UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 3 TO
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Report for Period January 1, 2005 to December 31, 2005
BRAVO! BRANDS INC.
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(Name of Small Business Issuer in its Amended Charter)
Formerly Bravo! Foods International Corp
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(Name Change Since Last Filing of Amendment No.1 To This Report)
Commission File Number 0-25039
Delaware 62-1681831
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11300 US Highway 1, Suite 202, North Palm Beach, Florida 33408 USA
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(Address of principal executive offices) (Zip Code)
Telephone number: (561) 625-1411
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Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act
Common Stock, $.001 par value
(Title of class)
================================================================================
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.[ ]
The issuer's revenues for its most recent fiscal year were $11,948,921.
The aggregate market value of the voting stock held by non-affiliates of the
issuer on October 27, 2006, based upon the $0.47 per share close price of such
stock on that date, was $79,302,616 based upon 168,728,971 shares held by
non-affiliates of the issuer. The total number of issuer's shares of common
stock outstanding held by affiliates and non-affiliates as of October 27, 2006
was 200,386,286.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
1
DOCUMENTS INCORPORATED BY REFERENCE: See Exhibits
EXPLANATORY NOTE
As stated in Amendment No. 1, we are filing this Amendment No. 3 to our
Annual Report on Form 10-KSB for our year ended December 31, 2005 to reflect the
restatement of our consolidated financial statements for the years ended
December 31, 2005 and 2004 and the quarterly periods therein. As more fully
described in Note 13 to the consolidated financial statements, included herein,
we have restated our consolidated financial statements to (i) properly account
for certain derivative financial instruments embedded in our notes payable,
convertible notes payable and redeemable preferred stock, (ii) properly account
for other derivative financial instruments (principally warrants) that were
issued in connection with our financing and other business arrangements, (iii)
reclassify and properly account for redeemable preferred stock and (iv) address
certain other matters more fully described in Note 13. We have also restated
Management's Discussion and Analysis and our Evaluation of Disclosure Controls
and Procedures, to give effect to the restated financial information.
We have not restated or presented our consolidated financial statements
for any period prior to 2004, since we have concluded that doing so would impose
a significant hardship on the Company. For purposes of the restated financial
statements presented herein, we calculated the effects of certain aspects of
financial transactions arising from the items which required restatement,
commencing with the inception dates of those transactions. We then made
appropriate cumulative adjustments to the beginning balances that served as the
basis for such restated financial statements in our amended Form 10-KSB for the
year ended December 31, 2005, as reflected in the consolidated financial
statements for the years ended December 3, 2004 and 2005 contained therein.
Factors that we considered in our determination that the restatement of
periods prior to 2004 would present a significant hardship, are as follows: (i)
the significant internal and external cost of preparing and filing restated
financial statements for periods prior to 2004; (ii) the significant negative
impact on our normal business operations resulting from the disruptions inherent
in such preparation; (iii) the delay such restatements would create in our
ability to have declared effective a pending Form SB-2 registration statement,
with the concomitant imposition of contractual registration penalties; (iv) the
delay in the release from escrow of $15,000,000 in financing that is conditioned
upon the effectiveness of the pending Form SB-2 registration statement; (v)
management's reasoned belief that restated financial information for periods
prior to 2004 are not currently indicative of the trends in our business
operations; and, finally, (vi) the fact that our independent registered public
accountants have performed the procedures that they believe are necessary to
provide their opinion that the restated financial statements filed by us were
otherwise fairly presented in all material respects.
FORWARD-LOOKING STATEMENTS
Statements that are not historical facts, including statements about our
prospects and strategies and our expectations about growth contained in this
report are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements represent our present
expectations or beliefs concerning future events. We caution that such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among other things, the uncertainty as to our future profitability; the
uncertainty as to whether our new business model can be implemented
successfully; the accuracy of our performance projections; and our ability to
obtain financing on acceptable terms to finance our operations until
profitability.
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PART I
ITEM 1 - DESCRIPTION OF BUSINESS
The Company
Bravo! Brands Inc. is a Delaware corporation, which was formed on April
26, 1996. We formerly owned the majority interest in two Sino-American joint
ventures in China, known as Green Food Peregrine Children's Food Co. Ltd. and
Hangzhou Meilijian Dairy Products Co., Ltd. These two joint ventures processed
milk products for local consumption in the areas of Shanghai and Hangzhou,
China, respectively. We closed Green Food Peregrine in December 1999 and sold
our interest in Hangzhou Meilijian Dairy in December 2000.
In December 1999, we obtained Chinese government approval for the
registration of a new wholly owned subsidiary in the Wai Gao Qiao "free trade
zone" in Shanghai, China. We formed this import-export company to import, export
and distribute food products on a wholesale level in China. In addition, China
Premium (Shanghai) was our legal presence in China with respect to contractual
arrangements for the development, marketing and distribution of branded food
products. We ceased all activities of this Chinese subsidiary in April 2004,
owing to low sales volume and insufficient financial or logistic resources to
market our products profitably in mainland China.
In December 1999, we formed Bravo! Foods, Inc., a wholly owned Delaware
subsidiary, which we utilized to advance the promotion and distribution of
branded Looney Tunes(TM) products in the United States, through production
agreements with local dairy processors. At the end of 2001, we assumed this
business, and our U.S. subsidiary ceased functioning as an operating company at
that time.
On February 1, 2000, we changed our name from China Peregrine Food
Corporation to China Premium Food Corporation. On March 16, 2001 we changed our
name to Bravo! Foods International Corp. On October 24, 2006, we changed our
name to Bravo! Brands Inc., pursuant to a resolution of our Board of Directors
and the affirmative vote of our shareholders at a special meeting called for
that purpose, in accordance with Delaware General Corporation Law.
In January 2005, we formed Bravo! Brands (UK) Ltd., a United Kingdom
registered company that is wholly owned by Bravo! Brands International Ltd. We
will utilize Bravo! Brands (UK) Ltd. to advance the production, promotion and
distribution of licensed branded products in the United Kingdom through
production and sales agent agreements with local entities. Currently, we are
evaluating our distribution and product mix in the UK in order to develop and
implement a more effective business plan going forward. During this period of
re-evaluation, we have ceased production of our products in the United Kingdom.
The Business
Our business involves the development and marketing of our own Slammers(R)
and Bravo!(TM) trademarked brands, the obtaining of license rights from third
party holders of intellectual property rights to other trademarked brands, logos
and characters and, in certain international markets, the granting of production
and marketing rights to processor dairies to produce branded flavored milk
utilizing our intellectual property. In addition, we anticipate the commencement
of exporting our products to Mexico and Canada in the fourth quarter 2006 and
first quarter 2007, respectively.
In the United States and the UK, we generate revenue from the sales of
finished branded flavored milks to retail consumer outlets or distributors for
resale to retail consumer outlets. Currently, we use a single third-party
processor in the United States and another in the UK to produce all of our
single serve milk based beverages. We anticipate the expanded production of our
products with the addition of HP Hood, LLC as a second processor in the United
States, with production commencing in the fourth quarter 2006. We recognize
revenue in the United
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States at the gross amount of our invoices for the sale of finished product to
wholesale buyers or distributors. We take title to our branded flavored milks
when they are shipped by our third party processors and recognize as revenue the
gross wholesale price charged to our wholesale customers or distributors. Our
gross margin is determined by the reported wholesale price less (i) the cost
charged by our third party processor, to produce our branded milk products and
(ii) shipping costs.
In the Middle East, we generate revenue primarily through our sale to
processors of flavor ingredients utilized for our products, which are developed
and refined by us, and the grant of production rights to processors to produce
our flavored milks. The consideration paid to us under these production
contracts consists of fees charged for our grant of production rights for our
branded flavored milks plus a charge for flavor ingredients.
All of our third party licensing agreements recognize that we will use
third party production agreements for the processing of flavored milk products
and that the milk products will be produced and may be sold directly by those
processors. Our responsibilities under our third party production agreements are
to design and provide approved packaging artwork, to help determine the best
tasting flavors for the particular market and to assist in the administration,
promotion and expansion of the respective branded milk programs. Ingredients for
the flavored milks are formulated to our specifications and supplied on an
exclusive basis by either Givaudan Flavors Group or Mastertaste, both of which
are flavor development and production companies. In the United States, we are
the vendor of record for our direct wholesale business and assume the
responsibility for sales and marketing of our flavored milks.
Master Distribution Agreement - Coca-Cola Enterprises
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On August 31, 2005, we entered into a ten-year Master Distribution
Agreement with Coca-Cola Enterprises Inc that we believe will significantly
expand the distribution and sales of our products. The agreement provides for
the distribution of our products in Coca-Cola Enterprises in the United States,
all U.S. possessions, Canada, Belgium, continental France, Great Britain,
Luxembourg, Monaco and the Netherlands, as well as any other geographic
territory to which, during the term of the agreement, Coca-Cola Enterprises
obtains the license to distribute beverages of The Coca-Cola Company. The
appointment of Coca-Cola Enterprises as the exclusive distributor for our
products was effective August 30, 2005, has an effective distribution date of
October 31, 2005 and an expiration date of August 15, 2015. Coca-Cola
Enterprises has the option to renew the Master Agreement for two subsequent
periods of ten additional years. Attendant to the execution of the agreements we
issued three-year warrants to Coca-Cola Enterprises for the right to purchase 30
million shares of our common stock at an exercise price of $0.36 per share.
Under the terms of the agreement, Coca-Cola Enterprises is obligated to
use all commercially reasonable efforts to solicit, procure and obtain orders
for our products and merchandise and actively promote the sale of such products
in the Territory, as defined in the agreement. The agreement establishes a
comprehensive process for the phased transition from our existing system of
distributors to Coca-Cola Enterprises, dependent upon distribution territory,
product and sales channels. Under the agreement, Coca-Cola Enterprises
implemented its distribution on a ramp-up basis, commencing , October 31, 2005.
Coca-Cola Enterprises' distribution in other Territory areas will be dependent
upon, among other things, third-party licensing considerations and compliance
with the regulatory requirements for the products in foreign countries.
We have agreed to provide the following:
o strategic direction of our products;
o maintain sales force education and support;
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o actively market and advertise our products and design and develop point
of sale materials and advertising.
We are also responsible for handling:
o consumer inquiries;
o product development; and
o the manufacture and adequate supply of our products for distribution by
Coca-Cola Enterprises.
The terms of the agreement require our company to maintain the
intellectual property rights necessary for our company to produce, market and/or
distribute and for Coca-Cola Enterprises to sell our products in the Territory.
We are obligated to spend a fixed dollar amount through 2006 on national and
local advertising, including actively marketing the Slammers trademark, based on
a plan as mutually agreed each year. Beginning in 2007, the Company shall
allocate an amount per year for such activities in each country in the defined
Territory equal or greater than an agreed upon percentage of our total revenue
in such country.
Under the agreement, Coca-Cola Enterprises has the right of first refusal
to distribute any new products developed by our company, and the agreement
establishes a process for the potential expansion of Coca-Cola Enterprises'
distribution of the Company's products to new territories. Either party may
terminate the agreement for a material breach, insolvency or bankruptcy.
Coca-Cola Enterprises may terminate (i) for change of control by our company,
(ii) upon a material governmental regulatory enforcement action or threatened
governmental action having a material adverse consumer or sales impact on our
products and (iii) upon twelve months notice after August 15, 2006.
Third Party Intellectual Property Licenses
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Marvel Enterprises, Inc. (Super Heroes(R) and Marvel Heroes(R))
On February 4, 2005, we entered into a two-year license agreement for the
utilization of Marvel Heroes characters on our flavored milks in the United
Kingdom and Ireland. We agreed to a royalty rate of 4% of net wholesale sales in
the territory against the prepayment of a guaranteed minimum royalty amount. We
have adopted the unit sales model currently used in the United States. We have
outsourced the infrastructure required for the production, promotion, marketing,
distribution and sale of our products through a production agreement with
Waterfront Corporation in the UK and through an exclusive sales agency agreement
with Drinks Brokers, Ltd. a UK registered company responsible for the launch and
growth of several major beverage brands in the licensed territory. Currently, we
are evaluating our distribution and product mix in the UK in order to develop
and implement a more effective business plan going forward. During this period
of re-evaluation, we have ceased production of our Marvel co-branded products in
the United Kingdom.
In March 2005, we entered into a new one-year license agreement with
Marvel Enterprises, Inc. to use its Super Heroes(R) properties to promote our
branded milk products in the United States, Canada and Mexico. Under the terms
of the license agreement, we agreed to a royalty rate of 5% of net wholesale
sales in the United States, 4% for school lunch channels and 2.5% for school hot
lunch programs. We also agreed to a 11% royalty on the amount invoiced to dairy
processors for production in Canada and Mexico. We have not renewed this license
agreement owing to the failure of our Marvel co-branded products to achieve
expected market penetration.
On February 4, 2005, we entered into an eighteen month license agreement
for the utilization of Marvel Heroes characters on our flavored milks in the
Middle East in conjunction with our execution of third party production
agreements for the manufacture and sale of our products in Saudi Arabia and
Oman. We agreed to a 11% royalty on the amount invoiced to third party dairy
processors for "kits" in the territory against the
5
prepayment of a guaranteed minimum royalty amount. We have not renewed this
license agreement owing to the failure of our Marvel co-branded products to
achieve expected market penetration.
Chattanooga Bakery, Inc.( Moon Pie(R) )
In October 2003, we assigned a two-year license with MD Enterprises, Inc.,
under which, we have the exclusive right to manufacture, distribute, market and
sell Moon Pie(R) flavored milk products in the United States, subject to a
variable royalty rate of 2% to 3% of net wholesale sales, depending upon volume.
This license has been extended verbally.
Masterfoods USA (Starburst(R), Milky Way(R), 3 Musketeers(R))
On September 21, 2004, we entered into a licensing agreement with
Masterfoods USA, a division of Mars, Incorporated, for the use of Masterfood's
Milky Way(R), Starburst(R) and 3 Musketeers(R) trademarks in connection with the
manufacture, marketing and sale of single serve flavored milk drinks in the
United States, its Possessions and Territories and US Military installations
worldwide. The license limits the relationship of the parties to separate
independent entities. The initial term of the license agreement expires December
31, 2007. We have agreed to pay a royalty based upon the total net sales value
of the licensed products sold and advance payments of certain agreed upon
guaranteed royalties. Ownership of the licensed marks and the specific milk
flavors to be utilized with the marks remains with Masterfoods. We have a right
of first refusal for other milk beverage products utilizing the Masterfoods
marks within the licensed territory. This license has amended to include
additional Masterfoods brands and to extend the term to December 31,2012.
In March 2006, we signed two new seven year licensing agreements for
Canada and Mexico with Masterfoods, effective January 1, 2006. The licensing
agreement for Canada covers single servings of the Mars(R) Brand flavored milk
drink, Starburst(R) brand flavored milk drink and the 3 Musketeers(R) brand
flavored milk. In Mexico the licensing agreement is for single serve Milky
Way(R) brand flavored milk, Starburst(R) brand flavored milk Drink and the 3
Musketeers(R) Brand Flavored Milk. These licensing agreements cover most trade
channels including grocery, food service, Club Stores as well as schools with
children over the age of 13, colleges and universities, vending machines,
amusement parks and movie theaters.
Diabetes Research Institute
In June 2005, we extended our licensing agreement with Diabetes Research
Institute to June 30, 2007. We agreed to a variable royalty rate of 0.25% of net
sales. We use this intellectual property, which consists of a logo plus design
on the labels of our Slim Slammers(TM) product line.
In House Intellectual Property
------------------------------
In addition to our third-party licenses, we have developed and sell
flavored milks bearing trademarks developed by us, including "Slammers(R)" "Pro
Slammers(TM)", "Slim Slammers(R)", Bravo!(TM) and "Breakfast Blenders(TM)".
Production Contracts/Administration
-----------------------------------
Our operations in the United States, the Middle East, Mexico and Canada
are run directly by Bravo! Brands Inc. Our United Kingdom business is managed
through our wholly owned subsidiary Bravo! Brands International Ltd., which is a
UK registered company.
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United States
Since 2003, our milk products have been produced by Jasper Products,
located in Joplin, Missouri. In addition to the production of our products,
Jasper has provided the infra-structure necessary for our invoicing, shipping
and collection activities. We anticipate that we will assume direct
responsibility for these activities in house in the fourth quarter 2006. We will
expand production of our products with the addition of HP Hood, LLC as a second
processor, with production commencing in the fourth quarter 2006
United Kingdom
In February 2005, we executed an exclusive sales agency agreement with
Drinks Brokers, Ltd., a division of Tactical Sales Resources Limited for sales
of our product lines in the United Kingdom. Pursuant to terms of the agreement,
Bravo! appointed Drinks Brokers as its Sales Agent in the United Kingdom for the
marketing, promotion, distribution and sale of Bravo!'s Slammers(R) Marvel
Heroes line of flavored milk, as well as other product lines that Bravo! may
introduce to the UK in the near future.
Drinks Brokers utilizes its established networks to manage all matters
relating to the sale and effective distribution of Bravo!'s products within the
United Kingdom, including the solicitation of sales from customers in applicable
market segments, marketing, advertising and promotion of Bravo!'s products,
distribution, and merchandising.
Our products are processed in the United Kingdom by Waterfront Corporation
Limited, on a third party co-pack basis. We generate revenue in the United
Kingdom from the unit sales of finished branded flavored milks to retail
consumer outlets. Currently, we use a single third-party processor in the United
Kingdom to produce all of our single serve milk based beverages. We recognize
revenue in the United Kingdom at the gross amount of our invoices for the sale
of finished product to wholesale buyers.. We take title to our branded flavored
milks when they are shipped by our third party processor and recognize as
revenue the gross wholesale price charged to our wholesale customers. Our gross
margin is determined by the reported wholesale price less the cost charged by
Waterfront Corporation Limited.
Middle East
In September 2005, we entered into a third party production agreement with
Oman National Dairy Products Co. Ltd., a Middle East dairy processor,
headquartered in Ruwi, Oman. Oman Dairy produces Slammers (R) branded flavored
milks, including the Marvel line, for distribution in Oman and Saudi Arabia. We
generate revenue in the Middle East by the sale of flavor ingredients and
production rights for our branded products. We are not responsible for
production, marketing, promotion or distribution of the product in the Middle
East.
Products
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In September of 2000, we commenced our United States business using third
party dairy processors for the production and sale of fresh branded flavored
milk in single serve plastic bottles. Our flavored milk products had a limited
shelf life of, generally, 21 days.
In early 2002, we developed branded extended shelf life and aseptic,
bacteria free, long life flavored milk products. The extended shelf life product
was sold in 11.5oz single serve plastic bottles and had to be refrigerated. The
shelf life of this product is 90 days. In addition, we developed a line of
aseptic packaged milks that do not require refrigeration and have a shelf life
of 8 months. This product
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was packaged in an 11.2oz Tetra Pak Prisma(TM) sterile paper container. Both of
these products were introduced to the public in the second and third quarters of
2002.
Commencing in May 2002, we developed a new branded fortified flavored milk
product under the "Slammers(R) Fortified Reduced Fat Milk" brand name. We use
our Slammers(R) brand in conjunction with our licensed third party trademarks.
Slammers(R) is made from reduced fat milk and is fortified with essential
vitamins. The introduction of this new product and the phase out of our
"regular" branded milks occurred in the fourth quarter of 2002. Our Slammers(R)
flavored milks were sold in the United States in single serve extended shelf
life plastic bottles, as well as the long life aseptic Tetra Pak Prisma(TM)
package.
In November 2002, we introduced Slim Slammers(R) Fortified Milk, a low
calorie version of our Slammers (R)Fortified Reduced Fat Milk. Slim Slammers(R)
Fortified Milk has no added sugar and is sweetened with sucralose, a natural
sweetener made from sugar. Slim Slammers(R) Fortified Milk is made from 1
percent fat milk, is fortified with 11 essential vitamins and is available in
the same flavors as our Slammers(R) brand. We reintroduced this product in the
United States with a new package and formulation during 2004.
In 2004, we announced our product development and brand strategy for seven
new, separate and distinct single serve product lines: Ultimate Slammers(TM),
Slim Slammers(R), Moon Pie Slammers(R), Pro-Slammers(TM), Starburst(R)
Slammers(R), 3 Musketeers(R) Slammers(R) and Milky Way(R) Slammers(R). These
product lines are all fortified and positioned to appeal directly to profiled
demographic segments, including teens and pre teens for Ultimate Slammers(TM),
Starburst(R) Slammers(R) and Milky Way(R) Slammers(R), teens and sports
enthusiasts for Pro-Slammers(TM), young to old for Moon Pie(R) Slammers(R) and
health conscious adults for Slim Slammers(R) and 3 Musketeers(R) Slammers(R).
We launched four brands in 2004, beginning with Ultimate Slammers(R) in
April and achieved national distribution of Ultimate Slammers(R) through both
retail grocers and convenience stores by mid- summer. Roughly 10,000 retail
supermarket stores carried this brand nationwide in 2004. This was followed by
our June launch of Slim Slammers(R) and Moon Pie (R)Slammers(R) and the July
release of our Pro-Slammers(TM) line.
In January 2005, we launched our Slammers(R) Starburst line of Fruit &
Cream Smoothies utilizing a "shelf stable" re-sealable plastic bottle for milk
products that does not require refrigeration. Until that launch, all single
serve flavored milk in plastic bottles required refrigeration for storage,
distribution and shelf placement. The tactical advantage of distributing milk
products ambient enables us to side-step a major entry barrier in our immediate
consumption strategy. Refrigerated milk is relegated to dairy
direct-store-delivery systems that are controlled by either regional dairy
processors or larger national dairy holding companies. Shelf stable re-sealable
plastic bottles allow us to use a more traditional distribution network that
accommodates the non-refrigerated beverages. Also, milk products packaged in
shelf stable re-sealable plastic bottles have significantly longer shelf life
for storage, allowing us to ship in full truckloads resulting in decreased
freight costs. We currently are converting all of our products to "shelf stable"
re-sealable plastic bottles.
In the first quarter 2005, we launched our Slammers(R) MilkyWay and 3
Musketeers lines utilizing a "shelf stable" re-sealable plastic bottle for milk
products that does not require refrigeration, under the Masterfoods License.
During this period, we also introduced Breakfasts Blenders(TM), which is a meal
replacement milk beverage developed for the "on the go" consumer.
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Industry Trends
---------------
The flavored milk industry has grown from approximately $750 million in
1995 to $2.5 billion in 2004. The single serve portion of this category is
difficult to measure, since approximately 2/3 of the sales in the single serve
milk industry are sold in immediate consumption channels or other channels that
do not report scan-data. For example, Wal-Mart has become the largest retailer
in the USA for milk, selling an estimated 15% of total milk sales. Wal-Mart does
not report sales for the industry data resources embodied in A.C. Neilson or IRI
analyses. Similarly, most convenience stores and "up-and-down-the-street"
retailers in the immediate consumption sales channels do not report either, and
neither do vending and schools.
We have analyzed the industry using reports available from milk and
beverage industry sources. These include the total, segmented and rate of growth
sales that are reported, the immediate consumption sales rates for all
consumables compared to retail grocery buying patterns and opinions of experts
in the milk industry as to the relative size of reported versus non-reported
sales. Based upon these reports and analysis, we believe the current size of the
single serve flavored milk industry (packaging 16 oz. or smaller) is
approximately $1.5 billion domestically. The industry grew at annual rates of
between 5 and 15 percent during the last five years but was virtually flat in
the last two years while it digested the remarkable 10-year growth rates. We
believe that this space is positioned for growth now and will continue to be in
the immediate consumption channels such as vending, convenience stores and food
service market segments.
Market Analysis
---------------
The flavored milk business is a relatively new category in the dairy
field. The flavored "refreshment" segment is both the fastest growing and most
profitable category in the industry and is receiving the most attention in the
industry today. Pioneered by Nestle with the NesQuik line and Dean Foods with
its Chug brand, this "good for you" segment is in demand both in the U.S. and
internationally.
The International Dairy Foods Association reports that, although flavored
milk currently amounts to only 5 to 6 percent of milk sales, it represents over
59% of the growth in milk sales. With the total milk category exceeding $9.3
billion in 2004, the flavored milk segment was approximately $2.5 billion in
2004, with single serve flavored milk growing to approximately $1.5 billion for
the same period. Statistically, as the flavored segment grows, the entire
category grows as well. In the past ten years, selling more flavored milks has
resulted in more sales of white milk as well.
In addition, the International Dairy Foods Association and Dairy
Management Inc. have reported on studies suggesting that dairy products may help
in weight loss efforts when coupled with a reduced calorie diet, based on data
associating adequate calcium intake with lower body weight and reduced body fat.
We continue to develop a niche in the single serve flavored milk business by
utilizing strong, national branding as part of the promotion of our Slammers(R),
Pro Slammers(TM) and Slim Slammers(R) products. This niche has as its focus the
increased demand for single serve, healthy and refreshing drinks.
Market Segment Strategy
-----------------------
The Bravo! product model addresses a very clear and concise target market.
We know from experience that the largest retailers of milk products are
demanding new and more diverse refreshment drinks, specifically in the dairy
area, in response to consumer interest and demand. To that end, we have and will
continue to differentiate our products from those of our competitors through
innovative product formulations and packaging designs, such as those implemented
in our Slammers(R) and Pro Slammers(TM) fortified milk product lines and our
Slim Slammers(R) low calorie, no sugar added products. Our Slammers(R) milk
products have had promising results penetrating this arena as consumers continue
to look for healthy alternatives to carbonated beverages. The positioning of our
products as a healthy, fun
9
and great tasting alternative refreshment drink at competitive prices to more
traditional beverages creates value for the producer and the retailer alike.
This "profit orientation" for the trade puts old-fashioned milk products in a
whole new light. The consumer is happy, the retailer is happy and the producer
is able to take advantage of the value added by the brand and the resulting
overall increase in milk sales.
We currently are implementing a very important "first-to-market" strategy
that we feel will dramatically reposition our brands and company. Until now, all
single served flavored milk in plastic bottles required refrigeration for
storage, distribution, and shelf placement. Our strategic partner, Jasper
Products, became America's first processor with FDA approval to offer a "shelf
stable" re-sealable plastic bottle for ambient milk products that do not require
refrigeration.
The tactical advantage of distributing our milk products at ambient
temperatures enables us to side-step a major entry barrier in our immediate
consumption strategy. Most beverages are distributed ambient either through
beverage distribution channels or warehouse "candy and tobacco" distributors.
Refrigerated milk was relegated to dairy direct-store-delivery systems that are
controlled by either regional dairy processors or larger national dairy holding
companies such as Dean Foods or H.P. Hood. We avoid the roadblock of being
reliant upon our competition for chilled distribution since we are now in the
unique position to use the more traditional distribution network that
accommodates non-refrigerated beverages. We currently are converting all of our
products into ambient "shelf stable" re-sealable plastic bottles.
We have been and continue to pursue a strategic goal of placing
Slammers(R) milks in elementary, middle and high schools through ala carte lunch
programs and vending facilities in school cafeterias, and we are promoting our
Slim Slammers(R) milks as low calorie, non-sugar added alternatives to
traditional soft drinks. Penetration of this market segment has been limited by
logistic and economic concerns of school administrators in the push to remove
traditional carbonated soft drinks from schools in favor of milk and milk based
products.
Competition
-----------
Nestle pioneered the single serve plastic re-sealable bottle which has
become the standard for this industry, and they currently enjoy a dominant
market share. Dean Foods owns a number of regional single serve brands that are
sold in this format, and they also have an exclusive license to produce Hershey
brand flavored milk nationwide. Our analysis indicates that the Nestle's Nesquik
brand accounts for approximately 30-35 percent of the U.S. single serve milk
category, while Hershey's market share is approximately half that, at around
15%. The other competition comes from private label and regional dairy brands.
Our Slammers(R) milks are the only other single serve brand distributed
nationally in America in plastic re-sealable containers.
Our resources for promotions have been limited, and we run significantly less
promotional activities in comparison to our competitors. Where we are in direct
competition with Nestle and Hershey, however, we have been able to maintain
competitive sales levels.
Employees
We have thirty three full time employees, twenty one of which work at our
North Palm Beach corporate offices.
10
ITEM 2 - DESCRIPTION OF PROPERTY
Neither our company nor our subsidiaries currently own any real property.
As of February 1, 1999, we moved our corporate offices from West Palm Beach to
11300 US Highway 1, Suite 202, North Palm Beach, Florida, pursuant to a lease
with HCF Realty, Inc., having an initial term of five years. The current
aggregate monthly rent amounts to approximately $7,468, which includes an
expansion of our office space from 2,485 square feet to 3,490 square feet. The
term of this lease has been extended for six years to October 30, 2010.
We have executed a lease for an expansion of our office space in North
Palm Beach, Florida to include an additional 2,190 square feet at $18.50 per
square foot.
We do not have a policy to acquire property for possible capital gains or
income generation. In addition, we do not invest in securities of real estate
entities or developed or underdeveloped properties.
ITEM 3. LEGAL PROCEEDINGS
There currently are no claims or lawsuits against us for which a report is
required.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None in the fourth quarter 2005 or the first and second quarters of 2006.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Common stock market price
-------------------------
Of the 200,386,286 shares of common stock outstanding as of October 27,
2006, all but approximately 32,000,000 shares can be traded on the
over-the-counter trading on the OTC Electronic Bulletin Board, which trading
commenced October 24, 1997. Of this amount, 17,219,793 shares are held by
affiliates. The following quarterly quotations for common stock transactions on
the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up,
markdown or commissions and may not represent actual transactions.
-------------------------------------------------------------------------------
QUARTER HIGH BID PRICE LOW BID PRICE
-------------------------------------------------------------------------------
2004
-------------------------------------------------------------------------------
First Quarter .17 .06
-------------------------------------------------------------------------------
Second Quarter .34 .14
-------------------------------------------------------------------------------
Third Quarter .27 .13
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Fourth Quarter .22 .09
-------------------------------------------------------------------------------
2005
-------------------------------------------------------------------------------
First Quarter .18 .10
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Second Quarter 1.21 .14
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Third Quarter 1.43 .51
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Fourth Quarter 0.80 .47
-------------------------------------------------------------------------------
11
Equity holders at October 27, 2006
------------------------------------
Common stock 200,386,286 shares 7,200 holders (approximate)
Series B preferred stock 107,440 shares 1 holder
Series H preferred stock 64,500 shares 1 holder
Series J preferred stock 200,000 shares 1 holder
Series K preferred stock 95,000 shares 1 holder
Dividends
---------
We have not paid dividends on our common stock and do not anticipate
paying dividends. Management intends to retain future earnings, if any, to
finance working capital, to expand our operations and to pursue our acquisition
strategy.
The holders of common stock are entitled to receive, pro rata, such
dividends and other distributions as and when declared by our board of directors
out of the assets and funds legally available therefore. The availability of
funds is dependent upon dividends or distribution of profits from our
subsidiaries and may be subject to regulatory control and approval by the
appropriate government authorities on either a regional or national level.
We have dividends in arrearage for our convertible preferred stock in the
amount of $336,303 and $388,632 for the years ended December 31, 2005 and 2004,
respectively.
Sale of unregistered securities
-------------------------------
Quarter Ended December 31, 2005
On November 28, 2005, we closed a funding transaction with 13 accredited
institutional investors, for the issuance and sale of 40,500,000 shares of our
common stock for a purchase price of $20,250,000. We also issued five-year
warrants for the purchase of an additional 15,187,500 shares of common stock at
an exercise price of $0.80 per share. The securities are restricted and have
been issued pursuant to an exemption to the registration requirements of Section
5 of the Securities Act of 1933 for "transactions of the issuer not involving
any public offering" provided in Section 4(2) of the Act and pursuant to a
Regulation D offering. In connection with this financing, we issued common stock
purchase warrants to purchase 1,012,500 shares of common stock at an exercise
price of $.50 per share and 304,688 shares of common stock at an exercise price
of $.80 per share to SG Cowen & Co., LLC, who acted as placement agent for this
financing.
The shares of common stock and the shares of common stock underlying the
warrants carry registration rights that obligate us to file a registration
statement within 45 days from closing and have the registration statement
declared effective within 120 days from closing.
12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Our business model includes the development and marketing of our Company
owned Slammers(R) and Bravo!(TM) trademarked brands, the obtaining of license
rights from third party holders of intellectual property rights to other
trademarked brands, logos and characters and the production of our branded
flavored milk drinks through third party processors. In the United States and
the United Kingdom, we generate revenue from the unit sales of finished branded
flavored milk drinks to retail consumer outlets or distributors. We generate
revenue in our Middle East business through the sale of flavor ingredients per
kit used to produce the flavored milk and a fee charged to the dairy processors
for the production, promotion and sales rights for the branded flavored milk.
Our new product introduction and growth expansion continues to be
expensive, and we reported a net loss of $79,528,653 for the year ended December
31, 2005, which included $60,823,574 of derivative expenses discussed at length
in the Results of Operations Section, and a $3,000,000 one time finder's fee
paid in connection with our execution of a Master Distribution Agreement with
Coca-Cola Enterprises, Inc. As shown in the accompanying financial statements,
we have suffered operating losses and negative cash flows from operations since
inception and, at December 31, 2005, have an accumulated deficit. These
conditions give rise to substantial doubt about our ability to continue as a
going concern. As discussed herein, we plan to work toward profitability in our
U.S. and international business and obtain additional financing. While there is
no assurance that funding will be available or that we will be able to improve
our operating results, we are continuing to seek equity and/or debt financing.
