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1. The Company and Description of Business and Future Liquidity Needs
The accompanying consolidated financial statements include the accounts of Infinity Resources Holdings Corp. and its subsidiaries, Earth911, Inc. (“Earth911”) and Youchange, Inc. (“Youchange”) along with the 50% ownership interest in Quest Resource Management Group, LLC (“Quest”), (collectively, “Infinity,” the “Company,” “we,” “us,” or “our”).
Operations – We are an environmental solutions company that serves as a single-source provider of recycling and environmental program services and information. We offer innovative, cost-effective, one-stop reuse, recycling, and waste disposal management programs designed to provide regional and national customers with a single point of contact for managing a variety of recyclables and disposables. We also own the Earth911.com website, offering original online environmental related content about reuse, recycling, and disposal of waste and recyclables, and we own a comprehensive online database of local recycling and proper disposal options. We also offer advertisers the opportunity to target an audience interested in environmental sustainability, recycling, and responsible disposition of waste products. We license customized logos and internet addresses to manufacturers to place on their products, which provide their customers with information about conveniently situated recycling locations and the proper disposal of various products.
We were incorporated in Nevada in July 2002 under the name BlueStar Financial Group, Inc. (“BSFG”). Prior to 2010, BSFG was a “shell company” under the rules of the Securities and Exchange Commission (the “SEC”). On March 30, 2010, BSFG (i) closed a transaction to acquire Youchange as a wholly owned subsidiary, (ii) ceased being a shell company, and (iii) experienced a change in control in which the former stockholders of Youchange acquired control of our company. In May 2010, we changed our name to YouChange Holdings Corp.
On October 17, 2012, immediately prior to closing a merger transaction with Earth911, we filed Amended and Restated Articles of Incorporation to (i) change our name to Infinity Resources Holdings Corp., (ii) increase the shares of common stock authorized for issuance to 100,000,000, (iii) authorize a total of 10,000,000 shares of preferred stock to be designated in series or classes as our board of directors may determine, (iv) effect a 1-for-5 reverse split of our common stock, and (v) divide our board of directors into three classes, as nearly equal in number as possible. On October 17, 2012, we closed the merger transaction (the “Earth911 Merger”) to acquire Earth911 as a wholly owned subsidiary and experienced a change in control in which the former stockholders of Earth911 acquired control of our company. Pursuant to the terms of the merger with Earth911, all outstanding common stock of Earth911 (the “Earth911 Shares”) was exchanged for shares of our common stock at a conversion ratio such that the former stockholders of Earth911 would hold an aggregate of 85% of our issued and outstanding common stock. In addition, all outstanding Earth911 options and warrants were exchanged and converted into options and warrants for the purchase of our common stock. Pursuant to this conversion ratio, we subsequently (i) issued 49,110,123 shares of our common stock in exchange for the Earth911 Shares, (ii) reserved for issuance an aggregate of 1,831,115 shares issuable upon the exercise of the Earth911 options, and (iii) reserved for issuance an aggregate of 8,786,689 shares issuable upon the exercise of the Earth911 warrants. On December 11, 2012, our board of directors approved a change to our fiscal year end from June 30 to December 31.
Effect of Merger – Pursuant to the terms of the merger agreement, pursuant to which we acquired Earth911, the stockholders of Earth911 exchanged their common stock for 85% of the common stock of the post-merger entity. Therefore, the merger for accounting purposes is considered a reverse merger, with Earth911 treated as the accounting acquirer.
Going Concern - During the year ended December 31, 2012, we incurred a net loss of $42,151,493 and used cash in operations of $3,820,068. At December 31, 2012, we had negative working capital of $600,294 and cash and cash equivalents of $485,728. As such, our independent registered public accounting firm has expressed an uncertainty about our ability to continue as a going concern in its opinion attached to our consolidated financial statements for the year ended December 31, 2012. We plan to seek to obtain additional working capital by increasing sales, maintaining efficient operating expenses, borrowing on a related party note, receiving distributions from Quest, and through other initiatives. We may require additional working capital to support operations and the expansion of sales channels and market distribution, to develop and introduce new products and services, to enhance existing product offerings, to address unanticipated competitive threats or technical problems, and for potential acquisition transactions. There can be no assurance that additional financing will be available to us on acceptable terms, or at all. Additional equity financing may involve substantial dilution to our then existing stockholders. In the event we are unable to raise additional capital or execute other alternatives, we may be required to sell portions of our business, or substantially reduce or curtail our activities. Such actions could result in charges that could be material to our results of operations and financial position. Our consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
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2. Summary of Significant Accounting Policies
Principals of Presentation, Consolidation and Reclassifications
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The accompanying consolidated financial statements include the operating activity of Infinity and its subsidiaries, for the years ended December 31, 2012 and 2011, as well as the equity method accounting for its investment in Quest. The Earth911 Merger was deemed to be a reverse acquisition, with Earth911 as the accounting acquirer. As such, the operating activity of Infinity (p/k/n YouChange Holdings Corp.) is consolidated in these consolidated financial statements from the date of the merger, October 17, 2012 to December 31, 2012. The operating activities for Infinity’s Earth911 subsidiary and the investment in Quest, is included for years ended December 31, 2012 and 2011. Quest is deemed to be a separate operating unit from Infinity and as such, there are no intercompany transactions that require elimination at this time. All other intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation.
As both Earth911 and Youchange are deemed to be operating as ecology based green service companies, no segment reporting was deemed necessary.
Accounting Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could materially differ from those estimates.
Significant estimates are used when accounting for the collectability of accounts receivable, depreciable lives of fixed assets, accruals, contingencies, assumptions used in the valuation and recognition of share-based payments and warrant liability, the realization of goodwill and intangible assets, deferred tax assets, the equity method investment in Quest, and the application of accounting for the senior secured convertible note, all of which are discussed in their respective notes to the consolidated financial statements.
Revenue Recognition
Revenue Recognition – We recognize revenue only when all of the following criteria have been met:
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persuasive evidence of an arrangement exists; |
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delivery has occurred or services have been rendered; |
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the fee for the arrangement is fixed or determinable; and |
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collectability is reasonably assured. |
Persuasive Evidence of an Arrangement – We document all terms of an arrangement in a quote signed or confirmed by the customer prior to recognizing revenue.
Delivery Has Occurred or Services Have Been Performed – We perform all services or deliver all products prior to recognizing revenue. Services are considered to be performed when the services are complete.
The Fee for the Arrangement is Fixed or Determinable – Prior to recognizing revenue, a customer’s fee is either fixed or determinable under the terms of the quote or accepted customer purchase order.
Collectability Is Reasonably Assured – We assess collectability on a customer by customer basis based on criteria outlined by management.
The revenues reported in 2012 and 2011 are derived primarily from the operations of Earth911 and represent licensing rights. These revenues are recognized ratably over the term of the license. Some revenues are derived from advertising contracts, which are also recognized ratably, over the term that the advertisement appears on our website. Revenues are not recognized until such time as persuasive evidence of an agreement exists, the price is fixed or determinable, and collectability is reasonably assured.
Cash and Cash Equivalents
We consider all highly liquid instruments with a remaining maturity of three months or less when purchased to be cash equivalents.
Accounts Receivable
We follow the allowance method of recognizing uncollectible accounts receivable. The allowance method recognizes bad debt expense based on a review of the individual accounts outstanding and our prior history of uncollectible accounts receivable. Our trade accounts receivable are primarily due from our customers. Credit is extended based on evaluation of each customer’s financial condition and are generally unsecured. Accounts receivable are typically due within 30 days and are stated net of an allowance for doubtful accounts. Accounts are considered past due if outstanding longer than contractual payment terms. We record an allowance on a specific basis by considering a number of factors, including the length of time trade accounts are past due, our previous loss history, the credit-worthiness of individual customers, economic conditions affecting specific customer industries, and economic conditions in general. We charge-off accounts receivable after all reasonable collection methods have been exhausted. Payments subsequently received on such receivables are credited against charge-offs in the period the payment is received.
As of December 31, 2012 and 2011, an allowance of $7,398 and nil, respectively, had been established for potentially uncollectible accounts receivable. We record delinquent finance charges on outstanding accounts receivables only if they are collected.
The changes in our allowance for doubtful accounts for the years ended December 31, 2012 and 2011 were as follows:
Years ended December 31, | ||||||||
2012 | 2011 | |||||||
Beginning balance |
$ | — | $ | 31,863 | ||||
Bad debt expense (recoveries) |
7,398 | — | ||||||
Uncollectible accounts written off |
— | (31,863 | ) | |||||
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Ending balance |
$ | 7,398 | $ | — | ||||
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Inventories
Inventories consist of used consumer electronics and computer devices and are stated at the lower of cost (average cost method which approximates first-in, first-out) or market. Cost is determined based on our estimate of the “collection” value of each item, which is what we then pay the supplier. We establish reserves for inventory to reflect situations in which the cost of the inventory is not expected to be recovered. In evaluating whether inventory is stated at the lower of cost or market, we consider such factors as the amount of inventory on hand, estimated time required to sell such inventory and current and expected market conditions. We record provisions for inventory obsolescence as part of cost of products sold. Inventories are presented net of allowances relating to the above provisions, however, as of December 31, 2012 and 2011, no provisions were deemed to be necessary.
Fair Value Measurements
ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices in active markets for identical assets or liabilities,
Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities,
Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimate of assumptions that market participants would use in pricing the asset or liability.
Fair value accounting has been applied to the valuation of stock-based compensation, warrants issued, and the impairment measurement of goodwill. The valuation methodologies and inputs used are discussed in the respective footnotes.
