Summary of significant accounting policies

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Summary of significant accounting policies

3.  Summary of significant accounting policies

The Company has identified the policies below as critical to its business operations and the understanding of the results of its operations. The impact and any of its associated risks related to these policies on the Company’s business operations are discussed throughout this section.

Inventories

Inventories, as estimated by management, consist primarily of finished goods, but at times will include certain raw materials and are recorded at the lower of cost (average cost basis) or market. The inventory is comprised of the following:

	June 30, 2011		December 31, 2010
	(Unaudited)
Finished goods	$	89,334	$	258,324
Raw materials		154,934		177,090
Total inventories	$	244,268	$	435,414

Property and Equipment

Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of five years.  

Intangible assets

Intangible assets consist of brand value resulted from the September 9, 2008 acquisition of certain net assets from Skae Beverage International, LLC.  Intangible assets consisted of the following at June 30, 2011 and December 31, 2010:

	Brand Value – New Leaf Brands
Asset carrying value at December 31, 2010	$	5,085,824
Accumulated amortization as of December 31, 2010		(1,045,000	)
Net asset carrying value at December 31, 2010	$	4,040,824
Asset carrying value at June 30, 2011	$	4,760,824
Accumulated amortization as of June 30, 2011		(1,286,248	)
Net asset carrying value at June 30, 2011	$	3,474,576

The Company evaluates intangible assets for potential impairment on an annual basis or whenever events or circumstances indicate that an impairment may have occurred using a two-step process. The first step of the impairment test, used to identify potential impairment, compares the estimated fair value of the reporting unit containing the amortizing intangible with the related carrying amount. If the estimated fair value of the reporting unit exceeds its carrying amount, the reporting unit’s amortizing intangible is not considered to be impaired and the second step is unnecessary. There has been no impairment of the intangible assets during the three and six months ended June 30, 2011.

The brand carrying values (including Trademarks and Trade Names) are being amortized over a ten-year period.  Amortization expense for the six months ended June 30, 2011 and 2010 was $241,248 and $241,251, respectively.  

Based on the Company's amortizable intangible assets as of June 30, 2011, amortization expense is expected to be approximately $241,252, for the remainder of 2011 and is $482,500, for each of the next five fiscal years.

Option -Warrants issued on debt and beneficial conversion

The Company estimates the fair value of each option and warrant grant on the date of grant using the Black-Scholes-Merton option-pricing model.  The option and warrant estimates are based on the following assumptions for the three and six months ended June 30, 2011 and 2010:

	June 30, 2011		June 30, 2010
Dividend yield		–		–
Volatility	81.47% to 98.07%		98.16% to 106.21%
Risk free interest rate	0.03% to 1.76%		0.32% to 1.79%
Expected term	0.19 to 4.35 years		1.19 to 4.87 years
Forfeiture rate (options)		8%		8%

The Company accounts for the beneficial conversion feature of debt and preferred stock using intrinsic value method measure at the date of the note.

Derivatives

As part of certain note and warrant agreements, the Company has provided holders with the option to convert the note or exercise the warrant into the Company’s common stock at a specified strike price. In order to prevent dilution, if the new strike price may be lower than the original strike price on the day of conversion or exercise, the strike price would be lowered to the new conversion or exercise price.   The Company has determined that these types of down round protection terms are considered derivatives.

The Company originally estimated the fair value of these warrants using a Black-Scholes-Merton valuation model. The same valuation model approach is applied to the market price of the Company’s common stock at June 30, 2011 and 2010 to determine the amount of the derivative relative to the down round protection. The change in this derivative value is included in the consolidated statement of operations as a change in fair value of derivative liabilities. The Company considers these derivative instruments as used for the purpose of securing financing.

During December 2009, the Company commenced a private placement offering of common stock and warrants with certain accredited investors. On February 16, 2010, the company issued a side letter agreement to the shareholders of this offering which included down round protection through April 30, 2010 in which additional shares of common stock and/or warrants would be issued, subject to certain conditions in the side letter agreement. As of April 6, 2010, the Company initiated a new private placement offering where the terms are more favorable than the December 2009 private placement offering.  Shareholders who participated in the December 2009 offering received an aggregate of 1,499,407 additional warrants with an exercise price of $0.45 per warrant.

