of 0% per annum. On January 28, 2011, the Company repaid $7,500 of this loan.

Also on February 24, 2011, David Tsiang the Company's CFO, lent the Company an aggregate of $20,000 for which he received a demand promissory note bearing interest at a rate of 6% per annum.
 
12.  Contingencies

In connecton with the acquisition of Skae Beverage International LLC (“Skae”) in 2008, the Company agreed to provide the former member of Skae, who is also the Company’s current Chief Executive Officer, with a three year earn-out arrangement. Under the terms of the earn-out arrangement, the Company can be required to pay an additional $4,776,100 to the owner of Skae if the acquired operations meet certain performance targets related to sales and gross profit. As of June 30, 2011 and December 31, 2010, the Company has accrued $260,000 and $535,000 respectively related to the achievement of the performance targets. Currently, the Company is unable to determine the likelihood that future performance targets will be met or estimate the future liability that will be incurred. In January 2011, the Company amended the earn-out agreement with the CEO, where by Mr. Skae forgave his 2010 earn-out of $325,000 which also reduce the intangible by a same amount.

On January 29, 2009, the Company was notified that it was named as a defendant, along with 54 other defendants, in a class action lawsuit under California Proposition 65 for allegedly failing to disclose the amount of lead in one of its products. The Company has responded to discovery requests from the Attorney General of California. To date, no trial date has been set. The Company is currently investigating the merits of the allegation and is unable to determine the likelihood of an unfavorable outcome or a range of possible loss. This matter remains pending.
 
On December 7, 2009, the Company received a demand notice for payment for $822,920 from the estate of a former owner of Nutritional Specialties, Inc. Without acknowledging liability, the Company offered to settle any claims against us in this matter for cash and restricted common stock. The Company's offer lapsed before it was accepted. The Company intends to continue to attempt to negotiate a settlement for this debt. The Company has accrued for this payment of $822,920 as of December 31, 2010 as a short-term note payable. On July 7, 2010, the Company was served with a Complaint demanding payment of the remaining balance of a $1,200,000 note payable with a current balance of $822,920 from the estate of a former owner of Nutritional Specialties, Inc. The parties have attended mediation and the Company is hopeful that this may be amicably resolved. This matter remains pending.
 
 
18

 
 
New Leaf Brands, Inc.
Notes to unaudited condensed consolidated financial statements
 
On March 12, 2010, the Company was notified that it was  named as a defendant in lawsuit in the United States District Court, Eastern District of Texas, brought by Vitro Packaging de Mexico, SA de CV, the assignee of a former supplier. Vitro Packaging alleges the Company owed unpaid accounts payable and is seeking payment of approximately $345,000. The Company has entered into a Side Compromise Settlement Agreement, Indemnity and Release with Vitro Packaging De Mexico, S.A. DE C.V. with Vitro agreeing not to execute on an Agreed Final Judgment for $245,275until after May 16, 2011, which the Company has not paid and is recorded as a current liability. On August 17, 2011the judgment was recorded in the State of New Jersey.

In December 2010, the Company’s Chief Operating Officer, William Sipper, resigned following an alleged incident involving a prospective employee of the Company. The Company has turned the matter over to its insurance carrier. Management believes its insurance is adequate to cover any liability in connection with the claim and takes the position that any acts by Mr. Sipper were done outside the scope of his employment. This matter remains pending.
 
On July 11, 2011, the Company was served with a complaint from Bett-A-Way Traffic Systems, Inc. demanding payment of $90,928 in a debt collection matter. The Company has accrued for this payment of $90,928 as of June 30, 2011 as part of accounts payable. The parties have been involved in settlement negotiations and the Company is hopeful that this may be amicably resolved. This matter is pending.
 
The Company filed a Certificate of Designation to its Certificate of Incorporation which created a class of 1,000 shares of Series K 10% Convertible Preferred Stock with a par value of $.001 per share.  As of June 30, 2011, Series K 10% Preferred stock dividends of $158,977 are due but are undeclared by the Board of Directors.
 
 13.  Net loss per share
 
Convertible preferred stock and outstanding options and warrants were not considered in the calculation for diluted net loss per share for the periods ended June 30, 2011 and 2010 because the effect of their inclusion would be anti-dilutive.

As of June 30, 2011, there were warrants and options to purchase 50,751,022 shares of common stock outstanding and Series K Preferred shares were convertible into 5,025,491 shares of common stock. As of June 30, 2010, there were warrants and options to purchase 9,617,803 shares of common stock outstanding. These securities were excluded from the computation of diluted earnings per share because the effect of their inclusion would be anti-dilutive.

