-------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO FORM 10Q-SB
QUARTERLY OR TRANSITIONAL REPORT
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
Commission File Number 000-25039
BRAVO! FOODS INTERNATIONAL CORP.
(Exact name of registrant as specified in its amended charter)
Delaware 62-1681831
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11300 US Highway 1, North Palm Beach, Florida 33408 USA
(Address of principal executive offices)
(561) 625-1411
Registrant's telephone number
---------------------------------------------------
(Former name, former address and former fiscal year
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934, 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 |_| Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after
the distribution of securities under a plan confirmed by a court. Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date is as follows:
Date Class Shares Outstanding
September 25, 2006 Common Stock 195,018,001
Preferred Stock 456,840
Transitional Small Business Disclosure Format (Check One) YES [ ] NO [x]
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial statements
Consolidated balance sheets as of F-1 to F-2
March 31, 2006 (unaudited) and December 31, 2005
Consolidated statements of operations F-3
for the three months
ended March 31, 2006 and 2005 (unaudited)
Consolidated statements of cash flows F-4
for the three months ended
March 31, 2006 and 2005 (unaudited)
Notes to consolidated financial statements (unaudited) F-5 to F-40
Item 2. Management's Discussion and Analysis of Financial F-41
Condition and Results of Operations
Item 3. Controls and Procedures F-50
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity and Use of Proceeds F-51
Item 3. Default on Senior Securities F-52
Item 6. Exhibits F-52
SIGNATURES F-53
DOCUMENTS INCORPORATED BY REFERENCE: See Exhibits
EXPLANATORY NOTE
We are filing this Amendment No. 1 to our Quarterly Report on Form 10-QSB
for the quarterly period ended March 31, 2006 to reflect the restatement of our
consolidated financial statements for the periods ended March 31, 2006 and 2005.
As more fully described in Note 10 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) certain other matters more fully described in Note 10. We have
also restated Management's Discussion and Analysis and our Evaluation of
Disclosure Controls and Procedures, also included herein, to give effect to the
restated financial information.
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 we become
profitable.
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2006 2005
----------- ------------
(Unaudited)
(Restated)
Assets
Current assets:
Cash and cash equivalents $ 609,785 $ 4,947,986
Accounts receivable, net of allowances for doubtful accounts
of $364,941 and $350,000 at 2006 and 2005, respectively 1,537,858 3,148,841
Inventories 3,043,914 391,145
Prepaid expenses 1,947,905 973,299
------------- ------------
Total current assets 7,139,462 9,461,271
Furniture and equipment, net 514,913 288,058
Intangible assets, net 17,881,647 18,593,560
Other assets 20,948 15,231
------------- ------------
Total assets $ 25,556,970 $ 28,358,120
============= =============
Liabilities, Redeemable Preferred Stock and Stockholders' Deficit
Current liabilities:
Accounts payable $ 7,997,298 $ 5,987,219
Accrued liabilities 4,387,187 4,872,277
Current maturities of notes payable 992,953 937,743
Convertible debt 1,023,856 1,012,780
Derivative liabilities 30,556,957 35,939,235
------------- ------------
Total current liabilities 44,958,251 48,749,254
Notes payable, less current maturities 109,797 -
------------- ------------
Total liabilities 45,068,048 48,749,254
------------- ------------
F-1
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2006 2005
----------- ------------
(Unaudited)
(Restated)
Commitments and contingencies (Note 9) -- --
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 shares
issued and outstanding 52,480 52,480
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 shares issued and outstanding 427,479 388,305
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 1,007,928 871,043
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 803,687 792,672
------------- ------------
Total redeemable preferred stock 2,291,574 2,104,500
------------- ------------
Stockholders' deficit:
Preferred stock, 5,000,000 shares authorized
Series B Preferred, 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,
185,753,753 and 184,253,753 shares issued and outstanding 185,754 184,254
Additional paid-in capital 97,675,101 96,507,932
Common stock subscription receivable (10,000) (10,000)
Accumulated deficit (119,729,498) (119,254,501)
Cumulative translation adjustment (31,449) (30,759)
------------- ------------
Total stockholders' deficit (21,802,652) (22,495,634)
------------- ------------
Total liabilities, redeemable preferred stock and stockholders'
deficit $ 25,556,970 $ 28,358,120
============= =============
See accompanying notes.
F-2
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Three Months Ended March 31,
-----------------------------
2006 2005
---- ----
(Unaudited) (Unaudited)
(Restated) (Restated)
Revenues $ 3,561,215 $ 897,770
Product costs (2,946,460) (677,663)
Shipping costs (393,452) (138,450)
------------ -----------
Gross margin 221,303 81,657
Operating expenses:
Selling 2,843,098 485,031
General and administrative 1,768,203 758,254
Product development 115,963 69,024
------------ -----------
Loss from operations (4,505,961) (1,230,652)
Other income (expense)
Derivative income, net 4,949,188 1,471,743
Interest expense, net (34,007) (894,161)
Liquidated damages (685,887)
------------ -----------
Income (loss) before income taxes (276,667) (653,070)
Provision for income taxes -
------------ -----------
Net loss (276,667) (653,070)
Preferred stock dividends and accretion (258,783) (271,115)
------------ -----------
Loss applicable to common stockholders $ (535,450) $ (924,185)
============ ===========
Loss per common share:
Basic $ (0.00) $ 0.02
============ ===========
Diluted $ (0.00) $ 0.02
============ ===========
Weighted average common shares outstanding 184,253,753 59,618,018
============ ===========
Comprehensive loss:
Net loss $ (276,667) $ (653,070)
Foreign currency translation (690) (8,023)
------------ -----------
Comprehensive loss $ (277,357) $ (661,093)
============ ===========
See accompanying notes.
F-3
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31
----------------------------
2006 2005
----------------------------
(Unaudited) (Unaudited)
(Restated) (Restated)
Cash Flows from Operating Activities:
Net income (loss) $ (276,667) $ (653,070)
Adjustments to net loss
Depreciation and amortization 896,505 234,005
Stock issuance for compensation -- 57,500
Bad debt expense 14,941 --
Derivative income (4,949,188) (1,471,743)
Amortization of debt discount 11,076 772,181
Stock option expense for consultants 347,566 --
Employee options issued for compensation 111,592 --
Stock option expense for consultants -- 30,000
Loss on disposal of fixed assets 1,999 --
Changes in operating assets & liabilities:
Accounts receivable 1,596,042 16,844
Inventories (2,652,769) 6,982
Prepaid expenses and other assets (980,325) (118,713)
Accounts payable and accrued expenses 1,668,557 397,710
----------- -----------
Net cash used in operating activities (4,210,671) (728,304)
----------- -----------
Cash Flows from Investing Activities
Licenses, finance and trademark costs (163,536) (371,649)
Purchases of equipment (249,910) (11,625)
----------- -----------
Net cash used in investing activities (413,446) (383,274)
----------- -----------
Cash Flows provided by financing activities:
Proceeds from conversion of warrants 150,000 --
Proceeds from convertible notes payable 169,323 1,150,000
Payment of dividends (11,257) --
Payment of notes payable (4,317) --
Registration costs for financing (17,143) (26,728)
----------- -----------
Net cash provided by financing activities 286,606 1,123,272
----------- -----------
Effect of changes in exchange rates on cash (690) (8,023)
----------- -----------
Net (decrease) increase in cash and cash equivalents (4,338,201) 3,671
Cash and cash equivalent, beginning of period 4,947,986 113,888
----------- -----------
Cash and cash equivalent, ending of period $ 609,785 $ 117,559
=========== ===========
See accompanying notes.
