NOTE 2 – BASIS OF PRESENTATION,
LIQUIDITY AND MANAGEMENT’S PLAN
These Consolidated
Financial Statements (unaudited) have been prepared in accordance with accounting principles generally accepted in the United States
(“GAAP”) for interim financial information. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring adjustments) considered necessary for fair presentation of results for the interim periods have been reflected
in these Consolidated Financial Statements (unaudited), and the presentations and disclosures herein are adequate when read in
conjunction with the Audited Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2012 and
Auditor’s Report, which included an explanatory paragraph reporting a going concern.
Operating results for the three months ended
March 31, 2013 are not necessarily indicative of the results that may be expected for the entire year. The Unaudited Consolidated
Financial Statements include the accounts and operations of Bluefly, Inc. and its subsidiaries. All intercompany accounts and transactions
have been eliminated in consolidation.
The
Consolidated Financial Statements contemplate continuation of the Company as a going concern. The Company has sustained
cumulative net losses and negative cash flows from operations since inception. As of March 31, 2013, the Company had an
accumulated deficit of $191,539,000 and incurred a net loss attributable to Bluefly, Inc. stockholders of $4,440,000 for the
three months ended March 31, 2013.
The
Company is currently in active discussions regarding a strategic transaction under the direction of a special
committee consisting of independent members of the Board of Directors, together with the assistance of an independent
financial advisor (“Proposed Strategic Transaction”). The Company expects that
the
consideration payable to shareholders of the Company will be minimal. We currently have sufficient funds from operations
and from our Credit Facility to support our operations until the anticipated closing of the Proposed Strategic
Transaction.
Management believes that the Proposed Strategic Transaction, if and
when consummated, will provide the necessary liquidity to
support
the
working
capital needs of the Company and eliminate the factors that resulted in the going concern uncertainty. There can be
no assurance that the Proposed Strategic Transaction can be consummated.
If
the Company is unable to complete the Proposed Strategic Transaction or an alternative
strategic transaction,
or to secure additional financing to fund our operations,
the Company will not be able to sustain its operations.
The Company has implemented certain cost containment measures,
which includes reduction in workforce and overhead, and delaying payments to suppliers.
NOTE 3 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Use of estimates
The preparation of the consolidated 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 the disclosures of contingent assets and
liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods.
Significant estimates and assumptions include the adequacy of the allowances for doubtful accounts and sales returns, recoverability
of inventories, useful lives of property and equipment (including website development costs) and intangible assets, realization
of deferred tax assets, and the calculations related to stock-based compensation expense. Actual results could differ from those
estimates. The Company’s success is largely dependent on its ability to anticipate, identify and respond to unexpected changes
in fashion trends and to provide merchandise that satisfies consumer preferences and demand. The Company’s failure to anticipate,
identify or respond to unexpected changes in fashion trends and consumer preferences could adversely affect its financial condition
and results of operations.
Revenue recognition
The Company recognizes revenue when the
earnings process is completed, and revenue is measurable. Gross sales consist primarily of revenue from product sales and shipping
and handling charges and are net of promotional discounts and sales-based taxes assessed by governmental authorities that are imposed
on sales transactions. Net sales represent gross sales, less provisions for returns and credit card chargebacks.
Gross sales are recognized when all
the following criteria are met (1) a customer executes an order, (2) the product price and the shipping and handling fee have
been determined, (3) credit card authorization has occurred and collection is reasonably assured, and (4) the product has
been shipped and received by the customer.
Deferred revenue (which consists primarily
of goods shipped to customers, but not yet received, and customer credits) totaled approximately $2,850,000 and $4,381,000 as of
March 31, 2013 and December 31, 2012, respectively, which are presented as Current liabilities in the Consolidated Balance
Sheets.
Shipping and handling fees billed to customers
are presented and included as part of gross sales, and freight costs incurred in connection with shipping customer orders are presented
and included as part of Cost of sales in the Consolidated Statements of Operations.
Sales incentives
The Company frequently offers sales incentives
to customers to receive a reduction in the sales price of merchandise. Sales incentives include, but are not limited to discounts,
coupons, daily deal programs and e-mail promotions through online marketing programs. For sales incentives issued to customers
in conjunction with the sale of merchandise, the Company recognizes the reduction in gross sales at the time of sale.
Provisions for sales returns and
doubtful accounts
The Company generally permits returns for
up to 40 days from the date of sale. The Company performs credit card authorizations and checks the verifications of its customers
prior to shipment of the merchandise. Accordingly, the Company establishes a reserve for estimated future sales returns and allowance
for doubtful accounts at the time of shipment based primarily on historical data. Accounts receivable (which represents billed
credit card transactions in process to be collected and a trade receivable (discussed further below) is presented in the Consolidated
Balance Sheets net of the allowance for doubtful accounts.
Stock-based compensation expenses
The Company’s Board of Directors
has adopted three stock-based employee compensation plans, one in April 2005, one in July 2000 (which expired in December
2012) and one in May 1997 (collectively, the “Plans”). The Plans, which provide for the granting of restricted
stock awards, deferred stock unit awards, stock option awards, and other equity and cash awards, were adopted for the purpose of
encouraging key employees, consultants and directors who are not employees to acquire a proprietary interest in the growth and
performance of the Company, and are similar in nature. Vesting terms for restricted stock generally range from three months to
one year, while deferred stock unit awards vest every three months over a period of one to three years. Stock option awards are
granted in terms not to exceed ten years and become exercisable as specified when the option is granted and vesting terms range
from immediately to a ratable vesting period of four years. As of March 31, 2013, the Plans have an aggregate balance of 1,153,103
shares available for future issuance.
Income taxes
Income taxes represent income taxes paid
or payable (or received or receivable) for the current year and includes any changes in deferred taxes during the year. Deferred
tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and
credit carry forwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents
the change during the period in deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and
liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced
by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
Basic and diluted net loss per
common share attributable to Bluefly, Inc. stockholders
Basic net loss per common share attributable
to Bluefly, Inc. stockholders excludes dilution and is computed by dividing net loss attributable to Bluefly, Inc. stockholders
by the weighted average number of common shares outstanding for the period.
