The accompanying unaudited consolidated financial statements of DaviSkin, Inc. ("Company") have been prepared in accordance with Securities and Exchange Commission requirements for interim financial statements. Therefore, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The financial statements should be read in conjunction with the Form 10-KSB of the Company for the year ended December 31, 2005.
The interim financial statements present the balance sheet, statements of operations, stockholders' equity and cash flows of the Company. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States.
The interim financial information is unaudited. In the opinion of management, all normally recurring adjustments necessary to present fairly the financial position as of March 31, 2006 and the results of operations, stockholders' equity and cash flows presented herein have been included in the financial statements. Interim results are not necessarily indicative of results of operations for the full year.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
accounting history of the acquirer would be carried forward as the history for the Company and no goodwill would be recorded. Accordingly, the accompanying financial statements reflect the history of Davi from its date incorporation of March 21, 2004 (incorporated in the State of Nevada). Prior to the merger transaction, the Company had 645,033 shares of its common stock outstanding, $1,922 in accounts payable, $200,000 in a note payable to a related party and no assets.
The Company periodically evaluates whether events and circumstances have occurred that may warrant revision of the estimated useful life of fixed assets or whether the remaining balance of fixed assets should be evaluated for possible impairment. The Company uses an estimate of the related un-discounted cash flows over the remaining life of the fixed assets in measuring their recoverability.
As of March 31, 2006, the Company has available net operating loss carryovers of approximately $ 7,320,151 that will expire in various periods through 2024. Such losses may not be fully deductible due to the significant amounts of non-cash service costs. The
Company has established a valuation allowance for the full tax benefit of the operating loss carryovers due to the uncertainty regarding realization.
The Board of Directors administers the Company’s stock option plan which provides for the granting of rights to purchase shares to the Company’s directors (including non-employee directors), executive officers, key employees, and outside consultants. As of December 31, 2005, all options issued under this plan were issued to non-employee outside consultants. No options have been issued to employees. The Board of Directors sets the vesting period and exercise price per issuance basis as determined by the purpose of the individual issuance.
On November 1, 2005, the Company entered into an employment agreement (“Agreement”) with its President. The term of the Agreement is for two years with an annual salary of $120,000. The Agreement provides for bonuses to its President based upon financial performance of the Company to be determined at the sole discretion of the Company’s Board of Directors after consultation with its President. The Agreement also provides for equity based compensation to purchase up to 1,250,000 shares of the Company’s common stock (“Stock Options”) at a purchase price of $0.25 per share. The Stock Options will vest as follows: 250,000 shares upon execution of the Agreement; 500,000 shares on March 1, 2006; and 250,000 shares on each March 1, and June 1, 2006. The estimated fair value of the Stock Options have been determined using Black-Scholes option pricing model using the following assumptions:
The estimated fair value of the Stock Options totaled $4,102,537, which will be expensed over the vesting period. Through the period ended March 31, 2006, the Company recorded an expense related to the Stock Options totaling $3,868,107.
In order to determine compensation on options issued to consultants, as well as fair value disclosures for employees options, the fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The Company estimates the requisite service period used in the Black-Scholes calculation based on an analysis of vesting and exercisability conditions, explicit, implicit, and/or derived service periods, and the probability of the satisfaction of any performance or service conditions. The Company also considers whether the requisite service has been rendered when recognizing compensation costs. The Company does not consider market conditions to be vesting conditions and an award is not deemed to be forfeited solely because a market condition is not satisfied.
In December 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure". SFAS No. 148 amends the transition and disclosure provisions of SFAS No. 123. The Company is currently evaluating SFAS No. 148 to determine if it will adopt SFAS No.123 to account for employee stock options using the fair value method and, if so, when to begin transition to that method.
3. RELATED PARTY TRANSACTIONS
The Company owes $200,000 to the former President of MW Medical. The note was originally due December 31, 2004 and carries an interest rate of 10% per annum. Accordingly, interest of $35,000 has been recorded. The creditor had agreed to extend the due date of the note until December 31, 2005. The note is currently in default and the Company is in discussions to extend that date.