F-4
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 -Nature of Business, Basis of Presentation and Liquidity and
Management's Plans
Nature of Business:
We are engaged in the sale of flavored milk products and flavor ingredients in
the United States, the United Kingdom and the Middle East, and we are
establishing an infrastructure to conduct business in Canada.
Basis of Presentation:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10QSB, Item 310(b) of
Regulation S-B and Article 10 (01)(c) of Regulation S-X. Accordingly, the
accompanying financial statements do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included in the accompanying financial statements. Operating results
for the three-month period ending March 31, 2006 are not necessarily indicative
of the results that may be expected for the year ended December 31, 2006.
As more fully described in Note 10, we have restated our balance sheets as of
March 31, 2006 and our statements of operations and cash flows for the three
months ended March 31, 2006 and 2005 for errors related to the accounting for
derivative instruments arising from certain of our financing transactions and
certain other matters. We have also made certain reclassifications to the March
31, 2006 and December 31, 2005 balance sheets and statements of operations and
cash flows for the three months ended March 31, 2006 to conform to presentations
and classifications in the current period. The consolidated balance sheet at
December 31, 2005, is audited.
Liquidity and Management's Plans:
As reflected in the accompanying consolidated financial statements, we have
incurred operating losses and negative cash flow from operations and have a
working capital deficiency of $37,818,789 as of March 31, 2006. In addition, we
are delinquent on certain of our debt agreements at March 31, 2006, 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 10). Our inability to make these filings is resulting in our
recognition of penalties payable 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 our ability to successfully complete financings as
we execute our business model and plans. Although our liquid reserves have been
substantially depleted as of March 31, 2006, we completed a $30.0 million
convertible note financing in July 2006 that is expected to fulfill our
liquidity requirements through the end of 2006. However, $15.0 million of this
financing is being held in escrow, pending approval by our shareholders of an
increase in our authorized shares of common stock. We were
F-5
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. On August 31, 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 this quarterly report. See
Item 3 of Part II of this report, entitled "Default on Senior Securities", for a
description of the terms of the Amendment Agreement.
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.
Note 2. - Summary of 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 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. Among the more 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. For the period
ended March 31, 2006, our revenues were
F-6
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
geographically dispersed 98% and 2% between the United States of America and
internationally, respectively. We currently have one customer in the United
States that provided 71% and 0% of our revenue during the three months ended
March 31, 2006 and 2005, respectively.
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! Foods
International Corp. (the "Company"), and its wholly-owned subsidiary Bravo!
Brands (UK) Ltd. All material intercompany balances and transactions have been
eliminated.
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
$393,452 and $138,450 for the three months ended March 31, 2006 and 2005,
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 March 31, 2006 and December 31, 2005, the allowance of
doubtful accounts aggregated approximately $365,000 and $350,000, respectively.
In addition, our accounts receivable are concentrated with one customer who
represents 54% and 34% of our gross accounts receivable balances at March 31,
2006 and December 31, 2005, respectively. Approximately, 6% of our gross
accounts receivable at March 31, 2006 are due from international customers.
F-7
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Inventories
-----------
Inventories, which consist primarily of finished goods, is stated at the lower
of cost on the first in, first-out method or market. Our inventories at March
31, 2006 have substantially increased from levels at December 31, 2005 because
we are building inventories to support our contractual arrangement with a
significant customer. 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 three months ended March 31, 2006, we did not
provide for unsalable 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 became
effective for our fiscal year beginning January 1, 2006. The adoption of FAS No.
151 did not have a material effect on our consolidated financial statements.
Furniture and Equipment
-----------------------
Furniture and equipment 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.
Intangible Assets
-----------------
Our intangible assets as of March 31, 2006 and December 31, 2005 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 illustrates information about our intangible assets:
March 31, 2006 December 31, 2005
-------------- -----------------
Distribution agreement $15,960,531 $15,960,531
Manufacturing agreement 2,700,000 2,700,000
Licenses and trademarks 586,482 1,370,958
Less accumulated amortization (1,365,366) (1,437,929)
----------- -----------
$17,881,647 $18,593,560
=========== ===========
Amortization expense amounted to $848,500 and $61,849 for the three months ended
March 31, 2006 and March 31, 2005, respectively.
Estimated future amortization of our intangible assets is as follows as of March
31, 2006:
Nine months ended December 31, 2006 $1,837,171
==========
Year ended:
December 31, 2007 $2,367,947
F-8
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
==========
December 31, 2008 $2,356,342
==========
December 31, 2009 $2,355,844
==========
December 31, 2010 $2,203,289
==========
December 31, 2011 $1,767,591
==========
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 March 31, 2006 and December 31, 2005, estimated fair values and respective
carrying values of our notes payable, convertible debt and redeemable preferred
stock are as follows:
Fair Value Carrying Value Fair Value Carrying Value
Instrument Note 2006 2006 2005 2005
------------------------------------------------------------------
$750,000 Note Payable 4(a) $ 750,000 $ 750,000 $ 750,000 $750,000
===============================================================
$187,743 Note Payable 4(b) 187,743 187,743 187,743 187,743
===============================================================
Other Notes Payable 4(c) 165,007 165,007 -- --
===============================================================
$200,000 Convertible Note 5(a) 200,000 196,569 190,000 187,934
===============================================================
$15,000 Convertible Note 5(b) 14,200 3,031 13,300 1,620
===============================================================
$600,000 Convertible Note 5(c) 668,000 600,000 668,000 600,000
===============================================================
$6,250 Convertible Note 5(e) 6,250 6,219 6,375 5,188
===============================================================
F-9
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
$25,000 Convertible Note 5(f) 25,500 30,278 25,500 30,278
===============================================================
$187,760 Convertible Note 5(g) 187,760 187,760 187,600 187,600
===============================================================
Series F Preferred Stock 6(d) 49,000 52,480 46,000 52,480
===============================================================
Series H Preferred Stock 6(a) 557,000 427,479 525,000 388,305
===============================================================
Series J Preferred Stock 6(b) 1,781,000 1,007,927 1,731,000 871,043
===============================================================
Series K Preferred Stock 6(c) 927,000 803,688 881,000 792,672
===============================================================
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 instrument 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 and
common stock 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
March 31, 2006 and December 31, 2005:
Note 2006 2005
-----------------------------------------
Compound derivative financial instruments that have
been bifurcated from the following financing arrangements:
----------------------------------------------------------
$400,000 Convertible Note Financing 5(a) $ (1,258,200) $ (1,311,000)
$2,300,000 Convertible Note Financing 5(b) (4,219) (4,867)
$600,000 Convertible Note Financing 5(c) (286,200) (153,700)
$693,000 Convertible Note Financing 5(e) (42,656) (42,878)
$660,000 Convertible Note Financing 5(f) (146,250) (159,250)
$1,080,000 Convertible Note Financing 5(g) (549,808) (564,735)
Series F Preferred Stock Financing 6(d) (20,329) (25,632)
Series H Preferred Stock Financing 6(a) (396,362) (381,377)
Series J Preferred Stock Financing 6(b) (4,704,000) (5,628,000)
Series K Preferred Stock Financing 6(c) (209,338) (206,200)
Freestanding derivative contracts arising from financing
and other business arrangements:
--------------------------------------------------------
Warrants issued with $693,000 Convertible Notes 5(e) -- (924,120)
Warrants issued with Series H Preferred Stock 6(a) (936,205) (1,264,109)
Warrants issued with Series F Preferred Stock 6(d) (505,231) (563,096)
Warrants issued with Series D Preferred Stock 6(d) (366,147) (400,214)
Other warrants 8(b) (21,132,012) (24,310,057)
-------------------------------
Total derivative liabilities $(30,556,957) $(35,939,235)
===============================
F-10
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
free-standing 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 and external market factors. 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 for the three
months ended March 31, 2006 and 2005:
Derivative income (expense): 2006 2005
---------------------------
Convertible note and warrant financings $ (50,904) $ 582,675
Preferred stock and warrant financings 1,331,015 816,751
Other warrants and derivative contracts 3,699,077 72,317
---------------------------
$4,949,188 $1,471,743
========== ==========
Our derivative liabilities as of March 31, 2006 and 2005 and our derivative
income during each of the quarters ended March 31, 2006 and 2005 were
significant to our financial statements. During the quarter ended March 31,
2006, the trading price of our common stock decreased from $0.59 at December 31,
2005 to $0.55 at March 31, 2006. During the quarter ended March 31, 2005, the
trading price decreased from $0.17 at December 31, 2004 to $0.15 at March 31,
2005. The lower stock prices decreased the fair value of our derivative
liabilities and, accordingly, we were required to adjust the derivatives to
these lower values with credits to income.
