(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes included in Item 8 of this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" at the beginning of this Report. Our actual results may differ materially from those described below. You should also read the "Risk Factors" section set forth in Item 1A of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Certain figures, such as interest rates and other percentages included in this section, have been rounded for ease of presentation. Percentage figures included in this section have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage and dollar amounts in this section may vary slightly from those obtained by performing the same calculations using the figures in our consolidated financial statements or in the associated text. Certain other amounts that appear in this section may similarly not sum due to rounding.
Our Business Model
We are a healthy beverages and lifestyles company engaged in the development and commercialization of a portfolio of organic, natural and other better-for-you healthy beverages, liquid dietary supplements, cannabidiol ("CBD") topical products, and other healthy lifestyle products. We compete in the growth segments of the beverage industry as a leading one-stop shop supplier for major retailers and distributors. We also are one of a few companies in our industry that commercializes its business across multiple channels including traditional retail, ecommerce, direct to consumer, and the medical channel. We market a full portfolio of Ready-to-Drink ("RTD") better-for-you beverages including competitive offerings in the kombucha, tea, yerba mate, coffee, functional waters, relaxation drinks, energy drinks, rehydrating beverages, and functional medical beverage segments. We also offer liquid dietary supplement products, including Tahitian Noni(R) Juice, through a direct-to-consumer model using independent distributors called independent product consultants ("IPCs"). We differentiate our brands through functional performance characteristics and ingredients and offer products that are organic and natural, with no high-fructose corn syrup ("HFCS"), no genetically modified organisms ("GMOs"), no preservatives, and only natural flavors, fruits, and ingredients. We rank among the largest healthy beverage companies in the world as well as one of the fastest growing beverage companies according to Beverage Industry Magazine annual rankings. Our goal is to become the world's leading healthy beverage and better-for-you products company, with leading brands for consumers, and leading growth for retailers and distributors. Our target market is health conscious consumers who are becoming more interested in and better educated on what is included in their diets, causing them to shift away from less healthy options such as carbonated soft drinks or other high caloric beverages and towards alternative beverage choices. We believe consumer awareness of the benefits of healthier lifestyles and the availability of heathier beverages is rapidly accelerating worldwide, and we are seeking to capitalize on that shift.
We market our RTD beverage products using a range of marketing mediums, including direct-to-consumer channels, in-store merchandising and promotions, experiential marketing, events and sponsorships, digital marketing and social media, direct marketing, and traditional media including print, radio and outdoor.
Our core business is to develop, market, sell, and distribute healthy liquid dietary supplements and ready-to-drink beverages. The beverage industry comprises $870 billion in annual revenue according to Euromonitor and Booz & Company and is highly competitive with three to four major multibillion-dollar multinationals that dominate the sector. We compete by differentiating our brands as healthier and better-for-you alternatives that are natural, organic, and/or have no artificial ingredients or sweeteners. Our brands include Tahitian Noni Juice, TruAge, Xing Tea, Aspen Pure(R), Marley, B�cha(R) Live Kombucha, PediaAde, Coco Libre, BioShield, and 'NHANCED Recovery, all competing in the existing growth and newly emerging dynamic growth segments of the beverage industry. Morinda also has several additional consumer product offerings, including a TeMana line of skin care and lip products, a Noni + Collagen ingestible skin care product, wellness supplements, and a line of essential oils.
For the years ended December 31, 2018 and 2019, our operating segments have consisted of the Morinda segment and the NewAge segment. We recently announced that Morinda has begun doing business as Noni by NewAge. As a result of this change, we refer to our former Morinda segment as the Noni by NewAge segment of our business.
The Noni by NewAge segment is engaged in the development, manufacturing, and marketing of Tahitian Noni(R) Juice, MAX and other noni beverages as well as other nutritional, cosmetic and personal care products. The Noni by NewAge segment has manufacturing operations in Tahiti, Germany, Japan, the United States, and China. The Noni by NewAge's products are sold and distributed in more than 60 countries using IPC's through its direct to consumer selling network and e-commerce business model. Approximately 80% of the net revenue of the Noni by NewAge segment is generated in the key Asia Pacific markets of Japan, China, Korea, Taiwan, and Indonesia.
