Attached files
file | filename |
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EX-10.1 - EXHIBIT 10.1 - Electronic Cigarettes International Group, Ltd. | s104569_ex10-1.htm |
EX-32.2 - EXHIBIT 32.2 - Electronic Cigarettes International Group, Ltd. | s104569_ex32-2.htm |
EX-32.1 - EXHIBIT 32.1 - Electronic Cigarettes International Group, Ltd. | s104569_ex32-1.htm |
EX-31.2 - EXHIBIT 31.2 - Electronic Cigarettes International Group, Ltd. | s104569_ex31-2.htm |
EX-31.1 - EXHIBIT 31.1 - Electronic Cigarettes International Group, Ltd. | s104569_ex31-1.htm |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2016
Or
¨ 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 000-52745
Electronic Cigarettes International Group, Ltd.
(Exact name of registrant as specified in its charter)
Nevada | 98-0534859 |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
1707 Cole Boulevard, Suite 350, Golden, Colorado | 80401 |
(Address of Principal Executive Offices) | (Zip Code) |
(720) 575-4222
(Registrant's Telephone Number, Including Area Code)
Not Applicable
(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. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
As of November 15, 2016, the Registrant had 116,731,183 shares of common stock issued and outstanding.
Electronic Cigarettes International Group, Ltd.
Table of Contents
Part I – FINANCIAL INFORMATION
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Amounts)
September 30, 2016 | (Notes 1 and 3) (Revised) December 31, 2015 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 946 | $ | 704 | ||||
Accounts receivable, net of allowance of $1,794 and $1,565, respectively | 2,161 | 1,542 | ||||||
Inventories | 2,821 | 4,330 | ||||||
Prepaid expenses and other | 3,017 | 2,074 | ||||||
Assets held for sale | 782 | 2,386 | ||||||
Total current assets | 9,727 | 11,036 | ||||||
Other assets: | ||||||||
Goodwill | 32,516 | 39,652 | ||||||
Identifiable intangible assets, net | 21,347 | 27,009 | ||||||
Property and equipment, net | 1,755 | 2,099 | ||||||
Debt issuance costs and other | - | 283 | ||||||
Assets held for sale | - | 15,235 | ||||||
Total assets | $ | 65,345 | $ | 95,314 | ||||
LIABILITIES AND STOCKHOLDERS' DEFICIT | ||||||||
Current liabilities: | ||||||||
Current maturities of debt financing | $ | 1,700 | $ | 22,942 | ||||
Accounts payable | 4,193 | 4,160 | ||||||
Accrued interest and other | 3,735 | 10,188 | ||||||
Current income taxes | 3,118 | 2,794 | ||||||
Warrant and derivative liabilities | 26,416 | 54,908 | ||||||
Liabilities held for sale | - | 397 | ||||||
Total current liabilities | 39,162 | 95,389 | ||||||
Long-term liabilities: | ||||||||
Debt financing, net of current maturities | 96,720 | 67,971 | ||||||
Deferred income taxes | 2,832 | 3,867 | ||||||
Total liabilities | 138,714 | 167,227 | ||||||
Commitments and contingencies (Note 13) | ||||||||
Stockholders' deficit: | ||||||||
Common stock, par value $0.001 per share; 300,000,000 shares authorized; 108,783,187 and 74,552,006 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively | 109 | 75 | ||||||
Additional paid-in capital | 398,659 | 387,793 | ||||||
Accumulated deficit | (460,905 | ) | (453,793 | ) | ||||
Accumulated other comprehensive loss | (11,232 | ) | (5,988 | ) | ||||
Total stockholders' deficit | (73,369 | ) | (71,913 | ) | ||||
Total liabilities and stockholders' deficit | $ | 65,345 | $ | 95,314 |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
1 |
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2016 and 2015
(Dollars in Thousands, Except Per Share Amounts)
(Note 3) (Revised) | ||||||||
2016 | 2015 | |||||||
Net sales | $ | 9,725 | $ | 12,902 | ||||
Cost of goods sold | 4,169 | 5,577 | ||||||
Gross profit | 5,556 | 7,325 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative: | ||||||||
Compensation and benefits: | ||||||||
Salaries, wages and benefits | 2,470 | 2,686 | ||||||
Stock-based compensation | 215 | (61 | ) | |||||
Professional fees and administrative | 1,505 | 4,307 | ||||||
Marketing and selling | 1,150 | 2,060 | ||||||
Depreciation and amortization | 1,368 | 1,476 | ||||||
Impairment of long-lived assets | 4,274 | - | ||||||
Severance | 20 | 74 | ||||||
Total operating expenses | 11,002 | 10,542 | ||||||
Loss from operations | (5,446 | ) | (3,217 | ) | ||||
Other income (expense): | ||||||||
Warrant fair value adjustment | 21,338 | 18,637 | ||||||
Derivative fair value adjustment | 8,603 | 495 | ||||||
Loss on extinguishment of debt | - | (334 | ) | |||||
Interest expense | (1,432 | ) | (3,809 | ) | ||||
Debt financing inducement expense | - | (1,331 | ) | |||||
Loss on troubled debt restructuring | (24,223 | ) | - | |||||
Gain on conversion of notes payable | 24 | - | ||||||
Total other income (expense) | 4,310 | 13,658 | ||||||
Income (loss) from continuing operations before income taxes | (1,136 | ) | 10,441 | |||||
Income tax expense | (227 | ) | (304 | ) | ||||
Income (loss) from continuing operations | (1,363 | ) | 10,137 | |||||
Loss from discontinued operations, including loss on disposal of $13,524, net of tax | (13,775 | ) | (908 | ) | ||||
Net income (loss) | (15,138 | ) | 9,229 | |||||
Other comprehensive loss: | ||||||||
Foreign currency translation loss | (1,120 | ) | (2,283 | ) | ||||
Comprehensive income (loss) | $ | (16,258 | ) | $ | 6,946 | |||
Income (loss) per common share - basic: | ||||||||
Income (loss) from continuing operations | $ | (0.01 | ) | $ | 0.14 | |||
Loss from discontinued operations | (0.13 | ) | (0.01 | ) | ||||
Net income (loss) | $ | (0.14 | ) | $ | 0.13 | |||
Income (loss) per common share - diluted: | ||||||||
Income (loss) from continuing operations | $ | (0.01 | ) | $ | 0.10 | |||
Loss from discontinued operations | (0.13 | ) | (0.01 | ) | ||||
Net income (loss) | $ | (0.14 | ) | $ | 0.09 | |||
Weighted average number of shares outstanding: | ||||||||
Basic | 105,874,000 | 71,511,000 | ||||||
Diluted | 105,874,000 | 113,361,000 |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
2 |
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2016 and 2015
(Dollars in Thousands, Except Per Share Amounts)
2016 | (Notes 1 and 3) (Revised) 2015 | |||||||
Net sales | $ | 28,412 | $ | 34,248 | ||||
Cost of goods sold | 12,819 | 15,082 | ||||||
Gross profit | 15,593 | 19,166 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative: | ||||||||
Compensation and benefits: | ||||||||
Salaries, wages and benefits | 7,251 | 7,783 | ||||||
Stock-based compensation | 4,034 | 12,235 | ||||||
Professional fees and administrative | 5,851 | 11,559 | ||||||
Marketing and selling | 3,655 | 7,125 | ||||||
Depreciation and amortization | 4,217 | 4,259 | ||||||
Impairment of long-lived assets | 4,274 | - | ||||||
Severance | 66 | 725 | ||||||
Total operating expenses | 29,348 | 43,686 | ||||||
Loss from operations | (13,755 | ) | (24,520 | ) | ||||
Other income (expense): | ||||||||
Warrant fair value adjustment | 54,921 | 98,898 | ||||||
Derivative fair value adjustment | 9,012 | 60,749 | ||||||
Loss on extinguishment of debt | (8,572 | ) | (70,690 | ) | ||||
Gain on extinguishment of warrants | 86 | 49,782 | ||||||
Interest expense | (7,989 | ) | (57,027 | ) | ||||
Debt financing inducement expense | - | (67,765 | ) | |||||
Loss on troubled debt restructuring | (24,163 | ) | - | |||||
Gain on conversion of notes payable | 24 | - | ||||||
Settlement of litigation and disputes | (65 | ) | - | |||||
Total other income (expense) | 23,254 | 13,947 | ||||||
Income (loss) from continuing operations before income taxes | 9,499 | (10,573 | ) | |||||
Income tax expense | (109 | ) | (748 | ) | ||||
Income (loss) from continuing operations | 9,390 | (11,321 | ) | |||||
Loss from discontinued operations, including loss on disposal of $13,524 | (16,502 | ) | (3,277 | ) | ||||
Net loss | (7,112 | ) | (14,598 | ) | ||||
Other comprehensive loss: | ||||||||
Foreign currency translation loss | (5,244 | ) | (1,514 | ) | ||||
Comprehensive loss | $ | (12,356 | ) | $ | (16,112 | ) | ||
Income (loss) per common share - basic: | ||||||||
Income (loss) from continuing operations | $ | 0.11 | $ | (0.22 | ) | |||
Loss from discontinued operations | (0.19 | ) | (0.07 | ) | ||||
Net loss | $ | (0.08 | ) | $ | (0.29 | ) | ||
Income (loss) per common share - diluted: | ||||||||
Income (loss) from continuing operations | $ | 0.04 | $ | (0.22 | ) | |||
Loss from discontinued operations | (0.06 | ) | (0.07 | ) | ||||
Net loss | $ | (0.02 | ) | $ | (0.29 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 85,555,000 | 51,171,000 | ||||||
Diluted | 251,767,000 | 51,171,000 |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
3 |
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Deficit
For the Nine Months Ended September 30, 2016
(Dollars in Thousands)
Accumulated | ||||||||||||||||||||||||
Additional | Other | |||||||||||||||||||||||
Common Stock | Paid-in | Accumulated | Comprehensive | |||||||||||||||||||||
Shares | Amount | Capital | Deficit | Loss | Total | |||||||||||||||||||
Balances, December 31, 2015 (Revised - Note 1) | 74,552,006 | $ | 75 | $ | 387,793 | $ | (453,793 | ) | $ | (5,988 | ) | $ | (71,913 | ) | ||||||||||
Issuance of common stock for: | ||||||||||||||||||||||||
Vesting of restricted stock | 259,698 | - | - | - | - | - | ||||||||||||||||||
Board of director fees | 756,069 | - | 181 | - | - | 181 | ||||||||||||||||||
Board of director shares exchanged for stock options | (756,069 | ) | - | - | - | - | - | |||||||||||||||||
Officer bonus | 115,385 | - | 30 | - | - | 30 | ||||||||||||||||||
Conversion of notes payable | 2,758,966 | 3 | 373 | - | - | 376 | ||||||||||||||||||
Payment of interest | 31,097,132 | 31 | 6,459 | - | - | 6,490 | ||||||||||||||||||
Other stock-based compensation | - | - | 3,823 | - | - | 3,823 | ||||||||||||||||||
Foreign currency translation loss | - | - | - | - | (5,244 | ) | (5,244 | ) | ||||||||||||||||
Net loss | - | - | - | (7,112 | ) | - | (7,112 | ) | ||||||||||||||||
Balances, September 30, 2016 | 108,783,187 | $ | 109 | $ | 398,659 | $ | (460,905 | ) | $ | (11,232 | ) | $ | (73,369 | ) |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
4 |
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2016 and 2015
(Dollars in Thousands)
2016 | (Notes 1 and 3) (Revised) 2015 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net loss | $ | (7,112 | ) | $ | (14,598 | ) | ||
Loss from discontinued operations | 16,502 | 3,277 | ||||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 4,217 | 4,259 | ||||||
Impairment of long lived assets | 4,274 | - | ||||||
Deferred income tax benefit | (1,035 | ) | (411 | ) | ||||
Stock-based compensation | 4,034 | 12,235 | ||||||
Issuance of common stock for services, cancellation of derivatives and interest | 6,490 | 9,351 | ||||||
Debt financing inducement expense | - | 67,765 | ||||||
Warrant fair value adjustment | (54,921 | ) | (98,898 | ) | ||||
Derivative fair value adjustment | (9,012 | ) | (60,749 | ) | ||||
Loss on extinguishment and conversion of debt | 8,548 | 70,690 | ||||||
Gain on extinguishment of warrants | (86 | ) | (49,782 | ) | ||||
Amortization of debt discount and issuance costs | 1,505 | 23,821 | ||||||
Warrants issued for interest | - | 24,445 | ||||||
Loss on troubled debt restructuring | 24,163 | - | ||||||
Changes in operating assets and liabilities: | ||||||||
Decrease (increase) in: | ||||||||
Accounts receivable, net | (618 | ) | (201 | ) | ||||
Inventories | 1,508 | 1,672 | ||||||
Prepaid expenses and other | (887 | ) | 2,960 | |||||
Increase (decrease) in: | ||||||||
Accounts payable and accrued expenses | (6,620 | ) | (3,332 | ) | ||||
Current income taxes | 324 | 345 | ||||||
Net cash used in operating activities – continuing operations | (8,726 | ) | (7,151 | ) | ||||
Net cash provided by (used in) operating activities – discontinued operations | (60 | ) | 628 | |||||
Net cash used in operating activities | (8,786 | ) | (6,523 | ) | ||||
Cash Flows from Investing Activities: | ||||||||
Proceeds from sale of property and equipment | - | 578 | ||||||
Payments for property and equipment | (869 | ) | (1,483 | ) | ||||
Net cash used in investing activities | (869 | ) | (905 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Proceeds from debt financings | 10,804 | 17,609 | ||||||
Principal payments under debt financings | (867 | ) | (10,936 | ) | ||||
Payments for debt issuance costs | (259 | ) | (109 | ) | ||||
Proceeds from exercise of stock options | - | 22 | ||||||
Net cash provided by financing activities | 9,678 | 6,586 | ||||||
Impact of changes in foreign exchange rates | 219 | (621 | ) | |||||
Net increase (decrease) in cash and equivalents | 242 | (1,463 | ) | |||||
Cash and Equivalents: | ||||||||
Beginning of period | 704 | 2,099 | ||||||
End of period | $ | 946 | $ | 636 |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
5 |
Electronic Cigarettes International Group, Ltd.
Unaudited Condensed Consolidated Statements of Cash Flows, Continued
For the Nine Months Ended September 30, 2016 and 2015
(Dollars in Thousands)
2016 | (Note 1) (Revised) 2015 | |||||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Cash paid for interest | $ | 1,237 | $ | 770 | ||||
Cash paid for income taxes | $ | - | $ | 849 | ||||
Supplemental Disclosure of Non-cash Investing and Financing Activities: | ||||||||
Fair value of derivatives issued in debt and equity financings | $ | - | $ | 156,527 | ||||
Settlement and rollover of debt financings, accrued interest and prepayment penalties in new borrowings | $ | 2,117 | $ | 43,328 | ||||
Issuance of common stock for settlement of convertible note payable | $ | 376 | $ | 14,658 | ||||
Revolver borrowings to settle debt issuance costs | $ | - | $ | 160 | ||||
Accrued liability for debt issuance costs | $ | - | $ | 150 |
The Accompanying Notes are an Integral Part of These Unaudited Condensed Consolidated Financial Statements.