We cannot give any assurances, however, that management will be successful in
carrying out our plans.
CRITICAL ACCOUNTING POLICIES
Estimates
---------
This discussion and analysis of our consolidated financial condition and results
of operations are based on our consolidated financial statements, which have
been prepared in accordance with accounting principles that are generally
accepted in the United States of America. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America 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 revenues and expenses during the reporting period. The
most significant estimates included in our financial statements are the
following:
- Estimating future bad debts on accounts receivable that are carried at net
realizable values.
- Estimating our reserve for unsalable and obsolete inventories that are
carried at lower of cost or market.
- Estimating the fair value of our financial instruments that are required
to be carried at fair value.
- Estimating the recoverability of our long-lived assets.
We use all available information and appropriate techniques to develop our
estimates. However, actual results could differ from our estimates.
13
Revenue Recognition and Accounts Receivable
-------------------------------------------
Our revenues are derived from the sale of branded milk products to customers in
the United States of America, Great Britain and the Middle East. Geographically,
our revenues are dispersed 98% and 2% between the United States of America and
internationally, respectively. We currently have one customer in the United
States that provided 34% and 0% of our revenue during the years ended December
31, 2005 and 2004, respectively. Since we commenced selling to this customer
during the fourth fiscal quarter of 2005, we expect that our revenue related to
this customer as a percentage of our total revenue will increase.
Revenues are recognized pursuant to formal revenue arrangements with our
customers, at contracted prices, when our product is delivered to their premise
and collectibility is reasonably assured. We extend merchantability warranties
to our customers on our products, but otherwise do not afford our customers with
rights of return. Warranty costs have historically been insignificant.
Our revenue arrangements often provide for industry-standard slotting fees where
we make cash payments to the respective customer to obtain rights to place our
products on their retail shelves for a stipulated period of time. We also engage
in other promotional discount programs in order to enhance our sales activities.
We believe our participation in these arrangements is essential to ensuring
continued volume and revenue growth in the competitive marketplace. These
payments, discounts and allowances are recorded as reductions to our reported
revenue. Unamortized slotting fees are recorded in prepaid expenses.
Our accounts receivable are exposed to credit risk. During the normal course of
business, we extend unsecured credit to our customers with normal and
traditional trade terms. Typically credit terms require payments to be made by
the thirtieth day following the sale. We regularly evaluate and monitor the
creditworthiness of each customer. We provide an allowance for doubtful accounts
based on our continuing evaluation of our customers' credit risk and our overall
collection history. As of December 31, 2005 and 2004, the allowance of doubtful
accounts aggregated $350,000 and $90,396, respectively.
In addition, our accounts receivable are concentrated with one customer who
represents 70% of our accounts receivable balances at December 31, 2005.
Approximately 2% of our accounts receivable at December 31, 2005 are due from
international customers.
Inventories
-----------
Our inventories, which consists primarily of finished goods, is stated at the
lower of cost on the first in, first-out method or market. Further, our
inventories are perishable. Accordingly, we estimate and record lower-of-cost or
market and unsalable-inventory reserves based upon a combination of our
historical experience and on a specific identification basis.
Impairment of Long-Lived Assets
-------------------------------
Our long-lived assets consist of furniture and equipment and intangible assets.
We evaluate the carrying value and recoverability of our long-lived assets when
circumstances warrant such evaluation by applying the provisions of Financial
Accounting Standard No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets ("FAS 144"). FAS 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value.
14
Financial Instruments
---------------------
We generally do not use derivative financial instruments to hedge exposures to
cash-flow, market or foreign-currency risks. However, we frequently enter into
certain other financial instruments and contracts, such as debt financing
arrangements, redeemable preferred stock arrangements, and freestanding warrants
with features that are either (i) not afforded equity classification, (ii)
embody risks not clearly and closely related to host contracts, or (iii) may be
net-cash settled by the counterparty. As required by FAS 133, these instruments
are required to be carried as derivative liabilities, at fair value, in our
financial statements.
We estimate fair values of derivative financial instruments using various
techniques (and combinations thereof) that are considered to be consistent with
the objective measuring fair values. In selecting the appropriate technique(s),
we consider, among other factors, the nature of the instrument, the market risks
that it embodies and the expected means of settlement. For less complex
derivative instruments, such as free-standing warrants, we generally use the
Black Scholes option valuation technique because it embodies all of the
requisite assumptions (including trading volatility, estimated terms and risk
free rates) necessary to fair value these instruments. For complex derivative
instruments, such as embedded conversion options, we generally use the Flexible
Monte Carlo valuation technique because it embodies all of the requisite
assumptions (including credit risk, interest-rate risk and exercise/conversion
behaviors) that are necessary to fair value these more complex instruments. For
forward contracts that contingently require net-cash settlement as the principal
means of settlement, we project and discount future cash flows applying
probability-weightage to multiple possible outcomes. Estimating fair values of
derivative financial instruments requires the development of significant and
subjective estimates that may, and are likely to, change over the duration of
the instrument with related changes in internal and external market factors. In
addition, option-based techniques are highly volatile and sensitive to changes
in our trading market price which has high-historical volatility. Since
derivative financial instruments are initially and subsequently carried at fair
values, our income will reflect the volatility in these estimate and assumption
changes.
RESULTS OF OPERATIONS
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Consolidated Revenues
We reported revenues for the year ended December 31, 2005 of $11,948,921, an
increase of $8,604,222, or 257%, compared to revenues of $3,344,699 in 2004.
This increase is the result of the acquisition of a significant new customer
("Coca Cola Enterprises" or "CCE") during the third fiscal quarter with sales
generation commencing in the fourth fiscal quarter. Our revenues to CCE for the
year ended December 31, 2005 comprise 34% of our total revenue. CCE will
continue to be a significant customer in the foreseeable future. Since we
commenced revenue generation with CCE in the fourth fiscal quarter, in future
periods we expect that our revenues from sales to CCE will increase as a
percentage of our total revenues.
Our revenues and gross margin are net of industry-standard slotting fees and
promotional discounts for the year ended December 31, 2005 in the amount of
$487,221 compared to $204,755 in 2004. We record these programs as reductions in
our revenues and we may enter into similar programs in future periods to
increase our market penetration.
Geographically, during the 2005 fiscal year, our revenues are dispersed 98% and
2% between the United States of America and internationally, respectively. While
our current international revenues have not been significant, we are taking
measures to further penetrate international markets and increase our
international revenues as a percentage of our total revenues.
15
Consolidated Product and Shipping Costs
We incurred product costs and shipping costs of $8,938,692 and $1,505,035,
respectively, for the year ended December 31, 2005. Product costs in 2005
increased by $6,563,887, a 276% increase compared to $2,374,805 in 2004.
Shipping costs in 2005 increased $1,006,722, or 202%, compared to $498,313 in
2004. The increase in product costs reflects an increase in revenues and the
concomitant increase in reported product and shipping costs associated with that
increase. Our overall gross margin for 2005 of 12.6% decreased slightly from our
14.0% gross margin in 2004 due to slightly higher production costs that were not
offset with reciprocal pricing increases due to competitive constraint.
Consolidated Operating Expenses
Selling Expense:
We incurred selling expense of $7,464,876 during the year ended December 31,
2005. We expense these costs, consisting largely of advertising and promotion,
as they are incurred. Our selling expense for this period increased by
$6,164,203, a 474% increase compared to our selling expenses of $1,300,673 for
the same period in 2004. The increase in selling expense in the current period
was due to higher advertising expenses as we penetrate new markets and, to a
lesser degree, the hiring of additional sales staff. In addition, in connection
with the acquisition of our new customer, CCE during 2005, we entered into a
commitment to spend an aggregate of $5,000,000 for advertising and promotion of
our products during the years ended 2005 and 2006. Thereafter, we have agreed to
spend an aggregate annual amount of 3% of our total CCE revenue for advertising
programs. Generally, since our revenue producing activities with CCE did not
commence until November of 2005, we did not incur a significant amount of
expense under this commitment. Accordingly, our selling expenses can be expected
to increase during 2006 and 2007 as we fulfill our obligations under these
important arrangements and we continue to address additional markets.
Product Development Expense:
We incurred product development expense for the years ended December 31, 2005 of
$636,342, representing a 209% increase over product development expense in 2004.
Additional expenditures were incurred in 2005 due to the launching of our
Slammers Starburst line of Fruit & Cream Smoothies, and to package redesign
costs associated with several of our product lines including Slim Slammers, Pro
Slammers and Breakfast Blenders.
General and Administrative Expense:
Our general and administrative expense for the year ended December 31, 2005 was
$7,263,284, an increase of $4,586,223 compared to $2,677,061 in 2004. The
increase is the result of additional payroll, increased occupancy costs, office
overhead costs and travel necessary to support the increase in revenues. As a
percentage of total revenue, our general and administrative expense decreased
from 80% in 2004, to 61% for 2005. We anticipate a continued effort to reduce
these expenses as a percentage of sales through revenue growth, certain cost
cutting efforts and the refinement of business operations.
Non-Recurring Finders' Fee:
We recorded a $3,000,000 one time, non-recurring finder's fee in connection with
our execution of the Master Distribution Agreement with CCE in 2005. We do not
currently anticipate incurring similar costs
16
during 2006 or in the foreseeable future since our business opportunity with CCE
is expected to be further developed over that period.
Consolidated Other Income (Expense)
Derivative Expense
------------------
Our derivative expense amounted to $60,823,574 for the year ended December 31
2005, compared to $6,309,933 in 2004. Derivative expense (and in some instances
income) arises from changes in the fair value of our derivative financial
instruments and, in rare instances, day-one losses when the fair value of
embedded and freestanding derivative financial instruments issued or included in
financing transactions exceed the proceeds or other basis. Derivative financial
instruments include freestanding warrants, compound embedded derivative features
that have been bifurcated from debt and preferred stock financings. In addition,
our derivative financial instruments arise from the reclassification of other
non-financing derivative and other contracts from stockholders' equity because
share settlement is not within our control while certain variable share price
indexed financing instruments are outstanding.
Our derivative loss during each of the years ended December 31, 2005 and 2004 is
significant to our consolidated financial statements. The magnitude of the
derivative loss during the year ended December 31, 2005 when compared with the
loss for the year ended December 31, 2004 reflects the following:
(a) During the year ended December 31, 2005, and specifically commencing in the
second quarter, the trading price of our common stock reached significantly high
levels relative to its trend. The trading price of our common stock
significantly affects the fair value of our derivative financial instruments. To
illustrate, our trading stock price at the end of the first quarter of 2005 was
$0.15 and then increased to $0.93 by the end of the second quarter. Our trading
stock price then declined to $0.61 and $0.59 at the end of the third and fourth
quarters, respectively. However, the higher stock price had the effect of
significantly increasing the fair value of our derivative liabilities and,
accordingly, we were required to adjust the derivatives to these higher values
with charges to our income. Also, due to the higher stock price commencing in
the second quarter, we experienced significant exercise and conversion activity
related to our derivative warrants and, to a lesser degree, with respect to the
embedded conversion options. Accordingly, our year end derivative liability
balances reflect, among other elements of our valuation assumptions, the higher
intrinsic values of the arrangements caused by the significant changes in our
stock price, which are offset by a smaller number of common shares indexed to
outstanding warrants due to the extraordinary level of exercise activity.
(b) During the year ended December 31, 2005, we entered into a $2,300,000 debt
and warrant financing arrangement, more fully discussed in Note 6(b). In
connection with our accounting for this financing we encountered the unusual
circumstance of a day-one loss related to the recognition of derivative
instruments arising from the arrangement. That means that the fair value of the
bifurcated compound derivative and warrants exceeded the proceeds that we
received from the arrangement and we were required to record a loss to record
the derivative financial instruments at fair value. The loss that we recorded
amounted to $8,663,869. We did not enter into any other financing arrangements
during the periods reported that reflected day-one losses.
Because our derivative financial instruments are carried at, and periodically
adjusted to, fair value, our income is likely to experience continuing
volatility as assumptions underlying our fair value techniques (including
internal factors and external market indicators) change. However, we are
currently evaluating contracts underlying the origination of these derivative
financial instruments to determine whether they may be modified with the
investor. There can be no assurance that we can reach an agreement to modify
these arrangements and, if we are able to execute such modifications, we would
be required to consider
17
whether such modification(s) is significant. In instances where modifications
are considered significant, we may be required to extinguish the original
financial instrument and reestablish it at fair value. These extinguishments, if
any, would likely be accompanied with extinguishment gains or losses that we
would be required to reflect in our income.
Finally, we entered into a $30.0 million debt and warrant financing in July 2006
(see "Material Events" below) that will likely require the bifurcation of
additional derivative financial instruments. We have not yet calculated the
amounts of these derivatives, but their effects on our income, arising from fair
value changes, will be afforded the same accounting treatment as those that we
currently carry.
Liquidated Damages
------------------
During the year ended December 31, 2005, we recorded liquidated damages expense
of $303,750 (none in 2004). We have entered into registration rights agreements
with certain investors that require us to file a registration statement covering
underlying indexed shares, become effective on the registration statement,
maintain effectiveness and, in some instances, maintain the listing of the
underlying shares. Certain of these registration rights agreements require our
payment of cash penalties to the investors in the event we do not achieve the
requirements. We also record estimated liquidated damages penalties as
liabilities and charges to our income when the cash penalties are probable and
estimable. We will evaluate our estimate of liquidated damages in future periods
and adjust our estimates for changes, if any, in the facts and circumstances
underlying their calculation. We record these liquidated damages when they are
probable and estimable pursuant to Financial Accounting Standard No. 5,
Accounting for Contingencies.
Interest Expense
----------------
We incurred interest expense for the year ended December 31, 2005 of $1,667,294.
Our interest expense increased by $231,889, a 16% increase compared to
$1,435,405 in 2004. The increase was due to the effects of application of the
effective interest method where an effective interest amount, as calculated at
the inception of the debt is applied to the carrying value at the end of each
period. Under this method, periodic interest charges increases over the debt
term as the debt carrying value increases.
Other expense
-------------
Other expense consists of debt extinguishment losses and (gains). These amounts
arose from certain modifications that we made to our debt arrangements that
required our re-measurement of the carrying value to fair value because the
modification was significant. We may modify other debt arrangements as discussed
under the discussion related to our derivative financial instruments. Each
modification will require a determination whether an extinguishment occurred
and, if so, an extinguishment gain or loss may require recognition.
Subsequent to our year ended December 31, 2005, we began to incur penalties
related to a financing arrangement that required us to, among other things,
become effective on a registration statement. We have not become effective on
the registration statement. As of June 30, 2006, we incurred in excess of $2.1
million of penalties under this arrangement, and we paid these amounts beginning
in the third fiscal quarter of our year ending December 31, 2006. Our other
expense in future periods will reflect charges related to these penalties, and
such penalties will continue until the events that give rise to the penalties
are cured. In the event that we cure the default events that give rise to the
penalties, certain default provisions will continue, such as maintaining
effectiveness, that could give rise to additional penalties.
Consolidated Net Loss
We had a net loss for the year ended December 31 2005 of $79,528,653 compared
with a net loss of $11,517,620 in 2004. There were a number of factors that gave
rise to our losses in 2005 and 2004. First, we are currently expending funds in
developing our administrative and operating infrastructure and our sales
channels and, as a result, our current revenue volume has not been sufficient to
offset our operating expenses resulting in an operating loss during the years
ended December 31, 2005 and 2004. We anticipate that our operating expenses as a
percentage of our sales will decrease in future periods as our revenues
increased and our costs level. In addition, we incurred a one-time $3,000,000
fee during the year ended December 31, 2005 related to the acquisition of our
customer, CCE. We do not currently anticipate incurring similar costs in the
foreseeable future. Finally, the overall magnitude of both the 2005 and 2004 net
loss can be attributable largely to the fair value adjustments related to our
derivative financial instruments of $60,823,574 and $6,309,933 in 2005 and 2004,
respectively. See the discussion above, about our derivative income (expense)
for additional information. Our earnings will continue to be affected by the
fair value adjustments of our derivative financial instruments until they are
disposed of
18
through contractual modifications, conversions and exercises of our share
indexed instruments, or expiration.
Consolidated Loss Applicable to Common Shareholders
Loss applicable to common shareholders represents net loss as adjusted for
preferred stock dividends and accretion of our redeemable preferred stock and
our equity classified preferred stock to redemption values using the effective
method. Many of our preferred stock series have cumulative dividend features and
we will continue to reflect preferred stock dividends in our loss applicable
common shareholders until the preferred stock is converted, if ever. In
addition, many of our redeemable preferred stock series were initially
discounted due to the allocation of financing proceeds to detachable warrants
and embedded derivative financial instruments. We use the effective method to
amortize these discounts. The use of the effective method to accrete our
discounted redeemable preferred stock to redemption values causes accretion to
increase over the redemption period as the carrying values increase.
Accordingly, accretions will increase in future periods until the preferred is
fully accreted to redemption values or converted.
Consolidated Loss per Common Share
The Company's basic loss per common share applicable to common stockholders for
the year ended December 31, 2005 was $(0.60) compared with a basic loss per
common share applicable to common stockholders for the same period in 2004 of
$(0.31). Because the Company experienced net losses in 2005 and 2004, all
potential common share conversions existing in our financial instruments would
have an antidilutive impact on earnings per share; therefore, diluted loss per
common share equals basic loss per common share for both years.
The weighted average common shares outstanding increased from 40,229,738 for the
year ended December 31, 2004 to 135,032,836 for the year ended December 31,
2005. The increase is attributed primarily to conversions of our convertible
debt and preferred instruments into common shares. Potential common stock
conversions excluded from the computation of diluted earnings per share amounted
to 108,059,082 and 126,767,057 for the years ending December 31 2005 and 2004,
respectively.
Consolidated Comprehensive Loss
Comprehensive loss differs from net loss for the year ended December 2005 and
2004 by ($30,759) and ($689), respectively, which represents the effects of
foreign currency translation on the financial statements of our subsidiaries
denominated in foreign currencies. Our foreign operations are currently not
significant. Increases in our foreign operations will likely increase the
effects of foreign currency translation adjustments on our financial statements.
LIQUIDITY AND CAPITAL RESOURCES
We have incurred operating losses and negative cash flow from operations and
have negative working capital of $39,287,983 as of December 31, 2005. This
negative figure is largely the effect of our recording of $35,939,235 for
derivative liabilities. In addition, we have experienced delays in filing our
financial statements and registration statements due to errors in our historical
accounting which have been corrected. Our inability to make these filings is
resulting in our recognition of penalties payable to the investors following
December 31, 2005. In fact, we incurred a total of $4.5 million in penalties by
June 30, 2006. Further, these penalties will continue until we can complete our
filings and register the common shares into which the investors' financial
instruments are convertible. Finally, commencing in the fourth fiscal quarter of
2005, our revenues are significantly concentrated with one major customer. This
concentration is currently expected to continue into the foreseeable future. The
loss of this customer or
19
curtailment in business with this customer could have a material adverse affect
on our business. These conditions raise substantial doubt about our ability to
continue as a going concern.
We have been dependent upon third party financings as we execute on our business
model and plans. In August 2006, we completed a $30.0 million convertible note
financing that is expected to fulfill our liquidity requirements through the end
of 2006. However, $15.0 million of this financing is held in escrow, and there
can be no assurance that the investor will release these amounts. We have
entered into an Amendment Agreement with the holders of the Notes to amend the
Notes in certain respects as consideration for the holders' release of the
Company's default resulting from its delay in the filing of the second quarterly
report.
We plan to increase our revenues, improve our gross margins, augment our
international business and, if necessary, obtain additional financing.
Ultimately, our ability to continue is dependent upon the achievement of
profitable operations. There is no assurance that further funding will be
available at acceptable terms, if at all, or that we will be able to achieve
profitability.
The accompanying financial statements do not reflect any adjustments that may
result from the outcome of this uncertainty.
Information about our cash flows
For the year ended December 31, 2005, we reported that net cash used in
operating activities was $9,301,078, net cash provided by financing activities
was $18,209,600 and net cash used in investing activities was $4,043,665. We had
a negative working capital of $39,287,983 as of December 31, 2005.
Compared to $3,629,863 of net cash used in operating activities in the
year ended December 31, 2004, our current year net cash used in operating
activities increased by $5,671,215 to $9,301,078. Changes in accounts receivable
contributed to an increase in cash used by operating activities of $3,356,477,
as compared to contributing to an increase of $77,217 for 2004 for a difference
of $3,279,260. Cash used by operating activities increased as a result of
changes in inventory during 2005 by $379,489, compared to cash provided of
$43,339 for the same period in 2004. This was the result of our building
inventory during 2005 in connection with the continued implementation of our
Master Distribution Agreement with Coca-Cola Enterprises. The changes in
accounts payable and accrued liabilities for the year ended December 31, 2005
contributed to a reduction in cash used by operating activities of $7,294,548,
whereas such changes in 2004 contributed to a decrease in cash used by operating
activities of $542,282. Cash flows generated by our operating activities were
inadequate to cover our cash disbursement needs for the year ended December 31,
2005, and we had to rely on private placement financing, prior equity and new
convertible debt financing to cover operating expenses.
Cash used in the year ended December 31, 2005 in our investing activities
was $4,043,665 for license and trademark costs and equipment purchases, compared
to $531,263 for the same period in 2004.
Net cash provided by our financing activities for the year ended December
31, 2005 was $18,209,600. Net cash provided by financing activities for the same
period in 2004 was $4,216,844, for a net increase of $13,992,756. The increase
is attributed to private placement financings amounting to $20,690,000.
Going forward, our primary requirements for cash consist of the following:
o the continued development of our business model in the United States
and on an international basis;
20
o promotional and logistic production support for the capacity demands
presented by our Master Distribution Agreement with Coca-Cola
Enterprises;
o general overhead expenses for personnel to support the new business
activities;
o development, launch and marketing costs for our line of new branded
flavored milk products; and
o the payment of guaranteed license royalties.
We estimate that our need for financing to meet cash requirements for
operations will continue through the fourth quarter of 2006, when we expect that
cash supplied by operating activities will approach the anticipated cash
requirements for operating expenses. We anticipated the need for additional
financing in 2006 to reduce our liabilities, assist in marketing and to improve
stockholders' equity status, and we secured $30 million in senior convertible
note financing in July 2006. We have received half of the proceeds from this
financing in the third quarter, with the balance held in escrow pending a
shareholder vote to increase our authorized shares to cover the escrowed
balance. No assurances can be given that we will be able to obtain the approval
of our shareholders to increase our authorized shares, or that operating cash
flows will be sufficient to fund our operations.
We currently have monthly working capital needs of approximately $550,000 for
operations. We expect that we will continue to incur significant selling and
other expenses in 2006 in order to derive more revenue in retail markets,
through the introduction and ongoing support of our new products and the
implementation of the Master Distribution Agreement with Coca-Cola Enterprises.
We anticipate that certain of these expenses, such as slotting fees and freight
charges, will be reduced as a function of unit sales costs as we expand our
sales markets and increase our revenues within established markets and that
freight charges will be reduced as we are able to ship more full truckloads of
product given the reduced per unit cost associated with full truckloads versus
less than full truckloads. Similarly, slotting fees, which are paid to
warehouses or chain stores as initial set up or shelf space fees, are
essentially one-time charges per new customer. We believe that along with the
increase in our unit sales volume, the average unit selling expenses and
associated costs will decrease, resulting in gross margins sufficient to
mitigate cash needs. In addition, we are actively seeking additional financing
to support our operational needs and to develop an expanded promotional program
for our products.
External Sources of Liquidity
-----------------------------
On May 12, 2006, we obtained financing in the amount $2,500,000 and issued
promissory notes in that aggregate principal amount to two accredited investors.
One of these investors has exercised rights of participation and has reinvested
$1,000,000 of this note in the July 27, 2006 financing described below. The
remaining $1,500,000 principal of the notes has been paid in full with the part
of the July 27, 2006 financing proceeds.
On July 27, 2006, we entered into definitive agreements to sell $30 million
senior convertible notes (the "Notes") that are due in 2010 to several
institutional and accredited investors in a private placement exempt from
registration under the Securities Act of 1933. The notes initially carry a 9%
coupon, payable quarterly, and are convertible into shares of common stock at
$0.70 per share. In 2007, the coupon may decline to LIBOR upon the Company
achieving certain financial milestones. The Notes will begin to amortize in
equal, bi-monthly payments beginning in mid-2007. We issued warrants to purchase
12,857,143 shares of common stock at $0.73 per share that expire in July 2011 to
the investors in the private placement. Under the terms of the financing, we
sold $30 million notes, of which $15.0 million of the notes are being held in
escrow. The release of the funds will be subject to stockholder approval of the
increase of our authorized shares from 300,000,000 to 500,000,000 and the
effectiveness of a registration statement covering the common stock underlying
the outstanding Notes, and the additional notes and associated warrants
currently held in escrow. We will utilize this financing for, among other
things, our
21
working capital needs. We have filed a proxy statement seeking such shareholder
approval at a Special Meeting of Shareholders.
As a result of our failure to file our June 30, 2006 Form 10-QSB timely, an
event of default has occurred under the terms of the notes and the interest rate
on the Notes, payable quarterly, was increased from 9% to 14% per annum.
Pursuant to the terms of the Notes, upon the occurrence of an event of default,
holders of the Notes may, upon written notice to the Company, each require the
Company to redeem all or any portion of their notes, at a default redemption
price calculated pursuant to the terms of the Notes. We have entered into an
Amendment Agreement with the holders of the notes to amend the Notes in certain
respects as consideration for the holders' release of the Company's default
resulting from its delay in the filing of this quarterly report.
Material Events
---------------
In January 2005, we launched our Slammers(R) Starburst line of Fruit & Cream
Smoothies utilizing a "shelf stable" re-sealable plastic bottle for milk
products that does not require refrigeration. Until that launch, all single
served flavored milk in plastic bottles required refrigeration for storage,
distribution, and shelf placement. The tactical advantage of distributing milk
products ambient enables us to side-step a major entry barrier in our immediate
consumption strategy. Refrigerated milk is relegated to dairy
direct-store-delivery systems that are controlled by either regional dairy
processors or larger national dairy holding companies. Shelf stable re-sealable
plastic bottle allows us to use a more traditional distribution network that
accommodates the non-refrigerated beverages. Also, milk products packaged in
shelf stable re-sealable plastic bottles have significantly longer shelf life
for storage, allowing us to ship in full truckloads resulting in decreased
freight costs. We currently are converting all of our products to "shelf stable"
re-sealable plastic bottles.
On August 31, 2005, we entered into a Master Distribution Agreement with
Coca-Cola Enterprises, Inc., which included the attendant grant of three year
warrants by CCE for the right to purchase 30 million shares of the Company's
common stock at an exercise price of $0.36 per share. The ten year exclusive
Master Distribution Agreement will expand significantly the distribution and
sales of our products. The Company capitalized a $15,960,531 intangible asset
associated with this agreement, which will be amortized over the 10-year term of
the Master Distribution Agreement.
On November 28, 2005, we closed a funding transaction with 13 accredited
institutional investors, for the issuance and sale of 40,500,000 shares of our
common stock for a purchase price of $20,250,000. In addition, we also issued
five-year warrants for the purchase of an additional 15,187,500 shares of common
stock at an exercise price of $0.80 per share. The securities are restricted and
have been issued pursuant to an exemption to the registration requirements of
Section 5 of the Securities Act of 1933 for "transactions of the issuer not
involving any public offering" provided in Section 4(2) of the Act and pursuant
to a Regulation D offering. In connection with this financing, we issued common
stock purchase warrants to purchase 1,012,500 shares of common stock at an
exercise price of $.50 per share and 304,688 shares of common stock at an
exercise price of $.80 per share to SG Cowen & Co., LLC, who acted as placement
agent for this financing.
EFFECTS OF INFLATION
We believe that inflation has not had any material effect on our net sales
and results of operations.
ITEM 7. - FINANCIAL STATEMENTS
The consolidated financial statements for the years ended December 31,
2005 and 2004 are contained on Pages F-1 to F-69 which follow.
22
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005 and 2004
F-1
BRAVO! BRANDS INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-3
Consolidated Financial Statements
Consolidated Balance Sheets F-4 to F-5
Consolidated Statements of Operations and Comprehensive Loss F-6
Consolidated Statements of Cash Flows F-7 to F8
Consolidated Statements of Stockholders' Deficit F-9
Notes to Consolidated Financial Statements F-10 to F-69
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Bravo! Brands Inc.
North Palm Beach, Florida
We have audited the accompanying consolidated balance sheets of Bravo! Brands
Inc. (formerly Bravo! Foods International Corp.) as of December 31, 2005 and
2004 and the related consolidated statements of operations and comprehensive
loss, stockholders' deficit and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Bravo! Brands Inc. as of
December 31, 2005 and 2004 and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company incurred a net loss of $79,528,653 for the year ended December 31,
2005 and as of that date had a working capital deficiency of $39,287,983. The
Company is also delinquent in payment of certain debts. These conditions raise
substantial doubt about their ability to continue as a going concern.
Management's actions in regard to these matters are more fully described in Note
1. The financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets, or the amounts and
classification of liabilities that might be necessary in the event the Company
cannot continue in existence.
As more fully described in Note 13 to the consolidated financial statements, the
accompanying consolidated balance sheets as of December 31, 2005 and 2004, and
the related consolidated statements of operations and comprehensive loss,
stockholders' deficit and cash flows for the years then ended, have been
restated to reflect the proper accounting for certain transactions.
