On February 1, 2012, the Company issued warrants to purchase 500,000 shares of the Company’s common stock to an investor relations professional engaged by the Company. The warrants can be exercised at a price equal to 70% of the average share price of the Company’s common stock for the 5 previous trading days prior to conversion. They expire on January 31, 2017. No warrants were issued for services in 2013.
Due to the exercise terms of common stock warrants, the option met the criteria to be bifurcated and presented as derivative liabilities. The Company calculated the estimated fair values of the liabilities for option derivative instrument at the original grant date and as of March 31, 2014 using the Black-Scholes option pricing model using the share prices of the Company’s stock on the dates of valuation and using the following ranges for volatility, expected term and the risk free interest rate at each respective valuation date, no dividend has been assumed for any of the periods:
The following reflects the initial fair value on the date of grant and changes in fair value through March 31, 2014 for warrant derivative liability:
For the periods ended March 31, 2014 and December 31, 2013 the Company recorded $8,987 and $8,990, respectively, in stock based compensation.
As of March 31, 2014, the Company has available approximately $12,700,000 of operating loss carry-forwards before applying the provision of Internal Revenue Code (“IRC”) Section 382, which may be used in the future filings of the Company’s tax returns to offset future taxable income for United States income tax purposes. Net operating losses will begin to expire in the year 2022. As of March 31, 2014 and December 31, 2013, the Company has determined that due to the uncertainty regarding profitability in the near future, a 100% valuation allowance is needed with regards to the deferred tax assets. Changes in the estimated tax benefit that will be realized from the tax loss carry-forwards and other temporary differences will be recognized in the financial statement in the years in which those changes occur.
For the period ended March 31, 2014 the change in of the valuation allowance was $243,723.
Under the provisions of the IRC Section 382, an ownership change is deemed to have occurred if the percentage of the stock owned by one or more 5% shareholders has increased, in the aggregate, by more than 50 percentage points over the lowest percentage of stock owned by said shareholders at any time during a three year testing period. Once an ownership change is deemed to have occurred under IRC Section 382, a limitation on the annual utilization of net operating loss carry-forwards is imposed and therefore, a portion of the tax loss carry-forwards would be subject to the limitation under Section 382.
The tax years 2009 through 2013 remain open to examination by federal authorities and state jurisdictions where the Company operates.
On April 1, 2014, the Company promoted Eric Fowler to the role of President and CEO, replacing Darren Marks who remains as a Director of the Company.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward looking statements made by, or on our behalf. We disclaim any obligation to update forward looking statements.
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.
COMPANY OVERVIEW AND HISTORY
DNA Brands, Inc. (hereinafter referred to as “us,” “our,” “we,” the “Company” or “DNA”) was incorporated in the State of Colorado on May 23, 2007 under the name Famous Products, Inc. Prior to July 6, 2010 we were a holding company operating as a promotion and advertising company.
We currently produce, market and sell a proprietary line of five carbonated blends of DNA Energy Drink®, Citrus, Sugar Free Citrus, Original (a unique combination of Red Bull® and Monster® energy drinks), Cryo-Berry (a refreshing mix of cranberry and raspberry) and Molecular Melon (a cool and refreshing taste); as well as three milk based energy coffees fortified with Omega 3. These flavors are Mocha, Vanilla Latte, and Carmel Macchiato.
Our current business commenced in May 2006 in the State of Florida under the name Grass Roots Beverage Company, Inc. (“Grass Roots”). Initial operations of Grass Roots included development of our energy drinks, sampling and other marketing efforts and initial distribution in the State of Florida. In May 2006 we formed DNA Beverage Corporation, a Florida corporation (“DNA Beverage”). Our early years were devoted to brand development, creating awareness through heavy sampling programs and creating credibility among our then core demographic by concentrating marketing efforts on action sports locations and events (surf, motocross, skate, etc.).
Effective July 6, 2010, we executed agreements to acquire all of the assets, liabilities and contract rights of DNA Beverage and 100% of the common stock of DNA Beverage’s wholly owned subsidiary Grass Roots Beverage Company, Inc. (“Grass Roots”) in exchange for the issuance of 31,250,000 shares of our common stock. The share issuance represented approximately 94.6% of our outstanding shares at the time of issuance. As a result of this transaction we also changed our name to “DNA Brands, Inc.”
Grass Roots was dissolved and ceased activity on December 31, 2013.
Our principal offices are located at 544 NW 77th Street, Boca Raton, Florida, 33487, telephone (954) 970-3826. Our website is www.dnabrandsusa.com.
Presented below are our results of operations for the three month periods ended March 31, 2014 and 2013.
