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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY OR TRANSITIONAL REPORT
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
Commission File Number 000-25039
BRAVO! FOODS INTERNATIONAL CORP.
(Exact name of registrant as specified in its amended charter)
Delaware 62-1681831
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11300 US Highway 1, North Palm Beach, Florida 33408 USA
(Address of principal executive offices)
(561) 625-1411 Registrant's telephone number
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(Former name, former address and former fiscal year
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934, during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after
the distribution of securities under a plan confirmed by a court.
Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date is as follows:
Date Class Shares Outstanding
September 11, 2006 Common Stock 195,018,001
Preferred Stock 461,188
Transitional Small Business Disclosure Format (Check One) YES [ ] NO [X]
BRAVO! FOODS INTERNATIONAL CORP.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial statements
Consolidated balance sheets as of 1
June 30, 2006 and December 31, 2005 (unaudited)
Consolidated statements of operations 3
for the three and six months
ended June 30, 2006 and 2005 (unaudited)
Consolidated statements of cash flows 4
for the six months ended
June 30, 2006 and 2005 (unaudited)
Notes to consolidated financial statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial 42
Condition and Results of Operations
Item 3. Controls and Procedures 53
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity and Use of Proceeds 54
Item 3. Default on Senior Securities 54
Item 6. Exhibits 55
SIGNATURES 56
EXHIBITS
1
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
(Restated)
Assets
Current assets:
Cash and cash equivalents $ 59,344 $ 4,947,986
Accounts receivable, net of allowances for doubtful accounts
of $365,000 and $350,000 at 2006 and 2005, respectively 1,192,840 3,148,841
Inventories 2,881,821 391,145
Prepaid expenses 1,216,870 973,299
------------- -------------
Total current assets 5,350,875 9,461,271
Furniture and equipment, net 521,123 288,058
Intangible assets, net 17,234,423 18,593,560
Other assets 217,999 15,231
------------- -------------
Total assets $ 23,324,420 $ 28,358,120
============= =============
Liabilities, Redeemable Preferred Stock and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable $ 7,784,012 $ 5,987,219
Accrued liabilities 5,746,155 4,568,527
Current maturities of notes payable 2,700,195 937,743
Convertible debt 973,214 1,012,780
Derivative liabilities 36,425,561 35,939,235
------------- -------------
Total current liabilities 53,629,137 48,445,504
Notes payable, less current maturities 95,783 --
------------- -------------
Total liabilities 53,724,920 48,445,504
------------- -------------
2
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
(Restated)
Commitments and contingencies (Note 9) -- --
Redeemable preferred stock:
Series F convertible, par value $0.001 per share, 200,000 shares designated,
Convertible Preferred Stock, stated value $10.00 per share, 5,248 shares
issued and outstanding 52,480 52,480
Series H convertible, par value $0.001 per share, 350,000 shares designated,
7% Cumulative Convertible Preferred Stock, stated value $10.00 per share,
63,500 and 64,500 shares issued and outstanding 457,867 388,305
Series J, par value $0 001 per share,500,000 shares designated, 8%
Cumulative Convertible Preferred Stock, stated value $10.00 per share,
200,000 shares issued and outstanding 1,166,325 871,043
Series K, par value $0 001 per share, 500,000 shares designated, 8% Cumulative
Convertible Preferred Stock, stated value $10.00 per share, 95,000 shares
issued and outstanding 814,873 792,672
------------- -------------
Total redeemable preferred stock 2,491,545 2,104,500
------------- -------------
Stockholders' equity (deficit):
Preferred stock, 5,000,000 shares authorized
Series B Preferred, par value $0.001 per share, 1,260,000 shares
designated, 9% Convertible Preferred Stock, stated value $1.00 per share,
107,440 shares issued and outstanding 107,440 107,440
Common stock, par value $0.001 per share, 300,000,000 shares authorized,
191,253,248 and 184,253,753 shares issued and outstanding 191,253 184,254
Additional paid-in capital 98,972,077 96,507,932
Common stock subscription receivable (10,000) (10,000)
Accumulated deficit (132,143,495) (118,950,751)
Cumulative translation adjustment (9,320) (30,759)
------------- -------------
Total stockholders' equity (deficit) (32,892,045) (22,191,884)
------------- -------------
Total liabilities, Redeemable Preferred Stock and Stockholders'
Equity (Deficit) $ 23,324,420 $ 28,358,120
============= =============
See accompanying notes.
3
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ----------------------------
2006 2005 2006 2005
---- ---- ---- ----
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
(Restated) (Restated)
Revenues $ 3,705,226 $ 2,448,618 $ 7,266,441 $ 3,346,388
Product costs (3,253,637) (1,680,464) (6,200,097) (2,358,127)
Shipping costs (351,185) (292,386) (744,636) (430,836)
------------ ------------ ------------ ------------
Gross margin 100,404 475,768 321,708 557,425
Operating expenses:
Selling expense 3,367,811 1,035,549 6,210,909 1,520,580
General and administrative expense 1,628,317 1,836,824 3,396,521 2,595,078
Product development 161,356 146,733 277,319 215,757
------------ ------------ ------------ ------------
Loss from operations (5,057,080) (2,543,338) (9,563,041) (3,773,990)
Other income (expense)
Derivative expense, net (5,047,199) (77,311,393) (98,011) (75,839,650)
Interest income (expense), net (397,252) (597,729) (431,261) (1,491,890)
Liquidated damages (2,049,889) - (2,128,275) -
Legal settlement (552,600) - (552,600) -
Other income (expense) - 7,164 - 7,164
------------ ------------ ------------ ------------
Income (loss) before income taxes (13,104,020) (80,445,296) (12,773,188) (81,098,366)
Provision for income taxes - - - -
------------ ------------ ------------ ------------
Net loss (13,104,020) (80,445,296) (12,773,188) (81,098,366)
Preferred stock dividends and accretion (282,477) (592,815) (541,260) (864,710)
------------ ------------ ------------ ------------
Loss applicable to common stockholders $(13,386,497) $(81,038,111) $(13,314,448) $(81,963,076)
============ ============ ============ ============
Loss per common share:
Basic loss per common share $ (0.07) $ (1.12) $ (0.07) $ (1.24)
============ ============ ============ ============
Diluted loss per common share $ (0.07) $ (1.12) $ (0.07) $ (1.24)
============ ============ ============ ============
Weighted average common shares outstanding 189,388,123 72,381,911 186,843,409 66,035,224
============ ============ ============ ============
Comprehensive income (loss):
Net income (loss) $(13,104,020) $(80,445,296) $(12,773,188) $(81,098,366)
Foreign currency translation 22,129 (9,763) 21,439 (5,327)
------------ ------------ ------------ ------------
Comprehensive income (loss) $(13,081,891) $(80,455,059) $(12,751,749) $(81,103,693)
------------ ------------ ------------ ------------
See accompanying notes.
4
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30
2006 2005
-----------------------------
(unaudited)
(unaudited) (restated)
Cash Flow from Operating Activities:
Net loss $(12,773,188) $(81,098,366)
Adjustment to net loss
Depreciation and amortization 1,638,941 188,185
Stock issuance for due diligence and finders' fees - 123,450
Allowance for doubtful accounts 14,941 -
Legal settlement for Marvel warrants 552,600 -
Stock issuance for consulting expense 347,566 352,954
(Gain)/loss on derivatives 98,011 75,839,650
Interest expense-debt discount 149,454 1,261,814
Stock compensation expense 222,957 551,810
Gain/Loss on disposal of fixed assets 1,998 -
Changes in operating assets & liabilities:
Accounts receivable 1,941,060 26,778
Inventories (2,490,676) (54,981)
Prepaid expenses and other assets (249,289) (587,267)
Accounts payable and accrued expenses 3,160,356 893,461
------------ ------------
Net cash used in operating activities (7,385,239) (2,502,512)
------------ ------------
Cash Flows from Investing Activities
Licenses and trademark costs (450,176) (84,166)
Purchases of equipment (286,338) (43,969)
------------ ------------
Net cash used in investing activities (736,514) (128,135)
------------ ------------
Cash Flows provided by financing activities:
Proceeds from conversion of warrants 500,000 1,038,509
Convertible notes payable 2,669,323 1,950,000
Private placement financing 100,000 -
Redeem warrants - (25,000)
Payment of dividends (22,514) -
Payment of notes payable (17,994) -
Registration costs for financing (17,143) (62,639)
------------ ------------
Net cash provided by financing activities 3,211,672 2,900,870
------------ ------------
Effect of changes in exchange rates on cash 21,439 (6,406)
------------ ------------
Net (decrease) increase in cash and cash equivalents (4,888,642) 263,817
Cash and cash equivalent, beginning of period 4,947,986 113,888
------------ ------------
Cash and cash equivalent, ending of period $ 59,344 $ 377,705
============ ============
See accompanying notes.
5
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 -Nature of Business, Basis of Presentation and Liquidity and
Management's Plans
Nature of Business:
We are engaged in the sale of flavored milk products and flavor ingredients in
the United States, the United Kingdom and the Middle East, and we are
establishing an infrastructure to conduct business in Canada.
Basis of Presentation:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10QSB, Item 310(b) of
Regulation S-B and Article 10 (01)(c) of Regulation S-X. Accordingly, the
accompanying financial statements do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included in the accompanying financial statements. Operating results
for the six-month period ending June 30, 2006 are not necessarily indicative of
the results that may be expected for the year ended December 31, 2006.
As more fully described in Note 10, we have restated our balance sheet as of
December 31, 2005 and our statements of operations and cash flows for the three
and six months ended June 30, 2005 for errors related to the accounting for
derivative instruments arising from certain of our financing transactions and
certain other matters more fully described in Note 10. We have also made certain
reclassifications to the December 31, 2005 balance sheet and statements of
operations and cash flows for the three and six months ended June 30, 2005 to
conform to presentations and classifications in the current period. The
consolidated balance sheet at December 31, 2005, as restated, is unaudited. We
currently are compiling an amended report on Form 10-KSB for the year ended
December 31, 2005 for filing in the near future.
Liquidity and Management's Plans:
As reflected in the accompanying consolidated financial statements, we have
incurred operating losses and negative cash flow from operations and have
working capital deficiency of $48,278,262 as of June 30, 2006. In addition, we
are delinquent on certain of our debt agreements at June 30, 2006, and we have
experienced delays in filing our financial statements and registration
statements due to errors in our historical accounting that have been corrected
(See Note 10). Our inability to make these filings is resulting in our
recognition of penalties to the investors, and these penalties will continue
until we can complete our filings and register the common shares into which the
investors' financial instruments are convertible. Finally, our revenues are
significantly concentrated with one major customer. The loss of this customer
or curtailment in business with this customer could have a material adverse
affect on our business. These conditions raise substantial doubt about our
ability to continue as a going concern.
We have been dependent upon third party financings as we execute our business
model and plans. While our liquid reserves have been substantially depleted as
of June 30, 2006, we completed a $30.0 million convertible note financing in
July 2006 that is expected to fulfill our liquidity requirements through the
end of 2006. However, $15.0 million of this financing is held in escrow, and we
are in default on this instrument due to the delay in filing our quarterly
financial report for the quarterly period ended June 30, 2006. As a result, an
event of default has occurred under the terms of the Notes, and the interest
rate on the Notes, payable quarterly, was increased from 9% to 14% per annum.
Pursuant to the terms of the Notes,
6
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
upon the occurrence of an event of default, holders of the Notes may, upon
written notice to the Company, each require the Company to redeem all or any
portion of their Notes at a default redemption price calculated pursuant to
the terms of the Notes. Subsequent to June 30, 2006, we have entered into an
Amendment Agreement with the holders of the Notes to amend the Notes in certain
respects as consideration for the holders' release of the Company's default
resulting from its delay in the filing of this quarterly report. See Item 3 of
Part II of this report, entitled "Default on Senior Securities", for a
description of the terms of the Amendment Agreement.
We plan to increase our sales, improve our gross profit margins, augment our
international business and, if necessary, obtain additional financing.
Ultimately, our ability to continue is dependent upon the achievement of
profitable operations. There is no assurance that further funding will be
available at acceptable terms, if at all, or that we will be able to achieve
profitability.
The accompanying financial statements do not reflect any adjustments that may
result from the outcome of this uncertainty.
Note 2. - Summary of Significant Accounting Policies:
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Among the more significant estimates
included in our financial statements are the following:
- Estimating future bad debts on accounts receivable that are carried at
net realizable values.
- Estimating our reserve for unsalable and obsolete inventories that are
carried at lower of cost or market.
- Estimating the fair value of our financial instruments that are required
to be carried at fair value.
- Estimating the recoverability of our long-lived assets.
We use all available information and appropriate techniques to develop our
estimates. However, actual results could differ from our estimates.
Business Segment and Geographic Information
-------------------------------------------
We operate in one dominant industry segment that we have defined as the single
serve flavored milk industry. While our international business is expected to
grow in the future, it currently contributes less than 10% of our revenues, and
we have no physical assets outside of the United States.
Revenue Recognition
-------------------
Our revenues are derived from the sale of branded milk products to customers in
the United States of America, Great Britain and the Middle East.
Geographically, our revenues are dispersed 98% and 2% between the United States
of America and internationally, respectively. We currently have one customer in
the United States that provided 74% and 0% of our revenue during the six months
ended June 30, 2006 and 2005, respectively.
7
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Revenues are recognized pursuant to formal revenue arrangements with our
customers, at contracted prices, when our product is delivered to their
premises and collectibility is reasonably assured. We extend merchantability
warranties to our customers on our products, but otherwise do not afford our
customers with rights of return. Warranty costs have historically been
insignificant.
Our revenue arrangements often provide for industry-standard slotting fees
where we make cash payments to the respective customer to obtain rights to
place our products on their retail shelves for a stipulated period of time. We
also engage in other promotional discount programs in order to enhance our
sales activities. We believe our participation in these arrangements is
essential to ensuring continued volume and revenue growth in the competitive
marketplace. These payments, discounts and allowances are recorded as
reductions to our reported revenue. Unamortized slotting fees are recorded in
prepaid expenses.
Principles of Consolidation
---------------------------
Our consolidated financial statements include the accounts of Bravo! Foods
International Corp. (the "Company"), and its wholly-owned subsidiary Bravo!
Brands (UK) Ltd. All material intercompany balances and transactions have been
eliminated.
Shipping and Handling Costs
---------------------------
Shipping and handling costs incurred to deliver products to our customers are
included as a component of cost of sales. These costs amounted to approximately
$351,000 and $292,000 for the three months ended June 30, 2006 and 2005,
respectively; $745,000 and $431,000 for the six months ended June 30, 2006 and
2005, respectively.
Cash and Cash Equivalents
-------------------------
We consider all highly liquid investments purchased with a remaining maturity
of three months or less to be cash equivalents.
Accounts Receivable
-------------------
Our accounts receivable are exposed to credit risk. During the normal course of
business, we extend unsecured credit to our customers with normal and
traditional trade terms. Typically credit terms require payments to be made by
the thirtieth day following the sale. We regularly evaluate and monitor the
creditworthiness of each customer. We provide an allowance for doubtful accounts
based on our continuing evaluation of our customers' credit risk and our overall
collection history. As of June 30, 2006 and December 31, 2005, the allowance of
doubtful accounts aggregated approximately $365,000 and $350,000, respectively.
In addition, our accounts receivable are concentrated with one customer who
represents 39% and 0% of our gross accounts receivable balances at June 30,
2006 and December 31, 2005, respectively. Approximately, 6% of our gross
accounts receivable at June 30, 2006 are due from international customers.
8
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Inventories
-----------
Inventories, which consist primarily of finished goods, is stated at the lower
of cost on the first in, first-out method or market. Our inventories at June
30, 2006 have substantially increased from levels at December 31, 2006 because
we are building inventories to support our contractual arrangement with a
significant customer. Further, our inventories are perishable. Accordingly, we
estimate and record lower-of-cost or market and unsalable-inventory reserves
based upon a combination of our historical experience and on a specific
identification basis. During the six months ended June 30, 2006, we did not
provide for unsaleable inventories.
In November 2004, the FASB issued Financial Accounting Standard No. 151,
Inventory Costs, an amendment of ARB No. 43 Chapter 4 (FAS 151), which
clarifies that inventory costs that are "abnormal" are required to be charged
to expense as incurred as opposed to being capitalized into inventory as a
product cost. FAS 151 provides examples of "abnormal" costs to include costs of
idle facilities, excess freight and handling costs and spoilage. FAS 151 became
effective for our fiscal year beginning January 1, 2006. The adoption of FAS
No. 151 did not have a material effect on our consolidated financial
statements.