/s/ Lazar Levine & Felix LLP
New York, New York
February 9, 2006, except for Note 13
as to which the date is September 8, 2006
F-3
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------
2005 2004
(Restated) (Restated)
------------------------------
Assets
Current assets:
Cash and cash equivalents $ 4,947,986 $ 113,888
Accounts receivable, net of allowance for doubtful accounts of
$350,000 and $90,396 for 2005 and 2004, respectively 3,148,841 51,968
Inventories 391,145 11,656
Prepaid expenses 973,299 387,866
------------- ------------
Total current assets 9,461,271 565,378
Fixed assets 288,058 111,206
Intangible assets, net 18,593,560 77,038
Other assets 15,231 342,186
------------- ------------
Total assets $ 28,358,120 $ 1,095,808
============= ============
See accompanying notes
F-4
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
Liabilities, Redeemable Preferred Stock and Stockholders' Deficit
Current liabilities:
Accounts payable $ 5,987,219 $ 1,763,339
Accrued liabilities 4,872,277 444,986
Notes payable 937,743 1,184,858
Convertible notes payable 1,012,780 1,099,231
Derivative liabilities 35,939,235 10,835,629
------------- ------------
Current and total liabilities 48,749,254 15,328,043
------------- ------------
Commitments and contingencies (Note 11) - -
Redeemable preferred stock:
Series F convertible, par value $0.001 per share, 200,000 shares designated
Convertible Preferred Stock, stated value $10.00 per share,
5,248 and 55,515 shares issued and outstanding 52,480 555,150
Series H convertible, par value $0.001 per share, 350,000 shares designated,
7% Cumulative Convertible Preferred Stock, stated value
$10.00 per share, 64,500 and 165,500 shares issued and outstanding 388,305 840,215
Series I convertible, par value $0.001 per share, 200,000 shares designated,
8% Cumulative Convertible Preferred Stock, stated value
$10.00 per share, 0 and 30,000 shares issued and outstanding - 300,000
Series J, par value $0 001 per share, 500,000 shares designated, 8% Cumulative
Convertible Preferred Stock, stated value $10.00 per share,
200,000 shares issued and outstanding 871,043 485,825
Series K, par value $0 001 per share, 500,000 shares designated, 8%
Cumulative Convertible Preferred Stock, stated value $10.00 per share,
95,000 shares issued and outstanding 792,672 750,265
------------- ------------
Total redeemable preferred stock 2,104,500 2,931,455
------------- ------------
Stockholders' Deficit:
Preferred stock, 5,000,000 shares authorized
Series B convertible, par value $0.001 per share, 1,260,000 shares designated,
9% Convertible Preferred Stock, stated value $1.00 per
share, 107,440 shares issued and outstanding 107,440 107,440
Common stock, par value $0.001 per share, 300,000,000 shares
authorized, 184,253,753 and 184,254, 501 shares issued and outstanding 184,254 57,791
Additional paid-in capital 96,507,932 21,387,210
Common stock subscription receivable (10,000) -
Accumulated deficit (119,254,501) (38,716,131)
Translation adjustment (30,759) -
------------- ------------
Total stockholders' deficit (22,495,634) (17,163,690)
------------- ------------
Total liabilities, redeemable preferred stock and stockholders' deficit $ 28,358,120 $ 1,095,808
============= ============
See accompanying notes
F-5
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
Years ended December 31,
------------------------------
2005 2004
------------------------------
(Restated) Restated)
Revenues $ 11,948,921 $ 3,344,699
Product costs (8,938,692) (2,374,805)
Shipping costs (1,505,035) (498,313)
------------- ------------
Gross margin 1,505,194 471,581
Operating expenses:
Selling 7,464,876 1,300,673
General and administrative 7,263,284 2,677,061
Product development 636,342 206,129
Non-recurring finder's fee 3,000,000 -
------------- ------------
Loss from operations (16,859,308) (3,712,282)
Other income (expenses), net:
Derivative income (expense) (60,823,574) (6,309,933)
Interest (1,667,294) (1,435,405)
Other 125,273 (60,000)
Liquidated damages (303,750) -
------------- ------------
Loss before income taxes (79,528,653) (11,517,620)
Provision for income taxes - -
------------- ------------
Net loss (79,528,653) (11,517,620)
Adjustments to net loss to arrive at loss applicable to common stockholders:
Preferred stock dividends (336,300) (388,632)
Accretion of preferred stock (985,717) (599,388)
------------- ------------
Loss applicable to common stockholders $ (80,850,670) $(12,505,640)
============= ============
Basic and diluted loss per common share $ (0.60) $ (0.31)
============= ============
Weighted average number of common shares outstanding 135,032,836 40,229,738
============= ============
Comprehensive loss and its components consist of the following:
Net loss $ (79,528,653) $(11,517,620)
Foreign currency translation adjustment (30,759) (689)
------------- ------------
Comprehensive loss $ (79,559,412) $(11,518,309)
============= ============
See accompanying notes
F-6
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Years ended December 31,
------------------------------
2005 2004
(Restated) (Restated)
------------ ------------
Cash flows from operating activities:
Net loss $(79,528,653) $(11,517,620)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 2,251,646 239,853
Stock issuances for compensation 346,438 675,632
Equity instruments to be issued for consulting expenses 1,472,261 -
Options issued for compensation 798,869 153,631
Bad debt expense 259,604 51,170
(Gain) loss on debt extinguishment (125,273) 60,000
Derivative expense 60,823,574 6,309,933
Amortization of debt discount 1,428,638 1,175,245
Loss on disposal of fixed assets - 6,216
Increase (decrease) in cash from changes in:
Accounts receivable (3,356,477) (77,217)
Other receivable - 6,331
Inventories (379,489) 43,339
Prepaid expenses and other assets (586,764) (214,094)
Accounts payable and accrued expenses 7,294,548 (542,282)
------------ ------------
Net cash used in operating activities (9,301,078) (3,629,863)
------------ ------------
Cash flows from investing activities:
Licenses and trademark costs (3,823,521) (452,311)
Purchase of equipment (220,144) (78,952)
------------ ------------
Net cash used in investing activities (4,043,665) (531,263)
------------ ------------
Cash flows from financing activities:
Proceeds from sale of preferred stock - 950,000
Exercise of warrants 3,208,509 -
Proceeds from convertible notes payable 2,850,000 3,427,500
Proceeds from sale of common stock and warrants 20,690,000 30,000
Payments for redemption of warrants (5,900,000) -
Payment of note payable (500,000) (150,000)
Registration costs of financing (2,138,909) (40,656)
------------ ------------
Net cash provided by financing activities 18,209,600 4,216,844
------------ ------------
Effect of changes in exchange rate on cash (30,759) (689)
------------ ------------
Net increase in cash and cash equivalents 4,834,098 55,029
Cash and cash equivalents, beginning of period 113,888 58,859
------------ ------------
Cash and cash equivalents, end of period $ 4,947,986 $ 113,888
============ ============
See accompanying notes
F-7
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
Supplemental Cash Flow Information (Restated) (Restated)
------------ ------------
Cash paid during the year for interest $ 10,741 $ 51,301
============ ============
Cash paid for taxes $ - $ -
============ ============
Non-cash investing and financing activities:
Purchase of intangible assets with derivative warrants $ 15,960,531 $ 612,538
============ ============
Conversion of notes payable and accrued interest $ 20,343,934 $ 531,494
============ ============
Conversion of redeemable preferred stock and related dividends $ 2,644,326 $ 927,146
============ ============
Exercise of derivative warrants $ 35,230,018 $ -
============ ============
Beneficial Conversion Feature $ - $ 220,000
============ ============
See accompanying notes
F-8
BRAVO! BRANDS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Accumulated
Additional Common Stock Other
Preferred Stock Common Stock Paid In Accumulated Subscription Comprehensive
Shares Amount Shares Amount Capital Deficit Receivable Loss Total
Balance, January 1, 2004
(Restated) 107,440 $107,440 28,047,542 $ 28,045 $18,430,875 $ (26,556,046) $ - $ 689 $ (7,988,997)
Issuance of common stock
for services - - 9,332,300 9,332 666,300 - - - 675,632
Conversion redeemable
preferred stock and
dividends - - 15,897,701 15,898 1,553,713 (642,465) - - 927,146
Conversion notes payable - - 4,265,958 4,266 527,228 - - - 531,494
Private Placement
financing - - 250,000 250 29,750 - - - 30,000
Beneficial conversion
feature - - - - 220,000 - - - 220,000
Financing Costs - - - - (40,656) - - - (40,656)
Net loss for 2004 - - - - - (11,517,620) - - (11,517,620)
Translation adjustment - - - - - - - (689) (689)
--------------------------------------------------------------------------------------------------------
Balance, December 31,
2004 (Restated) 107,440 107,440 57,793,501 57,791 21,387,210 (38,716,131) - - (17,163,690)
Conversion redeemable
preferred stock and
dividends - - 9,245,352 9,247 2,659,079 (24,000) - - 2,644,326
Exercise of warrants - - 32,474,792 32,475 38,406,052 - - - 38,438,527
Conversion notes payable - - 41,248,858 41,249 20,302,685 - - - 20,343,934
Private placement
financing - - 40,950,000 40,950 20,649,050 - - - 20,690,000
Common stock subscribed
but not paid - - - - - - (10,000) - (10,000)
Stock issued for
compensation - - 2,541,250 2,542 343,896 - - - 346,438
Financing costs - - - - (2,138,909) - - - (2,138,909)
Stock option expense - - - - 798,869 - - - 798,869
Redemption of warrants - - - - (5,900,000) - - - (5,900,000)
Accretion of preferred
stock - - - - - (985,717) - - (985,717)
Net loss for 2005 - - - - - (79,528,653) - - (79,528,653)
Translation adjustment - - - - - - - (30,759) (30,759)
--------------------------------------------------------------------------------------------------------
Balance, December 31,
2005 (Restated) 107,440 $107,440 184,253,753 $184,254 $96,507,932 $(119,254,501) $(10,000) $(30,759) $(22,495,634)
========================================================================================================
See accompanying notes
F-9
BRAVO! BRANDS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2005 AND 2004
Note 1 - Nature of Business, Liquidity and Management's Plans and Significant
Accounting Policies
Nature of Business:
We are engaged in the sale of flavored milk products and flavor ingredients in
the United States, the United Kingdom, Central America and the Middle East, and
we are establishing an infrastructure to conduct business in Canada.
Liquidity and Management's Plans:
As reflected in the accompanying consolidated financial statements, we have
incurred operating losses and negative cash flows from operations and have a
working capital deficiency of $39,287,983 as of December 31, 2005. In addition,
we are delinquent on certain of our debt agreements at December 31, 2005, and we
have experienced delays in filing our financial statements and registration
statements due to errors in our historical accounting that have been corrected
(See Note 13). Our inability to make these filings is resulting in our
recognition of penalties to the investors, and these penalties will continue
until we can complete our filings and register the common shares into which the
investors' financial instruments are convertible. Finally, our revenues are
significantly concentrated with one major customer. The loss of this customer or
curtailment in business with this customer could have a material adverse affect
on our business. These conditions raise substantial doubt about our ability to
continue as a going concern.
We have been dependent upon third party financings as we execute our business
model and plans. We completed a $30.0 million convertible note financing in
August 2006 that is expected to fulfill our liquidity requirements through the
end of 2006. However, $15.0 million of this financing is held in escrow, pending
approval by our shareholders of an increase in our authorized shares of common
stock. We were in default on this instrument due to the delay in filing our
quarterly financial report for the quarterly period ended June 30, 2006. As a
result, an event of default has occurred under the terms of the Notes and the
interest rate on the Notes, payable quarterly, was increased from 9% to 14% per
annum. Pursuant to the terms of the Notes, upon the occurrence of an event of
default, holders of the Notes may, upon written notice to the Company, each
require the Company to redeem all or any portion of their Notes, at a default
redemption price calculated pursuant to the terms of the Notes. During September
2006, we entered into an Amendment Agreement with the holders of the Notes to
amend the Notes in certain respects as consideration for the holders' release of
the Company's default resulting from its delay in the filing of our Form 10-QSB
for the quarter ended June 30, 2006.
We plan to increase our sales, improve our gross profit margins, augment our
international business and, if necessary, obtain additional financing.
Ultimately, our ability to continue is dependent upon the achievement of
profitable operations. There is no assurance that further funding will be
available at acceptable terms, if at all, or that we will be able to achieve
profitability.
The accompanying financial statements do not reflect any adjustments that may
result from the outcome of this uncertainty.
Significant Accounting Policies:
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the
F-10
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 revenues and expenses during the reporting period. The most significant
estimates included in our financial statements are the following:
- Estimating future bad debts on accounts receivable that are carried at net
realizable values.
- Estimating our reserve for unsalable and obsolete inventories that are
carried at lower of cost or market.
- Estimating the fair value of our financial instruments that are required
to be carried at fair value.
- Estimating the recoverability of our long-lived assets.
We use all available information and appropriate techniques to develop our
estimates. However, actual results could differ from our estimates.
Business Segment and Geographic Information
-------------------------------------------
We operate in one dominant industry segment that we have defined as the single
serve flavored milk industry. While our international business is expected to
grow in the future, it currently contributes less than 10% of our revenues, and
we have no physical assets outside of the United States.
Revenue Recognition
-------------------
Our revenues are derived from the sale of branded milk products to customers in
the United States of America, Great Britain and the Middle East. Geographically,
our revenues are dispersed 98% and 2% between the United States of America and
internationally, respectively. We currently have one customer in the United
States that provided 34% and 0% of our revenue during the years ended December
31, 2005 and 2004, respectively. Since we commenced business with this customer
during our fourth fiscal quarter of 2005, we expect that our revenue from this
customer will increase as a percentage of total sales in the near future.
Revenues are recognized pursuant to formal revenue arrangements with our
customers, at contracted prices, when our product is delivered to their premises
and collectibility is reasonably assured. We extend merchantability warranties
to our customers on our products but otherwise do not afford our customers with
rights of return. Warranty costs have historically been insignificant.
Our revenue arrangements often provide for industry-standard slotting fees where
we make cash payments to the respective customer to obtain rights to place our
products on their retail shelves for a stipulated period of time. We also engage
in other promotional discount programs in order to enhance our sales activities.
We believe our participation in these arrangements is essential to ensuring
continued volume and revenue growth in the competitive marketplace. These
payments, discounts and allowances are recorded as reductions to our reported
revenue. Unamortized slotting fees are recorded in prepaid expenses.
Principles of Consolidation
---------------------------
Our consolidated financial statements include the accounts of Bravo! Brands Inc.
(the "Company"), and its wholly-owned subsidiary Bravo! Brands (UK) Ltd. All
material intercompany balances and transactions have been eliminated. Cumulative
translation adjustments that we make to reflect the accounts of Bravo! Brands
(UK) Ltd. in United States Dollars are recorded as a component of other
comprehensive income (loss) and stockholder's equity. Foreign currency
transaction gains and losses are reported as a component of other income
(expense).
F-11
Shipping and Handling Costs
---------------------------
Shipping and handling costs incurred to deliver products to our customers are
included as a component of cost of sales. These costs amounted to approximately
$1,505,035 and $498,313 for the years ended December 31, 2005 and 2004,
respectively.
Cash and Cash Equivalents
-------------------------
We consider all highly liquid investments purchased with a remaining maturity of
three months or less to be cash equivalents.
Accounts Receivable
-------------------
Our accounts receivable are exposed to credit risk. During the normal course of
business, we extend unsecured credit to our customers with normal and
traditional trade terms. Typically credit terms require payments to be made by
the thirtieth day following the sale. We regularly evaluate and monitor the
creditworthiness of each customer. We provide an allowance for doubtful accounts
based on our continuing evaluation of our customers' credit risk and our overall
collection history. As of December 31, 2005 and 2004, the allowance of doubtful
accounts aggregated $350,000 and $90,396, respectively.
In addition, our accounts receivable are concentrated with one customer that
represents 70% and 0% of our gross accounts receivable balances at December 31,
2005 and 2004, respectively. Approximately 2% of our gross accounts receivable
at December 31, 2005 are due from international customers.
Inventories
-----------
Inventories, which consist primarily of finished goods, are stated at the lower
of cost on the first in, first-out method or market. Further, our inventories
are perishable. Accordingly, we estimate and record lower-of-cost or market and
unsalable-inventory reserves based upon a combination of our historical
experience and on a specific identification basis. During the years ended
December 31, 2005 and 2004, we did not provide for unsaleable inventories.
In November 2004, the FASB issued Financial Accounting Standard No. 151,
Inventory Costs, an amendment of ARB No. 43 Chapter 4 (FAS 151), which clarifies
that inventory costs that are "abnormal" are required to be charged to expense
as incurred as opposed to being capitalized into inventory as a product cost.
FAS 151 provides examples of "abnormal" costs to include costs of idle
facilities, excess freight and handling costs and spoilage. FAS 151 will become
effective for our fiscal year beginning January 1, 2006. The adoption of FAS No.
151 is not expected to have a material effect on our consolidated financial
statements.
Fixed Assets
------------
Fixed assets are stated at cost. Depreciation is computed using the
straight-line method over a period of seven years for furniture and five years
for equipment. Maintenance, repairs and minor renewals are charged directly to
expenses as incurred. Additions and betterments to property and equipment are
capitalized. When assets are disposed of, the related cost and accumulated
depreciation thereon are removed from the accounts, and any resulting gain or
loss is included in the statement of operations.
F-12
Intangible Assets
-----------------
Our intangible assets, which we record at cost, consist of our distribution
agreement with Coca-Cola Enterprises ("CCE") that we entered into during the
third fiscal quarter of 2005, our manufacturing agreement with Jasper Products,
Inc. and licenses and trademark costs with estimated lives of ten years, five
years and one-to-five years, respectively.
Impairment of Long-Lived Assets
-------------------------------
We evaluate the carrying value and recoverability of our long-lived assets when
circumstances warrant such evaluation by applying the provisions of Financial
Accounting Standard No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets ("FAS 144"). FAS 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value.
Financial Instruments
---------------------
Financial instruments, as defined in Financial Accounting Standard No. 107
Disclosures about Fair Value of Financial Instruments (FAS 107), consist of
cash, evidence of ownership in an entity and contracts that both (i) impose on
one entity a contractual obligation to deliver cash or another financial
instrument to a second entity, or to exchange other financial instruments on
potentially unfavorable terms with the second entity, and (ii) conveys to that
second entity a contractual right (a) to receive cash or another financial
instrument from the first entity or (b) to exchange other financial instruments
on potentially favorable terms with the first entity. Accordingly, our financial
instruments consist of cash and cash equivalents, accounts receivable, accounts
payable, accrued liabilities, notes payable, derivative financial instruments,
convertible debt and redeemable preferred stock that we have concluded is more
akin to debt than equity.
We carry cash and cash equivalents, accounts receivable, accounts payable, and
accrued liabilities at historical costs; their respective estimated fair values
approximate carrying values due to their current nature. We also carry notes
payable, convertible debt and redeemable preferred stock at historical cost;
however, fair values of debt instruments and redeemable preferred stock are
estimated for disclosure purposes (below) based upon the present value of the
estimated cash flows at market interest rates applicable to similar instruments.
As of December 31, 2005, estimated fair values and respective carrying values of
our notes payable, convertible debt and redeemable preferred stock are as
follows:
Instrument Note Fair Value Carrying Value
----------------------------------------------------------------------------
$750,000 Notes Payable 5(a) $ 750,000 $ 750,000
$187,843 Notes Payable 5(b) 187,743 187,743
Other Notes Payable 5(c) 0 0
$200,000 Convertible Note Payable 6(a) 190,000 187,934
$ 15,000 Convertible Note Payable 6(b) 13,300 1,620
$600,000 Convertible Note Payable 6(c) 668,000 600,000
$ 6,250 Convertible Note Payable 6(e) 6,375 5,188
$ 25,000 Convertible Note Payable 6(f) 25,500 30,278
$187,760 Convertible Note Payable 6(g) 187,760 187,760
Series F Preferred Stock 7(d) 46,000 52,480
Series H Preferred Stock 7(a) 525,000 388,305
Series I Preferred Stock 7(d) 0 0
Series J Preferred Stock 7(b) 1,731,000 871,043
Series K Preferred Stock 7(c) 881,000 792,672
As of December 31, 2004, estimated fair values and respective carrying values of
our notes payable, convertible debt and redeemable preferred stock are as
follows:
Instrument Fair Value Carrying Value
------------------------------------------------- ---------------- ----------------
$750,000 face value note payable $ 750,000 $ 750,000
================ ================
$187,743 face value note payable 187,743 187,743
================ ================
$275,000 note payable, due 11.30.06 246,621 175,055
================ ================
$600,000 convertible note payable, due 12.31.05 568,421 240,088
================ ================
$1,008,000 convertible note payable, due 11.30.05 1,679,832 402,607
================ ================
$577,500 convertible note payable, due 4.30.06 547,377 73,057
================ ================
$375,000 convertible note payable, due 10.1.06 339,901 208,424
================ ================
Other notes payable 247,115 247,115
================ ================
Series F Preferred Stock 555,150 555,150
================ ================
Series H Preferred Stock 1,459,846 840,215
================ ================
Series I Preferred Stock 260,778 300,000
================ ================
Series J Preferred Stock 1,701,772 485,825
================ ================
Series K Preferred Stock 729,429 750,265
================ ================
F-13
Derivative financial instruments, as defined in Financial Accounting Standard
No. 133, Accounting for Derivative Financial Instruments and Hedging Activities
(FAS 133), consist of financial instruments or other contracts that contain a
notional amount and one or more underlying (e.g. interest rate, security price
or other variable), require no initial net investment and permit net settlement.
Derivative financial instruments may be free-standing or embedded in other
financial instruments. Further, derivative financial instruments are initially,
and subsequently, measured at fair value and recorded as liabilities or, in rare
instances, assets.
We generally do not use derivative financial instruments to hedge exposures to
cash-flow, market or foreign-currency risks. However, we have entered into
certain other financial instruments and contracts, such as debt financing
arrangements, redeemable preferred stock arrangements, and freestanding warrants
with features that are either (i) not afforded equity classification, (ii)
embody risks not clearly and closely related to host contracts, or (iii) may be
net-cash settled by the counterparty. As required by FAS 133, these instruments
are required to be carried as derivative liabilities, at fair value, in our
financial statements.
The following table summarizes the components of derivative liabilities as of
December 31, 2005 and 2004:
Note 2005 2004
----------------------------------------
Compound derivative financial instruments that have been
bifurcated from the following financing arrangements:
--------------------------------------------------------
$ 400,000 Convertible Note Financing 6(a) $ (1,311,000) $ (201,000)
$2,300,000 Convertible Note Financing 6(b) (4,867) -
$ 600,000 Convertible Note Financing 6(c) (153,700) (27,833)
$ 693,000 Convertible Note Financing 6(e) (42,878) (794,750)
$ 660,000 Convertible Note Financing 6(f) (159,250) (440,648)
$1,008,000 Convertible Note Financing 6(g) - (378,756)
$ 240,000 Convertible Note Financing 6(d) - (258,400)
Series F Preferred Stock Financing 7(d) (25,632) (247,562)
Series H Preferred Stock Financing 7(a) (381,377) (156,927)
Series I Preferred Stock Financing 7(b) - (10,400)
Series J Preferred Stock Financing 7(b) (5,628,000) (728,000)
Series K Preferred Stock Financing 7(c) (206,200) (73,644)
Freestanding derivative contracts arising from financing
and other business arrangements:
--------------------------------------------------------
Warrants issued with $693,000 Convertible Notes 6(e) (924,120) (330,220)
Warrants issued with $400,000 Convertible Notes 6(a) - (1,264,600)
Warrants issued with $600,000 Convertible Notes 6(c) - (904,100)
Warrants issued with $660,000 Convertible Notes 6(f) - (446,400)
Warrants issued with $1,008,000 Convertible Notes 6(g) (564,735) (1,446,560)
Warrants issued with $240,000 Convertible Notes 6(d) - (121,040)
Warrants issued with Series H Preferred Stock 7(a) (1,264,109) (376,212)
Warrants issued with Series I Preferred Stock 7(i) - (177,257)
Warrants issued with Series F Preferred Stock 7(d) (563,096) (648,004)
Warrants issued with Series D Preferred Stock 7(d) (400,214) (188,982)
Warrants issued with Series J Preferred Stock 7(b) - (1,088,000)
Other warrants, including warrants issued with common
stock financing 9(b) (24,310,057) (526,334)
------------------------------
Total derivative liabilities $(35,939,235) $(10,835,629)
==============================
F-14
See the notes referenced in the table for details of the origination and
accounting for these derivative financial instruments. We estimate fair values
of derivative financial instruments using various techniques (and combinations
thereof) that are considered to be consistent with the objective measuring fair
values. In selecting the appropriate technique, we consider, among other
factors, the nature of the instrument, the market risks that it embodies and the
expected means of settlement. For less complex derivative instruments, such as
freestanding warrants, we generally use the Black-Scholes-Merton option
valuation technique because it embodies all of the requisite assumptions
(including trading volatility, estimated terms and risk free rates) necessary to
fair value these instruments. For complex derivative instruments, such as
embedded conversion options, we generally use the Flexible Monte Carlo valuation
technique because it embodies all of the requisite assumptions (including credit
risk, interest-rate risk and exercise/conversion behaviors) that are necessary
to fair value these more complex instruments. For forward contracts that
contingently require net-cash settlement as the principal means of settlement,
we project and discount future cash flows applying probability-weightage to
multiple possible outcomes. Estimating fair values of derivative financial
instruments requires the development of significant and subjective estimates
that may, and are likely to, change over the duration of the instrument with
related changes in internal factors and external market indicators. In addition,
option-based techniques are highly volatile and sensitive to changes in our
trading market price which has a high-historical volatility. Since derivative
financial instruments are initially and subsequently carried at fair values, our
income will reflect the volatility in these estimate and assumption changes.
The following table summarizes the effects on our income (loss) associated with
changes in the fair values of our derivative financial instruments by type of
financing for the years ended December 31, 2005 and 2004:
Derivative income (expense): 2005 2004
-----------------------------
Convertible note and warrant financings $(42,172,053) $(3,432,061)
Preferred stock and warrant financings (11,314,733) (2,561,043)
Other warrants and derivative contracts (7,336,788) (316,829)
-----------------------------
$(60,823,574) $(6,309,933)
=============================
Additional information related to individual financings can be found in notes 6,
7 & 9.
Our derivative liabilities as of December 31, 2005 and 2004, and our derivative
loss during each of the years ended December 31, 2005 and 2004 is significant to
our consolidated financial statements. The magnitude of the derivative loss
during the year ended December 31, 2005 when compared with the loss for the year
ended December 31, 2004 reflects the following:
(a) During the year ended December 31, 2005, and specifically commencing in the
second quarter, the trading price of our common stock reached significantly high
levels relative to its trend. The trading price of our common stock
significantly affects the fair value of our derivative financial instruments. To
illustrate, our trading stock price at the end of the first quarter of 2005 was
$0.15 and then increased to $0.93 by the end of the second quarter. Our trading
stock price then declined to $0.61 and $0.59 at the end of the third and fourth
quarters, respectively. However, the higher stock price had the effect of
significantly increasing the fair value of our derivative liabilities and,
accordingly, we were required to adjust the derivatives to these higher values
with charges to our income. Also, due to the higher stock price commencing in
the second quarter, we experienced significant exercise and conversion activity
related to our derivative warrants and, to a lesser degree, with respect to the
embedded conversion options. Accordingly, our year end derivative liability
balances reflect, among other elements of our valuation assumptions, the higher
intrinsic values of the arrangements caused by the significant changes
F-15
in our stock price, which are offset by a smaller number of common shares
indexed to outstanding warrants due to the extraordinary level of exercise
activity.
(b) During the year ended December 31, 2005, we entered into a $2,300,000 debt
and warrant financing arrangement, more fully discussed in Note 6(b). In
connection with our accounting for this financing we encountered the unusual
circumstance of a day-one loss related to the recognition of derivative
instruments arising from the arrangement. That means that the fair value of the
bifurcated compound derivative and warrants exceeded the proceeds that we
received from the arrangement and we were required to record a loss to record
the derivative financial instruments at fair value. The loss that we recorded
amounted to $8,663,869. We did not enter into any other financing arrangements
during the periods reported that reflected day-one losses.
The following table summarizes the number of common shares indexed to the
derivative financial instruments as of December 31, 2005:
Conversion
Financing or other contractual arrangement: Note Features Warrants Total
---------------------------------- --------------
$ 400,000 Convertible Note Financing 6(a) 4,320,000 - 4,320,000
$2,300,000 Convertible Note Financing 6(b) 120,000 2,000,000 2,120,000
$ 600,000 Convertible Note Financing 6(c) 4,100,000 - 4,100,000
$ 693,000 Convertible Note Financing 6(e) 65,104 1,700,000 1,765,104
$ 660,000 Convertible Note Financing 6(f) 250,000 1,500,000 1,750,000
$1,080,000 Convertible Note Financing 6(g) 1,924,540 - 1,924,540
Series D Convertible Preferred Stock 7(d) - 611,250 611,250
Series F Convertible Preferred Stock 7(d) 220,969 1,038,259 1,259,228
Series H Convertible Preferred Stock(a) 7(a) - 4,387,500 4,387,500
Series J Convertible Preferred Stock 7(b) 20,000,000 - 20,000,000
Series K Convertible Preferred Stock(a) 7(c) - - -
Other warrants and contracts 9(b) - 49,504,688 49,504,688
------------------------- --------------
31,000,613 60,741,697 91,742,310
========================================
(a) As more fully described in Notes 7(a) and 7(c) these instruments were
afforded the conventional convertible exemption, which means we did not
have to bifurcate the embedded conversion feature. However, we were
required to bifurcate certain other embedded derivatives as discussed in
the notes. Although the conversion features did not require derivative
accounting, we are required to also consider the 953,443 and 9,500,000
common shares, respectively, into which these instruments are indexed in
determining whether we have sufficient authorized and unissued common
shares for all of our share-settled obligations.
We have entered into registration rights agreements with certain investors that
require us to file a registration statement covering shares underlying a
financing arrangement, become effective on the registration statement, maintain
effectiveness and, in some instances, maintain the listing of the underlying
shares. Certain of these registration rights agreements require our payment of
liquidating damages to the investors in the event we do not achieve the
requirements. We record estimated liquidated damages as liabilities and charges
to our income when the liquidated damages are probable and estimable under
Financial Accounting Standard No. 5 Accounting for Contingencies. During the
years ended December 31, 2005 and 2004, we recorded liquidated damages expense
of $303,750 and $0, respectively.
Advertising and Promotion Costs
-------------------------------
Advertising and promotion costs, which are included in selling expenses, are
expensed as incurred and aggregated $2,515,062 and $656,614 for the years ended
December 31, 2005 and 2004, respectively.
Share-Based Payments
--------------------
Prior to 2005, we accounted for our stock options under the recognition and
measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. Effective January 1, 2005, the Company
adopted the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock Based Compensation ("FAS 123"). Under the modified
prospective method of adoption selected by the Company under the provisions of
FASB Statement No. 148, Accounting for Stock Based
F-16
Compensation - Transition and Disclosure ,("FAS 148") compensation costs
recognized in 2005 were the same as that which would have been recognized had
the recognition provisions of FAS 123 been applied from the options' grant
dates. This is because all outstanding options at December 31, 2004 were fully
vested on that date. Consistent with the requirements of this method of
adoption, results for prior years have not been restated. We recognized no tax
benefit for share-based compensation arrangements due to the fact that we are in
a cumulative loss position and recognize no tax benefits in our Consolidated
Statements of Operations. For further information regarding the adoption of SFAS
No. 123, see Note 8 to the consolidated financial statements.
Income Taxes
------------
We account for income taxes using the liability method, which requires an entity
to recognize deferred tax liabilities and assets. Deferred income taxes are
recognized based on the differences between the tax bases of assets and
liabilities and their reported amounts in the financial statements that will
result in taxable or deductible amounts in future years. Further, the effects of
enacted tax laws or rate changes are included as part of deferred tax expense or
benefit in the period that covers the enactment date. A valuation allowance is
recognized if it is more likely than not that some portion, or all, of a
deferred tax asset will not be realized.
Loss Per Common Share
---------------------
Our basic loss per common share is computed by dividing loss applicable to
common stockholders by the weighted average number of common share outstanding
during the reporting period. Diluted loss per common share is computed similar
to basic loss per common share except that diluted loss per common share
includes dilutive common stock equivalents, using the treasury stock method, and
assumes that the convertible debt instruments were converted into common stock
upon issuance, if dilutive. For the years ended December 31, 2005 and 2004
potential common shares arising from our stock options, stock warrants,
convertible debt and convertible preferred stock amounting to 108,059,082 and
126,767,057 shares, respectively, were not included in the computation of
diluted loss per share because their effect was antidilutive.
Note 2 - Fixed Assets
Our fixed assets are comprised of the following as of December 31, 2005 and
2004:
2005 2004
---- ----
Office equipment $ 209,085 $ 151,577
Furniture and fixtures 189,068 150,871
Automobiles 29,295 -
Leasehold improvements 23,714 23,714
Purchased software 3,223 3,223
--------- ---------
454,385 329,385
Less: accumulated depreciation and amortization (166,327) (218,179)
--------- ---------
$ 288,058 $ 111,206
========= =========
Depreciation and amortization expense of fixed assets aggregated $43,292 and
$30,153 for 2005 and 2004, respectively.
F-17
Note 3 - Intangible Assets
Our intangible assets consist of our distribution agreement with Coca-Cola
Enterprises ("CCE"), our manufacturing agreement with Jasper Products, Inc. and
licenses and trademark costs, with estimated lives of ten years, five years and
one-to-five years, respectively. The following table summarizes the components
of our intangible assets as of December 31, 2005 and 2004:
2005 2004
---- ----
Distribution agreement $15,960,531 $ -
Manufacturing agreement 2,700,000 -
Licenses and trademarks 1,370,958 365,431
Less accumulated amortization (1,437,929) (288,393)
----------- ---------
$18,593,560 $ 77,038
=========== =========
Amortization expense amounted to $1,411,004 and $269,242 for the years ended
December 31, 2005 and 2004, respectively.
Estimated future amortization of our intangible assets for each of the next five
years is as follows as of December 31, 2005:
December 31, 2006 $2,685,671
==========
December 31, 2007 $2,367,947
==========
December 31, 2008 $2,356,342
==========
December 31, 2009 $2,355,844
==========
December 31, 2010 $2,203,289
==========
Note 4 - Accrued Liabilities
Accrued liabilities consist of the following as of December 31, 2005 and
December 31, 2004:
2005 2004
---- ----
Investor relations liability $1,545,565 $ -
Production processor liability 182,814 -
Accrued payroll and related 636,757 15,000
Accrued interest 376,198 255,173
Discontinued products (a) 1,710,733 -
Liquidated damages due to late registraton (b) 303,750 -
Other 116,460 174,813
---------- --------
$4,872,277 $444,986
========== ========
(a) During the year ended December 31, 2005, we discontinued certain product
lines and, as a result, incurred certain penalties under purchase
commitments with our manufacturing vendors. We accrued these penalties
upon our decision to discontinue the products.
(b) Certain of our financings provide for penalties in the event of
non-registration of securities underlying the financial instruments.
Generally, these penalties are calculated as a percentage of the financing
proceeds, usually between 1.0% and 3.0% monthly. We record these
liquidated damages when they are probable and estimable pursuant to FAS 5.
Note 5 -- Notes Payable
Notes payable consist of the following as of December 31, 2005 and 2004:
2005 2004
---- ----
$750,000 face value note payable, due September 3, 2004 (a) $750,000 $ 750,000
$187,743 face value note payable, due December 31, 2005 (b) 187,743 187,743
$100,000 face value note payable due February 1, 2002 (c) - 100,000
F-18
Other 147,115
-------- ----------
Total notes payable 937,743 1,184,858
Less current maturities 937,743 1,184,858
-------- ----------
Long-term notes payable $ - $ -
======== ==========
(a) On May 9, 2004 we received the proceeds of a $750,000 loan from Mid-Am
Capital, payable September 3, 2004, with an interest rate of 8%. This loan
is secured by a general security interest in all of our assets. Mid-Am has
agreed to extend the note on a demand basis.
(b) In 1999, we issued a promissory note to assume existing debt owed by our
then Chinese joint venture subsidiary to a supplier, International Paper.
The face value of that unsecured note was $282,637 at an annual interest
rate of 10.5%. The note originally required 23 monthly payments of $7,250
and a balloon payment of $159,862 due on July 15, 2000. During 2000, we
negotiated an extension of this note to July 1, 2001. International Paper
imposed a charge of $57,000 to renegotiate the note, which amount
represents interest due through the extension date. The balance due on
this note is $187,743 at December 31, 2005, all of which is delinquent.
Although International Paper has not pursued collection of the note, it
is possible that they could do so in the future and, if they do, such
collection effort may have a significant adverse impact on the liquidity
of the Company.
(c) On November 6 and 7, 2001 respectively, the Company received proceeds of
two loans aggregating $100,000 from two offshore lenders. The two
promissory notes, one for $34,000 and the other for $66,000, were payable
on February 1, 2002 with interest at an annual rate of 8%. These loans
were secured by a general security interest on all of the assets of the
Company. These lenders had agreed to extend the notes without default on
a demand basis. Interest accrued and unpaid at December 31, 2004
aggregated $25,380.