14.  Subsequent events
 
On July 14, 2011, July 28, 2011 and July 29, 2011 the Company entered into Original Issue Discount Notes with lenders receiving amounts of $75,000, $50,000 and $25,000 respectively. These notes mature on January 14, 2012 at $170,458 and are secured by all of the Company assets, subject to subordinations of certain assets to present and future factoring facilities.
 
Vitro Packaging Litigation:  There is a Judgment against the Company held by Vitro Packaging De Mexico. S.A.DE C.V. Vitro has taken steps to domesticate and execute upon the Company’s assets in New Jersey.

 
 
19

 

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This report on Form 10-Q contains forward-looking statements that involve risk and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in this report, our annual report on Form 10-K and other filings we make from time to time with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report to conform theses statements to actual results or to changes in our expectations, except as required by law.

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with our Financial Statements, including the related Notes, appearing in our annual report on Form 10-K for the year ended December 31, 2010.

The preparation of this quarterly report on Form 10-Q requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our Financial Statements, and the reported amounts of revenue and expenses during the reporting period.  Our actual results reported in the future may differ from those estimates and revisions of these estimates may become necessary in the future.

GENERAL

Our beverages are classified as ready-to-drink teas and lemonades. We believe that our products are well-positioned to continue our growth to date and we have a competitive edge in ingredients, flavor and packaging. Our business plan is to build a competitive beverage company around our New Leaf brand of ready-to-drink teas, lemonades and other new functional beverages. As of June, 2011, we sell New Leaf beverages in 35 states, through approximately 130 distributors in over 15,000 outlets. We plan to expand our business by making inroads into larger mainstream grocery, convenience, drug stores and other larger accounts. We are making inroads with food, drug and mass accounts including grocery stores, drug stores and club stores. Our ability to develop new products is limited by our access to capital. We intend to continue to explore various strategic alternatives, including business combinations and private placements of debt and or equity securities to raise capital to grow our Company. We can provide no assurance that we will be able to raise sufficient capital under appropriate terms to complete our strategic objectives

We sold 167,935 cases in the first half of 2011, down 43.4% from 296,904 cases in the first half of 2010. We anticipate that, after our debts are repaid and renegotiated, we will be able to raise additional capital to grow our New Leaf brand as well as develop additional brands.
 
Our condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.  As reflected in the condensed consolidated financial statements accompanying this Quarterly Report on Form 10-Q, we had negative net working capital of approximately $3,621,076 at June 30, 2011.  We have not yet created positive cash flows from operating activities and its ability to generate profitable operations on a sustainable basis is uncertain.  These factors raise substantial doubt about our ability to continue as a going concern.
 
We believe that our existing cash resources, combined with projected cash flows from operations may not be sufficient to execute our business plan and continue operations for the next twelve months.  Additionally, we have taken steps to reduce our operating expenses. We will continue to explore various strategic alternatives, including business combinations and private placements of debt and or equity securities to raise capital. 
  
OUR PRODUCTS

New Leaf is a natural iced-tea beverage that is sweetened with organic cane sugar and specifically formulated to address what we believe is an unmet consumer demand in the very competitive, but rapidly growing, ready-to-drink beverage market. The organic cane sugar sweetening creates a premium and more healthy product with 20-30% fewer calories than high fructose corn syrup competitors. New Leaf is available in 15 varieties that are all-natural and organically-sweetened, of which 2 are diet varieties. Varieties include white, black, green and blue teas, lemonades and half tea/half lemonade beverages. New Leaf products include:
 
 
20

 
 
Blue Teas White Tea
  Diet Blue Tea with Lemon   White Tea with Ginseng & Honey
  Diet Blue Tea with Peach   White Tea with Honey Dew Melon
  Blue Tea with Lemon   White Tea with Strawberry
  Blue Tea with Peach Black Tea
  Blue Tea with Raspberry   Sweet Tea
Green Teas Lemonades
  Green Tea with Plum   Strawberry
  Green Tea with Mango   Lemon
      Cherry
     
Tiger – Half and Half

We also distinguish the New Leaf brand by creating unique flavors.  For example, New Leaf introduced blue tea, also known as Oolong tea, to mainstream consumers.  Oolong tea is sometimes referred to as “blue tea” because its dried leaves have a bluish hue.  We believe that unique flavors will continue to attract the attention of consumers.

In April 2010, we introduced a lemonade brand.  New Leaf's lemonades are available in three flavors -- Homemade, Black Cherry and Strawberry. Additionally, "The Tiger," half-iced tea / half lemonade, debuted as part of our lemonade line-up. Our 100% natural lemonades are made with pure organic cane juice and contain 10% real fruit juice.

