Form 10-K for CANNAVEST CORP.
31-Mar-2015
Annual Report
OVERVIEW
Our business focus is to produce, market and distribute hemp-based consumer products as well as supply raw hemp products including CBD to third parties in the industry. We cannot assure you that market conditions or our financial resources will be sufficient to undertake these and other steps that we anticipate will be necessary. The development of products in this highly regulated industry carries significant risks and uncertainties that are beyond our control. As a result, we cannot assure that we will successfully market and sell our planned products or, if we are able to do so, that we can achieve sales volume levels that will allow us to cover our fixed costs.
We expect that we will need to raise approximately $15 million in the next 12 months to fund our business and have begun raising funds under a private placement. Given the small size of our company and the early stage of our operations, we may find it difficult to raise sufficient capital to meet our needs. We do not have any firm commitments for all of our capital needs, and there are no assurances it will be available to us. If we are unable to access capital as necessary, our ability to generate revenues and to continue as a going concern will be in jeopardy.
Non-GAAP Financial Measures
We currently focus on Adjusted EBITDA to evaluate our business relationships and our resulting operating performance and financial position. Adjusted EBITDA is defined as EBITDA (net income plus interest expense, income tax expense, depreciation and amortization), further adjusted to exclude certain non-cash expenses and other adjustments as set forth below. We present Adjusted EBITDA because we consider it an important measure of our performance and it is a meaningful financial metric in assessing our operating performance from period to period by excluding certain items that we believe are not representative of our core business, such as certain non-cash items and other adjustments.
We believe that Adjusted EBITDA, viewed in addition to, and not in lieu of, our reported results in accordance with accounting principles generally accepted in the United States (“GAAP”), provides useful information to investors regarding our performance for the following reasons:
� because non-cash equity grants made to employees and non-employees at a certain price and point in time do not necessarily reflect how our business is performing at any particular time, stock-based compensation expense is not a key measure of our operating performance; and
� revenues and expenses associated with acquisitions, dispositions, equity issuance and related offering costs can vary from period to period and transaction to transaction and are not considered a key measure of our operating performance.
We used Adjusted EBITDA:
� as a measure of operating performance;
� to evaluate the effectiveness of our business strategies; and
� in communication with our board of directors concerning our financial performance
Adjusted EBITDA is a non-GAAP measure and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. The term Adjusted EBITDA is not defined under GAAP, and Adjusted EBITDA is not a measure of net income (loss), operating income or any other performance measure derived in accordance with GAAP.
Adjusted EBITDA has limitations as an analytical tool and should not be consider in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
� Adjusted EBITDA does not reflect all cash expenditures, future requirements for capital expenditures or contractual requirements;
� Adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs; and
� Adjusted EBITDA can differ significantly from company to company depending on strategic decisions regarding capital structure, the tax jurisdictions in which companies operate, the level of capital investment, thus, limiting is usefulness as a comparative measure.
Adjusted EBITDA should not be considered as a measure of discretionary cash available to us for investment in our business. We compensate for these limitations by relying primarily on GAAP results and using Adjusted EBITDA as supplemental information.
A reconciliation from our net loss to Adjusted EBITDA, a non-GAAP measure, for the years ended December 31, 2014 and 2013 is detailed below:
For the Years Ended December 31,
2014 2013
Net loss $ (1,311,951 ) $ (2,300,196 )
Interest income (30,703 ) -
Interest expense 615,344 372,109
Income tax expense - -
Amortization of purchased intangible assets 821,500 753,500
Depreciation of property & equipment 112,100 13,754
EBITDA 206,290 (1,160,833 )
EBITDA Adjustments:
Stock-based compensation expense (1) 7,957,988 -
KannaLife Sciences disposition related revenues (2) (7,899,306 ) -
Allocated loss on KannaLife Sciences equity
investment (3) 38,552 310,754
Other 34,816 -
Total EBITDA Adjustments 132,050 310,754
Adjusted EBITDA $ 338,340 $ (850,079 )
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(2) Represents non-cash revenues related to sale of KannaLife Sciences equity investment.
(3) Represents allocated losses related to KannaLife Sciences investment.