Note 6. Convertible Notes Payable
Convertible debt carrying values consist of the following as of December 31,
2005 and 2004:
2005 2004
---- ----
$200,000 Convertible Note Payable, due November 2006 (a) $ 187,934 $ 175,055
$15,000 Convertible Note Payable, due May 2007 (b) 1,620 -
$600,000 Convertible Note Payable, due December 2006 (c) 600,000 240,088
$6,250 Convertible Note Payable, due April 30, 2006 (e) 5,188 73,057
$25,000 Convertible Note Payable, due October 1, 2006 (f) 30,278 208,424
$187,760 Convertible Note Payable, due December 2006 (g) 187,760 402,607
---------- ----------
$1,012,780 $1,099,231
========== ==========
(a) $400,000 Convertible Note Financing
---------------------------------------
On November 20, 2003, we issued $400,000 of 8.0% convertible notes payable, due
November 20, 2005 plus warrants to purchase 14,000,000 shares of our common
stock with strike prices ranging from $0.05 to $1.00 for a period of three
years. The convertible notes had a face value outstanding of $200,000 and
$275,000 on December 31, 2005 and 2004, respectively following the modification
of the underlying note agreement, extending the maturity date of the remaining
balance to November 20, 2006. The convertible notes are convertible into a
variable number of our common shares based upon a variable conversion price of
the lower of $0.05 or 75% of the closing market price near the conversion date.
The holder has the option to redeem the convertible notes payable for cash at
130% of the face value in the event of defaults and certain other contingent
events, including events related to the common stock into which the
F-19
instrument is convertible, registration and listing (and maintenance thereof) of
our common stock and filing of reports with the Securities and Exchange
Commission (the "Default Put"). In addition, we extended registration rights to
the holder that required registration and continuing effectiveness thereof; we
would be required to pay monthly liquidating damages of 2.0% for defaults under
this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to a
variable conversion feature, and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because, as noted above, share settlement
and maintenance of an effective registration statement are not within our
control. Therefore, the warrants are also required to be carried as a derivative
liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inception dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $1,311,000 and $201,000 as of
December 31, 2005 and 2004, respectively. This amount is included in Derivative
Liabilities on our balance sheet. Warrants related to the financing were fully
converted prior to December 31, 2005.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $400,000
convertible note financing.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(1,110,000) $ 23,000
=============================
Warrant derivative $(5,842,900) $(1,031,800)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with the remaining compound derivatives.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes to zero. This discount, along
with related deferred finance costs and future interest payments, are amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $88,000 and $204,000, respectively.
F-20
As noted in the introductory paragraph of this section, the holders extended the
notes one additional year to November 2006. This modification was accounted for
as an extinguishment because the present value of the amended debt was
significantly different than the present value immediately preceding the
modification. As a result of the extinguishment, the existing debt carrying
value was adjusted to fair value using projected cash flows at market rates for
similar instruments. This extinguishment resulted in our recognition of a gain
on extinguishment of $22,733 in the fourth fiscal quarter of our year ended
December 31, 2005.
(b) $2,300,000 Convertible Note Financing:
------------------------------------------
On January 28, 2005, May 23, 2005 and August 18, 2005, we issued $1,150,000,
$500,000 and $650,000, respectively of 8.0% convertible notes payable, due
January 28, 2007, May 23, 2007 and August 18, 2007, plus, warrants
to purchase 9,200,000, 4,000,000 and 5,200,000 shares, respectively, of our
common stock with a strike price of $0.129 for a period of five years. The
convertible notes had a face value outstanding of $15,000 on December 31, 2005,
resulting from conversions of all other notes associated with this financing to
common stock. The remaining portion of the May 23, 2005 convertible notes are
convertible into a fixed number of our common shares based upon a conversion
price of $0.125 with anti-dilution protection for sales of securities below the
fixed conversion price. We have the option to redeem the convertible notes for
cash at 120% of the face value. The holder has the option to redeem the
convertible notes payable for cash at 120% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put").
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt instruments. We combined all embedded features that required
bifurcation into one compound instrument that is carried as a component of
derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants are
also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inception dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including volatility, expected terms, and risk free rates) that
are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $4,867 as of December 31, 2005.
As of December 31, 2005 2,000,000 warrants related to the financing remain
unconverted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $2,300,000
convertible note financing:
F-21
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $ (3,779,033) $-
=============================
Warrant derivative $(17,141,306) $-
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with these instruments.
In connection with our accounting for this financing arrangement we encountered
the unusual circumstance of a day-one loss related to the recognition of
derivative instruments arising from the arrangement. That means that the fair
value of the bifurcated compound derivative and warrants exceeded the proceeds
that we received from the arrangement and we were required to record a loss to
record the derivative financial instruments at fair value. The loss that we
recorded amounted to $8,663,869.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, are amortized
through periodic charges to interest expense using the effective method.
Interest expense during the year ended December 31, 2005 amounted to
approximately $462,000.
(c) $600,000 Convertible Note Financing:
----------------------------------------
On June 29, 2004, we issued $600,000 of 10.0% convertible notes payable, due
December 31, 2005, plus warrants to purchase 2,000,000 and 5,000,000 shares of
our common stock with strike prices of $0.25 and $2.00, respectively, for a
periods of five and two years, respectively. Net proceeds from this financing
arrangement amounted to $500,000. As of December 31, 2005, this debt is past due
and, accordingly, the outstanding carrying value of $600,000 does not include
the $68,000 of capitalized interest, which is being reflected as accrued
liabilities. The convertible notes are convertible into a fixed number of our
common shares based upon a conversion price of $0.15 with anti-dilution
protection for sales of securities below the fixed conversion price. We have the
option to redeem the convertible notes for cash at 120% of the face value. The
holder has the option to redeem the convertible notes payable for cash at 130%
of the face value in the event of defaults and certain other contingent events,
including events related to the common stock into which the instrument is
convertible, registration and listing (and maintenance thereof) of our common
stock and filing of reports with the Securities and Exchange Commission (the
"Default Put"). In addition, we extended registration rights to the holder that
required registration and continuing effectiveness thereof; we are required to
pay monthly liquidating damages of 2.0% for defaults under this provision. The
maturity dates for these notes have been extended to December 31, 2006.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for
F-22
equity classification because these instruments did not meet all of the criteria
necessary for equity classification. Therefore, the warrants are also required
to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inception dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in compound derivative balances
associated with this financing arrangement of $153,700 and $27,833 as of
December 31, 2005 and 2004, respectively. These amounts are included in
Derivative Liabilities on our balance sheet.
As of December 31, 2005 all warrants related to the financing had been
converted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $600,000
convertible note financing:
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $ (125,867) $ 47,134
=============================
Warrant derivative $(5,478,300) $(479,067)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with these instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, are amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $428,000 and $240,000, respectively.
(d) $240,000 Convertible Note Financing:
----------------------------------------
On December 22, 2004, we issued $240,000 of 10.0% convertible notes payable, due
April 30, 2006, plus warrants to purchase 800,000 shares of common stock at
$0.15 for five years. Net proceeds from this financing arrangement amounted to
$200,000. As of December 31, 2005, this debt had been fully converted. As of
December 31, 2004, this debt had a face value of $210,000. The convertible notes
were convertible into a fixed number of our common shares based upon a
conversion price of $0.10 with anti-dilution protection for sales of securities
below the fixed conversion price. We had the option to redeem the convertible
notes for cash at 120% of the face value. The holder has the option to redeem
the convertible notes payable for cash at 130% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we extended
registration rights to
F-23
the holder that required registration and continuing effectiveness thereof; we
are required to pay monthly liquidating damages of 2.0% for defaults under this
provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants are
also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. These amounts are included in Derivative
Liabilities on our balance sheet. We estimated the fair value of the warrants on
the inception dates, and subsequently, using the Black-Scholes-Merton Valuation
technique, because that technique embodies all of the assumptions (including,
volatility, expected terms, and risk free rates) that are necessary to fair
value freestanding warrants.
As of December 31, 2005 all warrant liabilities related to the financing had
been fully converted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $240,000
convertible note financing:
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(55,604) $ 64,600
=============================
Warrant derivative $ 55,540 $(220,515)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with the remaining compound derivative.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $66,781 and $-0-, respectively.
F-24
(e) $693,000 Convertible Note Financing:
----------------------------------------
On October 29, 2004, we issued $693,000 of 10.0% convertible notes payable, due
April 30, 2006, plus warrants to purchase 2,200,000 at $0.15 for five years. Net
proceeds from this financing arrangement amounted to $550,000. As of December
31, 2005, this debt had face value $6,250 outstanding. The convertible notes
were convertible into a fixed number of our common shares based upon a
conversion price of $0.10 with anti-dilution protection for sales of securities
below the fixed conversion price. We had the option to redeem the convertible
notes for cash at 120% of the face value. The holder has the option to redeem
the convertible notes payable for cash at 130% of the face value in the event of
defaults and certain other contingent events, including events related to the
common stock into which the instrument is convertible, registration and listing
(and maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put"). In addition, we extended
registration rights to the holder that required registration and continuing
effectiveness thereof; we are required to pay monthly liquidating damages of
2.0% for defaults under this provision. The maturity dates for these notes were
extended to October 1, 2006.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants are
also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inception dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in a compound derivative balance of
$42,878 as of December 31, 2005. Our valuation model resulted in a warrant
derivative balance, arising from the convertible note financing, of $924,120 and
$330,220 as of December 31, 2005 and 2004, respectively. These amounts are
included in Derivative Liabilities on our balance sheet.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $693,000
convertible note financing:
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(2,610,699) $(133,492)
=============================
Warrant derivative $ (668,950) $(373,967)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit
F-25
risk associated with our financial instruments. The fair value of the warrant
derivative is significantly affected by changes in our trading stock prices.
Future changes in these underlying market conditions will have a continuing
effect on derivative income (expense) associated with the remaining compound
instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $199,000 and $73,000, respectively.
(f) $660,000 Convertible Note Financing:
----------------------------------------
On April 2, 2004, we issued $660,000 of 10.0% convertible notes payable, due
October 1, 2005, plus warrants to purchase 3,000,000 at $0.15 for five years.
Net proceeds from this financing arrangement amounted to $500,000. As of
December 31, 2005, this debt had a face value of $25,000 outstanding. The
convertible notes were convertible into a fixed number of our common shares
based upon a conversion price of $0.10 with anti-dilution protection for sales
of securities below the fixed conversion price. We had the option to redeem the
convertible notes for cash at 120% of the face value. The holder has the option
to redeem the convertible notes payable for cash at 130% of the face value in
the event of defaults and certain other contingent events, including events
related to the common stock into which the instrument is convertible,
registration and listing (and maintenance thereof) of our common stock and
filing of reports with the Securities and Exchange Commission (the "Default
Put"). In addition, we extended registration rights to the holder that required
registration and continuing effectiveness thereof; we are required to pay
monthly liquidating damages of 2.0% for defaults under this provision.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants are
also required to be carried as a derivative liability, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in a compound derivative balance of
$159,250 and $440,648 as of December 31, 2005 and 2004, respectively. This
amount is included in Derivative Liabilities on our balance sheet.
As of June 30, 2006, all warrants related to the financing have been fully
converted.
F-26
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $660,000
convertible note financing:
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(2,787,246) $(194,962)
=============================
Warrant derivative $ 61,800 $(276,188)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with the remaining compound instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $74,000 and $256,000, respectively.
(g) $1,008,000 Convertible Note Financing:
------------------------------------------
On June 29, 2004, we issued $1,008,000 of 10.0% convertible notes payable, due
April 30, 2006, plus warrants to purchase 3,200,000 and 8,000,000 shares of our
common stock at $0.25 and $2.00, respectively, for periods of five and two
years, respectively. Net proceeds from this financing arrangement amounted to
$800,000. As of December 31, 2005, this debt had a face value of $187,760
outstanding. The convertible notes were convertible into a fixed number of our
common shares based upon a conversion price of $0.15 with anti-dilution
protection for sales of securities below the fixed conversion price. We had the
option to redeem the convertible notes for cash at 120% of the face value. The
holder has the option to redeem the convertible notes payable for cash at 130%
of the face value in the event of defaults and certain other contingent events,
including events related to the common stock into which the instrument is
convertible, registration and listing (and maintenance thereof) of our common
stock and filing of reports with the Securities and Exchange Commission (the
"Default Put"). In addition, we extended registration rights to the holder that
required registration and continuing effectiveness thereof; we are required to
pay monthly liquidating damages of 2.0% for defaults under this provision. The
maturity dates for these notes have been extended to December 31, 2006.
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection; and it did not otherwise meet the conditions for
equity classification. Since equity classification is not available for the
conversion feature, we were required to bifurcate the embedded conversion
feature and carry it as a derivative liability, at fair value. We also concluded
that the Default Put required bifurcation because, while puts on debt
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated with debt instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. We also determined that the warrants did not meet the
conditions for equity classification because these instruments did not meet all
of the criteria necessary for equity classification. Therefore, the warrants are
also required to be carried as a derivative liability, at fair value.
F-27
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inceptions dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in a compound derivative balance of
$564,735 and $1,446,560 as of December 31, 2005 and 2004, respectively. This
amount is included in Derivative Liabilities on our balance sheet.
As of December 31, 2005, all warrants related to the financing had been fully
converted.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the $1,008,000
convertible note financing:
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $ (185,979) $ (29,988)
=============================
Warrant derivative $(1,661,859) $(826,816)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with these instruments.
The aforementioned allocations to the compound and warrant derivatives resulted
in the discount in the carrying value of the notes. This discount, along with
related deferred finance costs and future interest payments, were amortized
through periodic charges to interest expense using the effective method.
Interest expense during the years ended December 31, 2005 and 2004 amounted to
approximately $383,000 and $403,000, respectively.
(h) $360,000 Convertible Note Financing:
----------------------------------------
On April 21, 2005, we issued $360,000, six-month-term, 10% convertible notes
payable, due October 31, 2005. Net proceeds for this financing transaction
amounted to $277,488. The notes were convertible into shares of common stock at
a fixed conversion rate of $0.20, with anti-dilution protection for sales of
securities below the fixed conversion price. The holder converted the notes on
September 30, 2005. We had the option to redeem the notes payable for cash at
120% of the face value. The holder has the option to redeem the convertible
notes payable for cash at 130% of the face value in the event of defaults and
certain other contingent events, including events related to the common stock
into which the instrument is convertible, registration and listing (and
maintenance thereof) of our common stock and filing of reports with the
Securities and Exchange Commission (the "Default Put").
In our evaluation of this instrument, we concluded that the conversion feature
was not afforded the exemption as a conventional convertible instrument due to
the anti-dilution protection afforded the holder; and it did not otherwise meet
the conditions for equity classification. Therefore, we were required to
bifurcate the embedded conversion feature and carry it as a derivative
liability. We also concluded that
F-28
the Default Put required bifurcation because, while puts on debt instruments are
generally considered clearly and closely related to the host, the Default Put is
indexed to certain events, noted above, that are not associated debt
instruments. We combined all embedded features that required bifurcation into
one compound instrument that was carried as a component of derivative
liabilities through the date of conversion.
We allocated the initial proceeds from the financing first to the compound
derivative instrument in the amount of $113,925 and the balance to the debt host
instrument. We estimated the fair value of the compound derivative on the
inception dates, and subsequently, using the Monte Carlo Valuation technique,
because that technique embodies all of the assumptions (including credit risk,
interest risk, stock price volatility and conversion estimates) that are
necessary to fair value complex derivative instruments.
The following table illustrates fair value adjustments that we have recorded
related to the compound derivative arising from the $360,000 convertible notes
payable.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(841,650) $-
=============================
Warrant derivative $ - $-
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. Since the instrument was converted on September 30, 2005,
there will be no future charges or credits to derivative income (expense)
associated with this instrument.
The above allocations resulted in a discount to the carrying value of the notes
amounting to approximately $173,925. This discount, along with related deferred
finance costs and future interest payments, was amortized through periodic
charges to interest expense using the effective method. Interest expense during
the year ended December 31, 2005 amounted to approximately $163,000.
Derivative warrant fair values are calculated using the Black-Scholes-Merton
Valuation technique. Significant assumptions as of December 31, 2005,
corresponding to each of the above financings (by paragraph reference) are as
follows:
6(a) 6(b) 6(c) 6(d) 6(e) 6(f)
-----------------------------------------------------------------
Trading market price $0.59 $0.59 $0.59 $0.59 $0.59 $0.59
Strike price $.05-$1.00 $.129 $.10 $.15 $.15 $.15
Volatility 148% 133% 136% 136% 136% 142%
Risk-free rate 3.25% 3.71% 3.30% 3.57% 3.30% 3.45%
Remaining term/life (years) .92 4.63 3.5 4.0 3.83 3.25
Our stock prices have been highly volatile. Future fair value changes are
significantly influenced by our trading common stock prices. As previously
discussed herein, changes in fair value of derivative financial instruments are
reflected in earnings.
F-29
Note 7. Preferred Stock
Our articles of incorporation authorize the issuance of 5,000,000 shares of
preferred stock. We have designated this authorized preferred stock, as follows:
(a) Series H Preferred Stock:
-----------------------------
We have designated 350,000 shares of our preferred stock as Series H Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series H Preferred Stock has cumulative dividend rights at 7.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a fixed conversion price of $0.40 per
common share. The Series H Preferred Stock is mandatorily redeemable for common
stock on the fifth anniversary of its issuance. We have the option to redeem the
Series H Preferred Stock for cash at 135% of the stated value. The holder has
the option to redeem the Series H Preferred Stock for cash at 140% of the stated
value in the event of defaults and certain other contingent events, including
events related to the common stock into which the instrument is convertible,
listing of our common stock and filing of reports with the Securities and
Exchange Commission (the "Default Put").
Based upon our evaluation of the terms and conditions of the Series H Preferred
Stock, we concluded that it was more akin to a debt instrument than an equity
instrument, which means that our accounting conclusions are based upon those
related to a traditional debt security, and that it should be afforded the
conventional convertible exemption regarding the embedded conversion feature
because the conversion price is fixed. Therefore, we are not required to
bifurcate the embedded conversion feature and carry it as a liability. However,
we concluded that the Default Put required bifurcation because, while puts on
debt-type instruments are generally considered clearly and closely related to
the host, the Default Put is indexed to certain events, noted above, that are
not associated debt-type instruments. In addition, due to the default and
contingent redemption features of the Series H Preferred Stock, we classified
this instrument as redeemable preferred stock, outside of stockholders' equity.
Between December 2001 and March 2002, we issued 175,500 shares of Series H
Preferred Stock for cash of $1,755,000, plus warrants to purchase an aggregate
of 4,387,500 shares of common stock at $0.50 for five years. As of December 31,
2005, 64,500 shares of preferred stock remain outstanding; all of the warrants
remain outstanding. We allocated $1,596,228 of the proceeds from the Series H
Preferred financings to the warrants at their fair values because the warrants
did not meet all of the conditions necessary for equity classification and,
accordingly, are carried as derivative liabilities, at fair value. We also
allocated $134,228 to the Default Puts which, as described above are carried as
derivative liabilities, at fair value. We also allocated proceeds of $34,210 to
paid-in capital because the aforementioned allocations resulted in an effective
beneficial conversion feature, which is recorded in equity. Finally, we recorded
derivative expense of $9,666 because one of the financings did not result in
sufficient proceeds to record the derivative financial instruments at fair
values on the inception date.
We estimated the fair value of the derivative warrants on the inception dates,
and subsequently, using the Black-Scholes-Merton valuation technique. As a
result of applying this technique, our valuation of the derivative warrants
amounted to $1,264,109 and $376,212 as of December 31, 2005 and 2004,
respectively. We estimated the fair value of the Default Puts on the inception
dates, and subsequently, using a cash flow technique that involves
probability-weighting multiple outcomes at net present values. Significant
assumptions underlying the probability-weighted outcomes included both our
history of similar default events, all available information about our business
plans that could give rise to or risk defaults, and the imminence of impending
or current defaults. As a result of these subjective estimates, our valuation
model resulted in Default Put balances associated with the Series H Preferred
Stock of
F-30
$381,377 and $156,927 as of December 31, 2005 and 2004, respectively. These
amounts are included in Derivative Liabilities on our balance sheet. The
following table illustrates fair value adjustments that we have recorded related
to the Default Puts on the Series H Preferred Stock.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(224,451) $ (22,701)
=============================
Warrant derivative $(887,896) $(253,571)
=============================
Derivative income (expense) related to the Default Put includes changes to the
fair value arising from changes in our estimates about the probability of
default events and amortization of the time-value element embedded in our
calculations. Higher derivative expense in the year ended December 31, 2005 when
compared to the same period of 2004, reflected the increased probability that
the Default Put would become exercisable because we would not timely file
certain reports with the Securities and Exchange Commission. In fact, we
ultimately did not file our Quarterly Report on Form 10-QSB for the June 2006
reporting period on a timely basis. While the Default Put became exercisable at
that time, the holders of the Series H Preferred Stock did not exercise their
right prior to curing the event. There can be no assurances that the holders of
the Series H Preferred Stock would not exercise their rights should further
defaults arise.
The discounts to the Series H Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
retained earnings using the effective method. The following table illustrates
the components of preferred stock dividends and accretions for the years ended
December 31, 2005 and 204:
Year ended Year ended
December 31, December 31,
2005 2004
-----------------------------
Preferred stock dividends $140,400 $140,400
=============================
Accretions $558,089 $357,392
=============================
As of December 31, 2005, $315,900 of cumulative dividends are in arrears on
Series H Preferred Stock.
(b) Series J Preferred Stock:
-----------------------------
We have designated 500,000 shares of our preferred stock as Series J Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series J Preferred Stock has cumulative dividend rights at 8.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a conversion price of $0.20 per common
share. The Series J Preferred Stock is mandatorily redeemable for common stock
on the fifth anniversary of its issuance. We have the option to redeem the
Series J Preferred Stock for cash at 135% of the stated value. The holder has
the option to redeem the Series J Preferred Stock for cash at 140% of the stated
value in the event of defaults and certain other contingent events, including
events related to the common stock into which the instrument is convertible,
registration and listing (and maintenance thereof) of our common stock and
filing of reports with the Securities and Exchange Commission (the "Default
Put").
Based upon our evaluation of the terms and conditions of the Series J Preferred
Stock, we concluded that its features were more akin to a debt instrument than
an equity instrument, which means that our accounting conclusions are generally
based upon standards related to a traditional debt security. Our
F-31
evaluation concluded that the embedded conversion feature was not afforded the
exemption as a conventional convertible instrument, since it did not meet the
conditions for equity classification. Therefore, we are required to bifurcate
the embedded conversion feature and carry it as a liability. We also concluded
that the Default Put required bifurcation because, while puts on debt-type
instruments are generally considered clearly and closely related to the host,
the Default Put is indexed to certain events, noted above, that are not
associated debt-type instruments. We combined all embedded features that
required bifurcation into one compound instrument that is carried as a component
of derivative liabilities. In addition, due to the default and contingent
redemption features of the Series J Preferred Stock, we classified this
instrument as redeemable preferred stock, outside of stockholders' equity.
In September 2002, February 2003 and May 2003 we issued 100,000 shares, 50,000
shares and 50,000 shares, respectively, of Series J Preferred Stock for cash of
$2,000,000. We also issued warrants for an aggregate of 14,000,000 shares of our
common stock in connection with the financing arrangement. The warrants have
terms of five years and an exercise price of $0.25. We initially allocated
proceeds of $658,000 and $1,190,867 from the financing arrangements to the
compound derivative discussed above and to the warrants, respectively. Since
these instruments did not meet the criteria for classification, they are
required to be carried as derivative liabilities, at fair value.
We estimated the fair value of the compound derivative on the inception dates,
and subsequently, using the Monte Carlo Valuation technique, because that
technique embodies all of the assumptions (including credit risk, interest risk,
stock price volatility and conversion estimates) that are necessary to fair
value complex derivative instruments. We estimated the fair value of the
warrants on the inception dates, and subsequently, using the
Black-Scholes-Merton Valuation technique, because that technique embodies all of
the assumptions (including, volatility, expected terms, and risk free rates)
that are necessary to fair value freestanding warrants. As a result of these
estimates, our valuation model resulted in a compound derivative balance
associated with the Series J Preferred Stock of $5,628,000 and $728,000 as of
December 31, 2005 and December 31,2004, respectively. This amount is included in
Derivative Liabilities on our balance sheet.
The following table illustrates fair value adjustments that we have recorded
related to the derivative financial instruments associated with the Series J
Preferred Stock.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(4,900,000) $(644,000)
=============================
Warrant derivative $(3,136,000) $(713,600)
=============================
Changes in the fair value of the compound derivative and, therefore, derivative
income (expense) related to the compound derivative is significantly affected by
changes in our trading stock price and the credit risk associated with our
financial instruments. The fair value of the warrant derivative is significantly
affected by changes in our trading stock prices. Future changes in these
underlying market conditions will have a continuing effect on derivative income
(expense) associated with these instruments.
The discounts to the Series J Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
paid-in capital using the effective method. The following table illustrates the
components of preferred stock dividends and accretions for the years ended
December 31, 2005 and 2004:
F-32
Year ended Year ended
December 31, December 31,
2005 2004
-----------------------------
Preferred stock dividends $160,000 $160,000
=============================
Accretions $385,218 $214,856
=============================
As of December 31, 2005 $480,000 of cumulative dividends are in arrears on
Series J Preferred Stock.
(c) Series K Preferred Stock:
-----------------------------
We have designated 500,000 shares of our preferred stock as Series K Cumulative
Convertible Preferred Stock with a stated and liquidation value of $10.00 per
share. Series K Preferred Stock has cumulative dividend rights at 8.0% of the
stated amount, ranks senior to common stock and is non-voting. It is also
convertible into our common stock at a fixed conversion price of $0.10 per
common share. The Series K Preferred Stock is mandatorily redeemable for common
stock on the fifth anniversary of its issuance. We have the option to redeem the
Series K Preferred Stock for cash at 120% of the stated value. The holder has
the option to redeem the Series K Preferred Stock for cash at 140% of the stated
value in the event of defaults and certain other contingent events, including
events related to the common stock into which the instrument is convertible,
listing of our common stock and filing of reports with the Securities and
Exchange Commission (the "Default Put").
Based upon our evaluation of the terms and conditions of the Series K Preferred
Stock, we concluded that it was more akin to a debt instrument than an equity
instrument, which means that our accounting conclusions are based upon those
related to a traditional debt security, and that it should afforded the
conventional convertible exemption regarding the embedded conversion feature
because the conversion price is fixed. Therefore, we are not required to
bifurcate the embedded conversion feature and carry it as a liability. However,
we concluded that the Default Put required bifurcation because, while puts on
debt-type instruments are generally considered clearly and closely related to
the host, the Default Put is indexed to certain events, noted above, that are
not associated debt-type instruments.. In addition, due to the default and
contingent redemption features of the Series K Preferred Stock, we classified
this instrument as redeemable preferred stock, outside of stockholders' equity.
In March 2004, we issued 80,000 shares of Series K Preferred Stock for cash of
$800,000. In April 2004, we issued 15,000 shares of Series K Preferred Stock to
extinguish debt with a carrying value of $150,000. At the time of these
issuances, the trading market price of our common stock exceeded the fixed
conversion price and, as a result, we allocated $160,000 and $60,000 from the
March and April issuances, respectively, to stockholders' equity which amount
represented a beneficial conversion feature. In addition, we recorded a debt
extinguishment loss of $60,000 in connection with the April exchange of Series K
Preferred Stock for debt because we estimated that it had a fair value that
exceeded the carrying value of the extinguished debt by that amount. Finally, we
allocated approximately $59,000 and $11,000 to the Default Puts, representing
fair values, in connection with the March and April issuances, respectively.
We estimated the fair value of the Default Puts on the inception dates, and
subsequently, using a cash flow technique that involves probability-weighting
multiple outcomes at net present values. Significant assumptions underlying the
probability-weighted outcomes included both our history of similar default
events, all available information about our business plans that could give rise
to or risk defaults, and the imminence of impending or current defaults. As a
result of these subjective estimates, our valuation model resulted in Default
Put balances associated with the Series K Preferred Stock of $206,200 and
$73,644 as of December 31, 2005 and 2004, respectively. These amounts are
included in Derivative
F-33
Liabilities on our balance sheet. The following table illustrates fair value
adjustments that we have recorded related to the Default Puts on the Series K
Preferred Stock.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $(132,556) $(3,768)
=============================
Warrant derivative $ - $ -
=============================
Derivative income (expense) related to the Default Put includes changes to the
fair value arising from changes in our estimates about the probability of
default events and amortization of the time-value element embedded in our
calculations. Higher derivative expense in the year ended December 31, 2005,
when compared to the same period of 2004, reflected the increased probability
that the Default Put would become exercisable because we would not timely file
certain reports with the Securities and Exchange Commission. In fact, we
ultimately did not file our Quarterly Report on Form 10-QSB for the June 2006
reporting period in a timely basis. While the Default Put became exercisable at
that time, the holders of the Series K Preferred Stock did not exercise their
right prior to curing the event. There can be no assurances that the holders of
the Series K Preferred Stock would not exercise their rights should further
defaults arise.
The discounts to the Series K Preferred Stock that resulted from the
aforementioned allocations are being accreted through periodic charges to
paid-in capital using the effective method. The following table illustrates the
components of preferred stock dividends and accretions for the years ended
December 31, 2005 and 2004:
Year ended Year ended
December 31, December 31,
2005 2004
-----------------------------
Preferred stock dividends $76,000 $57,000
=============================
Accretions $40,407 $30,140
=============================
As of December 31, 2005, $133,000 of cumulative dividends are in arrears on
Series K Preferred Stock.
(d) Other Preferred Stock Designations and Financings:
Series A Preferred: We have designated 500,000 shares of our preferred stock as
Series A Convertible Preferred Stock. There were no Series A Preferred Stock
outstanding during the periods presented.
Series B Preferred: We have designated 1,260,000 shares of our preferred stock
as Series B Convertible Preferred Stock with a stated and liquidation value of
$1.00 per share. Series B Preferred has cumulative dividend rights of 9.0%,
ranks senior to common stock and has voting rights equal to the number of common
shares into which it may be converted. Series B Preferred is convertible into
common on a share for share basis. Based upon our evaluation of the terms and
conditions of the Series B Preferred Stock, we have concluded that it meets all
of the requirements for equity classification. We have 107,440 shares of Series
B Preferred outstanding as of December 31, 2005.
Series D Preferred: We have designated 165,000 shares of our preferred stock as
Series D Cumulative Convertible Preferred Stock with a stated and liquidation
value of $10 per share. Series D Preferred has cumulative dividend rights of
6.0%, ranks senior to common stock and is non-voting. There are no shares of
Series D Preferred Stock outstanding during any of the periods presented.
However, we continue to
F-34
have 611,250 warrants outstanding that were issued in connection with the
original Series D Preferred Stock Financing arrangement.
Series F Preferred: We have designated 200,000 shares of our preferred stock as
Series F Convertible Preferred Stock with a stated and liquidation value of $10
per share. There were 5,248 and 55,515 shares of Series F Preferred Stock
outstanding as of December 31, 2005 and 2004, respectively. Series F Preferred
is non-voting and convertible into common stock at a variable conversion price
equal to the lower of $0.60 or 75% of the trading prices near the conversion
date. In addition, the holder has the option to redeem the convertible notes
payable for cash at 125% of the face value in the event of defaults and certain
other contingent events, including events related to the common stock into which
the instrument is convertible, registration and listing (and maintenance
thereof) of our common stock and filing of reports with the Securities and
Exchange Commission (the "Default Put"). We concluded that the conversion
feature was not afforded the exemption as a conventional convertible instrument
due to a variable conversion feature; and it did not otherwise meet the
conditions for equity classification. Since equity classification is not
available for the conversion feature, we were required to bifurcate the embedded
conversion feature and carry it as a derivative liability, at fair value. We
also concluded that the Default Put required bifurcation because, while puts on
debt-type instruments are generally considered clearly and closely related to
the host, the Default Put is indexed to certain events, noted above, that are
not associated with debt-type instruments. These two derivative features were
combined into one compound derivative instrument. In addition, due to the
default and contingent redemption features of the Series F Preferred Stock, we
classified this instrument as redeemable preferred stock, outside of
stockholders' equity.
Series I Preferred: We have designated 200,000 shares of our preferred stock as
Series I Convertible Preferred Stock with a stated and liquidation value of
$10.00 per share. Series I Preferred has cumulative dividend rights at 8.0% of
the stated value, ranks senior to common stock and is non-voting. Series I
Preferred is convertible into a variable number of common shares at the lower
conversion price of $0.40 or 75% of the average trading market price. There were
no Series I Preferred Stock outstanding as of December 31, 2005. However, we had
30,000 shares outstanding during the year ended December 31, 2004. We accounted
for Series I Preferred Stock, while it was outstanding as an instrument that was
more akin to a debt instrument. We also bifurcated the embedded conversion
feature and freestanding warrants issued with the financing and carried these
amounts as derivative liabilities, at fair value. The table below reflects
derivative income and (expense) associated with changes in the fair value of
this derivative financial instrument.
The following table summarizes derivative income (expense) related to compound
derivatives and freestanding warrant derivatives that arose in connection with
the preferred stock transactions discussed above.
