GNLKQ GeneLink Inc (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The accompanying condensed consolidated financial statements of GeneLink Inc., d/b/a GeneLink Biosciences, Inc. and subsidiaries (the “Company”) are unaudited, but in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the Company’s financial position, results of operations, and cash flows as of and for the dates and periods presented. The financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information.

These unaudited financial statements should be read in conjunction with the Company’s audited financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission (SEC). The results of operations for the three month period ended March 31, 2013 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2013 or for any future period.

NOTE 1 – ORGANIZATION

The Company is a leader in personalized, genetics-based health and wellness. Genelink has developed high-precision DNA assessments that measure an individual’s DNA variations. Certain gene variants, called SNP’s (“snips”), cause a gene to function differently from the norm by effecting biochemical pathways or altering the production of key proteins that regulate the way other processes in our bodies work.  These SNPs may have a significant impact on overall wellness of an individual client or customer.  GeneLink scientists use the DNA assessments information on each client to formulate customized products to address key areas of their health based on their individual DNA.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNT POLICIES

Principles of consolidation:

The condensed consolidated financial statements include the accounts of the GeneLink, Inc. and its wholly-owned Subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of estimates:

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents:

Highly liquid instruments purchased with a maturity of three months or less are considered to be cash equivalents. At times, cash and cash equivalents may exceed federally insured limits. The Company has not experienced any losses on such accounts. All non-interest bearing cash balances were fully insured at March 31, 2013.

Accounts receivable:

Accounts receivable include amounts due from our market partners. As of March 31, 2013 and December 31, 2012, the Company has not recorded an allowance for doubtful accounts as management believes all amounts are collectible.

Inventory :

Inventory consists primarily of raw materials for the custom nutritional and skincare products sold by the Company. Inventory is valued at the lower of cost (using the first-in, first-out method) or market.

Property and equipment:

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged against operations. Renewals and betterments that materially extend the life of the assets are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of 3 to 5 years of the related assets or the lesser of the expected life or term of the lease as to leasehold improvements.

Intangible Assets:

Intangible assets include costs incurred to apply and obtain patents for its products. Patents are amortized upon approval by regulatory authorities over the estimated useful life of the asset, generally fifteen years on a straight-line basis.

Deferred Loan Costs :

Loan acquisition costs are amortized over the term of the debt using the effective interest method.

Long lived assets:

The Company reviews its long-lived assets and certain identifiable intangibles for impairment whenever events or changes indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated future cash flows expected to result from the use of an asset and its eventual disposition is less than its carrying amount. The Company has not identified an impairment of any such assets for the three months ended March 31, 2013 or for the year ended December 31, 2012.

Revenue recognition:

The Company recognizes revenue from the sale of products upon shipment of those products.

The Company recognizes revenue from licensing agreements as earned.

Research and Development:

Research and development costs are expensed as incurred.

Advertising:

The Company expenses advertising when incurred. Advertising expense was $3,845 and $24,032 for the three months ended March 31, 2013 and March 31, 2012, respectively.

Stock-Based Compensation:

Stock-based compensation is recorded for recognition of the cost of employee or director services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. The stock-based compensation expense is recognized over the period during which an employee is required to provide service in exchange for the award (typically, the vesting period).

The Company estimates the fair value of each option award issued under its stock option plans on the date of grant using a lattice option-pricing model that uses the assumptions noted below. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of its common stock for a period commensurate with the expected life. These historical periods may exclude portions of time when unusual transactions occurred. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and post-vesting forfeitures. For shares that vest contingent upon achievement of certain performance criteria, an estimate of the probability of achievement is applied in the estimate of fair value. If the goals are not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company separates the grants into homogeneous groups and analyzes the assumptions for each group and computes the expense for each group utilizing these assumptions.

The Company granted 0 and 735,000 options during the three months ended March 31, 2013 and three months ended March 31, 2012, respectively.

