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CVSL INC. - 10-K/A - Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 22, 2014]

CVSL INC. - 10-K/A - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements ("forward-looking statements") that involve risks and uncertainties. For this purpose, any statements contained in this Annual 31 -------------------------------------------------------------------------------- Table of Contents Report that are not statements of historical fact may be deemed to be forward-looking statements. When used in this Annual Report and in documents incorporated by reference herein, forward-looking statements include, without limitation, statements regarding our expectations, beliefs, or intentions that are signified by terminology such as "subject to," "believes," "anticipates," "plans," "expects," "intends," "estimates," "may," "will," "should," "can," the negatives thereof, variations thereon and similar expressions. Such forward-looking statements reflect our current views with respect to future events, based on what we believe are reasonable assumptions; however, such statements are subject to certain risks and uncertainties. Our actual results may differ materially from those anticipated in any forward-looking statements due to known and unknown risks, uncertainties and other factors. We disclaim any intention or obligation to update or review any forward-looking statements or information, whether as a result of new information, future events or otherwise.



We undertake no obligation to comment on analyses, expectations or statements made by third-parties in respect of us or our operations and operating results.

Overview CVSL seeks to acquire companies primarily in the micro-enterprise (direct-selling) sector and companies potentially engaging in businesses related to micro-enterprise and to build within this sector an interconnected "network of networks," in which social connections aided by the power of social media will be combined with relationship-based commerce (that is, commerce conducted between friends, neighbors, relatives and colleagues). CVSL refers to this convergence as "social commerce." In making acquisitions, CVSL intends to acquire millions of coordinates of sellers and their customers, out of which will be formed a virtual, online economy which will offer its members a myriad of benefits and advantages. CVSL's acquisitions form the platform for this growing online economy.


In considering appropriate acquisition targets, CVSL anticipates that it will evaluate companies of varying sizes in our targeted space, particularly companies that management believes are accretive or otherwise add value to one or more of our businesses. CVSL plans to consider companies that are currently profitable and looking to enhance their growth, as well as companies that have experienced financial and operational difficulties or limitations and can, in our opinion, be strengthened by improved strategic and tactical guidance. All of the acquisitions, large or small, profitable or otherwise, will add additional coordinates of sellers and customers, thereby adding size and continually increasing the scope of CVSL's network of networks.

The Company owns a 51.7% controlling interest in The Longaberger Company ("TLC"). TLC is a direct-selling business based in Newark, Ohio that sells premium hand-crafted baskets and a line of products for the home, including pottery, cookware, wrought iron and other home décor products, through a nationwide network of independent sales representatives. TLC also has showrooms in various states, which offer merchandise and serve as sales force support centers.

The Company substantially owns 100% of Agel Enterprises Inc. ("AEI"). Because of foreign ownership regulations in our Argentina, Colombia, Mexico and Panama subsidiaries, AEI is limited to 99% ownership in these subsidiaries. An individual owns an approximately 1% noncontrolling interest in these subsidiaries of AEI. AEI is a direct-selling business based in Springville, Utah that sells nutritional supplements and skin care products through a worldwide network of independent sales representatives. AEI's products are sold in over 40 countries.

The Company owns 100% of Your Inspiration At Home Pty Ltd. ("YIAH"). YIAH is an innovative and award-winning direct seller of hand-crafted spices from around the world. YIAH originated in Australia and has expanded its operations to North America during the third quarter of 2013.

The Company owns 100% of CVSL TBT LLC which operates Tomboy Tools ("TBT"), a direct seller of a line of tools designed for women, as well as home security monitoring services.

32 -------------------------------------------------------------------------------- Table of Contents The Company owns 100% of Paperly, Inc., a direct seller that allows its independent sales consultants to work with customers to design and create custom stationery through home parties, events and individual appointments.

The Company owns a 90% controlling interest in My Secret Kitchen, Ltd ("MSK"), an award-winning United Kingdom-based direct seller of a unique line of food products.

