-------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO 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
---------------------------------------------------
(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 25, 2006 Common Stock 195,018,001
Preferred Stock 456,840
Transitional Small Business Disclosure Format (Check One) YES [ ] NO [x]
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial statements
Consolidated balance sheets as of F-1 to F-2
June 30, 2006 and December 31, 2005
Consolidated statements of operations F-3
for the three and six months
ended June 30, 2006 and 2005 (unaudited)
Consolidated statements of cash flows F-4
for the six months ended
June 30, 2006 and 2005 (unaudited)
Notes to consolidated financial statements (unaudited) F-5
Item 2. Management's Discussion and Analysis of Financial 41
Condition and Results of Operations
Item 3. Controls and Procedures 52
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity and Use of Proceeds 53
Item 3. Default on Senior Securities 53
Item 6. Exhibits 54
SIGNATURES 54
EXHIBITS
DOCUMENTS INCORPORATED BY REFERENCE: See Exhibits
EXPLANATORY NOTE
We are filing this Amendment No. 1 to our Quarterly Report on Form 10-QSB
for the quarterly period ended June 30, 2006 to reflect the restatement of our
consolidated financial statements for the periods ended June 30, 2006, and as of
June 30, 2006. As more fully described in Note 10 to the consolidated financial
statements, included herein, we have restated our consolidated financial
statements to record estimated liquidated damages that arose in connection with
a registration rights agreement, pursuant to financial accounting standard No.
5, Accounting for Contingencies. In our previous filing, we recorded these
amounts as incurred. We have also restated Management's Discussion and Analysis,
included herein, to give effect to the restated financial information.
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 our 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 we become
profitable.
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2006 2005
------------- -------------
(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 8,479,906 4,872,277
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 56,362,888 48,749,254
Notes payable, less current maturities 95,783 -
------------- -------------
Total liabilities 56,458,671 48,749,254
------------- -------------
F-1
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2006 2005
------------- -------------
(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 (134,877,246) (119,254,501)
Cumulative translation adjustment (9,320) (30,759)
------------- -------------
Total stockholders' equity (deficit) (35,625,796) (22,495,634)
------------- -------------
Total liabilities, Redeemable Preferred Stock and Stockholders'
Equity (Deficit) $ 23,324,420 $ 28,358,120
============= =============
See accompanying notes.
F-2
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
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 1,530,580
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 (397,254) (597,729) (431,261) (1,491,890)
Liquidated damages (3,872,388) - (4,558,275) -
Legal settlement (552,600) - (552,600) -
Other income (expense) - 7,164 - 7,164
------------ ------------ ------------ ------------
Income (loss) before income taxes (14,926,521) (80,445,296) (15,203,188) (81,098,366)
Provision for income taxes - - - -
------------ ------------ ------------ ------------
Net loss (14,926,521) (80,445,296) (15,203,188) (81,098,366)
Preferred stock dividends and accretion (282,477) (593,595) (541,260) (864,710)
------------ ------------ ------------ ------------
Loss applicable to common stockholders $(15,208,998) $(81,038,891) $(15,744,448) $(81,963,076)
============ ============ ============ ============
Loss per common share:
Basic loss per common share $ (0.08) $ (1.12) $ (0.08) $ (1.24)
============ ============ ============ ============
Diluted loss per common share $ (0.08) $ (1.12) $ (0.08) $ (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) $(14,926,521) $(80,445,296) $ (15,203,188) $(81,098,366)
Foreign currency translation 22,129 2,696 21,439 (5,327)
------------ ------------ ------------ ------------
Comprehensive income (loss) $(14,904,392) $(80,442,600) $(15,181,749) $(81,103,693)
============ ============ ============ ============
See accompanying notes.
F-3
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30
-------------------------------
2006 2005
-------------------------------
(Unaudited) (Unaudited)
(Restated)
Cash Flow from Operating Activities:
Net loss $(15,203,188) $(81,098,366)
Adjustments 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
Derivative expense, net 98,011 75,839,650
Amortization of 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 5,590,386 893,461
------------ ------------
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 exercise of warrants 500,000 1,038,509
Proceeds from convertible notes payable 2,669,323 1,950,000
Proceeds from sale of stock and warrants 100,000 -
Payments for redemption of 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.