6 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
1. | BASIS OF PRESENTATION |
Basis of Presentation. The accompanying unaudited condensed consolidated financial statements are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”) and have been prepared by Electronic Cigarettes International Group, Ltd. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements have been included.
Our organization and operations, the accounting policies we follow and other information are contained in the footnotes to our consolidated financial statements filed as part of our Annual Report on Form 10-K for the year ended December 31, 2015. This quarterly report should be read in conjunction with such Form 10-K. Our financial condition as of September 30, 2016, and operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the financial condition and results of operations that may be expected for any future interim period or for the year ending December 31, 2016. The condensed consolidated balance sheet as of December 31, 2015 included herein was derived from the audited financial statements as of that date, but does not include all disclosures, including notes required by GAAP.
Change in Estimate. The Company periodically reviews the depreciation and amortization periods for long-lived assets to ensure that the service lives coincide with the periods over which the assets are expected to provide service benefits. During the first quarter of 2016, management determined that the amortization periods for identifiable intangible assets associated with the FIN reporting unit should be reduced. Accordingly, the amortization period for customer relationships was reduced from 10 years to 4 years, and the amortization period for trade names was reduced from 13 years to 10 years. For the three and nine months ended September 30, 2016, the aggregate effect of this change in estimate resulted in an increase to net loss of $348 and $1,044 (net loss per basic and diluted share of $0.00 and $0.00 for the three months ended September 30, 2016 and $0.01 and $0.00 for the nine months ended September 30, 2016, respectively).
Revision of 2015 Statement of Operations. As discussed in Note 1 to the consolidated financial statements, included in the Company’s 2015 Annual Report on Form 10-K, during the fourth quarter of 2015 management discovered two errors, one of which affected the previously issued financial statements for the nine months ended September 30, 2015. This reporting error relates to the issuance of a credit to a large customer of the Company’s wholly-owned subsidiary, FIN Electronic Cigarette Corporation, Inc., in June 2014 and resulted from the Company’s agreement to provide retroactive price concessions. In the previously issued balance sheet as of December 31, 2014, the Company did not account for the unsettled portion of this price concession through the recognition of a liability of $2,269 as of that date. The impact of this error to the Company’s previously reported results of operations for the nine months ended September 30, 2015 was an understatement of net sales by $892. There was no impact for the three months ended September 30, 2015.
Management has evaluated the effect of this error on the Company’s results of operations and determined that the impact is quantitatively and qualitatively immaterial to the Company’s previously reported results of operations for the nine months ended September 30, 2015 and, therefore, the Company determined that an amendment to the previously filed Quarterly Reports on Form 10-Q was not necessary. Accordingly, under SEC Staff Accounting Bulletin No. 108, the Company has revised the previously issued financial statements for the nine months ended September 30, 2015 included herein to correct this error.
7 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following tables set forth the previously reported results of operations for the nine months ended September 30, 2015, along with the adjustments discussed above to reconcile previously reported amounts to the revised amounts presented in the accompanying consolidated financial statements:
Nine Months Ended September 30, 2015 | ||||||||||||
As Previously Reported (2) | Adjustments | As Revised | ||||||||||
Net sales (1) | $ | 33,356 | $ | 892 | $ | 34,248 | ||||||
Cost of goods sold | (15,082 | ) | (15,082 | ) | ||||||||
Gross profit | 18,274 | 892 | 19,166 | |||||||||
Operating expenses | (43,686 | ) | (43,686 | ) | ||||||||
Loss from operations | (25,412 | ) | 892 | (24,520 | ) | |||||||
Other income (expense) | 13,947 | 13,947 | ||||||||||
Loss from continuing operations before income taxes | (11,465 | ) | 892 | (10,573 | ) | |||||||
Income tax expense | (748 | ) | (748 | ) | ||||||||
Loss from continuing operations | (12,213 | ) | 892 | (11,321 | ) | |||||||
Loss from discontinued operations | (3,277 | ) | (3,277 | ) | ||||||||
Net loss | (15,490 | ) | 892 | (14,598 | ) | |||||||
Loss per common share - basic and diluted: | ||||||||||||
Loss from continuing operations | $ | (0.23 | ) | $ | 0.01 | $ | (0.22 | ) | ||||
Loss from discontinued operations | (0.07 | ) | - | (0.07 | ) | |||||||
Net loss | $ | (0.30 | ) | $ | 0.01 | $ | (0.29 | ) |
(1) | Revision of $892 for the nine months ended September 30, 2015 to previously reported net sales related to correction of the accounting for a retroactive price concession, as discussed above. |
(2) | The As Previously Reported amounts for the nine months ended September 30, 2015 reflect the impact resulting from reporting discontinued operations. See Note 3, Divestitures. |
Correction of Immaterial Errors – Identifiable Intangible Assets and Income Taxes
We identified errors while preparing the second quarter of 2016 unaudited condensed consolidated financial statements related to identifiable intangible assets and income taxes dating back to March 31, 2015 and December 31, 2014, respectively. Management evaluated the materiality of the errors described above from a qualitative and quantitative perspective. Based on such evaluation, we concluded that, while the errors were significant to the nine months ended September 30, 2016, the corrections would not be material to any individual prior period, nor did they have an effect on the trend of financial results, taking into account the requirements of the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). Accordingly, we are correcting the errors in the December 31, 2015 consolidated balance sheet, the unaudited condensed consolidated statement of operations and comprehensive income (loss) for the nine months ended September 30, 2015, the unaudited condensed consolidated statement of changes in stockholders’ deficit for the nine months ended September 30, 2016; there was no impact to the unaudited condensed consolidated statements of operations and comprehensive income (loss) for the three months ended September 30, 2015, and cash flows for the nine months ended September 30, 2015.
8 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following table sets forth the previously reported balance sheet as of December 31, 2015, along with adjustments to reconcile previously reported amounts to the revised amounts presented in the accompanying consolidated financial statements:
December 31, 2015 | ||||||||||||||
Notes | As Previously Reported | Adjustments | As Revised | |||||||||||
Current income taxes | 1 | $ | 1,392 | $ | 1,402 | $ | 2,794 | |||||||
Deferred income taxes | 1 | 4,318 | (451 | ) | 3,867 | |||||||||
Accumulated deficit | 1,2 | (454,352 | ) | 559 | (453,793 | ) | ||||||||
Accumulated other comprehensive loss | 1,2 | (4,478 | ) | (1,510 | ) | (5,988 | ) | |||||||
Nine Months Ended September 30, 2015 | ||||||||||||||
Notes | As Previously Reported | Adjustments | As Revised | |||||||||||
Net loss | 3 | $ | (15,490 | ) | $ | 892 | $ | (14,598 | ) | |||||
Other comprehensive income (loss): | ||||||||||||||
Foreign currency translation income (loss) | 2 | (2,287 | ) | 773 | (1,514 | ) | ||||||||
Comprehensive income (loss) | (17,777 | ) | 1,665 | (16,112 | ) |
(1) | Revision as of December 31, 2015 to increase current income taxes payable by $1,402, decrease deferred income taxes payable by $451, decrease accumulated deficit by $1,331 and increase accumulated other comprehensive loss by $2,282 resulting from corrections to the computation of UK income taxes. |
(2) | Revision to increase customer relationships by $515 and trade names by $258 as of March 31, 2015 for foreign currency translation adjustments with a corresponding reduction to accumulated other comprehensive loss, and the subsequent impairment of those identifiable intangible assets during the fourth quarter ended December 31, 2015. |
(3) | Revision to net loss discussed in Revision of 2015 Statement of Operations above. |
Reclassifications. Certain reclassifications have been made to prior period amounts and balances in order to conform to the current period presentation. These reclassifications had no impact on working capital, net loss, stockholders’ deficit or cash flows as previously reported.
Recent accounting pronouncements. The following recently issued accounting standards are not yet effective; the Company is assessing the impact these standards will have on its consolidated financial statements as well as the period in which adoption is expected to occur:
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers”. This comprehensive guidance will replace all existing revenue recognition guidance and, as amended, is effective for annual reporting periods beginning after December 15, 2018, and interim periods therein.
In August 2014, the FASB issued Update No. 2014-15—Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This was issued to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. The guidance is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. This ASU is intended to improve the recognition and measurement of financial instruments. Among other things, this ASU requires certain equity investments to be measured at fair value with changes in fair value recognized in net income. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods therein.
In February 2016, the FASB issued ASU 2016-02, “Leases”, which will supersede the existing guidance for lease accounting. This ASU will require lessees to recognize leases on their balance sheets, and leaves lessor accounting largely unchanged. This guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, and early adoption is permitted. The Company is currently assessing the impact this guidance will have on its consolidated financial statements.
9 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
In March 2016, the FASB issued ASU 2016-06, “ Contingent Put and Call Options in Debt Instruments ”, which clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, and early adoption is permitted.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”. The core change with this ASU is the simplification of several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years, and early adoption is permitted.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (ASU No. 2016-15). This guidance clarifies how certain cash receipts and payments should be presented in the statement of cash flows and is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted.
The following recently issued accounting standards were adopted effective January 1, 2016; the impact of adoption did not have a material impact on the Company’s consolidated financial statements:
In November 2014, the FASB issued ASU 2014-16, “Derivatives and Hedging: Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity ”. This ASU does not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required, but clarifies how current GAAP should be interpreted in the evaluation of the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share, reducing existing diversity in practice.
In January 2015, the FASB issued ASU 2015-01, “Income Statement—Extraordinary and Unusual Items”, that will simplify income statement classification by removing the concept of extraordinary items from GAAP. The separate disclosure of extraordinary items after income from continuing operations in the income statement is no longer permitted.
In February 2015, the FASB issued ASU No. 2015-02, “Consolidation: Amendments to the Consolidation Analysis”. The new standard is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures.
During 2015, the FASB issued ASUs No. 2015-03 and No. 2015-15 titled “Interest-Imputation of Interest”, which generally requires the presentation of debt issuance costs as a direct deduction from the carrying amount of the related debt liabilities. However, for debt issuance costs related to line-of-credit arrangements, the Company may continue presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. The Company elected to continue to present debt issuance costs related to its line of credit as an asset in its consolidated balance sheets.
In July 2015, the FASB issued ASU No. 2015-11, “Inventory: Simplifying the Measurement of Inventory”, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU No. 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
2. | LIQUIDITY AND GOING CONCERN |
The Company is continuing efforts to recover from certain obstacles it has faced, including unanticipated difficulties in fully integrating four business combinations completed over a period of seven months in 2014 and the inability to use proceeds from a proposed but aborted public offering of the Company’s common stock during the fourth quarter of 2014. This required major restructuring and financing activities and, in response to those challenges, the Company completed certain actions to improve liquidity and operating results as reflected in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
10 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following is summary financial information as of September 30, 2016 and for the nine months then ended:
September 30, 2016 | ||||
Working capital deficit (including warrant and derivative liabilities of $26,416) | $ | 29,435 | ||
Accumulated deficit | $ | 460,905 | ||
Current maturities of debt financing (face amount): | ||||
VIP promissory notes | $ | 3,600 | ||
Accrued interest payable: | ||||
Term loans | $ | 621 | ||
Convertible debt | 54 | |||
Forbearance agreement | 149 | |||
VIP promissory notes | 600 | |||
Total accrued interest payable (including $835 to be paid in cash) | $ | 1,424 | ||
Nine Months Ended September 30, 2016 | ||||
Loss from operations | $ | 13,755 | ||
Net cash used in operating activities | $ | 8,786 |
Over the past two fiscal years, the Company has relied on debt and equity financings to fund its 2014 acquisitions while experiencing negative operating cash flows. As of September 30, 2016, the Company had amortizing VIP promissory note payments of $300 per month commencing in October 2016.
To address past liquidity requirements, on July 8, 2016, the Company amended certain debt financing agreements that resulted in the following:
· | Deferral of the maturity date on $94,965 of debt financing to June 2020, including $74,257 of term loans, $19,457 of convertible debt and $1,251 under the forbearance agreement; | |
· | Reduction to the term loans, forbearance agreement and convertible debt interest rates from 12.0%, 14.0% and 8.0%, respectively, to 4.0%; | |
· | Elimination of amortizing payments on the term loans; | |
· | Use of shares of the Company’s common stock to pay interest on term loans due on a quarterly basis, and on convertible debt due on a monthly basis (holders of 84.7% of the amended term loans, the new term loan and the convertible debt elected to receive their interest in shares of the Company); | |
· | Entry into a fifth term loan for $4,000 on terms and conditions consistent with the four previous term loans, as amended; | |
· | Deferral of interest on the forbearance agreement; and | |
· | Payment of all outstanding accrued interest payable through the issuance of 30,676,704 shares of the Company’s common stock to Calm Waters Partnership (“Calm Waters”), with the remainder in cash. |
As a result of these efforts, the Company has improved its financial condition. However, capital resources may not be sufficient to enable the execution of its global business plan in the near term. Despite the actions taken to date, these and other conditions create ongoing substantial doubt about the Company’s ability to meet its financial obligations, to continue operations in the normal course of business, and to continue as a going concern. These consolidated financial statements do not include any adjustments for the recoverability and valuation of assets or the amounts and classification of liabilities if the Company is unable to continue as a going concern.
11 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
3. | DIVESTITURES |
On October 5, 2016, the Company and its wholly-owned subsidiary Hardwire Interactive Acquisition Company (“HIAC”), known internally as Global E-Commerce (“GEC”), entered into an Asset Purchase Agreement with Hardwire Interactive, Inc. (“HII”) for the sale of the majority of the assets of HIAC to HII for $800 cash. Beginning on September 30, 2016, the Company reported the operating results of HIAC as discontinued operations in the condensed consolidated statement of operations for all periods presented. In addition, the assets and liabilities associated with the discontinued operations are classified as assets and liabilities held for sale in the condensed consolidated balance sheets for all periods presented.
The following table provides the components of discontinued operations, net of tax:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net sales | $ | 2,118 | $ | 2,499 | $ | 6,904 | $ | 5,149 | ||||||||
Cost of goods sold | 654 | 519 | 2,245 | 2,066 | ||||||||||||
Gross profit | 1,464 | 1,980 | 4,659 | 3,083 | ||||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative: | ||||||||||||||||
Compensation and benefits: | ||||||||||||||||
Salaries, wages and benefits | 151 | 47 | 450 | 171 | ||||||||||||
Professional fees and administrative | 338 | 486 | 1,181 | 744 | ||||||||||||
Marketing and selling | 1,174 | 1,435 | 3,884 | 2,685 | ||||||||||||
Depreciation and amortization | 281 | 920 | 2,122 | 2,760 | ||||||||||||
Total operating expenses | 1,944 | 2,888 | 7,637 | 6,360 | ||||||||||||
Loss from operations | (480 | ) | (908 | ) | (2,978 | ) | (3,277 | ) | ||||||||
Loss on disposal (1) | (13,295 | ) | - | (13,524 | ) | - | ||||||||||
Loss from discontinued operations | $ | (13,775 | ) | $ | (908 | ) | $ | (16,502 | ) | $ | (3,277 | ) |
(1) | Includes deferred tax benefit of $229 for the three months ended September 30, 2016. There were no income taxes for the nine months ended September 30, 2016. |
The following table provides the components of assets and liabilities held for sale as of September 30, 2016 and December 31, 2015:
2016 | 2015 | |||||||
Cash | $ | - | $ | (14 | ) | |||
Accounts receivable | 782 | 1,415 | ||||||
Inventories | - | 788 | ||||||
Prepaid expenses and other | - | 197 | ||||||
Total current assets held for sale | 782 | 2,386 | ||||||
Goodwill | - | 8,071 | ||||||
Identifiable intangible assets, net | - | 7,164 | ||||||
Total long-term assets held for sale | - | 15,235 | ||||||
Total assets held for sale | $ | 782 | $ | 17,621 | ||||
Accounts payable | - | 303 | ||||||
Accrued interest and other | - | 94 | ||||||
Total current liabilities held for sale | $ | - | $ | 397 |
(2) As of September 30, 2016, total current assets held for sale represent the sales price of $800 less selling costs of $18.
