Florida	20-8380461
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
1601 Green Road, Deerfield Beach, Florida	33064
(Address of Principal Executive Offices)	(Zip Code)
(888) 404-7770
(Issuer’s Telephone Number, Including Area Code) ___________________________________________ (Former Name, if Changed Since Last Report)

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☑

 

 

		June 30,				December 31,
		2016				2015
		(Unaudited)
ASSETS
Current Assets
Cash		$	1,678,143			$	4,517,604
Accounts receivable, net			1,612,271				1,557,560
Inventories, net			2,931,960				3,733,213
Prepaid expenses and other current assets			140,014				255,980
Total Current Assets			6,362,388				10,064,357
Furniture and Equipment, net			121,239				99,539
Intangible Assets, net			402,813				483,765
Other Assets			132,226				67,765
TOTAL ASSETS		$	7,018,666			$	10,715,426
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable		$	1,705,654			$	1,235,152
Accrued expenses			1,057,585				1,400,552
Note payable			28,235				97,042
Other current liabilities			621,336				574,475
Total Current Liabilities			3,412,810				3,307,221
Long Term Debt, net of current portion			145,056				115,050
TOTAL LIABILITIES			3,557,866				3,422,271
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity
Preferred stock, $0.001 par value, 30 million shares authorized:
0 shares issued and outstanding at
June 30, 2016 and December 31, 2015.			—				—
Common stock, $0.001 par value, 300 million shares authorized:
22,556,765 shares issued and outstanding at
June 30, 2016 and December 31, 2015, respectively			22,557				22,557
Additional paid-in-capital			28,332,784				28,308,784
Accumulated deficit			(25,113,221	)			(20,978,751	)
Accumulated comprehensive income			218,680				(59,435	)
Total Shareholders' Equity			3,460,800				7,293,155
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	7,018,666			$	10,715,426

See accompanying notes to condensed consolidated financial statements

 

 

DS Healthcare Group, Inc. (dba DS Laboratories) and Subsidiaries

 Condensed Consolidated Statements of Operations and Comprehensive Loss

 (Unaudited)

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2016				2015				2016				2015
						(As restated)								(As restated)
Net Revenue		$	4,844,917			$	3,304,509			$	7,169,952			$	6,002,519
Cost of Goods Sold			3,332,052				1,338,943				4,766,118				2,553,158
Gross Profit			1,512,865				1,965,566				2,403,834				3,449,361
Operating Costs and Expenses:
Selling and marketing
Commissions and consulting			387,648				358,236				576,291				527,608
Marketing and promotion			448,247				151,652				927,572				392,522
Other selling and marketing expenses			423,278				394,378				913,369				774,414
			1,259,173				904,266				2,417,232				1,694,544
General and administrative
Salary and personnel costs			612,944				511,172				1,254,758				1,023,624
Professional fees and consulting costs			982,913				346,102				2,191,589				723,501
Other general and administrative expenses			284,198				271,301				538,451				711,633
			1,880,055				1,128,575				3,984,798				2,458,758
Total operating costs and expenses			3,139,228				2,032,841				6,402,030				4,153,302
Operating Income (Loss)			(1,626,363	)			(67,275	)			(3,998,196	)			(703,941	)
Other Income (Expense)
Interest expense			(62,530	)			(24,957	)			(72,761	)			(40,812	)
Impairment of intangible asset			—				—				—				(337,500	)
Other			67,980				(10,870	)			(63,513	)			109,605
Total other income (expense)			5,450				(35,827	)			(136,274	)			(268,707	)
Loss Before Income Taxes			(1,620,913	)			(103,102	)			(4,134,470	)			(972,648	)
Income Tax Expense			—				—				—				—
Net Loss			(1,620,913	)			(103,102	)			(4,134,470	)			(972,648	)
Net Loss Attributable to Non-Controlling Interest			—				—				—				—
Net Loss Attributable to Common Shareholders		$	(1,620,913	)		$	(103,102	)		$	(4,134,470	)		$	(972,648	)
Basic and Diluted Earnings per Share:
Weighted average shares outstanding			22,556,765				17,043,601				22,556,765				16,652,204
Loss per share		$	(0.07	)		$	(0.01	)		$	(0.18	)		$	(0.06	)
Other Comprehensive Income:
Foreign currency translation adjustment			54,943				(12,390	)			278,115				208,244
Comprehensive (loss) income		$	(1,565,970	)		$	(115,492	)		$	(3,856,355	)		$	(764,404	)

See accompanying notes to condensed consolidated financial statements

DS Healthcare Group, Inc. (dba DS Laboratories) and Subsidiaries

 Condensed Consolidated Statements of Cash Flows

 (Unaudited)

		For the Six Months Ended
		June 30,
		2016				2015
						(As Restated)
Cash Flows from Operating Activities:
Net Loss		$	(4,134,470	)		$	(972,648	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			197,572				83,354
Loss on impaired intangible asset			—				337,500
(Recovery) for bad debts			—				(6,656	)
(Recovery) for obsolete inventory			—				(15,910	)
Stock issued for services			24,000				136,760
Changes in operating assets and liabilities:
Accounts receivable			(54,710	)			(267,772	)
Inventories			801,253				(87,488	)
Prepaid expenses and other current assets			115,966				249,242
Accounts payable			470,502				(51,796	)
Accrued expenses			(342,967	)			(198,780	)
Other current liabilities			46,861				(306	)
Net cash used in operating activities			(2,875,993	)			(794,500	)
Cash Flows from Investing Activities:
Purchase of furniture and equipment			—				(457	)
Purchase of injection molds			(64,462	)			(18,459	)
Purchases from disposal of fixed asset			—				(212	)
Net cash used in investing activities			(64,462	)			(19,128	)
Cash Flows from Financing Activities:
Proceeds of credit facility			—				250,000
Proceeds of loans and notes			30,006				—
Repayment of loans and notes			(68,807	)			(5,974	)
Proceeds from sale of stock subscription			—				220,000
Net cash provided (used) by financing activities			(38,801	)			464,026
Effect of exchange rate changes on cash			139,795				200,157
Decrease in Cash			(2,839,461	)			(149,445	)
Cash, Beginning of Period			4,517,604				1,128,556
Cash, End of Period		$	1,678,143			$	979,111
Supplemental Information:
Cash paid for interest		$	—			$	40,812
Supplemental Noncash Investing and Financing Activities
Stock issued to settle debt		$	—			$	—
Conversion of note to common stock pending issuance		$	—			$	350,000
Common stock issued for prepaid services		$	—			$	328,000
Common stock issued to settle accrued expenses		$	—			$	380,902

See accompanying notes to condensed consolidated financial statements

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

NOTE 1. – ORGANIZATION AND NATURE OF BUSINESS

 

 

ASC	Accounting Standards Codification
ASU	Accounting Standards Update
FASB	Financial Accounting Standards Board
FIFO	First-in, First-out
US GAAP	Accounting principles generally accepted in the United States of America
SEC	Securities and Exchange Commission
2015-QTR	Three months ended June 30, 2015
2014-YTD	Six months ended June 30, 2015
2016-QTR	Three months ended June 30, 2016
2016-YTD	Six months ended June 30, 2016
VIE	Variable Interest Entity

DS Healthcare Group, Inc. (the “Company”, “DS Laboratories”, “DSKX”, “we”, “us” or “our”) was organized under the laws of the State of Florida in January 2007. The Company is engaged in the development and discovery of drug therapies for specialty pharmaceuticals and commercializes innovative personal care products for its consumer brand. The growing personal care products portfolio is distributed through a network of domestic and international retailers and distributors. The Company researches and develops its own products, which management believes keeps the Company at the forefront of innovation. Our goal is to immediately commercialize unique and disruptive technologies for personal care products that consumers use every day and to advance drug development to capitalize on both short term and long term projects.