Diluted net loss per common share attributable
to Bluefly, Inc. stockholders is computed by dividing net loss attributable to Bluefly, Inc. stockholders by the weighted average
number of common shares outstanding for the period, adjusted to reflect potentially dilutive securities using the “treasury
stock” method for stock option awards, warrants, restricted stock awards, deferred stock unit awards, and the “if-converted”
method for the Rho Notes. Due to the Company’s net losses for the periods presented, (i) stock option awards and warrants
to purchase shares of Common Stock (ii) restricted stock awards that have not yet vested and (iii) Rho Notes convertible into shares
of Common Stock were not included in the computation of diluted loss per common share attributable to Bluefly, Inc. stockholders,
as the effects would be anti-dilutive.
Cash and cash equivalents
The Company considers all
highly liquid investments with an original maturity of three months or less to be cash and cash equivalents. The
Company’s cash and cash equivalents are placed and maintained with financial institutions that it believes are of high
credit quality. However, the Company’s cash and cash equivalents are potentially exposed to concentration of credit
risk in the event of default by financial institutions to the extent that cash balances with financial institutions are in
excess of insured limits. At March 31, 2013, the Company reclassed overdraft amounts of approximately $26,000 to the
Revolving Credit Facility.
Restricted cash
As of March 31, 2013, the Company had $4,635,000
in restricted cash, which has been funded by and deducted against the availability of the Company’s revolving Credit Facility
that was held as cash collateral against the Company’s outstanding letters of credit issued, and outstanding under its previous
credit facility with Wells Fargo Retail Finance, LLC (“Wells Fargo”).
Fair value of financial instruments
The Company’s financial instruments consist of cash and
cash equivalents, accounts receivable, other assets, accounts payable and accrued expenses. The carrying amounts of these financial
instruments approximate fair value due to their short maturities.
Inventories, net
Inventories, which consist of finished
goods, are stated at the lower of cost or market value. Cost is determined by the first-in, first-out (“FIFO”) method.
The Company reviews its inventory levels in order to identify slow-moving and unsellable merchandise and establishes a reserve
for such merchandise. Inventory reserves are established based on historical data and management’s best estimate. Inventory
may be marked down below cost if management determines that the inventory stock will not sell at or above its cost. Inventory is
presented net of reserves in the Consolidated Balance Sheets.
Property and equipment, net
Property and equipment are stated at cost
net of accumulated depreciation and amortization expenses. Leasehold improvements are amortized over the shorter of their estimated
useful lives or the remaining term of the lease. Lease amortization is included in depreciation expense. Equipment and software
are depreciated on a straight-line basis over two to five years. Costs related to maintenance and repairs are expensed as incurred.
Website development costs
Website development costs, which consist
primarily of external direct costs, relate to the Company’s Websites. All costs incurred by the Company related to the development
phase, including costs incurred for enhancements that are expected to result in additional new functionality, are capitalized.
Such costs are amortized on a straight-line basis over 36 months. All costs related to the planning and post-implementation phase,
including training and maintenance are expensed as incurred. Capitalized costs related to website development are included in Property
and equipment, net in the Company’s Consolidated Balance Sheets.
Long-lived assets
The Company’s policy is to evaluate
long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable. This evaluation is based on a number of factors, including expectations for future operating income
and undiscounted cash flows that will result from the use of such assets. The Company has not identified any such impairment of
its long-lived assets at March 31, 2013 and 2012.
Deferred rent liability
The Company recognizes and records rent
expense related to its lease agreement, which includes scheduled rent increases, on a straight-line basis beginning on the commencement
date over the life of the lease. The Company also recognizes and records rent concessions, in the form of reduced rent payments,
on a straight-line basis over the life of the lease agreement. Differences between straight-line rent expense and actual rent payments
are recorded as Deferred rent liability and presented as a long-term liability in the Consolidated Balance Sheets.
Treasury stock
Treasury stock represents Common Stock
withheld by the Company to satisfy income tax withholding obligations of certain officers and employees of the Company in connection
with the distribution of Common Stock in respect of deferred stock units held by such officers and employees.
Recently issued, but not yet effective,
accounting pronouncements
The Company is not aware of any recently
issued, but not yet effective, accounting pronouncements that would have a significant impact on the Company’s consolidated
financial position or results of operations.
NOTE 4 – FAIR VALUE
Authoritative guidance relating to fair
value establishes a framework for measuring fair value and expands disclosure about fair value measurements except as it applies
to non-financial assets and non-financial liabilities. The Company’s financial instruments consist of cash and cash equivalents,
accounts receivable, other assets, accounts payable and accrued expenses. The carrying amounts of these financial instruments approximate
fair value due to their short maturities. The following is the fair value hierarchy for disclosure of fair value measurements:
Level 1 - Quoted prices in active markets for identical assets
or liabilities
Level 2 - Quoted prices for similar assets and liabilities in
active markets or inputs that are observable
Level 3 - Inputs that are unobservable (for example cash flow
modeling inputs based on assumptions)
In connection with the Embedded Derivative
in the Rho Notes discussed below in Note 6 – 2012 Financing, the Company evaluates the fair value measurement of the Embedded
Derivative on a recurring basis to determine the appropriate fair value level to classify the Embedded Derivative at each reporting
period. This determination requires significant estimates and judgments by the Company. The following table sets forth the Company’s
liabilities that were measured at fair value as of March 31, 2013, by level within the fair value hierarchy:
|
|
|
|
|
Quoted Prices in
|
|
|
|
|
|
|
|
|
|
|
|
|
Active Markets
|
|
|
Significant
|
|
|
Significant
|
|
|
|
|
|
|
for Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
March 31, 2013
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Embedded derivative financial liability to related
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
party stockholders
|
|
$
|
250,000
|
|
|
$
|
--
|
|
|
$
|
250,000
|
|
|
$
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total embedded derivative financial liability to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
related party stockholders
|
|
$
|
250,000
|
|
|
$
|
--
|
|
|
$
|
250,000
|
|
|
$
|
--
|
|
NOTE 5 – ACQUISITION
On January 10, 2012, the Company,
through a newly-formed wholly-owned subsidiary, EVT, entered into an asset purchase agreement with Moda for Friends LLC (the
“Seller”) and purchased certain intangible assets that include a contractual-related agreement, purchased
customer list, developed technologies and trademarks (the “Acquired Intangible Assets”) owned by the Seller for a
total purchase price of $600,000 plus transaction costs of $11,000. The Company paid the purchase price through the issuance
of 285,714 shares of its Common Stock, with each share being valued at $2.10 (the closing price of the Common Stock on the
day prior to the consummation of the transaction). The Company completed the asset acquisition because it would facilitate
the launch and operation of its own flash sales business.