12 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
4. | GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS |
Goodwill
During the third quarter of 2016, after evidencing declines in revenue, gross profit margins and cash flows relative to the corresponding period of 2015, and despite a reduction in operating expenses, these triggering events, gave rise for the need to perform an interim test of Vapestick’s goodwill for impairment. Based on an estimated enterprise value of $5,753 and a reporting unit carrying value of $10,027, the Company recorded impairment to goodwill of $4,274 for the three and nine months ended September 30, 2016. The third quarter of 2016 impairment loss was an estimate that, upon revision to forecasts to be generated during the fourth quarter of 2016, may require further adjustment during that period.
Goodwill consists of the following by reporting unit as of September 30, 2016 and December 31, 2015:
Reporting Unit | 2016 | 2015 | ||||||
FIN | $ | 16,586 | $ | 16,586 | ||||
VIP | 9,289 | 10,606 | ||||||
Vapestick | 6,641 | 12,460 | ||||||
Total | $ | 32,516 | $ | 39,652 |
Goodwill decreased by $2,862 from December 31, 2015 and September 30, 2016 due to foreign exchange translation adjustments associated with the VIP and Vapestick acquisitions.
Identifiable Intangible Assets
Identifiable intangible assets consist of the following as of September 30, 2016 and December 31, 2015:
2016 | 2015 | |||||||||||||||||||||||
Cost | Accumulated Amortization | Net Book Value | Cost | Accumulated Amortization | Net Book Value | |||||||||||||||||||
Customer relationships | $ | 22,720 | $ | (10,145 | ) | 12,575 | $ | 24,548 | $ | (8,308 | ) | $ | 16,240 | |||||||||||
Trade names | 12,428 | (4,376 | ) | 8,052 | 13,763 | (3,901 | ) | 9,862 | ||||||||||||||||
Internet domains and websites | 953 | (233 | ) | 720 | 1,091 | (184 | ) | 907 | ||||||||||||||||
Total | $ | 36,101 | $ | (14,754 | ) | 21,347 | $ | 39,402 | $ | (12,393 | ) | $ | 27,009 | |||||||||||
Amortization expense: | ||||||||||||||||||||||||
Three months ended September 30 | $ | 1,055 | $ | 1,151 | ||||||||||||||||||||
Nine months ended September 30 | $ | 3,265 | $ | 3,491 |
13 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
5. | PROPERTY AND EQUIPMENT |
Property and equipment consists of the following as of September 30, 2016 and December 31, 2015:
2016 | 2015 | |||||||
Office furniture and equipment | $ | 2,691 | $ | 2,376 | ||||
Retail inventory displays | 1,026 | 1,026 | ||||||
Leasehold improvements | 162 | 183 | ||||||
Other | 116 | 67 | ||||||
Total property and equipment | 3,995 | 3,652 | ||||||
Less accumulated depreciation and amortization | (2,240 | ) | (1,553 | ) | ||||
Property and equipment, net | $ | 1,755 | $ | 2,099 | ||||
Depreciation and amortization expense: | ||||||||
Three months ended September 30 | $ | 313 | $ | 325 | ||||
Nine months ended September 30 | $ | 952 | $ | 768 |
6. | DEBT FINANCING |
(a) Debt Summary
The Company’s debt financing arrangements as of September 30, 2016 and December 31, 2015 consist of the following:
September 30, 2016 | ||||||||||||||||||||||||
Original Date of Financing | Maturity Date | Interest Rate | Principal | Unamortized Discount | Net Balance | December 31, 2015 Net Balance | ||||||||||||||||||
Term loans: | ||||||||||||||||||||||||
April 2015 Term Loans (1) | April 2015 | June 2020 | 4.0 | % | $ | 41,214 | $ | (3,019 | ) | $ | 38,195 | $ | 38,027 | |||||||||||
June 2015 Term Loan (1) | June 2015 | June 2020 | 4.0 | % | 6,000 | (439 | ) | 5,561 | 6,000 | |||||||||||||||
October 2015 Term Loan (1) | October 2015 | June 2020 | 4.0 | % | 18,000 | (1,318 | ) | 16,682 | 18,000 | |||||||||||||||
January 2016 Term Loan (1) | January 2016 | June 2020 | 4.0 | % | 9,043 | (662 | ) | 8,381 | - | |||||||||||||||
July 2016 Term Loan (1) | July 2016 | June 2020 | 4.0 | % | 4,000 | (293 | ) | 3,707 | ||||||||||||||||
Total Term Loans | 78,257 | (5,731 | ) | 72,526 | 62,027 | |||||||||||||||||||
Forbearance Agreement (2) | September 2015 | June 2020 | 4.0 | % | 1,251 | - | 1,251 | 1,251 | ||||||||||||||||
Convertible Debt (3) | January & February 2014 | June 2020 | 4.0 | % | 19,055 | (1,395 | ) | 17,660 | 19,785 | |||||||||||||||
VIP Promissory Notes (4) | April 2014 | December 2017 | 5.4 | % | 6,983 | - | 6,983 | 7,400 | ||||||||||||||||
Unsecured Note (5) | March 2015 | March 2016 | 0.4 | % | - | - | - | 450 | ||||||||||||||||
Total | $ | 105,546 | $ | (7,126 | ) | 98,420 | 90,913 | |||||||||||||||||
Less current maturities, net of discount amortization | (1,700 | ) | (22,942 | ) | ||||||||||||||||||||
Long-term | $ | 96,720 | $ | 67,971 |
As of September 30, 2016, Calm Waters Partnership (“Calm Waters”) is the holder of $81,543 of the Company’s debt, including $35,000 of the April 2015 Term Loans, all of the June 2015, October 2015, January 2016 and July 2016 Term Loans, all of the Forbearance Agreement and $8,249 of the Convertible Debt, representing 77% of the outstanding balance.
14 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
(1) Credit Agreements. In January 2016, the Company and Calm Waters entered into an amendment that provided for an additional term loan of $9,043 with terms and conditions the same as those provided in the April 2015, June 2015 and October 2015 Term Loans (the “January 2016 Term Loan”).
The January 2016 Term Loan proceeds were used for (i) payment of $5,300 to settle patent infringement litigation and other legal settlements, (ii) repayment of convertible debt of $351 and accrued interest of $1,735 due Calm Waters, (iii) settlement of trade payables and costs of the financings for $650, (iv) repayment of $270 of principal on the VIP Promissory Notes, and (v) the remaining $737 was available for working capital and other general corporate purposes.
On July 8, 2016, the Company entered into an amendment to extend the maturity date of the Term Loans from April 2018 to June 2020, and to reduce the interest rate from 12.0% to 4.0%. The amendment also provides for (i) the elimination of amortizing payments and (ii) the use of shares of the Company’s common stock to pay interest on a quarterly basis at the one-time election of the lender. Holders of 84.7% of the amended term loans, the new term loan and the convertible debt elected to receive their interest in shares of the Company. Shares issued to pay interest shall be included in the securities subject to the Registration Rights Agreement entered into on April 27, 2015. Upon execution of the amendments, the Company issued 30,676,704 shares of common stock to Calm Waters to pay accrued but unpaid interest owing on the Term Loans and Convertible Debt, with the remainder of accrued but unpaid interest paid in cash. The Company also granted Calm Waters additional warrants to purchase 49,088,030 shares of common stock at $0.145 per share, 28,000,000 of which were associated with the new fifth term loan, and 21,088,030 of which were associated with the acquisition by Calm Waters of certain Term Loans and Convertible Debt from existing holders.
The Company also entered into a fifth term loan for $4,000 on terms and conditions consistent with those provided by the first four amended term loans. Proceeds from the fifth term loan are planned for working capital purposes. After consummation of the fifth term loan, the aggregate of new loans and loans amended of $98,563 constitute 93% of the outstanding debt of $105,546.
(2) Forbearance Agreement. On July 8, 2016, the Company entered into an amendment to extend the maturity date from March 2017 to June 2020, and to reduce the interest rate from 14.0% to 4.0%. As of September 30, 2016, $149 of accrued interest was payable to Calm Waters.
(3) Convertible Debt. On July 8, 2016, the Company entered into an amendment to extend the maturity dates from July and August 2016 to June 2020, and to reduce the interest rate from 8.0% to 4.0%. In addition, the price to convert debt into shares of common stock of the Company was reduced to $0.145 from a range of $0.45 to $0.75. The amendment to the Convertible Debt also provides for the use of shares of the Company’s common stock to pay interest that is due on a monthly basis at the one-time election of the lender. In addition, the Convertible Debt is no longer subordinate to the Term Loans.
(4) VIP Promissory Notes. The Company made a principal payment of $270 in January 2016 as a concession to obtain the January 2016 Term Loan discussed above, and a principal payment of $147 in July 2016 resulting in an outstanding principal balance of $6,983 as of September 30, 2016.
(5) Unsecured Note. The Unsecured Note was due March 1, 2016 and was paid off at maturity.
(b) Future Maturities under Debt Financing Agreements
Based on debt agreements in effect as of September 30, 2016, the future principal payment requirements are shown below:
Year ending September 30, | ||||
2017 | $ | 3,600 | ||
2018 | 3,383 | |||
2019 | - | |||
2020 | 98,563 | |||
Total | $ | 105,546 |
(c) Interest Expense
Interest expense consists of the following:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 (2) | 2016 | 2015 | |||||||||||||
Interest at stated rate of debt agreement | $ | 1,299 | $ | 2,616 | $ | 6,786 | $ | 6,501 | ||||||||
Amortization of discount on debt issuance (1) | 435 | 1,126 | 1,222 | 23,754 | ||||||||||||
Interest related to warrant issuance and other | - | - | - | 26,705 | ||||||||||||
Payment in-kind interest fair value adjustments (3) | (302 | ) | - | (302 | ) | - | ||||||||||
Amortization of debt issuance costs | - | 67 | 283 | 67 | ||||||||||||
Total | $ | 1,432 | $ | 3,809 | $ | 7,989 | $ | 57,027 |
15 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
(1) Except for the debt financing inducements, at the date of a financing the fair value of Common Stock purchase warrants and compound embedded derivatives associated with debt conversion features are calculated and recorded as a debt discount. Such debt discounts are amortized to interest expense using the effective interest method over the remaining terms. If the holder of a convertible note elects to convert prior to the maturity date, the unamortized discount on the conversion date is charged to interest expense.
(2) See Note 1, Basis of Presentation, Revision of 2015 Statement of Operations.
(3) Interest on certain Term Loans and Convertible Debt are paid with shares of the Company’s common stock on a quarterly and monthly basis, respectively. In both instances, the number of shares are derived based on a 90-day variable weighted average price (“VWAP”). The product of the number of shares times the difference between the VWAP and the share price at the settlement date results in a periodic fair value adjustment to interest.
7. | WARRANTS AND EMBEDDED DERIVATIVES |
The following table summarizes the Company’s liability under warrant and compound embedded derivative agreements:
September 30, 2016 | December 31, 2015 | |||||||||||||||
Number of Shares (2) | Liability (2) | Number of Shares | Liability | |||||||||||||
Warrants | 398,237,188 | $ | 21,705 | 305,068,558 | $ | 54,412 | ||||||||||
Embedded derivatives in convertible debt (1) | 131,410,334 | 4,711 | 28,068,159 | 496 | ||||||||||||
Total | 529,647,522 | 26,416 | 333,136,717 | 54,908 | ||||||||||||
Less current portion | (26,416 | ) | (54,908 | ) | ||||||||||||
Long-term | $ | - | $ | - |
(1) The convertible debt instruments contain features that permit the holders to elect conversion of the debt to shares of the Company’s common stock. The Company bifurcates the conversion features from the related debt instruments and accounts for each component at its estimated fair value with updated valuations performed at the end of each calendar quarter.
(2) As of September 30, 2016, there were 108,783,187 common shares issued and outstanding. The Company would need to issue an additional 586,198,860 common shares to accommodate in their entirety the exercise of warrants (398,237,188), conversion of debt (131,410,334), exercise of stock options (54,574,337) and vesting of restricted stock (1,977,001). Existing shares and shares issued for all common stock equivalents could aggregate total outstanding shares of 694,982,047; as the Company has 300,000,000 common shares authorized, this could result in a deficiency of 394,982,047 shares.
In order to increase the number of shares available to cover the authorized share deficiency, the Company would need either to (i) amend its articles of incorporation to increase the amount of its authorized common shares or (ii) effect a reverse stock split which would decrease the current number of shares issued and outstanding as well as the number of shares issuable upon exercise or conversion of its outstanding stock options, warrants and convertible debt. Either of these corporate actions would require shareholder approval. If the Company is not able to cure the authorized share deficiency by the point when holders of such options, warrants and convertible debt attempt to exercise or convert such securities and the Company no longer has common shares available to fill such exercise or conversion, the Company would be required to settle a portion of its warrant and derivative liabilities in cash which requires that these instruments continue to be classified as liabilities rather than equity instruments.