NOTE 2. – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The condensed consolidated financial statements are prepared using the accrual basis of accounting where revenues and expenses are recognized in the period in which they were incurred. The basis of accounting is US GAAP.

The condensed consolidated financial statements include the accounts of the Company and its operating subsidiaries DS Laboratories, Inc., Sigma Development and Holding Co., Inc., Polaris Labs, Inc., Polymer Research, Inc., and Divine Skin Laboratories, S.A. de CV (“DS Mexico”). Also included in the condensed consolidated financial statements are the operating activities of Velocity Storage and Packaging, LLC, which are accounted for as VIEs. All significant intercompany balances and transactions have been eliminated in consolidation.

On March 30, 2016, During the preparation of the Company’s 10-K, the company identified that certain transactions recorded in the company’s 10-K report for it consolidated financial statements for the years ended December 31, 2014 and the results of each quarterly 10-Q filings for the period ending September 30, 2015 became subject to an internal investigation.  The internal investigation resulted in the company’s inability to timely file it’s for 10-Q as required. 

The Company continued its review these transactions with its newly appointed independent accountants, the results of which have now been corrected and reflected in the consolidated financial statements for the three months, and six months ending June 30, 2016.   The corrective actions identified errors related to sales and customer returns and allowances amounts with respect to the recognition of revenues and customer accounts receivables, and the recording of certain stock transactions.

The Audit Committee of the Board of Directors consulted with management and analyzed the adjustments. The company needs to correct the 2014 and 2015 10-Q filings to reflect these errors.  However, because of the above mentioned errors, the Audit Committee has directed the Company to conduct a thorough review of the financial records for fiscal years 2014 and 2015 along with its independent accountants and believes the financial statements for the three months and six months ended June 30, 2016 and 2015 to be fairly presented.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

The interim condensed consolidated financial statements presented herein have been prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to such rules and regulations. The interim condensed consolidated financial statements should be read in conjunction with the Company’s annual consolidated financial statements and related disclosures included in the Company’s Annual Report on Form 10-K, filed with the SEC on October 7, 2016. In the opinion of management, all adjustments (consisting only of those of a normal recurring nature) which are necessary to provide a fair presentation of financial position as of June 30, 2016 and the related operating results and cash flows for the interim periods presented have been made.  The results of operations for the periods presented are not necessarily indicative of the results to be expected for future periods or for the year ending December 31, 2016.

---

The preparation of condensed consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Although these estimates are based on management’s knowledge of current events and actions it may undertake in the future, they may ultimately differ from actual results. We believe our estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates. Significant estimates and assumptions underlying these condensed consolidated financial statements include:

·

Estimates of allowances for uncollectable accounts receivable,

·

Estimates of inventory obsolescence and overhead and labor cost allocations,

·

Estimates assuming future earning capacity of our intangible assets,

·

Estimates of value of equity transactions for services rendered,

·

Estimates of returned or damaged product, and

·

Estimates made in our deferred income tax calculations, for which there is a full valuation allowance.

Accounts receivable are reported at their net realizable value. The Company establishes an allowance for doubtful accounts based upon factors pertaining to the credit risk of specific customers, historical trends, and other information. Delinquent accounts are written-off when it is determined that the amounts are uncollectible. The Company also provides for allowances against accounts receivables for product returns and cooperative advertising allowances. At June 30, 2016 and December 31, 2015, the allowance for uncollectable accounts was $665,976 and $663,161, respectively, $210,000 at both dates for defectives and product returns and $60,000 at both dates for advertising credits.

Inventory is reported at the lower of cost or market on the FIFO method. Our inventory is subject to expiration and obsolescence. Accordingly, quantities purchased and sell through rates are periodically monitored for potential overstocking or pending expiration as a basis for establishing the appropriate reserve for any estimated expiration or obsolescence.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

NOTE 2. – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The Company recognizes revenue when all of the following four criteria are met:

·

persuasive evidence of a sales arrangement exists,

·

shipping terms are FOB shipping point

·

delivery has occurred,

·

the sales price is fixed or determinable and

·

collectability is probable.

Shipping and handling charges related to sales transactions are recorded as sales revenues when billed to customers or included in the sales price.  Shipping and handling costs are included in cost of goods sold.

The Company currently maintains a functional laboratory employing a new product development director, Dr. Patel and a chemist and a lab technician that identify new technology, test product alternatives and improve existing formulations and technologies. In addition, our founder and CEO devotes a substantial portion of his time in identifying new technologies and formulations to develop new products and improve existing products with the newest technology available. Such activities are expensed in the year incurred. Such costs include laboratory supplies, salaries, materials and consultant fees. These costs are classified as product development, salaries, selling, general and administrative expenses in the condensed consolidated statements of operations, and amounted to $29,315 and $27,998 for 2016-QTR and 2015-QTR, respectively, and $64,051 and $75,324 for the 2016-YTD and 2015-YTD, respectively.

Potentially dilutive securities are excluded from the computation of diluted net loss per share for all of the periods presented in the accompanying condensed consolidated statements of operations because the reported net loss in each of these periods results in their inclusion being antidilutive. Antidilutive securities, which consist of stock options and warrants that are not included in the diluted net loss per share calculation, consisted of an aggregate of 444,213 and 316,526 shares as of June 30, 2016 and 2015, respectively.

The Company records, as a discount to notes, the relative fair value of warrants issued in connection with the issuances and the intrinsic value of any conversion options based on the differences between the fair value of the underlying common stock at the commitment date of the note and the effective conversion price embedded in the note.  Debt discounts under these arrangements are amortized to interest expense using the interest method over the earlier of the term of the related debt or its earliest redemption date.

 

NOTE 3. – LIQUIDITY and GOING CONCERN

We have sustained operational losses since our inception. At June 30, 2016, we had an accumulated deficit of $25,113,221. The Company cannot predict how long it will continue to incur further losses or whether it will ever become profitable as this is dependent upon the reduction of certain operating expenses, success of new and existing products and increase in overall revenue among other things. These conditions raise substantial doubt about the entity’s ability to continue as a going concern.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

As of June 30, 2016, we had $1,678,143 in cash. While we have historically financed our operations and growth primarily through the successful issuance and sale of shares of our common stock, a line of credit and the issuance of promissory notes, the Company has started several new revenue initiatives creating additional revenue streams.  Some of these initiatives include: establishing an online store (Shop.DSLaboratories.com) which became operational in the third quarter of 2014, generating $128,249 and $163,382 in net revenue for 2015-YTD and 2016-QTR , respectively,  and $213,885 and $288,423 for 2015-YTD 2016-QTR , respectively. In the third quarter 2015, we began selling through http://www.costco.com, which generated net revenue of $315,404 2016 QTD.
 

In the first quarter 2016, we have launched a range of new products. Although we cannot predict our success with these products or projects, all are currently under development and production and in various stages of completion. We have commenced implementing, and will continue to implement, various measures to address our financial condition, including but not limited to continuing to seek debt and equity financing. However, there can be no assurances that the Company will be able to raise additional capital on favorable terms, or at all.

 

Accordingly, the accompanying condensed consolidated financial statements have been prepared in conformity with US GAAP, which contemplates continuation of the Company as a going concern.  The condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and carrying amount or classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. We have commenced implementing, and will continue to implement, various measures to address our financial condition.

 

 

NOTE 4. – RESTATEMENT OF FINANCIAL STATEMENTS

On March 30, 2016, during the preparation of the Company’s 10-K for the year ended December 31, 2015, the company identified certain transactions recorded in the company’s 10-K report for it consolidated financial statements for the years ended December 31, 2014 and the results of each quarterly 10-Q filings for the period ending September 30, 2015, and determined these transactions did not reflect the proper matching of revenues and costs. The impact of these transactions on the Company’s financial statements for the year ended December 31, 2014, have been considered and have been disclosed and reported in the notes to the Company’s financial statements as reported in the annual 10-K report for the year ending December 31, 2015.