Stock Options - We estimate fair value of stock options using the Black-Scholes valuation model. Significant level 3 assumptions used in the calculation were determined as follows:
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Expected term is determined under the simplified method using an average of the contractual term and vesting period of the award as appropriate statistical data required to properly estimate the expected term was not available; |
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Expected volatility is measured using the historical changes in the market price of our common stock, disregarding identifiable periods of time in which share price was extraordinarily volatile due to certain events that are not expected to recur during the expected term; |
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Risk-free interest rate is to approximate the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards; and |
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Forfeitures are based on the history of cancellations of warrants granted by us and our analysis of potential future forfeitures. |
Warrants- We estimate fair value of the warrant liability using Level 3 inputs for the initial valuation of the warrants using the Black-Scholes valuation model. The Level 1 and 2 inputs utilized the March 29, 2013 cashless exercise value calculated from the exercise of all warrants that were exercisable on that date and the quoted common stock market price. See Note 7.
Goodwill - The fair value of the reporting unit used in the goodwill impairment analysis performed in the current year was determined in contemplation of suspension of funding of future development activities of the reporting unit and anticipated continuing negative cash flows from operations for the unit. These were determined to be level 3 inputs.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided for on the straight-line method, over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the useful life or the remaining term of the related leases. Expenditures for repairs and maintenance are charged to operations as incurred; renewals and betterments are capitalized when they occur. Gains and losses on the disposition of property and equipment are recorded in the period incurred. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Depreciation expense for the years ended December 31, 2012 and 2011 amounted to $68,576 and $51,472, respectively.
The useful lives of property and equipment for purposes of computing depreciation are as follows:
Computer equipment |
3 to 5 years | |||
Office furniture and equipment |
5 to 7 years | |||
Leasehold improvements |
5 to 7 years |
We review 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 assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset.
Intangible Assets
Legal fees and similar capitalizable costs relating to patents, copyrights, and trademarks are capitalized as appropriate. As of December 31, 2012 and 2011, our intangible assets consisted of indefinite lived intangibles relative to the Earth911 trademark of $128,800, which were not amortized. We review the carrying amounts of indefinite lived intangible assets at least annually in our fourth quarter, or whenever events or changes in circumstances indicate that the carrying amount of the asset may be impaired. These events or circumstances may include, but are not limited to (i) a significant decrease in the market value of an asset; (ii) a significant adverse change in the extent or manner in which an asset is used; or (iii) an accumulation of costs significantly in excess of the amount originally expected for the acquisition of an asset.
Impairment of Long-Lived Assets
Assets that are held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Impairment is recognized when the estimated undiscounted cash flow generated by those assets is less than the carrying amounts of such assets. The amount of impairment is the excess of the carrying amount over the fair value of such assets. Assets held for sale, if any, are carried at the lower of carrying amount or fair value less selling costs. No impairment charges were recognized during 2012 and 2011.
Goodwill
Goodwill is not amortized; however we annually evaluate qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test as of December 31, 2012 and 2011. Our’s test of goodwill by assessing the qualitative factors requires judgment in evaluating economic conditions, industry and market conditions, cost factors and entity-specific events, including overall financial performance. After evaluating these qualitative factors as of December 31, 2012 and 2011, the fair value was determined to not exceed the carrying value of the assets resulting in an impairment loss in 2012. Subsequent increases in goodwill value are not recognized in the consolidated financial statements. See Note 16 regarding the $17,636,569 impairment of goodwill recognized during 2012. No goodwill impairment was recorded as of December 31, 2011.
Taxes Collected From Customers and Remitted To Government Authorities
Taxes collected from customers and remitted to governmental authorities are presented in the accompanying statements of operations on a net basis.
Net Loss Per Share
We compute basic net loss per share by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The calculation of basic loss per share gives retroactive effect to the recapitalization related to our reverse acquisition of Earth911. We have other potentially dilutive securities outstanding that are not shown in a diluted net loss per share calculation because their effect in both 2012 and 2011 would be anti-dilutive. These potentially dilutive securities include options, warrants, and convertible promissory notes (see Note 14), and total 17,270,346 shares at December 31, 2012, and 1,381,115 shares at December 31, 2011.
Concentrations
Financial instruments that potentially subject us to credit risk consist principally of cash, cash equivalents and trade accounts receivable. We invest our cash and cash equivalents with commercial banks in Arizona. Cash and cash equivalents are at risk to the extent that they exceed the Federal Deposit Insurance Corporation (“FDIC”) insured level per institution for interest bearing accounts. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were at FDIC insured institutions through December 31, 2012 and were fully insured due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits.
We sell our products and services primarily to consumers, advertisers and businesses without requiring collateral; however, we routinely assess the financial condition of our customers and maintain allowances for anticipated losses. The following table discloses the number of customers that accounted for more than 10% of our annual revenues and related receivable balances:
Customers Exceeding 10% | ||||||||||||
of Revenues | ||||||||||||
Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
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2012 |
— | 0 | % | 0 | % | |||||||
2011 |
2 | 20 | % | 30 | % |
The following table discloses the number of customers that accounted for more than 10% of Quest’s annual revenues and receivable their related receivable balances:
Customers Exceeding
10% of Revenues |
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Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
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2012 |
1 | 89 | % | 71 | % | |||||||
2011 |
1 | 94 | % | 82 | % |
We believe we have no significant credit risk in excess of recorded reserves.
Investment in Quest
Investee companies that are not consolidated, but over which we exercise significant influence, are accounted for under the equity method of accounting. Whether or not we exercise significant influence with respect to an investee depends on an evaluation of several factors including among others, representation on the investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, an investee company’s accounts are not reflected within our balance sheet and statement of operations; however, our share of earnings or losses of the investee company is reflected in the caption “Equity in Quest Resource Management Group, LLC income” in our statement of operations. Our carrying value in an equity method investee company is reflected in the caption “Investment in Quest Resources Management Group, LLC” in our balance sheets.
We consider whether the fair value of our investment in Quest has declined below its carrying value whenever adverse events or changes in circumstances indicate that recorded values may not be recoverable. If there is a decline in the fair value below the carrying value of this investment, we will recognize an impairment charge for such difference. We performed an annual impairment analysis as of December 31, 2012 and 2011, resulting in no impairment losses, as we determined the fair value exceeded the carrying value of the assets. We will continue to evaluate our investment for potential impairment based upon any changes to Quest’s operations or its operating business environment. No impairment charges were recognized for our investment in Quest for the years ended December 31, 2012 and 2011.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the book and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established to reduce a deferred tax asset to the amount expected to be realized. We assess our ability to realize deferred tax assets based on current earnings performance and on projections of future taxable income in the relevant tax jurisdictions. These projections do not include taxable income from the reversal of deferred tax liabilities and do not reflect a general growth assumption but do consider known or pending events, such as the passage of legislation. Our estimates of future taxable income are reviewed annually. All tax positions are first analyzed to determine if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. After the initial analysis, the tax benefit is measured as the largest amount that is more than 50% likely of being realized upon ultimate settlement. Our income tax returns are subject to adjustment under audit for approximately the last three years.
If we are required to pay interest on the underpayment of income taxes, we recognize interest expense in the first period the interest becomes due according to the provisions of the relevant tax law.
If we are subject to payment of penalties, we recognize an expense for the amount of the statutory penalty in the period when the position is taken on the income tax return. If the penalty was not recognized in the period when the position was initially taken, the expense is recognized in the period when we change our judgment about meeting minimum statutory thresholds related to the initial position taken.
Advertising
Our advertising costs are charged to expense when incurred. During the years ended December 31, 2012 and 2011, advertising expense totaled $108,590 and $14,370, respectively.
Stock-Based Compensation
All share-based payments to employees, including grants of employee stock options, are expensed based on their estimated fair values at grant date, in accordance with ASC 718. Compensation expense for stock options is recorded over the vesting period using the estimated fair value on the date of grant, as calculated using the Black-Scholes model. We classify all share-based awards as equity instruments and recognize the vesting of the awards ratably over their respective terms. See Note 13 for a description of our share-based compensation plan and information related to awards granted under the plan.
Reverse Acquisition
We have accounted for the reverse acquisition discussed above in accordance with ASC 805-40 (Reverse Acquisitions). The 8,666,488 shares (post-split) of Infinity outstanding immediately prior to the reverse acquisition represent the consideration transferred for the Earth 911 Merger.
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3. Inventories
As of December 31, 2012, finished goods inventories were $4,292 and consisted of used consumer electronics and computer devices with no reserve for inventory obsolescence. As of December 31, 2011, we had no finished goods inventories.
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4. Property and Equipment
At December 31, 2012 and December 31, 2011, property and equipment consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Computer equipment |
$ | 157,305 | $ | 145,189 | ||||
Office furniture and equipment |
209,026 | 199,374 | ||||||
Leasehold improvements |
6,261 | 6,261 | ||||||
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372,592 | 350,824 | |||||||
Less: accumulated depreciation |
(215,904 | ) | (146,046 | ) | ||||
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$ | 156,688 | $ | 204,778 | |||||
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We lease certain furniture and fixtures under agreements that are classified as capital leases. The cost of equipment under these capital leases was $187,357 at December 31, 2012 and December 31, 2011 and is included in the consolidated financial statements as property and equipment. Accumulated depreciation of the leased equipment at December 31, 2012 and December 31, 2011 was $85,326 and $48,865, respectively. Interest expense in the amount of approximately $16,200 is expected to be recognized over the remainder of the lease term.
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5. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Compensation |
$ | 191,393 | $ | 433,821 | ||||
Deferred rent obligation |
138,926 | 101,608 | ||||||
Professional fees |
302,818 | 46,000 | ||||||
Accrued interest and other |
15,016 | 1,400 | ||||||
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$ | 648,153 | $ | 582,829 | |||||
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In June 2012, deferred compensation of $260,000 was converted into 110,490 shares of our common stock at $2.35 per share.
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6. Convertible Notes Payable
The activity from the date of the merger, October 17, 2012 to December 31, 2012 for convertible notes payable related to Youchange is summarized below. During that period ending December 31, 2012, $142,218 of principal and $7,747 of interest was converted into 118,035 shares of common stock. As of December 31, 2012, the outstanding convertible notes payable and associated accrued interest described below were convertible into a total of approximately 108,680 common shares. The intrinsic value of a beneficial conversion feature inherent to a convertible note payable, which is not bifurcated and accounted for separately from the convertible note payable and may not be settled in cash upon conversion, is treated as a discount to the convertible note payable. This discount is amortized over the period from the date of issuance to the date the note is due using the effective interest method. If the note payable is retired prior to the end of its contractual term, the unamortized discount is expensed in the period of retirement to interest expense. In general, the beneficial conversion feature is measured by comparing the effective conversion price, after considering the relative fair value of detachable instruments included in the financing transaction, if any, to the fair value of the common shares at the commitment date to be received upon conversion.