The Company owns 100% of Happenings Communications Group, Inc. ("HCG"). HCG publishes a monthly magazine, Happenings Magazine that references events and attractions, entertainment and recreation, and people and community in Northeast Pennsylvania. HCG also provides marketing and creative services to various companies, and can provide such services to direct-selling businesses. Services may include creating brochures, sales materials, websites and other communications for independent sales representatives and ultimate customers. As a result, HCG is available to serve as a valuable "in-house" resource for providing marketing and creative services to the direct-selling companies that we expect to acquire.

During the first quarter of 2014, the Company entered into a definitive agreement to acquire Golden Girls LLC, a direct seller of jewelry for cash and in March 2014 the Company completed the acquisition of Uppercase Living, LLC, a direct seller of customizable vinyl expressions for display on walls.

Paperly On December 31, 2013, CVSL acquired substantially all the assets of Paperly LLC ("Paperly"), a direct seller that allows its independent sales consultants to work with customers to design and create custom stationery through home parties, events and individual appointments.

My Secret Kitchen On December 20, 2013, CVSL acquired a 90% controlling interest of My Secret Kitchen, Ltd. ("MSK"), an award-winning United Kingdom-based direct seller of a unique line of food products.

Happenings Communications Group As part of the Share Exchange Agreement, CVSL acquired 100% of Happenings Communications Group, Inc. ("HCG"). HCG publishes a monthly magazine, Happenings Magazine that references events and attractions, entertainment and recreation, and people and community in Northeast Pennsylvania. HCG also provides marketing and creative services to various companies, and can provide such services to direct-selling businesses. Services may include creating brochures, sales materials, websites and other communications for independent sales representatives and ultimate customers. As a result, HCG is available to serve as a valuable "in-house" resource for providing marketing and creative services to the direct-selling companies that we expect to acquire.

Strategic Initiatives Assets One of the many aspects of TLC's operation that was attractive to CVSL was its abundance of assets. For example, TLC has $15.6 million in inventory as of December 31, 2013, compared to $19.3 million at December 31, 2012, with further reductions planned in future quarters. CVSL has worked with TLC to begin reducing its inventory through selling more items online, through TLC's showrooms and by opening up new territories. The sale of excess inventory generates cash to reduce debt and fund operations.

Another attractive aspect of acquiring TLC was the variety of fixed assets and real estate that are under-utilized in TLC's current operations. CVSL intends to utilize certain of these assets with future acquisitions. For example, YIAH has now begun operations in North America, operating out of our Newark, Ohio office building. TBT has shifted inventory and distribution to TLC's facilities. While we 33 -------------------------------------------------------------------------------- Table of Contents intend to find new uses for certain under-utilized assets, other assets owned by TLC are non-core assets that can be sold to further reduce debt and generate positive cash. During the fourth quarter of 2013, TLC sold the Longaberger Golf Club for $4.0 million and the proceeds were used to reduce TLC term debt to $0.4 million.

TLC owns and operates its manufacturing and distribution facilities near Frazeysburg, Ohio at the East Central Ohio (ECO) Business Park. TLC owns and operates ECO Business Park, which has warehouse buildings ranging from 35,000 square feet to 814,000 square feet, along with other facilities. TLC does not need all the space it currently owns in the Business Park, so CVSL intends to utilize it for other acquisitions and/or sell or structure sale/leaseback transactions to generate additional cash.

Results of Operations As a result of our acquisitions, we have grown at a rapid pace. With each acquisition we have expanded not only our product base but also our base of independent sales representatives. Because the acquisitions were made during the course of 2013 our financial statements for the year ended December 31, 2013 reflect only partial-year numbers for revenue derived from these companies after their acquisition by us and do not capture the full-year impact of these transactions.

CVSL's substantial growth during 2013 provides challenges for the comparison of year over year results. As described above we acquired TLC during the first quarter 2013, YIAH during the third quarter 2013 and TBT, AEI, MSK and Paperly during the fourth quarter of 2013. Inasmuch as all of the acquisitions were consummated in 2013, any comparison between our year end numbers for the year ended December 31, 2013 and December 31, 2012 would not be meaningful on a quantitative or qualitative basis.

During the year ended 2013, CVSL's gross sales increased $84.0 million to $84.9 million compared to $0.9 million for the year ended 2012.