The results of each quarterly 10-Q filings during the nine months ending September 30, 2015, as previously filed, also did not reflect the proper matching of revenues and costs. The impact of this restatement on the Company’s financial statements for the three months and six months ended June 30, 2015, are reflected in the tables below:

 

Condensed Consolidated Statements of Operations and Comprehensive Loss:
		Three Months
		Previously Reported				Adjustment				Restated 2015
Net Revenue		$	3,659,548			$	(355,039	)		$	3,304,509
Cost of Goods sold			1,595,181				(256,238	)			1,338,943
Gross Profit			2,064,367				(98,801	)			1,965,566
Operating Costs and Expenses:
Selling and marketing
Commissions and consulting			358,236				-				358,236
Marketing and promotion			151,652				-				151,652
Other selling and marketing expenses			380,878				13,500				394,378
			890,766				13,500				904,266
General and administrative
Salary and personnel costs			511,172				-				51,1172
Professional fees and consulting costs			346,102				-				346,102
Other general and administrative expenses			290,051				(18,750	)			271,301
			1,147,325				(18,750	)			1,128,575
Total operating costs and expenses			2,038,091				(5,250	)			2,032,841
Operating Loss			26,276				(93,551	)			(67,275	)
Other Income (Expense)
Interest expense			(24,957	)			-				(24,957	)
Other			(10,870	)			-				(10,870	)
Total other income (expense)			(35,827	)			-				(35,827	)
Net Loss			(9,551	)			(93,551	)			(103,102	)
Net Loss Attributable to Non-Controlling Interest			-				-				-
Net Loss Attributable to Common Shareholders		$	(9,551	)		$	(93,551	)		$	(103,102	)
Basic and Diluted Earnings per Share:
Weighted average shares outstanding			17,043,601				-				17,043,601
Net Loss per share		$	(0.00	)		$	(0.01	)		$	(0.01	)
Other Comprehensive Loss:
Foreign currency translation adjustment		$	(12,390	)		$	-			$	(12,390	)
Comprehensive loss		$	(21,941	)		$	(93,551	)		$	(115,492	)

Condensed Consolidated Statements of Operations and Comprehensive Loss:
		Six Months
		Previously Reported				Adjustment				Restated 2015
Net Revenue		$	6,463,468			$	(460,949	)		$	6,002,519
Cost of Goods sold			2,733,941				(180,783	)			2,553,158
Gross Profit			3,729,527				(280,166	)			3,449,361
Operating Costs and Expenses:
Selling and marketing
Commissions and consulting			527,608				-				527,608
Marketing and promotion			392,522								392,522
Other selling and marketing expenses			747,414				27,000				774,414
			1,667,544				27,000				1,694,544
General and administrative
Salary and personnel costs			1,023,624				-				1,023,624
Professional fees and consulting costs			722,513				988				723,501
Other general and administrative expenses			479,329				232,304				711,633
			2,225,466				233,292				2,458,758
Total operating costs and expenses			3,893,010				260,292				4,153,302
Operating Loss			(163,483	)			(540,458	)			(703,941	)
Other Income (Expense)
Interest expense			(40,812	)			-				(40,812	)
Impairment of intangible asset			-				(337,500	)			(337,500	)
Other			109,605				-				109,605
Total other income (expense)			68,793				(337,500	)			(268,707	)
Net Loss			(94,690	)			(877,958	)			(972,648	)
Net Loss Attributable to Non-Controlling Interest			-				-				-
Net Loss Attributable to Common Shareholders		$	( 94,690	)		$	(877,959	)		$	(972,648	)
Basic and Diluted Earnings per Share:
Weighted average shares outstanding			16,652,204				-				16,652,204
Net Loss per share		$	(0.01	)		$	(0.05	)		$	(0.06	)
Other Comprehensive Loss:
Foreign currency translation adjustment		$	208,244			$	-			$	208,244
Comprehensive loss		$	113,554			$	(877,958	)		$	(764,404	)

NOTE 5. – RECENT ACCOUNTING PRONOUNCEMENTS

Management continually evaluates the potential impact, if any, of all recent accounting pronouncements on our condensed consolidated financial statements or related disclosures and, if significant, makes the appropriate disclosures required by such new accounting pronouncements.

In February 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842).  ASU 2016-02 requires that a lessee recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities and all nonpublic business entities upon issuance. The Company has not yet determined the effect of the adoption of this standard on the Company’s consolidated financial position and results of operations.

In January 2016, the FASB issued Accounting Standards Update 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”), which addresses certain aspects of recognition, measurement, presentation and disclosure of financial statements. This guidance will be effective in the first quarter of fiscal year 2019 and early adoption is not permitted. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.

 

 

     

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement – Period Adjustments. This ASU simplifies the accounting for adjustments made to provisional amounts recognized in a business combination; the amendments eliminate the requirement to retrospectively account for those adjustments. This ASU will require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. It also requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts calculated as if the accounting had been completed at the acquisition date. This ASU is effective for the annual and interim reporting periods beginning after December 15, 2016. We are currently evaluating whether the adoption of this new guidance will have a significant impact on our consolidated financial statements and disclosures.

In July 2015, the FASB issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. This ASU simplifies the guidance on the subsequent measurement of inventory by requiring inventory within the scope of this update to be measured at the lower of cost or net realizable value rather than the lower of cost or market. This ASU is effective for the annual and interim reporting periods beginning after December 15, 2016. We are currently evaluating whether the adoption of this new guidance will have a significant impact on our consolidated financial statements and disclosures.

The FASB has issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to continue as a Going Concern. This ASU requires management to assess every reporting period whether there is substantial doubt about the entity’s ability to continue as a going concern and to provide related footnote disclosures.  The amendments define that substantial doubt exists when relevant conditions and events, considered in aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued or available to be issued.  When management identifies conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern, management should disclose: (1) principal conditions or events that raised substantial doubt; and (2) management’s evaluation of the significance of those events.  Further, management should also consider whether its plans that are intended to mitigate those conditions or events will alleviate the substantial doubt. If so, management should disclose information that enables users to understand those plans that alleviated the substantial doubt.  The amendments in this ASU are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter.  The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

The FASB has issued ASU No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. For all other entities (nonpublic entities), the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply this guidance earlier, however, only as prescribed in this ASU. The Company has not yet determined the effect of the adoption of this standard and its impact on the Company's consolidated financial position and results of operations.

 

NOTE 6. – INVENTORIES

Significant components of inventory at June 30, 2016 and December 31, 2015 consist primarily of:

 

		2016				2015
Bulk product and raw materials		$	2,109,105			$	2,502,402
Work in process			179,609				213,832
Merchandise inventory			919,259				1,172,614
Inventory in transit			103,602				231,623
Total			3,311,575				4,120,471
Less: Allowance			(379,615	)			(387,258	)
		$	2,931,960			$	3,733,213

 

In March 2016, the Company, under former management, entered in a credit barter agreement with a third party to sell slow moving, finished goods inventory in exchange for trade credits the company may use to purchase goods and/or services in the future.  For the six months ended June 30, 2016, the trade credits acquired under the agreement totaled $4,566,717, have no expiration and can be used at any time.  The cost of slow moving inventory under the arrangement totaled $505,623.

Subsequently, the existing board of directors, along with the audit committee, have reviewed this credit barter agreement and, in accordance with the criteria as defined in Accounting Standards Codification 605 (“ASC”), have determined that these credits have no economic value, and accordingly, revenue should not have been recognition.  Therefore, management has fully reserved these credits which are included in sales to the condensed consolidated statement of operations and comprehensive loss totaling $2,228,617 and $2,338,100 for the three months and six months ended June 30, 2016, respectively.