The following convertible notes payable were outstanding as of December 31, 2012:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Convertible note payable to unrelated parties, issuance date of October 2011 |
$ | 10,000 | $ | — | ||||
Convertible note payable to unrelated parties, issuance date of April 2012 |
5,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of August 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
12,500 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
25,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
25,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
25,000 | — | ||||||
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Total convertible notes payable - short term |
132,500 | — | ||||||
Less: unamortized discounts due to beneficial conversions features |
(33,394 | ) | — | |||||
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Total convertible notes payable - short term, net of discounts |
$ | 99,106 | $ | — | ||||
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Further details for the outstanding notes payable are as follows:
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During October 2011, we issued a $10,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matured three months from the date of issuance and was extended by an additional 30 days. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $5,200 for this convertible note. Although this note was past its maturity as of December 31, 2012, the holder converted the note and its accrued interest subsequent to year end into 9,278 shares of common stock. |
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During April 2012, we issued a $5,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matured six months from the date of issuance and was extended by an additional 30 days. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.75 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $2,712 for this convertible note. Although this note was past its maturity as of December 31, 2012, the holder converted the note and its accrued interest subsequent to year end into 3,130 shares of common stock. |
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During August 2012, we issued a $10,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $6,400 for this convertible note. This note matured in the period subsequent to year end and the holder converted the note and its accrued interest subsequent to year end into 8,460 shares of common stock. |
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During September 2012, we issued a $10,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $8,600 for this convertible note. This note matured in the period subsequent to year end and the holder converted the note and its accrued interest subsequent to year end into 8,339 shares of common stock. |
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During September 2012, we issued a $12,500 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $10,750 for this convertible note. This note matured in the period subsequent to year end and the holder converted the note and its accrued interest subsequent to year end into 10,418 shares of common stock. |
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During September 2012, we issued a $25,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $17,500 for this convertible note. Although this note is past its maturity in the period subsequent to year end, the holder is expected to exercise the conversion feature. |
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During October 2012, we issued a $25,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $11,000 for this convertible note. |
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During October 2012, we issued a $10,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $2,400 for this convertible note. Subsequent to December 31, 2012, the holder converted the note and its accrued interest into 8,292 shares of common stock. |
• |
During October 2012, we issued a $25,000 convertible note to an unrelated, accredited third party in exchange for cash. The note matures six months from the date of issuance and may be extended by an additional 30 days at our discretion. The note bears interest at a rate of 10.0% per annum and is convertible at any time, with accrued interest, at the discretion of the investor into shares of our common stock at a rate of $1.25 per share. Based on our share price at the time the note agreement was entered into, we recognized a beneficial conversion feature of $13,000 for this convertible note. |
|
7. Long Term Debt and Capital Lease Obligations
At December 31, 2012 and December 31, 2011, total debt outstanding consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Three convertible notes payable to related parties, principal plus accrued interest due July 2013, interest and repayment provisions discussed further below |
$ | — | $ | 6,276,897 | ||||
Senior secured convertible notes payable to a related party, 9% interest due monthly in arrears, due October 2014, repayment provisions discussed further below (Net of discount of $1,313,897 at December 31, 2012) |
686,103 | — | ||||||
Capital lease obligations, imputed interest at 43.0% to 46.0%, with monthly payments of $8,540 through December 2013, secured by office furniture and fixtures |
72,128 | 127,923 | ||||||
Note payable with monthly payments of $3,333 through January 2012 |
— | 3,333 | ||||||
|
|
|
|
|||||
Total |
758,231 | 6,408,153 | ||||||
Less: current maturities |
(72,128 | ) | (59,127 | ) | ||||
|
|
|
|
|||||
Long-term portion |
$ | 686,103 | $ | 6,349,026 | ||||
|
|
|
|
The three convertible notes payable to related parties in the above table had an annual stated interest rate of 9.0% and were modified as of October 1, 2010 to include a conversion feature to convert the notes into common stock at $0.72 per share. The addition of this substantive conversion feature was recognized in 2010 as an extinguishment, which resulted in a $3,955,644 debt extinguishment charge for the recognition of the convertible notes at fair value, which was based on the underlying shares the notes were convertible into. Following this modification, we have accrued interest at a rate representative of the fair value of the underlying shares the interest is convertible into, or 29.25%. In March 2012, the holders of the three convertible related party notes elected to convert to common stock. This conversion was later modified in June 2012 so that the notes were converted at a rate of $2.35 per share for 835,409 total shares.
On March 22, 2012, Earth 911, Inc., a Delaware corporation and our wholly owned subsidiary (“Earth 911”), entered into a Securities Purchase Agreement with Stockbridge Enterprises, L.P., a related party (“Stockbridge”), pursuant to which Earth 911 issued a senior secured convertible note (the “Convertible Note”) and an initial four warrants to Stockbridge. The Convertible Note is secured by all the assets of Earth 911. On each of October 10, 2012 and March 29, 2013, the terms of the note and the warrants were amended and additional warrants were issued to Stockbridge (the “Allonge” and the “Second Allonge”). The Convertible Note and warrants have also been adjusted for the merger in October 2012. See Note 17 regarding the Second Allonge.
The amended Convertible Note provides for up to $3,000,000 principal with a maturity date of October 1, 2015, which may be extended under certain circumstances. The annual interest rate was adjusted in October 2012 to 9.0% from the original 6.0%, and is due monthly in arrears. Reflecting the adjustment for the reverse merger, the Convertible Note is convertible into our shares of our common stock at $0.362 per share prior to the maturity date and $0.181 per common share after the maturity date, subject to a downward formula-based adjustment for future issuances of common stock or stock equivalents under certain conditions whereby the issue price is lower than the conversion price in effect immediately prior to such issue or sale (the “Fixed Conversion Price”). As a result of the merger, our common stock is listed on a United States exchange (a “Triggering Event”), therefore the conversion price is the lower of the Fixed Conversion Price or the average closing bid price during the ten trading days immediately preceding the conversion date. In the event that Earth 911 or any of its subsidiaries or affiliated companies closes a financing or funding transaction exceeding $100,000, at the election of Stockbridge, certain percentages of the proceeds of such transaction shall be applied to redeem the outstanding principal amounts of the Convertible Note.
In connection with the Convertible Note we issued five-year warrants that were subsequently adjusted for the merger and consist of the following:
(i) | a warrant issued March 2012 to acquire up to 1,381,115 shares of our common stock, exercisable immediately upon executing of the Convertible Note (“Warrant 1-1”); |
(ii) | three contingent warrants issued March 2012 exercisable only in the event that all outstanding principal and accrued interest on the Convertible Note is not paid in full at such dates as follows: a warrant to acquire up to 345,278 shares of our common stock, exercisable at the conclusion of forty-two (42) months after the issuance date of the warrant (“Warrant 1-2”); a warrant to acquire up to 345,278 shares of our common stock, exercisable at the conclusion of forty-five (45) months after the issuance date of the warrant (“Warrant 1-3”); and a warrant to acquire up to 690,557 shares of our common stock, exercisable at the conclusion of forty-eight (48) months after the issuance date of the warrant (“Warrant 1-4”); and |
(iii) | a warrant issued October 2012 upon execution of the Allonge to acquire up to 5,524,461 shares of our common stock and exercisable immediately (“Warrant 1-5”). |
Warrant 1-1 is exercisable at $0.37 per share of common stock, and as of any exercise date following the Triggering Event, the lower of the $0.37 exercise price or the average closing bid price during the ten trading days immediately preceding the exercise date. Warrant 1-5 is exercisable at $0.37 per share of common stock, and as of any exercise date following the Triggering Event, the lower of the $0.37 exercise price or the average closing bid price during the ten trading days immediately preceding the exercise date.
Warrant 1-1 and Warrant 1-5 were exercised in March 2013 as part of the Second Allonge using a cashless exercise formula. In addition, a new warrant was issued upon the signing of the Second Allonge to acquire up to 500,000 shares of our common stock, exercisable immediately upon execution of the amendment (“Warrant 1-6”) under the same exercise price and terms as Warrant 1-5. Warrant 1-6 was also exercised in March 2013. See Note 17 for further discussion.
If the contingent Warrant 1-2, Warrant 1-3 and Warrant 1-4 become exercisable, the exercise price would be $0.37 per share of common stock, and due to the Triggering Event, the lower of the $0.37 exercise price or the average closing bid price during the ten trading days immediately preceding the exercise date. The exercise price for all of the warrants is also subject to a downward formula-based adjustment for future issuances of common stock or stock equivalents under certain conditions whereby the issue price is lower than the exercise price in effect immediately prior to such issue or sale.
In connection with the issuance of the Convertible Note, Warrant 1-1 and Warrant 1-5 were initially valued and accounted for as a warrant liability of $18,742,526 and allocated as a discount to the Convertible Note of $1,500,000 with the remainder of $17,242,526 expensed as a financing cost. As of December 31, 2012, the warrants were valued at $20,233,338 increasing the warrant liability by $1,490,812 and recording a valuation loss of $1,490,812. See Note 10 regarding the valuations of the warrant liability. The Convertible Note increased by another $500,000 draw, which was accounted for as an additional discount and an adjustment to additional paid-in-capital. The Convertible Note discount total of $2,000,000, which is equal to the amount of the funds drawn on the Convertible Note as of December 31, 2012, is being amortized to interest expense over the life of the Convertible Note beginning March 22, 2012. As of December 31, 2012, the unamortized portion of the debt discount was $1,313,897. The amount of interest expense related to the amortization of the discount on the Convertible Note for the period ended December 31, 2012 was $686,103.