Year ended Year ended
December 31, December 31,
2005 2004
Derivative income (expense) -----------------------------
Compound derivative $ 152,310 $ (22,535)
=============================
Warrant derivative $(2,186,140) $(900,868)
=============================
F-35
The following table summarizes preferred stock dividends related to the
convertible preferred stock discussed above:
Year ended Year ended
December 31, December 31,
2005 2004
-----------------------------
Preferred stock dividends $5,600 $31,200
=============================
Accretions $ - $ -
=============================
Note 8. - Share Based Payments
On April 6, 2005, our Board of Directors adopted an incentive share-based plan
(the "2005 Stock Incentive Plan") that provides for the grant of stock options
for up to 10,397,745 shares of our common stock to our directors, officers, key
employees, and consultants. On May 10, 2005, our Board of Directors adopted the
recommendation of our Compensation Committee to grant options for 8,922,745
shares to our directors and key employees. As of December 31, 2005, there were
1,475,000 shares of common stock reserved for issuance under our stock plan.
Options granted under 2005 Stock Incentive Plan have a contractual life of 10
years and vest over two years in equal annual installments with the first third
exercisable on the grant date, provided that the individual is continuously
employed by us.
In years prior to 2005, we granted options for 650,000 shares to now former
employees and options for 220,000 shares to now former directors, all which are
fully vested and exercisable, under individual plans. Currently, there are no
shares reserved for future issuance under these individual plans.
We adopted the fair-value provisions of FAS No. 123, effective January 1, 2005,
and we recorded compensation costs aggregating $798,870 for the twelve months
ended December 31, 2005. We recognized no tax benefit for share-based
compensation arrangements due to the fact that we are in a cumulative loss
position and recognize no tax benefits in our Consolidated Statements of
Operations.
We estimate the fair value of each stock option on the date of grant using a
Black-Scholes-Merton (BSM) option-pricing formula, applying the following
assumptions and amortize that value to expense over the options' vesting periods
using the straight-line attribution approach. In addition to the issuance of the
outstanding options discussed above, we granted options for 750,000 shares in
2004, which were part of the options for 5,395,000 shares that were exchanged
into an equivalent number of common shares in 2004, as discussed further below.
2005
----
Expected Term (in years) 6
Risk-free rate 5%
Expected volatility 141%
Expected dividends 0%
Expected Term: The expected term represents the period over which the
share-based awards are expected to be outstanding. It has been determined as the
midpoint between the vesting date and the end of the contractual term.
Risk-Free Interest Rate: We based the risk-free interest rate used in our
assumptions on the implied yield currently available on U.S. Treasury
zero-coupon issues with a remaining term equivalent to the stock option award's
expected term.
F-36
Expected Volatility: The volatility factor used in our assumptions is based on
the historical price of our stock over the most recent period commensurate with
the expected term of the stock option award.
Expected Dividend Yield: We do not intend to pay dividends on our common stock
for the foreseeable future. Accordingly, we use a dividend yield of zero in our
assumptions.
A summary of option activity under the stock incentive plan for the years ended
December 31, 2005 and 2004 are presented below:
2005 2004
---------------------- ------------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Options Options Price Options Price
---------------------------------------- ------- -------- ---------- ---------
Outstanding Balance at beginning of year 1,025,000 $0.46 7,903,705 $ 0.43
Granted 9,122,743 $0.28 750,000 $ 0.29
Exercised - - - -
Forfeited (547,321) $0.28 - -
Expired - - (2,233,705) $(0.76)
Cancelled - - (5,395,000) $(0.27)
--------- ----------
Outstanding at the end of the year 9,600,422 $0.30 1,025,000 $ 0.46
========= ==========
Exercisable at the end of the year 3,816,806 $0.33 1,025,000 $ 0.46
========= ==========
The following table summarized the status of the stock options outstanding and
exercisable at December 31, 2005:
2005 2005
Options Outstanding Options Exercisable
--------------------------------------- -----------------------
Weighted-
Average
Remaining Weighted- Weighted-
Range Number Contractual Average Number Average
of Exercise of Term Exercise of Exercise
Prices Options (in years) Price Options Price
----------- ------- ----------- --------- ------- ---------
$.20 to $.35 9,200,422 9.18 $0.28 3,416,806 $0.16
$.60 to $1.00 400,000 4.94 $0.78 400,000 $0.78
--------- ---------
9,600,422 9.00 $0.30 3,816,806 $0.22
========= =========
The weighted-average exercise prices and weighted-average fair values of options
granted during 2005 for which the exercise prices exceeded the market prices of
the stock was $0.23 and $0.15, respectively. The weighted-average exercise price
and weighted-average fair value of options granted during 2005 for which
F-37
the exercise price equaled the market price of the stock was $0.61 and $0.56,
respectively. There were no exercises of options during the years ended December
31, 2005 and 2004.
During 2004 we granted options for 750,000 shares which were cancelled and
converted into common shares. These options were part of options for 5,395,000
shares that were exchanged into an equivalent number of unregistered common
shares in 2004. In connection with such cancellation, we recorded $269,750 of
compensation expenses at the value of $.05 per each common share. This valuation
was discounted from the quoted market price of $.08 due to restrictions imposed
by insider trading and short swing profits rules on the transferability of such
shares that were issued to our directors and senior management.
In May 2005, we extended the contractual life of fully vested options for
770,000 shares held by two directors. As a result of that modification, we have
recognized, on a restated basis, additional compensation expense of $104,000 for
the second quarter of 2005
Note 9 - Stockholders' Deficit
(a) Convertible Preferred Stock
---------------------------
We have designated 1,260,000 shares of our preferred stock as Series B
Convertible Preferred Stock. Series B Preferred accumulates dividends at the
rate of 9% per annum, payable only upon liquidation or redemption, as a
percentage of the stated value, out of the assets and available funds. Voting
rights of the Series B Convertible Preferred stock are the same as our common
stock. Series B Convertible Preferred stock is convertible anytime after
December 31, 1997 to our common stock at the fixed ratio of one share of common
stock for one share of Series B Convertible Preferred stock surrendered for
conversion. We account for Series B Preferred Stock as perpetual preferred
equity.
(b) Common Stock Warrants
---------------------
As of December 31, 2005, we had the following outstanding warrants:
Warrants/
Expiration Options Exercise
Warrants Grant date date Granted Price
Series D Preferred Stock Financing 3/9/1999 11/17/2008 17,500 0.100
Series D Preferred Stock Financing 4/23/1999 11/17/2008 8,750 0.100
Series D Preferred Stock Financing 2/1/2000 11/17/2008 130,000 0.100
Series D Preferred Stock Financing 2/1/2000 11/17/2008 455,000 0.100
Series F Preferred Stock Financing 10/13/2000 11/17/2008 1,038,259 0.100
Series H Preferred Stock Financing 12/5/2001 12/4/2006 2,637,500 0.500
Series H Preferred Stock Financing 1/30/2002 1/30/2007 375,000 0.500
Series H Preferred Stock Financing 2/15/2002 2/14/2007 125,000 0.500
Series H Preferred Stock Financing 3/18/2002 3/17/2007 1,250,000 0.500
January 2005 Convertible Debt Financing 11/20/2003 11/20/2008 2,000,000 0.050
Warrant to Licensor 6/20/2005 6/19/2007 1,000,000 0.050
Warrant Consultant 4/8/2005 4/7/2007 1,000,000 0.250
Warrant to Distributor 8/30/2005 8/29/2008 30,000,000 0.360
April 2004 Financing 4/20/2004 4/19/09 1,500,000 0.100
October 2004 Financing 10/29/2004 10/28/2009 500,000 0.100
F-38
January 2005 Financing 1/31/05 1/30/2010 2,000,000 0.100
November 2005 Common Stock Financing 11/28/2005 11/27/2010 15,667,188 0.800
November 2005 Common Stock Financing 11/28/2005 11/27/2010 1,012,500 0.500
Other Financings 12/27/2001 2/28/2007 25,000 0.400
----------
Total Warrants 60,741,697
==========
Certain conversion features in our debt and preferred stock are indexed to a
variable number of common shares based upon our trading stock price.
Accordingly, in the event of stock price declines, we may have insufficient
shares to share-settle all of our contracts that are convertible into or
exercisable for common stock. As a result, current accounting standards require
us to assume that we would not have sufficient authorized shares to settle these
other warrants and, therefore, reclassify other warrants and contracts that were
otherwise carried in stockholders' equity to derivative liabilities. Such
warrants and contracts that required reclassification were indexed to 49,504,688
and 47,679,688 shares of our common stock as of December 31, 2005 and 2004,
respectively. We are not required to reclassify certain exempt contracts and
employee stock options, so those items are not included in this caption.
Derivative income (expense) associated with these other warrants for the years
ended December 31, 2005 and 2004 are as follows:
Derivative income (expense) 2005 2004
---------------------------
Warrant derivative $(7,336,788) $(316,829)
===========================
Activity for our common stock warrants is presented below:
Weighted
Average
Shares Price
----------- ---------
Total warrants outstanding at December 31, 2003 34,700,277 $ 0.33
Warrants granted 27,950,000 1.03
Warrants exercised - -
Warrants expired (33,000) (2.75)
------------ ------
Total warrants outstanding at December 31, 2004 62,617,277 $ 0.64
Warrants granted
66,329,688 0.39
Warrants exercised (32,873,601) (0.15)
Warrants expired (3,331,667) (1.62)
Warrants redeemed (32,000,000) (0.18)
------------ ------
Total warrants outstanding at December 31, 2005 60,741,697 $ 0.44
============ ======
F-39
(c) Other Stockholders' Equity Transactions
---------------------------------------
Year ended December 31, 2005
Quarter Ended March 31, 2005
----------------------------
New Financing: January 2005 Convertible Notes. On January 31, 2005, we
closed a funding transaction with Longview Fund, LP, Longview Equity Fund, LP,
Longview International Equity Fund, LP, Alpha Capital Aktiengesellschaft and
Whalehaven Funds Limited, five institutional accredited investors, for the
issuance and sale to the Subscribers of up to $2,300,000 of principal amount of
promissory notes convertible into shares of our common stock, and Warrants to
purchase shares of common stock at 100% coverage of the common stock issuable
in accordance with the principal amount of the notes. One Million One Hundred
Fifty Thousand Dollars ($1,150,000) of the
F-40
purchase price was paid on the initial closing date, and One Million One Hundred
Fifty Thousand Dollars ($1,150,000) of the purchase price will be payable within
five (5) business days after the actual effectiveness of an SB-2 Registration
Statement as defined in the Subscription Agreement. The initial closing notes
were at prime plus 4% interest in the aggregate amount of $1,150,000, plus
five-year Warrants for the purchase of, in the aggregate, 9,200,000 shares of
common stock, at the lesser of (i) $0.16, or (ii) 101% of the closing bid price
of the Common Stock as reported by Bloomberg L.P. for the OTC Bulletin Board for
the trading day preceding the Closing Date. The notes are convertible into
shares of our common stock at $0.125 per common share. Conversions are limited
to a maximum ownership of 9.99% of the underlying common stock at any one time.
The notes have a maturity date two years from closing and are payable in twelve
equal monthly installments, commencing June 1, 2005. The installment payments
consist of principal equal to 1/20th of the initial principal amount which,
subject to certain conditions concerning trading volume and price, can be paid
in cash at 103% of the monthly installment, or common stock or a combination of
both. The notes have an acceleration provision upon the change in a majority of
the present Board of Directors except as the result of the death of one or more
directors, or a change in the present CEO. In connection with this transaction,
we issued restricted common stock in the aggregate amount of 460,000 shares plus
the aggregate cash amount of $57,500 for due diligence fees to the investors in
this transaction. We issued the Convertible Promissory Note and the underlying
common stock upon conversion to an accredited investor, pursuant to a Regulation
D offering. The underlying common stock is now registered pursuant to a Form
SB-2 registration statement declared effective August 2, 2005.
November 2003 Convertible Notes. We converted $25,000 of our November 2003
Convertible Promissory Notes into 549,340 shares of common stock pursuant to a
notice of conversion from Gamma Opportunity Capital Partners LP, at a fixed
conversion price of $0.05. The conversion included $2,467 of accrued and unpaid
interest on the converted amount. We issued the underlying common stock upon
conversion pursuant to a Form SB-2 registration statement, declared effective on
August 3, 2004.
April 2004 Convertible Notes. We converted $99,999 of our April 2004
Convertible Promissory Notes into 1,141,387 shares of common stock pursuant to
notices of conversion from Longview Fund LP, at a fixed conversion price of
$0.10. The conversions included $14,138 of accrued and unpaid interest. We
issued the underlying common stock upon conversion pursuant to our SB-2
registration statement, declared effective on August 3, 2004.
June 2004 Convertible Notes. We converted $41,666 of our June 2004
Convertible Promissory Notes into 430,327 shares of restricted common stock
pursuant to a notice of conversion from Longview Fund LP, at a fixed conversion
price of $0.15. The conversion included $22,822 of accrued and unpaid interest.
We issued the Convertible Promissory Note and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering. The
underlying common stock is now registered pursuant to a Form SB-2 registration
statement declared effective April 18, 2005.
Quarter Ended June 30, 2005
---------------------------
New Financing: April 2005 Convertible Note. On April 21, 2005, we closed a
funding transaction with Alpha Capital Aktiengesellschaft for the issuance of a
convertible 10% note in the aggregate amount of $300,000. The promissory note is
convertible into shares of common stock of the Company at $0.20 per common
share. Conversions are limited to a maximum ownership of 9.99% of the Company's
common stock at any one time. The note has an October 31, 2005 maturity and is
payable in five equal monthly installments, commencing June 1, 2005. The
installment payments consist of principal (equal to 1/5th of the initial
principal amount) plus accrued interest. Installments can be paid in cash or
common stock valued at the average closing price of the Company's common stock
during the
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five trading days immediately preceding the relevant installment due date. The
Company has repriced Class B Warrants issued on June 30, 2004 from $2.00 per
share to $0.125 per share and issued restricted common stock in the aggregate
amount of 93,750 shares for finder's fees to a third-party to facilitate this
transaction. The Company has the right to prepay the promissory note by paying
to the holder cash equal to 120% of the principal to be prepaid plus accrued
interest. The notes have an acceleration provision upon the change in a majority
of the present Board of Directors except as the result of the death of one or
more directors or a change in the present CEO of the Company. The common stock
underlying the note and the finder's fee common stock have "piggy back"
registration rights. We issued the convertible note and finder's fee common
stock to accredited investors, pursuant to a Regulation D offering.
New Financing: May 2005 Convertible Notes On May 23, 2005, we closed a
funding transaction (the "May '05 Transaction") with Longview Fund, LP,
Whalehaven Funds Limited, Ellis International Ltd., and Osher Capital Corp.,
four institutional accredited investors, for the issuance and sale to the
Subscribers of Five Hundred Thousand Dollars ($500,000) of principal amount of
promissory notes convertible into shares of our common stock and Warrants to
purchase shares of common stock at 100% coverage of the common stock issuable in
accordance with the principal amount of the notes. This May '05 Transaction was
a part of a January 23, 2005 funding transaction for an aggregate of Two Million
Three Hundred Thousand Dollars ($2,300,000), One Million One Hundred Fifty
Thousand Dollars ($1,150,000) of which was paid on the initial closing date, and
One Million One Hundred Fifty Thousand Dollars ($1,150,000) of which (the
"Second Tranche") was to be payable within five (5) business days after the
actual effectiveness of an SB-2 Registration Statement covering the aggregate
transaction, as defined in the Subscription Agreement. The May '05 Transaction
for Five Hundred Thousand Dollars ($500,000) is a partial interim closing of the
Second Tranche, which occurred prior to the anticipated effectiveness of the
SB-2 Registration Statement covering the aggregate transaction. Contemporaneous
with the May '05 Transaction, we agreed to a modification of the January 23,
2005 aggregate transaction for the substitution of Ellis International Ltd. and
Osher Capital Corp. in the place of Alpha Capital Aktiengesellschaft, one of the
original investors. The May '05 Transaction convertible notes are at prime plus
4% interest in the aggregate amount of $500,000, plus five-year Warrants for the
purchase of, in the aggregate, 4,000,000 shares of common stock, at an exercise
price of $0.129. The notes are convertible into shares of our common stock at
$0.125 per common share. Conversions are limited to a maximum ownership of 9.99%
of the underlying common stock at any one time. The notes have a maturity date
two years from closing and are payable in twelve equal monthly installments,
commencing June 1, 2005. The installment payments consist of principal equal to
1/20th of the initial principal amount which, subject to certain conditions
concerning trading volume and price, can be paid in cash at 103% of the monthly
installment or common stock or a combination of both. The notes have an
acceleration provision upon the change in a majority of the present Board of
Directors except as the result of the death of one or more directors, or a
change in the present CEO. In connection with this transaction, we issued
restricted common stock in the aggregate amount of 200,000 shares plus the
aggregate cash amount of $25,000 for due diligence fees to Longview Fund, LP,
Gem Funding LLC, Ellis International Ltd., and Osher Capital Corp. in this
transaction. The Second Tranche of the January 23, 2005 aggregate transaction,
now in the amount of $650,000, remains outstanding and will be triggered by the
effectiveness of the pending SB-2 registration statement.
Conversions: November 2003 Convertible Notes. We converted $50,000 of our
November 2003 Convertible Promissory Note into 1,106,740 shares of common stock
pursuant to a notice of conversion from Gamma Opportunity Capital Partners LP,
at a fixed conversion price of $0.05. The conversion included $5,337 of accrued
and unpaid interest. We issued the underlying common stock upon conversion
pursuant to a Form SB-2 registration statement, declared effective on August 3,
2004.
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Warrant Exercise: November 2003 Warrant. We issued 1,000,000 shares of
common stock to Gamma Opportunity Capital Partners LP pursuant to the exercise
of a Warrant issued in connection with the November 2003 financing transaction,
and received $50,000 in warrant exercise payments. The shares of common stock
underlying the warrant were issued pursuant to a Form SB-2 shelf registration
statement, declared effective by the SEC on August 3, 2004.
Warrant Exercise: April 2004 Warrant. We issued 1,500,000 shares of common
stock to Longview Fund LP pursuant to the exercise of a Warrant issued in
connection with the April 2004 financing transaction, and received $225,000 in
warrant exercise payments. The shares of common stock underlying the warrant
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on August 3, 2004.
Conversions: June 2004 Convertible Notes. We converted $528,573 of our
June 2004 Convertible Promissory Notes into 5,633,039 shares of common stock
pursuant to notices of conversion from Longview Fund LP, Gem Funding LLC,
Whalehaven Capital Fund Limited, Stonestreet Limited Partnership and Bi-Coastal
Consulting Corp. at a fixed conversion price of $0.10. The conversion included
$33,689 of accrued and unpaid interest. We issued the common stock upon
conversion pursuant to a Form SB-2 registration statement declared effective by
the Securities and Exchange Commission on April 18, 2005.
Warrant Exercise: June 2004 Warrant. We issued 2,200,000 shares of common
stock to Longview Fund LP, Whalehaven Capital Fund Limited and Stonestreet
Limited Partnership pursuant to the exercise of Warrants issued in connection
with the June 2004 financing transaction, and received $309,000 in warrant
exercise payments. The shares of common stock underlying the warrants were
issued pursuant to a Form SB-2 shelf registration statement, declared effective
by the SEC on April 18, 2005.
Conversions: October 2004 Convertible Notes. We converted $446,250 of our
October 2004 Convertible Promissory Notes into 4,718,514 shares of common stock
pursuant to notices of conversion from Longview Fund LP, Gem Funding LLC,
Whalehaven Capital Fund Limited, Stonestreet Limited Partnership and Bi-Coastal
Consulting Corp. at a fixed conversion price of $0.10. The conversion included
$25,602 of accrued and unpaid interest. We issued the common stock upon
conversion pursuant to a Form SB-2 registration statement declared effective by
the Securities and Exchange Commission on April 18, 2005.
Warrant Exercise: October 2004 Warrant. We issued 1,700,000 shares of
common stock to Longview Fund LP, Whalehaven Capital Fund Limited and
Stonestreet Limited Partnership pursuant to the exercise of Warrants issued in
connection with the October 2004 financing transaction, and received $248,700 in
warrant exercise payments. The shares of common stock underlying the warrants
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on April 18, 2005.
Conversions: December 2004 Convertible Notes. We converted $210,000 of our
December 2004 Convertible Promissory Notes into 2,176,706 shares of common stock
pursuant to notices of conversion, to Momona Capital Corp. and Ellis
International Ltd Inc., at a fixed conversion price of $0.10 per share. The
conversion included $7,450 of accrued and unpaid interest. We issued the
underlying common stock upon conversion pursuant to a Form SB-2 registration
statement, declared effective on April 18, 2005.
Warrant Exercise: December 2004 Warrant. We issued 500,000 shares of
common stock to Momona Capital Corp. and Ellis International Ltd Inc., pursuant
to the exercise of Warrants issued in
F-43
connection with the December 2004 financing transaction, and received $72,500 in
warrant exercise payments. The shares of common stock underlying the warrants
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on April 18, 2005.
Conversions: January 2005 Convertible Notes. We converted $534,304 of our
January 2005 Convertible Promissory Notes into 4,461,685 shares of restricted
common stock pursuant to notices of conversion, to Longview Fund LP, Longview
Equity Fund LP and Longview International Equity Fund LP at a fixed conversion
price of $0.125 per share. We issued the Convertible Promissory Note and the
underlying common stock upon conversion to an accredited investor, pursuant to a
Regulation D offering. The underlying common stock is now registered pursuant to
a Form SB-2 registration statement declared effective August 2, 2005.
Conversions: Series F Convertible Preferred. We converted 31,134 shares of
our Series F Convertible Preferred, having a stated value of $311,340 into
2,903,839 shares of common stock pursuant to notices of conversion, to
Austinvest Anstalt Balzers and Esquire Trade & Finance Inc. We issued the Series
F Convertible Preferred and the underlying common stock upon conversion to
accredited investors, pursuant to a Regulation D offering and Rule 144(k).
Conversions: Series H Convertible Preferred. We converted 100,000 shares
of our Series H Convertible Preferred, having a stated value of $1,000,000 into
2,500,000 shares of common stock pursuant to notices of conversion, to four
individual and two institutional investors. We issued the Convertible Preferred
and the underlying common stock upon conversion to accredited investors,
pursuant to a Regulation D offering and Rule 144(k).
Conversions: Series I Convertible Preferred. We converted 20,000 shares of
our Series I Convertible Preferred, having a stated value of $200,000 into
2,354,808 shares of common stock pursuant to a notice of conversion, to Alpha
Capital AG. We issued the Convertible Preferred and the underlying common stock
upon conversion to accredited investors, pursuant to a Regulation D offering and
Rule 144(k).
Warrant Exercise: Series I Warrant. We issued 1,333,333 shares of
restricted common stock to Alpha Capital AG, pursuant to the exercise of
Warrants issued in connection with the Series I financing transaction, and
received $133,333 in warrant exercise payments. The shares of common stock
underlying the warrants are now registered pursuant to a Form SB-2 shelf
registration statement, declared effective by the SEC on August 2, 2005.
Private Placements. On May 17, 2005 we issued the aggregate of 27,500
restricted shares of the Company's common stock, with a recorded value of
$4,950, to eleven product sales brokers as a bonus for the performance of
services for the Company. We issued the restricted common stock pursuant to
Section 4(6) of the Securities Act of 1933, which provides an exemption from the
registration requirements of the Act for transactions not involving a public
offering.
S-8 Registration. On April 14, 2005 and April 18, 2005, we issued 750,000
and 250,000 shares, respectively, of our common stock to Geoffrey Eiten, for
services rendered for strategic business planning. These shares were part of
1,500,000 shares of the Company's common stock registered under a Form S-8
registration statement filed December 23, 2004.
Warrant Issue. On June 20, 2005, we issued one year Warrant to Marvel
Enterprises Inc. to purchase 1,000,000 shares of our common stock a $0.05 per
share. This Warrant was issued in connection with the execution of a License
Agreement with Marvel for the United States, Canada and
F-44
Mexico. We issued the Warrant pursuant to Section 4(6) of the Securities Act of
1933, which provides an exemption from the registration requirements of the Act
for transactions not involving a public offering.
Quarter Ended September 30, 2005
--------------------------------
Warrant Exercise: Series D Warrant. We issued 696,042 shares of common
stock to Longview Fund LP, Longview Equity Fund LP, Longview International
Equity Fund LP and Esquire Trade & Finance Inc., pursuant to the cashless
exercises of warrants for 763,750 shares of common stock. We issued the Warrants
and the underlying common stock upon exercise to accredited investors, pursuant
to a Regulation D offering and Rule 144(k).
Conversions: Series F Convertible Preferred. We converted 19,133 shares of
our Series F Convertible Preferred, having a stated value of $191,330 into
804,752 shares of common stock pursuant to notices of conversion to Amro
International, SA. We issued the Series F Convertible Preferred and the
underlying common stock upon conversion to accredited investors, pursuant to a
Regulation D offering and Rule 144(k).
Warrant Exercise: Series F Warrant. We issued 3,345,417 shares of common
stock to Austinvest Anstalt Balzers and Esquire Trade & Finance Inc. and Libra
Finance, SA., pursuant to the cashless exercise of warrants for 3,676,518 shares
of common stock. We issued the Warrants and the underlying common stock upon
exercise to accredited investors, pursuant to a Regulation D offering and Rule
144(k).
Conversions: Series H Convertible Preferred. We converted 1,000 shares of
our Series H Convertible Preferred, having a stated value of $10,000 into 25,000
shares of common stock pursuant to notices of conversion, to one individual
investor. We issued the Convertible Preferred and the underlying common stock
upon conversion to accredited investors, pursuant to a Regulation D offering and
Rule 144(k).
Conversions: Series I Convertible Preferred. We converted 10,000 shares of
our Series I Convertible Preferred, having a stated value of $100,000 into
656,953 shares of common stock pursuant to a notice of conversion, to
Tradersbloom Limited. The conversion included $24,000 of accrued and unpaid
interest. We issued the Convertible Preferred and the underlying common stock
upon conversion to accredited investors, pursuant to a Regulation D offering and
Rule 144(k).
Conversions: April 2004 Convertible Notes. We converted $250,000 of our
April 2004 Convertible Promissory Notes into 2,808,219 shares of common stock
pursuant to notices of conversion from Osher Capital Inc., Ellis International
Ltd Inc. and Alpha Capital AG. The conversion included $3,082 of accrued and
unpaid interest on the converted amount. We issued the underlying common stock
upon conversion pursuant to a Form SB-2 registration statement, declared
effective on August 4, 2004.
Conversions: June 2004 Convertible Notes. We converted $250,000 of our
June 2004 Convertible Promissory Notes into 2,796,575 shares of common stock
pursuant to notices of conversion from Alpha Capital AG at a fixed conversion
price of $0.10. The conversion included $29,657 of accrued and unpaid interest
on the converted amount. We issued the common stock upon conversion pursuant to
a Form SB-2 registration statement declared effective by the Securities and
Exchange Commission on April 18, 2005.
Conversions: October 2004 Convertible Notes. We converted $125,000 of our
October 2004 Convertible Promissory Notes into 1,342,808 shares of common stock
pursuant to notices of conversion
F-45
from Alpha Capital AG at a fixed conversion price of $0.10. The conversion
included $9,280 of accrued and unpaid interest on the converted amount. We
issued the common stock upon conversion pursuant to a Form SB-2 registration
statement declared effective by the Securities and Exchange Commission on April
18, 2005.
Warrant Exercise: December 2004 Warrant. We issued 300,000 shares of
common stock to Momona Capital Corp. pursuant to the exercise of Warrants issued
in connection with the December 2004 financing transaction, and received $30,000
in warrant exercise payments. The shares of common stock underlying the warrants
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on April 18, 2005.
Conversions: January 2005 Convertible Notes. We converted $500,071 of our
January 2005 Convertible Promissory Notes into 4,186,644 shares of restricted
common stock pursuant to notices of conversion, to Longview Fund LP, Longview
Equity Fund LP and Longview International Equity Fund LP at a fixed conversion
price of $0.125 per share. The conversion included $23,260 of accrued and unpaid
interest on the converted amount. We issued the common stock upon conversion
pursuant to a Form SB-2 registration statement declared effective by the
Securities and Exchange Commission on August 2, 2005.
Warrant Exercise: January 2005 Warrant. We issued 7,200,000 shares of
common stock to Whalehaven Capital Fund Limited, Longview Fund LP, Longview
Equity Fund LP and Longview International Equity Fund LP pursuant to the
exercise of Warrants issued in connection with the January 2005 financing
transaction, and received $720,000 in warrant exercise payments. The shares of
common stock underlying the warrants were issued pursuant to a Form SB-2 shelf
registration statement, declared effective by the SEC on August 2, 2005.
Conversions: April 2005 Convertible Notes. We converted $300,000 of our
April 2005 Convertible Promissory Note into 1,556,438 shares of restricted
common stock pursuant to notices of conversion, to Alpha Capital AG at a fixed
conversion price of $0.20 per share. The conversion included $11,288 of accrued
and unpaid interest on the converted amount. We issued the common stock upon
conversion pursuant to a Form SB-2 registration statement declared effective by
the Securities and Exchange Commission on August 2, 2005.
Conversions: May 2005 Convertible Notes. We converted $475,000 of our May
2005 Convertible Promissory Notes into 4,141,270 shares of restricted common
stock pursuant to notices of conversion, to Whalehaven Capital Fund Limited,
Ellis International Ltd, Longview Fund LP and Osher Capital Corp. The conversion
included $9,317 of accrued and unpaid interest on the converted amount. We
issued the common stock upon conversion pursuant to a Form SB-2 registration
statement declared effective by the Securities and Exchange Commission on August
2, 2005.
Warrant Exercise: May 2005 Warrant. We issued 4,000,000 shares of common
stock to Whalehaven Capital Fund Limited, Ellis International Ltd, Longview Fund
LP and Osher Capital Corp. pursuant to the exercise of Warrants issued in
connection with the January 2005 financing transaction, and received $400,000 in
warrant exercise payments. The shares of common stock underlying the warrants
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on August 2, 2005.
New Financing: August 2005 Convertible Notes On August 18, 2005, we closed
a funding transaction (the "August '05 Transaction") with Longview Fund, LP,
Longview Equity Fund, LP and Longview International Equity Fund, LP, three
institutional accredited investors, for the issuance and sale
F-46
to the Subscribers of Six Hundred Fifty Thousand Dollars ($650,000) of principal
amount of promissory notes convertible into shares of our common stock and
Warrants to purchase shares of common stock at 100% coverage of the common stock
issuable in accordance with the principal amount of the notes. This August'05
Transaction was a part of a January 23, 2005 funding transaction for an
aggregate of Two Million Three Hundred Thousand Dollars ($2,300,000). The August
'05 Transaction is the Second Tranche of the January '05 transaction, which
occurred upon the effectiveness of the SB-2 Registration Statement covering the
aggregate transaction. The August'05 Transaction convertible notes are at prime
plus 4% interest in the aggregate amount of $650,000, plus five-year Warrants
for the purchase of, in the aggregate, 5,200,000 shares of common stock, at an
exercise price of $0.129. The notes are convertible into shares of our common
stock at $0.125 per common share. Conversions are limited to a maximum ownership
of 9.99% of the underlying common stock at any one time. The notes have a
maturity date two years from closing and are payable in twelve equal monthly
installments. The installment payments consist of principal equal to 1/20th of
the initial principal amount which, subject to certain conditions concerning
trading volume and price, can be paid in cash at 103% of the monthly
installment, or common stock or a combination of both. The notes have an
acceleration provision upon the change in a majority of the present Board of
Directors except as the result of the death of one or more directors, or a
change in the present CEO. In connection with this transaction, we issued
restricted common stock in the aggregate amount of 260,000 shares plus the
aggregate cash amount of $32,500 for due diligence fees to Longview Fund
companies. We issued the equity equivalents, the underlying common stock upon
conversion and the finders' fee common stock pursuant to a Form SB-2
registration statement declared effective by the Securities and Exchange
Commission on August 2, 2005.
On September 30, 2005, we prepaid $250,000 of the aggregate $650,000 of
the August '05 Transaction notes, as follows: $57,692 to Longview Fund, LP,
$144,231 to Longview Equity Fund, LP and $ $48,077 to Longview International
Equity Fund, LP. The holders of these notes waived the prepayment premium in
lieu of their retention of warrants attached to August '05 Transaction.
Conversions: August 2005 Convertible Notes. We converted $91,217 of our
August 2005 Convertible Promissory Notes into 743,750 shares of restricted
common stock pursuant to a notice of conversion, to Longview Fund LP, at a fixed
conversion price of $0.125 per share. The conversion included $1,752 of accrued
and unpaid interest on the converted amount. We issued the common stock upon
conversion pursuant to a Form SB-2 registration statement declared effective by
the Securities and Exchange Commission on August 2, 2005.
Warrant Exercise: August 2005 Warrant. We issued 5,200,000 shares of
common stock to Longview Fund LP, Longview Equity Fund LP and Longview
International Equity Fund LP pursuant to the exercise of Warrants issued in
connection with the August 2005 financing transaction, and received $520,000 in
warrant exercise payments. The shares of common stock underlying the warrants
were issued pursuant to a Form SB-2 shelf registration statement, declared
effective by the SEC on August 2, 2005.