 

NOTE 7. – INTANGIBLE ASSETS

Significant components of intangible assets at June 30, 2016 and December 31, 2015 consist of:

		2016				2015
Distribution rights in Brazil		$	750,000			$	750,000
Less: Accumulated amortization			(750,000	)			(750,000	)
Net distribution rights			---				---
Pure Guild brand rights		$	159,086			$	159,086
Less: Accumulated amortization			(159,086	)			(159,086	)
Net brand rights			---				---
DS Mexico customer list			657,975				704,087
Less: Accumulated amortization			(280,779	)			(247,734	)
Net customer list			377,196				456,353
Goodwill			25,617				27,412
		$	402,813			$	483,765

 

 

    

The following table represents the amortized cost of the various assets over the remaining years; the weighted average remaining period is 5.83 years.

	2016				2017				2018				2019				Beyond				Total
Asset:
Mexican Customer list			78,232				78232				78,232				78,232				143,425				456,353
		$	78,232			$	78,232			$	78,232			$	78,232			$	143,425			$	456,353

 

NOTE 8. – COMMITMENTS AND CONTINGENCIES

 

Pending and threatened litigation

We are a party to or otherwise involved in legal proceedings arising in the normal and ordinary course of business. As of the date of this report, except as otherwise disclosed below, we are not aware of any other proceeding, threatened or pending, against us which, if determined adversely, would have a material effect on our business, results of operations, cash flows or financial position.

 

On March 29, 2016, DS Healthcare, Mr. Khesin, and certain former members of the Board of Directors were sued in a class action styled, Prasant Shah v. DS Healthcare Group, Inc., et. al., Case No. 16-60661, which is pending in the United States District Court for the Southern District of Florida.  A later-filed class action has been consolidated.  The class action arises from the Company’s March 23, 2016 and March 28, 2016 8-K filings, which stated, in pertinent part, that the audit committee had concluded that the unaudited condensed consolidated financial statements of the Company for the two fiscal quarters ended June 30, 2015 and September 30, 2015 (the “June and September 2015 Quarters”), should no longer be relied upon because of certain errors in such financial statements, and that Daniel Khesin had been terminated for cause and removed a Chairman and a member of the Board of Directors.  Plaintiffs have until November 2, 2016 to file an Amended Complaint, which DS Healthcare must respond to no later than December 19, 2016.   The Company also received the first of three related shareholder derivative demands on March 29, 2016.  A mediation concerning the class action and the derivative demands is scheduled for October 17, 2016, in Miami, Florida.

 

On May 27, 2016, PhotoMedex, Inc., Radiancy, Inc., and PhotoMedex Technology, Inc. (collectively, “PhotoMedex”)  filed a civil action for damages and declaratory relief against DS Healthcare in the United States District Court for the Southern District of New York.  The lawsuit is styled PhotoMedex, Inc. v. DS Healthcare Group, Inc., Case No. 1:16-cv-03981.  The lawsuit arises from two merger agreements: (i) an Agreement and Plan of Merger and Reorganization among DS Healthcare Group, Inc., PHMD P Acquisition Corp., PhotoMedex, Inc. and Radiancy, Inc. dated February 19, 2016; and (ii) an Agreement and Plan of Merger and Reorganization by and among DS Healthcare Group, Inc., PHMD Professional Acquisition Corp., PhotoMedex Technology, Inc. and PhotoMedex, Inc. dated February 19, 2016.  PhotoMedex alleges that DS Healthcare breached both agreements by failing to meet its pre-closing obligations and not completing the transactions contemplated by the agreements.  PhotoMedex seeks a declaratory judgment that their terminations of the two agreements were proper, and requests an award of damages specified by the agreements, including a “break-up fee” of USD $3 million.   DS Healthcare disputes the claims asserted by PhotoMedex, including that PhotoMedex is entitled to the “break-up fee” under the agreements.  DS Healthcare has also asserted a counterclaims for damages against PhotoMedex for their breaches of the two agreements.  An initial case management conference is scheduled for October 13, 2016.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

On December 28, 2015, the Company, our chief executive officer, Daniel Khesin individually, and Abner Silva, a former consultant and employee was named in a lawsuit brought in the Circuit Court of the 11th Judicial Circuit in and for Miami-Dade County, Florida by a former investor relations contractor claiming monetary damages and allegations of using material or false misrepresentations.  The Plaintiff’s complaint alleges owed compensation in stock and cash. Management intends to vigorously defend the action and contends the suit is primarily without merit as the contractor was dismissed in writing. Accordingly, management has provided a contingency reserve this matter.

The Company accounts for its facility leases using the straight-line method and incurred $535,012 and $489,643 in total rent expense for 2015 and 2014, respectively. In 2015, the Company was served a suit in connection to its Asheville, NC (“Asheville”) abandoned office lease. The suit calls for payments of $73,000. On September 21, 2016, the Company was notified it has received default judgement in the amount of $73,000. The Company plans of appealing the default judgment. As of December 31, 2015, the Company had sufficiently accrued for the Asheville suit.

 

The Company has received several pre-litigation demand letters from various former employees, including but not limited to a demand for alleged past wages, shares and commissions on various sales which do not qualify as revenue under GAAP guidance from former Chief Executive Officer, Renee Barch- Niles. While we cannot determine the outcome of these disputes, the Company intends to vehemently defend its position to the fullest extent possible. Accordingly, the Company has not reserved for these disputes.

 

At this time, the amount of any loss, or range of loss, cannot be reasonably estimated as the case has only been initiated and no discovery has been conducted to determine the validity of any claim or claims made by plaintiffs. Therefore, the Company has recorded any reserve or contingent liability related to these particular legal matters. However, in the future, as the cases progress, the Company may be required to increase its contingent liability or reserve for these matters.  For additional information regarding these matters, see the Pending Transactions disclosures in the Company’s Form 10-K for the year ending December 31, 2015 filed on October 7, 2016.

 

NOTE 9. – RELATED PARTY TRANSACTIONS

For the six months ended June 30, 2016 and 2015, the Company was a party to the following related party transactions not disclosed elsewhere in these financial statements:

·

the Company paid $51,616 (2016) and $51,616 (2015) as compensation to the father of our Chief Executive Officer,

 

·

the Company paid $12,500 (2016) and $27,036 (2015) as compensation to the sister of our Chief Executive Officer,

 

·

the Company paid $30,000 (2016) and $30,000 (2015) as compensation to Dr. Fernando Tamez. Dr. Tamez who is President of Divine Skin Laboratories, S.A. D.E. C.V. (“DS Mexico”) since 2009, our Mexican subsidiary.  Dr. Tamez oversees the day-to-day operations of DS Mexico.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

NOTE 10. –  BARTER CREDITS

In December 2015, the Company, under former management entered into an agreement with a barter trading company to sell slow moving, finished goods in exchange for prepaid credits. During the three months and six months ended June 30, 2016, the Company sold merchandise totaling $2,338,100 and $4,566,717, respectively, to this barter trading company. However, these credits proved to have no economic value and accordingly revenue did not meet the criteria as defined in Accounting Standards Codification 605 (“ASC”). The Company has reversed the sales to this barter trading company since it failed to meet the revenue standards and has expensed the barter credits, the results of which are reflected in net revenue of the company’s consolidated condensed statement of operations and comprehensive loss for the three months and six months ended June 30, 2016.

 

NOTE 11. – SUBSEQUENT EVENTS

 

Management has evaluated subsequent events or transactions occurring through the date the financial statements were issued. The following items are a summary of events or transactions occurring subsequent to the balance-sheet date, but prior to the issuance of these financial statements, that have a material effect on the financial statements and therefore require adjustment or disclosure in these statements.

On October 7^th, the company issued an 8-K to inform the investors that previously submitted filings should not be relied upon for investing decisions. The company will be filing amended 10-Q’s for the periods ending March 31, 2015, June 30, 2015 and September 30, 2015. These amended financial statements will include adjustments to the comparable financial statements for 2014. The company became aware of the need to issue amended financial reports on or about September 25^th as part of the audit of its financials by its independent auditor, BF Borges CPA PC. The total impact of the adjustments for the nine months ending September 30, 2015 amount to an increased net loss of $1,125,792. The primary adjustments are between periods within 2015 and the company deemed that the adjustments required the filing of adjusted quarterly financial reports.