The following table summarizes the number of common shares indexed to the
derivative financial instruments as of March 31, 2006:
Conversion
Financing or other contractual arrangement: Note Features Warrants Total
----------------------------------------------------
$400,000 Convertible Note Financing 5(a) 4,000,000 -- 4,000,000
$2,300,000 Convertible Note Financing 5(b) 120,000 2,000,000 2,120,000
$600,000 Convertible Note Financing 5(c) 4,100,000 -- 4,100,000
$693,000 Convertible Note Financing 5(e) 63,542 -- 63,542
$660,000 Convertible Note Financing 5(f) 250,000 1,500,000 1,750,000
$1,080,000 Convertible Note Financing 5(g) 1,924,540 -- 1,924,540
F-11
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Series D Convertible Preferred Stock 6(d) -- 611,250 611,250
Series F Convertible Preferred Stock 6(d) 220,969 1,038,259 1,259,228
Series H Convertible Preferred Stock(a) 6(a) -- 4,387,500 4,387,500
Series J Convertible Preferred Stock 6(b) 20,000,000 -- 20,000,000
Series K Convertible Preferred Stock(a) 6(c) -- -- --
Other warrants and contracts 8(b) -- 50,704,688 50,704,688
------------------------------------------
30,679,051 60,241,697 90,920,748
==========================================
(a) As more fully described in Notes 6(a) and 6(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 990,905 and 9,500,000
common shares, respectively, into which these instruments are convertible
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
three months ended March 31, 2006, we recorded liquidated damages expense of
$685,887. These charges are significantly greater than the amounts we recorded
in previous periods due to the fact that we now have incurred approximately $2.1
million of liquidated damages, and currently estimate that additional damages
will accrue before we are able to cure our registration default.
Advertising and Promotion Costs
-------------------------------
Advertising and promotion costs, which are included in selling expenses, are
expensed as incurred and aggregated $1,243,908 and $138,722 for the three months
ended March 31, 2006 and 2005, respectively.
Share-based payments
--------------------
Effective January 1, 2005, we adopted the fair value recognition provisions of
Financial Accounting Standards No. 123 Accounting for Stock-Based compensation
("FAS 123"). Effective January 1, 2006 we adopted Financial Accounting Standards
No. 123(R), Share-Based Payments ("FAS123R"). Under the fair value method, we
recognize compensation expense for all share-based payments granted after
January 1, 2005, as well as all share-based payments granted prior to, but not
yet vested, as of January 1, 2005, in accordance with FAS 123. Under the fair
value recognition provisions of FAS 123R, we recognize share-based compensation
expense, net of an estimated forfeiture rate, over the requisite service period
of the award. Prior to the adoption of FAS 123 and FAS 123R, the Company
accounted for share-based payments under Accounting Principles Board Opinion No.
25 Accounting for Stock Issued to Employees and the disclosure provisions of FAS
123. For further information regarding the adoption of SFAS No. 123R, see Note 7
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 Applicable to Common Shareholders
--------------------------------------
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
F-12
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
applicable to common shareholders 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 three months ended March 31, 2006 and 2005
potential common shares arising from our stock options, stock warrants,
convertible debt and convertible preferred stock amounting to 81,913,744 and
129,857,869 shares, respectively, were not included in the computation of
diluted earnings per share because their effect was antidilutive.
Note 3. Accrued liabilities
Accrued liabilities consist of the following as of March 31, 2006 and December
31, 2005:
2006 2005
--------------------------
Liquidated damages due to late registration (a) $ 989,637 $ 303,750
Investor relations liability 1,402,000 1,545,565
Production processor liability 61,544 182,814
Accrued payroll and related 511,017 636,757
Accrued interest 414,301 376,198
Discontinued products (b) 876,873 1,710,733
Other 131,815 116,460
--------------------------
$4,387,187 $4,872,277
==========================
(a) Certain of our financing arrangements 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% each month. We record these liquidated damages
when they are probable and estimable pursuant to FAS 5.
(b) During 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.
Note 4. Notes Payable
Notes payable consist of the following as of March 31, 2006 and December 31,
2005:
2006 2005
--------------------------
$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
Vehicle notes payable (c) 165,007 --
--------------------------
Total notes payable 1,102,750 937,743
Less current maturities 992,953 937,743
--------------------------
Long-term notes payable $ 109,797 $ --
==========================
(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
F-13
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 March 31, 2006, 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) In March 2006 we signed notes with GMAC for the purchase of eight vehicles.
The initial principal balance was $169,323. The notes call for 36 monthly
payments of $4,887, which includes principal and interest. The interest rate for
seven of the notes is 1.9% with the other having a rate of 4.9%.
Note 5. Convertible Debt
Convertible debt carrying values consist of the following as of March 31, 2006
and December 31, 2005:
2006 2005
--------------------------
$200,000 Convertible Note Payable, due November 2006 (a) $ 196,569 $ 187,934
$15,000 Convertible Note Payable, due May 2007 (b) 3,030 1,620
$600,000 Convertible Note Payable, due December 2005 (c) 600,000 600,000
$6,250 Convertible Note Payable, due April 30, 2006 (e) 6,219 5,188
$25,000 Convertible Note Payable, due October 1, 2006 (f) 30,278 30,278
$187,760 Convertible Note Payable, due December 1, 2005 (g) 187,760 187,760
--------------------------
$1,023,856 $1,012,780
==========================
(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 a strike price ranging from $0.05 to $1.00 for a period of three
years. The convertible notes had a face value outstanding of $200,000 on March
31, 2006 and December 31, 2005 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 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
F-14
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 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 compound derivative balances
associated with this financing arrangement of $1,258,200 and $1,311,000 as of
March 31, 2006 and December 31, 2005, respectively. These amounts are 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.
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $52,800 $238,800
===============================
Warrant derivative $ -- $173,800
===============================
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 three months ended March 31, 2006 and 2005 amounted
to approximately $9,000 and $31,000, respectively.
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.
F-15
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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 plus warrants to purchase 9,200,000, 4,000,000 and 5,200,000,
respectively, shares 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 March 31, 2006 and December 31, 2005 resulting from conversions to
common stock. The 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 $4,219 and $4,867 as of March 31,
2006 and December 31, 2005, respectively.
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 $2,300,000
convertible note financing:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $648 $ 123,827
==============================
Warrant derivative $ -- $(672,590)
==============================
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-16
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 three months ended March 31, 2006 and 2005 amounted
to approximately $6,000, respectively.