CVSL's operating losses were $8.7 million compared to $1.7 million for the years ended 2013 and 2012, respectively. The dramatic increases were the result of six acquisitions completed throughout 2013.

Commissions and incentives CVSL incurred $16.4 million in commissions and incentives costs that are associated with operating in the direct selling industry. The costs represent commissions and incentive trips earned by the independent sales force.

Commissions and incentives represented 37% of our operating expenses for the year ended December 31, 2013 Selling, General and Administrative Our selling, general and administrative costs increased by $25.6 million when comparing year ended 2013 to year ended 2012. The year over year increase is primarily the result of various administrative departments at each of the acquired companies, including human resources, legal, information technology, finance and executive, as well as costs associated with leased buildings.

Additionally, we incurred professional fees associated with the acquisition and pursuit of companies in the direct selling industry. Selling, general and administrative expenses represented 63% of our operating expenses for the year ended December 31, 2013. Included in selling, general and administrative expenses for the years ended December 31, 2013 and 2012 are $1.9 million and $450 thousand, respectively of fees paid to Richmont Holdings pursuant to a Reimbursement of Services Agreement for due diligence, financial analysis, legal, travel and other services provided by Richmont Holdings incurred in identifying, analyzing, performing due diligence, structuring and negotiating potential transactions.

Interest expense Interest expense of $1.6 million during year ended 2013 compared to $43 thousand during year ended 2012. CVSL's interest expense is primarily associated with the $20 million convertible note issued to 34 -------------------------------------------------------------------------------- Table of Contents Richmont Capital Partners V L.P. and debt assumed in the TLC acquisition. The $20 million convertible note and accrued interest will likely be converted to Common Stock during the second quarter of 2014.

Liquidity and Capital Resources At December 31, 2013, we had cash and cash equivalents of approximately $3.9 million, marketable securities of $11.8 million, total current assets of $38.2 million and working capital of approximately $3.3 million as compared to cash and cash equivalents of $19 million, no marketable securities, total current assets of $19.2 million and a working capital of approximately $18.2 million as of December 31, 2012. The 2012 cash and cash equivalents reflect the $20 million proceeds we received in the sale of a Convertible Note to Richmont Capital Partners V L.P. in December 2012.

Net cash used by operating activities for the year ended December 31, 2013 was $4.6 million, as compared net cash used in operating activities of $1 million for the year ended December 31, 2012.

Our principal uses of cash have included legal and professional fees associated with the acquisitions, legal, due diligence and other fees related to other potential acquisitions and the cost of buying inventory. The Company plans to acquire additional businesses engaged in direct-selling and intends to fund such acquisitions primarily by issuing shares of our Common Stock as consideration for any such acquisition. To the extent that cash will need to be paid as some portion of the acquisition consideration, we expect, to the extent necessary, to use our cash on hand and if necessary to raise cash through debt and/or equity financing. We believe that additional debt or equity financing will be available to us based on the assets and financials of the acquisition candidate and based on management's experience with respect to debt financing and equity financing.

We expect to be able to raise capital from lenders and equity investors who will understand our direct-selling acquisition strategy.

As of December 31, 2013, the Company had an $11.8 million investment in marketable securities. The investments are readily available to provide liquidity for acquisitions, debt service and operating expenses. The Company also has a line of credit available for its TLC operations.

Net cash used in investing activities for the year ended December 31, 2013 was approximately $5.7 million, as compared to $0 the year ended December 31, 2012.

Net cash used in investing activities consisted primarily of investment in marketable securities of $16.5 million offset by proceeds from sale of property plant and equipment of $4.6 million, primarily the sale of the TLC golf course.

We also sold certain equity securities and attained cash through our acquisitions.

Net cash used in financing activities was $4.8 million for the year ended December 31, 2013 as we paid down the term loan with the sale of the TLC golf course. During 2013, we received $20 million from Richmont Capital Partners V L.P. through the sale of Convertible Notes.