Our products are sold in a proprietary 16.9 ounce glass bottle that is designed specifically for our New Leaf brand.  The bottles are labeled with vibrant colors and the New Leaf logo, which we believe appeals to and is recognizable by consumers.  New Leaf products emphasize wellness and innovation.  Our non-diet varieties of New Leaf Tea have 70-80 calories per 8 ounce serving and are sweetened with organic cane sugar, instead of high-fructose corn syrup.

Results of Continuing Operations for the Three and Six Months Ended June 30, 2011 and 2010

Net sales from our continuing operations, New Leaf Brands, for the six months ended June 30, 2011 were $1,346,113 compared to $2,619,781 for the same period last year.  The decrease in net sales is primarily due to capital constraints which delayed the production, shipments of open customer orders and inventory purchases from distributors to fulfill open orders in the amount of $320,000. Management is actively working to alleviate the capital constraint issue. For the three months ended June 30, 2011 net sales from our operations were $658,527 compared to $1,665,232 for the same period last year. The decrease in net sales is primarily due to capital constraints which delayed the production, shipment of open customer orders and inventory purchases from distributors. 
 
            Cost of sales decreased to $1,053,262 for the six months period ending June 30, 2011 compared to $1,766,802 for the same period in 2010.  The decrease of $713,540 or 40% was a result of lower sales.  Our gross profit margin for the six month periods ended June 30, 2011 was 22%, compared to 33% for the same period in 2010.  The overall decrease of eleven percentage points in gross profit margin is primarily due to smaller production runs which, by virtue of their size are less efficient than those for the period ended June 30, 2010.  For the three months ended June 30, 2011 cost of sales decreased to $496,144 for the three months period ending June 30, 2011 compared to $1,087,103 for the same period in 2010.  The decrease of $590,959 or 54% was a result of lower sales.  Our gross profit margin for the three month periods ended June 30, 2011 was 25%, compared to 35% for the same period in 2010.  The overall decrease of ten percentage points in gross profit margin is primarily due to smaller production runs which, by virtue of their size are less efficient than those for the period ended June 30, 2010.
 
 
21

 
 
Shipping and handling expenses were $212,522 for the six months period ending June 30, 2011, and $297,940 for the same period in the prior year.  The decrease of $85,418 or 29% was due primarily to lower sales offset by shipments to distributors further from our co-packer, higher fuel surcharges and the above mentioned inventories purchased from distributors. Marketing expenses decreased $1,549,464, or 57% from $2,714,828 for the six months ended June 30, 2010 to $1,165,364 in the same period in 2011.  The decrease was attributable to management’s decision to restrain marketing spending pending resolution of our capital constraints.  General and Administrative costs were $1,025,653 for the first half year of 2011 and $2,081,982 for the first half year of 2010.  The decrease of $1,056,329 or 51% was due to planned cost reductions and option and stock compensation expenses. Depreciation and amortization expense was $258,585 in the first six months of 2011, and $258,459 in the first six months of 2010. Shipping and handling expenses were $84,689 for the three months period ending June 30, 2011, and $177,142 for the same period in the prior year.  The decrease of $92,453 or 52% was due primarily to lower sales offset by shipments to distributors further from our co-packer, higher fuel surcharges and the above mentioned inventories purchased from distributors. Marketing expenses decreased $980,572, or 64% from $1,527,939 for the three months ended June 30, 2010 to $547,367 in the same period in 2011.  The decrease was attributable to management’s decision to restrain marketing spending pending resolution of our capital constraints.  General and Administrative costs were $455,824 for the second quarter in 2011 and $542,437 for the second quarter in 2010.  The decrease of $86,613 or 16% was due to planned cost reductions and option and stock compensation expenses. Depreciation and amortization expense was $129,293 in the second quarter of 2011, and $129,103 in the second quarter of 2010.
 
Total other income (expense) for the six month periods ended June 30, 2011 and 2010 was $88,061 and $(1,067,247), respectively. The change of $1,155,308 or 108% was due primarily to the change of fair values related to derivative liability and loss on extinguishment of debt. Total other income (expense) for the three month periods ended June 30, 2011 and 2010 was $389,727 and $(1,142,245), respectively. The change of $1,531,972 or 134% was due primarily to the increased change in fair value of derivative liability.

There is no income tax benefit recorded for either period because any potential benefit of the income tax net operating loss carryforwards has been equally offset by an increase in the valuation allowance on the deferred income tax asset.
 