The NewAge segment manufactures, markets and sells a portfolio of healthy beverage brands including Xing(R) Tea, Marley, B�cha(R) Live Kombucha, Coco-Libre(R), Evian(R) and Volvic(R). These products are distributed through the Company's DSD network and a hybrid of other routes to market throughout the United States and in 25 countries around the world. The NewAge brands are sold in all channels of distribution including hypermarkets, supermarkets, pharmacies, convenience, gas and other outlets.
The Morinda business combination that closed on December 21, 2018 significantly impacted our 2019 operating results compared to 2018. Reference is made to Notes 4, 6, 7, 8, and 9 to our consolidated financial statements included in Item 8 of this Report for a discussion of recent developments during 2019, including (i) a new credit facility (the "EWB Credit Facility") with East West Bank ("EWB") in March 2019 for $25.0 million of funding, as discussed in Note 8, (ii) the related repayment and termination of a revolving credit facility (the "Siena Revolver") with Siena Lending Group LLC ("Siena") in March 2019, as discussed in Note 8, (iii) a sale leaseback of real estate in Tokyo, Japan in March 2019 that resulted in a net selling price of $53.5 million, as discussed in Note 7, (iv) an At the Market Offering agreement entered into in April 2019 that has resulted in net proceeds of $19.5 million through December 31, 2019, as discussed in Note 9, (v) the closing of a business combination with BWR for total consideration of approximately $1.0 million in July 2019, as discussed in Note 4, and (vi) an amendment to the EWB Credit Facility in March 2020 as discussed in Note 16. These recent developments are also discussed below under the caption Liquidity and Capital Resources.
In December 2019, a novel strain of coronavirus (also known as COVID-19) was reported to have surfaced in Wuhan, China. In January 2020, this coronavirus spread to other countries, including the United States and Europe. The outbreak has continued to spread and is currently classified as a pandemic. Efforts to contain the spread of this coronavirus has intensified. To date, COVID-19 has not had a significant impact on our business. Although we currently expect that the disruptive impact of coronavirus on our business will be temporary, this situation continues to evolve and therefore we cannot predict the extent to which the coronavirus will directly or indirectly affect our business and operating results. The impact could be material.
Key Components of Consolidated Statements of Operations
Net revenue. We recognize revenue when we satisfy our performance obligations and we transfer control of the promised products to our customers, which generally occurs over a very short period of time. Performance obligations are typically satisfied by shipping or delivering products to customers, which is also the point when title transfers to customers. Revenue consists of the gross sales price, net of estimated returns and allowances, discounts, and personal rebates that are accounted for as a reduction from the gross sale price. Shipping and handling charges that are billed to customers are included as a component of revenue.
Cost of goods sold. Cost of goods sold primarily consists of direct costs attributable to the purchase from third party suppliers or the internal manufacture of beverage products. It also includes freight costs, shrinkage, ecommerce fulfillment, distribution and warehousing costs related to products sold.
Commissions. Commissions earned by our sales and marketing personnel are charged to expense in the same period that the related sales transactions are recognized.
Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses consist primarily of personnel costs for our administrative, human resources, finance and accounting employees and executives. General and administrative expenses also include contract labor and consulting costs, travel-related expenses, legal, auditing and other professional fees, rent and facilities costs, repairs and maintenance, advertising and marketing costs, and general corporate expenses.
Business combination expenses. When we enter into business combinations, the acquisition-related transaction costs are accounted for as expenses in the periods in which such costs are incurred. A portion of the consideration in business combinations may be contingent on future operating performance of the acquired business. In these circumstances, we determine the fair value of the contingent consideration as a component of the purchase price, and all future changes in the fair value of our obligations are reflected as an adjustment to our operating expenses in the period in which the change is determined. In periods when the fair value of contingent consideration increases, we recognize an expense and when the fair value of contingent consideration decreases, we recognize a gain.
Impairment expense. We periodically consider if events and circumstances have occurred that would indicate if it is "more likely than not" that an impairment of our long-lived assets has occurred. We also perform an annual goodwill impairment evaluation during the fourth quarter of each calendar year. Evaluating whether impairment exists involves substantial judgment and estimation. If we determine that impairment exists, we recognize an impairment charge to reduce the carrying value of the long-lived assets to the expected discounted cash flows associated with the impaired assets.
Depreciation and amortization expense. Depreciation and amortization expense is comprised of depreciation expense related to property and equipment, amortization expense related to leasehold improvements, and amortization expense related to identifiable intangible assets.