RESULTS OF OPERATIONS
Comparison of Results of Operations for the three month periods ended March 31, 2014 and 2013
Revenue
Sales for the three month period ended March 31, 2014 were $48,073, compared to $37,948 during the three month period ended March 31, 2013, an increase of $22,545 (37.3%). This increase in revenue is primarily attributable to our re-branding initiatives compared to a period when we winding down activities of our previous product line. In early July 2013, we began our rebranding efforts concurrent with the delivery of 50,000 cases of our energy drink, each consisting of ten thousand of our new SKU’s.
During the past two years we have experienced a shortage of available capital which has prevented us from making inventory purchases in sufficient quantities of our SKU's. Based upon our conversations with our retail customers we believe that they are interested in purchasing larger quantities of our products and putting it on their shelves but until we can raise additional capital we are not able to meet this demand. Also, the lack of capital has limited our marketing, advertising and promotions which are critical revenue drivers in the energy drink industry. No assurances can be provided that we will successfully raise the funding necessary to support our marketing efforts, or that these efforts will generate increased revenues. See “Liquidity and Capital Resources,” below.
Gross margin
We calculate gross margin by subtracting cost of goods sold from sales. Gross margin percentage is calculated by dividing the gross margin by sales. Gross margin for the three month period ended March 31, 2014 was $11,016, compared to $(1,179) during the three month period ended March 31, 2013. Gross margin percentage for the three month period ended March 31, 2014 was 10.9% compared to (3.0)% during the three month period ended March 31, 2013. The primary reasons for the significant increase in gross margin over the prior year is due to the introduction of our new rebranded product and the discontinuation of our previous product line where we sold our product significantly below cost to raise capital as well low margin sales in 2013 intended to generate interest in our new products.
Since we are still in the early stages of our rebranding efforts and continue to test varying price structures, a small number of sales and transactions can impact our gross margin percentage either positively or negatively. We believe that the gross margin percentage for the three months ended March 31, 2014 is not indicative of future results and that we expect to generate gross margins near historic levels of approximately 25%-30% when calculated over higher sales volumes, although there can be no assurances.
Compensation and benefits
Compensation and benefits for the three month period ended March 31, 2014 was $265,638 compared to $241,734 during the three month period ended March 31, 2013. The slight increase in compensation and benefits of $23,904 compared to the corresponding period in the prior year is attributable to a slight increase in salaries for our employees.
General and administrative
General and administrative expenses for the three month period ended March 31, 2014 were $91,948 compared to $122,088 during the three month period ended March 31, 2013. General and administrative expenses are primarily comprised of rent, utilities, insurance, travel and entertainment, and other expenses. This decrease compared to the corresponding period in the prior year is attributable to reduced spending for travel and other administrative activities in accord with our substantially lower revenue levels.
Professional and outside services
Professional and outside services for the three month period ended March 31, 2014 were $229,905, compared to $193,099 during the three month period ended March 31, 2013. Professional and outside services are comprised primarily of accounting fees, legal fees, investor and public relations expenses and other miscellaneous services. The increase in professional and outside services for the three month period ended March 31, 2014 compared to 2013 is attributable to public company expenditures that are required and not proportional to revenue levels.
Selling and marketing expenses
Selling and marketing expenses for the three month period ended March 31, 2014 were $35,110, compared to $27,761 during the three month period ended March 31, 2013. The increase in selling and marketing expenses over the prior year period is directly attributable to our efforts to increase awareness and the sales of our new products.
Interest expense
Interest expense for the three month period ended March 31, 2014 was $297,823, compared to $165,463 during the three month period ended March 31, 2013. The increase in interest expense over the prior year period is primarily attributable to the non-cash amortization of loan discounts related to convertible debentures.
These debentures and loans were issued with beneficial conversion features or other inducements to the lender to provide funding to us. As a result, we have recorded discounts against these loans that are being amortized over their terms. During the three months ended March 31, 2014 we recorded $260,574 in non-cash interest expense relative to the loan discounts on these notes.
Net loss
We incurred a net loss for the three month period ended March 31, 2014 of $793,728 or ($0.00) per basic and fully diluted share, compared to a net loss of $646,586, or ($0.01) per basic and fully diluted share during the three month period ended March 31, 2013. Since our inception, we have generated material operating losses. A significant portion of our losses are non-cash in nature; however, our losses remain substantial even after excluding those items.
We calculate weighted average shares outstanding based upon the physical issuance records of our stock transfer agent. The weighted average number of basic and fully diluted shares outstanding for the three month periods ended March 31, 2014 and 2013 were 183,211,402 and 64,832,425 shares, respectively. There were no dilutive equivalents included in our calculation of fully diluted shares during either period since their inclusion would be anti-dilutive due to our net loss per share.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2014, we had $110,379 in cash.
During the three month period ended March 31, 2014 we recorded a net loss of $793,728 and had negative cash flows of $402,600 from our operating activities. At March 31, 2014, we had a working capital deficit of $2,784,944 and a stockholders’ deficit of $3,052,003. We have relied, in large part, upon debt and equity financing to fund our operations. These matters collectively raise a substantial doubt about our ability to continue as a going concern.