F-4
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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
June 30, 2006 and our statements of operations and cash flows for the three and
six months ended June 30, 2006 for errors related to the accounting for
liquidated damages arising from certain of our financing transactions and
certain other matters more fully described in Notes 3 and 10.
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 $51,012,013 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, 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
F-5
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
F-6
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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.
F-7
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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 1,325,958
Less accumulated amortization (1,874,204) (1,382,929)
----------- -----------
$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.
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
==========
F-8
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
========== ==========
F-9
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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)
$1,080,000 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)
F-10
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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)
============ ============
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 effects on our income (loss) associated with
changes in the fair values of our derivative financial instruments by type of
financing for the three and six months ended June 30, 2006 and 2005.
Six months Six months
Three months ended Three months ended ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense): --------------------------------------------------------------------------------
Convertible note and warrant
financings $ (988,406) $(52,662,081) $(1,039,310) $(52,079,406)
Preferred stock and warrant
financings (1,429,847) (20,981,136) (132,898) (20,196,343)
Other warrants and derivative
contracts (2,628,946) (3,668,176) 1,074,197 (3,563,901)
----------------------------------------------------------------------------
$(5,047,199) $(77,311,393) $ (98,011) $(75,839,650)
============================================================================
Additional information related to individual financings can be found in notes
5, 6 and 8.
Our derivative liabilities as of June 30, 2006 and December 31, 2005, and our
derivative losses during the three and six months ended June 30, 2006 and 2005
is significant to our consolidated financial statements.
F-11
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The magnitude of the derivative loss for the three and six months ended June 30,
2005 when compared with the losses for the same periods ended June 30, 2006
reflects the following:
(a) During the six months ended June 30, 2005, and specifically commencing in
the second quarter, the trading price of our common stock reached significantly
high levels relative to its trend. The trading price of our common stock
significantly affects the fair value of our derivative financial instruments.
To illustrate, our trading stock price at the end of the first quarter of 2005
was $0.15 and then increased to $0.93 by the end of the second quarter. Our
trading stock price then declined to $0.61 and $0.59 at the end of the third
and fourth quarters, respectively. However, the higher stock price had the
effect of significantly increasing the fair value of our derivative liabilities
and, accordingly, we were required to adjust the derivatives to these higher
values with charges to our income. Also, due to the higher stock price
commencing in the second quarter, we experienced significant exercise and
conversion activity related to our derivative warrants and, to a lesser degree,
with respect to the embedded conversion options. Accordingly, our year end
derivative liability balances reflect, among other elements of our valuation
assumptions, the higher intrinsic values of the arrangements caused by the
significant changes in our stock price, which are offset by a smaller number of
common shares indexed to outstanding warrants due to the extraordinary level of
exercise activity.
(b) During the year ended December 31, 2005, we entered into a $2,300,000 debt
and warrant financing arrangement, more fully discussed in Note 5(b). In
connection with our accounting for this financing we encountered the unusual
circumstance of a day-one loss related to the recognition of derivative
instruments arising from the arrangement. That means that the fair value of the
bifurcated compound derivative and warrants exceeded the proceeds that we
received from the arrangement and we were required to record a loss to record
the derivative financial instruments at fair value. The loss that we recorded
amounted to $8,663,869. We did not enter into any other financing arrangements
during the periods reported that reflected day-one losses.
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
F-12
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
determining whether we have sufficient authorized and unissued common
shares for all of our share-settled obligations.
We have entered into registration rights agreements with certain investors that
require us to file a registration statement covering shares underlying a
financing arrangement, become effective on the registration statement, maintain
effectiveness and, in some instances, maintain the listing of the underlying
shares. Certain of these registration rights agreements require our payment of
liquidating damages to the investors in the event we do not achieve the
requirements. We record estimated liquidated damages as liabilities and charges
to our income when the liquidated damages are probable and estimable under
Financial Accounting Standard No. 5, Accounting for Contingencies. During the
three and six months ended June 30, 2006, we recorded liquidated damages expense
of $3,872,388 and $4,558,275.