The following table summarizes future maturities of debt and capital lease obligations, as amended, as of December 31, 2012:
Year Ending December 31, |
Amount | |||
2013 |
$ | 72,128 | ||
2014 |
— | |||
2015 |
2,000,000 | |||
|
|
|||
Subtotal (assuming repayment in cash) |
2,072,128 | |||
Less discount on Convertible Note |
(1,313,897 | ) | ||
Less current maturities |
(72,128 | ) | ||
|
|
|||
Total |
$ | 686,103 | ||
|
|
|
8. Investment in Quest Resource Management Group, LLC
We hold a 50% ownership interest in Quest which was acquired on August 21, 2008. The financial condition and operating results of Quest for the relevant periods are presented below:
Years ended December 31, | ||||||||
2012 | 2011 | |||||||
Condensed operating statement information: |
||||||||
Net sales |
$ | 130,621,675 | $ | 121,888,280 | ||||
Gross margin |
12,934,339 | 11,430,986 | ||||||
Income from operations |
4,005,383 | 4,904,646 | ||||||
Net income |
3,929,080 | 4,197,360 | ||||||
Company’s equity method income allocation |
1,964,540 | 2,233,028 | ||||||
As of December 31, | ||||||||
2012 | 2011 | |||||||
Condensed balance sheet information: |
||||||||
Current assets |
$ | 20,718,638 | $ | 24,916,207 | ||||
Long-term assets |
2,118,295 | 1,885,098 | ||||||
|
|
|
|
|||||
Total Assets |
$ | 22,836,933 | $ | 26,801,305 | ||||
|
|
|
|
|||||
Current liabilities |
$ | 17,925,175 | $ | 24,067,022 | ||||
Long-term liabilities |
— | — | ||||||
Equity |
4,911,758 | 2,734,283 | ||||||
|
|
|
|
|||||
Total liabilities and members’ equity |
$ | 22,836,933 | $ | 26,801,305 | ||||
|
|
|
|
|
9. Income Taxes
Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized. In our opinion, realization of our net operating loss carry forward is not reasonably assured as of December 31, 2012, and a valuation allowance of $2,433,000 has been provided against deferred tax assets in excess of deferred tax liabilities in the accompanying consolidated financial statements. The components of net deferred taxes are as follows:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Deferred tax assets (liabilities): |
||||||||
Net operating loss |
1,029,000 | 332,900 | ||||||
Stock-based compensation |
1,177,000 | 414,900 | ||||||
Accrued interest expense |
155,000 | 134,300 | ||||||
Allowance for doubtful accounts |
22,000 | 12,300 | ||||||
Deferred lease liability |
50,000 | 38,300 | ||||||
|
|
|
|
|||||
Total deferred tax assets |
2,433,000 | 932,700 | ||||||
Less: valuation allowance |
(2,433,000 | ) | — | |||||
|
|
|
|
|||||
Net deferred taxes |
$ | — | $ | 932,700 | ||||
|
|
|
|
The reconciliation between the income tax expense (benefit) calculated by applying statutory rates to net loss and the income tax benefit reported in the accompanying consolidated financial statements is as follows:
Year Ended December 31, | ||||||||
2012 | 2011 | |||||||
U.S. federal statutory rate applied to pretax income |
$ | (11,713,000 | ) | $ | (834,000 | ) | ||
Permanent differences |
10,344,000 | 106,000 | ||||||
State taxes and other |
(123,000 | ) | (147,000 | ) | ||||
Change in valuation allowance |
2,433,000 | — | ||||||
|
|
|
|
|||||
$ | 941,000 | $ | (875,000 | ) | ||||
|
|
|
|
At December 31, 2012 we had federal income tax net operating loss carryforwards of approximately $2,600,000, which expire at various dates beginning in 2031. We are subject to limitations existing under Internal Revenue Code Section 382 (Change of Control) relating to the availability of the operating loss.
As of December 31, 2012, we did not recognize any assets or liabilities relative to uncertain tax positions, nor do we anticipate any significant unrecognized tax benefits will be recorded during 2012. It is our policy to classify interest and penalties on income taxes as interest expense or penalties expense.
Tax positions are positions taken in a previously filed tax return or positions expected to be taken in a future tax return that are reflected in measuring current or deferred income tax assets and liabilities reported in the financial statements. Tax positions include, but are not limited to, the following:
• |
an allocation or shift of income between taxing jurisdictions; |
• |
the characterization of income or a decision to exclude reportable taxable income in a tax return; or |
• |
a decision to classify a transaction, entity or other position in a tax return as tax exempt. |
We are potentially subject to tax audits for United States federal and Arizona state tax returns for tax years ended 2012 to 2010. Tax audits by their very nature are often complex and can require several years to complete. Prior to July 13, 2010, as a limited liability company, we were not a tax paying entity for federal and state income tax purposes. Accordingly, our taxable income or loss was allocated to our members in accordance with their respective percentage ownership.
|
10. Fair Value of Financial Instruments
Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, convertible notes payable, notes payable and warrant liability. We do not believe that we are exposed to significant interest, currency or credit risks arising from these financial instruments. With the exception of the warrant liability, the fair values of these financial instruments approximates their carrying values using level 3 inputs, based on their short maturities or for long-term debt based on borrowing rates currently available to us for loans with similar terms and maturities. Gains and losses recognized on changes in fair value of financial instruments are reported in other income (expense).
Our initial warrant valuation was measured at fair value by applying the Black-Scholes option valuation model, which utilizes Level 3 inputs. The assumptions used in the Black-Scholes option valuation for the warrants are as follows: volatility of 66%; risk free interest rate of 1%, expected term of 5 years; and expected dividend yield of 0%. The grant date fair value of the initial warrant valuation described above was $2.56 per warrant. The risk free interest rate is based on United States Treasury rates with maturity dates approximating the expected term of the warrants. At the time of the initial warrant valuation we were a private company and common stock transactions were too infrequent, therefore we could not practicably estimate the expected volatility of our own stock. Accordingly, we have substituted the historical volatility of a relevant sector index, which we have generated from companies that are publicly traded and do business within the industry we operate.
The year-end valuations were measured at fair value by utilizing the quoted market price for our common stock and the valuation for the cash-less exercise of Warrant 1-1 and Warrant 1-5 in March 2013, which are Level 1 and Level 2 inputs. These inputs of (i) an observable warrant exercise transaction shortly after year end and (ii) publicly traded market price provided a reasonable basis for valuation for the warrants as of December 31, 2012. Based on that valuation using the $3.00 closing market price and exercisable rights in total to purchase 6,905,576 shares at $0.37 per share of common stock, Warrant 1-1 and Warrant 1-5 had a net number value, as described in Note 17, of $20,233,338. See Note 17 regarding the exercise of these warrants.
The following table summarizes the warranty liability valuation for the twelve months ended December 31, 2012:
Description |
Fair Value Measurements Warrant Liability |
|||
Beginning balance, December 31, 2011 |
$ | — | ||
Issuances (Level 3) |
18,742,526 | |||
Total (gains) or losses (Level 1 and 2) |
1,490,812 | |||
|
|
|||
Ending balance, December 31, 2012 |
$ | 20,233,338 | ||
|
|
|
11. Commitments and Contingencies
We lease corporate office space in Scottsdale, Arizona under a 66 month, non-cancelable operating lease. The lease expires in March 2017 and provides for a renewal option of 60 months. In addition, we lease office and warehouse space in Tempe, Arizona under a 39 month, non-cancellable operating lease, which expires in July 2015. Lease expense totaled $287,806 and $184,872 for the years ended December 31, 2012 and 2011, respectively. The following is a schedule, by year, of future minimum rental payments required under the operating lease agreement as of December 31, 2012:
Year Ended December 31, |
Amount | |||
2013 |
$ | 301,396 | ||
2014 |
315,517 | |||
2015 |
305,320 | |||
2016 |
286,870 | |||
2017 |
72,832 | |||
|
|
|||
$ | 1,281,935 | |||
|
|
Our operating lease agreement contains a provision that abate rent payments for a period of five months. The total amount of rental payments due over the lease term is being charged to rent expense on the straight-line method over the term of the lease. The difference between rent expense recorded and the amount paid is charged to accrued liabilities in the accompanying balance sheets.
Indemnifications
During the normal course of business, we make certain indemnities and commitments under which we may be required to make payments in relation to certain transactions. These may include (i) intellectual property indemnities to customers in connection with the use, sales, and/or license of products and services; (ii) indemnities to customers in connection with losses incurred while performing services on their premises; (iii) indemnities to vendors and service providers pertaining to claims based on negligence or willful misconduct; and (iv) indemnities involving the representations and warranties in certain contracts. In addition, under our bylaws we are committed to our directors and officers for providing for payments upon the occurrence of certain prescribed events. The majority of these indemnities and commitments do not provide for any limitation on the maximum potential for future payments that we could be obligated to make. We have not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of December 31, 2012.
|
12. Mezzanine Financing
During October 2010, a $0.72 conversion feature was added to three related party notes payable more fully described in Note 7. The three related party notes payable were originally funded from January through December 2009 and the conversion feature was understood to have been part of the notes; however, when the notes were formalized, this conversion feature was omitted in error. Because this error was discovered in September 2010, the notes were amended to include the $0.72 conversion feature. This conversion feature was not disclosed in the private placement and we determined to present the issuance of the 687,000 shares of our common stock from the private placement as mezzanine financing on the accompanying December 31, 2011 balance sheet.
During June 2012, the note holders agreed to modify the conversion price of the notes to $2.35 per share of common stock from $0.72 per share of common stock and the notes were converted. As a result of this modification, we have reclassified the proceeds and the common stock from this private placement from mezzanine financing to permanent equity at the time of the modification in June 2012.
|
13. Stockholders’ Equity
Preferred Stock - Our authorized preferred stock consists of 10,000,000 shares of preferred stock with a par value of $.001, of which no shares have been issued or outstanding.
Common Stock - Our authorized common stock consists of 100,000,000 shares of common stock with a par value of $.001 with 58,040,230 and 46,847,631 issued and outstanding as of December 31, 2012 and 2011, respectively.