At December 31, 2012, the Acquired Intangible
Assets were deemed to be impaired and the fair value was determined to be zero (Level 3 in the fair value hierarchy) due to the
Company’s potential inability to meet its obligations under the terms and conditions of the contract given the Company’s
current limited financial resources.
For the year ended December 31, 2012, the
Company recorded $383,000 of impairment loss in total amortization expense in the Consolidated Statement of Operations related
to the Acquired Intangible Assets.
NOTE 6 – 2012 FINANCING
On August 13, 2012 (the “Closing
Date”), the Company entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Rho Ventures
VI, L.P. (“Rho”) and Prentice Consumer Partners, LP (“Prentice”, and together with Rho, the “Purchasers”)
pursuant to which the Company issued (i) $1,500,000 aggregate principal amount of collateralized subordinated convertible promissory
notes to Rho (the “Rho Notes”) and (ii) $1,500,000 aggregate principal amount of collateralized subordinated promissory
notes to Prentice (the “Prentice Notes” and together with the Rho Notes, the “Notes”).
The Rho Notes bear interest at 12% per
annum, compounded annually, and interest is payable upon maturity or conversion. The Prentice Notes bear interest at 15%
per annum, compounded annually, and interest is payable quarterly. Prentice received an origination fee on the Closing Date
equal to two percent of the Prentice Notes.
The Rho Notes are convertible, at the holder's
option, (a) into equity securities that the Company might issue in any subsequent round of financing that results in proceeds to
the Company of at least $7,500,000 (a “Qualified Financing”) at a price equal to the lowest price per share paid by
any investor in such Qualified Financing or (b) into shares of the Company’s Common Stock at a price per share equal to $1.05,
which approximates the fair market value on the Closing Date (the “Rho Conversion Feature”).
The Notes have a one-year term but may
become due prior to the end of such term in the event of a change of control or a Qualified Financing. The Notes are collateralized
by second priority liens on all assets of the Company.
In connection with the issuance of the
Notes, the Company also issued warrants, with a seven year term, to purchase 476,190 shares of the Company’s Common
Stock (the “Warrants”) to each of Rho and Prentice at a price equal to $1.05 per share, which approximates the fair
market value of the Common Stock on the Closing Date.
The Notes contain a
financial covenant in which the Company is to maintain current assets in excess of $20,000,000 including cash and cash
equivalents, accounts receivable, inventories (which includes prepaid inventory), prepaid expenses and other current assets
(the “Financial Covenant”). In the event that the Company does not maintain this Financial Covenant, the
outstanding principal and accrued interest expense of the Notes shall be accelerated and automatically become due and
payable. In the event we are unable to complete the proposed strategic transaction; there can be no assurance that we will
remain in compliance with the Financial Covenant.
In connection with the issuance of the
Notes, the Company incurred approximately $127,000 of debt issuance costs (“Deferred Financing Costs”), which primarily
consisted of legal and other professional fees. These Deferred Financing Costs were deferred and are being amortized to interest
expense to related party stockholders over the term of the Notes. The Deferred Financing Costs are recorded within Other Current
Assets in the Company’s Consolidated Balance Sheet.
As the Notes were issued with detachable
Warrants, the Company has initially allocated the proceeds received from the issuance between the Notes and Warrants on a relative
fair value basis. With respect to the Rho Notes, the Company then has evaluated the Rho Conversion Feature to determine whether
this feature qualifies as a beneficial conversion feature or derivative instrument. The Company noted that the Rho Conversion Feature
contains both a fixed conversion price and a contingently adjustable conversion price based on a future event.
Based
on the terms of the Rho Notes and authoritative guidance, the Company has concluded that the entire Rho Conversion Feature is an
embedded derivative liability (the “Embedded Derivative”), which requires bifurcation and must be separately accounted
for as a derivative instrument.
The Company measured the fair value
of the Embedded Derivative using a Black-Scholes valuation model as of the Closing Date. Expected volatility is based on the
historical volatility of the price of the Company’s Common Stock, measured over the same period of time as the
remaining maturity life of the Rho Notes. The risk free interest rate is based on the interest rate for U.S. Treasury Notes
having a maturity period equal to the remaining maturity life of the Rho Notes. As a result of the bifurcation, the Company
recognized an Embedded Derivative of approximately $274,000 with a corresponding discount on the Rho Notes, which reduced the
carrying value of the Rho Notes on the date of issuance. This discount represents additional non-cash interest expense that
is to be amortized over the remaining life of the Rho Notes.
The Company also remeasures the fair value
of the Embedded Derivative at each reporting date. Any change in fair value is recorded as part of interest expense to related
party stockholders in the Company’s Consolidated Statements of Operations.
The assumptions used at March 31, 2013
are as follows:
Risk-free interest rate
|
|
|
0.11
|
%
|
Expected life (in years)
|
|
|
0.37
|
|
Dividend yield
|
|
|
0.00
|
%
|
Expected volatility
|
|
|
125.92
|
%
|
As of March 31, 2013, the Company’s
Notes and interest payable to related party stockholders, net consists of the following:
Notes payable to related party stockholders
|
|
$
|
3,000,000
|
|
Unamortized discount on notes payable to related party stockholders
|
|
|
(318,000
|
)
|
Total notes payable to related party stockholders, net
|
|
|
2,682,000
|
|
|
|
|
|
|
Interest payable to related party stockholders
|
|
|
180,000
|
|
|
|
|
|
|
Total notes and interest payable to related party stockholders, net
|
|
$
|
2,862,000
|
|
For the three months ended March 31, 2013,
the Company recognized interest expense in connection with the Notes, including changes in fair value of the Embedded Derivative
and amortization of the debt discount, which were included in total interest expense to related party stockholders in the Consolidated
Statements of Operations, as follows:
Amortization of discount on notes payable to related party stockholders
|
|
$
|
212,000
|
|
Appreciation in fair value of embedded derivative financial liability to related party
stockholders
|
|
|
(129,000
|
)
|
Interest expense to related party stockholders
|
|
|
107,000
|
|
Amortization expense of deferred financing costs
|
|
|
32,000
|
|
|
|
|
|
|
Total interest expense to related party stockholders
|
|
$
|
222,000
|
|
Costs incurred in connection with the
Company's financing activities are deferred and amortized over the terms of the related agreements using the straight-line
method. During 2012, we deferred approximately $127,000 and $432,000 relating to the August 2012 financing, and the new
revolving credit facility with Wells Fargo Capital Finance, and Salus Capital Partners, LLC, respectively. Amortization of
these costs, which is recognized in other interest expense and other income, net, in the accompanying consolidated statements
of operations, totaled approximately $32,000 for the three months ended March 31, 2013. Deferred financing costs, net of
accumulated amortization, included in other assets, net, amounted to approximately $47,000 as of March 31, 2013.