(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
periods of five and two years, respectively. Net proceeds from this financing
arrangement amounted to $500,000. As of March 31, 2006 and December 31, 2005,
this debt is past due and the outstanding carrying value of $600,000 does not
include $68,000 of capitalized interest, which is being reflected in 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.
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 compound derivative balances
associated with this financing arrangement of $286,200 and $153,700 as of March
31,
F-17
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2006 and December 31, 2005, 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:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $(132,500) $ 500
=================================
Warrant derivative $ -- $153,500
=================================
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 three months ended March 31, 2006 and 2005 amounted
to approximately $-0- and $117,000, 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. In June 2005 this debt was fully converted. 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
F-18
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $ -- $40,813
===============================
Warrant derivative $ -- $16,240
===============================
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 three months ended March 31, 2006 and 2005 amounted
to approximately $-0- and $45,000, respectively.
(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 shares of common stock at
$0.15 for five years. Net proceeds from this financing arrangement amounted to
$550,000. At March 31, 2006 and December 31, 2005, this debt had an outstanding
face value of $6,250. 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
F-19
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 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 of
$42,656 and $42,878 as of March 31, 2006 and December 31, 2005, respectively.
Our value model resulted in a warrant derivative balance, arising from the
convertible note financing, of $-0- and $924,120 as of March 31, 2006 and
December 31, 2005, 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:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $221 $122,739
=============================
Warrant derivative $ -- $ 34,510
=============================
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
F-20
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
payments, were amortized through periodic charges to interest expense using the
effective method. Interest expense during the three months ended March 31, 2006
and 2005 amounted to approximately $1,000 and $110,000, 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 shares of common stock at
$0.15 for five years. Net proceeds from this financing arrangement amounted to
$493,000. At March 31, 2006 and December 31, 2005, this debt had an outstanding
face value of $25,000. 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
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 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 of
$146,250 and $159,250 as of March 31, 2006 and December 31, 2005, respectively.
This amount is included in Derivative Liabilities on our balance sheet.
As of June 30, 2005, all warrants related to the financing had been fully
converted.
F-21
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $13,000 $75,915
===============================
Warrant derivative $ -- $61,800
===============================
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 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 three months ended March 31, 2006 and 2005 amounted
to approximately $-0- and $32,000, 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
$679,000. At March 31, 2006 and December 31, 2005, this debt had an outstanding
face value of $187,760. 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.
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-22
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
$549,808 and $564,735 as of March 31, 2006 and December 31, 2005, 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 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:
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $14,927 $ 22,179
===============================
Warrant derivative $ -- $190,642
===============================
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 three months ended March 31, 2006 and 2005 amounted
to approximately $-0- and $192,000, 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
F-23
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to bifurcate the embedded conversion feature and carry it as a derivative
liability. 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 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.
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $ -- $ --
==============================
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, are being amortized through periodic
charges to interest expense using the effective method. Interest expense during
the three months ended March 31, 2006 and 2005 amounted to approximately $-0-
and -0-, respectively.
Derivative warrant fair values are calculated using the Black-Scholes-Merton
Valuation technique. Significant assumptions as of March 31, 2006, corresponding
to each of the above financings (by paragraph reference) are as follows:
5(a) 5(b) 5(c) 5(d) 5(e) 5(f)
----------------------------------------------------------------------
Trading market price $0.55 $0.55 $0.55 $0.55 $0.55 $0.55
$.05--$1.00
Strike price $.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) .67 4.38 3.25 3.75 3.58 3.00
F-24
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
Note 6. 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. At March 31, 2006
and 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 $936,205 and $1,264,109 as of March 31, 2006 and December 31, 2005,
F-25
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $396,362 and $381,377 as of March 31, 2006 and December 31, 2005,
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.
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $(14,985) $(2,064)
===============================
Warrant derivative $327,903 $66,641
===============================
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 three months ended March 31, 2006
when compared to the same period of 2005, 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. 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:
Three months ended Three months ended
March 31, March 31,
2006 2005
------------------------------------------
Preferred stock dividends $35,100 $35,100
===============================
Accretions $39,174 $89,348
===============================
As of March 31, 2006, $351,000 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
F-26
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 evaluation
concluded that the embedded conversion feature was not afforded the exemption as
a conventional convertible instrument due to certain variability in the
conversion price and it further 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 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
associated with the Series J Preferred Stock of $4,704,000 and $5,628,000 as of
March 31, 2006 and December 31, 2005, 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 Series J
Preferred Stock.
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $924,000 $224,000
================================
Warrant derivative $ -- $168,000
================================
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-27
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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:
Three months ended Three months ended
March 31, March 31,
2006 2005
------------------------------------------
Preferred stock dividends $ 40,000 $40,000
================================
Accretions $136,885 $76,348
================================
As of March 31, 2006 $520,000 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 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 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
F-28
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $209,338 and
$206,200 as of March 31, 2006 and December 31, 2005, 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 K Preferred Stock.
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $(3,138) $(1,256)
===============================
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 three months ended March 31,
2006, when compared to the same period of 2005, 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. 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:
Three months ended Three months ended
March 31, March 31,
2006 2005
------------------------------------------
Preferred stock dividends $19,000 $19,000
===============================
Accretions $11,015 $10,359
===============================
As of March 31, 2006, $152,000 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.
F-29
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 had 107,440 shares of Series B
Preferred outstanding as of March 31, 2006 and December 31, 2005, respectively.
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 reported in this
quarterly report. However, we continue to 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 shares of Series F Preferred Stock outstanding at
March 31, 2006 and December 31, 2005. 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 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 March 31, 2006 or December 31,
2005. 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.
F-30
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three months ended Three months ended
March 31, March 31,
Derivative income (expense) 2006 2005
------------------------------------------
Compound derivative $ 5,303 $161,082
===============================
Warrant derivative $91,932 $200,348
===============================
The following table summarizes preferred stock dividends related to the
convertible preferred stock discussed above:
Three months ended Three months ended
March 31, March 31,
2006 2005
------------------------------------------
Preferred stock dividends $ -- $7,800
==============================
Accretions $ -- $ --
==============================
Note 7. - Stock Based Compensation Plans
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 options for up
to 10,397,745 shares of our common stock to our directors, officers, key
employees and consultants. On May 10, 2006, our Board of Directors adopted the
recommendation of our Compensation Committee to grant options for 8,872,745
shares to our directors, officers and key employees. As of March 31, 2006, there
were 1,475,000 shares of common stock reserved for future grants under our 2005
Stock Incentive Plan. Options granted under 2005 Stock Incentive Plan vest over
two years in equal annual installments with the first third exercisable on grant
date, provided that the individual is continuously employed by us.
Prior to May 2005, we granted options for 650,000 shares to now former
employees; 220,000 shares to now former directors and 360,714 shares to
consultants, all which are fully vested and exercisable, under individual plans.
Currently, there are no shares reserved for future issuances under these
individual plans.
On January 1, 2006, we adopted Financial Accounting Standard 123 (revised 2004),
Share-Based Payments ("FAS 123R") which is a revision of FAS No. 123, using the
modified prospective method. Under this method, compensation cost recognized for
the three months ended March 31, 2006 includes compensation cost for all
share-based payments modified or granted prior to but not yet vested as of,
January 1, 2006, based on the grant date fair value estimated in accordance with
the original provisions of FAS No. 123. Compensation cost is being recognized on
a straight-line basis over the requisite service period for the entire award in
accordance with the provisions of FAS 123R.