During 2012, we issued shares of common stock as follows:
Common Stock | ||||||||
Shares | Amount | |||||||
Related party notes conversions (See Note 7) |
835,409 | $ | 6,389,042 | |||||
Deferred compensation converted to stock |
110,490 | 260,000 | ||||||
Mezzanine financing reclassified to equity (See Note 7 and 12) |
687,051 | 1,375,933 | ||||||
Rights offering |
491,430 | 414,300 | ||||||
Common stock issued for loan fees |
138,112 | 117,000 | ||||||
Shares issued to effect reverse merger |
8,666,488 | 17,332,975 | ||||||
Common stock issued for services |
108,083 | 249,025 | ||||||
Note conversions and discounts (see Note 6) |
155,536 | 215,066 | ||||||
|
|
|
|
|||||
11,192,599 | $ | 26,353,341 | ||||||
|
|
|
|
• |
Deferred Compensation - In June 2012, deferred compensation of $260,000 was converted into 110,490 shares of our common stock at $2.35 per share. |
• |
Rights Offering and Subscription Agreement– In August 2012, the Board of Directors approved a rights offering for up to 2,500,000 shares of our common stock to all of our accredited stockholders, officers and directors, employees, certain persons with whom we have relationships, and any others who had expressed an interest in purchasing our shares. The price of the shares was the lesser of (i) $2.00 per share or (ii) 60% of the average closing price of YouChange common stock for the ten days prior to closing of the merger with YouChange times 5 to reflect the 1-for-5 reverse split of YouChange common stock that occurred immediately prior to the closing of the merger. Prior to the merger, we received subscription agreements of $416,300 less financing fees of $2,000 for a total of $414,300. The price of the shares for the rights offering was approximately $1.17 per share and a total of 491,430 shares were issued in conjunction with the rights offering. The rights offering also contains an anti-dilution provision that will provide additional shares of common stock if in the 12 months following the merger we complete a stock offering of $5 million or more at a per share price lower than the rights offering price of approximately $1.17 per share. |
• |
Common Stock for Loans Fees – Pursuant to the amendment to the Convertible Note on October 10, 2012, we issued 138,112 shares of common stock |
• |
Reverse Stock Split – We effected a 1 for 5 reverse split that was effective on October 17, 2012 associated with the reverse merger with Earth 911. As a result of the reverse split, each five shares of our common stock outstanding at the time of the reverse split was automatically changed into one share of common stock, and the total number of common stock shares outstanding were reduced from approximately 43.4 million shares to approximately 8.6 million shares post-split. The reverse stock split resulted in the same adjustment to our convertible notes outstanding. No fractional shares were issued in connection with the reverse stock split. Fractional shares were rounded up to the next whole share. All per share amounts and outstanding shares, including all common stock equivalents (convertible securities and stock options) have been restated in the consolidated financial statements, the notes to the consolidated financial statements and the loss per share for all periods presented to reflect the reverse stock split. |
• |
Common Stock for Services - We issued 108,083 shares of common stock to employees and consultants during the 12 months ended December 31, 2012 for $249,025 of services. |
Warrants - At December 31, 2012, we had outstanding exercisable warrants, as adjusted, to purchase 6,905,576 shares of common stock at $0.37 per share. See the discussion under Note 7 and Note 17 for further details regarding the issued warrants related to the Convertible Note, subsequent amendment, and exercise of warrants. The following table summarizes the warrants issued and outstanding as of December 31, 2012:
Warrants Issued and Outstanding as of December 31, 2012 |
||||||||||||||||
Date of | Exercise Price |
Shares of | ||||||||||||||
Description |
Issuance | Expiration | Common Stock | |||||||||||||
Exercisable warrants |
||||||||||||||||
Warrant 1-1 |
03/22/12 | 03/21/17 | $ | 0.37 | 1,381,115 | |||||||||||
Warrant 1-5 |
10/10/2012 | 10/9/2017 | $ | 0.37 | 5,524,461 | |||||||||||
|
|
|||||||||||||||
Total exercisable warrants |
6,905,576 | |||||||||||||||
Contingent warrants |
||||||||||||||||
Warrant 1-2 |
03/22/12 | 03/21/17 | $ | 0.37 | 345,278 | |||||||||||
Warrant 1-3 |
03/22/12 | 03/21/17 | $ | 0.37 | 345,278 | |||||||||||
Warrant 1-4 |
03/22/12 | 03/21/17 | $ | 0.37 | 690,557 | |||||||||||
|
|
|||||||||||||||
Total contingent warrants |
1,381,113 | |||||||||||||||
|
|
|||||||||||||||
Total warrants issued and outstanding |
|
8,286,689 | ||||||||||||||
|
|
Stock Option Plan - In October 2012, we adopted our 2012 Incentive Compensation Plan as the sole plan for providing equity-based incentive compensation to our employees, non-employee directors and other service providers. The plan allows for the grant of stock options, restricted stock, restricted stock units, stock appreciation rights, performance awards and other incentive awards to our employees, non-employee directors and other service providers who are in a position to make a significant contribution to our success and our affiliates. The purposes of the plan are to attract and retain individuals, further align employee and stockholder interests, and closely link compensation with our performance. The plan is administered by the Board of Directors. Our policy is to fulfill any exercise of options from common stock that is authorized and unissued. The maximum number of shares of common stock available for grant under the plan is 7,500,000. The number of shares available for award under the plan is subject to adjustment for certain corporate changes in accordance with the provisions of the plan.
Following is a summary of stock option activity from January 1, 2010 through December 31, 2012:
Stock Options | ||||||||||||
Weighted- | ||||||||||||
Exercise | Average | |||||||||||
Number | Price Per | Exercise Price | ||||||||||
of Shares | Share | Per Share | ||||||||||
Outstanding at January 1, 2010 |
— | $ | — | $ | — | |||||||
Granted |
1,381,115 | 2.35 | 2.35 | |||||||||
Canceled/Forfeited |
— | — | — | |||||||||
|
|
|||||||||||
Outstanding at December 31, 2011 |
1,381,115 | 2.35 | 2.35 | |||||||||
Granted |
1,969,000 | 2.00 - 2.79 | 2.10 | |||||||||
Canceled/Forfeited |
— | — | — | |||||||||
|
|
|||||||||||
Outstanding at December 31, 2012 |
3,350,115 | 2.00 - 2.79 | 2.20 | |||||||||
|
|
The weighted-average grant-date fair value of options granted was $2.10 and $2.35 for the years ended December 31, 2012 and 2011, respectively.
For the year ended December 31, 2012, the intrinsic value of options outstanding was $2,331,698 and of options exercisable was $1,199,613. The following additional information applies to options outstanding at December 31, 2012:
Ranges of Exercise Prices |
Outstanding at December 31, 2012 |
Weighted- Average Remaining Contractual Life |
Weighted- Average Exercise Price |
Excercisable at December 31, 2012 |
Weighted- Average Exercise Price |
|||||||||||||||
$2.00 - $2.79 |
3,350,115 | 9.6 | $ | 2.20 | 1,922,782 | $ | 2.27 |
Stock-based compensation expense was $1,661,673 and $1,037,235 for the years ended December 31, 2012 and December 31, 2011, respectively. At December 31, 2012, the balance of unearned stock-based compensation to be expensed in future periods related to unvested share-based awards, as adjusted for expected forfeitures, was approximately $2,435,000. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately three years.
Stock-Based Compensation - We account for all share-based payment awards made to employees and directors including stock options and employee stock purchases based on estimated fair values. We estimate the fair value of share-based payment awards on the date of grant using an option-pricing model and the value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period, net of forfeitures.
We use the Black-Scholes option-pricing model (“Black-Scholes”) as our method of valuation. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The fair value of share-based payment awards on the date of grant as determined by the Black-Scholes model is affected by our stock price as well as other assumptions. These assumptions include, but are not limited to, the expected stock price volatility over the term of the awards, the actual and projected employee stock option exercise behaviors, and an estimated forfeiture rate.
The weighted-average estimated value of employee stock options granted during the years ended December 31, 2012 and 2011 was estimated using the Black-Scholes model with the following weighted-average assumptions:
Year Ended December 31, | ||||||||
2012 | 2011 | |||||||
Expected volatility |
155 | % | 66 | % | ||||
Risk-free interest rate |
0.70 | % | 1.81 | % | ||||
Expected dividends |
0.00 | % | 0.00 | % | ||||
Expected term in years |
5.4 | 5.4 |
|
15. Related Party Transactions
As discussed in Note 7, in March 2012, the three convertible related party notes elected to convert to common stock. This conversion was later modified in June 2012 so that the notes were converted at a rate of $2.35 per share for 835,409 total shares.
In March 2012, we entered into a Senior Secured Convertible Note (the “Convertible Note”) with Stockbridge Enterprises, LP, a related party. In connection with the issuance of the Convertible Note, we issued four warrants (Warrants1-1 through 1-4) in March 2012. In October 2012, we amended the Convertible Note. The original principal amount was increased to $3,000,000 from the original $1,000,000 amount. The maturity of the note was changed to October 1, 2014 and then amended to October 1, 2015 in March 2013. The conversion rate of the Convertible Note was changed to $.50 per common share prior to the maturity date and $.25 per common share after the maturity, subject to certain adjustments. In connection with the amendment, we issued Warrant 1-5 in October 2012 and issued 100,000 shares of our common stock. See Note 7 for a discussion of the Convertible Note and Note 17 for a discussion of the subsequent amendment and exercise of warrants in March 2013.
Effective October 18, 2012, we entered into a one year marketing agreement with Infinity Solutions & Consultants, controlled by an affiliate of a related party. Under the marketing agreement commission is paid on revenue achieved from approved leads and stock options issued for achieving sales targets. In addition, a ten year stock option was granted to purchase 100,000 shares of our common stock at $2.10 per share, which was market value at the time of grant, with vesting concurrent with signing of the marketing agreement.