Liquidity and Capital Resources
 
As of June 30, 2011, we had $820,944 in current assets of which $317,927, or 39%, was cash and receivables.  On average, our receivables are collected after 45 days outstanding.  Inventories were $244,268 at June 30, 2011, a decrease of $191,146 over the December 31, 2010 balance of $435,414.  The decrease in inventories was primarily due to the sale of product and limited production.  Total current liabilities at June 30, 2011 totaled $4,442,020, of which $2,478,536, or 56%, represented trade and operating payables.  This represents a ratio of current assets to current liabilities of 1 to 5.41 at June 30, 2011.
 
At June 30, 2011, we had a net working capital deficiency of $3,621,076.  Our need for cash during the six months ended June 30, 2011 was primarily funded through the issuance of Series K Preferred stock, exercise of warrants and borrowings (including borrowings from related parties) totaling $2,810,565.
 
We have traditionally funded working capital needs through product sales, management of working capital components of our business, and by cash received from private offerings of our common stock, preferred stock, warrants to purchase shares of our common stock and convertible notes. We believe that our existing cash resources, combined with projected cash flows from operations may not be sufficient to execute our business plan and continue operations for the next twelve months.  We have taken steps to reduce our operating expense. Additionally, we are evaluating our strategic direction aimed at achieving profitability and positive cash flow. We intend to continue to initiate a private placement of debt or equity securities in order to raise additional capital. We have also engaged an investment banking firm to assist management in raising additional capital. However, we may not be successful in obtaining additional financing on acceptable terms, on a timely basis, or at all, in which case, we may be forced to make further cutbacks or cease operations.
  
Financings
 
On January 21, 2011, the Company completed a unit offering of an aggregate of $1,215,000 of its Series K 10% Convertible Preferred Stock (“Series K Preferred Stock”) and three series (Series X, Y and Z) of common stock purchase warrants (“Warrants”) to 11 accredited investors. Each unit sold consisted of one share of $25,000 stated value (and liquidation preference) of Series K Preferred Stock and Warrants to purchase up to an  aggregate of 333,333 shares of common stock at $0.15 per share, subject to adjustment. A total of 48.6 units were sold. The Series X Warrants are five-year warrants, exercisable immediately to purchase an aggregate of 4,049,999 shares of common stock. The Series Y Warrants are exercisable until 45 days after the effectiveness of a certain registration statement and are exercisable to purchase an aggregate of 4,049,999 shares of common stock.   The Series Z Warrants are five-year warrants whose effectiveness is conditional upon the exercise of the holder’s Y warrants and are exercisable to purchase an aggregate of 8,100,001 shares of common stock. Pursuant to a Registration Rights Agreement described below, Investors also received the right to demand that the Company file one or more registration statements covering the securities into which the Series K Preferred Stock is convertible and as to which the Warrants are exercisable.  As a condition to consummation of the offering, certain individuals converted outstanding debt in the original principal amount of $2,050,000 into 82 units of the Company’s Series K Preferred Stock and issued 6,833,334 Series Y Warrants. Additionally, all subscribers to the Company’s 12% Original Issue Discount Notes sold in September and October 2010, whose then current balances on such Notes aggregated $2,079,171, were automatically converted into 83.16 units of the Company’s Series K Preferred Stock and were issued X,Y and Z warrants  pari passu  to the current unit investors (an aggregate of 6,930,571 Series X warrants, 6,930,571 Series Y warrants and 13,861,139 Series Z warrants).
 
 
22

 

On January 21, 2011, O. Lee Tawes, a director of the Company, lent the Company an aggregate of $75,000 for which he received a demand promissory note bearing interest at the rate of 12% per annum. Mr. Tawes lent the Company an additional $30,000 on February 24, 2011 for which he received a promissory note bearing interest at the rate of 0% per annum. Mr. Tawes converted the second promissory note into shares of common stock in the April 29, 2011 private placement.
 
On January 12, 2011, Eric Skae, the Company's CEO and a director, lent the Company an aggregate of $20,000 for which he received a demand promissory note bearing interest a the rate of 0% per annum. On January 28, 2011 the Company repaid $7,500 of this note.

On February 24, 2011, David Tsiang the Company's CFO, lent the Company an aggregate of $20,000 for which he received a demand promissory note bearing interest at a rate of 6% per annum.
 
On April 29, 2011, we closed a private placement of common stock with certain accredited investors. We agreed to issue and sell to the investors, and the investors agreed to purchase, an aggregate of 5,666,667 shares of our common stock. Gross proceeds from the private placement were approximately $425,000.

On February 24, 2011, we received proceeds of $60,000 and $30,000 of unsecured notes from  investors and a director, respectively. On April 29, 2011, these unsecured notes were converted into 800,000 and 400,000 common shares, respectively.

On April 29, 2011 we and certain Series K Preferred shareholders agreed to convert 187.6 units of preferred shares for 52,531,893 shares of common stock, including an additional 21,262,909 shares of common stock as a deemed dividend to these Series K Preferred shareholders.