NOTE 7 – REVOLVING CREDIT FACILITY
FINANCING AGREEMENT
On November 13, 2012, the Company entered
into a new three-year revolving credit facility, expiring November 2015 (“Credit Facility”) with Salus Capital Partners,
LLC (“Salus”) collateralized by all assets of the Company. The Credit Facility refinanced the Company’s previous
credit facility with Wells Fargo. Pursuant to the terms of the Credit Facility, Salus provides the Company with a revolving credit
facility and facilitates the issuance of letters of credit in favor of suppliers or factors.
Availability under the Credit Facility
is determined by a formula that considers a specified percentage of the Company’s accounts receivable and a specified percentage
of the Company’s inventory. The maximum availability is $10 million, of which up to $5 million is available for the issuance
of letters of credit. Interest accrues under the Credit Facility at the prime rate plus 4.75%, subject to a minimum rate of 8.00%.
Letters of credit issued to third parties are cash collateralized by amounts drawn under the Credit Facility. At closing, $4,700,000
was drawn under the Credit Facility, which reduced the availability of the Credit Facility, to cash collateralize letters of credit
issued by Wells Fargo, which were outstanding at such date. In addition, the Company paid financing costs of $432,000 at closing,
which were capitalized, and will pay a collateral monitoring fee of $3,000 per month and will pay unused commitment fees of 0.75%
of the remaining availability under the Credit Facility. A termination fee of $75,000 was paid at closing to Wells Fargo, which
was included in Other interest expense in the 2012 Consolidated Statement of Operations.
As of March 31, 2013, maximum total availability
under the Credit Facility was approximately $5.0 million, of which $4.6 was outstanding, leaving approximately $0.4 million available
for further borrowings.
The terms of the Credit Facility contain
a material adverse condition clause. This feature may limit the Company’s ability to obtain additional borrowings or result
in a default on current outstanding letters of credit. The terms of the Credit Facility contain a material adverse effect clause
defined as a material adverse change in the ability of the Company to perform its obligations under the Credit Agreement or, upon
the operations, business, properties, liabilities (actual or contingent) or condition (financial or otherwise), or impairment of
the rights and remedies of the Agent or any lender under the Credit Facility, or upon the legality, validity, binding effect or
enforceability against any party to the Credit Facility. This feature may limit our ability to obtain additional borrowings or
result in a default on current outstanding letters of credit.
For the three months ended March 31, 2013,
the Company paid approximately $135,000 in interest expense and fees under the Credit Facility.
The Credit Facility was amended on April
11, 2013 to modify certain borrowing availability formulas for sixty days, which increased borrowing availability by up to $650,000.
The Company paid a $100,000 fee in connection with the amendment. Salus also waived covenant violations caused by the late delivery
of 2012 audited financial statements and the explanatory paragraph regarding a going concern uncertainty contained in the auditor’s
unqualified opinion for such financial statements.
NOTE 8 – COMMITMENTS AND CONTINGENCIES
The Company’s commitment and contingencies
associated with marketing contracts, lease obligations, and employment agreements did not change materially from that disclosed
in the Form 10-K filing for the year ended December 31, 2012.
NOTE 9 – STOCK-BASED COMPENSATION
Authoritative guidance relating to stock-based
compensation requires the Company to measure compensation cost for stock awards at fair value and recognize compensation over the
service period for awards expected to vest. Total stock-based compensation expense recorded in the Consolidated Statements of Operations
was $253,000 and $975,000 for the three months ended March 31, 2013 and 2012, respectively.
Stock Option Awards
The fair value of stock option awards granted
is estimated on the date of grant using a Black-Scholes option pricing model. Expected volatilities are calculated based on the
historical volatility of the price of the Company's Common Stock. Management monitors stock option exercise and employee termination
patterns to estimate forfeiture rates within the valuation model. The expected holding period of stock options represents the period
of time that stock options granted are expected to be outstanding. The risk-free interest rate for periods within the expected
life of the stock option award is based on the interest rate of U.S. Treasury notes in effect on the date of the grant.
The following table summarizes the Company’s
stock option award activity:
|
|
|
|
|
Weighted Average
|
|
|
|
Number of
|
|
|
Exercise Price
|
|
|
|
Shares
|
|
|
Per Share
|
|
Balance at December 31, 2012
|
|
|
4,205,881
|
|
|
$
|
2.11
|
|
Options granted
|
|
|
293,500
|
|
|
$
|
0.75
|
|
Options cancelled
|
|
|
(171,947
|
)
|
|
$
|
1.80
|
|
Options expired
|
|
|
(1,088,689
|
)
|
|
$
|
3.27
|
|
Options exercised
|
|
|
--
|
|
|
$
|
--
|
|
Balance at March 31, 2013
|
|
|
3,238,745
|
|
|
$
|
1.74
|
|
There were 293,500 stock option
awards granted during the first quarter of 2013. At March 31, 2013, there was no aggregate intrinsic value of the fully
vested stock option awards and the weighted average remaining contractual life of the stock option awards was approximately
eight years. The Company did not capitalize any compensation cost, or modify any of its stock option awards during the first
quarter of 2013. There were no stock option exercises and no cash was used to settle equity instruments granted under the
Company’s equity incentive plans during the first quarter of 2013.
For the three months ended March 31, 2013
and 2012, the Company recognized expense of approximately $247,000 and $975,000, respectively, in connection with these awards.