Private Placements. On August 3, 2005 we issued 500,000 restricted shares
of our common stock to Geoffrey Eiten, for services rendered for strategic
business planning. We issued the restricted common stock pursuant to Section
4(6) of the Securities Act of 1933, which provides an exemption from the
registration requirements of the Act for transactions not involving a public
offering.
On August 29 and September 19, 2005 we issued the aggregate of 1,000,000
restricted shares of our common stock to National Financial Communications Corp.
pursuant to the exercise of Warrants issued in connection with a consulting
agreement for services rendered for strategic business planning. We issued the
restricted common stock pursuant to Section 4(6) of the Securities Act of 1933,
which
F-47
provides an exemption from the registration requirements of the Act for
transactions not involving a public offering.
On September 19, 2005, we issued 450,000 restricted shares of our common
stock to Alpha Capital AG, an accredited investor, in a sale not involving a
public offering at a price of $1.00 per share. We issued the common stock
pursuant to a Regulation D offering.
Warrant Issue. On August 31, 2005, we issued a three year Warrant to
Coca-Cola Enterprises Inc. to purchase 30,000,000 shares of our common stock a
$0.36 per share. During the first 18 months of the exercise period, the Company
has the option to "call" the exercise of up to 10,000,000 shares of common stock
issuable upon exercise of the Warrant, upon the Company's satisfaction of
certain conditions, including a trading price of not less than $1.08 per share
for 20 consecutive trading days. This Warrant was issued in connection with the
execution of a Master Distribution Agreement on August 31, 2005. We issued the
Warrant pursuant to Section 4(6) of the Securities Act of 1933, which provides
an exemption from the registration requirements of the Act for transactions not
involving a public offering. The Company will record an $11,900,000 net charge
in deferred distribution costs for the issuance of a three year warrant to
Coca-Cola Enterprises to purchase of 30,000,000 shares of our common stock in
connection with the Master Distribution Agreement. The Company will recognize
that cost as a selling expense over the 10-year term of the agreement.
Quarter Ended December 31, 2005
-------------------------------
On November 28, 2005, we closed a funding transaction with 13 accredited
institutional investors, for the issuance and sale of 40,500,000 shares of our
common stock for a purchase price of $20,250,000. In addition, we also issued
five-year warrants for the purchase of an additional 15,187,500 shares of common
stock at an exercise price of $0.80 per share. The securities are restricted and
have been issued pursuant to an exemption to the registration requirements of
Section 5 of the Securities Act of 1933 for "transactions of the issuer not
involving any public offering" provided in Section 4(2) of the Act and pursuant
to a Regulation D offering. In connection with this financing, we issued common
stock purchase warrants to purchase 1,012,500 shares of common stock at an
exercise price of $.50 per share and 304,688 shares of common stock at an
exercise price of $.80 per share to SG Cowen & Co., LLC, who acted as placement
agent for this financing.
The shares of common stock and the shares of common stock underlying the
warrants carry registration rights that obligate us to file a registration
statement within 45 days from closing and have the registration statement
declared effective within 120 days from closing.
All of the above offerings and sales were deemed to be exempt under rule
506 of Regulation D and Section 4(2) of the Securities Act of 1933, as amended.
No advertising or general solicitation was employed in offering the securities.
The offerings and sales were made to a limited number of persons, all of whom
were accredited investors, or business associates of Bravo! Brands Inc.,
and transfer was restricted by Bravo! Brands Inc. in accordance with the
requirements of the Securities Act of 1933. In addition to representations by
the above-referenced persons, we have made independent determinations that all
of the above-referenced persons were accredited or sophisticated investors, and
that they were capable of analyzing the merits and risks of their investment and
that they understood the speculative nature of their investment. Furthermore,
all of the above-referenced persons were provided with access to our Securities
and Exchange Commission filings.
Warrant Exercise: June 2004 Warrant. In December 2005, we issued
2,500,000 shares of common stock to Alpha Capital AG pursuant to the exercise
of a "B" Warrant issued in connection with
F-48
the June 2004 financing transaction and received $250,000 in warrant exercise
payments. The shares of common stock underlying the warrants were issued
pursuant to a Form SB-2 shelf registration statement, declared effective by the
SEC on April 18, 2005.
Year ended December 31, 2004
On February 1, 2004, we agreed to issue 750,000 shares of our common stock
and warrants to purchase an additional 750,000 shares of common stock to Marvel
Enterprises, Inc. We issued this equity in connection with the grant of an
intellectual property license by Marvel on January 17, 2004, giving us the right
to use certain Marvel Comics characters on our Slammers(R) line of flavored
milks. The warrants have an exercise price of $0.10 per share for the first year
and, upon the occurrence of certain conditions tied to the royalty performance
under the license, can be extended for an additional year with an exercise price
of $0.14 per share. We made this private offering to Marvel Enterprises, an
accredited investor, pursuant to Rule 506 of Regulation D and Section 4(2) of
the Securities Act of 1933.
On February 12, 2004, we held a special meeting of shareholders at which
the shareholders approved an increase of our authorized common stock from
50,000,000 shares to 300,000,000 shares.
On February 17, 2004, we converted 875 shares of Series G Convertible
Preferred Stock into 215,164 shares of common stock pursuant to a January 12,
2004 notice of conversion from Nesher, LP, at a conversion price of $0.0407. The
conversion included accrued and unpaid dividends on the converted preferred. We
delayed processing this notice in light of our special meeting of shareholders
held February 12, 2004. The shares of common stock issued pursuant to this
conversion were retired and cancelled on March 5, 2004 and issued to third
parties on that date in accordance with the instructions of Nesher, LP.
On February 17, 2004, we converted 1,400 shares of Series G Convertible
Preferred Stock into 343,980 shares of common stock pursuant to a January 12,
2004 notice of conversion from Talbiya Investments, Ltd., at a conversion price
of $0.0407. The conversion included accrued and unpaid dividends on the
converted preferred. We delayed processing this notice in light of our special
meeting of shareholders held February 12, 2004. The shares of common stock
issued pursuant to this conversion were retired and cancelled on March 5, 2004
and issued to third parties on that date in accordance with the instructions of
Talbiya Investments, Ltd.
On February 17, 2004, we converted 700 shares of Series G Convertible
Preferred Stock into 172,162 shares of common stock pursuant to a January 12,
2004 notice of conversion from The Keshet Fund, LP, at a conversion price of
$0.0407. The conversion included accrued and unpaid dividends on the converted
preferred. We delayed processing this notice in light of our special meeting of
shareholders held February 12, 2004. The shares of common stock issued pursuant
to this conversion were retired and cancelled on March 5, 2004 and issued to
third parties on that date in accordance with the instructions of The Keshet
Fund, LP.
On February 17, 2004, we converted 2,025 shares of Series G Convertible
Preferred Stock into 497,951 shares of common stock pursuant to a January 12,
2004 notice of conversion from Keshet LP, at a conversion price of $0.0407. The
conversion included accrued and unpaid dividends on the converted preferred. We
delayed processing this notice in light of our special meeting of shareholders
held February 12, 2004. The shares of common stock issued pursuant to this
conversion were retired and cancelled on March 5, 2004 and issued to third
parties on that date in accordance with the instructions of Keshet, LP.
F-49
On March 1,2004, we issued 80,000 shares of non-voting Series K 8%
Convertible Preferred stock, to Mid-Am Capital, LLC, having a stated value of
$10.00 per Preferred K share, for the aggregate purchase price of $800,000. Each
preferred share is convertible to 100 shares of our common stock at a conversion
price of $0.10, representing 8,000,000 shares of common stock underlying the
preferred. In addition, we made the following adjustments to prior issued
warrants for the purpose of facilitating future fund raising by us arising out
of the exercise of the warrants by Holder. The purchase price, as defined in the
Warrant No. 2003-B-002, has been reduced to $0.10, subject to further adjustment
as described in the warrant. The expiration date, as defined in the warrant,
remains as stated. This private offering was made to Mid-Am, an accredited
investor, pursuant to Rule 506 of Regulation D and Section 4(2) of the
Securities Act of 1933.
On March 9, 2004, we converted 5,000 shares of Series F Convertible
Preferred Stock into 1,315,789 shares of common stock pursuant to a January 8,
2004 notice of conversion from Esquire Trade & Finance Inc., at a conversion
price of $0.038. The conversion did not include accrued and unpaid dividends on
the converted preferred. We delayed processing this notice in light of our
special meeting of shareholders held February 12, 2004. The shares of common
stock issued pursuant to this conversion were issued to third parties on that
date in accordance with the instructions of Esquire Trade & Finance Inc.
On April 1 2004, we converted 5,000 shares of Series F Convertible
Preferred Stock into 1,315,789 shares of common stock pursuant to a January 27,
2004 notice of conversion from Austinvest Anstalt Balzers, at a conversion price
of $0.038. The conversion did not include accrued and unpaid dividends on the
converted preferred. We delayed processing this notice in light of our special
meeting of shareholders held February 12, 2004. The shares of common stock
issued pursuant to this conversion were issued to third parties on that date in
accordance with the instructions of Austinvest Anstalt Balzers. We issued the
preferred and the underlying common stock upon conversion to an accredited
investor, pursuant to a Regulation D offering.
On April 2, 2004, the Company and Mid-Am Capital, LLC entered into
Supplement No.1 to the Series K Convertible Preferred Subscription Agreement, by
which we sold an additional 15,000 shares of our Series K Convertible Preferred
Stock utilizing the proceeds from a certain promissory note issued by us to
Mid-Am in the face amount of $150,000. With the consummation of this sale, the
$150,000 promissory note was deemed paid by us in full. We issued the preferred
and the underlying common stock upon conversion to an accredited investor,
pursuant to a Regulation D offering.
On April 8, 2004, we converted 4,862 shares of Series G Convertible
Preferred Stock into 700,000 shares of common stock pursuant to a March 25, 2004
notice of conversion from Nesher, LP, at a conversion price of $0.0853. The
conversion included accrued and unpaid dividends of $11,089 on the preferred
converted. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On April 8, 2004, we converted 4,478 shares of Series G Convertible
Preferred Stock into 650,000 shares of common stock pursuant to a March 25, 2004
notice of conversion from Talbiya B. Investments, Ltd., at a conversion price of
$0.0853. The conversion included accrued and unpaid dividends of $10,662 on the
preferred converted. We issued the preferred and the underlying common stock
upon conversion to an accredited investor, pursuant to a Regulation D offering.
On April 8, 2004, we converted 1,919 shares of Series G Convertible
Preferred Stock into 275,000 shares of common stock pursuant to a March 25, 2004
notice of conversion from The Keshet Fund, LP, at a conversion price of $0.0853.
The conversion included accrued and unpaid dividends of
F-50
$4,265 on the preferred converted. We issued the preferred and the underlying
common stock upon conversion to an accredited investor, pursuant to a Regulation
D offering.
On April 8, 2004, we converted 7,677 shares of Series G Convertible
Preferred Stock into 1,100,000 shares of common stock pursuant to a March 25,
2004 notice of conversion from Keshet, LP, at a conversion price of $0.0853. The
conversion included accrued and unpaid dividends of $17,060 on the preferred
converted. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On April 20, 2004, we entered into a Subscription Agreement with Longview
Fund, LP and Alpha Capital Aktiengesellschaft for the issuance of two
convertible 10% notes in the amount of $250,000 each and five-year warrants for
the purchase of, in the aggregate, 3,000,000 shares of common stock, at $0.15
per share. The notes are convertible into shares of our common stock at $0.10
per common share. Conversions are limited to a maximum ownership of 9.99% of the
underlying common stock at any one time. The notes are payable in twelve equal
monthly installments, commencing November 1, 2004. The installment payments
consist of principal and a "premium" of 20% of the principal paid per
installment. We have the option to defer such payment until the note's maturity
date on October 1, 2005, if our common stock trades above $0.20 for the five
trading days prior to the due date of an installment payment. In connection with
this transaction, we issued two additional notes in the aggregate amount of
$50,000, upon identical terms as the principal notes, as a finder's fee, and
paid $20,000 in legal fees. The common stock underlying all notes and warrants
carry registration rights. We issued the convertible notes and warrants to
accredited investors, pursuant to a Regulation D offering.
On April 30, 2004, we converted 20,000 shares of Series F Convertible
Preferred Stock into 1,945,525 shares of common stock pursuant to an April 27,
2004 notice of conversion from Esquire Trade & Finance Inc., at a conversion
price of $0.1028. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On April 30, 2004, we converted 20,000 shares of Series F Convertible
Preferred Stock into 1,945,525 shares of common stock pursuant to an April 27,
2004 notice of conversion from Austinvest Anstalt Balzers, at a conversion price
of $0.1028. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On April 30, 2004, we converted 2,500 shares of Series F Convertible
Preferred Stock into 243,191 shares of common stock pursuant to an April 27,
2004 notice of conversion from Esquire Trade & Finance Inc., at a conversion
price of $0.1028. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On April 30, 2004, we converted 2,500 shares of Series F Convertible
Preferred Stock into 243,191 shares of common stock pursuant to an April 27,
2004 notice of conversion from Austinvest Anstalt Balzers, at a conversion price
of $0.1028. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On May 20, 2004, we converted 9,226 shares of Series G Convertible
Preferred Stock into 620,578 shares of common stock pursuant to a May 19, 2004
notice of conversion from Nesher, LP, at a conversion price of $0.148. The
conversion did not include accrued and unpaid dividends on the converted
preferred. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
F-51
On May 20, 2004, we converted 13,972 shares of Series G Convertible
Preferred Stock into 939,782 shares of common stock pursuant to a May 19, 2004
notice of conversion from Keshet, LP, at a conversion price of $0.148. The
conversion did not include accrued and unpaid dividends on the converted
preferred. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering.
On June 17, 2004, we issued 87,195 of our common stock to Stephen Nollau,
a former consultant, for services rendered. We issued the common stock pursuant
to a Form S-8 registration statement, filed by us on June 16, 2004.
On June 29, 2004, we converted 234 shares of Series G Convertible
Preferred Stock into 13,604 shares of common stock pursuant to a June 15, 2004
notice of conversion from Nesher, LP, at a conversion price of $0.172. The
conversion did not include accrued and unpaid dividends on the converted
preferred. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering. This
conversion exhausted the outstanding Series G convertible preferred held by this
investor.
On June 29, 2004, we converted 1,850 shares of Series G Convertible
Preferred Stock into 107,558 shares of common stock pursuant to a June 15, 2004
notice of conversion from Keshet, LP, at a conversion price of $0.172. The
conversion did not include accrued and unpaid dividends on the converted
preferred. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering. This
conversion exhausted the outstanding Series G convertible preferred held by this
investor.
On June 29, 2004, we converted 3,472 shares of Series G Convertible
Preferred Stock into 201,860 shares of common stock pursuant to a June 15, 2004
notice of conversion from The Keshet Fund, LP, at a conversion price of $0.172.
The conversion did not include accrued and unpaid dividends on the converted
preferred. We issued the preferred and the underlying common stock upon
conversion to an accredited investor, pursuant to a Regulation D offering. This
conversion exhausted the outstanding Series G convertible preferred held by this
investor.
On June 29, 2004, we converted 8,091 shares of Series G Convertible
Preferred Stock into 470,406 shares of common stock pursuant to a June 15, 2004
notice of conversion from Talbiya B. Investments, Ltd, at a conversion price of
$0.172. The conversion did not include accrued and unpaid dividends on the
converted preferred. We issued the preferred and the underlying common stock
upon conversion to an accredited investor, pursuant to a Regulation D offering.
This conversion exhausted the outstanding Series G convertible preferred held by
this investor.
On June 30, 2004, we entered into Subscription Agreements with Longview
Fund, LP, Alpha Capital Aktiengesellschaft, Whalehaven Funds Limited,
Stonestreet Limited Partnership and Mid-Am Capital L.L.C for the issuance of
convertible 10% notes in the aggregate amount of $1,300,000 and five-year "A"
warrants for the purchase of, in the aggregate, 5,200,000 shares of common
stock, at $0.25 per share, and five-year "B" warrants for the purchase of, in
the aggregate, 13,000,000 shares of common stock, at $2.00 per share. The notes
are convertible into shares of our common stock at $0.15 per common share.
Conversions are limited to a maximum ownership of 9.99% of the underlying common
stock at any one time. The notes are payable in twelve equal monthly
installments, commencing January 1, 2005. The installment payments consist of
principal and a "premium" of 20% of the principal paid per installment. We have
the option to defer such payment until the note's maturity date on December 1,
2005, if our common stock trades above $0.20 for the five trading days prior to
the due date of an installment payment. In connection with this transaction, we
issued additional notes in the aggregate
F-52
amount of $40,000 to Gem Funding, LLC, Bi-Coastal Consulting Corp., Stonestreet
Limited Partnership and Libra Finance, S.A upon identical terms as the principal
notes, as a finder's fee, and paid $12,500 in legal fees. The common stock
underlying all notes and warrants carry registration rights. We issued the
convertible notes and warrants to accredited investors, pursuant to a Regulation
D offering.
On August 9, 2004, we converted $50,000 of our November 2003 Convertible
Promissory Note into 1,000,000 shares of common stock pursuant to an August 5,
2004 notice of conversion from Gamma Opportunity Capital Partners LP, at a fixed
conversion price of $0.05. The conversion did not include accrued and unpaid
interest on the converted amount. We issued the underlying common stock upon
conversion pursuant to our SB-2 registration statement, declared effective on
August 3, 2004.
On August 23, 2004, we converted $50,000 of our April 2004 Convertible
Promissory Note into 500,000 shares of common stock pursuant to an August 5,
2004 notice of conversion from Longview Fund LP, at a fixed conversion price of
$0.10. The conversion did not include accrued and unpaid interest on the
converted amount. We issued the underlying common stock upon conversion pursuant
to our SB-2 registration statement, declared effective on August 3, 2004.
On September 27, 2004, we converted $50,000 of our April 2004 Convertible
Promissory Note into 500,000 shares of common stock pursuant to a September 21,
2004 notice of conversion from Longview Fund LP, at a fixed conversion price of
$0.10. The conversion did not include accrued and unpaid interest on the
converted amount. We issued the underlying common stock upon conversion pursuant
to our SB-2 registration statement, declared effective on August 3, 2004.
On October 6, 2004, we converted $25,000 of our November 2003 Convertible
Promissory Note into 500,000 shares of common stock pursuant to a September 23,
2004 notice of conversion from Gamma Opportunity Capital Partners LP, at a fixed
conversion price of $0.05. The conversion did not include accrued and unpaid
interest on the converted amount. We issued the underlying common stock upon
conversion pursuant to our SB-2 registration statement, declared effective on
August 3, 2004.
On October 6, 2004, we issued 500,000 shares of our common stock to
Knightsbridge Holdings, LLC, pursuant to a consulting agreement dated November
10, 2003. We issued the common stock pursuant to our SB-2 registration
statement, declared effective on August 3, 2004. The issued and outstanding
equity reported in our Form 10QSB for the period ended March 31, 2004 reflects
these shares of common stock.
On October 13, 2004, we issued 250,000 restricted shares of our common
stock in a private placement to Arthur Blanding, at the market price of $0.12
per share, pursuant to Section 4(2) of the Securities Act of 1934. Mr. Blanding,
who solicited the purchase, is an accredited investor and has been a director of
the Company since 1999.
On October 15, 2004, we issued 750,000 shares of our common stock to
Marvel Enterprises, Inc., as partial compensation under a license agreement
dated February 1, 2004. We issued the common stock pursuant to our SB-2
registration statement, declared effective on August 3, 2004. The issued and
outstanding equity reported in our Form 10QSB for the period ended March 31,
2004 reflects these shares of common stock.
On October 29, 2004, we entered into Subscription Agreements with Longview
Fund, LP, Alpha Capital Aktiengesellschaft, Whalehaven Funds Limited and
Stonestreet Limited Partnership for the issuance of convertible 10% notes in the
aggregate amount of $550,000 and five-year "C" warrants for the purchase of, in
the aggregate, 2,200,000 shares of common stock, at $0.15 per share, and the
repricing
F-53
of five-year "A" warrants, issued June 30, 2004 for the purchase of, in the
aggregate, 3,200,000 shares of common stock, from $0.25 to $0.15 per share. The
notes are convertible into shares of our common stock at $0.10 per common share.
Conversions are limited to a maximum ownership of 9.99% of the underlying common
stock at any one time. The notes are payable in twelve equal monthly
installments, commencing May 1, 2005. The installment payments consist of
principal and a "premium" of 20% of the principal paid per installment. We have
the option to defer such payment until the note's maturity date on April 30,
2006, if our common stock trades above $0.15 for the five trading days prior to
the due date of an installment payment and the underlying common stock is
registered. In connection with this transaction, we issued additional notes,
without attached warrants, in the aggregate amount of $27,500 to Gem Funding,
LLC, Bi-Coastal Consulting Corp., Stonestreet Limited Partnership and Libra
Finance, S.A upon identical terms as the principal notes, as a finder's fee, and
paid $12,500 in legal fees. The common stock underlying all notes and warrants
carry registration rights. We issued the convertible notes and warrants to
accredited investors, pursuant to a Regulation D offering.
On December 17, 2004, we converted $50,000 of our April 2004 Convertible
Promissory Note into 500,000 shares of common stock pursuant to a December 8,
2004 notice of conversion from Longview Fund LP, at a fixed conversion price of
$0.10. The conversion did not include accrued and unpaid interest on the
converted amount. We issued the underlying common stock upon conversion pursuant
to our SB-2 registration statement, declared effective on August 3, 2004.
On December 20, 2004, we converted $25,000 of our April 2004 Convertible
Promissory Note into 265,958 shares of common stock pursuant to a December 9,
2004 notice of conversion from Bi Coastal Consulting Corp., at a fixed
conversion price of $0.10. The conversion included $1,595.89 accrued and unpaid
interest on the converted amount. We issued the underlying common stock upon
conversion pursuant to our SB-2 registration statement, declared effective on
August 3, 2004.
On December 20, 2004, we converted $50,000 of our November 2003
Convertible Promissory Note into 1,000,000 shares of common stock pursuant to a
December 8, 2004 notice of conversion from Gamma Opportunity Capital Partners
LP, at a fixed conversion price of $0.05. The conversion did not include accrued
and unpaid interest on the converted amount. We issued the underlying common
stock upon conversion pursuant to our SB-2 registration statement, declared
effective on August 3, 2004.
On December 27, 2004, we converted 10,000 shares of Series F Convertible
Preferred Stock into 1,290,323 shares of common stock pursuant to a December 27,
2004 notice of conversion from Austinvest Anstalt Balzers, at a conversion price
of $0.0775. The conversion did not include accrued and unpaid dividends on the
converted preferred. We issued the preferred and the underlying common stock
upon conversion to an accredited investor, pursuant to a Regulation D offering
and Rule 144.
On December 27, 2004, we converted 10,000 shares of Series F Convertible
Preferred Stock into 1,290,323 shares of common stock pursuant to a December 27,
2004 notice of conversion from Esquire Trade & Finance Inc., at a conversion
price of $0.0775. The conversion did not include accrued and unpaid dividends on
the converted preferred. We issued the preferred and the underlying common stock
upon conversion to an accredited investor, pursuant to a Regulation D offering
and Rule 144.
On December 29, 2004, we closed a funding transaction with Momona Capital
Corp. and Ellis International Ltd. for the issuance of convertible 10% notes in
the aggregate amount of $200,000 and five-year "C" warrants for the purchase of,
in the aggregate, 800,000 shares of common stock, at $0.15 per share. The notes
are convertible into shares of our common stock at $0.10 per common share.
Conversions are limited to a maximum ownership of 9.99% of the underlying common
stock at any one time. The notes are payable in twelve equal monthly
installments, commencing May 1, 2005. The
F-54
installment payments consist of principal and a "premium" of 20% of the
principal paid per installment. We have the option to defer such payment until
the note's maturity date on April 30, 2006, if our common stock trades above
$0.15 for the five trading days prior to the due date of an installment payment,
and the underlying common stock is registered. In connection with this
transaction, we issued additional notes, without attached warrants, in the
aggregate amount of $10,000 to the investors upon identical terms as the
principal notes, as a finder's fee, and paid $3,500 in legal fees. The common
stock underlying all notes and warrants carry registration rights. We issued the
convertible notes and warrants to accredited investors, pursuant to an amendment
to an October 29, 2004 Regulation D offering.
On December 31, 2004, we issued 8,095,105 shares of our common stock and
options for 150,000 shares at an exercise price of $0.25 per share to our
employees and consultants for services rendered, pursuant to a Form S-8
registration statement filed December 23, 2004.
Note 10 - Income Taxes
We have recorded no income tax benefit for our taxable losses during the years
ended December 31, 2005 and 2004 because there is no certainty that we will
realize those benefits. The components of our deferred tax assets and
liabilities as of December 31, 2005 and 2004 are as follows:
2005 2004
----------------------------
Tax effect of net operating loss carryforwards $ 14,875,732 $ 9,100,463
Accrued expenses that are deductible in future periods 1,479,268 57,304
Bad debt reserves that are deductible in future periods 130,550 33,718
Debt discounts that affect the timing of our interest 25,477 405,805
Depreciation and amortization method differences 1,645 (37,102)
----------------------------
Net deferred tax assets $ 16,512,672 $ 9,560,188
============================
Valuation allowances $(16,512,672) $(9,560,188)
============================
Our valuation allowances increased by $6,952,484 and $1,934,561 during the years
ended December 31, 2005 and 2004, respectively.
As of December 31, 2005, we have a net tax operating loss of $39,881,318 that
will be available to offset future taxable income, if any. The use of net
operating loss carryforwards to reduce future income tax liabilities is subject
to limitation and these amounts will begin to expire in 2022.
The following table illustrates the reconciliation of the tax benefit at the
federal statutory rate to our effective rate for each year ended December 31,
2005 and 2004:
2005 2004
------------------------
Benefit at federal statutory rate (34.00)% (34.00)%
Benefit at state rate, net of federal benefit (3.30)% (3.30)%
Non-deductible derivative fair value losses 28.64% 20.43%
Effect of changes in our valuation allowances 8.63% 16.80%
Non-deductible travel expenses and charitable donations 0.03% 0.07%
----------------------
Benefit at our effective rate (0.00)% (0.00)%
======================
We operate in certain foreign jurisdictions that are not reflected in the above
rate reconciliation because these operations are insignificant. However, we plan
to increase our foreign operations and, as a result, we may generate tax
liabilities in these foreign operations in future periods.
F-55
Note 11 - Commitments and Contingencies
Lease of Office
---------------
We lease office space at our corporate office in Florida under an original
operating lease that expired March 8, 2004. We have renewed the operating lease
for an additional six-year period that will expire October 30, 2015.
Future minimum rental payments required under the operating lease as of December
31, 2005 are as follows:
Years ending December 31, Amount
------------------------- -------
2006 $92,868
2007 $92,868
2008 $92,868
2009 $92,868
2010 $81,140
Rental expense for the years ended December 31, 2005 and 2004 are $90,000 and
$68,784, respectively.
Licenses
--------
Royalty advances are payable against earned royalties on a negotiated basis. The
table below identifies each Licensor to which our licenses require advance
payments and, in addition, reflects the term of the respective licenses as well
as the advance royalties remaining to be paid on such negotiated advance royalty
payments, as of September 25, 2006. We currently are in default of our
guaranteed royalty payments to Marvel Enterprises on our license for the United
Kingdom by the aggregate advance remaining listed below for Marvel (UK) .
---------------------------------------------------------------------------
Aggregate Advance
Licensor Term Remaining
---------------------------------------------------------------------------
Marvel (UK) Two years $120,960
---------------------------------------------------------------------------
Masterfoods Three years $2,430,000
---------------------------------------------------------------------------
Diabetes Research Institute One year $2,500
---------------------------------------------------------------------------
Marvel Enterprises, Inc. (Super Heroes(R) and Marvel Heroes(R))
On February 4, 2005, we entered into a two-year license agreement for the
utilization of Marvel Heroes characters on our flavored milks in the United
Kingdom and Ireland. We agreed to a royalty rate of 4% of net wholesale sales in
the territory as the cost of the license. We have adopted the unit sales model
currently used in the United States. We have outsourced the infrastructure
required for the production, promotion, marketing, distribution and sale of our
products through a production agreement with Waterfront Corporation in the UK
and through an exclusive sales agency agreement with Drinks Brokers, Ltd., a UK
registered company responsible for the launch and growth of several major
beverage brands in the licensed territory.
In March 2005, we entered into a new one-year license agreement with
Marvel Enterprises, Inc. to use its Super Heroes(R) properties to promote our
branded milk products in the United States, Canada and
F-56
Mexico. Under the terms of the license agreement, we agreed to a royalty rate of
5% of net wholesale sales in the United States, 4% for school lunch channels and
2.5% for school hot lunch programs. We also agreed to a 11% royalty on the
amount invoiced to dairy processors for "kits" in Canada and Mexico.
On February 4, 2005, we entered into an eighteen month license agreement
for the utilization of Marvel Heroes characters on our flavored milks in nine
Middle East Countries. We agreed to a 11% royalty on the amount invoiced to
third party dairy processors for "kits" in the territory against the prepayment
of a guaranteed minimum royalty amount of $75,600.
Chattanooga Bakery, Inc.( Moon Pie(R) )
In October 2003, we executed a two-year license agreement with MD
Enterprises, Inc. on behalf of Chattanooga Bakery. Under the terms of the
license agreement, we have the exclusive right to manufacture, distribute,
market and sell Moon Pie(R) flavored milk products in the United States. We
agreed to a variable royalty rate of 2% to 3% of net wholesale sales, depending
upon volume, as the cost of the license. This license has been extended
verbally.
Masterfoods USA (Starburst(R), Milky Way(R), 3 Musketeers(R))
On September 21, 2004, we entered into a licensing agreement with
Masterfoods USA, a division of Mars, Incorporated, for the use of Masterfood's
Milky Way(R), Starburst(R) and 3 Musketeers(R) trademarks in connection with the
manufacture, marketing and sale of single serve flavored milk drinks in the
United States, its Possessions and Territories and US Military installations
worldwide. The license limits the relationship of the parties to separate
independent entities. The amended term of the license agreement expires December
31, 2012. We have agreed to pay a 5% to 7% royalty based upon the total net
sales value of the licensed products sold as the cost of the license. Ownership
of the licensed marks and the specific milk flavors to be utilized with the
marks remains with Masterfoods. We have a right of first refusal for other milk
beverage products utilizing the Masterfoods marks within the licensed territory.
Diabetes Research Institute
In June 2005, we agreed to extend our licensing agreement with Diabetes
Research Institute for a term beyond the original June 30, 2006 termination
date.. We agreed to a variable royalty rate of 0.25% of net sales as the cost of
the license . We use this intellectual property, which consists of a logo plus
design on the labels of our Slim Slammers(TM) product line.
Employment Contracts
--------------------
Mr. Warren has an employment contract effective October 1, 2005, having an
annual base salary of $300,000, plus a bonus of .25% of top line net sales
revenue and normal corporate benefits. This contract has minimum two-year terms
plus a severance package upon change of control based on base salary.
Messrs. Toulan, Patipa, Edwards and Kee have employment contracts
effective January 1, 2006, having annual base salaries aggregating $710,000,
plus discretionary bonuses and normal corporate benefits. These contracts have
minimum two-year terms plus severance packages upon change of control based on
base salary.
Mr. Kaplan has an employment contract effective November 1, 2005, having
an annual base salary of $180,000 for year one, $200,000 for year two and
$220,000 for year three, plus discretionary
F-57
bonuses and normal corporate benefits. This contract has a minimum three-year
terms plus a severance package upon change of control based on base salary
Marketing Commitments
---------------------
Coca-Cola Enterprises. We are obligated to spend an aggregate of
$5,000,000 on marketing activities in 2005 and 2006 and thereafter, beginning in
2007, an amount per year in each country in the defined territory equal or
greater than 3% of our total revenue in such defined territory (on a country by
country basis). Such national and local advertising for our defined products
includes actively marketing the Slammers mark, based on a plan to be mutually
agreed each year. We are required to maintain our intellectual property rights
necessary for the production, marketing and distribution of our products by CCE.
Marvel UK. We are obligated to contribute to a discretionary marketing
fund at the rate of 3% of royalties payable to Marvel for our sales in the UK,
if requested by Marvel. We satisfied this obligation with a lump-sum payment of
$1,000 at the inception of the license.
Note 12 - Master Distribution Agreement
On August 31, 2005, we entered into a Master Distribution Agreement with
Coca-Cola Enterprises, Inc., which included the attendant grant of three year
warrants to CCE for the right to purchase 30 million shares of the Company's
common stock at an exercise price of $0.36 per share. The fair value of the
warrants has been recorded as deferred distribution costs and is being amortized
over the life of the distribution agreement.
Under the terms of the agreement, Coca-Cola Enterprises is obligated to
use all commercially reasonable efforts to solicit, procure and obtain orders
for our products and merchandise and actively promote the sale of such products
in the Territory, as defined in the agreement. The agreement establishes a
comprehensive process for the phased transition from our existing system of
distributors to Coca-Cola Enterprises, dependent upon distribution territory,
product and sales channels. The parties have agreed that Coca-Cola Enterprises
will implement its distribution on a ramp-up basis, with the initial
distribution commencing in the United States on or about the October 31, 2005
effective distribution date. Coca-Cola Enterprises' distribution in other
Territory areas will be dependent upon, among other things, third-party
licensing considerations and compliance with the regulatory requirements for the
products in foreign countries.