Gains from sale of property and equipment. Gains from the sale of property and equipment are reflected in the period that the sale transaction closes. Gains result when we sell assets for an amount in excess of the net carrying value. Losses from the disposal of property and equipment are netted against gains for presentation in our consolidated statements of operations.
Interest expense. Interest expense is incurred under our revolving credit facilities and other debt obligations. The components of interest expense include the amount of interest payable in cash at the stated interest rate, "make-whole" premium, accretion and amortization of debt discounts and issuance costs, and the write-off of debt discounts and issuance costs if we prepay the debt before the maturity date.
Gain (loss) on change in fair value of derivatives. We periodically enter into certain debt instruments that contain embedded derivatives that are required to be bifurcated and recorded at fair value. Examples of embedded derivatives are provisions that require us to pay the lender default interest upon the existence of an event of default and to pay "make-whole" interest or premiums for certain mandatory and voluntary prepayments of the outstanding principal balance. We also enter into interest rate swap agreements to effectively convert variable rate debt to fixed rate debt. We perform valuations of all material derivatives on a quarterly basis. Changes in the fair value of derivatives are reflected as net non-operating gains or losses in our consolidated statements of operations.
Interest and other income (expense), net. Interest and other income (expense), net consists of non-operating expenses which are partially offset by interest and other non-operating income.
Income tax expense. The provision for income taxes is based on the amount of our taxable income and enacted federal, state and foreign tax rates, as adjusted for allowable credits and deductions. Substantially all of our provision for current income taxes consists of foreign taxes for the periods presented since we had no taxable income for U.S. federal or state purposes.
Results of Operations
Our consolidated statements of operations for the years ended December 31, 2019 and 2018 are presented below (in thousands):
2019 2018 Change Net revenue $ 253,708 $ 52,160 $ 201,548 Cost of goods sold 101,001 42,865 58,136 Gross profit 152,707 9,295 143,412 Gross margin 60 % 18 % Operating expenses: Commissions 75,961 2,781 73,180 Selling, general and administrative 114,982 20,288 94,694 Business combination expense (gain): Financial advisor and other transaction costs - 3,189 (3,189 ) Change in fair value of earnout obligations (13,809 ) 100 (13,909 ) Long-lived asset impairment expense: Goodwill and identifiable intangible assets 44,925 - 44,925 Right-of-use assets 2,265 - 2,265 Depreciation and amortization expense 8,382 2,310 6,072 Total operating expenses 232,706 28,668 204,038 Operating loss (79,999 ) (19,373 ) (60,626 ) Non-operating income (expenses): Gain from sale of property and equipment 6,365 - 6,365 Interest expense (3,677 ) (1,068 ) (2,609 ) Gain (loss) from change in fair value of derivatives, net 371 (470 ) 841 Interest and other income (expense), net (227 ) (151 ) (76 ) Loss before income taxes (77,167 ) (21,062 ) (56,105 ) Income tax benefit (expense) (12,668 ) 8,927 (21,595 ) Net loss $ (89,835 ) $ (12,135 ) $ (77,700 )
Comparison of Years ended December 31, 2019 and 2018
Inflation and changing prices. For the years ended December 31, 2019 and 2018, the impact of inflation and changing prices have not had a significant impact on our net revenue, cost of goods sold and operating expenses.
Net Revenue. Net revenue increased from $52.2 million for the year ended December 31, 2018 to $253.7 million for the year ended December 31, 2019, an increase of $201.5 million or 386%. For the year ended December 31, 2019, this increase was primarily attributable to the Noni by NewAge, which had an increase in net revenue of $196.9 million. This was because the Morinda business combination did not close until December 21, 2018, whereby only $3.8 million of net revenue was generated by the Noni by NewAge segment for the year ended December 31, 2018 compared to $200.7 million for the year ended December 31, 2019.
Net revenue for the NewAge segment increased by $4.7 million from $48.3 million for the year ended December 31, 2018 to $53.0 million for the year ended December 31, 2019. The increase in net revenue for the NewAge segment was attributable to the acquisition of BWR, which had net revenue of $4.9 million for the period from the closing date on July 10, 2019 through December 31, 2019, partially offset by a decrease of $0.2 million in net revenue attributable to the legacy products of the NewAge segment.