Stock Option 1997 and 2000 Plans
On May 1, 2013, the 750 stock option
awards outstanding in the 1997 Plan contractually expired and there were no remaining shares in the 2000 Plan.
Restricted Stock Awards
The following table is a summary of activity
related to restricted stock awards for key employees at March 31, 2013:
|
|
|
|
|
Weighted Average
|
|
|
|
Restricted
|
|
|
Grant Date
|
|
|
|
Stock
|
|
|
Fair Value
|
|
|
|
Awards
|
|
|
(per share)
|
|
Balance at December 31, 2012
|
|
|
22,321
|
|
|
$
|
1.12
|
|
Shares granted
|
|
|
--
|
|
|
$
|
--
|
|
Shares forfeited
|
|
|
--
|
|
|
$
|
--
|
|
Shares restriction lapses
|
|
|
--
|
|
|
$
|
--
|
|
Balance at March 31, 2013
|
|
|
22,321
|
|
|
$
|
1.12
|
|
|
|
|
|
|
|
|
|
|
Aggregate grant date fair value
|
|
$
|
25,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vesting service period of shares granted
|
|
|
1 year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares vested during the three months ended March 31, 2013
|
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares non-vested at March 31, 2013
|
|
|
22,321
|
|
|
|
|
|
For the three months ended March 31, 2013,
the Company recognized expense of approximately $6,000 related to restricted stock awards. There were no restricted stock awards
issued during the three months ended March 31, 2012 or outstanding as of March 31, 2012 and, accordingly, the Company did not recognize
any expense related to restricted stock awards.
NOTE 10 – NET LOSS PER SHARE ATTRIBUTABLE TO BLUEFLY,
INC. STOCKHOLDERS
Basic net loss per common share attributable
to Bluefly, Inc. stockholders excludes dilution and is computed by dividing net loss attributable to Bluefly, Inc. stockholders
by the weighted average number of common shares outstanding for the period.
Diluted net loss per common share
attributable to Bluefly, Inc. stockholders is computed by dividing net loss attributable to Bluefly, Inc. stockholders by the
weighted average number of common shares outstanding for the period, adjusted to reflect potentially dilutive securities
using the treasury stock method for stock option awards, warrants, restricted stock awards, deferred stock unit awards, and
the if-converted method for the Rho Notes (as defined in Note 6 – 2012 Financing). Due to the Company’s net loss,
(i) stock option awards and warrants to purchase shares of Common Stock (ii) restricted stock awards that have not yet vested
and (iii) Rho Notes convertible into shares of Common Stock were not included in the computation of diluted loss per common
share attributable to Bluefly, Inc. stockholders, as the effects would be anti-dilutive. Accordingly, basic and diluted
weighted average shares outstanding are equal for the following periods presented:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
Net loss attributable to Bluefly, Inc. stockholders
|
|
$
|
(4,440,000
|
)
|
|
$
|
(7,870,000
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic)
|
|
|
28,576,612
|
|
|
|
28,523,237
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (diluted)
|
|
|
28,576,612
|
|
|
|
28,523,237
|
|
NOTE 11 – NASDAQ COMPLIANCE
On February 15, 2013, the Company was notified
by the Nasdaq Stock Market that it is not in compliance with the continued listing requirements for the Nasdaq Capital Market because
shares of the Company’s Common Stock had closed at a per share bid price of less than $1.00 for at least 30 consecutive trading
days. Under Nasdaq rules, the Company was given a 180-day grace period to regain compliance, which extends to August 14, 2013.
In order to regain compliance, shares of the Company’s Common Stock would need to close at a price of $1.00 per share or
more for at least ten consecutive trading days at any time prior to August 14, 2013. The Company may be granted an additional 180-day
grace period to regain compliance, if, at that time, it meets the initial listing criteria of the Nasdaq Capital Market, other
than the minimum bid price requirement. In the event that the Company does not regain compliance within the requisite time period,
it would have the right to appeal any delisting. The failure to maintain listing on the Nasdaq Capital Market may have an adverse
effect on the price and/or liquidity of the Company’s Common Stock.
NOTE 12 – SUBSEQUENT EVENTS
Bonus Arrangement
On April 2, 2013, the special committee
approved a bonus arrangement for Joseph Park, the Company’s Chief Executive Officer that had been recommended by the Company’s
compensation committee. The bonus arrangement is intended to incentivize Mr. Park to secure the best possible price in any sale
of the Company. Under the arrangement, Mr. Park will receive five per cent of the net proceeds, which would otherwise have been
payable to the shareholders of the Company, of any transaction constituting a sale of the Company approved by the Board. The special
committee reserved the right to make any determinations requiring the interpretation of the incentive, in its sole discretion.
Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations
Recent Developments
The
Company is currently in active discussions regarding a strategic transaction under the direction of a special committee consisting
of independent members of the Board of Directors, together with the assistance of an independent financial advisor (“Proposed
Strategic Transaction”). The Company expects that
the consideration payable
to shareholders of the Company will be minimal. We currently have sufficient funds to support our operations until the anticipated
closing of the Proposed Strategic Transaction.
Management believes that the Proposed
Strategic Transaction, if and when consummated, will provide the necessary liquidity to
support
the
working
capital needs of the Company and eliminate the factors that resulted in the going concern uncertainty. There can be no assurance
that the Proposed Strategic Transaction can be consummated.
If
the Company is unable to complete the Proposed Strategic Transaction or an alternative strategic transaction,
or
to secure additional financing to fund our operations, the Company will not be able to sustain its operations.
Our revolving credit facility with Salus
Capital Partners, LLC (“Salus”) was amended on April 11, 2013 to modify certain borrowing availability formulas for
sixty days. The amendment increased borrowing availability by up to $650,000. The Company paid a $100,000 fee in connection with
the amendment. Salus waived covenant violations caused by the late delivery of 2012 audited financial statements and the going
concern uncertainty paragraph contained in the Auditor’s Report for such financial statements.
Overview
Bluefly, Inc. is a leading Internet retailer
that sells over 350 brands of designer apparel and accessories at discounts of up to 75% off of retail value. We launched bluefly.com
in September 1998 and expanded our portfolio of web sites in 2011 by launching Belle & Clive, a members-only shopping destination
that presents highly-curated selections of important brands via limited-time sale events, and launching Eyefly, an online retailer
of fashionable prescription glasses.