Throughout the year ended 2014 and 2015, Daniel Khesin, the Company's former chief executive officer and former chief financial officer, received in addition to base compensation, reimbursement and payroll advances of expenses of approximately $76,000 and $40,000 respectively, which were for non-business related goods and services. Pursuant to his executive employment agreement $50,000 in shares were to be payable in shares of the Company's common stock at fiscal year-end. While Mr. Khesin believed that these payments were received as satisfaction of certain bonus or other perquisites earned by him on a monthly basis under his employment agreement, such payments, if any, required approval of our compensation committee, which approval was not received until subsequent to 2014 and 2015. Section 402 of the Sarbanes Oxley Act of 2002 prohibits advances or loans to a director or executive officer of a public company. While our audit committee has concluded that the payments made to Mr. Khesin prior to board approval may be in violation of Section 402 of the Sarbanes Oxley Act of 2002, in the event it is determined any such payments were a violation of the Sarbanes Oxley Act, such violation could have a material adverse effect on our Company, including, but not limited to criminal, civil or administrative sanctions, penalties, or investigations, in addition to potential securities litigation. As a consequence of these activities, the company received notice from its independent auditor of potential illegal acts concerning payments of personal expenses by the Company. The Company’s Audit Committee has agreed with the findings. On September 29^th, 2016. The company, in accordance with Section 10A of the Securities and Exchange Act of 1934, informed the Commission in a letter also dated September 29^th, 2016. See "Controls and Procedures" and "Executive Compensation" below.

 

 

During 2013, in addition to base compensation paid to Abner Silva, a consultant deemed to be an officer by our independent auditor for accounting purposes, our company advanced approximately $11,500, to Mr. Silva. While Mr. Silva, believed that these payments were received as satisfaction of certain moneys owed to him or his affiliate companies, such payments, if any, required prior approval of our compensation committee, which approval was not received. As a consequence of these activities, the company received notice from its independent auditor of potential illegal acts concerning payments of personal expenses by the company on September 29^th, 2016. The company, in accordance with Section 10A of the Securities and Exchange Act of 1934, informed the Commission in a letter also dated September 29^th, 2016.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

In December 2015, the Company, under former management entered into an agreement with a barter trading company to sell slow moving, finished goods in exchange for prepaid credits. During 2015 and through April 2016, the Company sold merchandise worth $956,176 and $4,566,717 to this barter trading company. However, these credits proved to have no economic value and accordingly revenue did not meet the criteria as defined in Accounting Standards Codification 605 (“ASC”). The Company has reversed the sales to this barter trading company that did not meet the revenue standards.

In January 2016, the company entered into a Stock Purchase Agreement with a private party in the amount of $1,996,500 for 605,000 shares of the company’s stock. To date, the purchase agreement has only partially settled. The Company’s has offset subscription receivable against the additional paid in capital of $1,196,500. The Board of Directors has decided to negotiate a revision to the original Stock Purchase Agreement to reach an appropriate resolution to the matter. The company has no way of knowing what the financial impact will be.

On May 2^nd, 2016, the company received a letter from an attorney representing its former CEO, Renee Barch-Niles requesting certain payments she believes are due arising from her employment contract. This includes salary demands, equity demands and commission demands on the above barter transaction. The total claims made by Ms. Barch-Niles are $2,500,000 worth of shares of the company’s stock, $123,000 in commissions from the barter trading arrangement, and $300,000 in severance payments. The company maintains that Ms. Barch-Niles is not due any payments subsequent to her separation from the company and will take all appropriate action to defend against the claims.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

On September 27, 2016, pursuant to the Company’s By-Laws, the current Board of Directors approved and ratified all shares to the former management through date of termination. It is the Company’s position that due to circumstances surrounding the terminations, no further shares or compensation are owned and will vehemently defend its position.

On April 20^th, 2016 the company was notified by Nasdaq that the Company did not comply with Nasdaq’s filing requirements set forth in Listing Rule 5250(c)(1) because it had not filed its Form 10-K for the period ended December 31, 2015.

On June 7^th, 2016 and August 19^th, 2016, the company was notified by Nasdaq that the Company did not comply with Nasdaq’s filing requirements set forth in Listing Rule 5250(c)(1) because it had not filed its Forms 10-Q for the periods ended March 31 and June 30, 2016, respectively.

On September 26^th, 2016, the company received Nasdaq’s staff determination letter, informing the company of Nasdaq’s intention to deny the company’s request for continued listing due to the delinquent reports. Separately, Nasdaq informed the company of its determination of additional basis for delisting due to public interest concerns under listing Rule 5101 raised by 1. The company’s failure to promptly initiate and conduct an independent investigation, recommended by its previous independent auditors, into concerns identified by its former board of directors, including concerns regarding revenue recognition and stock issuances, among other matters; and 2. The Company’s inability to produce minutes evidencing meetings of the Company’s board of directors for calendar year 2015 and for the first four months of calendar year 2016. Further, and also as a separate basis for delisting, Nasdaq informed the company of its belief the Company had made misleading statements and/or omitted material facts in its communications with Staff, in violation of Listing Rule 5250(a)(1). Pursuant to Nasdaq listing Rule 5800 series the Company appealed the staff’s determination to a Hearings Panel and requested an oral hearing to appeal the staff determination. In addition, the Company requested a stay of the suspension and delisting action pending the issuance of a written decision by the Hearings Panel. In the request, the company stated that the delinquent reports would be filed prior to the October 11^th due date, informed Nasdaq that an independent investigation had been initiated by the company with an expected completion date of approximately October 11^th, 2016, informed Nasdaq of its efforts to retrieve the missing minutes via a diligent search of its email archives and attempts to contact prior board members for their records, and its disagreement with the staff’s belief that any misleading statement had been made. The company received from Nasdaq, on September 26^th, 2016, a letter informing them that the requested hearing will take place on November 10^th.

On March 29, 2016, DS Healthcare, Mr. Khesin, and certain former members of the Board of Directors were sued in a class action styled, Prasant Shah v. DS Healthcare Group, Inc., et. al., Case No. 16-60661, which is pending in the United States District Court for the Southern District of Florida.  A later-filed class action has been consolidated.  The class action arises from the Company’s March 23, 2016 and March 28, 2016 8-K filings, which stated, in pertinent part, that the audit committee had concluded that the unaudited condensed consolidated financial statements of the Company for the two fiscal quarters ended June 30, 2015 and September 30, 2015 (the “June and September 2015 Quarters”), should no longer be relied upon because of certain errors in such financial statements, and that Daniel Khesin had been terminated for cause and removed a Chairman and a member of the Board of Directors.  Plaintiffs have until November 2, 2016 to file an Amended Complaint, which DS Healthcare must respond to no later than December 19, 2016.   The Company also received the first of three related shareholder derivative demands on March 29, 2016.  A mediation concerning the class action and the derivative demands is scheduled for October 17, 2016, in Miami, Florida.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

On May 27, 2016, PhotoMedex, Inc., Radiancy, Inc., and PhotoMedex Technology, Inc. (collectively, “PhotoMedex”)  filed a civil action for damages and declaratory relief against DS Healthcare in the United States District Court for the Southern District of New York.  The lawsuit is styled PhotoMedex, Inc. v. DS Healthcare Group, Inc., Case No. 1:16-cv-03981.  The lawsuit arises from two merger agreements: (i) an Agreement and Plan of Merger and Reorganization among DS Healthcare Group, Inc., PHMD P Acquisition Corp., PhotoMedex, Inc. and Radiancy, Inc. dated February 19, 2016; and (ii) an Agreement and Plan of Merger and Reorganization by and among DS Healthcare Group, Inc., PHMD Professional Acquisition Corp., PhotoMedex Technology, Inc. and PhotoMedex, Inc. dated February 19, 2016.  PhotoMedex alleges that DS Healthcare breached both agreements by failing to meet its pre-closing obligations and not completing the transactions contemplated by the agreements.  PhotoMedex seeks a declaratory judgment that their terminations of the two agreements were proper, and requests an award of damages specified by the agreements, including a “break-up fee” of USD $3 million.  DS Healthcare disputes the claims asserted by PhotoMedex, including that PhotoMedex is entitled to the “break-up fee” under the agreements.  DS Healthcare has also asserted a counterclaims for damages against PhotoMedex for their breaches of the two agreements.  An initial case management conference is scheduled for October 13, 2016.