The fair value of the derivative payable associated with the private placement in the side letter as of the grant date of February 28, 2010 was $25,000. The fair value of the derivative liabilities at June 30, 2010 was $977,715. The decrease in fair value of the Company’s derivative payable resulted in a gain of $636,150 and $933,541 for the three and six months ended June 30, 2010 and is included in the change in fair value of the derivative liabilities. The gain includes a decrease in the derivative liabilities due to the passage of time.

The following table summarizes the fair value of warrants classified as liability instruments, recorded on the consolidated balance sheet as of June 30, 2011 (all of which are calculated using level 3 fair value measurements):

	Total Fair Value
	of Derivative as of
Offering	June 30, 2011
2006 and 2008 Bridge Financing	$	518
Warrants issued to Series I and J Preferred Stock holders		372
October 2009 notes		7,287
February 2010 stock and warrant issuance		76,510
April 2010 stock and warrant issuance		53,749
September 2010 notes		84,648
	$	223,084

The following table summarizes the changes in fair value of warrant liabilities (a level 3 fair value measurement) during the six months ended June 30, 2011:

Balance at December 31, 2010	$	594,271
Change in fair value of derivative instruments included in net loss for the six months ended June 30, 2011		(371,187	)
Balance at June 30, 2011	$	223,084

Revenue Recognition

Revenue is recognized when the earnings process is complete and the risks and rewards of ownership have transferred to the customer, which is generally considered to have occurred upon the shipment of product to the customer. The earnings process is complete once the customer order has been placed and approved and the product shipped to the customer. Product is sold to customers on credit terms established on an individual basis. The credit factors used include historical performance, current economic conditions and the nature and volume of the product.

The Company offers its customers and consumers a variety of sales and incentive programs, including discounts, allowances, coupons, slotting fees, and co-op advertising; such amounts are estimated and recorded as a reduction in revenue. The Company sells its products to customers with a right of return and is obligated to accept returns.

Net Loss per Share of Common Stock

Net loss per share is calculated using the weighted average number of shares of common stock outstanding during the period.  The Company has adopted the Earnings Per Share Topic of the Codification (ASC Topic 260-10). Diluted earnings, or loss, per share is computed similar to basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.  Diluted earnings (loss) per share may not been presented if the effect of the assumed exercise of options and warrants to purchase common shares would have an anti-dilutive effect.

Income Taxes

The Company accounts for income taxes under the liability method. Deferred taxes arise from temporary differences, due to differences between accounting methods for tax and financial statement purposes. The Company establishes a valuation allowance for the uncertainty related to its ability to generate sufficient future taxable income to utilize the net operating loss carryforwards and other deferred items.

The Company recognizes interest and penalties related to uncertain tax positions in interest and general and administrative expense. As of June 30, 2011, the Company has no unrecognized uncertain tax positions, including interest and penalties.

The tax years 2007-2010 are open to examination by the major tax jurisdictions in which the Company operates.

Comprehensive Income (Loss)

Other comprehensive income (loss) consists of charges or credits to stockholders’ equity, other than contributions from or distributions to stockholders, excluded from the determination of net income (loss). There were no other components of comprehensive income (loss) other than the net loss for the three and six months ended June 30, 2011 and 2010, respectively.

Fair Value Measurements

The Company applies recurring fair value measurements to its derivative liabilities.  In determining fair value, the Company uses a market approach and incorporates assumptions that market participants would use in pricing the liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation techniques.  These inputs can be readily observable, market corroborated, or generally unobservable internally-developed inputs.  Based upon the observation of the inputs used in these valuation techniques, the Company's derivative liabilities are classified as follows:

● Level 1:  The fair value of derivative liabilities classified as Level 1 is determined by unadjusted quoted market prices in active markets for identical liabilities that are accessible at the measurement date.  The Level 1 inputs used in calculating the fair value of derivative liabilities include traded market values and volatilities calculated thereon.

● Level 2:  The fair value of derivative liabilities classified as Level 2 is determined by quoted market prices for similar assets or liabilities in active markets, quoted market prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data.  The Level 2 inputs used in calculating the fair value of derivative liabilities include current published yields on United States Treasury securities.

● Level 3:  The fair value of derivative liabilities classified as Level 3 is determined by internally-developed models and methodologies utilizing significant inputs that are generally less readily observable from objective sources.  The Level 3 inputs used in calculating the fair value of derivative liabilities include the remaining terms of the warrants and effective exercise prices.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

There have been no significant developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s consolidated financial statements from those disclosed in our 2010 Annual Report on Form 10-K.