During 2012, we embarked upon a new strategy
that focuses on lowering our customer acquisition costs, increasing the lifetime value of our customers and increasing our return
on invested capital. To increase our return on invested capital, we have focused on improving our inventory turns by being more
competitive with our pricing. Subject to appropriate levels of working capital, management believes that these initiatives will
take several additional quarters to materialize. During the three months ended March 31, 2013, this shift in strategy positively
impacted gross profit margin percentages as compared to prior year. We continued to deliberately reduce inventory receipts from
March 31, 2012 to March 31, 2013. This reduction contributed to a decrease in net sales whereby net sales for the three months
ended March 31, 2013 declined by 18.4%, as compared to the three months ended March 31, 2012. However, while our net sales declined,
we had $4.3 million less inventory than at December 31, 2012 and, therefore, we started seeing improvements in our returns on invested
capital related to inventory.
Our net sales decreased by approximately
18.4% to $19,794,000 for the three months ended March 31, 2013, from $24,266,000 for the three months ended March 31, 2012. Our
gross margin percentage increased to 20.1% for the three months ended March 31, 2013, from 15.4% for the three months ended March
31, 2012. Our gross profit increased by approximately 6.3% to $3,981,000 for the three months ended March 31, 2013, from $3,745,000
for the three months ended March 31, 2012. We
incurred an operating loss of $3,993,000 for the three months ended March 31, 2013
as compared to an operating loss of $7,832,000 for the three months ended March 31, 2012. The decrease in operating loss for the
three months ended March 30, 2013, as compared to the three months ended March 31, 2012, was primarily a result of an increase
in gross profit and a decrease in total operating expenses.
As a percentage of net sales, selling and
fulfillment expenses increased to 23.8% or $4,708,000 for the three months ended March 31, 2013, compared to 22.5% or $5,458,000
for the three months ended March 31, 2012. General and administrative expenses decreased to 10.3% or $2,035,000 for the three months
ended March 31, 2013, compared to 14.6% or $3,541,000 for the three months ended March 31, 2012.
Total marketing expenses (including staff
related costs) as a percentage of net sales decreased to 6.2% or $1,231,000 for the three months ended March 31, 2013, compared
to 10.6% or $2,578,000 for the three months ended March 31, 2012. Total marketing expenses (excluding staff related costs) decreased
to $1,231,000 for the three months ended March 31, 2013 from $2,578,000 for the three months ended March 31, 2012. Marketing expenses
(excluding staff related costs) decreased primarily as a result of a decrease in offline marketing expenditures related to television
advertising and as a result of the reduction in certain online marketing expenditures.
Our reserve for returns and credit card
chargebacks decreased to 33.4% of gross sales for the first quarter of 2013 compared to 35.3% for the first quarter of 2012. The
decrease was primarily caused by a reduction in our return rate, however, there can be no assurance that this trend will continue
in the future.
At March 31, 2013, we had an accumulated
deficit of $191,539,000. The net losses and accumulated deficit resulted primarily from operating losses including, but not limited
to, the costs associated with the strategic change in our product mix and sales incentives, decreases in average over size, selling
products at lower gross margin percentages, and to a lesser extent, the non-cash effects of equity-linked instruments previously
issued.
Results Of Operations
For The Three Months Ended March 31,
2013 Compared To The Three Months Ended March 31, 2012.
The following table sets forth our Consolidated
Statements of Operations data for the three months ended March 31. All data is in thousands except as indicated below:
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
As a % of
|
|
|
|
|
|
As a % of
|
|
|
|
|
|
|
Net Sales
|
|
|
|
|
|
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
19,794
|
|
|
|
100.0
|
|
|
$
|
24,266
|
|
|
|
100.0
|
|
Cost of sales
|
|
|
15,813
|
|
|
|
79.9
|
|
|
|
20,521
|
|
|
|
84.6
|
|
Gross profit
|
|
|
3,981
|
|
|
|
20.1
|
|
|
|
3,745
|
|
|
|
15.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and fulfillment expenses
|
|
|
4,708
|
|
|
|
23.8
|
|
|
|
5,458
|
|
|
|
22.5
|
|
Marketing expenses
|
|
|
1,231
|
|
|
|
6.2
|
|
|
|
2,578
|
|
|
|
10.6
|
|
General and administrative expenses
|
|
|
2,035
|
|
|
|
10.3
|
|
|
|
3,541
|
|
|
|
14.6
|
|
Total operating expenses
|
|
|
7,974
|
|
|
|
40.3
|
|
|
|
11,577
|
|
|
|
47.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(3,993
|
)
|
|
|
(20.2
|
)
|
|
|
(7,832
|
)
|
|
|
(32.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense to related party stockholders
|
|
|
(222
|
)
|
|
|
(1.1
|
)
|
|
|
--
|
|
|
|
--
|
|
Other interest expense, net
|
|
|
(225
|
)
|
|
|
(1.1
|
)
|
|
|
(72
|
)
|
|
|
(0.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,440
|
)
|
|
|
(22.4
|
)
|
|
$
|
(7,904
|
)
|
|
|
(32.6
|
)
|
We also measure and evaluate ourselves
against certain other key operational metrics. The following table, which excludes Eyefly, sets forth our actual results based
on these other metrics for the three months ended March 31, as indicated below:
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
Average
order size (including shipping and handling)
|
|
$
|
244.97
|
|
|
$
|
242.58
|
|
New members added during the period*
|
|
|
137,025
|
|
|
|
489,181
|
|
*Based
on unique email addresses
In addition to the financial statement
items and metrics listed, which are non-GAAP financial measurements above, we also report gross sales, another non-GAAP financial
measure. We define gross sales as the total dollar amount of orders received by customers (including shipping and handling) net
of customer credits, but before any reserves are taken for returns or bad debt. We believe that the presentation of gross sales
is useful to investors because (a) it provides an alternative measure of the total demand for the products sold by us and (b) it
provides a basis upon which to measure the percentage of total demand that is reserved for both returns and bad debt. Management
uses the gross sales measure for these same reasons.