Critical Accounting Policies
The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis management evaluates its critical accounting policies and estimates.
A “critical accounting policy” is one which is both important to the understanding of the financial condition and results of operations of the Company and requires management’s most difficult, subjective, or complex judgments, and often requires management to make estimates about the effect of matters that are inherently uncertain. Management believes the following accounting policies fit this definition:
Acquisition of PhytoSPHERE Assets- We have accounted for the acquisition of the assets of PhytoSPHERE Systems, LLC in accordance with the Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“ASC Topic 805”). ASC Topic 805 establishes principles and requirements for recognizing and measuring the total consideration transferred to and the assets acquired, liabilities assumed and any non-controlling interests in the acquired target in an asset purchase. ASC Topic 805 also provides guidance for recognizing and measuring goodwill acquired and other tangible and intangible assets.
Accounts receivable – Accounts receivable consists of trade accounts arising in the normal course of business. No interest is charged on past due accounts. Accounts for which no payments have been received after 30 days are considered delinquent and customary collection efforts are initiated. Accounts receivable are carried at original invoice amount less a reserve made for doubtful receivables based on a review of all outstanding amounts on a quarterly basis.
Management has determined the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition and credit history, and current economic conditions. As of December 31, 2014 and 2013, we recorded an allowance for doubtful accounts related to our accounts receivable in the amount of $100,000 and $400,000, respectively.
Inventory – Inventory is stated at lower of cost or market, with cost being determined on average cost basis. There was no reserve for obsolete inventory as of December 31, 2014 and 2013. Amounts paid to suppliers for inventory not received is classified as prepaid inventory. Once received, the cost of inventory received is reclassified to inventory.
Revenue Recognition – Our revenue recognition policy is consistent with the criteria set forth in Staff Accounting Bulletin 104- Revenue Recognition(“SAB 104”) for determining when revenue is realized or realizable and earned. We recognize revenue in accordance with the requirements of SAB 104 that:
� persuasive evidence of an arrangement exists including a signed purchase order; � delivery has occurred;
� the seller’s price to the buyer is fixed or determinable; and � collectability is reasonably assured.
The Company recognizes revenue in accordance with the ASC Topic 605, Revenue Recognition (“ASC Topic 605”) which requires persuasive evidence of an arrangement, delivery of a product or service, a fixed or determinable price and assurance of collection within a reasonable period of time. The Company records revenue when goods are delivered to customers and the rights of ownership have transferred from the Company to the customer.
Long-Lived Assets – In accordance with ASC Topic 360, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviews property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property and equipment is measured by comparing its carrying value to the undiscounted projected future cash flows that the asset(s) are expected to generate. If the carrying amount of an asset is not recoverable, we recognize an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is generally determined as the present value of estimated future cash flows or at the appraised value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property and equipment include a significant decrease in the market price of a long-lived asset, a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition and a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset including an adverse action or assessment by a regulator.
Goodwill and Intangible Assets- The Company evaluates the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill.
We make critical assumptions and estimates in completing impairment assessments of goodwill and other intangible assets. Our cash flow projections look several years into the future and include assumptions on variables such as future sales and operating margin growth rates, economic conditions, market competition, inflation and discount rates.
We amortize the cost of other intangible assets over their estimated useful lives, which range up to five years, unless such lives are deemed indefinite. Intangible assets with indefinite lives are tested in the fourth quarter of each fiscal year for impairment, or more often if indicators warrant.
Stock-Based Compensation- Certain employees, officers, directors and consultants of the Company participate in various long-term incentive plans that provide for granting stock options and restricted stock awards. Stock options generally vest in equal increments over a two- to four-year period and expire on the tenth anniversary following the date of grant. Restricted stock awards generally vest 100% at the grant date.
The Company recognizes stock-based compensation for equity awards granted to employees, officers, and directors as compensation and benefits expense on the consolidated statements of operations. The fair value of stock options is estimated using a Black-Scholes valuation model on the date of grant. The fair value of restricted stock awards is equal to the closing price of the Company’s stock on the date of grant. Stock-based compensation is recognized over the requisite service period of the individual awards, which generally equals the vesting period.