Furniture and Equipment
-----------------------
Furniture and equipment are stated at cost. Depreciation is computed using the
straight-line method over a period of seven years for furniture and five years
for equipment. Maintenance, repairs and minor renewals are charged directly to
expenses as incurred. Additions and betterments to property and equipment are
capitalized. When assets are disposed of, the related cost and accumulated
depreciation thereon are removed from the accounts, and any resulting gain or
loss is included in the statement of operations.
Intangible Assets
-----------------
Our intangible assets as of June 30, 2006 and December 31, 2005 consist of our
distribution agreement with Coca-Cola Enterprises ("CCE"), our manufacturing
agreement with Jasper Products, Inc. and licenses and trademark costs, with
estimated lives of ten years, five years and one-to-five years, respectively.
The following table illustrates information about our intangible assets:
June 30, 2006 December 31, 2005
-----------------------------------
Distribution agreement $ 15,960,531 $15,960,531
Manufacturing agreement 2,700,000 2,700,000
Licenses and trademarks 448,096 1,315,958
Less accumulated amortization (1,874,204) (1,387,929)
--------------------------------
$ 17,234,423 $18,593,560
================================
Amortization expense amounted to $848,501 and $1,549,289 for the three and six
months ended June 30, 2006 and $62,362 and $326,963 for the three and six
months ended June 30, 2005.
9
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Estimated future amortization of our intangible assets is as follows as of June
30, 2006:
Six months ended December 31, 2006 $1,136,382
==========
Year ended:
December 31, 2007 $2,367,947
==========
December 31, 2008 $2,356,342
==========
December 31, 2009 $2,355,844
==========
December 31, 2010 $2,203,289
==========
December 31, 2011 $1,767,591
==========
Impairment of Long-Lived Assets
-------------------------------
We evaluate the carrying value and recoverability of our long-lived assets when
circumstances warrant such evaluation by applying the provisions of Financial
Accounting Standard No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets ("FAS 144"). FAS 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value.
Financial Instruments
---------------------
Financial instruments, as defined in Financial Accounting Standard No. 107
Disclosures about Fair Value of Financial Instruments (FAS 107), consist of
cash, evidence of ownership in an entity and contracts that both (i) impose on
one entity a contractual obligation to deliver cash or another financial
instrument to a second entity, or to exchange other financial instruments on
potentially unfavorable terms with the second entity, and (ii) conveys to that
second entity a contractual right (a) to receive cash or another financial
instrument from the first entity, or (b) to exchange other financial
instruments on potentially favorable terms with the first entity. Accordingly,
our financial instruments consist of cash and cash equivalents, accounts
receivable, accounts payable, accrued liabilities, notes payable, derivative
financial instruments, convertible debt and redeemable preferred stock that we
have concluded is more akin to debt than equity.
We carry cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities at historical costs; their respective estimated fair values
approximate carrying values due to their current nature We also carry notes
payable, convertible debt and redeemable preferred stock at historical cost;
however, fair values of debt instruments and redeemable preferred stock are
estimated for disclosure purposes (below) based upon the present value of the
estimated cash flows at market interest rates applicable to similar
instruments.
As of June 30, 2006, estimated fair values and respective carrying values of
our notes payable, convertible debt and redeemable preferred stock are as
follows:
Instrument Fair Value Carrying Value
---------------------------------------------------------------------------
$2,500,000 Note Payable $2,458,000 $1,640,906
==========================
$200,000 Convertible Note Payable 202,000 200,000
==========================
$15,000 Convertible Note Payable 14,200 5,214
==========================
$600,000 Convertible Notes Payable 668,000 600,000
==========================
$168,000 Convertible Notes Payable 168,000 168,000
==========================
Series F Preferred Stock 49,000 52,480
==========================
Series H Preferred Stock 557,000 457,867
==========================
Series J Preferred Stock 1,781,000 1,166,325
==========================
Series K Preferred Stock 927,000 814,873
==========================
10
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As of December 31, 2005, estimated fair values and respective carrying values
of our notes payable, convertible debt and redeemable preferred stock were as
follows:
Instrument Fair Value Carrying Value
---------------------------------------------------------------------------
$200,000 Convertible Note Payable $ 190,000 $187,934
==========================
$15,000 Convertible Note Payable 13,300 1,620
==========================
$600,000 Convertible Notes Payable 668,000 600,000
==========================
$6,250 Convertible Note Payable 6,375 5,188
==========================
$25,000 Convertible Note Payable 25,500 30,278
==========================
$187,760 Convertible Note Payable 187,760 187,760
==========================
Series F Preferred Stock 46,000 52,480
==========================
Series H Preferred Stock 525,000 388,305
==========================
Series J Preferred Stock 1,731,000 871,043
==========================
Series K Preferred Stock 881,000 792,672
==========================
Derivative financial instruments, as defined in Financial Accounting Standard
No. 133, Accounting for Derivative Financial Instruments and Hedging Activities
(FAS 133), consist of financial instruments or other contracts that contain a
notional amount and one or more underlying (e.g. interest rate, security price
or other variable), require no initial net investment and permit net
settlement. Derivative financial instruments may be free-standing or embedded
in other financial instruments. Further, derivative financial instruments are
initially, and subsequently, measured at fair value and recorded as liabilities
or, in rare instances, assets.
We generally do not use derivative financial instruments to hedge exposures to
cash-flow, market or foreign-currency risks. However, we have entered into
certain other financial instruments and contracts, such as debt financing
arrangements, redeemable preferred stock arrangements, and freestanding
warrants with features that are either (i) not afforded equity classification,
(ii) embody risks not clearly and closely related to host contracts, or (iii)
may be net-cash settled by the counterparty. As required by FAS 133, these
instruments are required to be carried as derivative liabilities, at fair
value, in our financial statements.
The following table summarizes the components of derivative liabilities as of
June 30, 2006 and December 31, 2005:
Note 2006 2005
---------------------------------------
Compound derivative financial instruments that have
been bifurcated from the following financing arrangements:
----------------------------------------------------------
$2,500,000 Note Financing 4(a) $ (303,881) $ --
$400,000 Convertible Note Financing 5(a) (1,666,200) (1,311,000)
$2,300,000 Convertible Note Financing 5(b) (4,810) (4,867)
$600,000 Convertible Note Financing 5(c) (625,400) (153,700)
$693,000 Convertible Note Financing 5(e) -- (42,878)
$660,000 Convertible Note Financing 5(f) -- (159,250)
$1,008,000 Convertible Note Financing 5(g) (634,410) (564,735)
Series H Preferred Stock Financing 6(a) (502,451) (381,377)
Series J Preferred Stock Financing 6(b) (6,104,000) (5,628,000)
Series K Preferred Stock Financing 6(c) (272,250) (206,200)
Series F Preferred Stock Financing 6(d) (31,819) (25,632)
Freestanding derivative contracts arising from financing
and other business arrangements:
--------------------------------------------------------
Warrants issued with $2,500,000 Note Financing 4(a) (739,230) --
Warrants issued with $693,000 Convertible Notes 5(e) -- (924,120)
Warrants issued with Series H Preferred Stock 6(a) (840,269) (1,264,109)
Warrants issued with Series F Preferred Stock 6(d) (21,138) (563,096)
Warrants issued with Series D Preferred Stock 6(d) (406,419) (400,214)
Other warrants 8(b) (24,273,284) (24,310,057)
------------------------------
Total derivative liabilities $(36,425,561) $(35,939,235)
==============================
11
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
See the notes referenced in the table for details of the origination and
accounting for these derivative financial instruments. We estimate fair values
of derivative financial instruments using various techniques (and combinations
thereof) that are considered to be consistent with the objective measuring fair
values. In selecting the appropriate technique, we consider, among other
factors, the nature of the instrument, the market risks that it embodies and
the expected means of settlement. For less complex derivative instruments, such
as free-standing warrants, we generally use the Black-Scholes-Merton option
valuation technique because it embodies all of the requisite assumptions
(including trading volatility, estimated terms and risk free rates) necessary
to fair value these instruments. For complex derivative instruments, such as
embedded conversion options, we generally use the Flexible Monte Carlo
valuation technique because it embodies all of the requisite assumptions
(including credit risk, interest-rate risk and exercise/conversion behaviors)
that are necessary to fair value these more complex instruments. For forward
contracts that contingently require net-cash settlement as the principal means
of settlement, we project and discount future cash flows applying
probability-weightage to multiple possible outcomes. Estimating fair values of
derivative financial instruments requires the development of significant and
subjective estimates that may, and are likely to, change over the duration of
the instrument with related changes in internal and external market factors. In
addition, option-based techniques are highly volatile and sensitive to changes
in our trading market price which has a high-historical volatility. Since
derivative financial instruments are initially and subsequently carried at fair
values, our income will reflect the volatility in these estimate and assumption
changes.
The following table summarizes the number of common shares indexed to the
derivative financial instruments as of June 30, 2006:
Conversion
Financing or other contractual arrangement: Features Warrants Total
----------------------------------------------
$2,500,000 Note Financing -- 1,500,000 1,500,000
$400,000 Convertible Note Financing 4,000,000 -- 4,000,000
$2,300,000 Convertible Note Financing 120,000 -- 120,000
$600,000 Convertible Note Financing 4,000,000 -- 4,000,000
$1,080,000 Convertible Note Financing 1,680,000 1,680,000
Series D Convertible Preferred Stock -- 611,250 611,250
Series F Convertible Preferred Stock 220,969 38,259 259,228
Series H Convertible Preferred Stock (a) -- 4,387,500 4,387,500
Series J Convertible Preferred Stock 20,000,000 -- 20,000,000
Series K Convertible Preferred Stock (a) -- -- --
Other warrants and contracts (Note 8(b)) -- 50,704,688 50,704,688
----------------------------------------------
30,020,969 57,241,697 87,262,666
==============================================
(a) As more fully described in Notes 6(a) and 6(c) these instruments were
afforded the conventional convertible exemption, which means we did not
have to bifurcate the embedded conversion feature. However, we were
required to bifurcate certain other embedded derivatives as discussed in
the notes. Although the conversion features did not require derivative
accounting, we are required to also consider the 1,256,127 and 8,000,000
common shares, respectively, into which these instruments are convertible
in determining whether we have sufficient authorized and unissued common
shares for all of our share-settled obligations.
12
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Advertising and Promotion Costs
-------------------------------
Advertising and promotion costs, which are included in selling expenses, are
expensed as incurred and aggregated $934,057 and $2,187,133 for the three
months ended June 30, 2006 and 2005, respectively; $351,441 and $511,554 for
the six months ended June 30, 2006 and 2005, respectively.
Share-based payments
--------------------
Effective January 1, 2005, we adopted the fair value recognition provisions of
Financial Accounting Standards No. 123 Accounting for Stock-Based compensation.
Effective January 1, 2006 we adopted Financial Accounting Standards No. 123(R),
Share-Based Payments (FAS123R). Under the fair value method, we recognize
compensation expense for all share-based payments granted after January 1, 2005,
as well as all share-based payments granted prior to, but not yet vested, as of
January 1, 2005, in accordance with SFAS No. 123. Under the fair value
recognition provisions of FAS 123(R), we recognize share-based compensation
expense, net of an estimated forfeiture rate, over the requisite service period
of the award. Prior to the adoption of FAS 123 and FAS 123(R), the Company
accounted for share-based payments under Accounting Principles Board Opinion No.
25 Accounting for Stock Issued to Employees and the disclosure provisions of
SFAS No. 123. For further information regarding the adoption of SFAS No. 123(R),
see Note 7 to the consolidated financial statements.
Income Taxes
------------
We account for income taxes using the liability method, which requires an
entity to recognize deferred tax liabilities and assets. Deferred income taxes
are recognized based on the differences between the tax bases of assets and
liabilities and their reported amounts in the financial statements that will
result in taxable or deductible amounts in future years. Further, the effects
of enacted tax laws or rate changes are included as part of deferred tax
expense or benefit in the period that covers the enactment date. A valuation
allowance is recognized if it is more likely than not that some portion, or
all, of a deferred tax asset will not be realized.
Income (Loss) Per Common Share
------------------------------
Our basic income (loss) per common share is computed by dividing income (loss)
applicable to common stockholders by the weighted average number of common
share outstanding during the reporting period. Diluted income (loss) per common
share is computed similar to basic income (loss) per common share except that
diluted income (loss) per common share includes dilutive common stock
equivalents, using the treasury stock method, and assumes that the convertible
debt instruments were converted into common stock upon issuance, if dilutive.
For the three and six months ended June 30, 2006 potential common shares
arising from our stock options, stock warrants, convertible debt and
convertible preferred stock amounting to 62,272,513 and 61,178,096 shares,
respectively, were not included in the computation of diluted earnings per
share because their effect was antidilutive. For the three and six months ended
June 30, 2005 potential common shares arising from our stock options, stock
warrants, convertible debt
13
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
and convertible preferred stock amounting to 104,769,803 and 104,564,021
shares, respectively, were not included in the computation of diluted earnings
per share because their effect was antidilutive.
Note 3. Accrued liabilities:
Accrued liabilities consist of the following as of June 30, 2006 and December
31, 2005:
2006 2005
--------------------------
Penalties owed to investors due to late registration (a) $2,128,275 $ --
Investor relations liability 1,402,000 1,545,565
Production processor liability 681,275 182,814
Accrued payroll and related 600,612 636,757
Accrued interest 447,235 376,198
Discontinued products (b) -- 1,710,734
Other 486,758 116,459
--------------------------
$5,746,155 $4,568,527
==========================
(a) Certain of our financing arrangements provide for penalties in the event of
non-registration of securities underlying the financial instruments. Generally,
these penalties are calculated as a percentage of the financing proceeds,
usually between 1.0% and 2.0% each month. We accrue these penalties as they are
incurred.
(b) During our year ended December 31, 2005, we discontinued certain product
lines and, as a result, incurred certain penalties under purchase commitments
with our manufacturing vendors. We accrued these penalties upon our decision to
discontinue the products. These amounts were paid to the vendors prior to June
30, 2006.
Note 4. Notes Payable
Notes payable consist of the following as of June 30, 2006 and December 31,
2005:
2006 2005
------------------------
$2,500,000 face value note payable, due November 12, 2006 (a) $1,640,906 $ -
$750,000 face value note payable, due September 3, 2004 (b) 750,000 750,000
$187,743 face value note payable, due December 31, 2005 (c) 187,743 187,743
Other notes payable 217,329 --
------------------------
Total notes payable 2,795,978 937,743
Less current maturities 2,700,195 937,743
------------------------
Long-term notes payable $ 95,783 $ --
========================
(a) $2,500,000 Note Payable, due November 12, 2006:
On May 12, 2006, we issued $2,500,000, six-month-term, 10% notes payable plus
detachable warrants to purchase 1,500,000 shares of our common stock with a
strike price of $0.80 for a period of five-years. Net proceeds from this
financing transaction amounted to $2,235,000. The holder has the option to
redeem the notes for cash in the event of defaults and certain other contingent
events, including events related to the common stock into which the instrument
is convertible, registration and listing (and maintenance thereof) of our
common stock and filing of reports with the Securities and Exchange Commission
(the "Default Put"). We evaluated the terms and conditions of the notes and
warrants and determined that (i) the Default
14
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Put required bifurcation because it did not meet the "clearly and closely
related" criteria of FAS 133 and (ii) the warrants did not meet all of the
requisite conditions for equity classification under FAS 133. As a result, the
net proceeds from the arrangement were first allocated to the Default Put
($87,146) and the warrants ($901,665) based upon their fair values, because
these instruments are required to be initially and subsequently carried at fair
values. These instruments are carried in our balance sheet under the
classification, Derivative Liabilities.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $2,500,000
Note Payable, due November 12, 2006.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense): June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
---------------------------------------------------------- -------------
Default Put $(216,735) -- $(216,735) --
=======================================================================
Warrant derivative $ 162,435 -- $ 162,435 --
=======================================================================
We estimated the fair value of the put on the inception date using a cash flow
technique that involves probability weighting multiple outcomes. We estimated
the warrant value using the Black Scholes-Merton technique. Significant
assumptions included in our valuation models are as follows:
Inception June 30, 2006
--------------------------------------
Trading value of common stock $0.75 $0.61
Warrant strike price $0.80 $0.80
Volatility 133.00% 133.00%
Risk free rate 5.08% 5.04%
Expected term Stated term Remaining term
Discount rate used for cash flows 13.75% 14.00%
The fair value of the Default Put increased, resulting in a charge to income,
due to changes in management's weighted probability estimates following the
financing inception which generally are attributable to the increasing
probability of default events. The fair value of the warrants declined
principally due to the decline in our common stock trading price. Since these
instruments are measured at fair value, future changes in assumptions, arising
from both internal factors and general market conditions, may cause further
variation in the fair value of these instruments. Changes in fair values of
derivative financial instruments are reflected as charges and credits to income.