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16. Goodwill and Valuation Impairment
We primarily employ two methodologies for determining the fair value of a long-lived asset: (i) the amount at which the asset could be bought or sold in a current transaction between willing parties; or (ii) the present value of expected future cash flows grouped at the lowest level for which there are identifiable independent cash flows.
In connection with the Earth911 Merger, we recognized $17,636,569 of goodwill. Due to capital constraints, we have slowed down the planned expansion of Youchange, and we are not able to quantify with any certainty the future cash flows and therefore the value of the goodwill as of December 31, 2012. We have reviewed the fair value of the goodwill as of December 31, 2012 and have taken an impairment loss of $17,636,569 during the year then ended.
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17. Subsequent Events
Short Term Notes Payable.
Subsequent to year end, certain short term notes payable and interest totaling $61,461 were converted into 47,917 shares of common stock. See Note 6 for further details.
Second Allonge to the Convertible Note.
As discussed in Note 7, on March 22, 2012, Earth911, Inc., a Delaware corporation and our wholly owned subsidiary (“Earth911”), entered into a Securities Purchase Agreement with Stockbridge Enterprises, L.P., a Nevada limited partnership (“Stockbridge”), pursuant to which Earth911 issued a convertible note and four warrants to Stockbridge. On each of October 10, 2012 (the “Allonge”) and on March 29, 2013, the terms of the note and the warrants were amended and additional warrants were issued to Stockbridge. Under the amendment on March 29, 2013, Earth911 and Stockbridge entered into a Second Allonge to the Convertible Note (the “Second Allonge”), pursuant to which the parties agreed to (i) amend all references to common stock, options, warrants, warrant shares, or convertible securities of Earth911 in the original note documents and the Allonge documents to common stock, options, warrants, warrant shares, or convertible securities, respectively, of Infinity, and (ii) expand all references to a “Triggering Event” in the original note documents and the Allonge documents to include any exchanges on which the Infinity Common Stock may be listed or quoted for trading. The parties also (i) amended how the fair market value of the Infinity common stock, on the date of exercise, would be defined in a formula used to calculate the net number of shares that Stockbridge would receive upon a cashless exercise, (ii) extended the maturity date of the Convertible Note to October 1, 2015, (iii) revised the terms of Warrant 1-5 to apply the conversion rate from the merger to the number of shares of Infinity Common Stock underlying Warrant 1-5 and the exercise price at which such shares would be issued upon the exercise date, and (iv) amended the exercisable dates of the contingent Warrant 1-2, the contingent Warrant 1-3, and the contingent Warrant 1-4 to be exercisable 42 months, 45 months, and 48 months, respectively, following the issuance date of the contingent warrants. Finally, Stockbridge retroactively agreed to waive its right to effect a partial conversion of the Convertible Note, with such waiver to be effective for a period of 12 months from October 17, 2012.
To effect the changes in the Second Allonge, we issued to Stockbridge an additional warrant to purchase 500,000 shares of our common stock (“Warrant 1-6”). Warrant 1-6 is exercisable at or after the date of the Second Allonge, and is in the same form as Warrant 1-5, as amended by the Second Allonge. Warrant 1-6 will expire five years from the date of issuance.
On March 29, 2013, Stockbridge elected to exercise Warrants 1-1, 1-5 and 1-6 with exercisable rights in total to purchase 7,405,576 of our common stock at $0.37 per share under the cashless exercise option of the Second Allonge. The net number share calculation in the “Cashless Exercise” formula, as amended and restated, is as follows:
Net Number = (A x B) – (A x C)
D
For purposes of the foregoing formula as of March 29, 2013:
A = 7,406,576, the total number of warrant shares with respect to which these warrants were then being exercised.
B = $3.30, the closing price of the common stock plus 10.0% on the date of exercise of the warrant.
C = $0.37, the warrant exercise price then in effect for the applicable warrant shares at the time of such exercise.
D = $3.00, the closing price of the common stock on the date of exercise of the warrant.
Based on the cashless exercise formula, on March 29, 2013 Warrants 1-1, 1-5 and 1-6 yielded a net number value of $21,698,338. The net number value equaled 7,232,779 shares of common stock issued at $3.00 per share under the cashless exercise option.
Quest Option Agreement.
Effective January 15, 2013, Quest Resources Group, LLC (“QRG”) entered into an Option Agreement with Earth911 to acquire from QRG the remaining 50% of the issued and outstanding membership interests of Quest not already held by Earth911. Upon exercise of the option, Quest would become a wholly owned subsidiary of Earth911. The Option Agreement shall terminate automatically if Earth911 has not exercised the option and the closing shall not have occurred on or before April 30, 2013 (subject to extension or such later date as shall have been agreed to by the parties). Upon the exercise of the option, Quest’s Chief Executive Officer will enter into a five-year employment agreement as CEO and Quest’s President will enter into a five-year consulting agreement. Both will enter into six-year non-competition agreements.
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Principals of Presentation, Consolidation and Reclassifications
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The accompanying consolidated financial statements include the operating activity of Infinity and its subsidiaries, for the years ended December 31, 2012 and 2011, as well as the equity method accounting for its investment in Quest. The Earth911 Merger was deemed to be a reverse acquisition, with Earth911 as the accounting acquirer. As such, the operating activity of Infinity (p/k/n YouChange Holdings Corp.) is consolidated in these consolidated financial statements from the date of the merger, October 17, 2012 to December 31, 2012. The operating activities for Infinity’s Earth911 subsidiary and the investment in Quest, is included for years ended December 31, 2012 and 2011. Quest is deemed to be a separate operating unit from Infinity and as such, there are no intercompany transactions that require elimination at this time. All other intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation.
As both Earth911 and Youchange are deemed to be operating as ecology based green service companies, no segment reporting was deemed necessary.
Accounting Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could materially differ from those estimates.
Significant estimates are used when accounting for the collectability of accounts receivable, depreciable lives of fixed assets, accruals, contingencies, assumptions used in the valuation and recognition of share-based payments and warrant liability, the realization of goodwill and intangible assets, deferred tax assets, the equity method investment in Quest, and the application of accounting for the senior secured convertible note, all of which are discussed in their respective notes to the consolidated financial statements.
Revenue Recognition
Revenue Recognition – We recognize revenue only when all of the following criteria have been met:
• |
persuasive evidence of an arrangement exists; |
• |
delivery has occurred or services have been rendered; |
• |
the fee for the arrangement is fixed or determinable; and |
• |
collectability is reasonably assured. |
Persuasive Evidence of an Arrangement – We document all terms of an arrangement in a quote signed or confirmed by the customer prior to recognizing revenue.
Delivery Has Occurred or Services Have Been Performed – We perform all services or deliver all products prior to recognizing revenue. Services are considered to be performed when the services are complete.
The Fee for the Arrangement is Fixed or Determinable – Prior to recognizing revenue, a customer’s fee is either fixed or determinable under the terms of the quote or accepted customer purchase order.
Collectability Is Reasonably Assured – We assess collectability on a customer by customer basis based on criteria outlined by management.
The revenues reported in 2012 and 2011 are derived primarily from the operations of Earth911 and represent licensing rights. These revenues are recognized ratably over the term of the license. Some revenues are derived from advertising contracts, which are also recognized ratably, over the term that the advertisement appears on our website. Revenues are not recognized until such time as persuasive evidence of an agreement exists, the price is fixed or determinable, and collectability is reasonably assured.
Cash and Cash Equivalents
We consider all highly liquid instruments with a remaining maturity of three months or less when purchased to be cash equivalents.
Accounts Receivable
We follow the allowance method of recognizing uncollectible accounts receivable. The allowance method recognizes bad debt expense based on a review of the individual accounts outstanding and our prior history of uncollectible accounts receivable. Our trade accounts receivable are primarily due from our customers. Credit is extended based on evaluation of each customer’s financial condition and are generally unsecured. Accounts receivable are typically due within 30 days and are stated net of an allowance for doubtful accounts. Accounts are considered past due if outstanding longer than contractual payment terms. We record an allowance on a specific basis by considering a number of factors, including the length of time trade accounts are past due, our previous loss history, the credit-worthiness of individual customers, economic conditions affecting specific customer industries, and economic conditions in general. We charge-off accounts receivable after all reasonable collection methods have been exhausted. Payments subsequently received on such receivables are credited against charge-offs in the period the payment is received.
As of December 31, 2012 and 2011, an allowance of $7,398 and nil, respectively, had been established for potentially uncollectible accounts receivable. We record delinquent finance charges on outstanding accounts receivables only if they are collected.
The changes in our allowance for doubtful accounts for the years ended December 31, 2012 and 2011 were as follows:
Years ended December 31, | ||||||||
2012 | 2011 | |||||||
Beginning balance |
$ | — | $ | 31,863 | ||||
Bad debt expense (recoveries) |
7,398 | — | ||||||
Uncollectible accounts written off |
— | (31,863 | ) | |||||
|
|
|
|
|||||
Ending balance |
$ | 7,398 | $ | — | ||||
|
|
|
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Inventories
Inventories consist of used consumer electronics and computer devices and are stated at the lower of cost (average cost method which approximates first-in, first-out) or market. Cost is determined based on our estimate of the “collection” value of each item, which is what we then pay the supplier. We establish reserves for inventory to reflect situations in which the cost of the inventory is not expected to be recovered. In evaluating whether inventory is stated at the lower of cost or market, we consider such factors as the amount of inventory on hand, estimated time required to sell such inventory and current and expected market conditions. We record provisions for inventory obsolescence as part of cost of products sold. Inventories are presented net of allowances relating to the above provisions, however, as of December 31, 2012 and 2011, no provisions were deemed to be necessary.
Fair Value Measurements
ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices in active markets for identical assets or liabilities,
Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities,
Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimate of assumptions that market participants would use in pricing the asset or liability.
Fair value accounting has been applied to the valuation of stock-based compensation, warrants issued, and the impairment measurement of goodwill. The valuation methodologies and inputs used are discussed in the respective footnotes.