Earnings per share

Basic loss per share is calculated using the weighted average number of common shares outstanding for the period and diluted is computed using the weighted average number of common shares and dilutive common equivalent shares outstanding. Given that the Company is in a net loss position, there is no difference between basic and diluted weighted average shares since the common stock equivalents would be antidilutive.

The following common stock equivalents are excluded from the loss per share calculation as their effect would have been antidilutive:

Income taxes:

The Company has not recorded current income tax expense due to the generation of net operating losses. Deferred income taxes are accounted for using the balance sheet approach which requires recognition of deferred tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting basis and the tax basis of assets and liabilities. A valuation allowance is provided when it is more likely than not that a deferred tax asset will not be realized.

The Company identifies and evaluates uncertain tax positions, if any, and recognizes the impact of uncertain tax positions for which there is a less than more-likely-than-not probability of the position being upheld when reviewed by the relevant taxing authority. Such positions are deemed to be unrecognized tax benefits and a corresponding liability is established on the balance sheet. The Company has not recognized a liability for uncertain tax positions. If there were an unrecognized tax benefit, the Company would recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. The Company’s remaining open tax years subject to examination by the Internal Revenue Service include years ended December 31, 2009 and subsequent years.

Derivative Financial Instruments:

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risk. Terms of convertible debt and equity instruments are reviewed to determine whether or not they contain embedded derivative instruments that are required to be accounted for separately from the host contract, and recorded on the balance sheet at fair value. The fair value of derivative liabilities, if any, is required to be revalued at each reporting date, with corresponding changes in fair value recorded in current period operating results. An evaluation of specifically identified conditions is made to determine whether the fair value of warrants issued is required to be classified as equity or as a derivative liability.

Beneficial Conversion and Warrant Valuation:

The Company records a beneficial conversion feature (“BCF”) related to the issuance of convertible debt instruments that have conversion features at fixed rates that are in-the-money when issued. The Company also records the fair value of warrants issued in connection with debt instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants, based on their relative fair value, and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion feature. The discounts recorded in connection with the BCF and warrant valuation are recognized for convertible debt as interest expense over the term of the debt using the effective interest method.

Fair Value of Financial Instruments:

The Company’s financial instruments are recorded at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of March 31, 2013. The Company uses the market approach to measure fair value of its Level 1 financial assets. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These financial instruments include cash, accounts receivable, accounts payable, and accrued expenses. The fair value of the Company’s convertible notes payable approximate their carrying value based upon current rates available to the Company.

During 2012, the Company issued warrants in connection with a license and distribution agreement (see Note 3) and engaged a third party to complete a valuation of those warrants which were recorded as Prepaid Sales Incentive on the accompanying balance sheet. The valuation was completed using Level 2 inputs.

NOTE 3 – SALE OF SUBSIDIARY AND LICENSING AGREEMENTS

On October 13, 2011, the Company entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with Capsalus Corp. (“Capsalus”), pursuant to which the Company agreed to sell 100% of the stock of its wholly-owned subsidiary, GeneWize Life Sciences, Inc. (“GeneWize”). The Stock Purchase Agreement provided for a purchase price of $500,000 payable at the closing, plus an earn-out of between $1.5 million and $4.5 million, subject to the performance of GeneWize after the closing. The earn-out amount is calculated as the greater of $25,000 per month or 10% to 15% of GeneWize monthly gross revenues, payable monthly through April, 2017. The effective date of the closing was February 10, 2012 which was the date final documents were completed following approval of the transaction by the shareholders of GeneLink. Due to continuing involvement with GeneWize subsequent to the sale, this transaction was not accounted for as a discontinued operation.

GeneLink recorded a gain on sale of subsidiary as of February 10, 2012. Consideration for the sale included the $500,000 cash received from Capsalus and an additional $39,272 for working capital. Additional consideration included the earn-out amount which was valued at $164,358, the Company’s estimate of net present value of probable cash collections under the agreement. The total consideration of $703,630 was offset by net liabilities and related costs of sale resulting in a gain on sale of $669,054.

GeneLink, GeneWize and Capsalus also entered into an Interim Management Agreement dated October 13, 2011, pursuant to which Capsalus managed the operation of GeneWize until the closing date of February 10, 2012.