The above allocations resulted in a discount to the carrying value of the notes
amounting to approximately $1,254,000. This discount, along with related
deferred finance costs and future interest payments, are being amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 amounted to
approximately $165,000. Interest expense during the third and fourth quarters
of 2006 are currently estimated to be $637,000 and $577,000 respectively.
(b) On May 9, 2004 we received the proceeds of a $750,000 loan from Mid-Am
Capital, payable September 3, 2004, with an interest rate of 8%. This loan is
secured by a general security interest in all of our assets. Mid-Am has agreed
to extend the note on a demand basis.
(c) In 1999, we issued a promissory note to assume existing debt owed by our
then Chinese joint venture subsidiary to a supplier, International Paper. The
face value of that unsecured note was $282,637 at an annual interest rate of
10.5%. The note originally required 23 monthly payments of $7,250 and a balloon
15
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
payment of $159,862 due on July 15, 2000. During 2000, we negotiated an
extension of this note to July 1, 2001. International Paper imposed a charge of
$57,000 to renegotiate the note, which amount represents interest due through
the extension date. The balance due on this note is $187,743 at June 30, 2006
and December 31, 2005, all of which is delinquent. Although International Paper
has not pursued collection of the note, it is possible that they could do so in
the future and, if they do, such collection effort may have a significant
adverse impact on the liquidity of the Company.
Note 5. Convertible Debt
Convertible debt carrying values consist of the following as of June 30, 2006
and December 31, 2005:
2006 2005
------------------------
$200,000 Convertible Note Payable, due November 2006 (a) $200,000 $ 187,934
$15,000 Convertible Note Payable, due May 2007 (b) 5,214 1,620
$600,000 Convertible Note Payable, due December 2005 (c) 600,000 600,000
$6,250 Convertible Note Payable, due April 30, 2006 (e) -- 5,188
$25,000 Convertible Note Payable, due October 1, 2006 (f) -- 30,278
$168,000 Convertible Note Payable, due December 1, 2005 (g) 168,000 187,760
------------------------
$973,214 $1,012,780
========================
(a) $400,000 Convertible Note Financing
---------------------------------------
On November 20, 2003, we issued $400,000 of 8.0% convertible notes payable, due
November 20, 2005 plus warrants to purchase 14,000,000 shares of our common
stock with a strike prices ranging from $0.05 to $1.00 for a period of three
years. $200,000 face value of the convertible notes were outstanding on June
30, 2006 and December 31, 2005 following the modification of the underlying
note agreement, extending the maturity date of the remaining balance to
November 20, 2006. The convertible notes are convertible into a variable number
of our common shares based upon a variable conversion price of the lower of
$0.05 or 75% of the closing market price near the conversion date. The holder
has the option to redeem the convertible notes payable for cash at 130% of the
face value in the event of defaults and certain other contingent events,
including events related to the common stock into which the instrument is
convertible, registration and listing (and maintenance thereof) of our common
stock and filing of reports with the Securities and Exchange Commission (the
"Default Put"). In addition, we extended registration rights to the holder that
required registration and continuing effectiveness thereof; we would be
required to pay monthly liquidating damages of 2.0% for defaults under this
provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
variable conversion feature; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because, as noted above, share settlement
and maintenance of an effective registration statement are not within our
control. Therefore, the warrants are also required to be carried as a
derivative liability, at fair value.
16
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $1,666,200 and $1,311,000 as of
June 30, 2006 and December 31, 2005, respectively. These amounts are included
in Derivative Liabilities on our balance sheet. Warrants related to the
financing were fully converted prior to December 31, 2005.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $400,000
convertible note financing.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative $(408,000) $(2,980,800) $(355,200) $(2,942,400)
============================================================================
Warrant derivative $ -- $(6,016,700) $ -- $(5,733,700)
============================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with the remaining compound derivatives.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes to zero. This discount,
along with related deferred finance costs and future interest payments, are
amortized through periodic charges to interest expense using the effective
method. Interest expense during the six months ended June 30, 2006 and 2005
amounted to approximately $15,000 and $53,000, respectively.
As noted in the introductory paragraph of this section, the holders extended
the notes one additional year to November 2006. This modification was accounted
for as an extinguishment because the present value of the amended debt was
significantly different than the present value immediately preceding the
modification. As a result of the extinguishment, the existing debt carrying
value was adjusted to fair value using projected cash flows at market rates for
similar instruments. This extinguishment resulted in our recognition of a gain
on extinguishment of $22,733 in the fourth fiscal quarter of our year ended
December 31, 2005.
(b) $2,300,000 Convertible Note Financing:
------------------------------------------
On January 28, 2005, May 23, 2005 and August 18, 2005, we issued $1,150,000,
$500,000 and $650,000, respectively of 8.0% convertible notes payable, due
January 28, 2007 plus warrants to purchase 9,200,000, 4,000,000 and 5,200,000,
respectively, shares of our common stock with a strike price of $0.129 for a
period of five years. $15,000 face value of the convertible notes was
outstanding on June 30, 2006 and December 31, 2005 resulting from conversions
to common stock. The convertible notes are
17
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
convertible into a fixed number of our common shares based upon a conversion
price of $0.125 with anti-dilution protection for sales of securities below the
fixed conversion price. We have the option to redeem the convertible notes for
cash at 120% of the face value. The holder has the option to redeem the
convertible notes payable for cash at 120% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put").
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $4,810 and $4,867 as of June 30,
2006 and December 31, 2005, respectively. Further, our valuation model resulted
in warrant derivative balances associated arising from the convertible note
financing of $10,406,200 and $10,164,188 as of June 30, 2006 and December 31,
2005, respectively. These amounts are included in Derivative Liabilities on our
balance sheet.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $2,300,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
----------------------------------------------------------------------
Compound derivative $(590) $(8,284,283) $58 $(8,160,456)
=================================================================
Warrant derivative $ -- $(8,189,280) $-- $(8,360,400)
=================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with these instruments.
18
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, are amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $33,183 and $97,319, respectively.
(c) $600,000 Convertible Note Financing:
----------------------------------------
On June 29, 2004, we issued $600,000 of 10.0% convertible notes payable, due
December 31, 2005, plus warrants to purchase 2,000,000 and 5,000,000 shares of
our common stock with strike prices of $0.25 and $1.00, respectively, for a
periods of five and two years, respectively. Net proceeds from this financing
arrangement amounted to $500,000. As of June 30, 2006, this debt is past due
and, accordingly, the outstanding carrying value of $600,000 includes $68,000
of capitalized interest following the maturity date. The convertible notes are
convertible into a fixed number of our common shares based upon a conversion
price of $0.15 with anti-dilution protection for sales of securities below the
fixed conversion price. We have the option to redeem the convertible notes for
cash at 120% of the face value. The holder has the option to redeem the
convertible notes payable for cash at 130% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we
extended registration rights to the holder that required registration and
continuing effectiveness thereof; we are required to pay monthly liquidating
damages of 2.0% for defaults under this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $625,400 and $153,700 as of June
30, 2006 and December 31, 2005, respectively. These amounts are included in
Derivative Liabilities on our balance sheet.
As of December 31, 2005 all warrants related to the financing had been
converted.
19
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $600,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
----------------------------------------------------------------------
Compound derivative $(339,200) $(1,582,667) $(471,700) $(1,582,167)
==================================================================
Warrant derivative $ -- $(5,631,800) $ -- $(5,478,300)
==================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with these instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, are amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $-0- and $233,407, respectively.
(d) $240,000 Convertible Note Financing:
----------------------------------------
On December 22, 2004, we issued $240,000 of 10.0% convertible notes payable,
due April 30, 2006, plus warrants to purchase 800,000 at $0.15 for five years.
Net proceeds from this financing arrangement amounted to $196,500. As of
December 31, 2005, this debt had been fully converted. The convertible notes
were convertible into a fixed number of our common shares based upon a
conversion price of $0.10 with anti-dilution protection for sales of securities
below the fixed conversion price. We had the option to redeem the convertible
notes for cash at 120% of the face value. The holder has the option to redeem
the convertible notes payable for cash at 130% of the face value in the event
of defaults and certain other contingent events, including events related to
the common stock into which the instrument is convertible, registration and
listing (and maintenance thereof) of our common stock and filing of reports
with the Securities and Exchange Commission (the "Default Put"). In addition,
we extended registration rights to the holder that required registration and
continuing effectiveness thereof; we are required to pay monthly liquidating
damages of 2.0% for defaults under this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
20
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. These amounts are included in
Derivative Liabilities on our balance sheet. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As of December 31, 2005
all warrant liabilities related to the financing had been fully converted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $240,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative -- -- -- --
============================================================================
Warrant derivative -- $(226,440) $ -- $(210,200)
============================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with the remaining compound derivative.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $-0- and $90,306, respectively.
(e) $693,000 Convertible Note Financing:
----------------------------------------
On October 29, 2004, we issued $693,000 of 10.0% convertible notes payable, due
April 30, 2006, plus warrants to purchase 2,200,000 at $0.15 for five years.
Net proceeds from this financing arrangement amounted to $550,000. As of
December 31, 2005, this debt had face value $6,250 outstanding which amount had
been fully converted by June 30, 2006. The convertible notes were convertible
into a fixed number of our common shares based upon a conversion price of $0.10
with anti-dilution protection for sales of securities below the fixed
conversion price. We had the option to redeem the convertible notes for cash at
120% of the face value. The holder has the option to redeem the convertible
notes payable for cash at 130% of the face value in the event of defaults and
certain other contingent events, including events related to the common stock
into which the instrument is convertible, registration and listing (and
maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we
extended registration rights to the holder that required registration and
continuing effectiveness thereof; we are required to pay monthly liquidating
damages of 2.0% for defaults under this provision.
21
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value
of the warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances of $-0-
and $42,878 as of June 30, 2006 and December 31, 2005, respectively. Our value
model resulted in warrant derivative balances associated arising from the
convertible note financing of $0 and $924,120 as of June 30, 2006 and December
31, 2005, respectively. These amounts are included in Derivative Liabilities on
our balance sheet.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $693,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative $(6,365) $(2,336,319) $(6,143) $(2,213,579)
=========================================================================
Warrant derivative $ -- $(1,280,610) $ -- $(1,246,000)
=========================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with
our financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with the remaining compound instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $3,711 and $241,052, respectively.
22
(f) $660,000 Convertible Note Financing:
----------------------------------------
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On April 2, 2004, we issued $660,000 of 10.0% convertible notes payable, due
October 1, 2005, plus warrants to purchase 3,000,000 at $0.15 for five years.
Net proceeds from this financing arrangement amounted to $493,000. As of
December 31, 2005, this debt had face value $25,000 outstanding which amount
had been fully converted by June 30, 2006. The convertible notes were
convertible into a fixed number of our common shares based upon a conversion
price of $0.10 with anti-dilution protection for sales of securities below the
fixed conversion price. We had the option to redeem the convertible notes for
cash at 120% of the face value. The holder has the option to redeem the
convertible notes payable for cash at 130% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we
extended registration rights to the holder that required registration and
continuing effectiveness thereof; we are required to pay monthly liquidating
damages of 2.0% for defaults under this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances of $-0-
and $159,250 as of June 30, 2006 and December 31, 2005, respectively. These
amounts are included in Derivative Liabilities on our balance sheet. As of June
30, 2005, all warrants related to the financing had been fully converted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $660,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative $(22,750) $(3,139,950) $(9,750) $(3,002,235)
==========================================================================
Warrant derivative $ -- $ -- $ -- $ 61,800
==========================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit
23
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
risk associated with our financial instruments. The fair value of the warrant
derivative is significantly affected by changes in our trading stock prices.
Future changes in these underlying market conditions will have a continuing
effect on derivative income (expense) associated with the remaining compound
instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $-0- and $78,776, respectively.
(g) $1,008,000 Convertible Note Financing:
------------------------------------------
On June 29, 2004, we issued $1,008,000 of 10.0% convertible notes payable, due
April 30, 2006, plus warrants to purchase 3,200,000 and 8,000,000 shares of our
common stock at $0.25 and $2.00, respectively, for a periods of five years. Net
proceeds from this financing arrangement amounted to $679,000. We had an
outstanding balance of $168,000 and $187,760 as of June 30, 2006 and December
31, 2005, respectively on this note. The convertible notes were convertible
into a fixed number of our common shares based upon a conversion price of $0.15
with anti-dilution protection for sales of securities below the fixed
conversion price. We had the option to redeem the convertible notes for cash at
120% of the face value. The holder has the option to redeem the convertible
notes payable for cash at 130% of the face value in the event of defaults and
certain other contingent events, including events related to the common stock
into which the instrument is convertible, registration and listing (and
maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we
extended registration rights to the holder that required registration and
continuing effectiveness thereof; we are required to pay monthly liquidating
damages of 2.0% for defaults under this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also
concluded that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants
are also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. These amounts are
included in Derivative Liabilities on our balance sheet. As of December 31,
2005, all warrants related to the financing had been fully converted.
24
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $1,008,000
convertible note financing:
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative $(84,602) $(2,832,614) $(69,675) $(2,810,435)
==========================================================================
Warrant derivative -- (7,341,300) -- (7,140,800)
==========================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with these instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the six months ended June 30, 2006 and 2005 amounted to
approximately $0 and $432,759, respectively.
(h) $360,000 Convertible Note Financing:
----------------------------------------
On April 21, 2005, we issued $360,000, six-month-term, 10% convertible notes
payable, due October 31, 2005. Net proceeds for this financing transaction
amounted to $277,488. The notes were convertible into shares of common stock at
a fixed conversion rate of $0.20, with anti-dilution protection for sales of
securities below the fixed conversion price. The holder converted the notes on
September 30, 2005. We had the option to redeem the notes payable for cash at
120% of the face value. The holder has the option to redeem the convertible
notes payable for cash at 130% of the face value in the event of defaults and
certain other contingent events, including events related to the common stock
into which the instrument is convertible, registration and listing (and
maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put").
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection afforded the holder; and it did not otherwise meet
the conditions for equity classification. Therefore, we were required to
bifurcate the embedded conversion feature and carry it as a derivative
liability. We also concluded that the Default Put required bifurcation because,
while puts on debt instruments are generally considered clearly and closely
related to the host, the Default Put is indexed to certain events, noted above,
that are not associated debt instruments. We combined all embedded features
that required bifurcation into one compound instrument that was carried as a
component of derivative liabilities through the date of conversion.
We allocated the initial proceeds from the financing first to the compound
derivative instrument in the amount of $113,925 and the balance to the debt
host instrument. We estimated the fair value of the compound derivative on the
inception dates, and subsequently, using the Monte Carlo Valuation technique,
because that technique embodies all of the assumptions (including credit risk,
interest risk,
25
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments.
The following table illustrates fair value adjustments that we have recorded
related to the compound derivative arising from the $360,000 convertible notes
payable.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative -- $(1,464,750) -- $(1,464,750)
=============================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. Since the instrument was converted on September 30,
2005, there will be no future charges or credits to derivative income (expense)
associated with this instrument.
The above allocations resulted in a discount to the carrying value of the notes
amounting to approximately $173,925. This discount, along with related deferred
finance costs and future interest payments, are being amortized through
periodic charges to interest expense using the effective method. Interest
expense during the six months ended June 30, 2005 amounted to approximately
$52,000.
Derivative warrant fair values are calculated using the Black-Scholes-Merton
Valuation technique. Significant assumptions as of June 30, 2006, corresponding
to each of the above financings (by paragraph reference) are as follows:
5(a) 5(b) 5(c) 5(d) 5(e) 5(f)
-------------------------------------------------------------------------
Trading market price $0.61 $0.61 $0.61 $0.61 $0.61 $0.61
Strike price $.05--$1.00 $.129 $.10 $.15 $.15 $.15
Volatility 148% 132% 136% 136% 136% 142%
Risk-free rate 3.25% 3.83% 3.30% 3.57% 3.39% 3.45%
Remaining term/life (years) .42 4.13 3.0 3.5 3.33 2.75
Our stock prices have been highly volatile. Future fair value changes are
significantly influenced by our trading common stock prices. As previously
discussed herein, changes in fair value of derivative financial instruments are
reflected in earnings.