Note 13 - Restatements of Prior Financial Statements
We have restated our prior financial statements. This footnote is organized to
reflect (i) our annual and quarterly statements of operations as reported and as
restated, (ii) a tabular summary of the amounts of adjustments and descriptions
of matters that gave rise to the restatements of our statements of operations
and (iii) a tabular summary of the amounts of adjustments and the descriptions
of matters that gave rise to the restatements of our balance sheets. See also
Notes 1, 5, 6, 7, 8, 9 and 10 for additional disclosures.
F-58
Condensed Consolidated Statements of Operations
Years Ended December 31, 2005 and 2004
Year ended Year ended
December 31, 2005 December 31, 2005
(As Restated) (As Reported)
---------------------------------------
Revenues $ 11,948,921 $ 11,948,921
Product costs (10,443,727) (8,938,692)
Operating expenses (18,364,502) (17,209,180)
Other income (expense) (62,669,345) (307,679)
----------------------------------
Net (loss) (79,528,653) (14,506,630)
==================================
Loss applicable to common (80,850,670) (14,842,933)
==================================
Loss per common share (0.60) (0.11)
==================================
Comprehensive loss $(79,559,412) $(14,537,389)
==================================
Year ended Year ended
December 31, 2004 December 31, 2004
(As Restated) (As Reported)
---------------------------------------
Revenues $ 3,344,699 $ 3,344,699
Product costs (2,873,118) (2,374,805)
Operating expenses (4,183,863) (4,529,373)
Other income (expense) (7,805,338) (240,447)
----------------------------------
Net (loss) (11,517,620) (3,799,926)
==================================
Loss applicable to common (12,505,640) (4,188,558)
==================================
Loss per common share (0.31) (0.10)
==================================
Comprehensive loss $(11,518,309) $ (3,800,615)
==================================
Condensed Consolidated Statements of Operations
Three Months Ended March 31, 2005 and 2004
Three months ended Three months ended
March 31, 2005 March 31, 2005
(As Restated) (As Reported)
----------------------------------------
Revenues $ 897,770 $ 897,770
Product costs (816,113) (677,663)
Operating expenses (1,282,309) (1,340,290)
Other income (expense) 547,582 (117,065)
----------------------------------
Net (loss) (653,070) (1,237,248)
==================================
Loss applicable to common (924,185) (1,332,308)
==================================
Loss per common share (0.02) (0.02)
==================================
Comprehensive loss $ (661,093) $ (1,245,464)
==================================
Three months ended Three months ended
March 31, 2004 March 31, 2004
(As Restated) (As Reported)
----------------------------------------
Revenues $ 438,206 $ 438,206
Product costs (409,835) (330,121)
Operating expenses (976,424) (957,649)
Other income (expense) (3,524,664) (31,685)
----------------------------------
Net (loss) (4,472,717) (881,249)
==================================
Loss applicable to common (4,698,116) (974,717)
==================================
Loss per common share (0.15) (0.03)
==================================
Comprehensive loss $ (4,472,717) $ (881,249)
==================================
F-59
Condensed Consolidated Statements of Operations
Three and Six Months Ended June 30, 2005 and 2004
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2005 June 30, 2005 June 30, 2005 June 30, 2005
(As Restated) (As Reported) (As Restated) (As Reported)
-------------------------------------------------------------------
Revenues $ 2,448,618 $ 2,448,618 $ 3,346,388 $ 3,346,388
Product costs (1,972,850) (1,680,464) (2,788,963) (2,358,127)
Operating expenses (2,696,152) (2,007,000) (3,978,461) (3,347,290)
Other income (expense) (78,224,912) (103,181) (77,677,330) (220,246)
------------------------------------------------------------------
Net (loss) (80,445,296) (1,342,027) (81,098,366) (2,579,275)
==================================================================
Loss applicable to common (81,038,891) (1,421,928) (81,963,076) (2,754,236)
==================================================================
Loss per common share (1.12) (0.02) (1.24) (0.04)
==================================================================
Comprehensive loss $(80,442,600) $ (1,351,790) $(81,103,693) $ (2,597,254)
==================================================================
Three months Three months Six months Six months
ended ended Ended ended
June 30, 2004 June 30, 2004 June 30, 2004 June 30, 2004
(As Restated) (As Reported) (As Restated) (As Reported)
-------------------------------------------------------------------
Revenues $ 1,441,356 $ 1,441,356 $ 1,879,562 $ 1,879,562
Product costs (1,051,120) (934,966) (1,460,955) (1,265,087)
Operating expenses (1,198,967) (1,342,970) (2,175,391) (2,300,619)
Other income (expense) (9,376,541) (43,310) (12,901,205) (74,995)
------------------------------------------------------------------
Net (loss) (10,185,272) (879,890) (14,657,989) (1,761,139)
==================================================================
Loss applicable to common (10,431,608) (980,710) (15,129,724) (1,955,427)
==================================================================
Loss per common share (0.26) (0.02) (0.43) (0.06)
==================================================================
Comprehensive loss $(10,185,272) $ (879,890) $(14,657,989) $ (1,761,139)
==================================================================
Condensed Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2005 and 2004
Three months Three months Nine months Nine months
ended ended Ended ended
Sept. 30, 2005 Sept. 30, 2005 Sept. 30, 2005 Sept.
30, 2005 (As Restated) (As Reported) (As Restated)
(As Reported)
-------------------------------------------------------------------
Revenues $ 3,245,305 $ 3,245,305 $ 6,591,693 $ 6,591,693
Product costs (2,755,957) (2,360,884) (5,544,920) (4,719,011)
Operating expenses (2,439,020) (2,717,708) (6,417,482) (6,064,998)
Other income (expense) 19,628,825 (3,073,169) (58,048,505) (3,293,415)
------------------------------------------------------------------
Net (loss) 17,679,153 (4,906,456) (63,419,214) (7,485,371)
==================================================================
Loss applicable to common 17,463,463 (4,994,496) (64,499,613) (7,748,732)
==================================================================
Loss per common share 0.15 (0.04) (0.79) (0.09)
==================================================================
Comprehensive loss $ 17,660,830 $ (4,912,126) $(63,442,863) $ (7,509,380)
==================================================================
F-60
Three months Three months Nine months Nine months
ended ended Ended ended
Sept. 30, 2004 Sept. 30, 2004 Sept. 30, 2004 Sept.
30, 2004 (As Restated) (As Reported) (As Restated)
(As Reported)
-------------------------------------------------------------------
Revenues $ 825,430 $ 825,430 $ 2,704,992 $ 2,704,992
Product costs (781,856) (628,747) (2,242,811) (1,893,834)
Operating expenses (1,182,112) (1,237,853) (3,357,503) (3,538,472)
Other income (expense) 7,436,020 (79,822) (5,465,185) (154,817)
------------------------------------------------------------------
Net (loss) 6,297,482 (1,120,992) (8,360,507) (2,882,131)
==================================================================
Loss applicable to common 6,043,897 (1,218,164) (9,085,827) (3,173,591)
==================================================================
Loss per common share 0.14 (0.03) (0.24) (0.08)
==================================================================
Comprehensive loss $ 6,297,482 $ (1,120,992) $ (8,360,507) $ (2,882,131)
==================================================================
The following tables reflect the individual components of our restatements and a
description of the nature of the adjustment:
Quarter ended Quarter ended Quarter ended Quarter ended Year ended
March 31, 2005 June 30, 2005 Sept. 30, 2005 Dec. 31, 2005 Dec. 31, 2005
-------------- -------------- -------------- -------------- --------------
Net income (loss), as reported $ (1,237,248) $ (1,342,027) $ (4,906,456) $ (7,020,899) $ (14,506,630)
Share-based payments -- (551,810) (102,782) 569,620 (84,972)
Deferred development costs (12,586) (94,768) (128,711) -- (236,065)
Derivative income (expense) 1,471,743 (77,311,393) 23,321,020 (8,304,944) (60,823,574)
Amortization of debt discount (772,181) (489,633) (73,864) (92,960) (1,428,638)
Liquidated damages expense -- -- -- (303,750) (303,750)
Investor relations charges (30,000) (332,954) (634,541) (484,766) (1,482,261)
Other (72,798) (322,711) 204,487 (471,740) (662,762)
-------------- -------------- -------------- -------------- --------------
Net income (loss), as restated $ (653,070) $ (80,445,296) $ 17,679,153 $ (16,109,439) (79,528,653)
============== ============== ============== ============== ==============
Share-based payments: We improperly measured and deferred share-based payment
expense related to employee stock options that were issued commencing in the
second quarter of the year ended December 31, 2005. These adjustments, which are
reflected in operating expenses, reflect the effects of re-measurement of the
stock options and the elimination of previously deferred compensation amounts.
Deferred development costs: We improperly capitalized development costs on our
balance sheet. These adjustments reflect our revised policy that requires
development costs to be expensed as they are incurred. We record development
costs as a component of operating expenses.
Derivative income (expense): Derivative income (expense) arises from adjustments
to our derivative liabilities to carry these instruments at fair value at the
end of each reporting period. Our derivative financial instruments consist of
compound and freestanding instruments. These derivative financial instruments
arose from (i) our notes payable, convertible notes payable and preferred stock
financing transactions and (ii) the reclassification of non-exempt warrants from
stockholders' equity to derivative liabilities because share settlement is
presumed not to be within our control. We previously did not properly allocate
proceeds from our financing transactions to derivative liabilities where
applicable; nor did we reclassify our other warrants to derivative liabilities
when we presumably lost our ability to share settle such instruments.
Amortization of debt discounts and other charges: We have adjusted our notes
payable and convertible notes payable to reflect the allocation of proceeds to
derivative liabilities. These allocations have resulted in discounts to the face
value of the debt, and we are required to amortize these discounts through
periodic charges to interest expense using the effective method. The adjustments
reflect the difference between our previous method of recognizing interest
expense based upon the stated interest rate and amounts derived from the
application of the effective interest method. Other charges include gains and
losses on extinguishments of our debt instruments that have arisen when
modifications to such instruments were considered to be significant.
F-61
Liquidated Damages
------------------
Liquidated damages: We have restated our consolidated financial statements to
record estimated liquidated damages that arose in connection with a registration
rights agreement, pursuant to financial accounting standard No. 5, Accounting
for Contingencies. In our previous filing, we recorded these amounts as
incurred. During the years ended December 31, 2005 and December 31, 2004, we
recorded liquidated damages expense of $303,750 and $0, respectively.
Investor relations charges: We entered into a contract with an investor
relations firm during 2005 that required payment in our equity securities. We
incorrectly did not recognize the value of these services until the securities
were issued. This adjustment reflects the proper recognition of the consulting
cost in general and administrative expenses and a reciprocal amount in accrued
liabilities.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2005 June 30, 2005 Sept. 30, 2005 Dec. 31, 2005 31, 2005
--------------- --------------- --------------- --------------- ---------------
Loss applicable to common $ (1,332,308) $ (1,421,928) $ (4,994,496) $ (7,094,201) $ (14,842,933)
stockholders, as reported
Adjustments to net loss 584,178 (79,103,269) 22,585,608 (9,088,540) (65,022,023)
Preferred stock accretion (176,055) (513,694) (127,649) (168,316) (985,714)
--------------- --------------- --------------- --------------- ---------------
Loss applicable to common
stockholders, as restated $ (924,185) $ (81,038,891) $ 17,463,463 $ (16,351,057) $ (80,850,670)
=============== =============== =============== =============== ===============
Preferred stock accretions: We did not allocate proceeds from certain of our
preferred stock financings to derivative financial instruments (warrants and
compound derivatives) and stockholders' equity (beneficial conversion features).
These adjustments reflect the accretion of discounts to the preferred stock
carrying values, which are reductions to net income (loss) to arrive at income
(loss) applicable to common shareholders. We have accreted these discounts in
our restated financial statements through periodic charges to retained earnings
using the effective method.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended,
March 31, 2005 June 30, 2005 Sept. 30, 2005 Dec. 31, 2005 Dec, 2005
--------------- --------------- --------------- --------------- ---------------
Loss per common share, $ (0.02) $ (0.02) $ (0.04) $ (0.00) $ (0.11)
as reported
Share-based payments -- (0.01) (0.00) (0.00) (0.00)
Deferred development costs (0.00) (0.00) (0.00) -- (0.01)
Derivative income (expense) 0.02 (1.07) 0.21 (0.05) (0.45)
Amortization of debt discount (0.01) (0.01) (0.00) (0.00) (0.01)
Liquidated damages expense -- -- -- (0.00) (0.00)
Investor relations charges (0.00) (0.00) (0.01) (0.03) (0.01)
Preferred stock
accretions/dividends (0.00) (0.01) (0.00) (0.00) (0.01)
--------------- --------------- --------------- --------------- ---------------
Net income (loss) per common share,
as restated $ (0.02) $ (1.12) $ 0.15 $ (0.10) $ (0.60)
--------------- --------------- --------------- --------------- ---------------
Diluted income per common share, as
restated $ (0.02) $ (1.12) $ 0.01 $ (0.10) $ (0.60)
=============== =============== =============== =============== ===============
F-62
See descriptions that we have provided under the tables for net income (loss)
and income (loss) applicable to common stockholders. Our restated income (loss)
per common share reflects the application of the treasury stock method and the
if-converted methods where those methods are appropriate.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2005 June 30, 2005 Sept. 30, 2005 Dec. 31, 2005 31, 2005
--------------- --------------- --------------- --------------- ---------------
Comprehensive loss,
as reported $ (1,245,464) $ (1,351,790) $ (4,912,126) $ (7,028,009) $ (14,537,389)
--------------- --------------- --------------- --------------- ---------------
Comprehensive loss,
as restated $ (661,093) $ (80,442,600) $ 17,660,830 $ (16,116,549) $ (79,559,412)
=============== =============== =============== =============== ===============
Our restated comprehensive income (loss) reflects the adjustments attributable
to net income (loss), above.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2004 June 30, 2004 Sept. 30, 2004 Dec. 31, 2004 31, 2004
--------------- --------------- --------------- --------------- ---------------
Net income (loss), as reported $ (881,249) $ (879,890) $ (1,120,992) $ (917,795) $ (3,799,926)
Deferred development costs (102,951) (28,790) (1,089) 12,372 (120,458)
Derivative income (expense) (3,430,564) (9,105,816) 8,005,711 (1,779,264) (6,309,933)
Amortization of debt discount (57,500) (162,500) (484,901) (470,344) (1,175,245)
Other (453) (8,276) (101,247) (2,082) (112,058)
--------------- --------------- --------------- --------------- ---------------
Net income (loss), as restated $ (4,472,717) $ (10,185,272) $ 6,297,482 $ (3,157,113) $ (11,517,620)
=============== =============== =============== =============== ===============
Deferred development costs: We improperly capitalized development costs on our
balance sheet. These adjustments reflect our revised policy that requires
development costs to be expensed as they are incurred. We record development
costs as a component of operating expenses.
Derivative income (expense): Derivative income (expense) arises from adjustments
to our derivative liabilities to carry these instruments at fair value at the
end of each reporting period. Our derivative financial instruments consist of
compound and freestanding instruments. These derivative financial instruments
arose from (i) our notes payable, convertible notes payable and preferred stock
financing
F-63
transactions and (ii) the reclassification of non-exempt warrants from
stockholders' equity to derivative liabilities because share settlement is
presumed not to be within our control. We previously did not properly allocate
proceeds from our financing transactions to derivative liabilities where
applicable; nor did we reclassify our other warrants to derivative liabilities
when we presumably lost our ability to share settle such instruments.
Amortization of debt discounts and other charges: We have adjusted our notes
payable and convertible notes payable to reflect the allocation of proceeds to
derivative liabilities. These allocations have resulted in discounts to the face
value of the debt, and we are required to amortize these discounts through
periodic charges to interest expense using the effective method. The adjustments
reflect the difference between our previous method of recognizing interest
expense based upon the stated interest rate and amounts derived from the
application of the effective interest method. Other charges include gains and
losses on extinguishments of our debt instruments that have arisen when
modifications to such instruments were considered to be significant.
Investor relations charges: We entered into a contract with an investor
relations firm during 2005 that required payment in our equity securities. We
incorrectly did not recognize the value of these services until the securities
were issued. This adjustment reflects the proper recognition of the consulting
cost in general and administrative expenses and a reciprocal amount in accrued
liabilities.
See descriptions that we have provided under the tables for net income (loss)
and income (loss) applicable to common stockholders. Our restated income (loss)
per common share reflects the application of the treasury stock method and the
if-converted methods where those methods are appropriate.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2004 June 30, 2004 Sept. 30, 2004 Dec. 31, 2004 31, 2004
--------------- --------------- --------------- --------------- ---------------
Loss applicable to common $ (974,717) $ (980,710) $ (1,218,164) $ (1,014,967) $ (4,188,558)
stockholders, as reported
Adjustments to net loss (3,591,468) (9,305,352) 7,418,444 (2,239,318) (7,717,694)
Preferred stock accretion (131,931) (145,546) (156,383) (165,528) (599,388)
--------------- --------------- --------------- --------------- ---------------
Loss applicable to common
stockholders, as restated $ (4,698,116) $ (10,431,608) $ 6,043,897 $ (3,419,813) $ (12,505,640)
=============== =============== =============== =============== ===============
Preferred stock accretions: We did not allocate proceeds from certain of our
preferred stock financings to derivative financial instruments (warrants and
compound derivatives) and stockholders' equity (beneficial conversion features).
These adjustments reflect the accretion of discounts to the preferred stock
carrying values, which are reductions to net income (loss) to arrive at income
(loss) applicable to common shareholders. We have accreted these discounts in
our restated financial statements through periodic charges to retained earnings
using the effective method.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2004 June 30, 2004 Sept. 30, 2004 Dec. 31, 2004 31, 2004
--------------- --------------- --------------- --------------- ---------------
Loss per common share, $ (0.03) $ (0.02) $ (0.03) $ (0.02) $ (0.09)
as reported
Deferred development costs (0.00) (0.00) (0.00) 0.00 (0.00)
Derivative income (expense) (0.12) (0.24) 0.18 (0.04) (0.16)
Amortization of debt discount (0.00) (0.00) (0.01) (0.01) (0.03)
Investor relations charges (0.00) (0.00) (0.00) (0.00) (0.00)
Preferred stock accretions/dividends (0.01) (0.01) (0.01) (0.01) (0.02)
--------------- --------------- --------------- --------------- ---------------
Net income (loss) per common share,
as restated $ (0.15) $ (0.26) $ 0.14 $ (0.07) $ (0.31)
--------------- --------------- --------------- --------------- ---------------
Diluted income per common share, as
restated $ (0.15) $ (0.26) $ 0.01 $ (0.07) $ (0.31)
=============== =============== =============== =============== ===============
F-64
See descriptions that we have provided under the tables for net income (loss)
and income (loss) applicable to common stockholders. Our restated income (loss)
per common share reflects the application of the treasury stock method and the
if-converted methods where those methods are appropriate.
Quarter ended Quarter ended Quarter ended Quarter ended Year ended Dec.
March 31, 2004 June 30, 2004 Sept. 30, 2004 Dec. 31, 2004 31, 2004
--------------- --------------- --------------- --------------- ---------------
Comprehensive loss,
as reported $ (881,249) $ (879,890) $ (1,120,992) $ (918,494) $ (3,800,625)
--------------- --------------- --------------- --------------- ---------------
Comprehensive loss,
as restated $ (4,472,717) $ (10,185,272) $ 6,297,482 $ (3,157,802) $ (11,518,309)
=============== =============== =============== =============== ===============
Our consolidated balance sheets as of December 31, 2005 and 2004 have been
restated as illustrated in the following table:
Redeemable Stockholders
Total Total Preferred Equity
Assets Liabilities Stock (Deficit)
------------ ------------ ------------ ------------
As reported (December 31, 2005) $ 24,284,806 $(10,793,837) $ (3,153,316) $ 10,337,653
Adjustments:
Intangible assets 4,073,314 -- -- --
Accrued liabilities -- (1,656,988) -- --
Dividends payable -- 1,240,682 -- --
Derivative liabilities -- (35,939,235) -- --
Notes payable and convertible notes -- (1,599,876) -- --
Paid in capital -- -- -- 37,365,319
Preferred stock adjustments -- -- 1,048,816 --
Accumulated Deficit -- -- -- (70,674,539)
Deferred compensation -- -- 475,933
------------ ------------ ------------ ------------
As restated (December 31, 2005) $ 28,358,120 $(48,749,254) $ (2,104,500) $(22,495,634)
============ ============ ============ ============
Redeemable Stockholders
Total Total Preferred Equity
Assets Liabilities Stock (Deficit)
------------ ------------ ------------ ------------
As reported (December 31, 2004) $ 1,093,847 $ (4,123,541) $ (4,284,802) $ (7,314,496)
Adjustments:
Prepaid Expenses (163,644) -- -- --
Intangible assets 165,605 -- -- --
Accrued liabilities -- (69,024) -- --
Dividends payable -- 928,379 -- --
Derivative liabilities -- (10,835,629) -- --
Notes payable and convertible notes -- (1,228,228) -- --
Common Stock -- -- -- --
Paid in Capital -- -- -- (4,870,092)
Preferred stock adjustments -- -- 1,353,347 --
Accumulated Deficit -- -- -- (4,979,102)
------------ ------------ ------------ ------------
As restated (December 31, 2004) $ 1,095,808 $(15,328,043) $ (2,931,455) $(17,163,690)
============ ============ ============ ============
F-65
The components off our restated consolidated accumulated deficit as of December
31, 2005 and 2004 are set forth in the following tables:
Accumulated Deficit
-------------------
As reported (December 31, 2005) $ (48,579,962)
Adjustments:
Cumulative Derivative Expense (59,476,877)
Amortization of Licenses and Distribution Agreements (584,243)
Cumulative Amortization of Debt Expense (2,627,050)
Cumulative Accretion of Preferred Stock (6,774,620)
Cumulative Reversal of Accrued Dividends 1,240,682
Share based payments - 2005 (84,972)
Liquidated damages expense - 2005 (303,750)
Investor relations charges - 2005 (1,482,261)
Cumulative Other (581,448)
As restated (December 31, 2005) $ (119,254,501)
Accumulated Deficit
-------------------
As reported (December 31, 2004) $ (33,737,029)
Adjustments:
Cumulative Derivative Income 1,346,697
Cumulative Product Development Expenses (162,169)
Cumulative Amortization of Debt Discount Expense (1,198,412)
Cumulative Accretion of Preferred Stock (5,788,903)
Cumulative Reversal of Accrued Dividends 928,379
Cumulative Other (104,694)
As restated (December 31, 2004) $ (38,716,131)
Intangible assets: We entered into a Master Distribution Agreement with Coca
Cola Enterprises on August 31, 2005 that provided for the issuance of 30,000,000
warrants to purchase our common stock. We originally did not value these
warrants using a proper valuation method. We have restated the intangible asset
to reflect its proper valuation. In addition, the warrants did not meet all of
the criteria for equity classification and are carried as derivative liabilities
at fair value in the amount of $14,220,657 as of December 31, 2005.
Stockholders' equity (deficit) reflects the reclassification of the original
value, the adjustments to fair value and adjusted amortization for the revised
intangible asset carrying value.
Accrued liabilities: We entered into a contract with an investor relations firm
during 2005 that required payment in our equity securities. We incorrectly did
not recognize the value of these services until the securities were issued. This
adjustment reflects the proper recognition of the consulting cost in general and
administrative expenses and a reciprocal amount in accrued liabilities.
Dividends payable: We originally reported dividends payable of $1,240,682 on
certain series of our preferred stock; it was the only non-current liability at
December 31, 2005. These dividends were not declared and, therefore, they have
been reversed against the related charges in retained earnings. In the future we
will accrue preferred stock dividends when they have been declared.
Derivative liabilities: We issued certain debt and preferred stock that embody
variable conversion rates having the effect of extending share settlement of our
share obligations beyond our control. As a result, we reclassified our other
warrants to derivative liabilities and carry them at fair value in our revised
balance sheet. Derivative financial instruments are initially and subsequently
measured at fair values using techniques consistent with the risks associated
with the derivative financial instruments. Stockholders' equity (deficit)
reflects the reclassification of the original equity related to these warrants
and fair value adjustments.
Notes payable and convertible notes payable: We have allocated proceeds from our
note payable, convertible note payable and preferred stock financing
transactions, where applicable, to compound and freestanding derivative
financial instruments in our restated financial statements. As noted above, we
F-66
have also re-classed certain non-exempt warrants from stockholders' equity to
derivative liabilities because share settlement is presumed not to be within our
control. In addition to the adjustments to notes payable described under
derivative financial instruments above, we have restated other notes payable to
properly reflect discounts and their carrying amounts. These adjustments
generally were made through charges to interest expense using the effective
interest method over the periods such notes were outstanding.
Preferred Stock Adjustments: We previously reported the aggregate carrying value
of $3,153,316 related to our Series F, H, J and K Preferred Stock in
stockholders' equity. We are required to carry these instruments outside of
stockholders' equity, under the caption redeemable preferred stock, because
these instruments have features where the investors' could require us to redeem
them for cash. As of December 31, 2005 the carrying value of these series of
preferred stock amounted to $2,104,500. See also Note 7.
The financial instruments issued in the original preferred stock financing
transactions included both freestanding derivatives (principally warrants) and
compound embedded derivatives (principally conversion and default put features)
that we are required to carry as derivative liabilities, and at fair values. As
of December 31, 2005, these derivative liabilities had a fair value of
$36,868,468.
The allocation of proceeds from our preferred stock financing transactions
resulted in discounts to the carrying values of the preferred stock. The
restated financial statements reflect periodic accretions of these discounts,
through charges to retained earnings, using the effective method. We also
incorrectly accrued undeclared dividends and have reversed those provisions.
The aggregate of our adjustments to preferred stock, including the periodic
(charges) and credits to derivative income (expense), resulted in a decrease in
our stockholders' equity of $1,048,816. The effects on income (loss)
attributable to these adjustments are reflected in the tables, above.
Deferred Compensation: We previously reported deferred compensation as a
component of stockholders' equity of $475,933. We have restated our balance
sheet to revalue the underlying options and properly recognize the compensation
expense amounting to $560,904 and paid in capital of $84,972.
Note 14 - Subsequent Events (UNAUDITED)
On April 13, 2006, we issued 457,125 shares of common stock pursuant to a notice
of conversion of interest and premium associated with our June 2004 convertible
note. The common stock underlying this note was registered pursuant to a
registration statement declared effective on April 18, 2005.
On April 17, 2006, we issued 807,692 shares of common stock underlying our
Series F Warrant for 1,000,000 shares to an accredited investor. The shares of
common stock underlying the Warrant were issued pursuant Regulation D.
On April 21, 2006, we issued 437,500 shares of common stock to an accredited
investor pursuant to notices of conversion of our April, June and October 2004
convertible notes. The common stock underlying these notes was registered
pursuant to a registration statement declared effective on August 3, 2004 and
April 18, 2005, respectively.
F-67
On April 21, 2006, we issued 196,078 shares of our common stock in a private
placement, pursuant to Section 4(2) of the Securities Act of 1933, to an
accredited investor.
On April 28, 2006 we issued 1,500,000 shares of common stock underlying our
April 2004 Warrant. The shares of common stock underlying the Warrant were
registered pursuant to a registration statement declared effective on August 3,
2004.
On May 12, 2006, we issued $2,500,000, six-month-term, 10% notes payable plus
detachable warrants to purchase 1,500,000 shares of our common stock with a
strike price of $0.80 for a period of five-years. Net proceeds from this
financing transaction amounted to $2,235,000. The holder has the option to
redeem the notes for cash in the event of defaults and certain other contingent
events, including events related to the common stock into which the instrument
is convertible, registration and listing (and maintenance thereof) of our common
stock and filing of reports with the Securities and Exchange Commission (the
"Default Put"). We evaluated the terms and conditions of the notes and warrants
and determined that (i) the Default Put required bifurcation because it did not
meet the "clearly and closely related" criteria of FAS 133 and (ii) the warrants
did not meet all of the requisite conditions for equity classification under FAS
133. As a result, the net proceeds from the arrangement were first allocated to
the Default Put ($87,146) and the warrants ($901,665) based upon their fair
values, because these instruments are required to be initially and subsequently
carried at fair values. These instruments will be carried in our balance sheet
following the financing under the classification, Derivative Liabilities and
adjusted to fair value. The warrants and shares of common stock underlying the
warrants and notes were issued to two accredited investors in a private
placement exempt from registration under the Securities Act of 1933 pursuant
Regulation D.
On May 16, 2006, we issued 2,000,000 shares of common stock pursuant to an
exercise of a warrant associated with our January 2005 convertible note
financing. The common stock underlying this warrant was registered pursuant to a
registration statement declared effective by the Securities and Exchange
Commission on August 2, 2005.
On June 7, 2006, we issued 101,100 shares of common stock pursuant to a
conversion of our May 2005 convertible note. The shares of common stock
underlying this convertivle note issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission on August 2, 2005.
On June 23, 2006, we issued 2,000,000 shares of common stock pursuant to an
exercise of a warrant associated with our November 2003 convertible notes
financing. The common stock underlying this warrant was registered pursuant to a
registration statement declared effective by the Securities and Exchange
Commission on August2, 2005.
On July, 6, 2006, we issued 83,121 shares of our common stock in a private
placement, pursuant to Section 4(2) of the Securities Act of 1933, to an
accredited investor.
On July, 14, 2006, we issued 436,388 shares of common stock upon the cashless
exercise of a warrant associated with our Series D convertible preferred stock.
These shares were issued to an accredited investor pursuant to Regulation D and
Section 4(2) of the Securities Act of 1933.
On July 14, August 14 and August 31, 2006, we issued, in the aggregate, 250,000
shares of common stock pursuant to a conversion of our Series H preferred stock.
The shares of common stock underlying the preferred were issued pursuant to
Regulation D.
On July, 19, 2006, we issued 1,008,065 shares of common stock upon the cashless
exercise of a warrant associated with our Series H convertible preferred stock.
These shares were issued to an accredited investor pursuant to Regulation D and
Section 4(2) of the Securities Act of 1933.
On July 27, 2006, we entered into definitive agreements to sell $30 million
senior convertible notes that are due in 2010 to several institutional and
accredited investors in a private placement exempt from
F-68
registration under the Securities Act of 1933. The notes initially carry a 9%
coupon, payable quarterly and are convertible into shares of common stock at
$0.70 per share. In 2007, the coupon may decline to LIBOR upon the Company
achieving certain financial milestones. The notes will begin to amortize in
equal, bi-monthly payments beginning in mid-2007. We concurrently issued
warrants to purchase 12,857,143 shares of common stock at $0.73 per share that
expire in July 2011 to the investors in the private placement. Under the terms
of the financing, we will sell $30 million notes, of which $15.0 million of the
notes will be held in escrow. The release of the escrowed funds will be subject
to stockholder approval. We intend to file a proxy statement seeking such
shareholder approval as soon as practical. As a result of our failure to file
our March 31, 2006 Form 10QSB timely, an event of default has occurred under the
terms of the Notes, and the interest rate on the Notes, payable quarterly, was
increased from 9% to 14% per annum. Pursuant to the terms of the Notes, upon the
occurrence of an event of default, holders of the Notes may, upon written notice
to the Company, each require the Company to redeem all or any portion of their
Notes, at a default redemption price calculated pursuant to the terms of the
Notes. We have entered into an Amendment Agreement with the holders of the Notes
to amend the Notes in certain respects as consideration for the holders' release
of the Company's default resulting from its delay in the filing of this
quarterly report.
On August 24, 2006, we issued 168,937 shares of common stock pursuant to a
conversion of our May 2005 convertible note. The shares of common stock
underlying the convertible note were issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission on August 2, 2005.
On September 13 2006, we issued, in the aggregate, 161,527 shares of common
stock pursuant to a conversion of our Series F preferred stock. The shares of
common stock underlying the preferred were issued pursuant to Regulation D.
On September 28, 2006, we issued 4,000,000 shares of common stock pursuant to a
conversion of our November 2003 convertible note. The shares of common stock
underlying the convertible note were issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission on August 3, 2004.
On September28, 2006, we issued 1,000,000 shares of common stock pursuant to a
conversion of our June 2004 convertible note. The shares of common stock
underlying the convertible note were issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission on April 18, 2005.
F-69
ITEM 8A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain "disclosure controls and procedures," as such term is defined
in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the
"Exchange Act"), which are designed to ensure information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in Securities and Exchange Commission rules, regulations, and forms, and that
such information is accumulated and communicated to our management, including
our chief executive officer and chief accounting officer, as appropriate, to
allow timely and appropriate decisions regarding required disclosure to be made.
We carried out an evaluation, under the supervision and with the
participation of our audit committee and senior management, including our chief
executive officer and chief accounting officer, of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rules 13a-15(b) and 15d-15(b). During this evaluation, management
considered the impact any material weaknesses and other deficiencies in our
internal control over financial reporting might have on our disclosure controls
and procedures.