4. STOCK ACTIVITY
On March 27, 2006, The Company closed a Stock Purchase Agreement with Artist House Holdings, Inc. Under the Stock Purchase Agreement, Artist House has agreed to purchase 283,333 of our “Securities Units,” consisting of 566,667 shares of common stock and a warrant to purchase an additional 283,333 shares of common stock at $4.50 per share exercisable in 24 months, in exchange for $1,700,000 less $204,000 in fees for a net of $1,496,000 in cash; an effective price of $3.00 per share. Under the terms of the agreement, The Company must file a registration statement for the 566,667 shares of common stock within 45 days. Any failure to file this registration statement within the time frame described will cause The Company to incur a late fee of 1,000 shares per day to be issued to Artist House.
The warrants issued in the above mentioned investment were valued at $275,737 using the Black-Scholes option pricing model and is described as ”Additional paid in capital - warrants” in the stockholders’ equity section of the balance sheet. The following table summarizes the assumptions used in arriving at the valuation:
5. EQUITY SECURITIES OFFERINGS
There are currently no active equity offerings from The Company.
Forward-Looking Statements
Historical results and trends should not be taken as indicative of future operations. Management’s statements contained in this report that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934 (the “Exchange Act”), as amended. Actual results may differ materially from those included in the forward-looking statements. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “prospects,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on the operations and our future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, are included in this discussion and in our other filings with the Securities and Exchange Commission.
Plan of Operation
We were incorporated on December 4, 1997, as MW Medical, originally a wholly owned subsidiary of Dynamic Associates, Inc. On June 21, 2004, we completed and closed a Plan of Merger and Reorganization Agreement (“Merger”) with Davi Skin, Inc., an unrelated, privately-held Nevada corporation. That business was founded by the chairman of our board of directors, Mr. Carlo Mondavi, in March of 2003 with his vision of creating an all-natural grape-based luxury skin care line.
As a result of the merger, our primary business has been the establishment and development of a natural grape-based skin care line. Our plan has been to develop, manufacture and market a line of skin care products in the luxury segment of the skin care product market. Unfortunately, the development of our planned skin care line has taken longer and been more costly than originally anticipated by management. As a result, with addition of our new President, Mr. Joseph Spellman, in October 2005, we have formulated an expanded business plan that integrates our original goals with related business opportunities management believes will assist us in generating income more quickly and efficiently. Specifically, our management and board of directors has recently initiated a line of business around licensing the Mondavi name in a luxury branding approach. It is our intent to leverage our Board Chairman’s highly visible and well-respected Mondavi name into other market categories as well as to acquire new brands and intellectual properties to own, develop and license in the luxury category, while continuing to develop our original luxury skin care products. For clarity we have divided our description of these broader business opportunities into a separate section below under the heading of Licensing Agent.
To date, we have not completed the development of any products for our skin care product business. We do not have any agreements to manufacture, market or distribute our planned skin care products. We have entered into one licensing agreement for the development of a Robert Mondavi branded line of stemware for Waterford Wedgewood USA, Inc., which agreement resulted in revenue of $25,000 in
the period ending March 31, 2006. This represents our first revenues received from any line of business.
Skin Care Line
Planting techniques at select vineyards that we plan to utilize exclusively, produce deeper vines with a lower yield of grapes per vine. After processing, these grapes yield higher concentrations of minerals, vitamins, and nutrients than grapes from other vineyards. Many of the minerals, vitamins and nutrients are found in a by-product of the wine making process called the pomace. Additionally, the uniquely long maceration process to which these grapes are subjected yield polyphenols in relatively high quantity. Polyphenols are the free radical scavengers that, among other things, help to protect collagen and elastin fibers and prevent the destruction of hyaluronic acid in the skin. Management believes that the use of this pomace among other unique ingredients will allow for the creation of a skincare line that can help fight the visible signs of premature aging.
a. The Skin Care Market
The skin care market can be divided into four distinct segments: (a) Luxury; (b) Prestige; (c) Masstige; and (d) Mass. The following is a brief discussion of each of these segments.
Luxury
The luxury segment of the skin care market involves high-end products, sold in department stores such as Neiman Marcus, Barneys and Saks Fifth Avenue. Skin crème products in this market segment will generally be priced over $70. Examples of product lines sold in these markets, include La Prairie, Sisley, Crème de la Mer and Aqua di parma. We are planning to position our products in this market.
Prestige
The prestige segment of the skin care market involves quality products, sold in wide distribution through department stores, brand stores and specialty stores such as Sephora and Ultra. Examples of product lines sold in these markets include Lancôme, Estee Lauder, L’Occitane and Caudalie.