Stock Options - We estimate fair value of stock options using the Black-Scholes valuation model. Significant level 3 assumptions used in the calculation were determined as follows:
• |
Expected term is determined under the simplified method using an average of the contractual term and vesting period of the award as appropriate statistical data required to properly estimate the expected term was not available; |
• |
Expected volatility is measured using the historical changes in the market price of our common stock, disregarding identifiable periods of time in which share price was extraordinarily volatile due to certain events that are not expected to recur during the expected term; |
• |
Risk-free interest rate is to approximate the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards; and |
• |
Forfeitures are based on the history of cancellations of warrants granted by us and our analysis of potential future forfeitures. |
Warrants- We estimate fair value of the warrant liability using Level 3 inputs for the initial valuation of the warrants using the Black-Scholes valuation model. The Level 1 and 2 inputs utilized the March 29, 2013 cashless exercise value calculated from the exercise of all warrants that were exercisable on that date and the quoted common stock market price. See Note 7.
Goodwill - The fair value of the reporting unit used in the goodwill impairment analysis performed in the current year was determined in contemplation of suspension of funding of future development activities of the reporting unit and anticipated continuing negative cash flows from operations for the unit. These were determined to be level 3 inputs.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided for on the straight-line method, over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the useful life or the remaining term of the related leases. Expenditures for repairs and maintenance are charged to operations as incurred; renewals and betterments are capitalized when they occur. Gains and losses on the disposition of property and equipment are recorded in the period incurred. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Depreciation expense for the years ended December 31, 2012 and 2011 amounted to $68,576 and $51,472, respectively.
The useful lives of property and equipment for purposes of computing depreciation are as follows:
Computer equipment |
3 to 5 years | |||
Office furniture and equipment |
5 to 7 years | |||
Leasehold improvements |
5 to 7 years |
We review 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 assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset.
Intangible Assets
Legal fees and similar capitalizable costs relating to patents, copyrights, and trademarks are capitalized as appropriate. As of December 31, 2012 and 2011, our intangible assets consisted of indefinite lived intangibles relative to the Earth911 trademark of $128,800, which were not amortized. We review the carrying amounts of indefinite lived intangible assets at least annually in our fourth quarter, or whenever events or changes in circumstances indicate that the carrying amount of the asset may be impaired. These events or circumstances may include, but are not limited to (i) a significant decrease in the market value of an asset; (ii) a significant adverse change in the extent or manner in which an asset is used; or (iii) an accumulation of costs significantly in excess of the amount originally expected for the acquisition of an asset.
Impairment of Long-Lived Assets
Assets that are held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Impairment is recognized when the estimated undiscounted cash flow generated by those assets is less than the carrying amounts of such assets. The amount of impairment is the excess of the carrying amount over the fair value of such assets. Assets held for sale, if any, are carried at the lower of carrying amount or fair value less selling costs. No impairment charges were recognized during 2012 and 2011.
Goodwill
Goodwill is not amortized; however we annually evaluate qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test as of December 31, 2012 and 2011. Our’s test of goodwill by assessing the qualitative factors requires judgment in evaluating economic conditions, industry and market conditions, cost factors and entity-specific events, including overall financial performance. After evaluating these qualitative factors as of December 31, 2012 and 2011, the fair value was determined to not exceed the carrying value of the assets resulting in an impairment loss in 2012. Subsequent increases in goodwill value are not recognized in the consolidated financial statements. See Note 16 regarding the $17,636,569 impairment of goodwill recognized during 2012. No goodwill impairment was recorded as of December 31, 2011.
Taxes Collected From Customers and Remitted To Government Authorities
Taxes collected from customers and remitted to governmental authorities are presented in the accompanying statements of operations on a net basis.
Net Loss Per Share
We compute basic net loss per share by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The calculation of basic loss per share gives retroactive effect to the recapitalization related to our reverse acquisition of Earth911. We have other potentially dilutive securities outstanding that are not shown in a diluted net loss per share calculation because their effect in both 2012 and 2011 would be anti-dilutive. These potentially dilutive securities include options, warrants, and convertible promissory notes (see Note 14), and total 17,270,346 shares at December 31, 2012, and 1,381,115 shares at December 31, 2011.
Concentrations
Financial instruments that potentially subject us to credit risk consist principally of cash, cash equivalents and trade accounts receivable. We invest our cash and cash equivalents with commercial banks in Arizona. Cash and cash equivalents are at risk to the extent that they exceed the Federal Deposit Insurance Corporation (“FDIC”) insured level per institution for interest bearing accounts. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were at FDIC insured institutions through December 31, 2012 and were fully insured due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits.
We sell our products and services primarily to consumers, advertisers and businesses without requiring collateral; however, we routinely assess the financial condition of our customers and maintain allowances for anticipated losses. The following table discloses the number of customers that accounted for more than 10% of our annual revenues and related receivable balances:
Customers Exceeding 10% | ||||||||||||
of Revenues | ||||||||||||
Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
|||||||||
2012 |
— | 0 | % | 0 | % | |||||||
2011 |
2 | 20 | % | 30 | % |
The following table discloses the number of customers that accounted for more than 10% of Quest’s annual revenues and receivable their related receivable balances:
Customers Exceeding
10% of Revenues |
||||||||||||
Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
|||||||||
2012 |
1 | 89 | % | 71 | % | |||||||
2011 |
1 | 94 | % | 82 | % |
We believe we have no significant credit risk in excess of recorded reserves.
Investment in Quest
Investee companies that are not consolidated, but over which we exercise significant influence, are accounted for under the equity method of accounting. Whether or not we exercise significant influence with respect to an investee depends on an evaluation of several factors including among others, representation on the investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, an investee company’s accounts are not reflected within our balance sheet and statement of operations; however, our share of earnings or losses of the investee company is reflected in the caption “Equity in Quest Resource Management Group, LLC income” in our statement of operations. Our carrying value in an equity method investee company is reflected in the caption “Investment in Quest Resources Management Group, LLC” in our balance sheets.
We consider whether the fair value of our investment in Quest has declined below its carrying value whenever adverse events or changes in circumstances indicate that recorded values may not be recoverable. If there is a decline in the fair value below the carrying value of this investment, we will recognize an impairment charge for such difference. We performed an annual impairment analysis as of December 31, 2012 and 2011, resulting in no impairment losses, as we determined the fair value exceeded the carrying value of the assets. We will continue to evaluate our investment for potential impairment based upon any changes to Quest’s operations or its operating business environment. No impairment charges were recognized for our investment in Quest for the years ended December 31, 2012 and 2011.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the book and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established to reduce a deferred tax asset to the amount expected to be realized. We assess our ability to realize deferred tax assets based on current earnings performance and on projections of future taxable income in the relevant tax jurisdictions. These projections do not include taxable income from the reversal of deferred tax liabilities and do not reflect a general growth assumption but do consider known or pending events, such as the passage of legislation. Our estimates of future taxable income are reviewed annually. All tax positions are first analyzed to determine if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. After the initial analysis, the tax benefit is measured as the largest amount that is more than 50% likely of being realized upon ultimate settlement. Our income tax returns are subject to adjustment under audit for approximately the last three years.
If we are required to pay interest on the underpayment of income taxes, we recognize interest expense in the first period the interest becomes due according to the provisions of the relevant tax law.
If we are subject to payment of penalties, we recognize an expense for the amount of the statutory penalty in the period when the position is taken on the income tax return. If the penalty was not recognized in the period when the position was initially taken, the expense is recognized in the period when we change our judgment about meeting minimum statutory thresholds related to the initial position taken.
Advertising
Our advertising costs are charged to expense when incurred. During the years ended December 31, 2012 and 2011, advertising expense totaled $108,590 and $14,370, respectively.
Stock-Based Compensation
All share-based payments to employees, including grants of employee stock options, are expensed based on their estimated fair values at grant date, in accordance with ASC 718. Compensation expense for stock options is recorded over the vesting period using the estimated fair value on the date of grant, as calculated using the Black-Scholes model. We classify all share-based awards as equity instruments and recognize the vesting of the awards ratably over their respective terms. See Note 13 for a description of our share-based compensation plan and information related to awards granted under the plan.
Reverse Acquisition
We have accounted for the reverse acquisition discussed above in accordance with ASC 805-40 (Reverse Acquisitions). The 8,666,488 shares (post-split) of Infinity outstanding immediately prior to the reverse acquisition represent the consideration transferred for the Earth 911 Merger.