On December 28, 2015, Microcap Headlines, Inc. (“Microcap”), an investor awareness business located in North Babylon, New York, filed a civil action against DS Healthcare, Daniel Khesin and former DS Healthcare employee Abner Silva in the Circuit Court of the 11th Judicial Circuit in and for Miami-Dade County, Florida.  The lawsuit is styled Microcap Headlines Inc. v. DS Healthcare Group, Inc. et al., Case No. 2015-030046-CA-01.  Plaintiff Microcap asserts claims for breach of contract, negligent misrepresentation, fraud (solely against defendant Silva), violation of the Florida Securities and Investor Protection Act, and quantum meruit, all of which arise from an October 15, 2014 contract between Microcap and DS Healthcare pursuant to which Microcap promised to provide certain investor awareness services in exchange for compensation in the form of cash and warrants to purchase DS Healthcare stock.  Microcap seeks damages in an unspecified amount.  DS Healthcare disputes the claims asserted by Microcap in the lawsuit.  Court-ordered mediation is scheduled for November 22, 2016, and the case is scheduled for trial to commence sometime during the three-week trial period beginning on January 17, 2017.

On April 12, 2016, the SEC issued a “Formal Order” directing a private non-public formal investigation to determine whether violations of the federal securities law may have been committed, directly or indirectly, by the Company, its officers, directors, employees, partners, subsidiaries and/or affiliates, and/or other persons or entities.  The possible violations set forth in the Formal Order include Section 17(a) of the Securities Act of 1933 (“Securities Act”), Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 13(k), 14(a), and 14(f) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, 13a-14, 13b2-1, 13b2-2(a), 14a3, 14a-9, and 14f-1.   The relevant time period specified in the Formal Order is between January 1, 2010 and the present date. On April 15, 2016, the SEC issued a subpoena duces tecum to Mr. Khesin. On May 4, 2016, the SEC issued a subpoena duces tecum to the Company.  The company is complying with all requests to the SEC and the review and production process is ongoing in nature. On or about July 27, 2016, the SEC issued a second subpoena duces tecum to the Company seeking a current copy of its QuickBooks file with a user name and password.  The Company has complied with the second subpoena duces tecum. The company has no way of determining what the outcome of this investigation will be and cannot predict any financial impact.

 

 

DS HEALTHCARE GROUP, INC. (dba DS LABORATORIES) and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

    

Significant Changes to the Board of Directors and Executive Management:

On April 2^nd, 2016, Michael Pope, Diane Rosenfeld, Renee Barch-Niles and Carl Sweis were terminated as Directors of the company. Additionally, Renee Barch-Niles was removed as Chief Executive Officer. Daniel Khesin was appointed sole director, Chief Executive Officer and Chief Financial Officer.

Mr. Myron Lewis joined the Board of Directors on April 22, 2016.His role includes chairing the Compensation Committee. Subsequently, on September 12^th, 2016, Mr. Lewis was appointed executive director and tasked with supervising the company’s operations with a goal of facilitating profitability and compliance.

Mr. Yasuhiro Fujiwara joined the Board of Directors on April 22, 2016. Subsequently, on September 12^th, 2016, Mr. Fujiwara was appointed chairman of the Board of Directors.

Ms. Elina Yuabov joined the Board of Directors on April 22, 2016

Ms. Estella Ng joined the Board of Directors on May 6, 2016. Her role includes chairing the Audit Committee.

Mr. John Power joined the company on September 12^th, 2016 as Chief Financial Officer and Chief Administrative Officer.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

This filing contains forward-looking statements, including statements regarding, among other things, our projected sales and profitability, our Company’s growth strategies, our Company’s future financing plans and our Company’s anticipated needs for working capital. Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors, including, without limitation, the matters described in this filing generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this filing will in fact occur. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology.

 

This discussion is intended to supplement and highlight information contained in, and should be read in conjunction with, our condensed consolidated financial statements and related notes and the selected financial data presented elsewhere in this report.

 

Significant Accounting Policies

 

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Note 2 to condensed consolidated financial statements describes the significant accounting policies used in the preparation of the condensed consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.

 

A critical accounting policy is defined as one that is both material to the presentation of our condensed consolidated financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. Specifically, critical accounting estimates have the following attributes: 1) we are required to make assumptions about matters that are highly uncertain at the time of the estimate; and 2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on our financial condition or results of operations.

 

Estimates and assumptions about future events and their effects cannot be determined with certainty. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. These changes have historically been minor and have been included in the condensed consolidated financial statements as soon as they became known. Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that our condensed consolidated financial statements are fairly stated in accordance with accounting principles generally accepted in the United States, and present a meaningful presentation of our financial condition and results of operations. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our condensed consolidated financial statements:

 

Risks and Uncertainties – The Company’s business could be impacted by price pressure on its product manufacturing, acceptance of its products in the market place, new competitors, changes in federal and/or state legislation and other factors. The Company also has been experiencing significant growth which puts serious strains on its cash availability requirements. If the Company is unsuccessful in securing adequate liquidity, its plans may be curtailed. Adverse changes in these areas could negatively impact the Company’s financial position, results of operations and cash flows.

 

Accounts Receivable – Accounts receivable are reported at their net realizable value. The Company establishes an allowance for doubtful accounts based upon factors pertaining to the credit risk of specific customers, historical trends, and other information. Delinquent accounts are written-off when it is determined that the amounts are uncollectible.

 

 

Inventory – Inventory is reported at the lower of cost or market on the first-in, first-out (FIFO) method. Our inventory is subject to expiration and obsolescence. Accordingly, quantities purchased and sell through rates are periodically monitored for potential overstocking or pending expiration as a basis for establishing the appropriate reserve for any estimated expiration or obsolescence.

 

Revenue Recognition – The Company recognizes revenue when all of the following four criteria are met:

 

·

persuasive evidence of a sales arrangement exists,

·

delivery has occurred,

·

the sales price is fixed or determinable and

·

collectability is probable.

 

Shipping and handling charges related to sales transactions are recorded as sales revenues when billed to customers or included in the sales price. Shipping and handling costs are included in cost of goods sold.

 

Research and Development – The Company incurs formulation costs that include salaries, materials and consultant fees. These costs are classified as product development, selling and general and administrative expenses in the condensed consolidated statements of operations.

 

Results of Operations

 

Three Months Ended June 30, 2016 as Compared to the Three Months Ended June 30, 2015

 

Revenues, net – Total net revenues increased $1,540,408 or 46.6%, from $3,304,509 for the three months ended June 30, 2015 to $4,844,917 for the three months ended June 30, 2016.

 

Net revenue from our Mexican subsidiary increased 2.0% in 2016-QTR compared to 2015-QTR, accounting for $936,128 (19%) and $914,583 (25%) of consolidated net revenues for the three months ended June 30, 2016 and 2015 respectively. Net revenue from our Mexican subsidiary increased as a result of currency instability resulting in higher consumer prices.