16 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
Fair Value of Warrant Liability
The following table summarizes the terms and fair value of the Company’s liability related to warrants outstanding:
September 30, 2016 | ||||||||||||||
Year of Issuance | Year of Expiration | Exercise Price | Number of Shares | Fair Value of Liability(2) | ||||||||||
2015 | 2022 | $ | 0.15 | 251,045,614 | $ | 14,017 | ||||||||
2016 | 2023 | 0.15 | 94,302,805 | 5,650 | ||||||||||
2015 | 2020 | 0.15 | 17,206,821 | 927 | ||||||||||
2014 | 2019 | 0.15 | 10,098,766 | 478 | ||||||||||
2014 | 2019 | 0.45 | 9,908,131 | 259 | ||||||||||
2014 | 2019 | 0.37 | 6,666,669 | 208 | ||||||||||
2014 | 2019 | 1.01 | 4,148,214 | 61 | ||||||||||
2013 | 2018 | 0.75 | 2,006,667 | 35 | ||||||||||
2015 | 2020 | 1.01 | 1,496,214 | 28 | ||||||||||
2013 | 2019 | 0.75 | 1,000,000 | 27 | ||||||||||
2014 | 2019 | 0.21 | 176,339 | 7 | ||||||||||
2016 | 2019 | 0.15 | 109,052 | 5 | ||||||||||
2014 | 2019 | 0.21 | 71,896 | 3 | ||||||||||
Total | $ | 0.17 | (1) | 398,237,188 | $ | 21,705 | ||||||||
December 31, 2015 | ||||||||||||||
Year of Issuance | Year of Expiration | Exercise Price | Number of Shares | Fair Value of Liability(2) | ||||||||||
2015 | 2022 | $ | 0.45 | 246,198,582 | $ | 45,718 | ||||||||
2015 | 2020 | 1.01 | 14,860,382 | 1,491 | ||||||||||
2014 | 2019 | 0.45 | 10,969,265 | 1,887 | ||||||||||
2014 | 2019 | 1.01 | 13,185,185 | 1,859 | ||||||||||
2015 | 2022 | 0.21 | 5,995,453 | 1,270 | ||||||||||
2014 | 2019 | 0.37 | 6,666,669 | 1,171 | ||||||||||
2015 | 2020 | 0.45 | 3,842,653 | 552 | ||||||||||
2013 | 2018 | 0.75 | 2,006,667 | 299 | ||||||||||
2013 | 2019 | 0.75 | 1,000,000 | 114 | ||||||||||
2014 | 2019 | 0.21 | 248,236 | 50 | ||||||||||
2015 | 2016 | 0.75 | 66,667 | 1 | ||||||||||
2014 | 2016 | 1.49 | 28,799 | - | ||||||||||
Total | $ | 0.50 | (1) | 305,068,558 | $ | 54,412 |
(1) | Represents the weighted average exercise price. |
(2) | Please refer to Note 14, Fair Value Measurements, for additional information about methodologies used to determine the fair value of warrants. |
The Company has issued the following warrants to Calm Waters, which constitute 86% of the total outstanding warrants as of September 30, 2016:
Year of Issuance | Year of Expiration | Exercise Price | Number of Shares | |||||||
2014 | 2019 | $ | 0.145 | 4,444,444 | ||||||
2015 | 2020 | 0.145 | 16,229,542 | |||||||
2015 | 2022 | 0.145 | 228,405,638 | |||||||
2016 | 2023 | 0.145 | 94,302,805 | |||||||
Total | 343,382,429 |
As a condition of the warrant agreements, Calm Waters was not permitted to own more than 4.99% of the Company’s common stock (the “Beneficial Ownership Threshold”) upon exercise of outstanding warrants. Upon 61 days’ notice, Calm Waters was permitted to increase or decrease the Beneficial Ownership Threshold, but never increase the Beneficial Ownership Threshold in excess of 9.99%. On July 8, 2016, the Company amended certain debt financing arrangements. In connection therewith, existing warrant agreements with Calm Waters were amended to eliminate the Beneficial Ownership Threshold, and Calm Waters was granted additional warrants. As of September 30, 2016 and November 15, 2016, Calm Waters is the direct beneficial owner of 29.6% and 34.1% of the Company’s common stock, respectively.
17 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
On July 8, 2016, in connection with amendments to its loans, warrants previously issued to Calm Waters to acquire common stock were amended as follows:
Exercise Price | ||||||||||||||
Year of Issuance | Year of Expiration | Original | Amended | Number of Shares | ||||||||||
Convertible Debt | ||||||||||||||
2015 | 2022 | $ | 0.45 | $ | 0.145 | 3,842,653 | ||||||||
2015 | 2020 | 1.01 | 0.145 | 7,387,655 | ||||||||||
11,230,308 | ||||||||||||||
Term Loans | ||||||||||||||
2015 | 2022 | 0.45 | 0.145 | 222,410,185 | ||||||||||
2016 | 2023 | 0.25 | 0.145 | 45,214,775 | ||||||||||
2014 | 2019 | 1.01 | 0.145 | 9,443,678 | ||||||||||
2015 | 2020 | 0.21 | 0.145 | 5,995,453 | ||||||||||
283,064,091 | ||||||||||||||
Total | 294,294,399 |
18 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
Warrants previously issued to Convertible Debt and Term Loan holders, excluding those issued to Calm Waters and included above, were amended as follows:
Exercise Price | ||||||||||||||
Year of Issuance | Year of Expiration | Original | Amended | Number of Shares | ||||||||||
Convertible Debt | ||||||||||||||
2014 | 2019 | $ | 1.01 | $ | 0.145 | 4,543,212 | ||||||||
2015 | 2020 | 1.01 | 0.145 | 977,278 | ||||||||||
2014 | 2019 | 0.45 | 0.145 | 1,111,111 | ||||||||||
6,631,601 | ||||||||||||||
Term Loans | ||||||||||||||
2015 | 2022 | 0.45 | 0.145 | 23,022,782 | ||||||||||
29,654,383 |
The following table summarizes changes in the Company’s outstanding warrants and the related liability for the nine months ended September 30, 2016:
Number of Warrants | Warrant Liability | |||||||
Balance, beginning of period | 305,068,558 | $ | 54,412 | |||||
Issuance of warrants: | ||||||||
January 2016 Term Loan (1) | 45,214,775 | 8,571 | ||||||
July 2016 Term Loan (1) | 28,000,000 | 2,931 | ||||||
Restructuring (1) | 21,088,030 | 2,208 | ||||||
Anti-dilution adjustments (2) | 109,052 | - | ||||||
Modification of warrants: | ||||||||
Amendments | - | 8,504 | ||||||
Surrenders | (1,148,418 | ) | - | |||||
Expirations | (94,809 | ) | - | |||||
Periodic fair value adjustments | - | (54,921 | ) | |||||
Balance, end of period | 398,237,188 | $ | 21,705 |
(1) | Issued to Calm Waters. |
(2) | Some of the Company’s warrant agreements previously included anti-dilution adjustments whereby the exercise price and number of shares would reset to a lower exercise price and an increased number of shares (a “Reset Event”). Upon a Reset Event, the fair value of the warrant liability was adjusted and a loss was recognized. As of September 30, 2015, the warrant agreements were amended whereby substantially all such anti-dilution features were eliminated. |
Fair Value of Embedded Derivatives for Convertible Debt
As of September 30, 2016, the following presents the conversion prices, number of shares issuable, and the fair value of the Company’s liability under compound embedded derivative agreements:
Date of Financing | Principal Balance | Conversion Price | Shares Issuable | Derivative Liability | ||||||||||||||
Convertible debt | January & February 2014 | $ | 19,055 | $ | 0.145 | 131,410,334 | $ | 4,711 |
8. | OTHER INFORMATION |
Foreign Sales
The Company generated approximately $6,885 and $9,113 of foreign sales during the three months and $23,378 and $27,098 for the nine months ended September 30, 2016 and 2015, respectively. The concentration of foreign sales during 2016 were impacted by the declining value of the Great Britain Pound, which resulted in a decrease to net sales of $1,244 and $2,331 for the three and nine months ended September 30, 2016, respectively.
19 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
Disclosures Related to Statements of Operations
Presented below are certain expenses included in the accompanying statements of operations:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Marketing and selling expenses: | ||||||||||||||||
Advertising | $ | 50 | $ | 326 | $ | 152 | $ | 2,190 | ||||||||
Rent expense | 995 | 921 | 3,088 | 2,332 | ||||||||||||
Other | 105 | 813 | 415 | 2,603 | ||||||||||||
Total | $ | 1,150 | $ | 2,060 | $ | 3,655 | $ | 7,125 |
9. | RELATED PARTY TRANSACTIONS |
Certain marketing and logistics support services are provided by entities controlled by a key employee of the Company’s GEC division that was acquired from Hardwire Interactive, Inc. These services were provided prior to the Company’s 2014 acquisition of GEC and have continued under the Company’s ownership. These arrangements may be discontinued by either party at any time, and the total services provided amounted to $282 and $402 for the three months and $859 and $1,218 for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016 and December 31, 2015, accounts payable to this related party amounted to $109 and $49, respectively. On October 5, 2016, the Company sold the GEC division back to the previous owners and, therefore, the services were no longer provided thereafter.
In January 2015, warrant terms with two warrant holders were amended whereby the number of warrants would be 1,000,000 each at an exercise price of $0.75 per share, and certain adjustment provisions were removed. These transactions were entered into with affiliates of a former member of the Company’s board of directors. Management determined that the affiliates surrendered rights that were significantly greater in value than the consideration exchanged by $44,230 and, accordingly, this amount was treated as a capital contribution since it was entered into with related parties. Additionally, in March 2015, a consultant surrendered a warrant to purchase 1,000,000 shares of common stock at an exercise price of $0.75. The fair value of the warrant on the date of surrender resulted in a gain on extinguishment of warrants of $2,233.
In January 2015, the Company’s Chief Executive Officer purchased $195 principal amount of January 2014 15% Convertible Notes, which were purchased from another note holder, as well as warrants to purchase 260,608 shares of the Company’s common stock at an exercise price of $1.01, which were issued in conjunction with the note purchase. The 15% Convertible Notes and warrants were subject to the amendments as discussed in Note 6, Debt Financing.
10. | STOCK-BASED COMPENSATION |
Stock Options
In addition to options granted under shareholder-approved stock option plans, the Company has granted options outside of these plans for a total of 54,169,161 shares as of September 30, 2016. Since these options were not issued pursuant to a shareholder approved stock option plan, they are non-qualified stock options for income tax purposes. Total stock-based compensation related to stock options was approximately $183 and $(61) for the three months, and $3,543 and $12,235 for the nine months ended September 30, 2016 and 2015, respectively.
20 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following table summarizes share activity and the weighted average exercise prices related to stock options outstanding for the nine months ended September 30, 2016 and 2015:
Nine Months Ended September 30, 2016 | Nine Months Ended September 30, 2015 | |||||||||||||||
Shares | Weighted Average Price | Shares | Weighted Average Price | |||||||||||||
Outstanding, beginning of period | 26,547,399 | $ | 1.09 | 540,000 | $ | 26.10 | ||||||||||
Granted | 61,107,672 | 0.16 | 32,196,317 | 0.60 | ||||||||||||
Forfeited | (33,080,734 | ) | 0.54 | (1,373,334 | ) | 0.87 | ||||||||||
Outstanding, end of period | 54,574,337 | $ | 0.41 | 31,362,983 | $ | 1.02 | ||||||||||
Exercisable, end of period | 40,923,251 | $ | 0.47 | 20,381,935 | $ | 1.28 |
On June 30, 2016, the Company terminated options to acquire 31,014,067 shares of common stock and contemporaneously issued options to acquire 50,117,673 shares of common stock to certain key employees and directors.
The weighted average fair value for stock options granted for the nine months ended September 30, 2016 and 2015 was $0.10 and $0.49 per share, respectively. In estimating the fair value of options, the Company used the Black-Scholes option-pricing model based upon the closing price of the Company’s stock on the date of grant and the following weighted average assumptions for the nine months ended September 30, 2016 and 2015:
2016 | 2015 | |||||||
Expected lives (in years) | 5.3 | 5.3 | ||||||
Risk-free interest rate | 1.4 | % | 1.5 | % | ||||
Expected volatility | 85.0 | % | 139.0 | % | ||||
Expected forfeiture rate | 8.0 | % | 8.0 | % | ||||
Expected dividend yield | 0.0 | % | 0.0 | % |
We estimate expected volatility based on historical daily price changes of our common stock for a period equal to the current expected term of the options. The risk-free interest rate is based on the United States treasury yields in effect at the time of grant corresponding with the expected term of the options. The expected option term is the number of years we estimate that options will be outstanding prior to exercise considering vesting schedules and our historical exercise patterns.
Stock-based compensation expense is recognized over the vesting period of stock options and restricted stock awards. For a single award with a graded vesting schedule and only service conditions, the Company recognizes compensation cost on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was in substance multiple awards. For stock options granted through September 30, 2016, unrecognized stock compensation expense amounted to $911 which will be charged to expense over the remaining vesting periods of the options, which is a weighted average period of 1.58 years as of September 30, 2016. As of September 30, 2016, the aggregate intrinsic value of all outstanding stock options amounted to $0 based on the closing stock price of $0.09 per share on September 30, 2016. The following table summarizes information about stock options outstanding as of September 30, 2016:
Outstanding Options | Vested Options | |||||||||||||||||||||||||
Exercise Price | ||||||||||||||||||||||||||
Low | High | Weighted Average | Remaining Contractual Term | Number of Shares | Weighted Average Price | Number of Shares | ||||||||||||||||||||
$ | 0.16 | $ | 0.16 | $ | 0.16 | 9.8 | 29,847,398 | $ | 0.16 | 24,585,980 | ||||||||||||||||
0.16 | 0.16 | 0.16 | 9.8 | 23,593,605 | 0.16 | 15,203,937 | ||||||||||||||||||||
0.37 | 77.25 | 11.09 | 5.7 | 1,133,334 | 11.09 | 1,133,334 | ||||||||||||||||||||
$ | 0.16 | $ | 77.25 | $ | 0.41 | 9.7 | 54,574,337 | $ | 0.47 | 40,923,251 |
21 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
Restricted Stock
The fair value of the restricted stock grants is based upon the closing price of the Company’s stock on the date of grant. The following table summarizes share activity, the weighted average fair value per share, and the change in unrecognized compensation related to restricted stock grants outstanding:
Nine Months Ended September 30, 2016 | Nine Months Ended September 30, 2015 | |||||||||||||||||||||||
Number of Shares | Weighted Average Fair Value Per Share | Unrecognized Compensation | Number of Shares | Weighted Average Fair Value Per Share | Unrecognized Compensation | |||||||||||||||||||
Unvested shares, beginning of period | 2,596,999 | $ | 0.64 | $ | 1,177 | 66,667 | $ | 5.85 | $ | 1,445 | ||||||||||||||
Shares granted | - | - | - | 2,963,665 | 0.65 | 1,646 | ||||||||||||||||||
Compensation recognized | - | - | (276 | ) | - | - | (1,560 | ) | ||||||||||||||||
Forfeited | (360,300 | ) | 0.69 | (247 | ) | (77,777 | ) | 3.66 | - | |||||||||||||||
Shares vested | (259,698 | ) | 0.64 | - | (22,223 | ) | 5.85 | - | ||||||||||||||||
Unvested shares, end of period | 1,977,001 | $ | 0.63 | $ | 654 | 2,930,332 | $ | 0.65 | $ | 1,531 |
Unrecognized compensation expense of $654 related to restricted stock will be recognized over the vesting period set forth in the restricted stock agreements, which extends through June 2019. The aggregate intrinsic value of unvested restricted stock was $178 based on the closing price of $0.09 for the Company’s common stock on September 30, 2016.
11. | INCOME TAXES |
The Company is subject to federal and state income taxes in the United States. Additionally, as a result of business combinations completed in 2014, the Company has been subject to foreign income taxes in the United Kingdom (“U.K.”) since the date of the acquisitions. The following is a summary of U.S. and U.K income taxes:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Income tax benefit (expense): | ||||||||||||||||
U.S. | $ | 11 | $ | (14 | ) | $ | 1 | $ | (23 | ) | ||||||
U.K. | 7 | (290 | ) | 135 | (725 | ) | ||||||||||
$ | 18 | $ | (304 | ) | $ | 136 | $ | (748 | ) |
A valuation allowance has been provided for all the U.S.-based net deferred tax assets, including the Federal tax net operating losses and foreign tax credits, since the “more likely than not” realization criteria was not met as of September 30, 2016 and 2015. As of September 30, 2016, gross unrecognized tax benefits are immaterial and there was no change in such benefits during the nine months ended September 30, 2016. The Company does not expect a significant increase or decrease to the uncertain tax positions within the next twelve months.