As we had previously adopted the fair-value provisions of FAS 123, effective
January 1, 2005, the adoption of FAS 123R had a negligible impact on our
earnings before income taxes and net earnings for the first quarter of 2006.
Accordingly, there was no impact on basic or diluted loss applicable to common
shareholders per share for the first quarter of 2006. We recorded compensation
costs of $111,592 and $0 for the first quarter of 2006 and 2005, respectively.
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 Statement of Operations.
F-31
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As required by FAS 123R, we estimate forfeitures of employee stock options and
recognize compensation costs only for those awards expected to vest. Forfeiture
rates are determined for two groups of employees - directors / officers and key
employees based on historical experience. We adjust estimated forfeitures to
actual forfeiture experience as needed. The cumulative effect of adopting FAS
123R of $17,000, which represents estimated forfeitures for options outstanding
at the date of adoption, was not material and therefore has been recorded as a
reduction of our stock-based compensation costs in General and Administrative
expense rather than displayed separately as a cumulative change in accounting
principle in the Consolidated Statement of Operations. The adoption of SFAS No.
123R had no effect on cash flow from operating activities or cash flow from
financing activities for the three months ended March 31, 2006.
We estimate the fair value of each stock option on the date of grant using a
Black-Scholes-Merton option-pricing formula, applying the following assumptions
and amortize that value to expense over the option's vesting period using the
straight-line attribution approach.
Assumptions
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.
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 plans for the three
months ended March 31, 2006 is presented below:
F-32
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Weighted- Remaining
Average Contractual Aggregate
Exercise Term Intrinsic
Options Shares Price (in years) Value
------------------------------------------- --------- --------- ----------- ---------
Outstanding at December 31, 2005 9,600,422 $0.30
Granted - -
Exercised - -
Forfeited (33,333) $0.30
Expired (155,000) $0.27
Outstanding at March 31, 2006 9,412,088 $0.30 8.75 $2,476,584
========= ===== ==== ==========
Vested or expected to vest at March 31 2006 8,861,971 $0.30 8.73 $2,325,453
========= ===== ==== ==========
Exercisable at March 31 , 2006 3,810,913 $0.33 8.23 $ 938,133
========= ===== ==== ==========
No options were granted during the three months ended March 31, 2006 or 2005,
and there were no exercises of options during those the three month periods.
At March 31, 2006, the Company had $534,191 of total unrecognized compensation
expense related to non-vested stock options, which is expected to be recognized
over a weighted-average period of one year.
Note 8. - Other Stockholders' Equity
(a) Issuances of Common Stock
-----------------------------
On March 31, 2005, we received notices of exercise for and issued 1,000,000
shares of common stock as provided in our June 2004 A Warrant and 500,000 shares
of our October 2004 C Warrant. The shares of common stock underlying these
Warrants were registered pursuant to a registration statement declared effective
April 18, 2005.
(b) Outstanding Warrants
------------------------
As of March 31, 2006, 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
F-33
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 (c) 6/20/2005 6/19/2007 1,000,000 0.050
Warrant to 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
November 2005 Common Stock Financing (d) 11/28/2005 11/27/2010 15,667,188 0.800
November 2005 Common Stock Financing (d) 11/28/2005 11/27/2010 1,012,500 0.500
January 2005 Financing 1/31/05 1/30/2010 2,000,000 0.100
Other Financings 12/27/2001 2/28/2007 25,000 0.400
----------
Total Warrants 60,241,697
==========
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 48,679,688
and 47,679,688 shares of our common stock as of March 31, 2006 and December 31,
2005, 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 are summarized
in the following table.
Three months ended Three months ended
March 31, 2006 March 31, 2005
------------------------------------------
Derivative income (expense)
---------------------------------
Warrant derivative $3,669,077 $72,317
=================================
Note 9- Commitments and Contingencies
Lease of Office
---------------
We lease office space, used for our corporate offices in Florida, under an
operating lease that expires October 31, 2015. Future non-cancelable minimum
rental payments required under the operating lease as of March 31, 2006 are as
follows:
Amount
-------
Nine months ending December 31, 2006 $69,651
Years ending December 31,
2007 $92,868
2008 $92,868
2009 $92,868
2010 $92,868
2011 $92,868
Rent expense for the three months ended March 31, 2006 amounted to $23,217; and,
rent expense for the three months ended March 31, 2005 amounted to $22,404.
F-34
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Royalties:
----------
We license trademarks and trade dress from certain Licensors for use on our
products. Royalty advances are payable against earned royalties on a negotiated
basis for these licensed intellectual property rights. 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 March 31, 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 Six years 2,430,000
Diabetes Research Institute One year 2,500
Employment Contacts
-------------------
Our Chief Executive Officer, Mr. Warren, has a two-year employment contract,
expiring October 2007, that provides a base salary of $300,000, plus a bonus of
one quarter percent (0.25%) of net revenue and normal corporate benefits. This
contract has a minimum two-year term plus a severance package upon change of
control based on base salary.
Officers Toulan, Patipa, Edwards and Kee have employment contracts with base
salaries aggregating $710,000 annually, 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.
Our Chief Financial Officer, Mr. Kaplan, has an employment contract, expiring
November 2008, that provides a base salary of $180,000 for year one, $200,000
for year two and $220,000 for year three, plus discretionary bonuses and normal
corporate benefits. This contract has a minimum three-year term plus a severance
package upon change of control based on base salary
Marketing Commitments
---------------------
Coca-Cola Enterprises ("CCE"). In August 2005, we executed a Master Distribution
Agreement with CCE. Pursuant to this agreement, we are contractually obligated
to spend an aggregate of $5,000,000 on marketing activities in 2005 and 2006 for
our products that are distributed by CCE. Beginning in 2007, we are further
obligated to spend an amount annually in each country within a defined territory
equal or greater than 3% of our total CCE revenues in such territory (on a
country by country basis). Such national and local advertising for our 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.
During the period commencing at the inception of the CCE agreement through the
period ended March 31, 2006, we have spent $1.6 million on marketing activities
pursuant to our agreement with CCE.
F-35
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 10. Restatement of Prior Financial Statements
Our statements of operations for the three months ended March 31, 2006 and March
31, 2005, and our balance sheet as of December 31, 2005 have been restated as
illustrated in the following tables:
--------------------------------------------------------------------------------------------------
Three months ended Three months ended
March 31, 2006 March 31, 2005
--------------------------------------------------------------------------------------------------
Net income (loss), as reported $(3,885,572) $(1,237,248)
--------------------------------------------------------------------------------------------------
Share-based payments (39,356) --
--------------------------------------------------------------------------------------------------
Deferred development costs -- (12,586)
--------------------------------------------------------------------------------------------------
Derivative income (expense) 4,949,188 1,471,743
--------------------------------------------------------------------------------------------------
Amortization of debt discounts and other charges (265,725) (772,181)
--------------------------------------------------------------------------------------------------
Investor relations charges (347,566) (30,000)
--------------------------------------------------------------------------------------------------
Liquidated damages expense (685,887) --
--------------------------------------------------------------------------------------------------
Other (1,749) (72,798)
--------------------------------------------------------------------------------------------------
Net income (loss), as restated $ (276,667) $ (653,070)
------------------------------------------------------------======================================
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.
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.
F-36
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
----------------------------------------------------------------------------------------------------
Three months ended Three months ended
March 31, 2006 March 31, 2005
----------------------------------------------------------------------------------------------------
Loss applicable to common shareholders, as reported $(3,957,281) $(1,332,308)
----------------------------------------------------------------------------------------------------
Cumulative adjustments to net income (loss), above 3,608,905 584,178
----------------------------------------------------------------------------------------------------
Preferred stock accretions (187,074) (176,055)
----------------------------------------------------------------------------------------------------
Loss applicable to common shareholders, as restated $ (535,450) $ (924,185)
-------------------------------------------------------------=======================================
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.