At December31, 2013, we had total long-term borrowings of which consisted of the following: Interest December 31, December 31, Description rate 2013 2012 Convertible Subordinated Unsecured Promissory Note-Richmont Capital Partners V L.P. (including accrued interest) 4.00 % $ 20,881,096 $ 20,041,644 Promissory Note-payable to former shareholder of TLC 2.63 % 3,734,695 - Promissory Note-Lega Enterprises, LLC (formerly Agel Enterprises, LLC) 5.00 % 1,649,880 - Term loan-KeyBank 7.70 %* 427,481 - Other, equipment notes 30,244 - Total debt 26,723,396 20,041,644 Less current maturities 1,128,674 - Long-term debt $ 25,594,722 $ 20,041,644 35 -------------------------------------------------------------------------------- Table of Contents The schedule of maturities of our long-term debt are as follows: 2014 $ 1,128,674 2015 696,406 2016 722,928 2017 750,565 2018 714,939 Thereafter 1,828,788 Total excluding convertible note 5,842,300 Convertible note 20,881,096 Total long-term debt including current maturities $ 26,723,396 Convertible Subordinated Unsecured Promissory Note-Richmont Capital Partners V L.P.

On December 12, 2012 (the "Issuance Date"), we received cash proceeds of 20,000,000 and issued to Richmont Capital Partners V L.P., a Texas limited partnership ("RCP V"), a Convertible Subordinated Unsecured Promissory Note, in the original principal amount of $20,000,000 (the "Note"), The Note is (i) an unsecured obligation of ours and (ii) subordinated to any bank, financial institution, or other lender providing funded debt to us or any direct or indirect subsidiary of ours, including any seller debt financing provided by the owners of any entity(ies) that may be acquired by us. Principal payments of $1,333,333 are due and payable on each anniversary of the Issuance Date beginning on the third anniversary of the Issuance Date. A final principal payment, equal to the then unpaid principal balance of the Note, is due and payable on the 10th anniversary of the Issuance Date. The Note bears interest at an annual rate of 4%, which interest is payable on each anniversary of the Issuance Date; provided, however, that interest payable through the third anniversary of the Issuance Date may, at our option, be paid in kind ("PIK Interest") and any such PIK Interest will be added to the outstanding principal amount of the Note. Beginning 380 days from the Issuance Date, the Note may be prepaid, in whole or in part, at any time without premium or penalty.

On June 17, 2013, the Note was amended to extend the date of mandatory conversion of the Note to provide that the Note be mandatorily convertible into shares of Common Stock (subject to a maximum of 3,200,000 shares being issued) within ten days of June 17, 2014. The full amount of the Note (including any and all accrued interest thereon, whether previously converted to principal or otherwise) will be converted (the "Conversion"), into no more than 3,200,000 shares of Common Stock at a price of $6.60 per share of Common Stock.

John Rochon, Jr., one of our directors and the son of our Chief Executive Officer, is the 100% owner and is in control of Richmont Street LLC, the sole general partner of RCP V. Michael Bishop, one of our directors, is a limited partner of RCP V.

Promissory Note-Lega Enterprises, LLC On October 22, 2013, we issued a $1,700,000 Promissory Note to Lega Enterprises, LLC in connection with the Asset Purchase Agreement between AEI and Agel Enterprises, LLC. The Promissory Note bears interest at 5% per annum, and is payable in equal monthly installments of outstanding principal and interest.

Promissory Note-payable to former shareholder of TLC On March 14, 2013, we issued a $4,000,000 Promissory Note in connection with the Purchase Agreement with TLC. The Promissory Note bears interest at 2.63% per annum, has a ten-year maturity, and is payable in equal monthly installments of outstanding principal and interest.

36 -------------------------------------------------------------------------------- Table of Contents Term loan-Key Bank In conjunction with the Line of Credit described below, on October 23, 2012, TLC obtained a $6,500,000 term loan from Key Bank. The interest rate on the term loan is either Key Bank's prime rate plus 5.75% or LIBOR plus 7.50%. The term note is due in monthly installments beginning April 1, 2013 and due in full on October 23, 2015. As of March 1, 2014, TLC has paid in full the outstanding balance of the term note through monthly amortization payments beginning April 1, 2013 and proceeds of the sale of non-core assets, primarily real estate. The line of credit described below is collateralized by substantially all assets of TLC. Under the agreement, TLC is subject to certain financial covenants, including a fixed charge coverage ratio and limitations on capital expenditures, additional indebtedness, and incurrence of liens. TLC was in compliance with the financial covenants at December 31, 2013.