12. | NET INCOME (LOSS) PER SHARE |
Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding warrants, stock options, shares issuable under convertible debt and unvested restricted stock using the as-converted and treasury stock methods. During most periods when there is a net loss, all potentially dilutive shares are anti-dilutive and are excluded from the calculation of diluted net loss per share. When there is income from continuing operations, a loss from discontinued operations and a net loss, potentially dilutive shares are included in the calculation of diluted net loss per share.
22 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following table sets for the computation of basic and diluted net income (loss) per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 (1) | 2016 | 2015 | |||||||||||||
Income (loss) from continuing operations | $ | (1,363 | ) | $ | 10,137 | $ | 9,390 | $ | (11,321 | ) | ||||||
Interest expense on convertible debt | - | 1,280 | 985 | - | ||||||||||||
$ | (1,363 | ) | $ | 11,417 | $ | 10,375 | $ | (11,321 | ) | |||||||
Loss from discontinued operations | $ | (13,775 | ) | (908 | ) | (16,502 | ) | (3,277 | ) | |||||||
Net income (loss) | $ | (15,138 | ) | $ | 9,229 | $ | (7,112 | ) | $ | (14,598 | ) | |||||
Interest expense on convertible debt | - | 1,280 | 985 | - | ||||||||||||
$ | (15,138 | ) | $ | 10,509 | $ | (6,127 | ) | $ | (14,598 | ) | ||||||
Income (loss) from continuing operations per share: | ||||||||||||||||
Basic | $ | (0.01 | ) | $ | 0.14 | $ | 0.11 | $ | (0.22 | ) | ||||||
Diluted | $ | (0.01 | ) | $ | 0.10 | $ | 0.04 | $ | (0.22 | ) | ||||||
Loss from discontinued operations per share: | ||||||||||||||||
Basic | $ | (0.13 | ) | $ | (0.01 | ) | $ | (0.19 | ) | $ | (0.07 | ) | ||||
Diluted | $ | (0.13 | ) | $ | (0.01 | ) | $ | (0.06 | ) | $ | (0.07 | ) | ||||
Net income (loss) per share: | ||||||||||||||||
Basic | $ | (0.14 | ) | $ | 0.13 | $ | (0.08 | ) | $ | (0.29 | ) | |||||
Diluted | $ | (0.14 | ) | $ | 0.09 | $ | (0.02 | ) | $ | (0.29 | ) | |||||
Weighted average common shares outstanding: | ||||||||||||||||
Basic | 105,874,000 | 71,511,000 | 85,555,000 | 51,171,000 | ||||||||||||
Dilutive effect of warrants, stock options, convertible debt and unvested restricted stock | - | 41,850,000 | 166,212,000 | - | ||||||||||||
Diluted | 105,874,000 | 113,361,000 | 251,767,000 | 51,171,000 | ||||||||||||
Anti-dilutive common stock equivalents: | ||||||||||||||||
Warrants | 398,237,188 | 258,824,869 | 25,474,130 | 265,068,558 | ||||||||||||
Stock options | 54,574,337 | - | 1,133,332 | 38,894,655 | ||||||||||||
Convertible debt | 131,410,334 | 31,112,983 | - | 31,362,983 | ||||||||||||
Unvested restricted stock | 1,977,001 | - | - | 2,930,332 | ||||||||||||
Total | 586,198,860 | 289,937,852 | 26,607,462 | 338,256,528 |
(1) | See Note 1, Basis of Presentation, Revision 2015 Statement of Operations. |
13. | COMMITMENTS AND CONTINGENCIES |
Operating Leases
As of September 30, 2016, future minimum lease payments are as follows:
Year ending September 30, | ||||
2017 | $ | 1,103 | ||
2018 | 615 | |||
2019 | 306 | |||
2020 | 111 | |||
Total | $ | 2,135 |
For leases that provide for an abated rent period, the value of this inducement is being reflected as a reduction to rent expense over the term of the lease.
Royalties
On January 5, 2016, the Company reached a settlement to resolve a lawsuit that was filed in June 2012. During the fourth quarter of 2015, the Company recognized a charge for damages incurred under the settlement. Under the terms of the settlement, the Company was granted a non-exclusive license under the patents asserted in the litigation and certain other e-vapor technology related patents in exchange for an ongoing royalty based on net sales of certain products. Total royalties of $376 and $1,273 were incurred during the three and nine months ended September 30, 2016 and are included in cost of goods sold in the accompanying statement of operations.
23 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
Other Contingencies
From time to time we may be involved in various claims and legal actions arising in the ordinary course of our business. When the Company becomes aware of potential litigation, it evaluates the merits of the case in accordance with the applicable accounting literature. The Company evaluates its exposure to the matter, possible legal or settlement strategies and the likelihood of an unfavorable outcome. If the Company determines that an unfavorable outcome is probable and can be reasonably estimated, it establishes the necessary accruals. Certain insurance policies held by the Company may reduce the cash outflows with respect to an adverse outcome on certain of these litigation matters. The Company does not believe it is reasonably possible that any of these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations and cash flows.
14. | FAIR VALUE MEASUREMENTS |
The carrying amounts of cash, accounts receivable, and accounts payable approximate fair value as of September 30, 2016 and December 31, 2015, because of the relatively short maturities of these instruments. The estimated fair values for financial instruments presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. The carrying values of certain borrowings approximate fair value because the underlying instruments are fixed-rate notes based on current market rates and current maturities.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 | Quoted prices for identical assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. |
Level 2 | Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data. Level 2 also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. |
Level 3 | Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for nonbinding single dealer quotes not corroborated by observable market data. |
While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
24 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
The following is a description of the valuation methodologies used for complex financial instruments measured at fair value:
Warrant Valuation Methodologies
The Black Scholes model was used to compute the fair value of outstanding warrants. Key inputs into the valuation models include a risk-free interest rate and an expected stock price volatility. Significant assumptions include the following:
September 30, 2016 | December 31, 2015 | |||||||
Risk-free interest rate | 0.77% - 1.42 | % | 0.01% - 1.75 | % | ||||
Historical volatility | 84.7% - 112.3 | % | 90.4% - 129.7 | % | ||||
Weighted average term | 5.50 | 6.82 | ||||||
Expected dividend yield | 0.00 | % | 0.00 | % |
The risk-free interest rate is based on the yield of U.S. Treasury Bonds over the expected term. The expected share price volatility is based on historical common stock prices for the Company and comparable publicly-traded companies over a period commensurate with the expected term of the warrant. As these assumptions are revised in the future, significant adjustments to future valuation of warrants may result.
Recurring Fair Value Measurements
The Company does not have any recurring measurements of the fair value of assets. Recurring measurements of the fair value of liabilities are summarized as follows:
September 30, 2016 | December 31, 2015 | |||||||||||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||||
Warrant liability | $ | - | $ | - | $ | 21,705 | $ | 21,705 | $ | - | $ | - | $ | 54,412 | $ | 54,412 | ||||||||||||||||
Derivative liability | - | - | 4,711 | 4,711 | - | - | 496 | 496 | ||||||||||||||||||||||||
Total | $ | - | $ | - | $ | 26,416 | $ | 26,416 | $ | - | $ | - | $ | 54,908 | $ | 54,908 |
The Company did not make any transfers in or out of Level 3 for the nine months ended September 30, 2016. The following table presents a reconciliation of changes in liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2016:
Warrants | Derivatives | Total | ||||||||||
Fair value of liability, beginning of period | $ | 54,412 | $ | 496 | $ | 54,908 | ||||||
Issuances of new instruments and other | 13,710 | (1 | ) | 13,709 | ||||||||
Total net losses (gains) included in: | ||||||||||||
Fair value adjustments (1) | (54,921 | ) | (9,012 | ) | (63,933 | ) | ||||||
Extinguishments through modifications | 8,504 | 13,314 | 21,818 | |||||||||
Extinguishments through cancellations | - | (86 | ) | (86 | ) | |||||||
Fair value of liability, end of period | $ | 21,705 | $ | 4,711 | $ | 26,416 |
(1) | For the three and six months ended September 30, 2016, the loss on troubled debt restructuring of $24,223 and $24,163, respectively, included extinguishments through modifications of $21,818, a loss of $2,024 from revision to the amount of accrued interest through the July 8, 2016 date of restructuring and certain debt issuance costs, net of $381 and $321, respectively. |
25 |
Electronic Cigarettes International Group, Ltd.
Notes to Unaudited Condensed Consolidated Financial Statements
(Dollars in Thousands, Except Per Share Amounts)
15. | SUBSEQUENT EVENTS |
On October 5, 2016, the Company sold its GEC division. See Note 3, Divestiture.
On November 9, 2016, the Company entered into a second amendment (the “O’Neill Amendment”) to its employment agreement with Mr. Daniel J. O’Neill that was entered into on March 17, 2015, and amended on September 21, 2015 (the “O’Neill Employment Agreement”). The O’Neill Amendment amends the O’Neill Employment Agreement by providing that if Mr. O’Neill terminates his employment upon a Change of Control, as defined in the O’Neill Employment Agreement, then the Company is required to pay him a lump sum consisting of his earned but unpaid base salary through the termination date, a pro-rata annual bonus, the prior year’s annual bonus, to the extent earned but not paid, the amount of any unreimbursed business expenses, any accrued vacation or other pay pursuant to the Company’s vacation policy, to the extent not previously paid, and an amount equal to 36 months of base salary.
26 |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of the results of our operations and financial condition should be read in conjunction with the accompanying unaudited condensed consolidated financial statements in Item 1. Certain figures, such as interest rates and other percentages, included in this section have been rounded for ease of presentation. Percentage figures included in this section have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage amounts in this section may vary slightly from those obtained by performing the same calculations using the figures in our unaudited condensed consolidated financial statements or in the associated text. Certain other amounts that appear in this section may similarly not sum due to rounding.
Cautionary Note Regarding Forward Looking Statements
The information contained in Item 2 contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Actual results may materially differ from those projected in the forward-looking statements as a result of certain risks and uncertainties set forth in this report. Although we believe that the assumptions made and expectations reflected in the forward-looking statements are reasonable, there is no assurance that the underlying assumptions will, in fact, prove to be correct or that actual results will not be different from expectations expressed in this report.
This filing contains a number of forward-looking statements which reflect our current views and expectations with respect to our business, strategies, products, future results and events, and financial performance. All statements made in this filing other than statements of historical fact, including statements addressing operating performance, events, or developments which we expect or anticipate will or may occur in the future, including statements related to distributor channels, volume growth, net sales, profitability, new products, adequacy of funds from operations, statements expressing general optimism about future operating results, and non-historical information, are forward looking statements. In particular, the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “may,” variations of such words, and similar expressions identify forward-looking statements, but are not the exclusive means of identifying such statements, and their absence does not mean that the statement is not forward-looking. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below. Our actual results, performance or achievements could differ materially from historical results as well as those expressed in, anticipated, or implied by these forward-looking statements. We do not undertake any obligation to revise these forward-looking statements to reflect any future events or circumstances.
Readers should not place undue reliance on these forward-looking statements, which are based on our current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions (including those described below), and apply only as of the date of this filing. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors which could cause or contribute to such differences include, but are not limited to, the risks discussed in our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q, press releases and other communications to shareholders issued by us from time to time. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Overview
We are an independent marketer and distributor of vaping products and E-cigarettes. Our objective is to become a leader in the rapidly growing, global E-cigarette segment of the broader nicotine related products industry which includes traditional tobacco. E-cigarettes are battery-powered products that simulate tobacco smoking through inhalation of nicotine vapor without the fire, flame, tobacco, tar, carbon monoxide, ash, stub, smell and other chemicals found in traditional combustible cigarettes. The growth in the global E-cigarette market is forecast to come at the expense of traditional tobacco, and not from new smokers entering the category. Numerous research studies and publications have recognized that E-cigarettes are a preferred method for smokers to quit, and possibly one of the most effective.
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We accommodate the various product preferences of E-cigarette users by offering a comprehensive set of products, including disposables, rechargeables, tanks, starter kits, E-liquids, open and closed-end vaping systems and accessories. Our products consist of durable components and nicotine liquids that undergo rigorous quality testing during production. Our global brand portfolio includes the VIP, FIN and VAPESTICK. As of October 2016, we co-branded VIP with several leading technology brands. We believe that this combination of product breadth and quality, combined with our effective brand strategy, resonates strongly with adult consumers who associate our products with ease of use, quality, reliability and great taste.
The previous focus of “striving to offer our product to every point of distribution where traditional cigarettes are available” has been altered over the last year. In fact, ECIG has been paring back retail distribution and focusing on accounts where profitable, long-term, strategic partnerships can be developed. Our goal is to become the most valuable independent E-cigarette company in the world, delivering profitable growth to enhance shareholder value. We expect to achieve this goal by focusing on six primary strategic drivers:
· | Establish VIP as the # 1 premium global brand in the segment, measured by net revenue; | |
· | Utilize the FIN and Vapestick brands as the traditional retail brands; | |
· | Expand profitably into non-traditional channels and new markets through distribution partnerships; | |
· | Strengthen the organizational talent base; | |
· | Become a low-cost provider; and | |
· | Continue to improve working capital. |
Results of Operations
Foreign Exchange Movements
Due to the international aspect of our business, our net sales and expenses are affected by foreign currency exchange movements. Our primary exposures to foreign exchange rates are the Great Britain Pound and secondarily the Euro against the U.S. dollar. The financial results of our foreign operations are translated to U.S. dollars for consolidation purposes. The functional currency of our foreign subsidiaries is generally the local currency of the country of domicile. Accordingly, income and expense items are translated at the average rates prevailing during each reporting period and initially reported as a component of other comprehensive loss. Changes in exchange rates that affect cash flows and the related receivables or payables are recognized in our operating results as transaction gains and losses. The average Great Britain Pound to U.S. dollar foreign exchange rate decreased from 1.549619 for the three months ended September 30, 2015 to 1.312467 for the three months ended September 30, 2016. The average Great Britain Pound to U.S. dollar foreign exchange rate decreased from 1.532281 for the nine months ended September 30, 2015 to 1.393347 for the nine months ended September 30, 2016.
Risks Related to Government Regulation
As discussed in Part II, Item 1A, Risk Factors, Risks Related to Government Regulation, the FDA recently issued final rules, some of which became effective on August 8, 2016 and others that will be phased in during future periods. We cannot predict the impact that these new regulations will have on our company and what additional restrictions the FDA may subsequently impose. In this regard, total compliance and related costs are not possible to predict. The costs of compliance by us and our suppliers will likely result in higher costs to purchase the products we sell. To the extent it is not possible to pass increased costs on to customers, our financial results would likely deteriorate. Additionally, if we are unable to secure FDA approval to continue selling our existing products and any new products we would like to introduce, our net sales will be adversely impacted. The ultimate outcome of these matters could have a material adverse effect on our business, results of operations and financial condition. However, with approximately 82% of our 2016 net sales derived from products sold in the U.K., we will likely be impacted by the new regulations to a lesser extent than our competitors with a higher concentration of sales in the United States.