----------------------------------------------------------------------------------------------------
Three months ended Three months ended
March 31, 2006 March 31, 2005
----------------------------------------------------------------------------------------------------
Income (loss) per common share, basic and diluted
as reported $(0.02) $(0.02)
----------------------------------------------------------------------------------------------------
Share-based payments (0.00) --
----------------------------------------------------------------------------------------------------
Deferred development costs -- (0.00)
----------------------------------------------------------------------------------------------------
Derivative income (expense) 0.03 0.02
----------------------------------------------------------------------------------------------------
Amortization of debt discounts and other charges (0.00) (0.02)
----------------------------------------------------------------------------------------------------
Investors relations charges (0.00) --
----------------------------------------------------------------------------------------------------
Liquidated damages expense (0.01) --
----------------------------------------------------------------------------------------------------
Preferred stock accretions (0.00) (0.00)
----------------------------------------------------------------------------------------------------
Preferred stock accretions (0.00) (0.00)
----------------------------------------------------------------------------------------------------
Income (loss) per common share, as restated $(0.00) $(0.02)
----------------------------------------------------------------====================================
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.
----------------------------------------------------------------------------------------------------
Three months ended Three months ended
March 31, 2006 March 31, 2005
----------------------------------------------------------------------------------------------------
Comprehensive income (loss), as reported $(3,886,262) $(1,245,464)
-------------------------------------------------------------=======================================
Comprehensive income (loss), as restated (a) $ (277,357) $ (661,093)
-------------------------------------------------------------=======================================
F-37
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(a) Our restated comprehensive income (loss) reflects the adjustments
attributable to net income (loss), above.
Note 11. - Subsequent Events
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.
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 April 28, 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 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
F-38
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 November 2003 convertible note
financing. The common stock underlying these notes was registered pursuant to a
registration statement declared effective by the Securities and Exchange
Commission in 2004.
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 the preferred were issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission in 2004.
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 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. See
Item 3 of Part II of this report, entitled "Default on Senior Securities", for a
description of the terms of the Amendment Agreement.
F-39
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 preferred were issued pursuant to a registration statement
declared effective by the Securities and Exchange Commission in 2004.
F-40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 the
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 we are
profitable.
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. We generate revenue in our
Middle East business through the sale of "kits" to these dairies. The price of
the "kits" consists of an invoiced price for a fixed amount 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 business in the United Kingdom started at the end of the second
quarter of 2005. Our UK business has not been profitable owing to the
difficulties encountered in initial market penetration with new products
introduced in the last half of 2005 through the first quarter of 2006. In the
current period we had a negative gross margin for our UK operations. We are
examining other distribution alternatives in the UK and, while we are making
this determination, we have curtailed our production of inventory necessary to
maintain a normal supply pipeline.
RESTATEMENT DISCLOSURE - NON-RELIANCE ON OUR PRIOR FINANCIAL STATEMENTS
On December 1, 2005, the Securities and Exchange Commission ("SEC") issued
a comment letter concerning accounting issues associated with our Form 10-KSB
for the year ended December 31, 2004 (the "Initial Comment Letter"). In an
effort to satisfy our registration requirements, on December 21, 2005, in
accordance with a Registration Rights Agreement associated with our November
2005 financing, we filed a registration statement registering the Shares and the
shares of common stock underlying the Warrants issued in connection with the
financing with the SEC, as well as a response letter addressing the seven
comments discussed by the SEC in the Initial Comment Letter.
In its letter of December 1, 2005, the SEC's Division of Corporation
Finance issued questions on the application of EITF 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, ("EITF 00-19") and Statement of Financial Accounting
Standard No. 133, Accounting for Derivative Instruments and Hedging Activities
("FAS 133"),to financial instruments containing an embedded conversion feature,
such as convertible preferred stock,
F-41
BRAVO! FOODS INTERNATIONAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
convertible notes and associated warrants. In general, EITF 00-19 requires that
certain types of convertible equity instruments be reclassified as liabilities
in cases where the issuer's ability to settle the instrument in equity is not
entirely within the issuer's control. The standard also requires, if liability
classification is determined to be appropriate, that the instrument be valued at
fair value with future changes in the value reflected in income. As we have
financed our operations with various convertible instruments over the last
several years, we were required to reevaluate each of our financings in order to
ensure the proper treatment under EITF 00-19.
As a result of the SEC's December 1, 2005 comment letter, we immediately
began to examine the classification of and our accounting methodology for our
convertible preferred and convertible debt financing. Based upon comments from
the SEC Staff and the completion of our internal examination, we have changed
the classification of certain convertible preferred stock and convertible notes
from equity to liabilities. We have examined the accounting methodology utilized
to report the value of embedded derivatives associated with our financing
instruments, including the balance sheet reclassification and valuation of
warrants associated with such financing instruments. We have made changes in the
accounting treatment of these derivatives in that they will have been valued
separately, and fluctuations of value will be reflected on our past consolidated
statements of operations and balance sheets. We also reviewed our accounting for
the amortization of discounts, the impact of certain modifications to warrants
and the beneficial conversion features associated with our various financing
instruments.
Additionally, we reviewed our accounting for employee stock options,
including the fair value calculations made, the method of recognizing
compensation expense and the impact of modifications made to certain options,
and our treatment of deferred development costs. Lastly, the Staff of the SEC
has requested that we restate our historical financial statements to reclassify
shipping and handling costs from selling expenses to cost of product sales.
As a result of the items described above, we have restated our annual
report on Form 10-KSB for the year ended December 31, 2005 and our quarterly
report on Form 10-QSB for the quarterly period ended March 31, 2006. We have
also restated the quarterly and year-to-date results for March 31, 2005.
Notwithstanding these restatements, the SEC may have further comments on
our financial information based on the restated financial results that will be
filed as soon as practicable. The possibility exists that we may be required to
adjust and further modify our proposed restated financial results for the
periods in question. Such adjustments and modifications, if any, may have a
material effect on the financial results set forth in those reports.
CORPORATE GOVERNANCE
The Board of Directors
Our board has positions for seven directors that are elected as Class A or
Class B directors at alternate annual meetings of our shareholders. Six of the
seven current directors of our board are independent. Our chairman and chief
executive officer are separate. The board meets regularly either in person or by
telephonic conference at least four times a year, and all directors have access
to the information necessary to enable them to discharge their duties. The
board, as a whole, and the audit committee in particular, review our financial
condition and performance on an estimated vs. actual basis and financial
projections as a regular agenda item at scheduled periodic board meetings, based
upon separate reports submitted by our Chief Executive Officer and Chief
Accounting Officer. Our shareholders elect directors after nomination by the
board, or the board appoints directors when a vacancy arises prior to an
election. This year we have adopted a nomination procedure based upon a rotating
nomination committee made up of those members of the director Class not up for
election. The board
F-42
presently is examining whether this procedure, as well as the make up of the
audit and compensation committees, should be the subject of an amendment to the
by-laws.