Net cash used in operations for the three month period ended March 31, 2014 was $402,600, compared to $442,193 during the three month period ended March 31, 2013. The improvement in net cash used in operating activities of $37,756 is primarily due to the improvement in our consolidated results of operations excluding non-cash expenses over the prior year period. We recorded a net loss of $793,728 as compared to $646,856 in the corresponding period of the prior year.
No net cash was provided by or used in investing activities for the three month periods ended March 31, 2014 and March 31, 2013, respectively.
Net cash provided by financing activities for the three month period ended March 31, 2014 was $451,643 compared to $457,000 during the three month period ended March 31, 2013. During the three months ended March 31, 2014, we raised $478,500 in new capital from debt and equity sources compared to proceeds of $457,000 during the prior year period.
Since 2011 we have funded our operations through officer loans, the sale of equity, and the sale of convertible notes on terms favorable to investors in order to fund our operations. During 2013 our officers forgave $944,000 in accrued salaries and $1,900,000 in officer loans. We can no longer rely on our officers as the primary source of capital to fund our operations going forward. Our on hand cash balance is not sufficient to fund our operations. We estimate that we will require $1.0 million to fund our business plan. We believe we can continue to raise equity capital and debt financing to fund our operations and can begin generating positive gross margins from our products in 2014.
TRENDS
In order to increase revenues, our emphasis over the next 12 months will be to increase distribution for both our rebranded and expanded line of energy drinks, our new line of energy coffees, and our “on premise” bag-in-box program. To accomplish our goals we also plan to expand operations into NY, ME, ND, SD, MN, NE, IA, WI, GA, LA, and Florida, New York and Texas represent three of the four top convenience store outlets in the USA. As stated throughout this report, our efforts to accomplish these objectives are directly linked to our ability to raise additional capital. We have been actively involved in discussions with potential investors to provide us with this additional funding.
Creating more brand awareness and trials will be addressed through a significant public relations and advertising program. Public relations, targeted advertising, tab and coupon redemption programs, endorsement of regionally known athletes, increased "cans in hand" sampling, events at new store openings, concerts, festivals and sporting events will be included in this program. We also plan to place regional marketing representatives in territories where distribution volume warrants the expense.
INFLATION
Although our operations are influenced by general economic conditions, we do not believe that inflation had a material effect on our results of operations during the three month period ended March 31, 2014.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are a smaller reporting company and are not required to provide the information under this item pursuant to Regulation S-K.
ITEM 4. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures - Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Report.
These controls are designed to ensure that information required to be disclosed in the reports we file or submit pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2014. We believe that our consolidated financial statements presented in this Report fairly present, in all material respects, our financial position, results of operations, and cash flows for all periods presented herein.
Inherent Limitations - Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdown can occur because of simple error or mistake. In particular, many of our current processes rely upon manual reviews and processes to ensure that neither human error nor system weakness has resulted in erroneous reporting of financial data.
Internal Control over Financial Reporting - Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act. Those rules define internal control over financial reporting as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
| | ● | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; |
| | ● | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and the receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and |
| | ● | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of the company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of our CEO and CFO management conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2014 using the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation management concluded that under this framework that our internal control over financial reporting was not effective for the following reasons:
| | ● | Insufficient resources |
| | ● | Lack of personnel with requisite accounting knowledge |
| | ● | Inadequate segregation of duties |
| | ● | Insufficient written procedures |
| | ● | Inadequate closing financial statement process |
| | ● | Lack of an audit committee and outside directors on the Company’s Board of Directors |
Changes in Internal Control over Financial Reporting - There were no changes in our internal control over financial reporting during the three months ended March 31, 2014, which were identified in conjunction with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to lawsuit P3DG Protein Enhanced Products, Ltd. et v. Jeff Jonke and DNA Brands, Inc. The suit alleges that DNA conspired with Jonke to steal P30G's products. The Company believes the suit is without merit and will vigorously defend its position.
ITEM 1A. RISK FACTORS
We are a smaller reporting company and are not required to provide the information under this item pursuant to Regulation S-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended March 31, 2014 we sold 24,187,500 shares of our common stock and received $193,500 in gross proceeds. We utilized these proceeds for working capital to fund our operations.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. MINE SAFETY DISCLOSURE
Not Applicable
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
| 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on May 20, 2014.
| | DNA BRANDS, INC. | |
| | | | |
| | By: | /s/ Eric Fowler | |
| | | Eric Fowler | |
| | | Principal Executive Officer | |
| | | | |
| | By: | /s/ Melvin Leiner | |
| | | Melvin Leiner, | |
| | | Principal Financial Officer and | |
| | | Principal Accounting Officer | |