Pursuant to the Interim Management Agreement, Capsalus was responsible for all expenses and received all revenues of GeneWize from October 1, 2011 through the date of closing. Capsalus advanced $204,500 to GeneWize prior to December 31, 2011 to fund operations which was recorded as “Advances from Purchaser” on the accompanying balance sheet at December 31, 2011 and an additional $75,000 was advanced to GeneWize by Capsalus prior to the closing of the sale of GeneWize. This amount was assumed by GeneWize in February 2012 upon the closing of the sale of GeneWize.

On October 13, 2011, GeneLink entered into a License and Distribution Agreement (the “LDA”) with Gene Elite LLC (“Gene Elite”) which expires in 2017 with successive five-year renewal options provided Gene Elite meets sales and performance criteria. Pursuant to the LDA, GeneLink granted Gene Elite the exclusive right to sell certain skin care and nutrition products in the direct sales, multi- level marketing (MLM) and athletic formula channels. Pursuant to the LDA, the Company received $1,500,000 in license fees, of which $1,000,000 (the “Up-front fee”) was received during 2011 and $500,000 was received on February 10, 2012, the closing date of the sale of GeneWize. The LDA provides for $750,000 of the Up-front fee as a Nonrefundable Advance Deposit which accrues interest at 4% per year and will be paid through product credits or issuance of common stock at market price, at the discretion of Gene Elite. The remaining $750,000 of the license fees was recorded as “Deferred Revenue - License Fees” on the accompanying balance sheet, which will be recognized over the term of the LDA beginning on February 10, 2012. As of March 31, 2013 the remaining balance in deferred revenue was $575,000 and $37,500 of the deferred revenue has been amortized into revenue during the first quarter of 2013.

In connection with the LDA, GeneLink and Gene Elite entered into a Warrant Purchase Agreement dated October 13, 2011 pursuant to which GeneLink granted Gene Elite warrants to purchase (i) 6,000,000 shares of common stock of GeneLink at an exercise price of $0.10 per share and (ii) 2,000,000 shares of common stock of GeneLink at an exercise price of $0.45 per share (collectively, the “non-performance warrants”). In addition, and, subject to certain performance requirements being satisfied, Gene Elite was granted warrants to purchase 6,000,000 shares of common stock of GeneLink at an exercise price of $0.20 per share (the “performance warrants”). The 8,000,000 shares underlying the non-performance warrants, valued at $460,000 at issue date, are accounted for as “Prepaid Sales Incentives” on the accompanying balance sheet and will be amortized over the life of the licensing agreement. As of March 31, 2013, $360,329 of the prepaid sales incentive remained on the balance sheet as an asset and $23,001 was amortized into expense during the first quarter of 2013.

The non-performance warrants were valued using a Binomial Lattice Option Valuation Technique (“Binomial”) and the following assumptions:

The issuance date of the performance warrants was the date of closing, February 10, 2012, and management currently does not expect the performance warrants to be earned.

On February 10, 2012, GeneLink, Gene Elite and GeneWize entered into a sub-licensing and distribution agreement (SLDA) which grants GeneWize the exclusive rights contained in the LDA to market and sell certain skin care and nutrition products in the direct sales, multi- level marketing (MLM) and athletic formula channels. The term of the SLDA is concurrent with the term of the LDA including the successive renewal options granted under the LDA.

Through March 31, 2013, Capsalus has paid $165,900 of the earn-out amount. As of March 31, 2013, Capsalus had failed to pay any earn-out due subsequent to June 30, 2012. The Company is in discussions with Capsalus regarding the earn-out and on April 15, 2013, Capsalus paid GeneLink, Inc. $50,000 toward the balance of the earn-out.

NOTE 4 – RELATED PARTIES

Consulting Fees:

The Company has a consulting agreement with a shareholder and officer of the Company for scientific advisory services. The agreement provides for annual payments of $30,000, payable $2,500 per month. As of March 31, 2013 amounts owed to the shareholder were $10,000 and were included in accounts payable.