Masstige
The masstige segment of the skin care market involves discounted products sold primarily in drug stores, high-end discount stores such as Target and Kohl’s and select department stores. Direct sales distributions are also often considered to involve masstige product sales. Skin crème products in this market segment are generally priced below the prestige segment, but higher than the mass segment. This market segment is identified by a higher perceived brand image based on quality, effectiveness and style, and includes product lines such as Neutrogena, L’Oreal and Olay.
Mass
The mass segment of the skin care market involves products sold in grocery and drug stores. These products are generally priced at the lower end of market and this segment of the market includes product lines such as Dove, Herbal Essence, and Aveeno.
b. Development of Skin Care Products
We are still in the development process, which we see as involving two basic phases: (1) creating the
products with a formulator; and (2) testing the formulations as they are developed.
Formulation
We have a contract with a formulator to create a series of skin crème products, including the following:
| iv. | Revitalizing Moisturizer; |
| v. | Daily Moisturizer with an SPF rating for sun protection; |
| vi. | Intensive treatment serum; |
| vii. | Purifying Clay Mask; |
We have developed formulations for our products using a proprietary bio complex blend of 10 different raw materials, which are consistent across all of the products we are developing. The key items are the materials containing the anti-oxidant properties that are believed to help fight free radical damage caused by sunlight, stress and other environmental factors. Other key ingredients used in these formulas have been selected for their efficacy in helping to correct existing damage and thereby also supporting our anti-aging goals.
We are currently in the process of testing our new products with our formulator and making adjustments to the formulations where necessary. Our goal is to create an end product that provides consumers with a pleasurable sensory experience, most particularly smell and touch, along with the anti-aging cosmetic results we plan to promote.
We consider these formulations as they are being developed and tested to be proprietary, and thus have been and will remain vigilant in protecting the details of our developing product mix.
As the products are expected to be sold over the counter, we do not anticipate needing or obtaining any Federal Food and Drug Administration approvals and we do not plan on doing any clinical testing of any kind. The products containing SPF or any other over the counter ingredients, however, will need to meet FDA testing regulations and the global standards for sales in countries other than the United States.
Manufacture
Once the formula is fixed for each product, the manufacturer will create a commercial batch of each product, bottle and package the products for us. We are also in the process of choosing all the peripheral items involved in the manufacturing and marketing process, including:
| i. | the shape and size of the product containers; |
| iv. | the logo and label designs; and |
c. Marketing and Distribution
Currently, we have no distribution agreements; however, we have contacted a number of distributors and retailers and are exploring several different methods of marketing the products once manufactured. In general, we are hoping to start manufacturing and marketing our products to consumers through high-end retailers and distributors. We now anticipate that we will not be able to introduce these products to market until at least the third quarter of 2006. We originally had expected to launch our skin care line of products during 2005; however, we are now in negotiations with major international cosmetic companies with the idea of creating a strategic alliance exclusively with one of them for licensing and/or distribution. This alliance would immediately relieve our small company of the very large financial burdens associated with financing and marketing. The proposed alliance would enable us to capitalize on already established distribution and marketing contracts. The alliance would run parallel to our going directly to retailers as previously indicated. Management believes this will help establish us in the marketplace as a quality provider of skin crème products.
d. Competition
Among all the brands found in this industry, we consider our closest competitor to be Caudalie. Caudalie is a French spa and skincare line that reflects our product concept and closely resembles our proposed product line. The creators behind Caudalie are wine makers with a family vineyard located in the wine region of France. The concept of the Caudalie product line, like ours, is an extrapolation on the benefits of the antioxidants and polyphenols found mainly in grape seeds. The advantage of Caudalie over our proposed product in the marketplace at this time is two fold: (a) they have been on the market for over a decade and have grown to be a global brand with distribution outlets all over the world; and (b) they serve a larger target audience with a lower price point than we anticipate.
The prime difference between Caudalie and our proposed product line is expected to be based on the market segment and quality of ingredients that will be included in our products. Unlike Caudalie, who is segmented in the prestige market, we expect our product line to be sold in the luxury market. We further expect our brand will use only the highest quality ingredients available, including wine extract, a highly concentrated preparation of antioxidant polyphenols. We have also created our own proprietary bio-delivery complex that encapsulates a variety of selected antioxidant ingredients to be effectively delivered directly to the skin without compromising their integrity. We are also creating and using our own uniquely innovative raw materials derived from the wine making process as opposed to only using commercially available raw materials. Our product line will also be packaged in high quality containers with inviting labels, versus the lesser quality plastic tubes and bottles used by Caudalie.