Cost of goods sold. Cost of goods sold increased from $42.9 million for the year ended December 31, 2018 to $101.0 million for the year ended December 31, 2019, an increase of $58.1 million. For the year ended December 31, 2019, $44.1 million of this increase was attributable to the Noni by NewAge segment. The Morinda business combination did not close until December 21, 2018, whereby only $0.9 million of cost of goods sold was incurred by the Noni by NewAge segment for the year ended December 31, 2018 as compared to $56.0 million for the year ended December 31, 2019. The remainder of the increase in cost of goods sold of $13.1 million was attributable to the NewAge segment, which increased from $42.0 million for the year ended December 31, 2018 to $56.0 million for the year ended December 31, 2019, an increase of 33%. This increase in cost of goods sold for the NewAge segment was due to (i) the acquisition of BWR, which had cost of goods sold of $4.9 million for the period from the closing date on July 10, 2019 through December 31, 2019, and (ii) approximately $8.2 million attributable to the legacy products of NewAge due to higher product costs incurred in the second half of 2018 due to smaller production runs and buying raw materials in smaller amounts on the spot market, which was related to our working capital constraints in 2018. In fiscal 2019, the Company incurred significant discounting of branded products from national distributors which decreased our margins on these products. For the year ended December 31, 2019, we continued to cycle through these higher cost inventories, which increased our cost of goods sold. Additionally, during the year ended December 31, 2019, we completed full inventory counts and reconciliations which resulted in an expense of $1.6 million.
Gross profit. Gross profit increased from $9.3 million for the year ended December 31, 2018 to $152.7 million for the year ended December 31, 2019, an increase of $143.4 million. Gross margin increased from 18% for the year ended December 31, 2018 to 60% for the year ended December 31, 2019. The increase in gross profit and gross margin was attributable to the business combination with Morinda on December 21, 2018. Gross profit for the Noni by NewAge segment increased by $152.8 million and resulted in a gross margin of 78%.
Gross profit for the NewAge segment decreased by $9.4 million, resulting in negative gross profit of $3.0 million for the year ended December 31, 2019. Gross profit for the BWR reporting unit acquired in July 2019 was breakeven with net revenue and cost of goods sold of $4.9 million. For the year ended December 31, 2019, the overall reduction of $9.4 million in gross profit for the legacy products of the NewAge segment was due to cost of goods sold that increased by 22% compared to net revenue that decreased by 1%. The poor performance by the NewAge segment was a key factor that resulted in significant charges for impairment of long-lived assets discussed below. Based on the fiscal 2019 results of the BWR and legacy brands businesses, the Company is reviewing its strategic alternatives for these products.
Commissions. Commissions increased from $2.8 million for the year ended December 31, 2018 to $76.0 million for the year ended December 31, 2019, an increase of $73.2 million. The Morinda business combination accounted for $72.9 million of the increase in commissions. The remainder of the increase in commissions of $0.3 million was primarily attributable to the NewAge segment, including $0.1 million attributable to the BWR reporting unit. For the year ended December 31, 2019, commissions for the Noni by NewAge segment amounted to approximately 37% of the related net revenue whereas commissions for the NewAge segment were approximately 3% of the related net revenue of the NewAge segment.
Selling, general and administrative expenses. SG&A expenses increased from $20.3 million for the year ended December 31, 2018 to $115.0 million for the year ended December 31, 2019, an increase of $94.7 million. This increase consisted of $83.1 million related to the Noni by NewAge segment and $11.6 million related to the NewAge segment. The key components of the $83.1 million of SG&A expenses for the Noni by NewAge segment consist of (i) compensation and benefit costs of $44.5 million, including stock-based compensation expense of $3.1 million, (ii) business meetings, awards, promotions and travel of $17.0 million, (iii) rent, repairs and other occupancy costs of $10.0 million, (iv) professional fees of $4.1 million, and (v) transaction fees, communications expense and other of $7.5 million.
The increase in SG&A for the NewAge segment was partially driven by the business combination with BWR that accounted for $2.9 million of SG&A for the period from July 10, 2019 through December 31, 2019. The remainder of the increase in SG&A for the NewAge segment of $8.7 million consisted of (i) compensation and benefits of $3.2 million, including an increase in stock-based compensation of $0.7 million, (ii) rent and occupancy costs of $3.0 million, (iii) director and officer insurance premiums and other costs of $1.2 million, and (iv) professional fees of $1.3 million.