Note 6. Preferred Stock
Our articles of incorporation authorize the issuance of 5,000,000 shares of
preferred stock. We have designated this authorized preferred stock, as
follows:
(a) Series H Preferred Stock:
-----------------------------
We have designated 350,000 shares of our preferred stock as Series H Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series H Preferred Stock has cumulative dividend rights at 7.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a fixed conversion price of $0.40 per
common share. The Series H Preferred Stock is mandatorily redeemable for common
stock on the fifth anniversary of its issuance. We
26
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
have the option to redeem the Series H Preferred Stock for cash at 135% of the
stated value. The holder has the option to redeem the Series H Preferred Stock
for cash at 140% of the stated value in the event of defaults and certain other
contingent events, including events related to the common stock into which the
instrument is convertible, listing of our common stock and filing of reports
with the Securities and Exchange Commission (the "Default Put").
Based upon our evaluation of the terms and conditions of the Series H Preferred
Stock, we concluded that it was more akin to a debt instrument than an equity
instrument, which means that our accounting conclusions are based upon those
related to a traditional debt security, and that it should afforded the
conventional convertible exemption regarding the embedded conversion feature
because the conversion price is fixed. Therefore, we are not required to
bifurcate the embedded conversion feature and carry it as a liability. However,
we concluded that the Default Put required bifurcation because, while puts on
debt-type instruments are generally considered clearly and closely related to
the host, the Default Put is indexed to certain events, noted above, that are
not associated with debt-type instruments. In addition, due to the default and
contingent redemption features of the Series H Preferred Stock, we classified
this instrument as redeemable preferred stock, outside of stockholders' equity.
Between December 2001 and March 2002, we issued 175,500 shares of Series H
Preferred Stock for cash of $1,755,000, plus warrants to purchase an aggregate
of 4,387,500 shares of common stock at $0.50 for five years. As of June 30, 2006
and December 31, 2005, 63,500 and 64,500 shares of preferred stock remain
outstanding; all of the warrants remain outstanding. We allocated $1,596,228 of
the proceeds from the Series H Preferred financings to the warrants at their
fair values because the warrants did not meet all of the conditions necessary
for equity classification and, accordingly, are carried as derivative
liabilities, at fair value. We also allocated $134,228 to the Default Puts
which, as described above are carried as derivative liabilities, at fair value.
Finally, we recorded derivative expense of $9,666 because one of the financings
did not result in sufficient proceeds to record the derivative financial
instruments at fair values on the inception date.
We estimated the fair value of the derivative warrants on the inception dates,
and subsequently, using the Black-Scholes-Merton valuation technique. As a
result of applying this technique, our valuation of the derivative warrants
amounted to $840,269 and $1,264,109 as of June 30, 2006 and December 31, 2005,
respectively. We estimated the fair value of the Default Puts on the inception
dates, and subsequently, using a cash flow technique that involves
probability-weighting multiple outcomes at net present values. Significant
assumptions underlying the probability-weighted outcomes included both our
history of similar default events, all available information about our business
plans that could give rise to or risk defaults and the imminence of impending
or current defaults. As a result of these subjective estimates, our valuation
model resulted in Default Put balances associated with the Series H Preferred
Stock of $502,451 and $381,377 as of June 30, 2006 and December 31, 2005,
respectively. These amounts are included in Derivative Liabilities on our
balance sheet. The following table illustrates fair value adjustments that we
have recorded related to the Default Puts on the Series H Preferred Stock.
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Default Put $(106,089) $ (2,064) $(121,074) $ (4,127)
===========================================================================
Derivative Warrants $ 95,936 $(2,775,061) $ 423,839 $(2,708,401)
===========================================================================
27
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Derivative income (expense) related to the Default Put includes changes to the
fair value arising from changes in our estimates about the probability of
default events and amortization of the time-value element embedded in our
calculations. Higher derivative expense in the three and six months ended June
30, 2006, when compared to the same periods of 2005, reflected the increased
probability that the Default Put would become exercisable because we would not
timely file certain reports with the Securities and Exchange Commission. In
fact, we ultimately did not file our Quarterly Report on Form 10-QSB. While the
Default Put became exercisable at that time, the holders of the Series H
Preferred Stock did not exercise their right prior to curing the event. There
can be no assurances that the holders of the Series H Preferred Stock would not
exercise their rights should further defaults arise.
The discounts to the Series H Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
paid-in capital using the effective method. The following table illustrates the
components of preferred stock dividends and accretions for the three and six
months ended June 30, 2006 and 2005:
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Cumulative dividends at 7% $11,115 $ 28,088 $ 22,225 $ 56,175
Accretions 40,388 413,269 79,562 502,617
=========================================================================
$51,503 $441,357 $101,787 $558,792
=========================================================================
As of June 30, 2006, $386,100 of cumulative dividends are in arrears on Series
H Preferred Stock.
(b) Series J Preferred Stock:
-----------------------------
We have designated 500,000 shares of our preferred stock as Series J Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series J Preferred Stock has cumulative dividend rights at 8.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a conversion price of $0.20 per common
share. The Series J Preferred Stock is mandatorily redeemable for common stock
on the fifth anniversary of its issuance. We have the option to redeem the
Series J Preferred Stock for cash at 135% of the stated value. The holder has
the option to redeem the Series J Preferred Stock for cash at 140% of the
stated value in the event of defaults and certain other contingent events,
including events related to the common stock into which the instrument is
convertible, registration and listing (and maintenance thereof) of our common
stock and filing of reports with the Securities and Exchange Commission (the
"Default Put").
Based upon our evaluation of the terms and conditions of the Series J Preferred
Stock, we concluded that its features were more akin to a debt instrument than
an equity instrument, which means that our accounting conclusions are generally
based upon standards related to a traditional debt security. Our evaluation
concluded that the embedded conversion feature was not afforded the exemption
as a conventional convertible instrument due to certain variability in the
conversion price and it further did not meet the conditions for equity
classification. Therefore, we are required to bifurcate the embedded conversion
feature and carry it as a liability. We also concluded that the Default Put
required bifurcation because, while puts on debt-type instruments are generally
considered clearly and closely related to the host, the Default Put is indexed
to certain events, noted above, that are not associated debt-type instruments.
We combined all embedded features that required bifurcation into one compound
instrument that is carried as a component of derivative liabilities. In
addition, due to the default and contingent
28
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
redemption features of the Series J Preferred Stock, we classified this
instrument as redeemable preferred stock, outside of stockholders' equity.
In September 2002, February 2003 and May 2003 we issued 100,000 shares, 50,000
shares and 50,000 shares, respectively, of Series J Preferred Stock for cash of
$2,000,000. We also issued warrants for an aggregate of 14,000,000 shares of
our common stock in connection with the financing arrangement. The warrants
have terms of five years and an exercise price of $0.25. We initially allocated
proceeds of $658,000 and $1,190,867 from the financing arrangements to the
compound derivative discussed above and to the warrants, respectively. Since
these instruments did not meet the criteria for classification, they are
required to be carried as derivative liabilities, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest
risk, stock price volatility and conversion estimates) that are necessary to
fair value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all
of the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with the Series J Preferred Stock of $6,014,000 and $5,628,000 as of
June 30, 2006 and December 31, 2005, respectively. These amounts are included
in Derivative Liabilities on our balance sheet.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the Series J
Preferred Stock.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Compound derivative $(1,400,000) $(8,260,000) $(476,000) $(8,036,000)
============================================================================
Warrant derivative $ -- $(5,819,200) $ -- $(5,651,200)
============================================================================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected
by changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is
significantly affected by changes in our trading stock prices. Future changes
in these underlying market conditions will have a continuing effect on
derivative income (expense) associated with these instruments.
The discounts to the Series J Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
paid-in capital using the effective method. The following table illustrates the
components of preferred stock dividends and accretions for the three and six
months ended June 30, 2006 and 2005:
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
-----------------------------------------------------------------------------
Cumulative dividends at 8% $ 40,000 $ 40,000 $ 80,000 $ 80,000
Accretions 158,397 88,346 295,281 164,694
------------------------------------------------------------------------
$198,397 $128,346 $375,281 $244,694
========================================================================
29
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As of June 30, 2006, $560,000 of cumulative dividends are in arrears on Series
J Preferred Stock.
(c) Series K Preferred Stock:
-----------------------------
We have designated 500,000 shares of our preferred stock as Series K Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series K Preferred Stock has cumulative dividend rights at 8.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a fixed conversion price of $0.10 per
common share. The Series K Preferred Stock is mandatorily redeemable for common
stock on the fifth anniversary of its issuance. We have the option to redeem
the Series K Preferred Stock for cash at 120% of the stated value. The holder
has the option to redeem the Series K Preferred Stock for cash at 140% of the
stated value in the event of defaults and certain other contingent events,
including events related to the common stock into which the instrument is
convertible, listing of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put").
Based upon our evaluation of the terms and conditions of the Series K Preferred
Stock, we concluded that it was more akin to a debt instrument than an equity
instrument, which means that our accounting conclusions are based upon those
related to a traditional debt security, and that it should afforded the
conventional convertible exemption regarding the embedded conversion feature
because the conversion price is fixed. Therefore, we are not required to
bifurcate the embedded conversion feature and carry it as a liability. However,
we concluded that the Default Put required bifurcation because, while puts on
debt-type instruments are generally considered clearly and closely related to
the host, the Default Put is indexed to certain events, noted above, that are
not associated debt-type instruments.. In addition, due to the default and
contingent redemption features of the Series K Preferred Stock, we classified
this instrument as redeemable preferred stock, outside of stockholders' equity.
In March 2004, we issued 80,000 shares of Series K Preferred Stock for cash of
$800,000. In April 2004, we issued 15,000 shares of Series K Preferred Stock to
extinguish debt with a carrying value of $150,000. At the time of these
issuances, the trading market price of our common stock exceeded the fixed
conversion price and, as a result, we allocated $160,000 and $60,000 from the
March and April issuances, respectively, to stockholders' equity which amount
represented a beneficial conversion feature. In addition, we recorded a debt
extinguishment loss of $60,000 in connection with the April exchange of Series
K Preferred Stock for debt because we estimated that it had a fair value that
exceeded the carrying value of the extinguished debt by that amount. Finally,
we allocated approximately $59,000 and $11,000 to the Default Puts,
representing fair values, in connection with the March and April issuances,
respectively.
We estimated the fair value of the Default Puts on the inception dates, and
subsequently, using a cash flow technique that involves probability-weighting
multiple outcomes at net present values. Significant assumptions underlying the
probability-weighted outcomes included both our history of similar default
events, all available information about our business plans that could give rise
to or risk defaults, and the imminence of impending or current defaults. As a
result of these subjective estimates, our valuation model resulted in Default
Put balances associated with the Series K Preferred Stock of $272,250 and
$206,200 as of June 30, 2006 and December 31, 2005, respectively. These amounts
are included in Derivative Liabilities on our balance sheet. The following
table illustrates fair value adjustments that we have recorded related to the
Default Puts on the Series K Preferred Stock.
30
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
-----------------------------------------------------------------------------
Derivative income (expense) $(62,912) $(1,256) $(66,050) $(2,513)
========================================================================
Derivative income (expense) related to the Default Put includes changes to the
fair value arising from changes in our estimates about the probability of
default events and amortization of the time-value element embedded in our
calculations. Higher derivative expense in the three and six months ended June
30, 2006, when compared to the same periods of 2005, reflected the increased
probability that the Default Put would become exercisable because we would not
timely file certain reports with the Securities and Exchange Commission. In
fact, we ultimately did not file our Quarterly Report on Form 10-QSB. While the
Default Put became exercisable at that time, the holders of the Series K
Preferred Stock did not exercise their right prior to curing the event. There
can be no assurances that the holders of the Series K Preferred Stock would not
exercise their rights should further defaults arise.
The discounts to the Series K Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
paid-in capital using the effective method. The following table illustrates the
components of preferred stock dividends and accretions for the three and six
months ended June 30, 2006 and 2005:
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
----------------------------------------------------------------------
Cumulative dividends at 8% $19,000 $19,000 $38,000 $38,000
Accretions 11,186 10,519 22,201 20,878
----------------------------------------------------------------
$30,186 $29,519 $60,201 $58,878
================================================================
As of June 30, 2006, $171,000 of cumulative dividends are in arrears on Series
K Preferred Stock.
(d) Other Preferred Stock Designations and Financings:
Series A Preferred: We have designated 500,000 shares of our preferred stock as
Series A Convertible Preferred Stock. There were no Series A Preferred Stock
outstanding during the periods presented.
Series B Preferred: We have designated 1,260,000 shares of our preferred stock
as Series B Convertible Preferred Stock with a stated and liquidation value of
$1.00 per share. Series B Preferred has cumulative dividend rights of 9.0%,
ranks senior to common stock and has voting rights equal to the number of
common shares into which it may be converted. Series B Preferred is convertible
into common on a share for share basis. Based upon our evaluation of the terms
and conditions of the Series B Preferred Stock, we have concluded that it meets
all of the requirements for equity classification. We have 107,440 shares of
Series B Preferred outstanding as of June 30, 2006 and December 31, 2005.
Series D Preferred: We have designated 165,000 shares of our preferred stock as
Series D Cumulative Convertible Preferred Stock with a stated and liquidation
value of $10 per share. Series D Preferred has cumulative dividend rights of
6.0%, ranks senior to common stock and is non-voting. There are no shares of
Series D Preferred Stock outstanding during any of the periods reported in this
quarterly report. However, we continue to have 611,250 warrants outstanding
that were issued in connection with the original Series D Preferred Stock
Financing arrangement.
31
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Series F Preferred: We have designated 200,000 shares of our preferred stock as
Series F Convertible Preferred Stock with a stated and liquidation value of $10
per share. There were 5,248 shares of Series F Preferred Stock outstanding as
of June 30, 2006 and December 31, 2005. Series F Preferred is non-voting and
convertible into common stock at a variable conversion price equal to the lower
of $0.60 or 75% of the trading prices near the conversion date. In addition,
the holder has the option to redeem the convertible notes payable for cash at
125% of the face value in the event of defaults and certain other contingent
events, including events related to the common stock into which the instrument
is convertible, registration and listing (and maintenance thereof) of our
common stock and filing of reports with the Securities and Exchange Commission
(the "Default Put"). We concluded that the conversion feature was not afforded
the exemption as a conventional convertible instrument due to variable
conversion feature and it did not otherwise meet the conditions for equity
classification. Since equity classification is not available for the conversion
feature, we were required to bifurcate the embedded conversion feature and
carry it as a derivative liability, at fair value. We also concluded that the
Default Put required bifurcation because, while puts on debt-type instruments
are generally considered clearly and closely related to the host, the Default
Put is indexed to certain events, noted above, that are not associated
debt-type instruments. These two derivative features were combined into one
compound derivative instrument. In addition, due to the default and contingent
redemption features of the Series F Preferred Stock, we classified this
instrument as redeemable preferred stock, outside of stockholders' equity.
Series I Preferred: We have designated 200,000 shares of our preferred stock as
Series I Convertible Preferred Stock with a stated and liquidation value of
$10.00 per share. Series I Preferred has cumulative dividend rights at 8.0% of
the stated value, ranks senior to common stock and is non-voting. Series I
Preferred is convertible into a variable number of common shares at the lower
conversion price of $0.40 or 75% of the trading market price. There were no
Series I Preferred Stock outstanding as of June 30, 2006 and December 31, 2005.
However, we had 30,000 shares outstanding during the six months ended June 30,
2005. We accounted for Series I Preferred Stock while it was outstanding as an
instrument that was more akin to a debt instrument. We also bifurcated the
embedded conversion feature and freestanding warrants issued with the financing
and carried these amounts as derivative liabilities, at fair value. The table
below reflects derivative income and (expense) associated with changes in the
fair value of this derivative financial instrument.
The following table summarized derivative income (expense) related to compound
derivatives and freestanding warrant derivatives that arose in connection with
the preferred stock transactions discussed above.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
-----------------------------------------------------------------------------
Series D Preferred:
Warrant derivative $(40,272) $(1,009,480) $ (6,205) $ (977,522)
Series F Preferred:
Compound derivative (11,490) (279,306) (6,187) (122,124)
Warrant derivative 54,708 (3,461,437) 112,573 (3,351,857)
Series I Preferred:
Compound derivative -- (73,520) -- (69,620)
Warrant derivative -- (309,292) -- (250,482)
-------------------------------------------------------------------------
$ 2,946 $(5,133,035) $100,181 $(4,771,605)
=========================================================================
32
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 7. - Share Based Payments
We have adopted certain incentive share-based plans that provide for the grant
of up to 10,397,745 stock options to our directors, officers and key employees.