Other brands with similar lifestyle stories include SKII, Creme de la Mer and L’Occitane. These brands share the theme of being derived from nature and generally having a named or unnamed individual who was inspired by the benefits of certain raw materials. For example, the secret formula behind SKII is their “Pitera”, a yeast extract discovered by a monk who noticed the wonderfully youthful hands of workers who make Sake. These brands have revealed their stories and their inspirations by creating product lines where customers are invited to share in their innovations.
Licensing Agent
In view of the difficulties we have incurred in developing and bringing our planned skin care line to market, our management team has been searching for other business opportunities that would allow us to diversify and generate quicker sources of revenue.
In order to accomplish this result, our management and board of directors has decided to operate a line of business around licensing the Mondavi name in a luxury branding approach. It is our intent to leverage our Board Chairman’s highly visible and well-respected Mondavi name into other market
categories as well as to acquire new brands and intellectual properties to own, develop and license in the luxury category, while continuing to develop our original luxury skin care products.
In doing so, we expect to house a number of distinct intellectual properties, trademarks, copyrights and licenses of the various operating businesses we are either able to acquire or with whom we can partner. Each arrangement is likely to be unique and result in our owning anywhere from 0% to 100% of the business. Depending on the circumstances surrounding each agreement, we could opt to fund these operational companies or enter into a joint venture with them. We, as the holding company will receive monies from all licenses which use the Mondavi, Davi and Carlo Mondavi names, among other intellectual property we may develop.
As our first step to further our new objective, we entered into an agreement with Constellation Brands Group (“CBG”), the parent entity of The Robert Mondavi Corporation (“RMC”). RMC has retained us to act as their licensing agent in agreements with Waterford Wedgewood USA, Inc. (“Waterford”) on the development of a Robert Mondavi stemware line. CBG owns certain intellectual property rights held in RMC, including the valued Robert-Mondavi licensed marks (the “Intellectual Property”), and we have been engaged to: (1) negotiate opportunities with Waterford to license the Intellectual Property with Waterford’s stemware products, (2) develop and implement strategic plans for branding Waterford’s products, and (3) facilitate the terms and conditions of any agreements with Waterford. In exchange, CBG has agreed to compensate us with a revenue share of one-third (33 -1/3%) of the gross revenues collected in any agreement we establish with Waterford. Gross revenues means the gross receipts actually received from any agreement with Waterford, including without limitation advance payments, minimum guarantees, royalty payments and other license fees.
We received a one-time $25,000 signing bonus for the successful negotation and execution of the Constellation licensing arrangement. Per the terms of the agreement we do not expect significant revenues from this agreement to begin until the first quarter of 2007.
Under the terms of the investment from Artist House, Artist House became a licensee of Davi to help market and distribute our products in Japan. Under the terms of the agreement, Artist House will facilitate the terms and conditions of any agreements with Davi. In exchange, Davi has agreed to compensate Artist House with a revenue share of one-third (33 -1/3%) of the gross revenues collected in any agreement we establish with Artist House.
Management has learned that certain parties have applied for our trademark in Japan, and believes those parties are obligated to transfer that trademark to us. We have begun that process. Failure to recapture that trademark could have a material impact on our financial performance.
a. Business Development
As part of our effort to generate revenue from licensing intellectual property, we are seeking opportunities to acquire small companies in related businesses. Any acquisition we enter into at this point is expected to bring new capital and new opportunities with it; thereby offsetting our current corporate overhead and maximizing our ability to pursue future opportunities.
b. Sub-Agencies
We recently entered into a Stock Purchase Agreement with Artist House Holdings, Inc. in which Artist House invested an additional $1,700,000 into our stock and we received $1,496,000 after payment of a finder's fee. As part of this agreement, we have agreed that Artist House Holdings, Inc. will be made our licensing agent in Japan. In this way we expect to create a more global presence and thereby generate additional revenues.
c. Competition
Competition for our proposed new venture of housing various luxury brands under one parent company
are Louis Vuitton, Moet Hennesey and Gucci Group. These competitors focus mainly on brands that tend to complement their already existing line of business, while we are intending to focus on luxury brands in all areas of daily living. We feel that there are numerous companies that are available for acquisition or partnering who would ultimately be considered too small for our competition to acquire. We anticipate that such acquisitions will complement our licensing efforts related to the Mondavi and Davi names.