Line of Credit Payable Key Bank TLC has a line of credit agreement which expires on October 23, 2015. Under the agreement, TLC has available borrowings up to $12,000,000, limited to a formula primarily based on accounts receivable and inventory. The agreement provides for interest based on Key Bank's prime rate plus 1.75% or LIBOR plus 3.50%. Interest at December 31, 2013 was 3.94%. The line of credit balance was $8,067,573 of December 31, 2013.

UBS Margin Loan We have a margin loan agreement with UBS that allows us to purchase investments.

The maximum loan amount is based on a percentage of marketable securities held by the Company. Interest on the outstanding balance of $1,663,534 was 1.67% at December 31, 2013. The loan is included in the line of credit on our consolidated balance sheets.

Critical Accounting Policies The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent liabilities. We evaluate the appropriateness of these estimations and assumptions, including those related to the valuation allowances for receivables, inventory and sales returns and allowances, the carrying value of non-current assets and income taxes, on an ongoing basis. Estimates and assumptions are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Accordingly, actual results in future periods could differ materially from these estimates.

Significant judgments and estimates used in the preparation of the consolidated financial statements apply to the following critical accounting policies: Revenue Recognition and Deferred Revenue CVSL receives payment, primarily via credit card, for the sale of products at the time customers place orders. Sales and related fees such as shipping and handling, net of applicable sales discounts, are recorded as revenue when the product is shipped and when title and the risk of ownership passes to the customer. Payments received for undelivered products are recorded as deferred revenue and are included in other current liabilities. Certain incentives offered on the sale of our products, including sales discounts, are classified as a reduction of revenue. A provision for product returns and allowances is recorded and is founded on historical experience.

37 -------------------------------------------------------------------------------- Table of Contents Income Taxes CVSL and its U.S. subsidiaries excluding TLC file a consolidated Federal income tax return. Deferred income taxes are provided for temporary differences between accrual basis and tax bases of asset and liabilities. The principal differences are described in footnote (11), income taxes. Benefits from tax credits are reflected currently in earnings. CVSL records income tax positions based on a more likely than not threshold that the tax positions will be sustained on examination by the taxing authorities having full knowledge of all relevant information.

Impairment of Long-Lived Assets CVSL reviews long-lived assets, including property, plant and equipment and other intangibles with definite lives for impairment or whenever events or changes in circumstances indicated that the carrying amount of such an asset might not be recoverable. When indicators are present, management determines whether there has been an impairment of long-lived assets held for use in the business by comparing anticipated undiscounted future cash flow from the use and eventual disposition of the asset or asset group to the carrying value of the asset. The amount of any resulting impairment is calculated by comparing the carrying value to the fair value. Long-lived assets that meet the definition of held for sale are valued at the lower of carrying amount or net realizable value. Assets or asset groups are determined at the lowest level possible for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets whose aggregate undiscounted cash flows are less than its carrying value, the assets are considered potentially impaired and actual impairments, if any, would be determined to the extent the assets carrying value exceeds its aggregate fair value.

Goodwill and Other Intangibles CVSL performs its goodwill and other indefinite-lived intangible impairment test annually or when changes in circumstances indicate an impairment event may have occurred by estimating the fair value of each reporting unit compared to its carrying value. CVSL's reporting units represent an operating segment or a reporting level below an operating segment.

Additionally, the reporting units are aggregated based on similar economic characteristics, nature of products and services, nature of production processes, type of customers and distribution methods. CVSL uses a discounted cash flow model and a market approach to calculate the fair value of its reporting units. The model includes a number of significant assumptions and estimates regarding future cash flows and these estimates could be materially impacted by adverse changes in market conditions.

Other Accounting Policies and Recent Accounting Pronouncements See footnote (2), Summary of Significant Accounting Policies, to our consolidated financial statements included in this report.

Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors.

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