As of June 30, 2006, there were 660,655 shares of common stock reserved for
issuance under our stock plans. Options granted under plans prior to May, 2005
are fully vested. Subsequent options granted are under plans which become
exercisable over two years in equal annual installments with the first third
exercisable on grant date, provided that the individual is continuously
employed by us. We did not grant options during the six months ended June 30,
2006.
On January 1, 2006, we adopted Financial Accounting Standard 123 (revised
2004), Share-Based Payments ("FAS 123(R)") which is a revision of FAS No. 123,
using the modified prospective method. Under this method, compensation cost
recognized for the six months ended June 30, 2006 includes compensation cost
for all share-based payments modified or granted prior to but not yet vested as
of, January 1, 2006, based on the grant date fair value estimated in accordance
with the original provisions of FAS No. 123. Compensation cost is being
recognized on a straight-line basis over the requisite service period for the
entire award in accordance with the provisions of SFAS 123R.
As we had previously adopted the fair-value provisions of FAS No. 123,
effective January 1, 2005, the adoption of FAS 123(R) had a negligible impact
on our earnings. We recorded compensation costs of $111,365 and $222,957 for
the second quarter and first half of 2006, respectively, and $551,810 for the
second quarter and first half of 2005. We recognized no tax benefit for
share-based compensation arrangements due to the fact that we are in a
cumulative loss position and recognize no tax benefits in our Consolidated
Statement of Operations.
As required by FAS 123(R), we estimate forfeitures of employee stock options
and recognize compensation cost only for those awards expected to vest.
Forfeiture rates are determined for two groups of employees - directors /
officers and key employees based on historical experience. We adjust estimated
forfeitures to actual forfeiture experience as needed. The cumulative effect of
adopting FAS 123(R) of $17,000, which represents estimated forfeitures for
options outstanding at the date of adoption, was not material and therefore has
been recorded as a reduction of our stock-based compensation costs in Selling
and General and Administrative expenses expense rather than displayed
separately as a cumulative change in accounting principle in the Consolidated
Statement of Operations. The adoption of SFAS No. 123(R) had no effect on cash
flow from operating activities or cash flow from financing activities for the
six months ended June 30, 2006.
We estimate the fair value of each stock option on the date of grant using a
Black-Scholes-Merton (BSM) option-pricing formula, applying the following
assumptions and amortize that value to expense over the option's vesting period
using the straight-line attribution approach:
33
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Second Six months Second Six months
Quarter ended Quarter ended
2006 * 2006 * 2005 2005
---------------------------------------------
Expected Term (in years) n/a n/a 6 6
Risk-free rate n/a n/a 5.01% 5.01%
Expected volatility n/a n/a 141% 141%
Expected dividends n/a n/a 0% 0%
* No options were granted for the six months ended June 30, 2006.
Expected Term: The expected term represents the period over which the
share-based awards are expected to be outstanding. It has been determined as
the midpoint between the vesting date and the end of the contractual term.
Risk-Free Interest Rate: We based the risk-free interest rate used in our
assumptions on the implied yield currently available on U.S. Treasury
zero-coupon issues with a remaining term equivalent to the stock option award's
expected term.
Expected Volatility: The volatility factor used in our assumptions is based on
the historical price of our stock over the most recent period commensurate with
the expected term of the stock option award.
Expected Dividend Yield: We do not intend to pay dividends on our common stock
for the foreseeable future. Accordingly, we use a dividend yield of zero in our
assumptions.
A summary of option activity under the stock incentive plans for the six months
ended June 30, 2006 is presented below:
Weighted-
Average
Weighted- Remaining
Average Contractual Aggregate
Exercise Term Intrinsic
Options Shares Price (in years) Value
-------------------------------------------- -------------- -------------- ------------- ------------------
Outstanding at December 31, 2005 10,161,138 $0.30
Granted -- $0.00
Exercised -- $0.00
Forfeited (33,333) $0.30
Expired (390,715) $0.29
Outstanding at June 30, 2006 9,737,090 $0.30 8.51 $3,088,060
========= ===== ==== ==========
Vested or expected to vest at June 30, 2006 9,355,365 $0.30 8.50 $2,993,924
========= ===== ==== ==========
Exercisable at June 30 , 2006 6,769,838 $0.31 8.37 $2,130,133
--------- ----- ---- ----------
No options were granted during the six months ended June 30, 2006. The
weighted-average fair value of options granted during the second quarter of
2005 was $0.15. There were no exercises of options during the six months ended
June 30, 2006 and the same period in 2005.
34
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
At June 30, 2006, the Company had $422,826 of total unrecognized compensation
expense related to non-vested stock options, which is expected to be recognized
over a weighted-average period of one year.
In May 2005, we extended the contractual life of 770,000 fully vested options
held by two directors. As a result of that modification, we have recognized, on
a restated basis, additional compensation expense of $104,000 for the second
quarter of 2005
Note 8. - Other Stockholders' Equity
(a) Issuances of Common Stock
-----------------------------
During the period ended June 30, 2006, we issued 995,725 shares of common stock
upon the conversion of certain of our convertible notes. These shares were
issued pursuant to registration statements declared effective by the Securities
and Exchange Commission in 2004 and 2005.
During the period ended June 30, 2006, we issued 3,500,000 shares of common
stock upon the exercise of warrants associated with certain of our convertible
notes. These shares were issued pursuant to registration statements declared
effective by the Securities and Exchange Commission in 2004 and 2005.
During the period ended June 30, 2006, we issued 807,692 shares of common stock
upon the cashless exercise of warrants associated with certain of our
convertible preferred stock. These shares were issued to an accredited investor
pursuant to Regulation D and Section 4(2) of the Securities Act of 1933
During the period ended June 30, 2006, we issued 196,078 shares of our common
stock in a private placement to an accredited investor, pursuant to Section
4(2) of the Securities Act of 1933.
On May 12, 2006, we obtained financing in the amount $2,500,000 and issued a
promissory note in that principal amount to two accredited investors. We also
issued five year warrants for 1,500,000 of our common stock at an exercise
price of $0.80 per share in connection with this financing. The warrants and
underlying common stock were issued pursuant to Regulation D
35
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(b) Outstanding Warrants
------------------------
As of June 30, 2006, we had the following outstanding warrants:
Warrants/
Expiration Options Exercise
Warrants Grant date date Granted Price
Series D Preferred Stock Financing 3/9/1999 11/17/2008 17,500 0.100
Series D Preferred Stock Financing 4/23/1999 11/17/2008 8,750 0.100
Series D Preferred Stock Financing 2/1/2000 11/17/2008 130,000 0.100
Series D Preferred Stock Financing 2/1/2000 11/17/2008 455,000 0.100
Series F Preferred Stock Financing 10/13/2000 11/17/2008 38,259 0.100
Series H Preferred Stock Financing 12/5/2001 12/4/2006 2,637,500 0.500
Series H Preferred Stock Financing 1/30/2002 1/30/2007 375,000 0.500
Series H Preferred Stock Financing 2/15/2002 2/14/2007 125,000 0.500
Series H Preferred Stock Financing 3/18/2002 3/17/2007 1,250,000 0.500
January 2005 Convertible Debt Finanicng 11/20/2003 11/20/2008 2,000,000 0.050
Warrant to Licensor (also see (c), below) 6/20/2005 6/19/2007 1,000,000 0.050
Warrant to Consultant 4/8/2005 4/7/2007 1,000,000 0.250
Warrant to Distributor 8/30/2005 8/29/2008 30,000,000 0.360
November 2005 Common Stock Financing 11/28/2005 11/27/2010 15,667,188 0.800
November 2005 Common Stock Financing 11/28/2005 11/27/2010 1,012,500 0.500
May 2006 Debt Financing 5/12/2006 5/11/2011 1,500,000 0.800
Other Financings 12/27/2001 2/28/2007 25,000 0.400
----------
Total Warrants 57,241,697
==========
Certain conversion features in our debt and preferred stock are indexed to a
variable number of common shares based upon our trading stock price.
Accordingly, in the event of stock price declines, we may have insufficient
shares to share-settle all of our contracts that are convertible into or
exercisable for common stock. As a result, current accounting standards require
us to assume that we would not have sufficient authorized shares to settle
these other warrants and, therefore, reclassify other warrants and contracts
that were otherwise carried in stockholders' equity to derivative liabilities.
Such warrants and contracts that required reclassification were indexed to
48,679,688 and 47,679,688 shares of our common stock as of June 30, 2006 and
December 31, 2005, respectively, We are not required to reclassify certain
exempt contracts and employee stock options, so those items are not included in
this caption. Derivative income (expense) associated with these other warrants
are summarized in the following table.
Three months Three months Six months Six months
ended ended Ended ended
Derivative income (expense) June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------------------------------------------------------------------------
Warrant derivative $(3,012,689) $(997,826) $463,528 $(968,905)
============================================================================
(c) Warrants issued in Settlement: During the quarterly period ended June 30,
2006 we settled a legal dispute with a licensor that resulted in the extension
of the term by one year on 1,000,000 warrants previously issued to the
licensor. We accounted for this extension as a reissuance and remeasurement of
36
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
the warrants, which resulted in a charge to our income of $552,600. We revalued
the warrants using the Black-Scholes-Merton valuation model.
Note 9 - Commitments and Contingencies
Lease of Office
---------------
We lease office space, used for our corporate offices in Florida, under an
operating lease that expires October 31, 2015. Future non-cancelable minimum
rental payments required under the operating lease as of June 30, 2006 are as
follows:
Amount
-----------
Six months ending December 31, 2006 $ 46,433
Years ending December 31,
2007 92,868
2008 92,868
2009 92,868
2010 92,868
Rent expense for the three and six months ended June 30, 2006 amounted to
$31,855 and $69,761; and, rent expense for the three and six months ended June
30, 2005 amounted to $22,404 and $44,704.
Royalties:
----------
We license trademarks and trade dress from certain Licensors for use on our
products. Royalty advances are payable against earned royalties on a negotiated
basis for these licensed intellectual property rights. The table below
identifies each Licensor to which our licenses require advance payments and, in
addition, reflects the term of the respective licenses as well as the advance
royalties remaining to be paid on such negotiated advance royalty payments, as
of June 30, 2006. We currently are in default of our guaranteed royalty
payments to Marvel Enterprises on our license for the United Kingdom by the
aggregate advance remaining listed below for Marvel (UK)
Aggregate Advance
Licensor: Term Remaining
---------------------------------------------------------------------
Marvel (UK) Two years $ 120,960
Masterfoods Six years 2,430,000
Diabetes Research Institute One year 2,500
Employment Contacts
-------------------
Our Chief Executive Officer, Mr. Warren, has a two-year employment contract,
expiring October 2007, that provides a base salary of $300,000, plus a bonus of
one quarter percent (0.25%) of net revenue and normal corporate benefits. This
contract has a minimum two-year term plus a severance package upon change of
control based on base salary.
37
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Officers Toulan, Patipa, Edwards and Kee have employment contracts with base
salaries aggregating $710,000 annually, plus discretionary bonuses and normal
corporate benefits. These contracts have minimum two-year terms plus severance
packages upon change of control based on base salary.
Our Chief Financial Officer, Mr. Kaplan, has an employment contract, expiring
November 2008, that provides a base salary of $180,000 for year one, $200,000
for year two and $220,000 for year three, plus discretionary bonuses and normal
corporate benefits. This contract has a minimum three-year term plus a
severance package upon change of control based on base salary
Marketing Commitments
---------------------
Coca-Cola Enterprises ("CCE"). In August 2005, we executed a Master
Distribution Agreement with CCE. Pursuant to this agreement, we are
contractually obligated to spend an aggregate of $5,000,000 on marketing
activities in 2005 and 2006 for our products that are distributed by CCE.
Beginning in 2007, we are further obligated to spend an amount annually in each
country within a defined territory equal or greater than 3% of our total CCE
revenues in such territory (on a country by country basis). Such national and
local advertising for our products includes actively marketing the Slammers
mark, based on a plan to be mutually agreed each year. We are required to
maintain our intellectual property rights necessary for the production,
marketing and distribution of our products by CCE.
During the period commencing at the inception of the CCE agreement through the
period ended June 30, 2006, we have spent $1.6 million on marketing activities
pursuant to our agreement with CCE.
Note 10. Restatement of Prior Financial Statements
Our statements of operations for the three and six months ended June 30, 2005,
our statement of cash flows for the six months ended June 30, 2005 and our
balance sheet as of December 31, 2005 have been restated as illustrated in the
following tables:
Three months ended Six months ended
June 30, 2005 June 30, 2005
--------------------------------------------
Net income (loss), as reported $ (1,342,027) $ (2,579,275)
Share-based payments (492,319) (492,319)
Deferred development costs (100,059) (105,492)
Derivative income (expense) (77,311,393) (75,839,650)
Amortization of debt discounts and other charges (487,384) (1,264,480)
Investor relations charges (712,114) (817,150)
---------------------------------------
Net income (loss), as restated $(80,445,296) $(81,098,366)
=======================================
Share-based payments: We improperly measured and deferred share-based payment
expense related to employee stock options that were issued commencing in the
second quarter of the year ended December 31, 2005. These adjustments, which
are reflected in operating expenses, reflect the effects of re-measurement of
the stock options and the elimination of previously deferred compensation
amounts.
Deferred development costs: We improperly capitalized development costs on our
balance sheet. These adjustments reflect our revised policy that requires
development costs to be expensed as they are incurred. We record development
costs as a component of operating expenses.
38
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Derivative income (expense): Derivative income (expense) arises from
adjustments to our derivative liabilities to carry these instruments at fair
value at the end of each reporting period. Our derivative financial instruments
consist of compound and freestanding instruments. These derivative financial
instruments arose from (i) our note payable, convertible note payable and
preferred stock financing transactions and (ii) the reclassification of
non-exempt warrants from stockholders' equity to derivative liabilities because
share settlement is presumed not to be within our control. We previously did
not properly allocate proceeds from our financing transactions to derivative
liabilities where applicable; nor did we reclassify our other warrants to
derivative liabilities when we presumably lost our ability to share settle such
instruments.
Amortization of debt discounts and other charges: We have adjusted our notes
payable and convertible notes payable to reflect the allocation of proceeds to
derivative liabilities. These allocations have resulted in discounts to the
face value of the debt, and we are required to amortize these discounts through
periodic charges to interest expense using the effective method. The
adjustments reflect the difference between our previous method of recognizing
interest expense based upon the stated interest rate and amounts derived from
the application of the effective interest method. Other charges include gains
and losses on extinguishments of our debt instruments that have arisen when
modifications to such instruments were considered to be significant.
Investor relations charges: We entered into a contract with an investor
relations firm during 2005 that required payment in our equity securities. We
incorrectly did not recognize the value of these services until the securities
were issued. This adjustment reflects the proper recognition of the consulting
cost in general and administrative expenses and a reciprocal amount in accrued
liabilities.
Preferred stock accretions: We did not allocate proceeds from certain of our
preferred stock financings to derivative financial instruments (warrants and
compound derivatives) and stockholders' equity (beneficial conversion
features). These adjustments reflect the accretion of discounts to the
preferred stock carrying values, which are reductions to net income (loss) to
arrive at income (loss) applicable to common shareholders. We have accreted
these discounts in our restated financial statements through periodic charges
to retained earnings using the effective method.
Three months ended Six months ended
June 30, 2005 June 30, 2005
--------------------------------------------
Loss applicable to common shareholders, as reported $ (1,421,928) $ (2,754,236)
Cumulative adjustments to net income (loss), above (79,103,269) (78,519,091)
Preferred stock accretions (512,914) (689,749)
---------------------------------------
Loss applicable to common shareholders, as restated $(81,038,111) $(81,963,076)
=======================================
Three months ended Six months ended
June 30, 2005 June 30, 2005
--------------------------------------------
Income (loss) per common share, basic and diluted, as reported $ (0.02) $ (0.04)
Share-based payments (0.01) (0.01)
Deferred development costs -- --
Derivative income (expense) (1.08) (1.15)
Amortization of debt discounts and other charges -- (0.02)
Preferred stock accretions (0.01) (0.02)
---------------------------------------
Income (loss) per common share, as restated $ (1.12) $(1.24)
=======================================
39
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
See descriptions that we have provided under the tables for net income (loss)
and income (loss) applicable to common stockholders. Our restated income (loss)
per common share reflects the application of the treasury stock method and the
if-converted methods where those methods are appropriate.