The Company recognizes stock-based compensation for equity awards granted to consultants as selling, general and administrative expense on the consolidated statements of operations. The fair value of stock options is estimated using a Black-Scholes valuation model on the date of grant and unvested shares are revalued at each reporting period. The fair value of restricted stock awards is equal to the closing price of the Company’s stock on the date of grant multiplied by the number of shares awarded. Stock-based compensation is recognized over the requisite service period of the individual awards, which generally equals the vesting period.
Recent Accounting Pronouncements
Refer to Note 2 of our consolidated financial statements for a discussion of recent accounting standards and pronouncements.
Results of Operations
Year ended December 31, 2014 vs. December 31, 2013
Revenues
We had sales of $10,190,667 and gross profit of $5,803,665, representing a gross profit percentage of 56.9% for the year ended December 31, 2014 versus sales of $2,154,063 and gross profit of $1,273,593, representing a gross profit percentage of 59.1% for the year ended December 31, 2013. The sales increase in 2014 over 2013 is the result of the Company’s expansion of its existing customer markets.
Selling, general and administrative expenses – For the year ended December 31, 2014, the Company incurred selling, general and administrative (the “SG&A”) expenses in the amount of $13,357,633 compared with $2,366,450 for the year ended December 31, 2013. This increase is primarily driven by the continued growth of Company operations, increase in our headcount, marketing and legal expense, and stock based compensation. SG&A expense during 2014 includes $7,851,685 of stock-based compensation, a non-cash expense. Our legal expenses have increased due to various matters that we are vigorously defending. The SG&A expenses include $821,500 and $753,500 of amortization expense of intangible assets acquired through the Agreement for Purchase and Sale of Assets (the “PhytoSPHERE Agreement”) entered into by the Company with PhytoSPHERE for the years ended December 31, 2014 and 2013, respectively.
Research and development expenses – For the years ended December 31, 2014 and 2013, the Company incurred research and development expenses of $999,280 and $524,476, respectively. These expenses are related to the cost of process development, rental of our laboratory facility, payroll expenses, laboratory supplies, product development and testing, and outsourced research personnel for the period. The increase in 2014 over 2013 relates primarily to expansion of our laboratory facility and related expenses. Research and development expense during 2014 includes $64,148 of stock-based compensation, a non-cash expense.
Interest income/expense – Interest income was $30,703 and $0, respectively, for the years ended December 31, 2014 and 2013. Interest expense was $615,344 for the year ended December 31, 2014 versus interest expense of $372,109 for the year ended December 31, 2013. Interest for 2014 includes interest accrued under the Roen Ventures Note in the amount of $25,870 and $589,474 representing the amortization of the remaining debt discount at the date of conversion. Interest for 2013 includes $161,583 of interest accrued on the note payable to Roen Ventures plus $210,526 as amortization of the discount calculated on the note payable to Roen Ventures, LLC related to a beneficial conversion feature.
Gain/Loss on Equity Investment- For the years ended December 31, 2014 and 2013, the Company recognized losses of $38,552 and $310,754, respectively, representing its pro rata share (24.97%) of the loss of KannaLife. On June 2, 2014, the Company sold its 24.97% equity investment in KannaLife to PhytoSPHERE in exchange for 500,000 shares of Company common stock held by PhytoSPHERE, an affiliate of KannaLife. Accordingly, the Company recognized a gain on sale of equity investment of $7,899,306 based on the number of shares of Company common stock received at the closing trading price of Company common stock on June 2, 2014 of $16.60 per share.
Liquidity and Capital Resources
A summary of our changes in cash flows for the years ended December 31, 2014 and 2013 is provided below:
For the years ended December 31,
2014 2013
Net cash flows provided by (used in):
Operating activities $ (6,711,999 ) $ (4,879,234 )
Investing activities (1,384,384 ) (1,875,819 )
Financing activities 8,155,131 8,998,292
Net increase in cash 58,748 2,243,239
Cash, beginning of year 2,243,670 431
Cash, end of year $ 2,302,418 $ 2,243,670
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Operating Activities
Net cash provided by or used in operating activities includes net loss adjusted for non-cash expenses such as depreciation and amortization, loss on equity investment, gain on sale of equity investment, bad debt expense and stock-based compensation. Operating assets and liabilities primarily include balances related to funding of inventory purchases and customer accounts receivable. Operating assets and liabilities that arise from the funding of inventory purchases and customer accounts receivable can fluctuate significantly from day to day and period to period depending on the timing of inventory purchases and customer behavior.