The Company has a consulting agreement with a shareholder and officer of the Company for medical advisory services. The agreement provides for annual payments of $24,000, payable $2,000 per month. As of March 31, 2013, amounts owed to the shareholder were $6,000 and were included in accounts payable.

The Company also has a consulting agreement with a shareholder to provide strategic and business development assistance. The agreement provides for a stipend of $5,000 per month for such services. Payment is reviewed monthly by the Company’s Chairman, Dr. Bernard Kasten, who will decide whether any payment is due and whether such payment should be made or accrued. . At March 31, 2013, amounts owed to the shareholder for consulting fees were $45,000 and were included in accounts payable.

Due to Shareholder:

A shareholder advanced the Company $10,000 which was due as of March 31, 2013. Such advance does not bear interest and is due upon demand.

NOTE 5 - CONTINGENCIES

In September 2009, the Company brought action against two prior law firms in New Jersey Superior Court, alleging that their failure to timely provide legal services and make or authorize required filings caused the Company to lose valuable Japanese and U.S. patent rights. In March 2010, the Company voluntarily dismissed one of the law firms from the action. In August 2010, the remaining law firm filed a counterclaim for alleged unpaid legal fees owed to it by the Company. The defendant attempted to remove the matter to U.S. District Court, but in it was remanded back to the New Jersey Superior Court. The defendant appealed the remand decision, but in 2012 the Federal Circuit dismissed the defendants appeal. In January of 2013 the exchanged an executed Settlement Agreement and Mutual Release as well as a Stipulation dismissing all claims against each other with prejudice On October 26, 2012, the Federal Trade Commission Regulation and Matters and the Company entered into a proposed consent order with the staff of the Federal Trade Commission with regard to the previously reported investigation. The pending consent order does not include any fine and/or economic redress. The order is subject to approval by the full Commission.

In 2012, we switched our provider of genetic testing laboratory services. Our former provider of genetic testing laboratory services claims that we owe it approximately $150,000 under our arrangement with such company due to the failure to meet certain minimum volume requirements. Although we believe that we have valid defenses to these claims and do not owe our former laboratory any amounts, there is no assurance that we will be able to resolve such a dispute amicably or on terms that are acceptable to us.

In November 2012, we were sued in the Circuit Court for the 11 ^th Judicial Circuit in and for Miami – Dade County, Florida by a former consultant, alleging breach of contract and unjust enrichment. In the first quarter of 2013 the Company filed motions to dismiss the complaint. The Complaint was dismissed in January and an Amended Complaint was filed which was dismissed on May 9, 2013.   Plaintiff has 10 days to file an additional Amended Complaint.  Although we believe that the amount in dispute is likely to be less than $25,000, we are unable at this time to determine the amount alleged to be owed by us to the former consultant.

NOTE 6 – GOING CONCERN AND MANAGEMENT’S PLANS

The opinions of the Company’s independent registered public accounting firm on the audited financial statements as of and for the years ended December 31, 2012 and 2011 contain an explanatory paragraph regarding substantial doubt about the Company’s ability to continue as a going concern.

The Company has a working capital deficit of $1,372,610, has incurred recurring operating losses since inception including a loss of $3,468,997 million in 2012 and had an accumulated deficit at March 31, 2013 of $27,965,833. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

To execute the Company's growth plans, it may need to seek additional funding through public or private financings, including debt or equity financings, and through other means, including collaborations and license agreements. Additional financing may not be available when needed, or if available, the Company may not be able to obtain financing on favorable terms. The Company's ability to continue as a going concern is dependent upon the achievement of its marketing plans to enhance sales and its ability to raise capital. Management continues to work with existing market partners as well as pursuing additional distribution opportunities. Management also believes it has the opportunities before it to increase sales which will provide a foundation for raising additional capital. The Company’s financial statements have been prepared on the basis that it is a going concern, which assumes continuity of operations and the realization of assets and satisfaction of liabilities in the ordinary course of business. The financial statements do not include any adjustments that might result if the Company was forced to discontinue its operations.