Three months ended Six months ended
June 30, 2005 June 30, 2005
--------------------------------------------
Comprehensive income (loss), as reported $ (1,351,790) $ (2,597,254)
---------------------------------------
Comprehensive income (loss), as restated (a) $(80,455,059) $(81,103,693)
=======================================
Our restated comprehensive income (loss) reflects the adjustments attributable
to net income (loss), above.
Our balance sheet as of December 31, 2005 has been restated as illustrated in
the following table:
Redeemable Stockholders
Total Total Preferred Equity
Assets Liabilities Stock (Deficit)
-------------------------------------------------------------------------
As reported $ 24,284,806 $ (10,793,837) $ -- $ 13,490,969
Adjustments:
Intangible assets 3,949,773 (14,220,657) -- (10,270,884)
Accrued liabilities -- (1,280,542) -- (1,280,542)
Dividends payable -- 1,240,682 -- 1,240,682
Derivative liabilities--warrants -- (8,962,945) -- (8,962,945)
Notes payable and convertible notes 123,541 (6,359,791) -- (6,236,250)
Preferred stock adjustments -- (8,068,414) (2,104,500) (10,172,914)
Deferred compensation -- --
-------------------------------------------------------------------------
As restated $ 28,358,120 $ (48,445,504) $(2,104,500) $(22,191,884)
=========================================================================
Intangible assets: We entered into a Master Distribution Agreement with Coca
Cola Enterprises on August 31, 2005 that provided for the issuance of
30,000,000 warrants to purchase our common stock. We originally did not value
these warrants using a proper valuation method. We have restated the intangible
asset to reflect its proper valuation. In addition, the warrants did not meet
all of the criteria for equity classification and are carried as derivative
liabilities at fair value in the amount of $14,220,657 as of December 31, 2005.
Stockholders' equity (deficit) reflects the reclassification of the original
value, the adjustments to fair value and adjusted amortization for the revised
intangible asset carrying value.
Accrued liabilities: We entered into a contract with an investor relations firm
during 2005 that required payment in our equity securities. We incorrectly did
not recognize the value of these services until the securities were issued.
This adjustment reflects the proper recognition of the consulting cost in
general and administrative expenses and a reciprocal amount in accrued
liabilities.
Dividends payable: We originally reported dividends payable of $1,240,682 on
certain series of our preferred stock; it was the only non-current liability at
December 31, 2005. These dividends were not declared and, therefore, they have
been reversed against the related charges in retained earnings. In the future
we will accrue preferred stock dividends when they have been declared.
Derivative liabilities--warrants: We issued certain debt and preferred stock
that embody variable conversion rates having the effect of extending share
settlement of our share obligations beyond our control. As a result, we
reclassified our other warrants to derivative liabilities and carry them at
fair value
40
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
in our revised balance sheet. Stockholders' equity (deficit) reflects the
reclassification of the original equity related to these warrants and fair
value adjustments.
Notes payable and convertible notes payable: We have allocated proceeds from
our note payable, convertible note payable and preferred stock financing
transactions, where applicable, to compound and freestanding derivative
financial instruments in our restated financial statements. As noted above, we
have also re-classed certain non-exempt warrants from stockholders' equity to
derivative liabilities because share settlement is presumed not to be within
our control. Derivative financial instruments are initially and subsequently
measured at fair values using techniques consistent with the risks associated
with the derivative financial instruments. In addition to the adjustments to
notes payable described under derivative financial instruments above, we have
restated other notes payable to properly reflect their carrying amounts. These
adjustments generally were made through charges to interest expense using the
effective interest method over the periods such notes were outstanding.
Preferred Stock Adjustments: We previously reported the aggregate carrying
value of $3,153,316 related to our Series F, H, J and K Preferred Stock in
stockholders' equity. We are required to carry these instruments outside of
stockholders' equity, under the caption redeemable preferred stock, because
these instruments have features where the investors' could require us to redeem
them for cash. As of December 31, 2005 the carrying value of these series of
preferred stock amounted to $2,104,500.
The financial instruments issued in the original preferred stock financing
transactions included both freestanding derivatives (principally warrants) and
compound embedded derivatives (principally conversion and default put features)
that we are required to carry as derivative liabilities, and at fair values. As
of December 31, 2005, these derivative liabilities had a fair value of
$8,068,414.
The allocation of proceeds from our preferred stock financing transactions
resulted in discounts to the carrying values of the preferred stock. The
restated financial statements reflect periodic accretions of these discounts,
through charges to retained earnings, using the effective method. We also
incorrectly accrued undeclared dividends and have reversed those provisions.
The aggregate of our adjustments to preferred stock, including the periodic
(charges) and credits to derivative income (expense), resulted in a decrease in
our stockholders' equity of $10,172,914. The affects on income (loss)
attributable to these adjustments are reflected in the tables, above.
Deferred Compensation: We previously reported deferred compensation as a
component of stockholders' equity of $475,932. We have restated our balance
sheet to revalue the underlying options and properly recognize the
compensation expense amounting to $560,904 and paid in capital of $84,972.
Note 11. - Subsequent Events
Subsequent to June 30, 2006, we issued 2,000,000 shares of common stock
pursuant to an exercise of a warrant associated with our November 2003
convertible note financing. The common stock underlying these notes was
registered pursuant to a registration statement declared effective by the
Securities and Exchange Commission in 2004.
Subsequent to June 30, 2006, we issued 1,444,453 shares of common stock upon
the cashless exercise of warrants associated with certain of our convertible
preferred stock. These shares were issued to accredited investors pursuant to
Regulation D and Section 4(2) of the Securities Act of 1933.
41
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Subsequent to June 30, 2006, we issued 168,937 shares of common stock pursuant
to a conversion of a convertible note. The shares of common stock underlying
the preferred were issued pursuant to a registration statement declared
effective by the Securities and Exchange Commission in 2004.
Subsequent to June 30, 2006, we issued 250,000 shares of common stock pursuant
to a conversion of our Series H preferred stock. The shares of common stock
underlying the preferred were issued pursuant to Regulation D.
Subsequent to June 30, 2006, we issued 83,121 shares of our common stock in a
private placement, pursuant to Section 4(2) of the Securities Act of 1933,
which is an accredited investor.
On July 27, 2006, we entered into definitive agreements to sell $30 million
senior convertible notes that are due in 2010 to several institutional and
accredited investors in a private placement exempt from registration under the
Securities Act of 1933. The notes initially carry a 9% coupon, payable
quarterly and are convertible into shares of common stock at $0.70 per share.
In 2007, the coupon may decline to LIBOR upon the Company achieving certain
financial milestones. The notes will begin to amortize in equal, bi-monthly
payments beginning in mid-2007. We concurrently issued warrants to purchase
12,857,143 shares of common stock at $0.73 per share that expire in July 2011
to the investors in the private placement. Under the terms of the financing, we
will sell $30 million notes, of which $15.0 million of the notes will be held
in escrow. The release of the escrowed funds will be subject to stockholder
approval. We intend to file a proxy statement seeking such shareholder approval
as soon as practical. As a result of our failure to file our June 30, 2006 Form
10QSB timely, an event of default has occurred under the terms of the Notes and
the interest rate on the Notes, payable quarterly, was increased from 9% to 14%
per annum. Pursuant to the terms of the Notes, upon the occurrence of an event
of default, holders of the Notes may, upon written notice to the Company, each
require the Company to redeem all or any portion of their Notes, at a default
redemption price calculated pursuant to the terms of the Notes. We have entered
into an Amendment Agreement with the holders of the Notes to amend the Notes in
certain respects as consideration for the holders' release of the Company's
default resulting from its delay in the filing of this quarterly report. See
Item 3 of Part II of this report, entitled "Default on Senior Securities", for
a description of the terms of the Amendment Agreement.
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Statements that are not historical facts, including statements about our
prospects and strategies and our expectations about growth contained in this
report, are "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements represent the
present expectations or beliefs concerning future events. We caution that such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among other things, the uncertainty as to our future profitability; the
uncertainty as to whether our new business model can be implemented
successfully; the accuracy of our performance projections; and our ability to
obtain financing on acceptable terms to finance our operations until
profitability.
OVERVIEW
Our business model includes the development and marketing of our Company
owned Slammers(R) and Bravo!(TM) trademarked brands, the obtaining of license
rights from third party holders of intellectual property rights to other
trademarked brands, logos and characters and the production of our branded
flavored milk drinks through third party processors. In the United States and
the United Kingdom, we generate revenue from the unit sales of finished branded
flavored milk drinks to retail consumer outlets. We generate revenue in our
Middle East business through the sale of "kits" to these dairies. The price of
the "kits" consists of an invoiced price for a fixed amount of flavor
ingredients per kit used to produce the flavored milk and a fee charged to the
dairy processors for the production, promotion and sales rights for the branded
flavored milk.
Our business in the United Kingdom started at the end of the second
quarter of 2005. Our UK business has not been profitable owing to the
difficulties encountered in initial market penetration with new products
introduced in the last half of 2005 through the first half of 2006. In the
current period we had a negative gross margin for our UK operations. We are
examining other distribution alternatives in the UK and, while we are making
this determination, we have curtailed our production of inventory necessary to
maintain a normal supply pipeline.
Our new product introduction and growth expansion continues to be
expensive, and we reported a loss from operations of $9,563,041 for the period
ended June 30, 2006. We had a net loss during this period of $12,773,188,
largely as a result of a penalty interest expense of $2.1 million associated
with our failure to have declared effective a registration statement for the
common stock underlying our November 2005 financing in a timely manner. That
registration statement currently is pending, and we are working to restate and
file the necessary financial statements required to have that registration
statement declared effective.
RESTATEMENT DISCLOSURE - NON-RELIANCE ON OUR PRIOR FINANCIAL STATEMENTS
On December 1, 2005, the Securities and Exchange Commission ("SEC") issued
a comment letter concerning accounting issues associated with our Form 10-KSB
for the year ended December 31, 2004 (the "Initial Comment Letter"). In an
effort to satisfy our registration requirements, on December 21, 2005, in
accordance with a Registration Rights Agreement associated with our November
2005
43
financing, we filed a registration statement registering the Shares and the
shares of common stock underlying the Warrants issued in connection with the
financing with the SEC, as well as a response letter addressing the seven
comments discussed by the SEC in the Initial Comment Letter.
In its letter of December 1, 2005, the SEC's Division of Corporation
Finance issued questions on the application of EITF 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, ("EITF 00-19)" and Statement of Financial Accounting
Standard No. 133, Accounting for Derivative Instruments and Hedging Activities
("FAS 133"),to financial instruments containing an embedded conversion feature,
such as convertible preferred stock, convertible notes and associated warrants.
In general, EITF 00-19 requires that certain types of convertible equity
instruments be reclassified as liabilities in cases where the issuer's ability
to settle the instrument in equity is not entirely within the issuer's control.
The standard also requires, if liability classification is determined to be
appropriate, that the instrument be valued at fair value with future changes in
the value reflected in income. As we have financed our operations with various
convertible instruments over the last several years, we were required to
reevaluate each of our financings in order to ensure the proper treatment under
EITF 00-19.
As a result of the SEC's December 1, 2005 comment letter, we immediately
began to examine the classification of and our accounting methodology for our
convertible preferred and convertible debt financing. Based upon comments from
the SEC Staff, we believe that our classification of our convertible preferred
stock and convertible notes as equity or liabilities as previously reported will
change. We have examined the accounting methodology utilized to report the value
of embedded derivatives associated with our financing instruments, including the
balance sheet reclassification and valuation of warrants associated with such
financing instruments. We have made changes in the accounting treatment of these
derivatives in that they will have been valued separately, and fluctuations of
value will be reflected on our past income statements and our balance sheets. We
also reviewed our accounting for the amortization of discounts, the impact of
certain modifications to warrants and the beneficial conversion features
associated with our various financing instruments.
Additionally, we reviewed our accounting for employee stock options,
including the fair value calculations made, the method of recognizing
compensation expense and the impact of modifications made to certain options,
and our treatment of deferred development costs. Lastly, the Staff of the SEC
has requested that we restate our historical financial statements to reclassify
shipping and handling costs from selling expenses to cost of sales.
As a result of the items described above, we will restate our annual
report on Form 10-KSB for the year ended December 31, 2005 and our quarterly
report on Form 10-QSB for the quarterly period ended March 31, 2006. We have
also restated the quarterly and year-to-date results for June 30, 2005 and our
balance sheet as of December 31, 2005 (unaudited) in the accompanying financial
presentations for comparative purposes. Until we file an amended Annual Report
on Form 10-KSB for the year ended December 31, 2005 and an amended Quarterly
Report on Form 10-QSB for the quarterly period ended March 31, 2006, you should
not rely on our prior financial reports.
Notwithstanding these restatements, the SEC may have further comments on
our financial information based on the restated financial results that will be
filed as soon as practicable. The possibility exists that we may be required to
adjust and further modify our proposed restated financial results for the
periods in question. Such adjustments and modifications, if any, may have a
material effect on the financial results set forth in those reports.
44
CORPORATE GOVERNANCE
The Board of Directors
Our board has positions for seven directors that are elected as Class A or
Class B directors at alternate annual meetings of our shareholders. Six of the
seven current directors of our board are independent. Our chairman and chief
executive officer are separate. The board meets regularly either in person or by
telephonic conference at least four times a year, and all directors have access
to the information necessary to enable them to discharge their duties. The
board, as a whole, and the audit committee in particular, review our financial
condition and performance on an estimated vs. actual basis and financial
projections as a regular agenda item at scheduled periodic board meetings, based
upon separate reports submitted by our Chief Executive Officer and Chief
Accounting Officer. Our shareholders elect directors after nomination by the
board, or the board appoints directors when a vacancy arises prior to an
election. This year we have adopted a nomination procedure based upon a rotating
nomination committee made up of those members of the director Class not up for
election. The board presently is examining whether this procedure, as well as
the make up of the audit and compensation committees, should be the subject of
an amendment to the by-laws.
Audit Committee
Our audit committee is composed of three independent directors and
functions to assist the board in overseeing our accounting and reporting
practices. Our financial information is recorded in house by our Chief
Accounting Officer's office, from which we prepare financial reports. Lazar
Levine & Felix LLP, independent registered public accountants and auditors,
audit or review these financial reports. Our Chief Accounting Officer reviews
the preliminary financial and non-financial information prepared in house with
our securities counsel and the reports of the auditors. The committee reviews
the preparation of our audited and unaudited periodic financial reporting and
internal control reports prepared by our Chief Accounting Officer. The committee
reviews significant changes in accounting policies and addresses issues and
recommendations presented by our internal accountants as well as our auditors.
Compensation Committee
Our compensation committee is composed of three independent directors and
reviews the compensation structure and policies concerning executive
compensation. The committee develops proposals and recommendations for executive
compensation and presents those recommendations to the full board for
consideration. The committee periodically reviews the performance of our other
members of management and the recommendations of the chief executive officer
with respect to the compensation of those individuals. Given the size of our
company, the board periodically reviews all such employment contracts. The board
must approve all compensation packages that involve the issuance of our stock or
stock options. Currently, there is one vacancy on the compensation committee.
Nominating Committee
The nominating committee was established in the second quarter 2002 and
consists of those members of the director Class not up for election. The
committee is charged with determining those individuals who will be presented to
the shareholders for election at the next scheduled annual meeting. The full
board fills any mid term vacancies by appointment.
45
CRITICAL ACCOUNTING POLICIES
Estimates
---------
This discussion and analysis of our consolidated financial condition and
results of operations are based on our consolidated financial statements, which
have been prepared in accordance with accounting principles for interim reports
that are generally accepted in the United States of America. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Among the more significant estimates included in our financial
statements are the following:
- Estimating future bad debts on accounts receivable that are carried at net
realizable values.
- Estimating our reserve for unsalable and obsolete inventories that are
carried at lower of cost or market.
- Estimating the fair value of our financial instruments that are required to
be carried at fair value.
- Estimating the recoverability of our long-lived assets.
We use all available information and appropriate techniques to develop our
estimates. However, actual results could differ from our estimates.
Revenue Recognition and Accounts Receivable
-------------------------------------------
Our revenues are derived from the sale of branded milk products to
customers in the United States of America, , Great Britain and the Middle East.
Geographically, our revenues are dispersed 98% and 2% between the United States
of America and internationally, respectively. We currently have one customer in
the United States that provided 74% and 0% of our revenue during the six months
ended June 30, 2006 and 2005, respectively.
Revenues are recognized pursuant to formal revenue arrangements with our
customers, at contracted prices, when our product is delivered to their premises
and collectibility is reasonably assured. We extend merchantability warranties
to our customers on our products but otherwise do not afford our customers with
rights of return. Warranty costs have historically been insignificant.