Planned Purchases of Equipment
We do not anticipate purchasing any real property or significant equipment during the next twelve (12) months.
Employees
On April 18, 2006, Ms. Margaret Robley resigned as our Chief Financial Officer. There was no known disagreement with Ms. Robley on any matter relating to our operations, policies or practices. Effective as of May 11, 2006, one of our directors, Mr. Josh LeVine, agreed to serve as our interim CFO until a permanent replacement may be found.
On June 1, 2006, we expect to appoint Theodore Lanes as our Chief Financial Officer. Mr. Lanes has been acting in a consulting capacity to the Company for the past 2 months. The final compensation package for Mr. Lanes has not yet been approved by the board.
We currently have only one full-time administrative employee and three officers of the company on our payroll. The majority of our administrative requirements are handled by outside sources. Our employees are not represented by labor unions or collective bargaining agreements and our only key employee is Mr. Carlo Mondavi, our founder and chairman of our board of directors.
Executive Advisory Board
Our board of directors has created a blue ribbon Executive Advisory Board, assembled to assist our officers in making certain high level planning decisions. While the members of the Executive Advisory Board have no authority over our business operations, the board anticipates that their input will provide great value to our executives in their decision making process. This advisory board includes the following persons along with a brief description of their business background:
Robert G. Mondavi is the Founder and Chairman Emeritus of Robert Mondavi Winery. At the age of 90, Mr. Mondavi is a global emissary of American food and wine. He is also currently active as a major benefactor of cultural and educational institutions, including Copia, an American center for Wine Food and the Arts; and the University of California at Davis, establishing the Robert Mondavi Institute for Wine and Food Science.
Timothy J. Mondavi is the Vice Chairman and Winegrower for Robert Mondavi Winery. In this role, Mr. Mondavi leads the winegrowing team at the winery in setting the style and vision for every wine made. Mr. Mondavi graduated from the University of California at Davis in 1974.
R. Michael Mondavi is the former President and CEO of Robert Mondavi Winery. Mr. Mondavi has been active since 1966 as a winemaker and spokesperson for the winery and the wine making industry, traveling extensively on behalf of the business and industry.
Jean-Marc Benet grew up in the beauty industry. His father, Andre Benet, was the founder of Decleor, a Paris-based botanical professional skincare company. The Benet Family acquired Darphin, which at the time has a small skincare line based on aromatherapy and natural plant extracts. Over the last decade, the Bene family has grown Darphin to a full professional and retail skincare line with over 90 products. Today the company is dedicated to the development, manufacturing and marketing of prestige
skin care and makeup products. Under the guidance of Jean-Marc Benet and his family, Darphin has grown from $500,000 in annual sales to in excess of $50,000,000 in annual sales and is currently sold in over 60 countries around the world. Estee Lauder acquired Darphin in 2003. Jean-Marc has remained on as General Manager for Darphin USA.
Jerry LeVine is a partner with Grobstein, Horwath & Company LLP. He is a Certified Public Accountant with more than 30 years experience. Mr. LeVine specializes in providing accounting and auditing services to both private and publicly held companies. Mr. LeVine is a graduate from California State University, Northridge and is a member of the AICPA and the California Society of Certified Public Accountants.
Assets
Our total assets as of March 31, 2006 were $2,897,554. Our assets largely consist of cash in the amount of $102,576 and a certificate of deposit in the amount of $2,705,352. Our total assets as of March 31, 2005, were $2,112,360, including cash and certificates of deposit in the combined amount of $2,075,612. The increase in our assets for the period ending March 31, 2006, is a result of our sales of additional common stock through the private placements.
Liabilities and Stockholders Deficit
Our total liabilities as of March 31, 2006 were $281,343. Our liabilities consisted of (i) accounts payable in the amount of $46,343, and (ii) $200,000 in convertible notes payable to a related party, namely our former President. The accrued interest on the note payable is $35,000, including $5,000 accrued in this reporting period. The note was originally issued in March of 2003. It came due, after extensions, on December 31, 2005 and remains unpaid.
Liquidity and Capital Resources
As of March 31, 2006, we had total current assets consisting of cash and certificates of deposit in the combined amount of $2,809,953. As of March 31, 2005, we had current assets consisting of cash and certificates of deposit in the combined amount of $2,075,612. The increase in our cash position from the period ending March 31, 2005, is primarily attributable to the sales of common stock in our private equity offering.