Change in fair value of earnout obligations. For the year ended December 31, 2019, we recognized a gain of $13.8 million from changes in the fair value of earnout obligations. A gain of $12.9 million was attributable to the Morinda business combination and a gain of $0.9 million was attributable to the Marley business combination, for a total of $13.8 million.
In connection with the Morinda business combination, we issued Series D Preferred Stock that provides for an annual dividend of $0.2 million and a milestone dividend of up to an aggregate of $15.0 million if the Adjusted EBITDA of Morinda is at least $20.0 million for the year ended December 31, 2019. As of December 31, 2019 and December 31, 2018, the estimated fair value of the Series D Preferred Stock was approximately $0.2 million and $13.1 million, respectively. The reduction in fair value was due to our assessment that the Adjusted EBITDA target would not be achieved and that the only value associated with the Series D Preferred Stock is approximately $0.2 million for the annual dividend. Accordingly, we recognized an unrealized gain of approximately $12.9 million for the year ended December 31, 2019.
We are also subject to an earnout obligation in connection with the Marley business combination that provides for a one-time payment of $1.25 million beginning at such time that revenue for the Marley reporting unit is equal to or greater than $15.0 million during any trailing 12 calendar month period. As of December 31, 2018, the estimated fair value of the Marley earnout was approximately $0.9 million. Due to deteriorating net revenue and gross profit for the Marley reporting unit, we determined that it is unlikely that the Marley earnout will ever be achieved. Accordingly, there was no fair value associated with the Marley earnout obligation as of December 31, 2019, which resulted in a gain of $0.9 million. For the year ended December 31, 2018, the fair value of the Marley earnout increased by $0.1 million, which was reported as a business combination expense for the year ended December 31, 2018.
Impairment expense. For the year ended December 31, 2019, we recognized an aggregate charge of $47.2 million for the impairment of long-lived assets. During the fourth quarter of 2019, we performed our annual goodwill impairment testing. Our qualitative assessment indicated that impairment may exist for each reporting unit within the NewAge segment. Therefore, as of December 31, 2019 we also performed a quantitative assessment of the fair value of each of our reporting units within the NewAge and Noni by NewAge segments. The primary basis for our quantitative assessment was a valuation report for all of our reporting units that was performed by an independent specialist. The result of this valuation resulted in an aggregate impairment charge of $44.9 million to eliminate the net carrying value of all goodwill and substantially all identifiable intangible assets related to all of the reporting units of the NewAge segment.
In June 2019, we began attempting to sublease a portion of our right-of-use ("ROU") assets previously used for warehouse space that were no longer needed for current operations. As a result, an impairment evaluation was completed that resulted in recognition of an impairment charge of $1.5 million in June 2019. This evaluation was based on the expected time to obtain a suitable subtenant and current market rates for similar commercial properties. As of December 31, 2019, we were continuing our efforts to obtain a subtenant for this space. Accordingly, an updated impairment evaluation was performed which resulted in an additional impairment charge of $0.8 million for total impairment of $2.3 million for the year ended December 31, 2019. It is possible that further impairment charges will be incurred if we are not able to locate a subtenant in the next six to eight months, or if the sublease terms are less favorable than our current expectations.
Depreciation and amortization expense. Depreciation and amortization expense included in operating expenses increased from $2.3 million for the year ended December 31, 2018 to $8.4 million for the year ended December 31, 2019, an increase of $6.1 million. Approximately $6.3 million of this increase was due to assets acquired in the Morinda business combination, which accounted for approximately $2.9 million of depreciation related to property and equipment and $3.4 million of amortization related to identifiable intangible assets. Identifiable intangible assets acquired in the BWR business combination also accounted for an increase in amortization expense of $0.1 million. These increases totaled $6.4 million and were partially offset by a reduction in amortization expense of $0.3 million due to the impairment charges that eliminated the net carrying value of substantially all of the intangible assets of the NewAge segment.
Gain from sale of building. On March 22, 2019, we entered into an agreement with a major Japanese real estate company resulting in the sale for approximately $57.0 million of the land and building in Tokyo that serves as the corporate headquarters of Morinda's Japanese subsidiary. Concurrently with the sale, we entered into a lease of this property for an expected term of 20 years with an extension option for an additional seven years. The sale of this property resulted in a gain of $24.1 million. We determined that $17.6 million of the gain was the result of above-market rent inherent in the leaseback arrangement. The $17.6 million portion of the gain related to above-market rent is being . . .
Mar 16, 2020
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