Net sales
: Gross sales for the three
months ended March 31, 2013 decreased by approximately 20.7% to $29,716,000, from $37,461,000 for the three months ended March
31, 2012. For the three months ended March 31, 2013, we recorded a provision for returns and credit card chargebacks of $9,922,000,
or approximately 33.4% of gross sales. For the three months ended March 31, 2012, the provision for returns and credit card chargebacks
was $13,195,000, or approximately 35.2% of gross sales. The decrease in this provision as a percentage of gross sales resulted
from a decrease in sales, and a decrease in return rate to 33.1% at March 31, 2013 from 35.2% at March 31, 2012. There can be no
assurance that this trend will continue.
After the necessary provisions for returns,
credit card chargebacks, our net sales for the three months ended March 31, 2013 were $19,794,000. This represents a decrease of
approximately 18.4% compared to the three months ended March 31, 2012, in which net sales totaled $24,266,000.
Cost of sales:
Cost of sales consists
of the cost of product sold to customers, in-bound and out-bound shipping costs, inventory reserves, commissions and packing materials.
Cost of sales for the three months ended March 31, 2013 was $15,813,000, resulting in a gross margin percentage of approximately
20.1%. Cost of sales for the three months ended March 31, 2012 was $20,521,000 resulting in a gross margin percentage of approximately
15.4%. Gross profit increased by approximately 4.7% to $3,981,000 for the three months ended March 31, 2013, compared to $3,745,000
for the three months ended March 31, 2012. The increase in both gross profit and gross margin percentage is attributable to the
deliberate shift in our strategy discussed above as we increased inventory turns by being more competitive with our pricing and
selling merchandise at closer to cost. In addition, cost of product decreased primarily as a result of a reduction of sales, as
well as an increase in product margin.
Selling
and fulfillment expenses:
Selling and fulfillment expenses decreased by approximately 13.7% for the three months ended
March 31, 2013 compared to the three months ended March 31, 2012. Selling and fulfillment expenses include a total of $0
and $105,000 of costs related to Eyefly for the three months ended March 31, 2013 and 2012, respectively. The decrease in
Selling and fulfillment is primarily attributable to the following: (a)
Fulfillment costs – lower order volume,
lower fulfillment and credit card fees (b) Ecommerce - decrease in personnel costs/photo shoot/temporary help costs (c)
Technology – increase in depreciation expense and software support during the three months ended March 31, 2013.
Marketing expenses:
Marketing expenses
(including staff related costs) decreased by approximately 52.2% to $1,231,000 for the three months ended March 31, 2013, from
$2,578,000 for the three months ended March 31, 2012. The decrease is primarily attributable to decreased customer acquisition
costs.
Marketing expenses include expenses related
to (a) online marketing programs, which consist of social media programs, online integration partnerships, paid search, and fees
paid to marketing affiliates and comparison engines, (b) offline marketing programs, which consist of direct mail campaigns, television
advertising and production costs, as well as (c) staff related costs. As a percentage of net sales, our marketing expenses decreased
to 6.2% for the three months ended March 31, 2013 from 10.6% for the three months ended March 31, 2012.
General and administrative expenses:
General and administrative expenses include merchandising, finance and administrative salaries and related expenses, insurance
costs, accounting and legal fees, depreciation and other office related expenses. General and administrative expenses for the three
months ended March 31, 2013 decreased to $2,035,000, as compared to $3,541,000 for the three months ended March 31, 2012. The decrease
in general and administrative expenses was primarily the result of a decrease in severance costs.
As a percentage of net sales, general and
administrative expenses for the three months ended March 31, 2013 decreased to 10.3%, from 14.6% for the three months ended March
31, 2012.
Loss from operations:
For the three
months ended March 31, 2013, we incurred an operating loss of $3,993,000, compared to an operating loss of $7,832,000 for the three
months ended March 31, 2012.
Interest expense to related party
stockholders:
Interest expense to related party stockholders for the three months ended March 31, 2013 was $222,000.
Interest expense to related party stockholders consists of non-cash amortization expense of the discount relating to our
outstanding notes issued to certain related parties in connection with the recent financing, non-cash changes in fair value
of the embedded derivative, accrued interest expense and amortization expense related to deferred financing charges.
Other interest expense, net
: Interest
expense for the three months ended March 31, 2013 increased to approximately $225,000, compared to $72,000 for the three months
ended March 31, 2012. Interest expense consists primarily of fees paid in connection with our financing facilities (as described
further below).
We earned less than $1,000 in interest
income for the three months ended March 31, 2013 and 2012. These amounts related primarily to interest income earned on our cash
balances.
Net loss per share attributable to Bluefly,
Inc. stockholders:
Net loss per share attributable to Bluefly, Inc. stockholders decreased to $0.16 per share for the three
months ended March 31, 2013, compared to $0.28 per share for the three months ended March 31, 2012. The decrease in net loss per
share attributable to Bluefly, Inc. stockholders was primarily attributable to a decrease in our operating loss.
Liquidity And Capital Resources
General
At March 31, 2013, we
had approximately zero in cash and cash equivalents compared to $1.3 million and $2.5 million at December 31, 2012 and March
31, 2012, respectively. As of March 31, 2013 we had availability under the Credit Facility of $0.4 million. Subsequently,
we amended the Credit Facility, which increased our overall availability. (See Note 7 - Revolving Credit Facility Financing
Agreement.) Working capital, which is computed as total current assets less total current liabilities and represents a measure
of operating liquidity, at March 31, 2013 and December 31, 2012 was $(4.6) million and $(0.9) million, respectively. As of
March 31, 2013, we had an accumulated deficit of approximately $191.5 million. We have incurred negative cash flows and
cumulative net losses since inception.
Working capital levels at any specific
date are subject to variability based upon seasonality, inventory management and sales levels. These factors, in turn, affect the
levels of accounts receivable and inventory.
Our needs for liquidity have been primarily
to support operating losses, satisfy our working capital requirements, make capital expenditures, and make principal and interest
payments on debt obligations. Historically, such requirements have been funded through normal operations and through the use of
our financing arrangements and capital raising activities. During 2012, we embarked upon a new strategy that focuses on lowering
our customer acquisition costs, increasing the lifetime value of our customers and increasing our return on invested capital. To
increase our return on invested capital, we have focused on improving our inventory turns by being more competitive with our pricing
and management believes that these initiatives will take several quarters to materialize.