On April 29, 2011 we made an offer to series X, Y and Z warrants holders to exercise their warrants at a exercise price of $0.075 per warrant share; certain warrant holders accepted our offer and exercised 6,666,665 warrants for $500,000. In addition a warrant holder series K Preferred shareholder forfeited 666,667 series X warrants and 1,333,313 series Y warrants and a warrant holder who, as previously described, received warrants as part of the conversion certain notes payable agreed to forfeit 4,066,667 series X warrants.
 
On May 25, 2011, the Company entered into a short-term Accounts Receivable Financing Note with a lender in the amount of $150,000. The note was subsequently paid in full with accrued interest by June 24, 2011.

On June 30, 2011, we issued a $10,000 Demand 10% Promissory Note to O. Lee Tawes, a director of the Company. The note required a $5,000 repayment on July 7, 2011 which the holder waived on the same day at no additional cost to the Company.

On June 15, 2011, the Company entered into a Secured Factoring Loan with a principal amount of $426,680 with lenders receiving the aggregate amount of $400,000 which includes $25,000 from a related party. These notes matured on August 20, 2011 and is secured by inventory in stock and pending production and all future accounts receivable.
 
Contractual Obligations
 
There has been no material change to our contractual obligations as disclosed in the fiscal year 2010 Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on May 23, 2011, except as follows:
  
On July 14, 2011, July 28, 2011 and July 29, 2011 we entered into Original Issue Discount Notes with lenders in the amounts of $75,000, $50,000 and $25,000 respectively. These notes mature on January 14, 2012 at $170,458 and are secured by all of the Company assets, subject to subordinations of certain assets to present and future factoring facilities.
 
Off Balance Sheet Arrangements
 
We do not have off-balance sheet arrangements, financing, or other relationships with unconsolidated entities or other persons, also known as “variable interest entities”.
 
 
23

 
 
 ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.
 
ITEM 4 - CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
 
Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our management concluded that our disclosure controls and procedures, including internal control over financial reporting, were not effective as of June 30, 2011 to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to  allow timely decisions regarding required disclosure.  Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management.  Our disclosure controls and procedures include components of our internal control over financial reporting. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, with our Company have been detected.
 
Our management identified control deficiencies during 2009 that continued to exist in the six months ended June 30, 2011 because we lacked adequate controls in place to properly evaluate and account for all the complex characteristics of the debt and equity transactions executed by our Company in accordance with U.S. generally accepted accounting principles.  In addition, management concluded that there were not adequate controls in place to properly evaluate and account for stock-based awards issued by our Company in accordance with U.S. generally accepted accounting principles.  These deficiencies are the result of the complexity of the individual debt and equity transactions entered into by our Company and the limited amount of personnel available to provide for the proper level of oversight needed in accounting for these transactions. Management has determined that these control deficiencies represent material weaknesses. In addition, we lacked sufficient staff to segregate accounting duties.  Based on our review of our accounting controls and procedures, we believe this control deficiency resulted primarily because we have one person performing all accounting-related duties.  As a result, we did not maintain adequate segregation of duties within our critical financial reporting applications. Management believes these are “material weaknesses.”
 
 
24

 
 
A material weakness is defined as a deficiency, or combination of deficiencies in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.
 
In preparing our financial statements and in reviewing the effectiveness of the design and operation of our internal accounting controls and procedures and our disclosure controls and procedures for the six months ended June 30, 2011, we performed transaction reviews and control activities in connection with reconciling and compiling our consolidated financial records for the six months ended June 30, 2011.  These reviews and procedures were undertaken in order to confirm that our financial statements for the six months ended June 30, 2011 were prepared in accordance with generally accepted accounting principles, fairly presented and free of material errors.
 
Our management is in the process of actively addressing and remediating the material weaknesses in internal control over financial reporting described above.  During 2009, we undertook actions to remediate the material weaknesses identified, including installation of a new ERP software system to allow for appropriate checks and reviews of internal control record-keeping and reporting.
 
We believe that the step outlined above will strengthen our internal control over financial reporting and addresses the material weaknesses described above. However, we continue to have only one person who performs our accounting and reporting functions. Our management will test and evaluate these additional controls to be implemented in 2011 to assess whether they will be operating effectively.
 
We intend to continue to remediate material weaknesses and enhance our internal controls, but cannot guarantee that our efforts will result in remediation of our material weakness or that new issues will not be exposed in this process.
 
Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II - OTHER INFORMATION
 
ITEM 1 - LEGAL PROCEEDINGS
 
We are currently involved in the following legal proceedings:

On January 29, 2009, we were notified that we were named as a defendant, along with 54 other defendants, in a class action lawsuit under California Proposition 65 for allegedly failing to disclose the amount of lead in one of its products. We have responded to discovery requests from the Attorney General of California. To date, no trial date has been set. We are currently investigating the merits of the allegation and is unable to determine the likelihood of an unfavorable outcome or a range of possible loss. This matter remains pending.
 
On December 7, 2009, we received a demand notice for payment for $822,920 from the estate of a former owner of Nutritional Specialties, Inc. Without acknowledging liability, we offered to settle any claims against us in this matter for cash and restricted common stock. Our offer lapsed before it was accepted. We intend to continue to attempt to negotiate a settlement for this debt. We have accrued for this payment of $822,920 as of December 31, 2010 as a short term note payable. On July 7, 2010, we were served with a Complaint demanding payment of the remaining balance of a $1,200,000 note payable with a current balance of $822,920 from the estate of a former owner of Nutritional Specialties, Inc. The parties have attended mediation and we are hopeful that this may be amicably resolved. This matter remains pending.

On March 12, 2010, we were notified that we were named as a defendant in lawsuit in the United States District Court, Eastern District of Texas, brought by Vitro Packaging de Mexico, SA de CV, the assignee of a former supplier. On March 23, 2011, Vitro Packaging alleges we owed unpaid accounts payable and is seeking payment of approximately $345,000. We have entered into a Side Compromise Settlement Agreement, Indemnity and Release with Vitro Packaging De Mexico, S.A. DE C.V. with Vitro agreeing not to execute on an Agreed Final Judgment for $245,275 until after May 16, 2011. This matter remains pending. There is a Judgment against the Company held by Vitro Packaging De Mexico. S.A.DE C.V. Vitro has taken steps to domesticate and execute upon the Company’s assets in New Jersey.

In December 2010, our Chief Operating Officer, William Sipper, resigned following an alleged incident involving a prospective employee of the Company. We have turned the matter over to its insurance carrier. Management believes its insurance is adequate to cover any liability in connection with the claim and takes the position that any acts by Mr. Sipper were done outside the scope of his employment. This matter remains pending.
 
On July 11, 2011, we were served with a complaint from Bett-A-Way Traffic Systems, Inc. demanding payment of $90,928 in a debt collection matter. We have accrued for this payment of $90,928 as of June 30, 2011 as part of accounts payable. The parties have been involved in settlement negotiations and we remain hopeful that we will be able to amicably resolve this matter.
 
We are not a party to any other legal proceeding that we believe would have a material adverse effect on our business, results of operations or financial condition.
 
On May 19, 2011 the OTC Bulletin Board (“OTCBB”) delisted our common stock from trading thereon due to lateness in filing our Annual Report on Form 10-K. That Annual Report was subsequently filed. Since May 19, 2011 our common stock has been listed for quotation on the “Pink Sheets” under the symbol "NLEF.PK". We are now current in our periodic filing obligations. While we will try to re-list our shares on the OTCBB, there can be no assurance that same will occur.
 
ITEM 1A.  RISK FACTORS

There have been no material changes from the risk factors as previously disclosed under 1A of our annual report on  Form 10-K for the fiscal year ended December 31, 2010.
 
 
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 ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On January 21, 2011, we completed a unit offering of an aggregate of $1,215,000 of its Series K 10% Convertible Preferred Stock (“Series K Preferred Stock”) and three series (Series X, Y and Z) of common stock purchase warrants (“Warrants”) to 11 accredited investors. Each unit sold consisted of one share of $25,000 stated value (and liquidation preference) of Series K Preferred Stock and Warrants to purchase up to an  aggregate of 333,333 shares of common stock at $0.15 per share, subject to adjustment. A total of 48.6 units were sold. The Series X Warrants are five-year warrants, exercisable immediately to purchase an aggregate of 4,049,999 shares of common stock. The Series Y Warrants are exercisable until 45 days after the effectiveness of a certain registration statement and are exercisable to purchase an aggregate of 4,049,999 shares of common stock. The Series Z Warrants are five-year warrants whose effectiveness is conditional upon the exercise of the holder’s Y warrants and are exercisable to purchase an aggregate of 8,100,001 shares of common stock. Pursuant to a Registration Rights Agreement described below, Investors also received the right to demand that the Company file one or more registration statements covering the securities into which the Series K Preferred Stock is convertible and as to which the Warrants are exercisable.  As a condition to consummation of the offering, certain individuals converted outstanding debt in the original principal amount of $2,050,000 into 82 units of the Company’s Series K Preferred Stock and issued 6,833,334 Series Y warrants. Additionally, all subscribers to the Company’s 12% Original Issue Discount Notes sold in September and October 2010, whose then current balances on such Notes aggregated $2,079,171, were automatically converted into 83.16 units of the Company’s Series K Preferred Stock and were issued X, Y and Z warrants pari passu to the current unit investors (an aggregate of 6,930,571 Series X warrants, 6,930,571 Series Y warrants and 13,861,139 Series Z warrants).
 