Sales generated from US operations had an increased as a result of the timing and receipt of customer orders. Net revenue from our US operations increased 63% in 2016-QTR compared to 2015-QTR, accounting for $3,908,789 (81%) and $2,389,926 (75%) of consolidated net sales for the three months ended June 30, 2016 and 2015, respectively.  We continue our marketing and sales efforts to expand our customer base, with our primary focus on expanding our distributor base, both domestic and foreign.

 

Cost of Goods Sold – Total cost of goods sold increased $1,993,110 or 148.9%, from $1,338,943 (2015-QTR) to $3,332,052 (2016-QTR). We continued additional cost cutting efforts during the quarter ending June 30, 2016 that included improved sales mix, reformulations, and improved manufacturing efficiencies and will continue to do so during 2016.

Consequently, the gross margin has decreased from 59.5% (2015-QTR) to 31.2% (2016-QTR), with US operations accounting for $1,452,883 or 75% (2015-QTR) and $970,907 or 64% (2016-QTR) of the gross margin dollars and with DS Mexico accounting for $512,683 or 36% (2015-QTR) and $541,958 or 36% (2016-QTR) of gross margin dollars.

 

Selling and Marketing Costs – Selling and marketing costs increased $354,907 or 39.2% from $904,266 (2015-QTR) to $1,259,173 (2016-QTR). The increase was due to the following:

 

–

Increases of:

 

·

$29,411 for consulting and commissions, as a result of increased sales incentives,

 

·

$55,497 for freight and shipping, as a result of the increase in net revenue, however concentrating shipments to fewer freight forwarders so as to achieve volume discounts and reduce expedited shipments which are more expensive, and

–

Partially offset by decreases of:

·

$24,293 for warehouse expenses associated with overhead cost reduction efforts during the period.

General and Administrative Costs – General and administrative costs increased $751,480 or 66.6%, from $1,128,575(2015-QTR) to $1,880,055 (2016-QTR). The increase is due to the following:

 

–

increases of:

·

$636,810 for professional fees primarily with legal fees associated with defending the class action law suit dated March 29, 2016,

·

$101,770 for personnel costs, as a result an increase in the number of full time employees over the prior period a year ago,

 

Other Income and Expenses – Other expense decreased $41,278 or 115.2%, from $35,827 expense (2015-QTR) to $5,451 income (2016-QTR).  The decrease is a result of foreign transaction gains arising from our Mexico subsidiary.

 

 

Six Months Ended June 30, 2016 as Compared to the Six Months Ended June 30, 2015

 

Revenues, net – Total net revenues increased $1,167,433 or 19.4%, from $6,002,518 for the six months ended June 30, 2015 to $7,169,952 for the six months ended June 30, 2016.

 

Net revenue from our Mexican subsidiary increased slightly by 1% in 2016-YTD compared to 2015-YTD, accounting for $1,624,106 (23%) and $1,604,178 (24%) of consolidated net sales for the six months ended June 30, 2016 and 2015, respectively.

Net revenue generated from US operations had an increased as a result of the timing and receipt of customer orders. Net revenue from our US operations increased 26% in 2016-YTD compared to 2015-YTD, accounting for $5,545,846 (77%) and $4,398,341 (76%) of consolidated net sales for the six months ended June 30, 2016 and 2015, respectively.  We continue our marketing and sales efforts to expand our customer base, with our primary focus on expanding our distributor base, both domestic and foreign.

 

Cost of Goods Sold – Total cost of goods sold increased $2,212,960 or 86.7%, from $2,553,158 (2015-YTD) to $4,766,118 (2016-YTD). The increase in cost of goods sold is a result of the increase in additional sales for 2016-YTD over the same period a year ago.  Additionally, as a result of the company entering into a barter credit arrangement, under previous management, cost of goods sold associated with the transactions totaled $505,623.   We continued additional cost cutting efforts during the period ending June 30, 2016 that included improved sales mix, reformulations, and improved manufacturing efficiencies and will continue to do so during 2016.

Consequently, the gross margin has decreased from 57.5% (2015-YTD) to 33.5% (2016-YTD), with US operations accounting for $2,832,630 or 75.9% (2015-YTD) and $1,473,076 or 61.2% (2016-YTD) of the gross margin dollars and with DS Mexico accounting for $896,897 or 24.1% (2015-YTD) and $930,758 or 38.8% (2015-YTD) of gross margin dollars.

Selling and Marketing Costs – Selling and marketing costs increased $722,688 or 42.6% from $1,694,544 (2015-YTD) to $2,417,233 (2015-YTD). The increase was due to the following:

 

–

increases of:

 

·

$48,684 for consulting and commissions, as a result of increased sales incentives,

 

·

$150,887 for freight and shipping, as a result of the increase in net revenue, however concentrating shipments to fewer freight forwarders so as to achieve volume discounts and reduce expedited shipments which are more expensive, and

–

Partially offset by decreases of:

·

$11,273 for product development associated with improved product reformulations.

General and Administrative Costs – General and administrative costs increased $1,526,040 or 62.1%, from $2,458,758(2015-YTD) to $3,984,798 (2016-YTD). The increase is due to the following:

 

–

increases of:

·

$1,468,088 for professional fees primarily with legal fees associated with defending the class action law suit dated March 29, 2016, and

 

·

$231,133 for personnel costs, as a result an increase in the number of full time employees over the prior period a year ago.

 

 

–

Partially offset by increases of:

·

$211,988 for bad debt, as a result of an improvement in collection efforts with our international customers in 2016-YTD.

 

Other Income and Expenses – Other income and expense decreased $132,432 or 49.3%, from $268,707 expense (2015-YTD) to $136,275 expense (2016-YTD). The increase is due to recording an impairment on an intangible brand rights agreement totaling $337,500 in the same period a year ago.

 

Liquidity and Capital Resources

 

We had cash of $1,678,143 and working capital of $2,949,578 at June 30, 2016. Our operating and capital requirements in connection with supporting our expanding operations and introducing new products have been and will continue to be significant to us. Since inception, our losses from operations and working capital required to grow our business were satisfied primarily through the private sales of our common stock and by credit financing.

 

Despite our losses since inception, we believe that by increasing our sales and gross profit margins while maintaining and better optimizing our current operational structure and administrative expenses, we can minimize the cash needed to support our operations. Our largest consumption of cash is the working capital necessary to support expanding sales. The sale of additional equity or convertible debt securities will result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and may also result in covenants that would restrict our operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

 

We have commenced implementing, and will continue to implement, various measures to address our financial condition, including methods to increase gross profit margins and reducing and streamlining our operational costs and overhead. We have historically satisfied our working capital requirements through the sale of common stock, advances from related parties and third parties, and through our credit facility. We are continuing to seek debt and equity financing; however, there can be no assurances that the Company will be able to raise additional capital on favorable terms, or at all.

Cash Flows for the Six Months Ended June 30, 2015

 

Cash Flows from Operating Activities

 

Operating activities used net cash for the six months ended June 30, 2016 of $2,875,994. Our net loss, when adjusted by various items aggregating $3,912,898 which impact net loss but do not impact cash during the period, such as stock issued for services or depreciation and amortization, was $221,572. In addition, changes in operating assets and liabilities necessary to support our operations used cash of $1,480,048 as follows:

 

·

$54,711 used by a increase in gross accounts receivable not including the non-cash effect of changes in the allowance for doubtful accounts,

·

$801,253 provided by a decrease in inventory component levels which is not considered significant,

·

$470,502 provided by a increase in accounts payable which is not considered significant,

·

$342,967 provided by a decrease in accrued expenses as a result of commissions and compensation commitments, and

·

$46,861 provided by net changes in other current assets primarily as a result of increased other assets associated with the expansion of our Mexican operations.

 

Cash Flows used in Investing Activities

 

Our investing activities used $64,462 in net cash during the six months ended June 30, 2016. Net cash used is primarily the result of injection mold purchases for production in the US and sales operations in Mexico.

 

 

Cash Flows from Financing Activities

 

Our financing activities used $38,801 in net cash during the six months ended June 30, 2016, primarily as a result of  $30,006 from the proceeds of loans and notes payable, less the use of $68,807 in repayment of loans and notes.