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The changes in our allowance for doubtful accounts for the years ended December 31, 2012 and 2011 were as follows:
Years ended December 31, | ||||||||
2012 | 2011 | |||||||
Beginning balance |
$ | — | $ | 31,863 | ||||
Bad debt expense (recoveries) |
7,398 | — | ||||||
Uncollectible accounts written off |
— | (31,863 | ) | |||||
|
|
|
|
|||||
Ending balance |
$ | 7,398 | $ | — | ||||
|
|
|
|
The useful lives of property and equipment for purposes of computing depreciation are as follows:
Computer equipment |
3 to 5 years | |||
Office furniture and equipment |
5 to 7 years | |||
Leasehold improvements |
5 to 7 years |
The following table discloses the number of customers that accounted for more than 10% of our annual revenues and related receivable balances:
Customers Exceeding 10% | ||||||||||||
of Revenues | ||||||||||||
Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
|||||||||
2012 |
— | 0 | % | 0 | % | |||||||
2011 |
2 | 20 | % | 30 | % |
The following table discloses the number of customers that accounted for more than 10% of Quest’s annual revenues and receivable their related receivable balances:
Customers Exceeding
10% of Revenues |
||||||||||||
Year |
Number of Customers |
Revenues Combined Percent |
Accounts Receivable Combined Percent |
|||||||||
2012 |
1 | 89 | % | 71 | % | |||||||
2011 |
1 | 94 | % | 82 | % |
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At December 31, 2012 and December 31, 2011, property and equipment consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Computer equipment |
$ | 157,305 | $ | 145,189 | ||||
Office furniture and equipment |
209,026 | 199,374 | ||||||
Leasehold improvements |
6,261 | 6,261 | ||||||
|
|
|
|
|||||
372,592 | 350,824 | |||||||
Less: accumulated depreciation |
(215,904 | ) | (146,046 | ) | ||||
|
|
|
|
|||||
$ | 156,688 | $ | 204,778 | |||||
|
|
|
|
|
Accrued expenses and other current liabilities consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Compensation |
$ | 191,393 | $ | 433,821 | ||||
Deferred rent obligation |
138,926 | 101,608 | ||||||
Professional fees |
302,818 | 46,000 | ||||||
Accrued interest and other |
15,016 | 1,400 | ||||||
|
|
|
|
|||||
$ | 648,153 | $ | 582,829 | |||||
|
|
|
|
|
The following convertible notes payable were outstanding as of December 31, 2012:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Convertible note payable to unrelated parties, issuance date of October 2011 |
$ | 10,000 | $ | — | ||||
Convertible note payable to unrelated parties, issuance date of April 2012 |
5,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of August 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
12,500 | — | ||||||
Convertible note payable to unrelated parties, issuance date of September 2012 |
25,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
25,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
10,000 | — | ||||||
Convertible note payable to unrelated parties, issuance date of October 2012 |
25,000 | — | ||||||
|
|
|
|
|||||
Total convertible notes payable - short term |
132,500 | — | ||||||
Less: unamortized discounts due to beneficial conversions features |
(33,394 | ) | — | |||||
|
|
|
|
|||||
Total convertible notes payable - short term, net of discounts |
$ | 99,106 | $ | — | ||||
|
|
|
|
|
At December 31, 2012 and December 31, 2011, total debt outstanding consisted of the following:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Three convertible notes payable to related parties, principal plus accrued interest due July 2013, interest and repayment provisions discussed further below |
$ | — | $ | 6,276,897 | ||||
Senior secured convertible notes payable to a related party, 9% interest due monthly in arrears, due October 2014, repayment provisions discussed further below (Net of discount of $1,313,897 at December 31, 2012) |
686,103 | — | ||||||
Capital lease obligations, imputed interest at 43.0% to 46.0%, with monthly payments of $8,540 through December 2013, secured by office furniture and fixtures |
72,128 | 127,923 | ||||||
Note payable with monthly payments of $3,333 through January 2012 |
— | 3,333 | ||||||
|
|
|
|
|||||
Total |
758,231 | 6,408,153 | ||||||
Less: current maturities |
(72,128 | ) | (59,127 | ) | ||||
|
|
|
|
|||||
Long-term portion |
$ | 686,103 | $ | 6,349,026 | ||||
|
|
|
|
The following table summarizes future maturities of debt and capital lease obligations, as amended, as of December 31, 2012:
Year Ending December 31, |
Amount | |||
2013 |
$ | 72,128 | ||
2014 |
— | |||
2015 |
2,000,000 | |||
|
|
|||
Subtotal (assuming repayment in cash) |
2,072,128 | |||
Less discount on Convertible Note |
(1,313,897 | ) | ||
Less current maturities |
(72,128 | ) | ||
|
|
|||
Total |
$ | 686,103 | ||
|
|
|
The financial condition and operating results of Quest for the relevant periods are presented below:
Years ended December 31, | ||||||||
2012 | 2011 | |||||||
Condensed operating statement information: |
||||||||
Net sales |
$ | 130,621,675 | $ | 121,888,280 | ||||
Gross margin |
12,934,339 | 11,430,986 | ||||||
Income from operations |
4,005,383 | 4,904,646 | ||||||
Net income |
3,929,080 | 4,197,360 | ||||||
Company’s equity method income allocation |
1,964,540 | 2,233,028 | ||||||
As of December 31, | ||||||||
2012 | 2011 | |||||||
Condensed balance sheet information: |
||||||||
Current assets |
$ | 20,718,638 | $ | 24,916,207 | ||||
Long-term assets |
2,118,295 | 1,885,098 | ||||||
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Total Assets |
$ | 22,836,933 | $ | 26,801,305 | ||||
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Current liabilities |
$ | 17,925,175 | $ | 24,067,022 | ||||
Long-term liabilities |
— | — | ||||||
Equity |
4,911,758 | 2,734,283 | ||||||
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Total liabilities and members’ equity |
$ | 22,836,933 | $ | 26,801,305 | ||||
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The components of net deferred taxes are as follows:
As of December 31, | ||||||||
2012 | 2011 | |||||||
Deferred tax assets (liabilities): |
||||||||
Net operating loss |
1,029,000 | 332,900 | ||||||
Stock-based compensation |
1,177,000 | 414,900 | ||||||
Accrued interest expense |
155,000 | 134,300 | ||||||
Allowance for doubtful accounts |
22,000 | 12,300 | ||||||
Deferred lease liability |
50,000 | 38,300 | ||||||
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Total deferred tax assets |
2,433,000 | 932,700 | ||||||
Less: valuation allowance |
(2,433,000 | ) | — | |||||
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Net deferred taxes |
$ | — | $ | 932,700 | ||||
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The reconciliation between the income tax expense (benefit) calculated by applying statutory rates to net loss and the income tax benefit reported in the accompanying consolidated financial statements is as follows:
Year Ended December 31, | ||||||||
2012 | 2011 | |||||||
U.S. federal statutory rate applied to pretax income |
$ | (11,713,000 | ) | $ | (834,000 | ) | ||
Permanent differences |
10,344,000 | 106,000 | ||||||
State taxes and other |
(123,000 | ) | (147,000 | ) | ||||
Change in valuation allowance |
2,433,000 | — | ||||||
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$ | 941,000 | $ | (875,000 | ) | ||||
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The following table summarizes the warranty liability valuation for the twelve months ended December 31, 2012:
Description |
Fair Value Measurements Warrant Liability |
|||
Beginning balance, December 31, 2011 |
$ | — | ||
Issuances (Level 3) |
18,742,526 | |||
Total (gains) or losses (Level 1 and 2) |
1,490,812 | |||
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Ending balance, December 31, 2012 |
$ | 20,233,338 | ||
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The following is a schedule, by year, of future minimum rental payments required under the operating lease agreement as of December 31, 2012:
Year Ended December 31, |
Amount | |||
2013 |
$ | 301,396 | ||
2014 |
315,517 | |||
2015 |
305,320 | |||
2016 |
286,870 | |||
2017 |
72,832 | |||
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$ | 1,281,935 | |||
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During 2012, we issued shares of common stock as follows:
Common Stock | ||||||||
Shares | Amount | |||||||
Related party notes conversions (See Note 7) |
835,409 | $ | 6,389,042 | |||||
Deferred compensation converted to stock |
110,490 | 260,000 | ||||||
Mezzanine financing reclassified to equity (See Note 7 and 12) |
687,051 | 1,375,933 | ||||||
Rights offering |
491,430 | 414,300 | ||||||
Common stock issued for loan fees |
138,112 | 117,000 | ||||||
Shares issued to effect reverse merger |
8,666,488 | 17,332,975 | ||||||
Common stock issued for services |
108,083 | 249,025 | ||||||
Note conversions and discounts (see Note 6) |
155,536 | 215,066 | ||||||
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11,192,599 | $ | 26,353,341 | ||||||
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The following table summarizes the warrants issued and outstanding as of December 31, 2012:
Warrants Issued and Outstanding as of December 31, 2012 |
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Date of | Exercise Price |
Shares of | ||||||||||||||
Description |
Issuance | Expiration | Common Stock | |||||||||||||
Exercisable warrants |
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Warrant 1-1 |
03/22/12 | 03/21/17 | $ | 0.37 | 1,381,115 | |||||||||||
Warrant 1-5 |
10/10/2012 | 10/9/2017 | $ | 0.37 | 5,524,461 | |||||||||||
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Total exercisable warrants |
6,905,576 | |||||||||||||||
Contingent warrants |
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Warrant 1-2 |
03/22/12 | 03/21/17 | $ | 0.37 | 345,278 | |||||||||||
Warrant 1-3 |
03/22/12 | 03/21/17 | $ | 0.37 | 345,278 | |||||||||||
Warrant 1-4 |
03/22/12 | 03/21/17 | $ | 0.37 | 690,557 | |||||||||||
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Total contingent warrants |
1,381,113 | |||||||||||||||
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Total warrants issued and outstanding |
|
8,286,689 | ||||||||||||||
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Following is a summary of stock option activity from January 1, 2010 through December 31, 2012:
Stock Options | ||||||||||||
Weighted- | ||||||||||||
Exercise | Average | |||||||||||
Number | Price Per | Exercise Price | ||||||||||
of Shares | Share | Per Share | ||||||||||
Outstanding at January 1, 2010 |
— | $ | — | $ | — | |||||||
Granted |
1,381,115 | 2.35 | 2.35 | |||||||||
Canceled/Forfeited |
— | — | — | |||||||||
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Outstanding at December 31, 2011 |
1,381,115 | 2.35 | 2.35 | |||||||||
Granted |
1,969,000 | 2.00 - 2.79 | 2.10 | |||||||||
Canceled/Forfeited |
— | — | — | |||||||||
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Outstanding at December 31, 2012 |
3,350,115 | 2.00 - 2.79 | 2.20 | |||||||||
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The following additional information applies to options outstanding at December 31, 2012:
Ranges of Exercise Prices |
Outstanding at December 31, 2012 |
Weighted- Average Remaining Contractual Life |
Weighted- Average Exercise Price |
Excercisable at December 31, 2012 |
Weighted- Average Exercise Price |
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$2.00 - $2.79 |
3,350,115 | 9.6 | $ | 2.20 | 1,922,782 | $ | 2.27 |
The weighted-average estimated value of employee stock options granted during the years ended December 31, 2012 and 2011 was estimated using the Black-Scholes model with the following weighted-average assumptions:
Year Ended December 31, | ||||||||
2012 | 2011 | |||||||
Expected volatility |
155 | % | 66 | % | ||||
Risk-free interest rate |
0.70 | % | 1.81 | % | ||||
Expected dividends |
0.00 | % | 0.00 | % | ||||
Expected term in years |
5.4 | 5.4 |
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