On April 29, 2011, we closed a private placement of common stock with certain accredited investors. We agreed to issue and sell to the investors, and the investors agreed to purchase, an aggregate of 5,666,667 shares of our common stock. Gross proceeds from the private placement were approximately $425,000.

With respect to the issuance of our securities and notes as described above, we relied on the Section 4(2) exemption from securities registration under the federal securities laws for transactions not involving any public offering. No advertising or general solicitation was employed in offering the securities. The securities were sold to accredited investors. The securities were offered for investment purposes only and not for the purpose of resale or distribution, and the transfer thereof was appropriately restricted by us.

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

We are in negotiation with certain former shareholders of Nutritional Specialties, Inc. The value of these notes as of June 30, 2011 in the aggregate amount of $822,920. As of June 30, 2011, we are in default and therefore this amount is reflected as currently due.
 
ITEM 5 - OTHER INFORMATION
 
Item 1.01 Entry into a Material Definitive Agreement.
 
 
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ITEM 6 - EXHIBITS
 
3.1
Articles of Incorporation, as amended (included as Exhibit 3.1 to the Form 10-KSB filed April 18, 1996, and incorporated herein by reference).
 
3.2
By-Laws, dated February 14, 1988 (included as Exhibit 3 to the Form S-1 filed January 27, 1987, and incorporated herein by reference).
 
3.3
Amendment to Articles of Incorporation, dated December 6, 2007, and effective on December 18, 2007 (included as Exhibit 3.1 to the Form 8-K filed December 26, 2007, and incorporated herein by reference).
 
3.4
Amendment to Articles of Incorporation, effective October 16, 2009 (included as Exhibit 3.1 to the Form 8-K filed October 14, 2009, and incorporated herein by reference).
 
4.1
Specimen Common Stock Certificate, dated July 9, 1993 (included as Exhibit 1 to the Form 8-A filed July 2, 1993, and incorporated herein by reference).
 
4.2
Certificates of Designation for Class A, Class B and Class C Preferred Shares (included as Exhibit 4.3 to the Form 10-QSB filed August 11, 1997, and incorporated herein by reference).
 
4.3
Certificate of Designation of Preferences and Rights of Series H Preferred Stock, dated December 21, 2005 (included as Exhibit 4.1 to the Form 8-K filed January 3, 2006, and incorporated herein by reference).
 
4.4
Certificate of Designation of Series I 8% Cumulative Convertible Preferred Stock, dated March 30, 2007 (included as Exhibit 4.X to the Form 8-K filed April 11, 2007, and incorporated herein by reference).
 
4.5
Form of Common Stock Purchase Warrant between the Company and investors in the 2007 Private Placement, dated March 30, 2007 (included as Exhibit 4.iii to the Form 8-K filed on April 11, 2007, and incorporated herein by reference).
 
4.6
Common Stock Purchase Warrants between the Company and O. Lee Tawes and John Talty, dated March 30, 2007 (included as Exhibit 4.v to the Form 8-K filed on April 11, 2007, and incorporated herein by reference).
 
4.7
Common Stock Purchase Warrant between the Company and JSH Partners, dated March 30, 2007 (included as Exhibit 4.vii to the Form 8-K filed on April 11, 2007, and incorporated herein by reference).
 
4.8
Common Stock Purchase Warrants between the Company and Thomas Pinkowski, Charles Ung and M. Amirul Karim, dated March 30, 2007 (included as Exhibit 4.ix to the Form 8-K filed on April 11, 2007, and incorporated herein by reference).
 
4.9
Form of Common Stock Purchase Warrant between the Company and Northeast Securities, Inc., dated March 30, 2007 (included as Exhibit 4.23 to the Form SB-2/A filed on October 12, 2007, and incorporated herein by reference).
 
4.10
Common Stock Purchase Warrant between the Company and Ira. J. Gaines, dated June 28, 2006 (included as Exhibit 4.25 to the Form SB-2/A filed on October 12, 2007, and incorporated herein by reference).
 
4.11
Letter Agreement by and between the Company and Northeast Securities, Inc., dated September 7, 2006 (included as Exhibit 4.26 to the Form SB-2/A filed on October 12, 2007, and incorporated herein by reference).
 