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Comparison of the Three Months Ended September 30, 2016 and 2015 (dollars in thousands)
2016 | 2015 | Impact to Results of Operations | Percentage Change in Component | |||||||||||||
Net sales | $ | 9,725 | $ | 12,902 | $ | (3,177 | ) | (24.6 | )% | |||||||
Cost of goods sold | 4,169 | 5,577 | 1,408 | 25.2 | % | |||||||||||
Gross profit | 5,556 | 7,325 | (1,769 | ) | (24.2 | )% | ||||||||||
Gross profit percentage | 57 | % | 57 | % | 0 | % | ||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative: | ||||||||||||||||
Compensation and benefits: | ||||||||||||||||
Salaries, wages and benefits | 2,470 | 2,686 | 216 | (8.0 | )% | |||||||||||
Stock-based compensation | 215 | (61 | ) | (276 | ) | - | ||||||||||
Professional fees and administrative | 1,505 | 4,307 | 2,802 | (65.1 | )% | |||||||||||
Marketing and selling | 1,150 | 2,060 | 910 | (44.2 | )% | |||||||||||
Depreciation and amortization | 1,368 | 1,476 | 108 | (7.3 | )% | |||||||||||
Impairment of long-lived assets | 4,274 | - | (4,274 | ) | - | |||||||||||
Severance | 20 | 74 | 54 | (73.0 | )% | |||||||||||
Total operating expenses | 11,002 | 10,542 | (460 | ) | 4.4 | % | ||||||||||
Loss from operations | (5,446 | ) | (3,217 | ) | (2,229 | ) | 69.3 | % | ||||||||
Other income (expense): | ||||||||||||||||
Warrant fair value adjustment | 21,338 | 18,637 | 2,701 | 14.5 | % | |||||||||||
Derivative fair value adjustment | 8,603 | 495 | 8,108 | 1,638.0 | % | |||||||||||
Loss on extinguishment of debt | - | (334 | ) | 334 | (100.0 | )% | ||||||||||
Interest expense | (1,432 | ) | (3,809 | ) | 2,377 | (62.4 | )% | |||||||||
Debt financing inducement expense | - | (1,331 | ) | 1,331 | (100.0 | )% | ||||||||||
Loss on troubled debt restructuring | (24,223 | ) | - | (24,223 | ) | - | ||||||||||
Gain on conversion of notes payable | 24 | - | 24 | - | ||||||||||||
Total other income (expense) | 4,310 | 13,658 | (9,348 | ) | (68.4 | )% | ||||||||||
Income (loss) from continuing operations before income taxes | (1,136 | ) | 10,441 | (11,577 | ) | - | ||||||||||
Income tax expense | (227 | ) | (304 | ) | 77 | - | ||||||||||
Income (loss) from continuing operations | (1,363 | ) | 10,137 | (11,500 | ) | - | ||||||||||
Loss from discontinued operations, including loss on disposal of $13,524, net of tax | (13,775 | ) | (908 | ) | (12,867 | ) | (1,417.1 | )% | ||||||||
Net income (loss) | $ | (15,138 | ) | $ | 9,229 | $ | (24,367 | ) | - |
Net Sales
Approximately 71% and 71% of net sales for the three months ended September 30, 2016 and 2015, respectively, were transacted in the Great Britain Pound currency and translated into the U.S. dollar functional currency. Due to the concentration of business in the U.K., lower foreign exchange rates accounted for an overall reduction of $1.2 million in net sales for the three months ended September 30, 2016.
The $3.2 million decrease in net sales was primarily due to a decrease to the FIN, VIP and Vapestick reporting units of $1.0 million, $1.5 million and $0.7 million, respectively. The decrease in net sales from the combined U.K. businesses of VIP and Vapestick was $2.2 million; excluding the $1.2 million reduction related to lower foreign exchange rates, the combined U.K. businesses net sales would have decreased $1.0 million.
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Cost of Goods Sold
The $1.4 million decrease in cost of goods sold was primarily attributable to a decrease to the FIN reporting unit of $0.3 million and to the VIP and Vapestick reporting units of $0.6 million and $0.5 million, respectively, primarily associated with lower net sales.
The estimated impact of lower foreign exchange rates in 2016 was a contributing factor in the changes discussed above for our VIP and Vapestick reporting units. This reduction in foreign exchange rates accounted for an overall reduction of $0.5 million in our 2016 cost of goods sold due to the concentration of business in the U.K.
In January 2016, we settled ongoing patent infringement litigation. In connection with the settlement, we were granted a non-exclusive license under the patents asserted in the litigation and certain other e-vapor technology related patents in exchange for an ongoing royalty based on net sales of certain products. For the three months ended September 30, 2016, our cost of goods sold includes royalties based on the sale of products that are subject to the license agreement.
Gross profit
Despite the increased cost associated with the royalty payments, the gross profit percentage remained static at 57% for both the three months ended September 30, 2016 and 2015.
Selling, General and Administrative Expenses
Compensation and Benefits
In addition to salaries, wages and benefits, we also incur non-cash stock-based compensation expenses. While our mix of personnel has changed significantly over the past year, the total cost incurred for salaries, wages and benefits has declined slightly.
During the third quarter of 2016, the increase in stock-based compensation was primarily due to expense related to the grant of options during 2016 for 28.0 million shares, net of terminated options for 33.1 million shares, primarily in connection with the amendment to certain debt financing arrangements. During the third quarter of 2015, the decrease in stock-based compensation was partially attributable to the reversal of previously recognized stock-based compensation expense of $1.2 million due to forfeitures of unvested stock options for terminated employees in 2015. As of September 30, 2016, stock-based compensation expense related to unvested stock options and restricted stock of $1.6 million is expected to be recognized in future periods as the options and restricted stock continue to vest.
Professional Fees and Administrative Expenses
Presented below are the major components of professional fees and other administrative expenses for the three months ended September 30, 2016 and 2015 (dollars in thousands):
2016 | 2015 | Impact to Results of Operations | Percentage Change in Component | |||||||||||||
Professional fees: | ||||||||||||||||
Auditing, accounting and tax | $ | 191 | $ | 653 | $ | 462 | (70.8 | )% | ||||||||
Financings, contracts and litigation | (149 | ) | 2,075 | 2,224 | (107.2 | )% | ||||||||||
Administrative expenses | 1,463 | 1,579 | 116 | (7.3 | )% | |||||||||||
Total | $ | 1,505 | $ | 4,307 | $ | 2,802 | (65.1 | )% |
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During the third quarter of 2015, we experienced inefficiencies during changes in personnel and independent auditors combined with a significant increase in the complexity of technical accounting and financial reporting services. Beginning in June 2015, we revised our personnel structure and changed our professional services providers, which was primarily responsible for the reduction in professional fees related to auditing, accounting and tax services for the three months ended September 30, 2016.
During the three months ended September 30, 2015, we incurred costs related to the settlement of our patent infringement case, legal fees associated with an amendment to our debt financing arrangements, and other general corporate matters. During the three months ended September 30, 2016, we incurred costs related to general corporate matters, which was offset by a reclassification of certain legal and professional fees to loss on troubled debt restructuring related to the July 8, 2016 refinancing that was previously expensed during the second quarter of 2016.
Marketing and Selling Expenses
During 2015, we made significant modifications to our mix of spending to focus more resources on kiosk rentals which we believe will be more effective at increasing net sales. Accordingly, we had an increase of $0.1 million from kiosk rentals due to an increase in the number of kiosks for the three months ended September 30, 2016 compared to the comparable period in 2015. This increase was offset by the effects of (i) a reduction in advertising expense of $0.3 million, and (ii) a $0.7 million reduction in other marketing and selling expenses as we eliminated less effective strategies.
Impairment of Long-Lived Assets
During the third quarter of 2016, after evidencing declines in revenue, gross profit margins and cash flows relative to the corresponding period of 2015, and despite a reduction in operating expenses, these triggering events, gave rise for the need to perform an interim test of Vapestick’s goodwill for impairment. Based on an estimated enterprise value of $5,753 and a reporting unit carrying value of $10,027, the Company recorded impairment to goodwill of $4,274 for the three months ended September 30, 2016. The third quarter of 2016 impairment loss was an estimate that, upon revision to forecasts to be generated during the fourth quarter of 2016, may require further adjustment during that period.
Warrant and Derivative Fair Value Adjustment
Our warrant and derivative liabilities are adjusted to fair market value using appropriate valuation models at the end of each calendar quarter. If the fair market value of these liabilities increases we recognize a loss in the statement of operations, and if the fair market value of the liabilities decreases a gain is recognized in the statement of operations. While numerous factors affect the changes in valuation, gains generally result as the market price for our common stock decreases and losses typically results as the market price increases.
During the three months ended September 30, 2016, our stock price decreased to $0.09 per share from $0.16 per share and the number of warrants subject to valuation increased by approximately 49 million shares. During the three months ended September 30, 2015, our stock price decreased to $0.27 per share from $0.29 per share and the number of warrants subject to valuation increased by approximately six million shares. Consequently, for the three months ended September 30, 2016 and 2015, this resulted in gains of $21.3 million and $18.6 million, respectively.
Our derivative liabilities are associated with the value of the convertible debt conversion feature. As of July 8, 2016, the conversion price was reduced to $0.145 and, because the stock price on that date was $0.19, we recorded an expense of $13.3 million that was included in the loss on debt restructuring. Because our stock price at both reporting dates was substantially lower than the conversion prices, the value of the derivative liabilities decreased, which resulted in gains of $8.6 million and $0.5 million for the three months ended September 30, 2016 and 2015, respectively.
Loss on Extinguishment of Debt
When debt is modified, restructured, refinanced or repaid with the same lender before the scheduled maturity date, gains and losses may result if the cash and other consideration exchanged by us is less than or greater than the carrying value of the debt. Careful consideration is required to determine whether each transaction is a modification or an extinguishment since the accounting recognition requirements are substantially different depending on this determination. Additionally, certain of our debt financing agreements provide for penalties if the loans are paid off before maturity and such penalties would also be a factor in determining any gain or loss on extinguishment. For the three months ended September 30, 2016, there was no loss on extinguishment of debt. For the three months ended September 30, 2015, we recognized a loss on extinguishment of debt of $0.3 million which resulted because the cash and other consideration exchanged to retire debt was greater than the related carrying value of the debt.
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Interest Expense
The $2.4 million decrease in interest expense for the three months ended September 30, 2016 was primarily attributable to a reduction in interest expense at the stated rate of the debt instruments of $1.3 million, debt discount amortization of $0.7 million and the impact of fair value adjustments on the interest paid in-kind of $0.3. The impact of lower interest rates resulting from the debt restructuring exceeded the impact of higher borrowings to $105.5 million as of September 30, 2016 from $85.1 million as of September 30, 2015.
Loss on Troubled Debt Restructuring
For the three months ended September 30, 2016, we recognized a loss on troubled debt restructuring of $24.2 million. There was no gain or loss during the three months ended September 30, 2015. Of the $24.2 million loss, $13.3 million resulted from a revision to the value of the convertible debt conversion feature by reducing the common stock conversion price on $19.5 million of debt to $0.145 from a range of $0.45 to $0.75 and extending the maturity date to June 2020 from July and August 2016. In addition, a loss of $8.5 million resulted from a revision to the value of warrants by reducing the exercise price to $0.145 on warrants issued with certain of the convertible debt and term loans to acquire 323,948,782 shares of common stock that previously had exercise prices ranging from $0.21 to $1.01 and years of expiration ranging from 2019 to 2023. Also, a loss of $2.0 million resulted from a revision to the amount of previously accrued interest payable pursuant to the terms of the restructured borrowings. The remainder of the loss was $0.4 million associated with legal costs to consummate the restructuring.
Income Tax Benefit (Expense)
For the three months ended September 30, 2016 and 2015, income tax benefit (expense) related primarily to our U.K businesses, and was comprised of the following:
2016 | (Revised) 2015 | Impact to Results of Operations | Percentage Change in Component | |||||||||||||
Income tax benefit (expense): | ||||||||||||||||
Current | $ | (779 | ) | $ | (304 | ) | $ | (475 | ) | 156.3 | % | |||||
Deferred | 552 | - | 552 | - | ||||||||||||
$ | (227 | ) | $ | (304 | ) | $ | 77 | (25.3 | )% |
Loss from Discontinued Operations
For additional information about our discontinued operations, see Notes to Consolidated Financial Statements – Note 3, Divestitures.
The following table provides the components of discontinued operations, net of tax:
Three Months Ended September 30, | ||||||||
2016 | 2015 | |||||||
Net sales | $ | 2,118 | $ | 2,499 | ||||
Cost of goods sold | 654 | 519 | ||||||
Gross profit | 1,464 | 1,980 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative: | ||||||||
Compensation and benefits: | ||||||||
Salaries, wages and benefits | 151 | 47 | ||||||
Professional fees and administrative | 338 | 486 | ||||||
Marketing and selling | 1,174 | 1,435 | ||||||
Depreciation and amortization | 281 | 920 | ||||||
Total operating expenses | 1,944 | 2,888 | ||||||
Loss from operations | (480 | ) | (908 | ) | ||||
Loss on disposal (1) | (13,295 | ) | - | |||||
Loss from discontinued operations | $ | (13,775 | ) | $ | (908 | ) |
(1) | Includes deferred tax benefit of $229 for the three months ended September 30, 2016. There are no income taxes for the nine months ended September 30, 2016. |
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Comparison of the Nine Months Ended September 30, 2016 and 2015 (dollars in thousands)
2016 | (Revised) (1) 2015 | Impact to Results of Operations | Percentage Change in Component | |||||||||||||
Net sales | $ | 28,412 | $ | 34,248 | $ | (5,836 | ) | (17.0 | )% | |||||||
Cost of goods sold | 12,819 | 15,082 | 2,263 | (15.0 | )% | |||||||||||
Gross profit | 15,593 | 19,166 | (3,573 | ) | (18.6 | )% | ||||||||||
Gross profit percentage | 55 | % | 56 | % | (1 | )% | ||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative: | ||||||||||||||||
Compensation and benefits: | ||||||||||||||||
Salaries, wages and benefits | 7,251 | 7,783 | 532 | (6.8 | )% | |||||||||||
Stock-based compensation | 4,034 | 12,235 | 8,201 | (67.0 | )% | |||||||||||
Professional fees and administrative | 5,851 | 11,559 | 5,708 | (49.4 | )% | |||||||||||
Marketing and selling | 3,655 | 7,125 | 3,470 | (48.7 | )% | |||||||||||
Depreciation and amortization | 4,217 | 4,259 | 42 | (1.0 | )% | |||||||||||
Impairment of long-lived assets | 4,274 | - | (4,274 | ) | - | |||||||||||
Severance | 66 | 725 | 659 | (90.9 | )% | |||||||||||
Total operating expenses | 29,348 | 43,686 | 14,338 | (32.8 | )% | |||||||||||
Loss from operations | (13,755 | ) | (24,520 | ) | 10,765 | (31.2 | )% | |||||||||
Other income (expense): | ||||||||||||||||
Warrant fair value adjustment | 54,921 | 98,898 | (43,977 | ) | (44.5 | )% | ||||||||||
Derivative fair value adjustment | 9,012 | 60,749 | (51,737 | ) | (85.2 | )% | ||||||||||
Loss on extinguishment of debt | (8,572 | ) | (70,690 | ) | 62,118 | (87.9 | )% | |||||||||
Gain on extinguishment of warrants | 86 | 49,782 | (49,696 | ) | (99.8 | )% | ||||||||||
Interest expense | (7,989 | ) | (57,027 | ) | 49,038 | (86.0 | )% | |||||||||
Debt financing inducement expense | - | (67,765 | ) | 67,765 | (100.0 | )% | ||||||||||
Loss on troubled debt restructuring | (24,163 | ) | - | (24,163 | ) | - | ||||||||||
Gain on troubled debt restructuring | 24 | - | 24 | - | ||||||||||||
Settlement of litigation and disputes | (65 | ) | - | (65 | ) | - | ||||||||||
Total other income (expense) | 23,254 | 13,947 | 9,307 | 66.7 | % | |||||||||||
Income (loss) from continuing operations before income taxes | 9,499 | (10,573 | ) | 20,072 | - | |||||||||||
Income tax expense | (109 | ) | (748 | ) | 639 | - | ||||||||||
Income (loss) from continuing operations | 9,390 | (11,321 | ) | 20,711 | - | |||||||||||
Loss from discontinued operations, including loss on disposal of $13,524 | (16,502 | ) | (3,277 | ) | (13,225 | ) | 403.6 | % | ||||||||
Net loss | $ | (7,112 | ) | $ | (14,598 | ) | $ | 7,486 | (51.3 | )% |
(1) See Note 1, Basis of Presentation, Revision of 2015 Statement of Operations, to the Unaudited Condensed Consolidated Financial Statements.