Financial Position

 

Total Assets – Our total assets decreased $3,696,760 or 34.5% from $10,715,426 as of December 31, 2015 to $7,018,666 as of June 30, 2016, primarily as a result of the cash used to repay creditors, increase inventory components, and repay notes and loans. The decrease in total assets was also the result of a decrease of $80,952 in intangible assets, due to amortization, which was partially offset by an increase of $21,700 in equipment, net of depreciation and an increase of $64,461 in other assets.

There was a net decrease in current assets of $3,701,969 the components of which are discussed further below.

 

Current Assets – The net decrease in current assets of $3,701,969 was primarily associated with a decrease in accounts receivable of $801,253 as a result of the timing of customer orders, offset by a decrease in prepaid expenses of $115,966. These net changes are primarily driven by changes discussed below:

 

Inventory – Inventory levels decreased 21.5% from December 31, 2015 to June 30, 2016, as a result of increased sales and the continued efforts to replenish inventory in key raw material components in anticipation of sales in the latter half of 2016. 

 

Accounts Receivable, net – Accounts receivable increased $54,711, primarily as a result of increased sales in 2016-YTD. The receivables are in line with historical averages for previous quarters and these levels of sales.

 

Prepaid Expenses and other current assets – Prepaid expenses decreased 45.3%, primarily as a result of amortization of associated with capitalized transactions with an expiration life of one year.

 

Material Commitments

 

None.

 

Off Balance Sheet Arrangements

 

None.

 

Recent Accounting Pronouncements

Management continually evaluates the potential impact, if any, of all recent accounting pronouncements on our financial statements or related disclosures and, if significant, makes the appropriate disclosures required by such new accounting pronouncements.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable to smaller reporting companies.

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d–15(e) under the Exchange Act) are designed to provide reasonable assurance that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the forms and rules of the SEC and that such information is accumulated and communicated to management, including the CEO and CFO, in a manner to allow timely decisions regarding required disclosures.

 

In connection with the preparation of this Form 10–Q, our management, including the CEO and CFO, updated its December 31, 2014 evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2015. As described below, management has identified material weaknesses in our internal control over financial reporting, which is an integral component of our disclosure controls and procedures. As a result of those material weaknesses, our management has concluded that, as of June 30, 2015, our disclosure controls and procedures were not effective, as a result of certain material weaknesses.

 

The specific material weaknesses that management identified in our internal controls as of June 30, 2015 that persist are as follows:

·

We did not have adequate staffing resources to provide appropriate review and supervision for all necessary areas and our general staff do not have the necessary training to perform appropriate analytical or review procedures.

·

We did not have a sufficient number of adequately trained technical accounting and external reporting personnel to support standalone external financial reporting under SEC requirements.

·

We did not have personnel with sufficient experience with United States generally accepted accounting principles to address complex transactions.

·

We did not obtain adequate documentation to support all credit card transactions.

 

Plans for Remediation of Material Weaknesses

We have begun implementing changes to strengthen our internal controls and will continue to implement remediation plans for the identified material weaknesses and expect the work on the plan will continue throughout 2015, as financial resources permit. The Company plans to hire a full-time Chief Financial Officer. The Company continues to formalizing its policies and procedures in writing and to improve the integration of its financial consolidation and reporting system into non- accounting departments. Where appropriate, the Company is receiving advice and assistance from third-party experts as it implements and refines its remediation plan.

 

Additional measures may be necessary, and the measures we expect to take to improve our internal controls may not be sufficient to address the issues identified, to ensure that our internal controls are effective or to ensure that such material weakness or other material weaknesses would not result in a material misstatement of our annual or interim financial statements. In addition, other material weaknesses or significant deficiencies may be identified in the future. If we are unable to correct deficiencies in internal controls in a timely manner, our ability to record, process, summarize and report financial information accurately and within the time periods specified in the rules and forms of the SEC will be adversely affected. This failure could negatively affect the market price and trading liquidity of our common stock, cause investors to lose confidence in our reported financial information, subject us to civil and criminal investigations and penalties, and generally materially and adversely impact our business and financial condition.

 

Changes in Internal Control over Financial Reporting

Except as otherwise stated above, there were no changes in our internal control over financial reporting or in other factors during the quarter ended June 30, 2016, that have materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

 

On May 27, 2016, PhotoMedex, Inc., Radiancy, Inc., and PhotoMedex Technology, Inc. (collectively, “PhotoMedex”)  filed a civil action for damages and declaratory relief against DS Healthcare in the United States District Court for the Southern District of New York.  The lawsuit is styled PhotoMedex, Inc. v. DS Healthcare Group, Inc., Case No. 1:16-cv-03981.  The lawsuit arises from two merger agreements: (i) an Agreement and Plan of Merger and Reorganization among DS Healthcare Group, Inc., PHMD P Acquisition Corp., PhotoMedex, Inc. and Radiancy, Inc. dated February 19, 2016; and (ii) an Agreement and Plan of Merger and Reorganization by and among DS Healthcare Group, Inc., PHMD Professional Acquisition Corp., PhotoMedex Technology, Inc. and PhotoMedex, Inc. dated February 19, 2016.  PhotoMedex alleges that DS Healthcare breached both agreements by failing to meet its pre-closing obligations and not completing the transactions contemplated by the agreements.  PhotoMedex seeks a declaratory judgment that their terminations of the two agreements were proper, and requests an award of damages specified by the agreements, including a “break-up fee” of USD $3 million.   DS Healthcare disputes the claims asserted by PhotoMedex, including that PhotoMedex is entitled to the “break-up fee” under the agreements.  DS Healthcare has also asserted a counterclaims for damages against PhotoMedex for their breaches of the two agreements.  An initial case management conference is scheduled for October 13, 2016.

 

On December 28, 2015, Microcap Headlines, Inc. (“Microcap”), an investor awareness business located in North Babylon, New York, filed a civil action against DS Healthcare, Daniel Khesin and former DS Healthcare employee Abner Silva in the Circuit Court of the 11th Judicial Circuit in and for Miami-Dade County, Florida.  The lawsuit is styled Microcap Headlines Inc. v. DS Healthcare Group, Inc. et al., Case No. 2015-030046-CA-01.  Plaintiff Microcap asserts claims for breach of contract, negligent misrepresentation, fraud (solely against defendant Silva), violation of the Florida Securities and Investor Protection Act, and quantum meruit, all of which arise from an October 15, 2014 contract between Microcap and DS Healthcare pursuant to which Microcap promised to provide certain investor awareness services in exchange for compensation in the form of cash and warrants to purchase DS Healthcare stock.  Microcap seeks damages in an unspecified amount.  DS Healthcare disputes the claims asserted by Microcap in the lawsuit.  Court-ordered mediation is scheduled for November 22, 2016, and the case is scheduled for trial to commence sometime during the three-week trial period beginning on January 17, 2017.

     

ITEM 1A.

RISK FACTORS

 

Not Applicable to smaller reporting companies.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

Not Applicable.

 

ITEM 5.

OTHER INFORMATION

 

None.

 

ITEM 6.

EXHIBITS

 

Exhibit Number		Description
31.1		Certification pursuant to Rule 13a-14(a) (Provided herewith)
31.2		Certification pursuant to Rule 13a-14(a)/15d-14(a) (provided herewith)
32.1		Certification pursuant to Section 1350 (Provided herewith)
32.2		Certification pursuant to Section 1350 (Provided herewith)
101		XBRL Interactive Data File

 

 

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

Date: October 7, 2016	DS HEALTHCARE GROUP, INC.
	By:	/s/ Daniel Khesin
		Daniel Khesin
		President/Chief Executive Officer

 

Date: October 7, 2016
	By:	/s/ John Power
		John Power Chief Financial Officer/ Principal Accounting Officer

 

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