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
F-13
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 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
---------- ----------
Liquidated damages due to late registration (a) 4,862,026 $ 303,750
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
---------- ----------
$8,479,906 $4,872,277
========== ==========
(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 3.0% each month. We record these liquidated damages
when they are probable and estimable pursuant to FAS 5.
(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
F-14
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 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.
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense): --------------------------------------------------------------------------------
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 and 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.
F-15
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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
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
F-16
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
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.
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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.
F-17
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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 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:
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
Compound derivative $(590) $(8,284,283) $58 $(8,160,456)
=========================================================================
Warrant derivative $ -- $(8,189,280) $-- $(8,360,400)
=========================================================================
F-18
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $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
F-19
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
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:
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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,
F-20
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. 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:
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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
F-21
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $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:
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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.
F-22
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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, 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.
(f) $660,000 Convertible Note Financing:
----------------------------------------
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:
F-23
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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 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.
F-24
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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. 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.
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:
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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
F-25
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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, 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.
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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:
F-26
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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 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.
F-27
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
Default Put $(106,089) $ (2,064) $(121,074) $ (4,127)
===========================================================================
Derivative Warrants $ 95,936 $(2,775,061) $ 423,839 $(2,708,401)
===========================================================================
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
F-28
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
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.
Six months Six months
Three months ended Three months ended ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
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:
F-29
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Six months Six months
Three months ended Three months 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
=========================================================================
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
F-30
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
Six months Six months
Three months ended Three months 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:
Six months Six months
Three months ended Three months 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.
F-31
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
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:
F-32
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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)
===================================================================
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:
F-33
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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.
F-34
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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
F-35
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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 Financing 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.
Six months Six months
Three months ended Three months ended Ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
Derivative income (expense) --------------------------------------------------------------------------------
Warrant derivative $(2,628,946) $(3,668,176) $1,074,197 $(3,563,901)
===========================================================================
(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
F-36
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
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.
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.
F-37
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
Our statements of operations for the three and six months ended June 30, 2006,
our statement of cash flows for the six months ended June 30, 2006 and our
balance sheet as of June 30, 2006 have been restated to reflect our estimation
of liquidating damages related to certain registration rights agreements entered
into in connection with certain of our financing transactions applying Financial
Accounting Standard No. 5, Accounting for Contingencies. We previously reported
our liquidated damages expenses as they had been incurred.
The following tables reflect the significant elements of statements of
operations that were restated:
Three months ended Six months ended
June 30, 2006 June 30, 2006
------------------ ----------------
Net income (loss), as reported $(13,104,020) $(12,773,188)
Liquidated damages expense (1,822,501) (2,430,000)
----------------------------------
Net income (loss), as restated $(14,926,521) $(15,203,188)
==================================
Three months ended Six months ended
June 30, 2006 June 30, 2006
------------------ ----------------
Loss applicable to common shareholders, as reported $(13,386,497) $(13,314,448)
Liquidated damages expense (1,822,501) (2,430,000)
----------------------------------
Loss applicable to common shareholders, as restated $(15,208,998) $(15,744,448)
==================================
Three months ended Six months ended
June 30, 2006 June 30, 2006
------------------ ----------------
Income (loss) per common share, basic and diluted
as reported $(0.07) $(0.07)
Liquidated damages expense (0.01) (0.01)
---------------------------
Income (loss) per common share, as restated $(0.08) $(0.08)
===========================
F-38
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three months ended Six months ended
June 30, 2006 June 30, 2006
------------------ ----------------
Comprehensive income (loss), as reported $(13,081,891) $(12,751,749)
==================================
Comprehensive income (loss), as restated $(14,904,392) $(15,181,749)
==================================
The following table reflects the significant elements of our balance sheet at
June 30, 2006 that were restated:
Redeemable Stockholders
Total Total Preferred Equity
Assets Liabilities Stock (Deficit)
-------------------------------------------------------------
As reported $23,324,420 $(53,724,920) $(2,491,545) $(32,892,045)
Adjustments:
Accrued liabilities -- (2,733,751) -- (2,733,751)
-------------------------------------------------------------
As restated $23,324,420 $(56,458,671) $(2,491,545) $(35,625,796)
=============================================================
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.