We expect that our current cash on hand will be sufficient to fund our operations for approximately the next twelve (12) months and meet our requirements for completing our product, packaging, and marketing.
Off Balance Sheet Arrangements
As of March 31, 2006, there were no off balance sheet arrangements.
Going Concern
We may require additional capital for our operational activities and our ability to raise capital through future issuances of common stock is unknown. Obtaining additional financing and attaining profitable operations are necessary for us to continue operations. These factors, among others, raise substantial doubt about our ability to continue as a going concern. The unaudited consolidated financial statements do not include any adjustments that may result from the outcome of these aforementioned uncertainties.
Critical Accounting Policies
In December 2001, the SEC requested that all registrants list their three to five most “critical accounting polices” in the Management Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the following accounting policies fit this definition:
Revenue recognition. Revenues are recognized when services are rendered and/or delivered. Costs and expenses are recognized during the period in which they are incurred.
Stock-based compensation - We apply Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees, and Related Interpretations,” in accounting for stock options issued to employees. Under APB No. 25, employee compensation cost is recognized when estimated fair value of the underlying stock on date of the grant exceeds the exercise price of the stock option. For stock options and warrants issued to non-employees, we apply SFAS No. 123,”Accounting for Stock-Based Compensation,” which requires the recognition of compensation cost based upon the fair value of stock options at the grant date using the Black-Scholes option pricing model.
Our Board of Directors administers our stock option plan which provides for the granting of rights to purchase shares to our directors (including non-employee directors), executive officers, key employees, and outside consultants. As of December 31, 2005, all options issued under this plan were issued to non-employee outside consultants. No options have been issued to employees. Our Board of Directors sets the vesting period and exercise price per issuance basis as determined by the purpose of the individual issuance.
On November 1, 2005, we entered into an employment agreement (“Agreement”) with our President. The term of the Agreement is for two years with an annual salary of $120,000. The Agreement provides for bonuses to our President based upon our financial performance to be determined at the sole discretion of our Board of Directors after consultation with our President. The Agreement also provides for equity based compensation to purchase up to 1,250,000 shares of our common stock (“Stock Options”) at a purchase price of $0.25 per share. The Stock Options will vest as follows: 250,000 shares upon execution of the Agreement; 500,000 shares on March 1, 2006; and 250,000 shares on each March 1, and June 1, 2006. The estimated fair value of the Stock Options have been determined using Black-Scholes option pricing model using the following assumptions:
| exercise price of | $0.25 |
| closing stock price on date of the Agreement of | $3.50 |
| historical stock price volatility of | 77% |
| risk free interest rate of | 3.50% |
| dividend yield of | 0% and 3 year term. |
The estimated fair value of the Stock Options totaled $4,102,537, which will be expensed over the vesting period. Through the period ended March 31, 2006, we recorded an expense related to the Stock Options totalling $3,868,107.
In order to determine compensation on options issued to consultants, as well as fair value disclosures for employees options, the fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. We estimate the requisite service period used in the Black-Scholes calculation based on an analysis of vesting and exercisability conditions, explicit, implicit, and/or derived service periods, and the probability of the satisfaction of any performance or service
conditions. We also consider whether the requisite service has been rendered when recognizing compensation costs. We do not consider market conditions to be vesting conditions and an award is not deemed to be forfeited solely because a market condition is not satisfied.
In December 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure". SFAS No. 148 amends the transition and disclosure provisions of SFAS No. 123. We are currently evaluating SFAS No. 148 to determine if it will adopt SFAS No.123 to account for employee stock options using the fair value method and, if so, when to begin transition to that method.
Use of estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Fixed assets. Fixed assets are stated at cost less accumulated depreciation. Depreciation is provided principally on the straight-line method over the estimated useful lives of the assets, which are generally 3 to 10 years. The cost of repairs and maintenance is charged to expense as incurred. Expenditures for property betterments and renewals are capitalized. Upon sale or other disposition of a depreciable asset, cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in other income (expense). We periodically evaluatewhether events and circumstances have occurred that may warrant revision of the estimated useful life of fixed assets or whether the remaining balance of fixed assets should be evaluated for possible impairment. We use an estimate of the related un-discounted cash flows over the remaining life of the fixed assets in measuring their recoverability.