Net Sales
Approximately 82% and 79% of our net sales for the nine months ended September 30, 2016 and 2015, respectively, were transacted in the Great Britain Pound currency and translated into the U.S. dollar functional currency. Due to the concentration of business in the U.K., lower foreign exchange rates accounted for an overall reduction of $2.3 million in the net sales for the nine months ended September 30, 2016.
The $5.8 million decrease in net sales was primarily attributable to a decrease to the FIN, VIP and Vapestick reporting units of $1.9 million, $1.9 million and $1.8 million, respectively. The decrease in net sales from the combined U.K. businesses of VIP and Vapestick was $3.7 million; excluding the $2.3 million reduction related to lower foreign exchange rates, the combined U.K. businesses net sales would have decreased $1.4 million.
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Cost of Goods Sold
The $2.3 million decrease in cost of goods sold was primarily attributable to a decrease to the FIN reporting unit of $1.2 million and the Vapestick reporting unit of $0.8 primarily associated with lower net sales.
The estimated impact of lower foreign exchange rates in 2016 was a contributing factor in the changes discussed above for our VIP and Vapestick reporting units. This reduction in foreign exchange rates accounted for an overall reduction of $1.0 million in our 2016 cost of goods sold due to our concentration of business in the U.K.
In January 2016, we settled ongoing patent infringement litigation. In connection with the settlement, we were granted a non-exclusive global license under the patents asserted in the litigation and certain other e-vapor technology related patents in exchange for an ongoing royalty based on net sales of certain products. For the nine months ended September 30, 2016, our cost of goods sold includes royalties based on the sale of products that are subject to the license agreement.
Gross profit
Despite the increased cost associated with the royalty payments, the gross profit percentage decreased modestly to 55% from 56% for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.
Selling, General and Administrative Expenses
Compensation and Benefits
In addition to salaries, wages and benefits, we also incur non-cash stock-based compensation expenses. While our mix of personnel has changed significantly over the past year, the total cost incurred for salaries, wages and benefits declined by $0.5 million due to the elimination of certain duplicative personnel.
During the first three quarters of 2016, the decrease in stock based compensation was primarily due to a 2015 issuance of options to acquire 16.5 million shares of the Company’s stock with a grant date fair value of $8.1 million that vested immediately for which there was no comparable transaction during 2016.
Professional Fees and Administrative Expenses
Presented below are the major components of professional fees and other administrative expenses for the nine months ended September 30, 2016 and 2015 (dollars in thousands):
2016 | 2015 | Impact to Results of Operations | Percentage Change | |||||||||||||
Professional fees: | ||||||||||||||||
Auditing, accounting and tax | $ | 1,003 | $ | 2,956 | $ | 1,953 | (66.1 | )% | ||||||||
Financings, contracts and litigation | 718 | 3,906 | 3,188 | (81.6 | )% | |||||||||||
Administrative expenses | 4,130 | 4,697 | 567 | (12.1 | )% | |||||||||||
Total | $ | 5,851 | $ | 11,559 | $ | 5,708 | (49.4 | )% |
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During the third quarter of 2015, we experienced inefficiencies during changes in personnel and independent auditors combined with a significant increase in the complexity of technical accounting and financial reporting services. Beginning in June 2015, we revised our personnel structure and changed our professional services providers, which was primarily responsible for the reduction in professional fees related to auditing, accounting and tax services for the nine months ended September 30, 2016.
During the nine months ended September 30, 2016, we incurred costs related to the settlement of our patent infringement case and legal fees associated with the January 2016 term loan. During the nine months ended September 30, 2015, we incurred substantial costs related to restructuring of numerous debt agreements; employment agreements with new executive officers; legal defense costs under patent infringement litigation that was not settled until January 2016, and legal fees related to our SEC filings and execution of a reverse stock split.
Marketing and Selling Expenses
During 2015, we made significant modifications to our mix of spending to focus more resources on the expansion of rental locations for kiosk retail sales which we believe will be more effective at increasing net sales. Accordingly, we had an increase of $0.8 million from kiosk rentals due to an increase in the number of kiosks for the nine months ended September 30, 2016 compared to the comparable period in 2015. This increase was offset by the effects of (i) a reduction in advertising expense of $2.0 million, and (ii) a $2.2 million reduction in other marketing and selling expenses as we eliminated less effective strategies.
Impairment of Long-Lived Assets
During the third quarter of 2016, after evidencing declines in revenue, gross profit margins and cash flows relative to the corresponding period of 2015, and despite a reduction in operating expenses, these triggering events, gave rise for the need to perform an interim test of Vapestick’s goodwill for impairment. Based on an estimated enterprise value of $5,753 and a reporting unit carrying value of $10,027, the Company recorded impairment to goodwill of $4,274 for the nine months ended September 30, 2016. The third quarter of 2016 impairment loss was an estimate that, upon revision to forecasts to be generated during the fourth quarter of 2016, may require further adjustment during that period.
Warrant and Derivative Fair Value Adjustments
Our warrant and derivative liabilities are adjusted to fair market value using appropriate valuation models at the end of each calendar quarter. If the fair market value of these liabilities increases we recognize a loss in the statement of operations, and if the fair market value of the liabilities decreases a gain is recognized in the statement of operations. While numerous factors affect the changes in valuation, gains generally result as the market price for our common stock decreases and losses typically result as the market price increases.
During the nine months ended September 30, 2016, our stock price decreased to $0.09 per share from $0.26 per share and the number of warrants subject to valuation increased by approximately 93 million shares. During the nine months ended September 30, 2015, our stock price decreased to $0.27 per share from $1.30 per share and the number of warrants subject to valuation increased by approximately 152 million shares. Consequently, for the nine months ended September 30, 2016 and 2015, this resulted in gains of $54.9 million and $98.9 million, respectively.
Our derivative liabilities are associated with value of the convertible debt conversion feature. As of July 8, 2016, the conversion price was reduced to $0.145 and, because the stock price on that date was $0.19, we recorded an expense of $13.3 million that was included in the loss on debt restructuring. Because our stock price at September 30, 2016 and 2015 was substantially lower than the conversion prices, the value of the derivative liabilities decreased, which resulted in gains of $9.0 million and $60.7 million for the nine months ended September 30, 2016 and 2015, respectively.
Loss on Extinguishment of Debt
When debt is modified, restructured, refinanced or repaid with the same lender before the scheduled maturity date, gains and losses may result if the cash and other consideration exchanged by us is less than or greater than the carrying value of the debt. Careful consideration is required to determine whether each transaction is a modification or an extinguishment since the accounting recognition requirements are substantially different depending on this determination. Additionally, certain of our debt financing agreements provide for penalties if the loans are paid off before maturity and such penalties would also be a factor in determining any gain or loss on extinguishment. For the nine months ended September 30, 2016 and 2015, we recognized a loss on extinguishment of debt of $8.6 and $70.7 million, respectively, which resulted because the cash and other consideration exchanged to retire debt was greater than the related carrying value of the debt.
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Gain on Extinguishment of Warrants
We may enter into negotiations with warrant holders to extinguish warrant agreements whereby gains and losses may result if the cash and other consideration exchanged is less than or greater than the fair value of the warrants on the date of the extinguishment. For the nine months ended September 30, 2016 and 2015, we recognized gains on extinguishment of warrants of $0.1 million and $49.8 million, respectively.
Interest Expense
The $49.0 million decrease in interest expense for the nine months ended September 30, 2016 was primarily attributable to a reduction in debt discount amortization of $22.5 million, the elimination of interest related to warrant issuances of $26.7 million and the impact of fair value adjustments on the interest paid in-kind of $0.3, partially offset by higher interest expense at the stated rate of the debt instruments of $0.3 million, resulting from an increase in borrowings to $105.5 million as of September 30, 2016 from $85.1 million as of September 30, 2015, and higher debt issuance cost amortization of $0.2 million.
Debt Financing Inducement Expense
The inclusion of conversion features and stock purchase warrants represent inducements to obtain certain debt financings. Debt financing inducement expense is recognized when the fair value of inducements issued in connection with debt financings exceeds the proceeds from the loan. Under generally accepted accounting principles, these financial instruments are bifurcated and accounted for by first determining the fair value of the warrants and conversion features with any residual value assigned to the debt instrument.
Debt financing inducement expenses are generally incurred when we require funding to address immediate needs for cash. The market terms to obtain such financings have required us to issue inducements valued for accounting purposes at amounts that exceed the amounts borrowed. We did not incur any debt financing inducement expense for the nine months ended September 30, 2016. For the nine months ended September 30, 2015, we incurred debt financing inducement expense of $67.8 million because the fair value of warrants and embedded conversion features issued to the lenders were valued at $87.1 million compared to the proceeds received from the lenders of $19.4 million.
Loss on Troubled Debt Restructuring
For the nine months ended September 30, 2016, we recognized a loss on troubled debt restructuring of $24.2 million. There was no gain or loss during the nine months ended September 30, 2015. Of the $24.2 million loss, $13.3 million resulted from a revision to the value of the convertible debt conversion feature by reducing the common stock conversion price on $19.5 million of debt to $0.145 from a range of $0.45 to $0.75 and extending the maturity date to June 2020 from July and August 2016. In addition, a loss of $8.5 million resulted from a revision to the value of warrants by reducing the exercise price to $0.145 on warrants issued with certain of the convertible debt and term loans to acquire 323,948,782 shares of common stock that previously had exercise prices ranging from $0.21 to $1.01 and years of expiration ranging from 2019 to 2023. Also, a loss of $2.0 million resulted from a revision to the amount of previously accrued interest payable pursuant to the terms of the restructured borrowings. The remainder of the loss was $0.4 million associated with legal costs to consummate the restructuring.
Income Tax Benefit (Expense)
For the nine months ended September 30, 2016 and 2015, income tax benefit (expense) related primarily to our U.K businesses, and was comprised of the following:
2016 | (Revised) 2015 | Impact to Results of Operations | Percentage Change in Component | |||||||||||||
Income tax benefit (expense): | ||||||||||||||||
Current | $ | (667 | ) | $ | (1,159 | ) | $ | 492 | (42.5 | )% | ||||||
Deferred | 558 | 411 | 147 | 35.8 | % | |||||||||||
$ | (109 | ) | $ | (748 | ) | $ | 639 | (85.4 | )% |
Loss from Discontinued Operations
For additional information about our discontinued operations, see Notes to Consolidated Financial Statements – Note 3, Divestitures.
The following table provides the components of discontinued operations, net of tax:
Nine Months Ended September 30, | ||||||||
2016 | 2015 | |||||||
Net sales | $ | 6,904 | $ | 5,149 | ||||
Cost of goods sold | 2,245 | 2,066 | ||||||
Gross profit | 4,659 | 3,083 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative: | ||||||||
Compensation and benefits: | ||||||||
Salaries, wages and benefits | 450 | 171 | ||||||
Professional fees and administrative | 1,181 | 744 | ||||||
Marketing and selling | 3,884 | 2,685 | ||||||
Depreciation and amortization | 2,122 | 2,760 | ||||||
Total operating expenses | 7,637 | 6,360 | ||||||
Loss from operations | (2,978 | ) | (3,277 | ) | ||||
Loss on disposal (1) | (13,524 | ) | - | |||||
Loss from discontinued operations | $ | (16,502 | ) | $ | (3,277 | ) |
(1) | There are no income taxes for the nine months ended September 30, 2016. |
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Non-GAAP Financial Measures- EBITDA and Adjusted EBITDA
We define EBITDA as net income (loss), as determined under U.S. GAAP, plus interest expense, income taxes, depreciation and amortization expense. We define Adjusted EBITDA as EBITDA plus stock-based compensation expense, severance and retention costs, professional fees related to the restructuring of debt agreements, offering expenses, acquisition expense, losses on sale of assets, impairment of long-lived assets, debt financing inducement expense, settlement of litigation and disputes and loss from discontinued operations; and by subtracting gains from warrant and derivative fair value adjustments, gains from extinguishment of warrants and debt, gains on sale of assets, and gain on conversion of notes payable to common stock. These further adjustments eliminate the impact of items that we do not consider indicative of our core operating performance. In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to many of the adjustments in this presentation. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.