Our revenue arrangements often provide for industry-standard slotting fees
where we make cash payments to the respective customer to obtain rights to place
our products on their retail shelves for stipulated period of time. We also
engage in other promotional discount programs in order to enhance our sales
activities. We believe our participation in these arrangements is essential to
ensuring continued volume and revenue growth in the competitive marketplace.
These payments, discounts and allowances are recorded as reductions to our
reported revenue. Unamortized slotting fees are recorded in prepaid expenses.
Our accounts receivable are exposed to credit risk. During the normal
course of business, we extend unsecured credit to our customers with normal and
traditional trade terms. Typically credit terms require payments to be made by
the thirtieth day following the sale. We regularly evaluate and monitor the
creditworthiness of each customer. We provide an allowance for doubtful accounts
based on our continuing evaluation of our customers' credit risk and our overall
collection history. As of June 30, 2006 and December 31, 2005, the allowance of
doubtful accounts aggregated $365,000 and $350,000, respectively.
46
In addition, our accounts receivable are concentrated with one customer
who represents 39% of our accounts receivable balances at June 30, 2006.
Approximately, 6% of our accounts receivable at June 30, 2006 are due from
international customers.
Inventories
-----------
Our inventories, which consists primarily of finished goods, are stated at
the lower of cost on the first in, first-out method or market. Further, our
inventories are perishable. Accordingly, we estimate and record lower-of-cost or
market and unsalable-inventory reserves based upon a combination of our
historical experience and on a specific identification basis.
Impairment of Long-Lived Assets
-------------------------------
Our long-lived assets consist of furniture and equipment and intangible
assets. We evaluate the carrying values and recoverability of our long-lived
assets when circumstances warrant such evaluation by applying the provisions of
Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets ("FAS 144"). FAS 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value.
Financial Instruments
---------------------
We generally do not use derivative financial instruments to hedge
exposures to cash-flow, market or foreign-currency risks. However, we frequently
enter into certain other financial instruments and contracts, such as debt
financing arrangements, redeemable preferred stock arrangements, and
freestanding warrants with features that are either (i) not afforded equity
classification, (ii) embody risks not clearly and closely related to host
contracts, or (iii) may be net-cash settled by the counterparty. As required by
FAS 133, these instruments are required to be carried as derivative liabilities,
at fair value, in our financial statements.
We estimate fair values of derivative financial instruments using various
techniques (and combinations thereof) that are considered to be consistent with
the objective measuring fair values. In selecting the appropriate technique, we
consider, among other factors, the nature of the instrument, the market risks
that it embodies and the expected means of settlement. For less complex
derivative instruments, such as freestanding warrants, we generally use the
Black Scholes option valuation technique because it embodies all of the
requisite assumptions (including trading volatility, estimated terms and risk
free rates) necessary to fair value these instruments. For complex derivative
instruments, such as embedded conversion options, we generally use the Flexible
Monte Carlo valuation technique because it embodies all of the requisite
assumptions (including credit risk, interest-rate risk and exercise/conversion
behaviors) that are necessary to present these more complex instruments at fair
value. For forward contracts that contingently require net-cash settlement as
the principal means of settlement, we project and discount future cash flows
applying probability-weightage to multiple possible outcomes. Estimating fair
values of derivative financial instruments requires the development of
significant and subjective estimates that may, and are likely to, change over
the duration of the instrument with related changes in internal and external
market factors. In addition, option-based techniques are highly volatile and
sensitive to changes in our trading market price which has a high-historical
volatility. Since derivative financial instruments are initially and
subsequently carried at fair values, our income will reflect the volatility in
these estimate and assumption changes.
47
RESULTS OF OPERATIONS
Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005
--------------------------------------------------------------------------
Consolidated Revenues
We had revenue for the six months ended June 30, 2006 of $7,266,441, with
product costs of $6,200,097, and shipping costs of $744,636, resulting in a
gross margin of $321,708. Our reported revenues for the six months ended June
30, 2006 increased by $3,920,053, or 117%, compared to revenues of $3,346,388
for the comparable period in 2005. This increase is the result of an increase in
market penetration and distribution, owing to the continued implementation of
our Master Distribution Agreement with Coca-Cola Enterprises in the first half
of 2006. Revenues and gross margin are net of slotting fees and promotional
discounts for the six months ended June 30, 2006 in the amount of $294,332
compared to $187,295 for the comparable period in the prior year.
Geographically, our revenues are dispersed 98% and 2% between the United
States of America and internationally, respectively. We plan to take measures to
increase our international revenues as a percentage of our total revenues. In
addition, we currently have one customer in the United States that provided 74%
and 0% of our revenue during the six months ended June 30, 2006 and 2005,
respectively. The loss of this customer or curtailment in business with this
customer could have a material adverse affect on our business.
Consolidated Product Costs
We incurred product costs and shipping costs of $6,200,097 and $744,636,
respectively, for the six months ended June 30, 2006. Product costs in this
period increased by $3,841,970, a 163% increase compared to $2,358,127 for the
same period in 2005. Shipping costs in this period increased $313,800, a 73%
increase compared to $430,836 for the same period in 2005. The increase in
product costs reflects an increase in revenues and the concomitant increase in
reported product costs and shipping costs associated with that increase.
Consolidated Operating Expenses
We incurred selling expenses of $6,210,909 for the six months ended June
30, 2006. Our selling expenses for this period increased by $4,690,329, a 308%
increase compared to our selling expenses of $1,520,580 for the same period in
2005. The increase in selling expenses in the current period was due to the
hiring of additional sales staff and promotional charges associated with
increased revenues and our development of four new product lines.
We incurred general and administrative expense for the six months ended
June 30, 2006 of $3,396,521. Our general and administrative expense for this
period increased by $801,443, a 31% increase compared to $2,595,078 for the same
period in 2005. As a percentage of total revenue, our general and administrative
expense decreased from 77.5% in the period ended June 30, 2005, to 47% for the
current period in 2006. We anticipate a continued effort to reduce this expense
as a percentage of revenues through revenue growth, cost cutting efforts and the
refinement of business operations. The increase in general and administrative
expense for the current period is the result of the hiring of additional staff
and other costs associated with the management and implementation of our
relationship with Coca-Cola Enterprises under the Master Distribution Agreement.
48
We incurred product development expense for the six months ended June 30,
2006 of $277,319 representing a 28.5% increase over product and development
expense for the comparable period of the prior year. This increase resulted from
the reformulation of existing products and the development of new products under
our license agreement with General Mills.
Interest Expense
We incurred interest expense for the six months ended June 30, 2006 of
$431,261. Our interest expense decreased by $1,060,629, a 71% decrease compared
to $1,491,890 for the same period in 2005. The decrease was due to conversions
of debt to common stock in late 2005 that eliminated the accrual of interest
associated with that debt.
Liquidated Damages
On November 28, 2005, we sold 40,500,000 shares of the Company's common
stock to the Subscribers for $20,250,000 to thirteen accredited institutional
investors. We also issued five-year warrants for the purchase of an additional
15,187,500 shares of common stock at an exercise price of $0.80 per share. The
issued securities are restricted and have been issued pursuant to an exemption
to the registration requirements of Section 5 of the Securities Act of 1933 for
"transactions of the issuer not involving any public offering" provided in
Section 4(2) of the Act and pursuant to a Regulation D offering. The securities
carry registration rights that obligate the Company to file a registration
statement within 45 days and have the registration statement declared effective
120 days from closing. We are in default of our obligation to register the
securities sold in this transaction and have incurred liquidated damages of
$2,128,275 for the six months ended June 30, 2006, pursuant to the terms of the
stock purchase agreements for this transaction as a result of that default.
Legal Settlement
In June 2005, we issued Marvel Enterprises a warrant to purchase 1,000,000
shares of our common stock in connection with the grant of a trademark license
by Marvel to the Company. The warrant contained an expiration date of June 16,
2006. In connection with the issuance of the warrant, we executed a registration
rights agreement with Marvel that required us to use our reasonable best efforts
to cause the effectiveness of a registration statement, under the Securities Act
of 1933, for the resale by Marvel of the shares purchasable under the warrant.
In December 2005, the Company filed a registration statement under From SB-2
that included the common stock underlying the Marvel warrant. As of March 31,
2006, however, the Registration Statement had not been declared effective. In
the second quarter of 2006, Marvel filed a complaint against the Company,
alleging that Marvel had been damaged by our failure to cause a registration
statement to become effective. On June 7, 2006, we settled the lawsuit, without
the necessity of filing an answer to the complaint, by delivering to Marvel an
amendment to the Warrant extending its term through June 16, 2007, and Marvel
dismissed its complaint.
Gain on Debt Extinguishment
We reported a gain on debt extinguishments for the six months ended June
30, 2005 of $7,164, resulting from the modification of the terms of certain
notes.
Derivative Expense
Derivative expense arises from changes in the fair value of our derivative
financial instruments and, in rare instances, day-one losses when the fair value
of embedded and freestanding derivative financial instruments issued or included
in financing transactions exceed the proceeds or other basis. Derivative
financial instruments include freestanding warrants, compound embedded
derivative features that have been bifurcated from debt and preferred stock
financings. In addition, our derivative financial instruments arise from the
reclassification of other non-financing derivative and other contracts from
stockholders' equity because share settlement is not within our control while
certain variable share price indexed financing instruments are outstanding.
Our derivative expense amounted to $98,011 for the six months ended June
30, 2006, compared to $75,839,650 for the corresponding period of the prior
year as a result of changes in fair value.
Changes in the fair value of compound derivatives indexed to our common
stock are significantly affected by changes in our trading stock price and the
credit risk associated with our financial instruments. The fair value of warrant
derivatives is significantly affected by changes in our trading stock prices.
The fair value of derivative financial instruments that are settled solely with
cash fluctuate with changes in management's weighted probability estimates
following the financing inception and are
49
generally attributable to the increasing probability of default events on debt
and preferred stock financings. The fair value of the warrants declined
principally due to the decline in our common stock trading price. Since these
instruments are measured at fair value, future changes in assumptions, arising
from both internal factors and general market conditions, may cause further
variation in the fair value of these instruments. Future changes in these
underlying internal and external market conditions will have a continuing effect
on derivative expense associated with our derivative financial instruments.
In addition, we entered into a $30 million debt and warrant financing in
July 2006 that will require the bifurcation of derivative financial instruments.
We have not calculated the amounts of these derivatives, but their effects on
our earnings, arising from fair value changes, will be consistent with the
derivatives that we include in our financial statements as of June 30, 2006.
Net Loss
We had a net loss for the six months ended June 30, 2006 of $12,773,188
compared with a net loss of $81,098,366 for the same period in 2005. The
magnitude of both the 2006 and 2005 net loss is principally related to the
result of our recording changes in derivative expense on the consolidated
statement of operations.
Loss Applicable to Common Shareholders
Loss applicable to common shareholders represents net loss less preferred
stock dividends and accretion of our redeemable preferred stock to redemption
value using the effective method. Diluted loss per common share reflects the
assumed conversion of all dilutive securities, such as convertible preferred
stock, convertible debt, warrants, and employee stock options.
Loss per Common Share
The Company's basic loss per common share for the six months ended June
30, 2006 was $(0.07), compared with a basic loss per common share for the same
period in 2005 of $(1.24). Because the Company experienced net losses for all
periods presented, all potential common share conversions existing in our
financial instruments would have an antidilutive impact on earnings per share;
therefore, diluted loss per common share equals basic loss per common share for
all periods presented.
The weighted average common shares outstanding increased from 66,035,224
for the six months ended June 30, 2005 to 186,843,409 for the same period in
2006. The increase is attributed primarily to conversions of our convertible
debt and preferred instruments into common shares. Potential common stock
conversions excluded from the computation of diluted earnings per share amounted
to 61,178,096 and 104,564,021 for the six month periods ending June 30, 2006 and
June 30, 2005, respectively.
Comprehensive Loss
Comprehensive loss differs from net income (loss) for the six months ended June
30, 2006 and 2005 by $21,439 and ($5,327), respectively, which represents the
effects of foreign currency translation on the financial statements of our
subsidiaries denominated in foreign currencies. Our foreign operations are
currently not significant. Increases in our foreign operations will likely
increase the effects of foreign currency translation adjustments on our
financial statements.
50
Three Months Ended June 30, 2006 Compared to the Three Months
-------------------------------------------------------------
Ended June 30, 2005
-------------------
Consolidated Revenues
The Company had revenues for the three months ended June 30, 2006 of
$3,705,226, with product costs of $3,253,637 and shipping costs of $351,185,
resulting in a gross margin of $100,404, or 2.7 % of sales. Our revenues for the
three months ended June 30, 2006 increased by $1,256,608, a 51% increase
compared to revenues of $2,448,618 for the three months ended June 30, 2005. The
increase in revenue in the United States for the three months ended June 30,
2006 is the result of the increased distribution of our product through
Coca-Cola Enterprises.
Consolidated Product Costs
The Company incurred product costs of $3,253,637 and shipping costs of
$351,185 for the three months ended June 30, 2006. Product costs for this period
increased by $1,573,173, a 93.6% increase compared to $1,680,464 for the three
months ended June 30, 2005. The increase in product costs and shipping costs in
the United States for the three months ended June 30, 2006 is the result of
increased revenues.
Consolidated Operating Expenses
The Company incurred selling expenses for the three months ended June 30,
2006 of $3,367,811. Selling expenses increased for the three months ended June
30, 2006 by $2,332,262, a 225% increase compared to the selling expenses of
$1,035,549 for the three months ended June 30, 2005. The increase in selling
expenses is the result of increased sales.
The Company incurred general and administrative expenses for the three
months ended June 30, 2006 of $1,628,317. General and administrative expenses
for the three months ended June 30, 2006 decreased by $208,507, a 11.3% increase
compared to $1,836,824 for the same period in 2005. The decrease in general and
administrative expenses for the current period is the result of the recognition
of warrant costs recognized in 2005 for warrants granted to an investor
relations firm.
Interest Expense
The Company incurred interest expense for the three months ended June 30,
2006 of $397,252. Interest expense for the three months ended June 30, 2006
decreased by $200,477, a 33.5% decrease compared to $597,729, for the same
period in 2005. This decrease was the result of conversions of debt to common
stock in late 2005 that eliminated the accrual of interest associated with that
debt.
Liquidated Damages
On November 28, 2005, we sold 40,500,000 shares of the Company's common
stock to the Subscribers for $20,250,000 to thirteen accredited institutional
investors. We also issued five-year warrants for the purchase of an additional
15,187,500 shares of common stock at an exercise price of $0.80 per share. The
issued securities are restricted and have been issued pursuant to an exemption
to the registration requirements of Section 5 of the Securities Act of 1933 for
"transactions of the issuer not involving any public offering" provided in
Section 4(2) of the Act and pursuant to a Regulation D offering. The securities
carry registration rights that obligate the Company to file a registration
statement within 45 days and have the registration statement declared effective
within 120 days from closing. We are in default of our obligation to register
the securities sold in this transaction and have incurred liquidated damages of
$2,049,889 for the three months ended June 30, 2006, pursuant to the terms of
the stock purchase agreements for this transaction as a result of that default.
Derivative Expense
Derivative expense arises from changes in the fair value of our derivative
financial instruments and, in rare instances, day-one losses when the fair value
of embedded and freestanding derivative financial instruments issued or included
in financing transactions exceed the proceeds or other basis. Derivative
financial instruments include freestanding warrants, compound embedded
derivative features that have been bifurcated from debt and preferred stock
financings. In addition, our derivative financial instruments arise from the
reclassification of other non-financing derivative and other contracts from
stockholders' equity because share settlement is not within our control while
certain variable share price indexed financing instruments are outstanding.
Our derivative expense amounted to $5,047,199 for the three months ended
June 30, 2006, compared to $77,311,393 for the corresponding period of the prior
year.
Changes in the fair values of compound derivatives indexed to our common
stock are significantly affected by changes in our trading stock price and the
credit risk associated with our financial instruments. The fair values of
warrant derivatives is significantly affected by changes in our trading stock
prices. The fair values of derivative financial instruments that are settled
solely with cash fluctuate with changes in management's weighted probability
estimates following the financing inception and are generally attributable to
the increasing probability of default events on debt and preferred stock
financings. The fair values of the warrants declined principally due to the
decline in our common stock trading price. Since these instruments are measured
at fair value, future changes in assumptions, arising from both internal factors
and general market conditions, may cause further variation in the fair values of
these instruments. Future changes in these underlying internal and external
market conditions will have a continuing effect on derivative expense associated
with our derivative financial instruments.