Audit Committee
Our audit committee is composed of three independent directors and
functions to assist the board in overseeing our accounting and reporting
practices. Our financial information is recorded in house by our Chief
Accounting Officer's office, from which we prepare financial reports. Lazar
Levine & Felix LLP, independent registered public accountants and auditors,
audit or review these financial reports. Our Chief Accounting Officer reviews
the preliminary financial and non-financial information prepared in house with
our securities counsel and the reports of the auditors. The committee reviews
the preparation of our audited and unaudited periodic financial reporting and
internal control reports prepared by our Chief Accounting Officer. The committee
reviews significant changes in accounting policies and addresses issues and
recommendations presented by our internal accountants as well as our auditors.
Compensation Committee
Our compensation committee is composed of three independent directors and
reviews the compensation structure and policies concerning executive
compensation. The committee develops proposals and recommendations for executive
compensation and presents those recommendations to the full board for
consideration. The committee periodically reviews the performance of our other
members of management and the recommendations of the chief executive officer
with respect to the compensation of those individuals. Given the size of our
company, the board periodically reviews all such employment contracts. The board
must approve all compensation packages that involve the issuance of our stock or
stock options. Currently, there is one vacancy on the compensation committee.
Nominating Committee
The nominating committee was established in the second quarter 2002 and
consists of those members of the director Class not up for election. The
committee is charged with determining those individuals who will be presented to
the shareholders for election at the next scheduled annual meeting. The full
board fills any mid term vacancies by appointment.
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 for interim reports
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. Among the more 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.
F-43
We use all available information and appropriate techniques to develop our
estimates. However, actual results could differ from our estimates.
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 71% and 0% of our revenue during the three
months ended March 31, 2006 and 2005, respectively.
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 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 March 31, 2006 and December 31, 2005, the allowance of
doubtful accounts aggregated approximately $365,000 and $350,000, respectively.
In addition, our accounts receivable are concentrated with one customer
who represents 54% of our accounts receivable balances at March 31, 2006.
Approximately, 6% of our accounts receivable at March 31, 2006 are due from
international customers.
Inventories
-----------
Our inventories, which consists 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.
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
F-44
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
---------------------
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 techniques, 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 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 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.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2006 Compared to the Three Months
--------------------------------------------------------------
Ended March 31, 2005
--------------------
Consolidated Revenues
The Company had revenues for the three months ended March 31, 2006 of
$3,561,215, with product costs of $2,946,460 and shipping costs of $393,452,
resulting in a gross margin of $221,303, or 6.2 % of sales. Our revenues for the
three months ended March 31, 2006 increased by $2,663,445, a 297% increase
compared to revenues of $897,770 for the three months ended March 31, 2005. The
increase in revenue is the result of the increased distribution of our product
through Coca-Cola Enterprises.
Consolidated Product Costs
The Company incurred product costs of $2,946,460 and shipping costs of
$393,452 for the three months ended March 31, 2006. Product costs for this
period increased by $2,268,797, a 335% increase compared to $677,663 for the
three months ended March 31, 2005. The increase in product costs and
F-45
shipping costs in the United States for the three months ended March 31, 2006 is
the result of increased revenues.
Consolidated Operating Expenses
The Company incurred selling expenses for the three months ended March 31,
2006 of $2,843,098. Selling expenses increased for the three months ended March
31, 2006 by $2,358,067, a 486% increase compared to the selling expenses of
$485,031 for the three months ended March 31, 2005. The increase in selling
expenses is the result of increased sales.
The Company incurred general and administrative expenses for the three
months ended March 31, 2006 of $1,768,203. General and administrative expenses
for the three months ended March 31, 2006 increased by $1,009,949, a 133%
increase compared to $758,254 for the same period in 2005. The increase in
general and administrative expenses for the current period is the result of the
hire of additional staff and other costs associated with the management and
implementation of our relationship with Coca-Cola Enterprises under the Master
Distribution Agreement.
As a percentage of total revenue, our general and administrative expenses
decreased from 84% in the period ended March 31, 2005, to 50% for the current
period in 2006. We anticipate a continued effort to reduce these expenses as a
percentage of sales through revenue growth, cost cutting efforts and the
refinement of business operations.
Consolidated Derivative Income (Expense)
Derivative income (expense) 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, and 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 income amounted to $4,949,188 for the three months ended
March 31, 2006, compared to $1,471,743 for the corresponding period of the prior
year.
Changes in the fair value of compound derivatives indexed to our common
stock are significantly affected by changes in our trading stock price and the
credit risk associated with our financial instruments. The fair value of warrant
derivatives is significantly affected by changes in our trading stock prices.
The fair value of derivative financial instruments that are settled solely with
cash fluctuate with changes in management's weighted probability estimates
following the financing inception and are generally attributable to the
increasing probability of default events on debt and preferred stock financings.
The fair value of the warrants fluctuate principally due to the fluctuation in
our common stock trading price. Since these instruments are measured at fair
value, future changes in assumptions, arising from both internal factors and
general market conditions, may cause further variation in the fair value of
these instruments. Future changes in these underlying internal and external
market conditions will have a continuing effect on derivative expense associated
with our derivative financial instruments.
In addition, we entered into a $30 million debt and warrant financing in
July 2006 that will require the bifurcation of derivative financial instruments.
We have not calculated the amounts of these
F-46
derivatives, but their effects on our earnings, arising from fair value changes,
will be consistent with the derivatives that we carry as of March 31, 2006.
Consolidated Interest Expense
We incurred interest expense for the period ended March 31, 2006 of
$34,007. Our interest expense decreased by $860,154 compared to $894,161 for the
same period in 2005. The decrease was due to conversions of several of our debt
instruments to equity, and to our payment of debt instruments incurred in 2005
to finance our operations.
Consolidated Liquidating Damages Expense
During the three months ended March 31, 2006, we recorded liquidated damages
expense of $685,887 (none in the comparable period of 2005). However, we
recorded $303,750 in liquidated damages during the fourth fiscal quarter of our
year ended December 31, 2005. 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 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.
Consolidated Net Loss
We have net loss for the three months ended March 31, 2006 of $276,667,
compared with a net loss of $653,070 for the same period in 2005. Net income for
the quarter of March 2006 is largely the result of our recording changes in the
fair value in our derivatives.
Consolidated Loss Applicable to Common Shareholders
Loss applicable to common shareholders represents net income less
preferred stock dividends and accretion of our redeemable preferred stock to
redemption value using the effective method. Diluted income per common share
reflects the assumed conversion of all dilutive securities, such as convertible
preferred stock, convertible debt, warrants, and employee stock options.
Consolidated Loss per Common Share
The Company's basic loss per common share for the three months ended March
31, 2006 was $0.00 compared with a basic per common share for the same period in
2005 of $(0.02).
The weighted average common shares outstanding increased from 59,618,018
for the three months ended March 31, 2005 to 184,253,753 for the same period in
2006. 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 loss applicable to common
shareholders per share because they would be antidilutive amounted to 81,913,744
and 129,857,869 for the three months ended March 31, 2006 and 2005,
respectively.
Comprehensive Loss
Comprehensive loss differs from net income (loss) for the three months ended
March 31, 2006 and 2005 by $(690) and ($8,023), 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
Management's Plans:
As reflected in the accompanying consolidated financial statements, we
have incurred operating losses and negative cash flow from operations and have
negative working capital of $37,818,789 as of
F-47
March 31, 2006. This negative figure is largely the effect of our recording for
derivative liabilities. In addition, we are delinquent on certain of our debt
agreements at March 31, 2006, and, we have experienced delays in filing our
financial statements and registration statements due to errors in our historical
accounting that currently are being corrected. Our inability to make these
filings is resulting in our recognition of penalties payable to the investors.
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 on our
business model and plans. While our liquid reserves have been substantially
depleted as of March 31, 2006, we completed a $30.0 million convertible note
financing in July 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, and we are in default on this instrument due to the delay in filing our
quarterly financial report for the quarterly period ended June 30, 2006. 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.