Net cash used in operating activities for the years ended December 31, 2014 and 2013 totaled $6,711,999 and $4,879,234, respectively. Cash used for prepayments of inventory and inventory purchases was approximately $7,977,718 for the year ended December 31, 2014 compared to $2,602,166 for the year ended December 31, 2013. Cash provided by accounts receivable collection was $1,205,952 for the year ended December 31, 2014 compared to $1,744,064 used to fund accounts receivable for the year ended December 31, 2013. During the year ended December 31, 2014, collection of accounts receivable was greater than anticipated resulting in a $300,000 reduction of our allowance for doubtful accounts with a corresponding adjustment (credit) to bad debt expense of $300,000. Cash provided by accounts payable and accrued expenses was $369,411 for the year ended December 31, 2014 and $247,325 for the year ended December 31, 2013. Amortization of the debt discount totaled $589,474 for the year ended December 31, 2014 compared to $210,526 for the year ended December 31, 2013. Additionally, in June 2014, the Company sold its 24.97% equity investment in KannaLife to PhytoSPHERE in exchange for 500,000 shares of Company common stock held by PhytoSPHERE, an affiliate of KannaLife. Accordingly, the Company recognized a gain on sale of equity investment of $7,899,306 based on the number of shares of Company common stock received at the closing trading price of Company common stock on June 2, 2014 of $16.60 per share. This was a non-cash transaction and accordingly is an adjustment to cash used in operating activities for the year ended December 31, 2014. Stock-based compensation totaled $7,915,833 for the year ended December 31, 2014 while there was no expense in 2013. Depreciation and amortization totaled $933,600 for the year ended December 31, 2014 compared to $767,254 for the year ended December 31, 2013.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2014 and 2013 totaled $1,384,384 and $1,875,819, respectively. The net cash used in investing activity for the year ended December 31, 2014 consisted of $449,211 of property and equipment purchases, $264,827 of principal repayments on note receivable and issuance of a $1,200,000 note receivable in connection with sale of inventory to a customer. The net cash used in investing activity for the year ended December 31, 2013 consisted primarily of cash paid for the PhytoSPHERE Agreement totaling $950,000 and the investment in KannaLife totaling $750,000.
Financing Activities
Net cash provided by financing activities for the year ended December 31, 2014 and 2013 totaled $8,155,131 and $8,998,292, respectively. Cash flows provided by financing activities in 2014 primarily include $8,247,500 in proceeds from the sale of common stock. Cash flows provided by financing activities in 2013 primarily include proceeds of $6,192,069 from the Roen Ventures, LLC loan and $2,731,423 in proceeds from the sale of common stock.
The Company has yet to attain a level of operations which allows it to meet operating and working capital cash flow needs. Therefore, the Company has commenced an offering and plans to raise an additional amount up to $24 million through a private placement. We expect to be dependent upon obtaining additional financing in order to adequately fund working capital, infrastructure and expenses in order to execute plans for future operations so that we can achieve a level of revenue adequate to support our cost structure, none of which can be assured.
Off-Balance Sheet Arrangements
The Company has two supply agreements in place with European farmers to supply raw material in future years. These arrangements are critical to Company operations since the worldwide supply of raw hemp is currently limited.
The first contract is for the growth and processing of 2,600 kilograms of product currently being delivered and scheduled to be delivered through August 31, 2015. The total amount left to be paid under this contract is approximately $7.2 million through December 2015. The second contract provides up to 1 million kilograms of raw product to the Company. There is approximately $1.8 million remaining to be paid under this second contract. We have contractual rights for the growth and processing of hemp oil for delivery through October 2018 under both of these contracts. We anticipate the cost under both contracts will remain consistent with current year prices.
MAPH Enterprises, LLC | (305) 414-0128 | 1501 Venera Ave, Coral Gables, FL 33146 | new@marijuanastocks.com