In addition, we entered into a $30 million debt and warrant financing in
July 2006 that will require the bifurcation of derivative financial instruments.
We have not calculated the amounts of these derivatives, but their effects on
our earnings, arising from fair value changes, will be consistent with the
derivatives that we include in our financial statements as of June 30, 2006.
Net Loss
We had had a net loss for the three months ended June 30, 2005 of
$13,104,020, compared with a net loss of $80,445,296 for the same period in
2005. The magnitude of the 2006 and 2005 loss is the result of our recording
changes in the fair value in our derivatives.
Loss Applicable to Common Shareholders
Loss applicable to common shareholders represents net loss less preferred
stock dividends and accretion of our redeemable preferred stock to redemption
value using the effective method.
Loss per Common Share
The Company's basic loss per common share for the three months ended June
30, 2006 was $(0.07), compared with a basic loss per common share for the same
period in 2005 of $(1.12). Because the Company experienced net losses for all
periods presented, all potential common share conversions existing in our
financial instruments would have an antidilutive impact on earnings per share;
therefore, diluted loss per common share equals basic loss per common share for
all periods presented.
The weighted average common shares outstanding increased from 72,381,911
for the three months ended June 30, 2005 to 189,388,123 for the same period in
2006. The increase is attributed primarily to conversions of our convertible
debt and preferred instruments into common shares. Potential common stock
conversions excluded from the computation of diluted earnings per share amounted
to 80,359,701 and 156,093,017 for the three month periods ending June 30, 2006
and June 30, 2005, respectively.
Comprehensive Loss
Comprehensive loss differs from net loss for the three months ended June
30, 2006 and 2005 by $22,129 and ($9,763), respectively, which represents the
effects of foreign currency translation on the financial statements of our
subsidiaries denominated in foreign currencies. Our foreign operations are
currently not significant. Increases in our foreign operations will likely
increase the effects of foreign currency translation adjustments on our
financial statements.
51
LIQUIDITY AND CAPITAL RESOURCES
Management's Plans:
As reflected in the accompanying consolidated financial statements, we
have incurred operating losses and negative cash flow from operations and have
negative working capital of $48,278,262 as of June 30, 2006. This negative
figure is largely the effect of our recording of $36,425,561 for derivative
liabilities. In addition, we are delinquent on certain of our debt agreements at
June 30, 2006, and, we have experienced delays in filing our financial
statements and registration statements due to errors in our historical
accounting that currently are being corrected. Our inability to make these
filings is resulting in our recognition of penalties payable to the investors.
These penalties will continue until we can complete our filings and register the
common shares into which the investors' financial instruments are convertible.
Finally, our revenues are significantly concentrated with one major customer.
The loss of this customer or curtailment in business with this customer could
have a material adverse affect on our business. These conditions raise
substantial doubt about our ability to continue as a going concern.
We have been dependent upon third party financings as we execute on our
business model and plans. While our liquid reserves have been substantially
depleted as of June 30, 2006, we completed a $30.0 million convertible note
financing in July 2006 that is expected to fulfill our liquidity requirements
through the end of 2006. However, $15.0 million of this financing is being held
in escrow, and we are in default on this instrument due to the delay in filing
our quarterly financial report for the quarterly period ended June 30, 2006. We
have entered into an Amendment Agreement with the holders of the Notes to amend
the Notes in certain respects as consideration for the holders' release of the
Company's default resulting from its delay in the filing of this quarterly
report.
We plan to increase our revenues, improve our gross margins, augment our
international business and, if necessary, obtain additional financing.
Ultimately, our ability to continue is dependent upon the achievement of
profitable operations. There is no assurance that further funding will be
available at acceptable terms, if at all, or that we will be able to achieve
profitability.
The accompanying financial statements do not reflect any adjustments that
may result from the outcome of this uncertainty.
Information about our cash flows
As of June 30, 2006, we reported that net cash used in operating
activities was $7,385,239, net cash provided by financing activities was
$3,211,672 and net cash used in investing activities was $736,514 during the six
months ended June 30, 2006. We had a negative working capital of $48,278,262 as
of June 30, 2006. This negative working capital is largely the effect of our
recording of $36,425,561 for derivative liabilities during this period.
Compared to $2,502,512 of net cash used in operating activities in the six
months ended June 30, 2005, our current period net cash used in operating
activities increased by $4,882,727 to $7,385,239. This increase was the result
of our utilization of cash rather than equity to pay service providers in this
current period and significant growth in our inventories.
Changes in accounts receivable during the six months ended June 30, 2006
resulted in a cash increase of $1,941,060, compared to a cash increase in
receivables of $26,778 for the same period in 2005, having a net result of an
increase of $1,914,282. Inventory increased during this period by $2,490,676 in
2006, compared to an increase of $54,981 for the same period in 2005. This
increase was the result of our building inventories in connection with the
continued implementation of our Master
52
Distribution Agreement with Coca-Cola Enterprises. The changes in accounts
payable and accrued liabilities in the six months ended June 30, 2006
contributed to a cash increase of $3,160,386, whereas the changes in accounts
payable and accrued liabilities for the same period in 2005 amounted to an
increase of $893,461. Cash flows provided by our operating activities was
inadequate to cover all of our cash disbursement needs in the period ended June
30, 2006 and we had to rely on prior equity and new convertible debt financing
to cover operating expenses.
Cash used during the six months ended June 30, 2006 in our investing
activities was $736,514 for license and trademark costs, furniture, computer
equipment and our purchase of eight vans in the U.S., compared to $128,135 for
the same period in 2005.
Net cash provided by our financing activities for the six months ended
June 30, 2006 was $3,211,672. Net cash provided by financing activities for the
same period in 2005 was $2,900,870, for a net increase of $310,802.
Going forward, our primary requirements for cash consist of the following:
o the continued development of our business model in the United States
and on an international basis;
o promotional and logistic production support for the capacity demands
presented by our Master Distribution Agreement with Coca-Cola
Enterprises;
o general overhead expenses for personnel to support the new business
activities;
o development, launch and marketing costs for our line of new branded
flavored milk products and
o the payment of guaranteed license royalties.
We estimate that our need for financing to meet cash requirements for
operations will continue through the third or fourth quarter of 2006, when we
expect that cash supplied by operating activities will approach the anticipated
cash requirements for operating expenses. We anticipated the need for additional
financing in 2006 to reduce our liabilities, assist in marketing and to improve
stockholders' equity status, and we secured $30 million in senior convertible
note financing in July 2006. We have received half of the proceeds from this
financing in the third quarter, with the balance held in escrow pending a
shareholder vote to increase our authorized shares to cover the escrowed
balance. No assurances can be given that we will be able to obtain the approval
of our shareholders to increase our authorized shares, or that operating cash
flows will be sufficient to fund our operations.
We currently have monthly working capital needs of approximately $400,000.
We will continue to incur significant selling and other expenses in 2006 in
order to derive more revenue in retail markets, through the introduction and
ongoing support of our new products and the implementation of the Master
Distribution Agreement with Coca-Cola Enterprises. Certain of these expenses,
such as slotting fees and freight charges, will be reduced as a function of unit
sales costs as we expand our sales markets and increase our revenues within
established markets. Freight charges will be reduced as we are able to ship more
full truckloads of product given the reduced per unit cost associated with full
truckloads versus less than full truckloads. Similarly, slotting fees, which are
paid to warehouses or chain stores as initial set up or shelf space fees, are
essentially one-time charges per new customer. We believe that along with the
increase in our unit sales volume, the average unit selling expenses and
associated costs will decrease, resulting in gross margins sufficient to
mitigate cash needs. In addition, we are actively seeking additional financing
to support our operational needs and to develop an expanded promotional program
for our products.
53
External Sources of Liquidity
-----------------------------
On May 12, 2006, we obtained financing in the amount $2,500,000 and issued
promissory notes in that aggregate principal amount to two accredited investors.
One of these investors has exercised rights of participation and has reinvested
$1,000,000 of this note in the July 27, 2006 financing described below. The
remaining $1,500,000 principal of the notes has been paid in full with the part
of the July 27, 2006 financing proceeds.
On July 27, 2006, we entered into definitive agreements to sell $30
million senior convertible notes (the "Notes")that are due in 2010 to several
institutional and accredited investors in a private placement exempt from
registration under the Securities Act of 1933. The notes initially carry a 9%
coupon, payable quarterly, and are convertible into shares of common stock at
$0.70 per share. In 2007, the coupon may decline to LIBOR upon the Company
achieving certain financial milestones. The Notes will begin to amortize in
equal, bi-monthly payments beginning in mid-2007. We issued warrants to purchase
12,857,143 shares of common stock at $0.73 per share that expire in July 2011 to
the investors in the private placement. Under the terms of the financing, we
sold $30 million notes, of which $15.0 million of the notes are being held in
escrow. The release of the funds will be subject to stockholder approval of the
increase of our authorized shares from 300,000,000 to 500,000,000 and the
effectiveness of a registration statement convering the common stock underlying
the Notes, Additional Notes and associartes warrants. We will utilize this
financing for, among other things, our working capital needs. We have filed a
proxy statement seeking such shareholder approval at a Special Meeting of
Shareholders.
As a result of our failure to file our June 30, 2006 Form 10QSB timely, an
event of default has occurred under the terms of the Notes and the interest rate
on the Notes, payable quarterly, was increased from 9% to 14% per annum.
Pursuant to the terms of the Notes, upon the occurrence of an event of default,
holders of the Notes may, upon written notice to the Company, each require the
Company to redeem all or any portion of their Notes, at a default redemption
price calculated pursuant to the terms of the Notes. We have entered into an
Amendment Agreement with the holders of the Notes to amend the Notes in certain
respects as consideration for the holders' release of the Company's default
resulting from its delay in the filing of this quarterly report. See Item 3 of
Part II of this report, entitled "Default on Senior Securities", for a
description of the terms of the Amendment Agreement.
EFFECTS OF INFLATION
We believe that inflation has not had any material effect on our net sales
and results of operations.
ITEM 3. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain "disclosure controls and procedures," as such term is defined
in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the
"Exchange Act") designed to ensure information required to be disclosed by us in
reports that we file or submit under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is accumulated
and communicated to our management, including our chief executive officer and
chief accounting officer, as appropriate, to allow timely decisions regarding
required disclosure.
We have carried out an evaluation, under the supervision and with the
participation of our audit committee and management, including our chief
executive officer and chief accounting officer, of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to
Exchange
54
Act Rules 13a-15(b) and 15d-15(b). During this evaluation, management considered
the impact any material weaknesses and other deficiencies in our internal
control over financial reporting might have on our disclosure controls and
procedures.
Based upon this evaluation, we determined that the following material
weakness existed:
Inadequate controls over the process for the identification and
implementation of the proper accounting for complex and non-routine
transactions, particularly as they relate to accounting for derivatives, which
has caused the Company to restate its consolidated financial statements for each
of the two years ended December 31, 2004 and 2005, and for the quarterly periods
contained within those years (collectively, the "financial statements") in order
to properly present those financial statements;
Because the material weakness identified in connection with the assessment
of our internal control over financial reporting as of June 30, 2006 has not
been fully remedied, our Chief Executive Officer and our Chief Accounting
Officer concluded our disclosure controls and procedures were not effective as
of June 30, 2006. To address these control weaknesses, the Company engaged
advisory accountants, who performed additional analysis and performed other
procedures for our preparation of the unaudited quarterly consolidated financial
statements appearing in this Form 10-QSB in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-QSB, Item 310(b) of Regulation S-B and Article 10(01)(c)
of Regulation S-X.
In addition, we have added or are initiating the following additional
controls to the Company's internal control over financial reporting which will
improve such internal control subsequent to the date of the evaluation. These
changes are:
o We have restructured certain departmental responsibilities as they
relate to the financial reporting function.
o We have added one more experienced full-time accountant to our
accounting staff, whose responsibilities will include the identification
and implementation of proper accounting procedures relating to current
and new guidance on financial reporting issues which apply to the
Company.
o We have commenced a search for a consultant to perform a review for the
purpose of performing an independent evaluation of the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
See Note 8 of Notes to Consolidated Financial Statements.
Item 3. Default on Senior Securities
On July 27, 2006, we entered into definitive agreements to sell $30 million
senior convertible notes (the "Notes") that are due in 2010 to several
institutional and accredited investors in a private placement exempt from
registration under the Securities Act of 1933. Under the terms of the financing,
we sold $30 million notes, of which $15.0 million were issued upon closing (the
"Notes") with the balance of the notes (the "Additional Notes") held in escrow
until our satisfaction of certain conditions.. As a result of the Company's
non-timely filing of its Form 10-QSB for the quarterly period ended June 30,
2006, an event of default occurred under the terms of the $30 million Senior
Convertible Notes issued on July 27,
55
2006 and the annual interest rate on the Notes and Additional Notes was
increased from 9% to 14%. In the event, however, that such event of default is
subsequently cured, interest on the Notes shall revert to the rate of 9% per
annum. In addition, upon the occurrence of an event of default, holders of the
Notes and Additional Notes may, upon written notice to the Company, require the
Company to redeem all or any portion of their Notes.
On August 31, 2006, the Company entered into Amendment Agreements with the
holders of the Notes and Additional Notes, pursuant to the which holders each
agreed to release the Company from the events of default that occurred under the
terms of the Notes as a result the Company's non-filing of its Form 10-QSB for
the quarterly period ended June 30, 2006. The Company agreed, in consideration
for such releases, to exchange the $15 million Additional Notes for amended and
restated notes (the Amended and Restated Notes). The Amendment Agreement
provides for termination by the non-breaching party if closing of the
transactions contemplated by the Amendment Agreement does not occur by September
1, 2006 due to one party's failure to satisfy its conditions to closing. The
Amendment Agreement also provides for the extension of certain time limits with
regard to dates set forth in the financing documentation in connection with the
Securities Purchase Agreement, dated as of July 26, 2006.
The Amended and Restated Notes will be issued upon closing of the transactions
contemplated by the Amendment Agreement. The terms of the Amended and Restated
Notes differ from the terms of the Additional Notes in certain regards. The
conversion price applicable to the conversion of any portion of the principal of
the Amended and Restated Notes is $0.51, which price is reduced from $0.70 for
the Additional Notes. The Amended and Restated Notes also provide that, from and
after the earlier of (i) October 10, 2006 and (ii) the date the Stockholder
Approval is obtained, the holder may require the Company to redeem at such
holder's option any portion of the holder's Amended and Restated Note in cash at
a price equal to 125% of the amount redeemed. Notwithstanding the foregoing,
between November 15, 2006 and December 15, 2006, provided the Company meets
certain conditions, the Company may request the holder to require that the
Company redeem any portion of such holder's notes. In the event that such holder
does not so request, the holder's right to any such optional redemptions shall
terminate; provided, however, that once a holder delivers such a request, its
right to deliver a subsequent request shall terminate. The holders, pursuant to
the Amended and Restated Notes, each will also agree, upon such holder's
delivery of an optional redemption request, to waive certain debt and equity
restrictions applicable to the Company pursuant to the financing documentation
in connection with the Securities Purchase Agreement, dated as of July 26, 2006.
Subsequent Events
See Note 11 of Notes to Consolidated Financial Statements.
Item 6. Exhibits
Exhibits - Required by Item 601 of Regulation S-B:
No. 20.1: Form 8-K filed August 2, 2006 Item 8.01 Transaction
Documents for $30 million financing (incorporated by
reference)
No. 20.2: Form 8-K Filed August 14, 2006 Item 7.01 Triggering
Events of Default (incorporated by reference)
No. 20.3: Form 8-K Filed August 22, 2006 Item 4.02 Non-Reliance on
Previously Issued Financial Statements (incorporated by
reference)
56
No. 20.4: Form 8-K Filed September 5, 2006 Item 1.01 Amendment
Agreement -Release of Default (incorporated by reference)
No. 31: Rule 13a-14(a) / 15d-14(a) Certifications
No. 32: Section 1350 Certifications
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the registrant
caused this report to be signed on its behalf of the undersigned, duly
authorized.
BRAVO! FOODS INTERNATIONAL CORP.
(Registrant)
Date: September 11, 2006
/s/Roy G. Warren
Roy G. Warren, Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, Bravo! Foods
International Corp. has caused this report to be signed on its behalf by the
undersigned in the capacities and on the dates stated.
Signature Title Date
--------- ----- ----
/S/ Roy G. Warren Chief Executive Officer September 11, 2006
and Director
/S/ Tommy E. Kee Chief Accounting Officer September 11, 2006