The
Company is currently in active discussions regarding a strategic transaction under the direction of a special
committee consisting of independent members of the Board of Directors, together with the assistance of an independent
financial advisor (“Proposed Strategic Transaction”). The Company expects that
the
consideration payable to shareholders of the Company will be minimal. We currently have sufficient funds from operations and
under our Credit Facility to support our operations until the anticipated closing of the Proposed Strategic
Transaction.
Management believes that the Proposed Strategic Transaction, if and
when consummated, will provide the necessary liquidity to
support
the
working
capital needs of the Company and eliminate the factors that resulted in the going concern uncertainty. There can be
no assurance that the Proposed Strategic Transaction can be consummated.
If
the Company is unable to complete the Proposed Strategic Transaction or an alternative
strategic transaction,
or to secure additional financing to fund our operations,
the Company will not be able to sustain its operations.
The Company has implemented certain cost containment
measures, which includes reduction in workforce and overhead, and delaying payments to suppliers.
Credit Facility
On November 13, 2012, we entered into a
new three-year revolving credit facility (“Credit Facility”) with Salus Capital Partners, LLC (“Salus”)
secured by all of our assets. The Credit Facility refinanced our previous credit facility with Wells Fargo Retail Finance, LLC
(“Wells Fargo”).
Pursuant to the terms of the Credit
Facility, Salus provides us with a revolving credit facility and facilitates the issuance of letters of credit in favor of
suppliers or factors. Availability under the Credit Facility is determined by a formula that considers a specified percentage
of our accounts receivable and a specified percentage of our inventory. The maximum availability is $10 million, of which up
to $5 million is available for the issuance of letters of credit. Interest accrues under the Credit Facility at the prime
rate plus 4.75%, subject to a minimum rate of 8.00%. Letters of credit issued to third parties are cash collateralized by
amounts drawn under the Credit Facility. At closing, $4.7 million was drawn under the Credit Facility to cash collateralize
letters of credit issued by Wells Fargo, which were outstanding at such date. In addition, we paid an origination fee of
$187,500 at closing, will pay a collateral monitoring fee of $3,000 per month and will pay unused commitment fees of 0.75% of
the remaining availability under the Credit Facility. A termination fee of $75,000 was paid at closing to Wells Fargo.
As of March 31, 2013, maximum total availability
under the Credit Facility was approximately $5.0 million, of which $4.6 was outstanding at March 31, 2013, leaving approximately
$0.4 million available for further borrowings.
The terms of the Credit Facility contain
a material adverse effect clause defined as a material adverse change in the ability of the Company to perform its obligations
under the Credit Agreement or, upon the operations, business, properties, liabilities (actual or contingent) or condition (financial
or otherwise), or impairment of the rights and remedies of the Agent or any lender under the Credit Facility, or upon the legality,
validity, binding effect or enforceability against any party to the Credit Facility. This feature may limit our ability to obtain
additional borrowings or result in a default on current outstanding letters of credit.
Both availability under our Credit Facility
and our operating cash flows are affected by the payment terms that we receive from suppliers and service providers, and the extent
to which suppliers require us to provide credit support under our Credit Facility. In some instances, new vendors may require prepayments.
We may make prepayments in order to open up these new relationships, or to gain access to inventory that would not otherwise be
available to us. As of March 31, 2013, we had approximately $0.3 million of prepaid inventory in our Consolidated Balance Sheet,
compared to $0.5 million as December 31, 2012.
The Credit Facility was amended on
April 11, 2013 to modify certain borrowing availability formulas for a sixty day period. This amendment increased borrowing
availability by up to $650,000. The Company paid a $100,000 fee in connection with the amendment. The interest rate payable
under the facility was increased by one percent for sixty days and thereafter the rate will be the greater of (i) the prime
rate plus 8.75% and (ii) 12.00%. Salus also waived covenant violations caused by the late delivery of 2012 audited financial
statements and the explanatory paragraph regarding a going concern uncertainty contained in the auditor’s opinion for
such financial statements. Salus has waived our going concern uncertainty at December 31, 2012 and increased our borrowing
availability only through mid-June, 2013, after which we would need additional waivers and/or accommodations from Salus.
2012 Financing Transaction
On August 13, 2012 (the “Closing
Date”), we entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Rho Ventures VI,
L.P. (“Rho”) and Prentice Consumer Partners, LP (“Prentice” and together with Rho, the “Purchasers”)
pursuant to which we issued (i) $1,500,000 aggregate principal amount of collateralized subordinated convertible promissory notes
to Rho (the “Rho Notes”) and (ii) $1,500,000 aggregate principal amount of collateralized subordinated promissory notes
to Prentice (the “Prentice Notes” and together with the Rho Notes, the “Notes”). The Rho Notes bear
interest at 12% per annum, compounded annually, and interest is payable upon maturity or conversion. The Prentice Notes bear
interest at 15% per annum, compounded annually, and interest is payable quarterly. Prentice received an origination fee on
the Closing Date equal to 2 percent of the Prentice Notes. The Rho Notes are convertible, at the holder's option, (a) into equity
securities that we might issue in any subsequent round of financing that results in proceeds to us of at least $7,500,000 (a “Qualified
Financing”) at a price equal to the lowest price per share paid by any investor in such Qualified Financing or (b) into shares
of our Common Stock at a price per share equal to $1.05, which represents the fair market value on the Closing Date.
The Notes have a one-year term but may
become due prior to the end of such term in the event of a change of control or a Qualified Financing. The Notes are collateralized
by second priority liens on all our assets.
In connection with the issuance of the
Notes, we also issued warrants, with a seven year term, to purchase 476,190 shares of our common stock (the “Warrants”)
to each of Rho and Prentice, respectively, at a price equal to $1.05 per share, which represents the fair market value of the Common
Stock on the Closing Date.
We incurred approximately $127,000 of debt
issuance costs (“Deferred Financing Costs”) related to the issuance of the Notes, which primarily consisted of legal
and other professional fees. These Deferred Financing Costs were deferred and are being amortized to interest expense to related
party stockholders over the term of the Notes.
Refer to the consolidated financial statements within Note 6
– 2012 Financing for further details.