We present EBITDA and Adjusted EBITDA because we believe they assist investors in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. EBITDA and Adjusted EBITDA have limitations as an analytical tool. Some of these limitations are:
· | EBITDA and Adjusted EBITDA do not reflect our cash expenditures, or future requirements for capital expenditures, contractual commitments or working capital needs; | |
· | EBITDA and Adjusted EBITDA do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; | |
· | Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; | |
· | Similarly, while impairment of long-lived assets is a non-cash expense, recognition of the impairment charge may have a significant impact on the value of our common stock; | |
· | Adjusted EBITDA excludes expenses under our related party advisory agreement, stock-based compensation arrangements, excess embedded derivative inducements, changes in the fair value of warrant and derivative instruments, and gains and losses from the extinguishment of debt. While these are non-cash gains and losses, their exclusion ignores the significant dilutive impact to our common stockholders as represented by the underlying transactions that gave rise to these excluded gains and losses; | |
· | EBITDA and Adjusted EBITDA do not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; and | |
· | Other companies in our industry may calculate EBITDA and Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. |
We compensate for these limitations by considering the economic effect of the excluded expense items independently as well as in connection with our analysis of net income (loss). EBITDA and Adjusted EBITDA should be considered in addition to, but not as a substitute for, any measure of financial performance reported in accordance with U.S. GAAP, such as total revenues, income from operations, and net income (loss). The following table presents a reconciliation of net loss to EBITDA and Adjusted EBITDA for the three and nine months ended September 30, 2016 and 2015 (dollars in thousands):
Calculation of EBITDA and Adjusted EBITDA
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015(2) | |||||||||||||
Net income (loss) | $ | (15,138 | ) | $ | 9,229 | $ | (7,112 | ) | $ | (14,598 | ) | |||||
Interest expense | 1,432 | 3,809 | 7,989 | 57,027 | ||||||||||||
Depreciation and amortization | 1,368 | 1,476 | 4,217 | 4,259 | ||||||||||||
Income tax expense | 227 | 304 | 109 | 748 | ||||||||||||
EBITDA | (12,111 | ) | 14,818 | 5,203 | 47,436 | |||||||||||
Stock-based compensation | 215 | (61 | ) | 4,034 | 12,235 | |||||||||||
Issuance of common stock for services and settlements of claims | - | 133 | - | 138 | ||||||||||||
Severance expense | 20 | 74 | 66 | 725 | ||||||||||||
Retention bonus | - | - | - | 310 | ||||||||||||
Warrant fair value adjustment | (21,338 | ) | (18,637 | ) | (54,921 | ) | (98,898 | ) | ||||||||
Derivative fair value adjustment | (8,603 | ) | (495 | ) | (9,012 | ) | (60,749 | ) | ||||||||
Loss on extinguishment of debt | - | 334 | 8,572 | 70,690 | ||||||||||||
Gain on extinguishment of warrants | - | - | (86 | ) | (49,782 | ) | ||||||||||
Debt financing inducement expense | - | 1,331 | - | 67,765 | ||||||||||||
Loss on troubled debt restructuring | 24,223 | - | 24,163 | - | ||||||||||||
Gain on conversion of notes payable to common stock | (24 | ) | - | (24 | ) | - | ||||||||||
Professional fees related to debt restructuring | (284 | ) | 865 | 135 | 1,611 | |||||||||||
Settlement of litigation and disputes | - | - | 65 | - | ||||||||||||
Loss from discontinued operations | 13,775 | 908 | 16,502 | 3,277 | ||||||||||||
Impairment of long-lived assets | 4,274 | - | 4,274 | - | ||||||||||||
Adjusted EBITDA(1) | $ | 147 | $ | (730 | ) | $ | (1,029 | ) | $ | (5,242 | ) |
(1) For the three and nine months ended September 30, 2015, the previously reported Adjusted EBITDA has been revised to reflect the loss from discontinued operations.
(2) See Note 1, Basis of Presentation, Revision of 2015 Statement of Operations, to the Unaudited Condensed Consolidated Financial Statements.
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Liquidity and Capital Resources
The Company is continuing efforts to recover from certain obstacles it has faced, including unanticipated difficulties in fully integrating four business combinations completed over a period of seven months in 2014 and the inability to use proceeds from a proposed but aborted public offering of the Company’s common stock during the fourth quarter of 2014. This required major restructuring and financing activities and, in response to those challenges, the Company completed certain actions to improve liquidity and operating results as reflected in the Company’s Annual Report on Form 10-K.
The following is summary financial information as of September 30, 2016 and for the nine months then ended (dollars in thousands):
September 30, 2016 | ||||
Working capital deficit (including warrant and derivative liabilities of $26,416) | $ | 29,435 | ||
Accumulated deficit | $ | 460,905 | ||
Current maturities of debt financing (face amount): | ||||
VIP promissory notes | $ | 3,600 | ||
Accrued interest payable: | ||||
Term loans | $ | 621 | ||
Convertible debt | 54 | |||
Forbearance agreement | 149 | |||
VIP promissory notes | 600 | |||
Total accrued interest payable (including $835 to be paid in cash) | $ | 1,424 | ||
Nine Months Ended September 30, 2016 | ||||
Loss from operations | $ | 13,755 | ||
Net cash used in operating activities | $ | 8,786 |
Over the past two fiscal years, the Company has relied on debt and equity financings to fund its 2014 acquisitions while experiencing negative operating cash flows. As of September 30, 2016, the Company has amortizing VIP promissory note payments of $0.3 million per month commencing in October 2016.
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To address past liquidity requirements, on July 8, 2016, the Company amended certain debt financing agreements that resulted in the following:
· | Deferral of the maturity date on $95.0 million of debt financing to June 2020, including $74.3 million of term loans, $19.5 million of convertible debt and $1.3 million under the forbearance agreement; | |
· | Reduction to the term loans, forbearance agreement and convertible debt interest rates from 12.0%, 14.0% and 8.0%, respectively, to 4.0%; | |
· | Elimination of amortizing payments on the term loans; | |
· | Use of shares of the Company’s common stock to pay interest on term loans due on a quarterly basis, and on convertible debt due on a monthly basis (holders of 84.7% of the amended term loans, the new term loan and the convertible debt elected to receive their interest in shares of the Company); | |
· | Entry into a fifth term loan for $4.0 million on terms and conditions consistent with the four previous term loans, as amended; | |
· | Deferral of interest on the forbearance agreement; and | |
· | Payment of all outstanding accrued interest payable through the issuance of 30,676,704 shares of the Company’s common stock to Calm Waters, with the remainder in cash. |
Prior to entering into amendments to the debt financing arrangements, on January 11, 2016, we obtained additional Term Debt financing for $9.0 million. The loan proceeds were used for (i) payment of $5.3 million to settle patent infringement litigation and other legal settlements, (ii) repayment of convertible debt and accrued interest of $2.1 million, (iii) settlement of trade payables and costs of the financings for $0.7 million, (iv) repayment of $0.3 million of principal on the VIP Promissory Notes, and (v) the remaining $0.8 million was available for working capital and other general corporate purposes.
As a result of these efforts, the Company has improved its financial condition. However, capital resources may not be sufficient to enable the execution of its global business plan in the near term. We believe the actions outlined above represent significant progress to improve liquidity and position us for future growth. However, despite the substantial actions taken to date, uncertainty about our ability to continue as a going concern remains. This may require that we seek additional financing. There can be no assurance that we will be able to generate sufficient operating cash flows or secure additional financing to continue operations in the normal course of business.
Our strategic plans are now keenly focused on profitable growth and improving cash flows from operating activities through initiatives that are designed to improve efficiency and lower costs. Specifically, our strategic plans include (i) establishing VIP as an international premium brand, (ii) utilizing FIN and Vapestick as traditional retail brands, (iii) expanding profitably into non-traditional channels, (iv) strengthening the organizational talent base, (v) becoming a low-cost provider, and (vi) improving working capital.
For a discussion of our outstanding debt and equity securities, please see the tables and related discussions in Note 6 - Debt Financing, and Note 7 - Warrants and Embedded Derivatives to our Consolidated Financial Statements included in Part I, Item 1 of this Report.
Comparison of Cash Flows for the Nine Months ended September 30, 2016 and 2015
The following table summarizes our cash flows for the nine months ended September 30, 2016 and 2015 (in thousands):
2016 | 2015 | Impact on cash | Percentage Change | |||||||||||||
Net cash provided by (used in): | ||||||||||||||||
Operating activities | $ | (8,786 | ) | $ | (6,523 | ) | $ | (2,263 | ) | 34.6 | % | |||||
Investing activities | (869 | ) | (905 | ) | 36 | (4.0 | )% | |||||||||
Financing activities | 9,678 | 6,586 | 3,092 | 46.9 | % | |||||||||||
Impact of changes in foreign exchange rates | 219 | (621 | ) | 840 | - | |||||||||||
Net change in cash and equivalents | $ | 242 | $ | (1,463 | ) | $ | 1,705 | - |
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Operating Cash Flows
For the nine months ended September 30, 2016, the increase to cash used in operating activities resulted primarily from our loss from operations adjusted for changes in working capital as compared to the corresponding period during 2015.
Investing Cash Flows
The primary use of investing cash flow for the nine months ended September 30, 2016 was for retail kiosks and computer equipment associated with an expansion of our business in the U.K.
Financing Cash Flows
For the nine months ended September 30, 2016 and 2015, our primary source of financing cash flows consisted of the aggregate net proceeds from borrowings of $10.8 and $17.6 million, respectively. The primary use of financing cash flows for the nine months ended September 30, 2016 and 2015 consisted of principal payments on debt obligations of $0.9 and $10.9 million, respectively.
Off-Balance Sheet Arrangements
There were no off-balance sheet arrangements for the nine months ended September 30, 2016.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this Item.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant.
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An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this Report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on this evaluation, because of the identification of multiple and significant control deficiencies that, in aggregate, constitute material weaknesses in our internal control described below, the Company concluded that as of September 30, 2016, our disclosure controls and procedures were not effective. The material weaknesses in our internal control over financial reporting identified at the end of the quarter ended September 30, 2016, are set forth below:
· | Inadequate and ineffective controls over the timeliness and accuracy of the financial reporting process. The Company did not have adequate design or operational controls and procedures that provided reasonable assurance that financial statements could be accurately prepared in accordance with GAAP. Several factors contributed to this material weakness including (i) the rapid growth that the Company experienced as a result of multiple significant domestic and international acquisitions in 2014, (ii) the relocation of the Company’s corporate headquarters and information technology assets to Colorado during the third quarter of 2015, and (iii) hiring of new personnel to provide corporate accounting and financial reporting services. While management believes significant improvements were achieved through the first three quarters of 2016, additional time is required to evaluate the effectiveness of these changes and to fully develop the Company’s entity level and process level control environment. For many controls that were in place, the Company did not have adequate documentation of the operating effectiveness or have an adequate sample size to validate the operating effectiveness of the controls. |
· | Inadequate and ineffective Information Technology controls. The Company did not have an adequate design or operational controls and procedures that provided reasonable assurance of the financial integrity of the Company’s accounting system and that supporting electronic files were free of material misstatement. The Company was not able to validate the design or operational effectiveness of several information technology controls. In September 2016, to mitigate this material weakness, the Company entered into a contract with a major enterprise resource planning (“ERP”) software provider to migrate from the current information technology system to an ERP system across all reporting units. |
Changes in Internal Controls
During the first three quarters ended September 30, 2016, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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From time to time, we may become involved in legal proceedings, lawsuits, claims and regulations in the ordinary course of our business. We are not currently involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to our knowledge, threatened against or affecting us, our common stock, any of our subsidiaries or of our officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect on our financial condition or results of operations.
Except as set forth below, there have been no changes that constitute a material change from the risk factors previously disclosed in our 2015 Annual Report on Form 10-K filed on March 28, 2016, as amended:
Risks Related to Our Business
The United Kingdom's pending departure from the European Union could have a material adverse effect on us.
Because our consolidated financial statements are presented in U.S. dollars, increases or decreases in the value of the U.S. dollar relative to other currencies in which we transact business could materially adversely affect our financial results. In particular, the United Kingdom held a referendum on June 23, 2016 in which a majority of voters voted to exit the European Union ("Brexit"). Negotiations are expected to commence to determine the future terms of the United Kingdom's relationship with the European Union, including, among other things, the terms of trade between the United Kingdom and the European Union. The effects of the United Kingdom's withdrawal from the European Union will depend on agreements the United Kingdom makes to retain access to European Union markets either during a transitional period or more permanently.
Potential adverse consequences of Brexit such as global market uncertainty, volatility in currency exchange rates, greater restrictions on imports and exports between UK and EU countries and increased regulatory complexities could have a negative impact on our business, financial condition and results of operations.
Risks Related to Government Regulation
The FDA has recently adopted rules to further regulate E-cigarettes.
On May 5, 2016, the U.S. Food and Drug Administration (“FDA”) issued a final rule deeming certain products to be subject to the Federal Food, Drug, and Cosmetic Act and regulations thereunder, which includes regulation of electronic nicotine delivery systems (“ENDS”). The effective date of the final rule was August 8, 2016. The contract manufacturers have three years to comply with the regulations. Pertinent sections of the final rule that apply to us include:
· | Manufacturers and importers of e-liquids will be required to submit ingredient listings, effective February 8, 2017, and to report harmful and potentially harmful constituents (“HPHC”), effective August 8, 2019; | |
· | Prohibition on the distribution of free samples, effective August 8, 2016; | |
· | Prohibition on the sale to customers under the age of 18 with various requirements for age verification, effective August 8, 2016; | |
· | Prohibition on the sale of ENDS in vending machines (with a few rare exceptions), effective August 8, 2016; | |
· | Requirement for a prominent health warning on all ENDS labels (“WARNING: This product contains nicotine. Nicotine is an addictive chemical.”), effective May 10, 2018; and | |
· | Requirement for premarket review by the FDA before marketing any new ENDS product, effective August 8, 2016. |
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The FDA approval process will be phased in, whereby we will have until August 2018 to submit applications to obtain approval to continue to sell our existing products. We may continue to sell existing products during this two-year period, and we can continue to sell existing products for an additional year while the FDA reviews our applications. Failure to obtain approval for any of our existing products would prevent us from marketing and selling such products in the United States beginning in August 2019, which could have a material adverse effect on our business, financial condition and results of operations at that time.
We cannot predict the impact these new regulations will have on our business and what additional restrictions the FDA may subsequently impose. In this regard, total compliance and related costs are not possible to predict. The costs of compliance by us and our suppliers may result in higher costs to purchase our products. To the extent it is not possible to pass increased costs on to customers, our financial results may deteriorate. Additionally, if we are unable to secure FDA approval to continue selling our existing products and any new products targeted for introduction, our net sales could be adversely impacted. The ultimate outcome of these matters could have a material adverse effect on our business, results of operations and financial condition.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 5, 2016, April 22, 2016 and July 12, 2016, we issued an aggregate of 461,541, 107,028 and 187,500 shares of our common stock, respectively, or a total of 756,069 shares, for services rendered by our board of directors. All of the shares were returned to the Company in exchange for options to purchase 1,200,000 shares of our common stock. On January 4, 2016, we issued 115,385 shares to an executive officer as part of his 2015 bonus consideration. The shares were issued in reliance upon exemptions from registration pursuant to Section 4(a)(2) and Rule 506 of Regulation D of the Securities Act.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
There have been no material changes to the procedures by which security holders may recommend nominees to our Board of Directors.
Exhibit | ||
Number | Description | |
10.1 | Amendment No. 2 to Employment Agreement with Daniel J. O’Neill, dated November 9, 2016. | |
31.1 | Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Schema | |
101.CAL | XBRL Taxonomy Calculation Linkbase | |
101.DEF | XBRL Taxonomy Definition Linkbase | |
101.LAB | XBRL Taxonomy Label Linkbase | |
101.PRE | XBRL Taxonomy Presentation Linkbase |
In accordance with SEC Release 33-8238, Exhibits 32.1 and 32.2 are being furnished and not filed.
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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.
ELECTRONIC CIGARETTES INTERNATIONAL GROUP, LTD |
|||
Date: November 15, 2016 | By: | /s/ Daniel J. O’Neill | |
Daniel J. O’Neill | |||
Chief Executive Officer | |||
(Duly Authorized Officer and Principal Executive Officer) | |||
Date: November 15, 2016 | /s/ William Seamans | ||
William Seamans | |||
Chief Financial Officer | |||
(Duly Authorized Officer and Principal Financial Officer) |
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