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
We reported that net cash used in operating activities was $4,210,671, net
cash provided by financing activities was $286,606 and net cash used in
investing activities was $413,446 during the three months ended March 31, 2006.
We had a negative working capital of $37,818,789 as of March 31, 2006. This
negative figure is largely the effect of our recording for derivative
liabilities at their fair value.
Compared to $728,304 of net cash used in operating activities in the three
months ended March 31, 2005, our current period net cash used in operating
activities increased by $3,482,367 to $4,210,671. This increase was primarily
the result of our inventory build up.
Changes in accounts receivable in this current period in 2006 resulted in
a cash increase of $1,596,042, compared to a cash increase in receivables of
$16,844 for the same period in 2005, having a net result of an increase of
$1,579,198. Cash used for inventory in the current period was $2,652,769,
compared to cash generated of $6,982 for the same period in 2005. This increase
was the result of our building inventory in connection with the continued
implementation of our Master Distribution Agreement with Coca-Cola Enterprises.
The changes in accounts payable and accrued liabilities in the current period
ending March 31, 2006 contributed to a cash increase of $1,668,557, whereas the
changes in accounts payable and accrued liabilities for the three months ended
March 31, 2005 contributed to such an increase of $397,710. Cash flow generated
through our operating activities were inadequate to cover all of our operating
cash needs in the period ended March 31, 2006, and we had to rely on prior
equity and debt financing to cover those expenses.
F-48
Cash used in the period ended March 31, 2006 by our investing activities
was $413,446 compared to $383,274 for the same period in 2005. During 2006, we
incurred $163,536 for license, trademark and finance costs and $249,910 in the
purchase of new equipment, which included eight vans that are being used for
sales and promotional purposes.
Net cash provided by our financing activities for the three months ended
March 31, 2006 was $286,606. Net cash provided by financing activities for the
same period in 2005 was $1,123,272.
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;
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 during the remainder of 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 being 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.
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 expect 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. 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 satisfy our cash needs. In addition, we are actively seeking
additional financing to support our operating 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.
F-49
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 proceeds are being held in
escrow. The release of these 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 converting the common stock underlying
the Notes, Additional Notes and associated warrants. We will utilize this
financing for, among other things, our 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 timely file our Form 10QSB for the six
months ended June 30, 2006, 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 the above
mentioned Form 10-QSB. See Item 3 of Part II of this report, entitled "Default
on Senior Securities", for a description of the terms of the Amendment
Agreement.
EFFECTS OF INFLATION
We believe that inflation has not had any material effect on our net sales
and results of operations.
ITEM 3. 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") 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 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 decisions regarding
required disclosure.
We have carried out an evaluation, under the supervision and with the
participation of our audit committee and 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, 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
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derivatives, which has caused the Company to restate its consolidated financial
statements for each of the two years ended December 31, 2004 and 2005, and for
the quarterly periods contained within those years (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 as of March 31, 2006 has not
been fully remedied, our Chief Executive Officer and our Chief Accounting
Officer concluded our disclosure controls and procedures were not effective as
of March 31, 2006. To address these control weaknesses, the Company engaged
advisory accountants, who performed additional analysis and performed other
procedures in order to prepare the unaudited quarterly condensed consolidated
financial statements appearing in this Form 10-QSB 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 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 current and new 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.
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
See Note 8 of Notes to Consolidated Financial Statements.
Item 3. Default on Senior Securities
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. Under the terms of the financing,
we sold $30 million notes, of which $15.0 million were issued upon closing (the
"Notes") with the balance of the notes (the "Additional Notes") held in escrow
until our satisfaction of certain conditions.. As a result of the Company's
non-timely filing of its Form 10-QSB for the six months ended June 30, 2006, an
event of default occurred under the terms of the $30 million Senior Convertible
Notes issued on July 27, 2006 and the annual interest rate on the Notes and
Additional Notes was increased from 9% to 14%. In the event, however, that such
event of default is subsequently cured, interest on the Notes shall revert to
the rate of 9% per annum. In addition, upon the occurrence of an event of
default, holders of the Notes and Additional Notes may, upon written notice to
the Company, require the Company to redeem all or any portion of their Notes.
On August 31, 2006, the Company entered into Amendment Agreements with the
holders of the Notes and Additional Notes, pursuant to the which holders each
agreed to release the Company from the events of default that occurred under the
terms of the Notes as a result the Company's non-filing of its Form 10-QSB for
the six months ended June 30, 2006. The Company agreed, in consideration for
such releases, to
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exchange the $15 million Additional Notes for amended and restated notes (the
Amended and Restated Notes). The Amendment Agreement provides for termination by
the non-breaching party if closing of the transactions contemplated by the
Amendment Agreement does not occur by September 1, 2006 due to one party's
failure to satisfy its conditions to closing. The Amendment Agreement also
provides for the extension of certain time limits with regard to dates set forth
in the financing documentation in connection with the Securities Purchase
Agreement, dated as of July 26, 2006.
The Amended and Restated Notes will be issued upon closing of the transactions
contemplated by the Amendment Agreement. The terms of the Amended and Restated
Notes differ from the terms of the Additional Notes in certain regards. The
conversion price applicable to the conversion of any portion of the principal of
the Amended and Restated Notes is $0.51, which price is reduced from $0.70 for
the Additional Notes. The Amended and Restated Notes also provide that, from and
after the earlier of (i) October 10, 2006 and (ii) the date the Stockholder
Approval is obtained, the holder may require the Company to redeem at such
holder's option any portion of the holder's Amended and Restated Note in cash at
a price equal to 125% of the amount redeemed. Notwithstanding the foregoing,
between November 15, 2006 and December 15, 2006, provided the Company meets
certain conditions, the Company may request the holder to require that the
Company redeem any portion of such holder's notes. In the event that such holder
does not so request, the holder's right to any such optional redemptions shall
terminate; provided, however, that once a holder delivers such a request, its
right to deliver a subsequent request shall terminate. The holders, pursuant to
the Amended and Restated Notes, each will also agree, upon such holder's
delivery of an optional redemption request, to waive certain debt and equity
restrictions applicable to the Company pursuant to the financing documentation
in connection with the Securities Purchase Agreement, dated as of July 26, 2006.
Subsequent Events
See Note 11 of Notes to Consolidated Financial Statements.
Item 6. Exhibits
Exhibits - Required by Item 601 of Regulation S-B:
No. 20.1: Form 8-K filed August 2, 2006 Item 8.01 Transaction
Documents for $30 million financing (incorporated by
reference)
No. 20.2: Form 8-K Filed August 14, 2006 Item 7.01 Triggering
Events of Default (incorporated by reference)
No. 20.3: Form 8-K Filed August 22, 2006 Item 4.02 Non-Reliance
on Previously Issued Financial Statements (incorporated by
reference)
No. 20.4: Form 8-K Filed September 5, 2006 Item 1.01 Amendment
Agreement -Release of Default (incorporated by reference)
No. 31: Rule 13a-14(a) / 15d-14(a) Certifications
No. 32: Section 1350 Certifications
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SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the registrant
caused this report to be signed on its behalf of the undersigned, duly
authorized.
BRAVO! FOODS INTERNATIONAL CORP.
(Registrant)
Date: October 2, 2006
/s/Roy G. Warren
Roy G. Warren, Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, Bravo! Foods
International Corp. 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 October 2, 2006
and Director
/S/ Tommy E. Kee Chief Accounting Officer October 2, 2006
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