Based upon this evaluation, in July 2006 we determined that the following
material weakness existed:
Inadequate controls over the process for the identification and
implementation of the proper accounting for complex and non-routine
transactions, particularly as they relate to accounting for derivatives, which
resulted in the Company restating its consolidated financial statements for each
of the two years ended December 31, 2004 and 2005 (collectively, the "financial
statements") in order to properly present those financial statements;
Because the material weakness identified in connection with the assessment
of our internal control over financial reporting had not been fully remedied as
of July 2006, our Chief Executive Officer and our Chief Accounting Officer have
concluded that our disclosure controls and procedures were not effective as of
December 31, 2005. To address the issues raised by these control weaknesses, the
Company engaged advisory accountants, who performed additional analysis and
performed other procedures in order to prepare the restated condensed
consolidated financial statements appearing in this Amendment No. 1 to Form
10-KSB in accordance with generally accepted accounting principles in the United
States of America.
In addition, we have added or are initiating the following additional
controls to the Company's internal control over financial reporting which we
expect will improve such internal control subsequent to the date of the
evaluation. These changes are:
o We have restructured certain departmental responsibilities as they
relate to the financial reporting function.
o We have added one more experienced full-time accountant to our
accounting staff, whose responsibilities will include the
identification and implementation of proper accounting procedures
relating to guidance on financial reporting issues which apply to
the Company.
o We have commenced a search for a consultant to perform a review for
the purpose of evaluating the Company's internal control over
financial reporting on an ongoing basis.
ITEM 8B. OTHER INFORMATION
None
23
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The directors, executive officers and significant employees/advisors as of
December 31, 2005, are as follows. Our directors serve for staggered terms of
two years, or until their successors are elected.
Name of Officer and Age Position with the Company Year Appointed
----------------------- ------------------------- --------------
Stanley A. Hirschman 59 Chairman and Director 2000
Roy G. Warren 50 Director, Chief Executive Officer 1997/1999
Jeffrey J. Kaplan 57 Chief Financial Officer 2005
Tommy E. Kee 57 Chief Accounting Officer 2003
Roy D. Toulan, Jr. 60 Vice President, Corporate Secretary, General Counsel 2003
Michael Edwards 45 Chief Revenue Officer 2000
Benjamin Patipa 49 Chief Operating Officer 2002
Arthur W. Blanding 77 Director 1999
Robert Cummings 63 Director 1997
John McCormack 47 Director 1997
Phillip Pearce 78 Director 1997
The experience and background of the Company's executive officers follow:
Mr. Stanley A. Hirschman - Chairman and Director since September 2000
Mr. Hirschman is president of CPointe Associates, Inc., an executive
management and consulting firm specializing in solutions for emerging companies
with technology-based products. CPointe was formed in 1996. In addition, he is a
director of Energy & Engine Technology, 5 G Wireless Communications, Bronco
Energy Fund and GoldSpring, Inc. Prior to establishing CPointe Associates, Mr.
Hirschman was vice president of operations of Software, Etc., Inc., a retail
software chain, from 1989 until 1996. Mr. Hirschman has also held senior
management positions with retailers T.J. Maxx, Gap Stores and Banana Republic.
Mr. Hirschman currently serves on the Audit Committee of the Company's board of
directors.
Mr. Roy G. Warren - Chief Executive Officer since May 1999; Director since 1997
Mr. Warren serves as our Chief Executive Officer and as a director. As
Chief Executive Officer, Mr. Warren continues to develop strategy for our growth
and external financial matters.
For 15 years from 1981 through 1996, Mr. Warren was in the securities
brokerage industry. During those years, Mr. Warren acted as executive officer,
principal, securities broker and partner with brokerage firms in Florida, most
notably Kemper Financial Companies, Alex Brown & Sons and Laffer Warren &
Company. Mr. Warren currently serves on the Executive Committee of the Company's
board of directors.
Mr. Warren also serves as a director of our wholly owned U.K. subsidiary,
Bravo! Brands (UK) Ltd.
Mr. Tommy E. Kee -Chief Financial Officer 2003 - 2005; Chief Accounting Officer
since 2005
Tommy Kee joined our company in March 2003 as Chief Financial Officer. Mr.
Kee currently serves as our Chief Accounting Officer for our company. He
graduated with an MBA from the University of Memphis and a BS degree in
accounting from the University of Tennessee. Before joining us, he served for
several years as CFO for Allied Interstate, Inc. in the West Palm Beach area.
Prior to that, Mr.
24
Kee served as CFO and Treasurer for Hearx Ltd. a West Palm Beach, Florida
public company. He also served 18 years as International Controller and
Financial Director with the Holiday Inns Inc. organization in Memphis and
Orlando. Mr. Kee handles all financial management and reporting for our company
and works closely with our external auditors and general counsel for financial
reporting and SEC compliance.
Mr. Jeffrey Kaplan - Chief Financial Officer since 2005
Mr. Kaplan joined Bravo! in October 2005 as Chief Financial Officer. Mr.
Kaplan served as Executive Vice President and Chief Financial Officer of BIB
Holdings, Ltd. and then its private company spin-off, Elk Canyon Ltd., designers
of jeanswear and loungewear, from October 2003 to September 2005. He served as
Executive Vice President of Business Affairs of Viewpoint Corporation, a
graphics software company, from November 2001 to September 2003 and its
Executive Vice President and Chief Financial Officer from February 2001 to
October 2001. Mr. Kaplan served as Executive Vice President and Chief Financial
Officer of Rare Medium Group Inc., an IT professional services company, from
October 1999 to February 2001. Mr. Kaplan received his Bachelor of Arts degree
in political science from Brown University in 1970 and his Masters of Business
Administration in finance from New York University in 1972.
Mr. Roy D. Toulan, Jr. - Vice President, Corporate Secretary, General Counsel
since 2003
Roy Toulan began with the original founders as outside corporate counsel
in 1997 and has been responsible for all of our corporate and business legal
work, including securities matters. Mr. Toulan became Corporate Counsel in
October 2002, when he left his private legal practice in Boston, and Vice
President in January 2003. He received his law degree from Catholic University
in Washington D.C., and for the first 15 years of his career practiced corporate
and securities litigation with large law firms in New York and Boston. Before
joining our company full time, he spent the last 18 years of his private
practice in Boston, Massachusetts, engaged in general corporate and securities
law helping companies with corporate structure and funding, both domestically
and internationally. Mr. Toulan also serves as a director of our wholly owned
U.K. subsidiary, Bravo! Brands (UK) Ltd.
Mr. Michael Edwards - Chief Revenue Officer since 2003
Mr. Edwards has been with our company in a sales and marketing capacity
since 2000. Prior to that time, he worked for 5 years in beverage marketing
research for Message Factors, Inc., a Memphis, Tennessee marketing research
firm. Mr. Edwards has a BS degree from Florida State University in Management
and Marketing and spent 13 years in the banking industry, leaving CitiBank to
join Message Factors in 1995.
Dr. Benjamin Patipa - Chief Operating Officer since 2004
Dr. Patipa is a pediatrician with over fifteen years of experience in
directing operations, marketing, sales and facilitating growth in both public
and private companies. In 1987, Dr. Patipa founded and served as the chairman
and CEO of Weight For Me, Inc., a company that developed a proprietary program
which pioneered the delivery of weight control and nutrition services to the
over 12 million obese children and adolescents in America. Weight For Me earned
national and international recognition as the premier program for the control of
obesity in children and adolescents. Dr. Patipa also served at HEARx Ltd. as a
member of the Executive Operating Committee and Sonus USA, Inc., where he lead
the company's franchise licensing and buying group business in the Southeast
United States. Most recently, Dr. Patipa served as Senior Vice President and
Operational Head of eHDL/HealthNet Data Link, Inc., a national electronic
healthcare information company.
25
Mr. Arthur W. Blanding - Director Since November 1999
Mr. Blanding is president of The Omega Company, an international dairy
industry consulting company. Mr. Blanding has over 50 years experience in
management of dairy processing, sales and strategic planning consulting. He
graduated from Michigan State University in 1956, with a degree in food science,
and in 1964 from Oregon State University with a degree in Food Microbiology and
attended Harvard Business School.
As President of The Omega Company for the past 20 years, Mr. Blanding has
completed over 200 projects successfully, both in the U.S. and abroad. Clients
of The Omega Company include Abbott International, Cumberland Farms, Dairy Gold,
Farm Fresh, Inc., Haagen Dazs, Labatt, Ross Laboratories and Stop & Shop
Company, among others. Mr. Blanding was a consultant for the design and
construction of the dairy processing facility built in Shanghai by Green Food
Peregrine. The Omega Company is a party to a consulting contract with the
Company concerning technical and production issues.
Mr. Robert J. Cummings - Director Since 1997
Mr. Cummings' work experience includes ten years in purchasing at Ford
Motor Company. In 1975, he founded and currently operates J & J Production
Service, Inc., a manufacturing representative business, which is currently
responsible for over $300 million in annual sales.
Mr. Phillip Pearce - Director Since 1997
Mr. Pearce is a "retired" member of the securities industry. Mr. Pearce
served as Chairman of the NASD during which time he was instrumental in the
founding of NASDAQ. Additionally, Mr. Pearce was a former Director of E.F.
Hutton and has served as Governor of the New York Stock Exchange. Since his
retirement in 1988, Mr. Pearce has remained active in the securities industry as
a corporate financial consultant. Mr. Pearce serves on the compensation
committee of our board of directors. Mr. Pearce also serves on our audit
committee.
Mr. John McCormack - Director since 1997
From December 2000 to March 2003, Mr. McCormack served as our President
and Chief Operating Officer. Prior to his employment with the Company, Mr.
McCormack served as an executive with Dean Foods Co. for over 15 years. As a
Vice President of Dean Foods, he was in charge of Dean Food's mid-western
division out of Chicago, Illinois. Mr. McCormack currently is employed by
Coca-Cola Enterprises Inc. as a Regional Sales Manager for the supermarket
channel in Wisconsin, Minnesota and Northern Illinois.
Compliance With Section 16(A) of the Exchange Act
-------------------------------------------------
Based upon a review of the appropriate Forms 3, 4 and 5 and any amendments
to such forms filed pursuant to Section 16(a), we report the following: during
2005, our directors and executive officers did not file Form 4s for options that
were authorized pursuant to an incentive stock option compensation plan until
issued.
ITEM 10. EXECUTIVE COMPENSATION
Compensation of directors
We compensated Directors for their travel expenses to and from board of
directors' meetings in 2002, 2003, 2004 and, in 2005, an additional $1,000 per
personal attendance and $500 for a telephonic attendance. In 2004, there were
three in person meetings and four telephonic board meetings. In 2005, there were
three in person meetings and four telephonic board meetings. Directors received
26
options for 35,000 shares of common stock for each year as a director through
2001. Each member of the executive committee has received options for an
additional 40,000 shares of common stock for their services from 1998 through
2001. Directors received additional options for 25,000 shares for 2002 and 2003.
Mr. Hirschman, our Chairman, received total compensation of $48,000 for the year
ended December 31, 2005 for his services as Chairman of both our Board of
Directors and Audit Committee. On January 13, 2004, the Directors unanimously
voted to convert the options to common stock on a one for one basis. The common
shares so converted were issued pursuant to a Form S-8 registration statement
filed December 23, 2004.
On January 13, 2004, the Board of Directors adopted a plan to convert on a
one for one basis the options granted to our present employees and the directors
currently serving on the Board into a like number of our restricted shares of
common stock at the discounted value of $0.05 per share. The conversion of the
options to common stock for any individual director or employee was conditioned
upon a "lockup" agreement by such director or employee, pursuant to which the
recipients of such common stock could not sell, transfer, pledge or hypothecate
such common stock for a six-month period.
On April 6, 2005, our Directors voted to adopt a Stock Option Incentive
Plan for the grant of options to directors, employees and consultants for the
purchase of up to 10,397,745 shares of our common stock. On May 12, 2005, the
Board of Directors accepted and adopted the determination of the Compensation
Committee to grant 3,572,744 of the authorized options to our directors.
Compensation of executive officers
The following table sets forth the compensation paid during the last three
fiscal years to our Chief Executive Officer and our other executive officers:
Summary Compensation
Annual Compensation Long-Term Compensation
---------------------------------------------------------------------------------------------
Restricted Stock
Base Awards and All Other
Name & Position Year Salary Bonus Other Options
Compensation (6)
Roy G. Warren 2003 $220,000 2005 Ten Year $300,000
salary
President & CEO Options for $16,272
Director 2004 220,000 $137,750 (1) 2,500,000 (insurance)
$8,462 bonus (3) common valued
2005 240,000 156,538 bonus (4) $42,000 (5) at $300,000;
vested over 18
months
Roy D. Toulan, Jr. 2003 $180,000 $28,000 (2) $5,841 2005 Ten Year $190,000
salary
Vice President Life & Options for $10,178
Secretary 2004 180,000 15,000(1) disability 600,000 common (insurance)
Corporate Counsel 6,923 (bonus (3) insurance valued at
2005 182,231 7,308 bonus (3) $38,552 (5) $72,000; vested
over 18 months
Michael Edwards 2005 $162,923 $6,923 bonus (3) $34,161 (5) 2005 Ten Year $180,000
salary
Chief Revenue Options for $13,407
Officer 600,000 common (insurance)
valued at
$72,000; vested
over 18 months
27
Benjamin Patipa 2005 $142,615 $6,923 bonus (3) $32,107 (3) 2005 Ten Year $180,000
salary
Chief Operating 11,000 bonus (4) Options for $13,336
Officer 600,000 common (insurance)
valued at
$72,000; vested
over 18 months
Tommy E. Kee 2003 $120,000 2005 Ten Year $160,000
salary
Chief Accounting; Options for $14,874
Officer 2004 120,000 $15,000(1) 600,000 common (insurance)
4,615 bonus (3) valued at
2005 140,923 6,154 bonus (3) $31,415 (3) $72,000; vested
10,000 bonus (4) over 18 months
(1) The reported values of options converted in 2004 are pursuant to a January
13, 2004 vote of Directors authorizing conversion, and are valued $0.05
per share.
(2) 100,000 shares of common stock in 2003 as a signing bonus, valued at
$28,000.
(3) Year end bonus
(4) Special performance based bonus
(5) SEP/IRA Bonus, 2005
(6) Amount paid for termination of employment owing to change of control,
based on base salary for 2006
Option Grants 2005
On April 6, 2005, our Directors voted to adopt a Stock Option Incentive
Plan for the grant of options to directors, employees and consultants for the
purchase of up to 10,397,745 shares of our common stock. On May 12, 2005, the
Board of Directors accepted and adopted the determination of the Compensation
Committee to grant 3,572,744 of the authorized options to our directors and
4,900,000 to our senior management.
Aggregated Options Exercised in Last Fiscal Year And Fiscal Year-End Option
Values
None
Compensation Plans
------------------
Senior Management
On April 6, 2005, our Directors voted to adopt a Stock Option Incentive
Plan for the grant of options to directors, employees and consultants for the
purchase of up to 10,397,745 shares of our common stock. On May 12, 2005, the
Board of Directors accepted and adopted the determination of the Compensation
Committee to grant 4,900,000 of the authorized option to our senior management.
Employment contracts
Roy G. Warren Chief Executive Officer
-------------------------------------
On September 14, 2005, the Compensation Committee of the Board of
Directors recommended a new compensation package for Mr. Warren in recognition
of his work to expand our business and in light of the then recent execution of
a ten-year Master distribution Agreement with Coca-Cola Enterprises Inc. The
basic compensation package adopted by the Company for Mr. Warren provides, as
follows:
28
o Annual base salary of $300,000 paid in accordance with established
Company payment procedures.
o Quarterly bonus of one-quarter of one percent (.0025) of top-line
net sales revenue.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o A "Special Circumstances" bonus of $500,000 to be awarded upon the
signing of a Master Distribution Agreement with CCE. Bonus to be
paid in the following manner:
o One-half paid as a cash award or, at the awardees option, in
Company stock.
o One-half paid in Company stock, with the issuance of such
being in the form of S-8 or other method as determined by
counsel.
o Effective October 1, 2005, and for a period of not less than 24
months
Roy D. Toulan, Jr., Vice President, General Counsel and Corporate
-----------------------------------------------------------------
Secretary
---------
A new compensation package became effective for Mr. Toulan on January 1,
2006. The basic compensation package adopted by the Company for Mr. Toulan
provides, as follows:
o Annual base salary of $190,000 paid in accordance with established
Company payment procedures.
o Quarterly bonus at discretion of management based upon meeting
performance goals.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o Effective January 1, 2006, and for a period of not less than 24
months
Jeffrey J. Kaplan, Chief Financial Officer
------------------------------------------
Mr. Kaplan's employment contract provides, as follows:
o Annual base salary of $180,000 in year one paid in accordance with
established Company payment procedures; $200,000 in year two and
$220,000 in year three.
o Quarterly bonus at discretion of management based upon meeting
performance goals.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o Options for 200,000 common shares at market on November 1, 2005 as
signing bonus
o Effective November 1, 2005, and for a period of not less than 36
months
Benjamin Patipa, Chief Operating Officer
----------------------------------------
A new compensation package became effective for Dr. Patipa on January 1,
2006. The basic compensation package adopted by the Company for Dr. Patipa
provides, as follows:
o Annual base salary of $180,000 paid in accordance with established
Company payment procedures.
o Quarterly bonus at discretion of management based upon meeting
performance goals.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o Effective January 1, 2006, and for a period of not less than 24
months
Michael Edwards, Chief Revenue Officer
--------------------------------------
A new compensation package became effective for Mr. Edwards on January 1,
2006. The basic compensation package adopted by the Company for Mr. Edwards
provides, as follows:
29
o Annual base salary of $180,000 paid in accordance with established
Company payment procedures.
o Quarterly bonus at discretion of management based upon meeting
performance goals.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o Effective January 1, 2006, and for a period of not less than 24
months
Tommy E. Kee, Chief Accounting Officer
--------------------------------------
A new compensation package became effective for Mr. Kee on January 1,
2006. The basic compensation package adopted by the Company for Mr. Kee
provides, as follows:
o Annual base salary of $160,000 paid in accordance with established
Company payment procedures.
o Quarterly bonus at discretion of management based upon meeting
performance goals.
o Company benefits as customarily awarded to executive members of
management.
o Participation in Employee and Director Stock Option programs.
o Effective January 1, 2006, and for a period of not less than 24
months
Securities authorized for issuance under equity compensation plans
------------------------------------------------------------------
The equity compensation reported in this section has been a issued
pursuant to individual compensation contracts and arrangements with employees,
directors, consultants, advisors, vendors, suppliers, lenders and service
providers. The equity is reported on an aggregate basis as of December 31, 2005.
Our security holders have not approved the compensation contracts and
arrangements underlying the equity reported.
--------------------------------------------------------------------------------------------------------------
Compensation Plan Number of securities Weighted average Number of securities remaining
Category to be issued upon price of outstanding for future issuance under equity
exercise of options, options, warrants compensation plans
warrants and rights and rights
--------------------------------------------------------------------------------------------------------------
Directors (former) 325,000 $0.71 0 individual plans
--------------------------------------------------------------------------------------------------------------
Employees (former) 650,000 $0.87 60,000 individual plans
--------------------------------------------------------------------------------------------------------------
Directors/Management 8,872,745 $0.245 1,475,000 2005 Stock Option
& Employees Incentive Plan(1)
--------------------------------------------------------------------------------------------------------------
Consultants 510,714 $0.30 0 individual plans
--------------------------------------------------------------------------------------------------------------
Total 10,358,459 $0.77 1,535,000
--------------------------------------------------------------------------------------------------------------
On April 6, 2005, our Directors voted to adopt a Stock Option Incentive
Plan for the grant of option to directors, employees and consultants for the
purchase of up to 10,397,745 shares of our common stock. On May 12, 2005, the
Board of Directors accepted and adopted the determination of the Compensation
Committee to grant 8,922,745 of the authorized option to our employees,
directors and certain consultants. The ten-year options vest over a period of
eighteen months and have exercise prices varying from $0.20 per share to $0.30
per share, with a weighted average exercise price of $0.24 per share.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of our company's
common stock as of October 27, 2006 as to
o each person known to beneficially own more than 5% of the Company's
common stock
30
o each of our directors
o each executive officer
o all directors and officers as a group
The following conditions apply to all of the following tables:
o except as otherwise noted, the named beneficial owners have direct
ownership of the stock and have sole voting and investment power
with respect to the shares shown
o the class listed as "common" includes the shares of common stock
underlying the Company's issued convertible preferred stock, options
and warrants
Beneficial Owners
-----------------
----------------------------------------------------------------------------------------------------
Title of Class Name and Address of Amount and Nature of Percent of Class (2)
Beneficial Owner (1) Beneficial Ownership
----------------------------------------------------------------------------------------------------
Common Coca-Cola Enterprises Inc. 30,000,000 14.97%
2500 Windy Ridge Parkway
Atlanta, GA 30339
----------------------------------------------------------------------------------------------------
Common Mid-Am Capital, L.L.C. (3) 19,970,723 9.97%
Northpointe Tower
10220 North Ambassador Drive
Kansas City, MO 64190
----------------------------------------------------------------------------------------------------
Common Lombard Odier Darier 16,500,000 8.23%
Hentsch & Cie (4)
Rue de la Corraterie 11
1204 Geneva
----------------------------------------------------------------------------------------------------
Common Magnetar Capital Master 13,750,000 6.86%
Fund, Ltd (4)
1603 Orrington Avenue
13th Floor
Evanston, IL 60201
----------------------------------------------------------------------------------------------------
(1) Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of common stock
subject to options or warrants currently exercisable or convertible, or
exercisable or convertible within 60 days of October 27, 2006 are deemed
outstanding for computing the percentage of the person holding such option
or warrant but are not deemed outstanding for computing the percentage of
any other person.
(2) Percentage calculated from base of 200,386,286 shares of common stock
issued and outstanding.
(3) This owner is contractually limited to a beneficial ownership of our
equity not to exceed 9.99%. Equity listed consists of convertible
preferred, convertible debentures and/or warrants.
(4) Equity listed consists of common stock and warrants to purchase common
stock
31
Management Owners
-----------------
-----------------------------------------------------------------------------------------------------
Title of Class Name and Address of Amount and Nature of Percent of Class (2)
Management Owner Ownership (1)
-----------------------------------------------------------------------------------------------------
Common Roy G. Warren 5,810,765 (3) 2.89%
11300 US Highway No.1
N. Palm Beach, FL
-----------------------------------------------------------------------------------------------------
Common Robert Cummings 1,130,038 (4) Less than 1%
2829 N.E. 44th Street
Lighthouse Point, FL
-----------------------------------------------------------------------------------------------------
Common John McCormack 1,312,538 (4) Less than 1%
8750 South Grant
Burridge, IL 60521
-----------------------------------------------------------------------------------------------------
Common Mr. Arthur W. Blanding 947,297 (5) Less than 1%
Janesville, WI 53545
-----------------------------------------------------------------------------------------------------
Common Phillip Pearce 962,297 (6) Less than 1%
6624 Glenleaf Court
Charlotte, NC 28270
-----------------------------------------------------------------------------------------------------
Common Stanley Hirschman 1,040,652 (7) Less than 1%
2600 Rutgers Court
Plano, Texas 75093
-----------------------------------------------------------------------------------------------------
Common Roy D. Toulan, Jr. 1,615,121 (8) Less than 1%
VP, General Counsel
6 Wheelers Pt. Rd
Gloucester, MA 01930
-----------------------------------------------------------------------------------------------------
Common Tommy Kee 1,042,385 (8) Less than 1%
Chief Accounting Officer
11300 US Highway 1
N. Palm Beach, FL 33408
-----------------------------------------------------------------------------------------------------
Common Benjamin Patipa 1,358,700 (8) Less than 1%
Chief Operating Officer
6139 Indian Forest Circle
Lake Worth, FL 33463
-----------------------------------------------------------------------------------------------------
Common Michael Edwards 2,000,000 (8) Less than 1%
Vice President Sales
4140 S.E. Old St. Lucie Blvd.
Stuart, FL 34996
-----------------------------------------------------------------------------------------------------
Common Executive officers and 17,219,793 8.59%
directors as a group
-----------------------------------------------------------------------------------------------------
32
(1) Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of common stock
subject to options or warrants currently exercisable or convertible, or
exercisable or convertible within 60 days of October 27, 2006 are deemed
outstanding for computing the percentage of the person holding such option
or warrant but are not deemed outstanding for computing the percentage of
any other person.
(2) Percentage calculated from base of 200,386,286 shares of common stock
issued and outstanding.
(3) Includes options to purchase 2,500,00 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
(4) Includes options to purchase 565,038 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
(5) Includes options to purchase 494,408 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
(6) Includes options to purchase 706,297 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
(7) Includes options to purchase 670,982 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
(8) Includes options to purchase 600,000 shares of our common stock pursuant
to a 2005 Incentive Stock Option Plan adopted by the Board of Directors on
May 12, 2005.
There currently are no arrangements that may result in a change of
ownership or control.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
John Mc McCormack has been a director of the Company since 1997 and was
our Chief Operating Officer from December 200 to March 2003. Since December
2005, Mr. McCormack has been employed by Coca-Cola Enterprises Inc. as a
Regional Sales Manager for the supermarket channel, in Wisconsin, Minnesota and
Northern Illinois.
ITEM 13. EXHIBITS
Exhibit No. Document Description Incorporated Filed
by Reference Herewith
-------------------------------------------------------------------------------------------------------
3.1 Articles of Incorporation (1)
3.2 Amended Articles (name change) (1)
3.4 Restated Bylaws (1)
4 Rights of Equity Holders
4.1 Preferred, Series B Designation (1)
4.2 Preferred, Series F Designation (2)
4.3 Preferred, Series G Designation (3)
4.4 Preferred, Series H Designation (6)
4.5 Preferred, Series I Designation (7)
4.6 Preferred, Series J Designation (8)
4.7 Preferred, Series K Designation (10)
4.8 Subscription Agreement dated November 2003 entered with (11)
Gamma Opportunity Capital Partners, LP
4.9 Class A Common Stock Purchase Warrant issued to Gamma (11)
Opportunity Capital Partners, LP
33
4.10 Class B Common Stock Purchase Warrant issued to Gamma (11)
Opportunity Capital Partners, LP
4.11 Convertible Note issued to Gamma Opportunity Capital (11)
Partners, LP dated November 2003
4.12 Class A Common Stock Purchase Warrant issued to Libra (11)
Finance, S.A.
4.13 Subscription Agreement dated November 2003 entered with (11)
MID-AM CAPITAL, L.L.C
4.14 Class A Common Stock Purchase Warrant issued to MID-AM (11)
CAPITAL, L.L.C.
4.15 Class B Common Stock Purchase Warrant issued to MID-AM (11)
CAPITAL, L.L.C
4.16 Convertible Note issued to MID-AM CAPITAL, L.L.C. dated (11)
November 2003
4.17 Subscription Agreement dated April 2, 2004 entered with (11)
Alpha Capital Aktiengesellschaft and
Longview Fund LP
4.18 Convertible Note issued to Alpha Capital (11)
Aktiengesellschaft dated April 2004
4.19 Convertible Note issued to Longview Fund LP dated April (11)
2004
4.20 Common Stock Purchase Warrant issued to Alpha Capital (11)
Aktiengesellschaft dated April 2004
4.21 Common Stock Purchase Warrant issued to Longview Fund (11)
LP dated April 2004
4.22 Subscription Agreement entered by and between the (12)
Company and Mid-AM Capital LLC dated June 2004
4.23 Convertible Note issued to Mid-AM Capital LLC dated (12)
June 2004
4.24 Common Stock Purchase Warrant A issued to Mid-AM (12)
Capital LLC dated June 2004
4.25 Common Stock Purchase Warrant B issued to Mid-AM (12)
Capital LLC dated June 2004
4.26 Subscription Agreement entered by and between the (12)
Company and Alpha Capital, Longview Fund LP,
Stonestreet Limited Partnership, Whalehaven Funds
Limited and Gamma Opportunity Capital Partners LP dated
June 2004
4.27 Form of Common Stock Purchase A issued to Alpha (12)
Capital, Longview Fund LP, Stonestreet Limited
Partnership, Whalehaven Funds Limited and Gamma
Opportunity Capital Partners LP dated June 2004
4.28 Form of Common Stock Purchase B issued to Alpha (12)
Capital, Longview Fund LP, Stonestreet Limited
Partnership, Whalehaven Funds Limited and Gamma
Opportunity Capital Partners LP dated June 2004
4.29 Form of Convertible Note issued to Alpha Capital, (12)
Longview Fund LP, Stonestreet Limited Partnership,
Whalehaven Funds Limited and Gamma Opportunity Capital
Partners LP dated June 2004
4.30 Subscription Agreement entered by and between the (12)
Company and Alpha Capital, Longview Fund LP,
Stonestreet Limited Partnership and Whalehaven Funds
Limited dated October 2004
4.31 Form of Common Stock Purchase C issued to Alpha (12)
Capital, Longview Fund LP, Stonestreet Limited
Partnership and Whalehaven Funds Limited dated October
2004
34
4.32 Form of Convertible Note issued to Alpha Capital, (12)
Longview Fund LP, Stonestreet Limited Partnership,
Whalehaven Funds Limited and Gamma Opportunity Capital
Partners LP dated October 2004
4.33 Subscription Agreement entered by and between the (12)
Company and Momona Capital Corp. and Ellis
International Ltd. dated December 2004
4.34 Form of Common Stock Purchase C issued to Momona (12)
Capital Corp. and Ellis International Ltd. dated
December 2004
4.35 Form of Convertible Note issued to Momona Capital Corp. (12)
and Ellis International Ltd. dated December 2004
4.36 Form of Convertible Note issued to Alpha Capital, (13)
Longview Fund LP, Longview Equity Fund LP, Longview
International Equity Fund LP and Whalehaven Funds
Limited dated January 2005
4.37 Subscription Agreement entered by and between the (13)
Company and Alpha Capital, Longview Fund LP, Longview
Equity Fund LP, Longview International Equity Fund LP
and Whalehaven Funds Limited dated January 2005
4.38 Form of Common Stock Purchase Warrant issued to Alpha (13)
Capital, Longview Fund LP, Longview Equity Fund LP,
Longview International Equity Fund LP and Whalehaven
Funds Limited dated January 2005
4.39 Form of Securities Purchase Agreement with 13 (14)
institutional investors in connection with November 28,
2005 $20,250,000 financing
4.40 Form of Stock Purchase Warrant in connection with (14)
November 28, 2005 $20,250,000 financing
10 Material Contracts
10.1 Warner Bros China License Agreement (5)
10.2 Warner Bros. China License Agreement (modified) (5)
10.3 Warner Bros. U.S. License Agreement. (5)
10.4 Warner Bros. Mexico. License Agreement (6)
10.5 Warner Bros. Canada. License Agreement (6)
10.6 MoonPie License Agreement (10)
10.7 Marvel License Agreement (US) (10)
10.8 SADAFCO Production Agreement (10)
10.9 Real Estate Lease Amendment Extending Term (10)
10.10 Masterfoods License (13)
Marvel Enterprises License (UK) (13)
Coca-Cola Enterprises Master Distribution Agreement (15)
16.1 Letter on change or certifying accountant (9)
21.1 Subsidiary Articles of Association (4)
31.1 Certification of CEO, Rules 13a-14(a) & 15d-14(a) X
31.2 Certification of CFO, Rules 13a-14(a) & 15d-14(a) X
32.1 Certifications of CEO & CFO, 18 U.S.C. Sec. 1350 X
(1) Filed with Form 10SB/A First Amendment
(2) Filed with Form 10K-SB for 12-31-99
(3) Filed with Form 10QSB for 6-30-00
(4) Filed with Form SB-2/A Second Amendment
(5) Filed with Form SB-2/A Third Amendment
(6) Filed with Form 10K-SB 2001
35
(7) Filed with Form 10QSB for 6-30-02
(8) Filed with Form 8-K for 10-02-02
(9) Filed with Form 8-K for 3-26-04
(10) Filed with Form 10K-SB 2003
(11) Filed with Form SB-2 June 4, 2004
(12) Filed with Form SB-2 January 21, 2005
(13) Filed with Form 10K-SB 2004
(14) Filed with Form 8-K for 11-28-05
(15) Filed with Form 10QSB for 9-30-05
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The aggregated fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the audit of our
annual financial statements and review of financial statements included in our
Forms 10-QSB were $109,279 and $86,493 respectively for 2005 and 2004.
Audit Related Fees
------------------
None
Tax Fees
--------
In 2005, we paid an aggregate of $37,000 for the preparation of 2004 and
prior years' tax returns.
All Other Fees
--------------
During 2005, we paid $3,522 to the principal accountant for services
performed in connection with the implementation of Sarbanes Oxley Section 404.
Audit Committee Pre-Approval Policies
-------------------------------------
The audit committee makes reasonable inquiry as to the independence of our
principal auditors based upon the considerations set forth in Rule 2-01 of
Regulation S-X, including the examination of representation letters furnished by
the principal accountant. The audit committee has not approved any services
beyond those required for the audit of our annual financial statements, review
of financial statements included in our Forms 10-KSB and preparation of
corporate tax returns.
36
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, Bravo! Brands Inc. has caused this restated report (Amendment 2) to be
signed on its behalf by the undersigned, thereunder duly authorized.
BRAVO! BRANDS INC.
(Formerly Bravo! Foods International Corp.)
By: /S/ Roy G. Warren, Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, Bravo! Brands Inc.
has caused this report to be signed on its behalf by the undersigned in the
capacities and on the dates stated.
Signature Title Date
--------- ----- ----
/S/ Roy G. Warren Chief Executive Officer November 6, 2006
/S/ Tommy E. Kee Chief Accounting Officer, Treasurer November 6, 2006
37