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
F-39
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.
F-40
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
We have restated 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 in the accompanying financial
presentations for comparative purposes. Notwithstanding these restatements, the
SEC may have further comments on our financial information based on the
restated financial results that we have filed. The
41
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 this report.
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.
42
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.
43
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 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
---------------------
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 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.
44
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.
45
We incurred product development expense for the six months ended June 30,
2006 of $277,319 representing a 28.5% increase over product 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.
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 (loss) 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.
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
46
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 carry as of June 30, 2006.
Liquidated Damages
During the three and six months ended June 30, 2006, we recorded liquidated
damages expense of $3,872,388 and $4,558,275; none in the comparable periods of
2005. However, we recorded $303,750 of liquidated damages during the fourth
fiscal quarter of our year ended December 31, 2005. We have entered into
registration rights agreements with certain investors that require us to file a
registration statement covering underlying indexed shares, become effective on
the registration statement, maintain effectiveness, and, in some instances,
maintain the listing of the underlying shares. Certain of these registration
rights agreements require our payment of cash penalties to the investors in the
event we do not achieve the requirements. We record estimated liquidated
damages penalties as liabilities and charges to our income when the cash
penalties are probable and estimable. We will evaluate our estimate of
liquidated damages in future periods and adjust our estimates for changes, if
any, in the facts and circumstances underlying their classification.
Net Loss
We had a net loss for the six months ended June 30, 2006 of $15,203,188
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 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 $(0.08), 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
47
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 Income (Loss)
Comprehensive income (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.
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, an 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 $397,254. Interest expense for the three months ended June 30, 2006
decreased by $200,475, 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.
48
Liquidated Damages
During the three months ended June 30, 2006, we recorded liquidated damages
expense of $3,872,388; none in the comparable period of 2005. However, we
recorded $303,750 of liquidated damages during the fourth fiscal quarter of our
year ended December 31, 2005. We have entered into registration rights
agreements with certain investors that require us to file a registration
statement covering underlying indexed shares, become effective on the
registration statement, maintain effectiveness, and, in some instances,
maintain the listing of the underlying shares. Certain of these registration
rights agreements require our payment of cash penalties to the investors in the
event we do not achieve the requirements. We record estimated liquidated
damages penalties as liabilities and charges to our income when the cash
penalties are probable and estimable. We will evaluate our estimate of
liquidated damages in future periods and adjust our estimates for changes, if
any, in the facts and circumstances underlying their classification.
Net Loss
We had had a net loss for the three months ended June 30, 2005 of
$14,926,521, 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.
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 $51,012,013 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 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.
49
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
$51,012,013 as of June 30, 2006. This negative figure is largely the effect of
our recording of $36,425,561 for derivative liabilities.
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 our recording of changes in value on a cumulative basis in
derivative expense in the consolidated statement of operations.
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. Cash increased during this period by $2,490,676,
compared to cash provided of $54,981 for the same period in 2005. This increase
was the result of our building inventory in connection with the continued
implementation of our Master 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 $5,590,386, whereas the changes
in accounts payable and accrued liabilities for the period ended June 30, 2005
amounted to an increase of $893,461. Cash flows generated through our operating
activities was inadequate to cover all of our cash disbursement needs in the
period ended June 30, and we had to rely on prior equity and new convertible
debt financing to cover operating expenses.
Cash used in the period 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
50
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
$550,000. 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.
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 converting the
common stock underlying the Notes, Additional Notes and associated 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.
51
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 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 in order to prepare the unaudited quarterly condensed
consolidated financial statements appearing in this Form 10-QSB in accordance
with generally accepted accounting principles in the United States of America.
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 evaluating the Company's internal control over
financial reporting.
52
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, 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.
53
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)
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: October 2, 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 October 2, 2006
and Director
/S/ Tommy E. Kee Chief Accounting Officer October 2, 2006
54