4.12
Letter Agreement by and between the Company and Northeast Securities, Inc., dated March 12, 2007 (included as Exhibit 4.27 to the Form SB-2/A filed on October 12, 2007, and incorporated herein by reference).

4.13
Letter Agreement by and between the Company and Northeast Securities, Inc., dated August 21, 2006 (included as Exhibit 4.28 to the Form SB-2/A filed on October 12, 2007, and incorporated herein by reference).
 
4.14
Common Stock Purchase Warrant between the Company and Ira J. Gaines, dated April 5, 2005 (included as Exhibit 4.30 to the Form SB-2/A filed October 12, 2007, and incorporated herein by reference).
 
 
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4.15
Certificate of Designation of Series J 6% Redeemable Convertible Preferred Stock, dated December 22, 2008 (included as Exhibit 4.1 to the Form 8-K filed December 23, 2008, and incorporated herein by reference).

4.16
Baywood International, Inc. 2008 Stock Option and Incentive Plan, dated May 14, 2008 (included as Exhibit 4.1 to the Registration Statement on Form S-8 filed June 27, 2008, and incorporated herein by reference).
 
4.17
Common Stock Purchase Warrant between the Company and Eric Skae, dated March 20, 2009 (included as Exhibit 4.1 to the Form 8-K filed March 24, 2009, and incorporated herein by reference).
 
4.18
Form of Common Stock Purchase Warrant, dated September 5, 2008 (included as Exhibit 10.2 to the Form 8-K filed September 11, 2008, and incorporated herein by reference).
 
4.19
Common Stock Purchase Warrant between the Company and O. Lee Tawes, III, dated February 4, 2008 (included as Exhibit 4.29 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.20
Common Stock Purchase Warrant between the Company and O. Lee Tawes, III, dated February 19, 2008 (included as Exhibit 4.30 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.21
Form of Subscription Agreement (included as Exhibit 4.31 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.22
Form of Warrant (included as Exhibit 4.32 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.23
Common Stock Purchase Warrant between the Company and O. Lee Tawes, dated July 14, 2008 (included as Exhibit 4.33 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.24
Common Stock Purchase Warrant between the Company and Eric Skae, dated October 23, 2008 (included as Exhibit 4.34 to the Form 10-Q filed May 20, 2009, and incorporated herein by reference).
 
4.25
Certificate of Designation of Series K 10% Cumulative Convertible Preferred Stock, dated January 21, 2011 (included as Exhibit 4.5 to the Form 8-K filed January 26, 2011, and incorporated herein by reference).
 
10.17
Asset Purchase Agreement by and among the Company, Nutritional Specialties, Inc., and Nutra, Inc., dated July 24, 2009 (included as Exhibit 10.1 to the Form 8-K filed July 30, 2009, and incorporated herein by reference).
 
10.18
Settlement Agreement and Mutual Release between Farmatek IC VE DIS TIC, LTD. STI and Oskiyan Hamdemir on the one hand and the Company and Nutritional Specialties, Inc. on the other hand, dated June 12, 2009 (included as Exhibit 10.45 to the Form 10-Q filed August 19, 2009, and incorporated herein by reference).
 
10.19
Assignment of Lease between Nutritional Specialties, Inc. and Boyd Business Center of Orange, dated October 9, 2009 (included as Exhibit 10.1 to the Form 8-K filed October 14, 2009, and incorporated herein by reference).
 
10.20
Non-interest bearing subordinated note issued by the Company to Eric Skae, dated April 1, 2010 ( included as Exhibit 10.20 to the Form 10-Q filed May 17, 2010, and incorporated herein by reference ).
 
10.21
10% Subordinated note issued by the Company to O. Lee Tawes, dated April 30, 2010 (included as Exhibit 10.21 to the Form 10-Q filed May 17, 2010, and incorporated herein by reference ).
 
10.22
Employment agreement between the Company and David Tsiang, dated May 11, 2010 (included as Exhibit 10.22 to the Form 10-Q filed May 17, 2010, and incorporated herein by reference ).
 
10.23
Purchase Order and Working Capital Financing Agreement, by and among the Company, John Tally, O. Lee Tawes, Lorraine DiPaolo and Jack Harris (filed herewith).
 
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 (filed herewith).
 
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 
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  SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
NEW LEAF BRANDS, INC.
 
       
Date:  August 22, 2011
By:
/s/ Eric Skae
 
   
Eric Skae
 
   
Chief Executive Officer
 
   
(Principal Executive Officer)
 
 
Date:  August 22, 2011
By:
/s/ David Tsiang
 
   
David Tsiang
 
   
Chief Financial Officer
 
   
(Principal Financial Officer and Principal Accounting Officer)
 
 
 
 
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