Fair value of financial instruments .Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosure About Fair Value of Financial Instruments”, requires us to disclose, when reasonably attainable, the fair market values of its assets and liabilities which are deemed to be financial instruments. The carrying amounts and estimated fair values of our financial instruments approximate their fair value due to their short-term nature.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123-R, "Share-Based Payment," which requires that the compensation cost relating to share-based payment transactions (including the cost of all employee stock options) be recognized in the financial statements. That cost will be measured based on the estimated fair value of the equity or liability instruments issued. SFAS No. 123-R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No.123-R replaces SFAS No. 123, and supersedes APB Opinion No. 25. Small Business Issuers are required to apply SFAS No. 123-R in the first reporting period or fiscal years that begin after December 15, 2005. Thus, our consolidated financial statements will reflect an expense for (a) all share-based compensation arrangements granted after December 31, 2005 and for any such arrangements that are modified, cancelled, or repurchased after that date, and (b) the portion of previous share-based awards for which the requisite service has not been rendered as of that date, based on the grant-date estimated fair value.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections," which replaces APB Opinion No. 20 and FASB Statement No. 3. This pronouncement applies to all voluntary
changes in accounting principle, and revises the requirements for accounting for and reporting a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle, unless it is impracticable to do so. This pronouncement also requires that a change in the method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 retains many provisions of APB Opinion 20 without change, including those related to reporting a change in accounting estimate, a change in the reporting entity, and correction of an error. The pronouncement also carries forward the provisions of SFAS No. 3 which govern reporting accounting changes in interim financial statements. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of SFAS No. 154.
In February 2006, the FASB issued SFAS No. 155 entitled “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS No. 133 (“Accounting for Derivative Instruments and Hedging Activities”) and SFAS No. 140 (“Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”). In this context, a hybrid financial instrument refers to certain derivatives embedded in other financial instruments. SFAS No. 155 permits fair value re-measurement of any hybrid financial instrument which contains an embedded derivative that otherwise would require bifurcation under SFAS No. 133. SFAS No. 155 also establishes a requirement to evaluate interests in securitized financial assets in order to identify interests that are either freestanding derivatives or “hybrids” which contain an embedded derivative requiring bifurcation. In addition, SFAS No. 155 clarifies which interest/principal strips are subject to SFAS No. 133, and provides that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS No. 155 amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative. When SFAS No. 155 is adopted, any difference between the total carrying amount of the components of a bifurcated hybrid financial instrument and the fair value of the combined “hybrid” must be recognized as a cumulative-effect adjustment of beginning deficit/retained earnings.
SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted only as of the beginning of a fiscal year, provided that the entity has not yet issued any annual or interim financial statements for such year. Restatement of prior periods is prohibited.
Management does not believe that SFAS No. 154 and No. 155 will have an impact on our consolidated financial statements.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on our present or future consolidated financial statements included elsewhere herein.
We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2006. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer, Mr. Joseph Spellman, and our interim Chief Financial Officer, Mr. Josh LeVine. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2006, our disclosure controls and procedures are effective. There have been no significant changes
in our internal controls over financial reporting during the quarter ended March 31, 2006 that have materially affected or are reasonably likely to materially affect such controls.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Limitations on the Effectiveness of Internal Controls
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our operations have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
We are not a party to any pending legal proceeding. Other than as described below, we are not aware of any pending or threatened legal proceeding to which any of our officers, directors, or any beneficial holders of 5% or more of our voting securities are adverse to us or have a material interest adverse to us.
On May 4, 2006, we received a letter from legal counsel representing Artist House Holdings, Inc. ("Artist House") in which Artist House purportedly terminated that certain Stock Purchase Agreement, dated as of March 27, 2006, to which we and Artist House are parties (the "SPA") and demanded unconditional return of $1.7 million, representing Artist House's purchase price under the SPA for 566,667 shares of our common stock plus warrants exerciseable into 283,333 shares of our common stock. In its demand letter, Artist House alleges that we have failed to timely perform certain conditions and obligations under the SPA, including (a) appointing certain individuals affiliated with Artist House to our board of directors, (b) obtaining directors and officers liability insurance, (c) modifying rights related to stock options issued to our CEO, Joe Spellman, (d) appointing Artist House as our licensing agent in Japan, and (e) requiring board approval for any salary increases to our officers. We have, directly and through our legal counsel, responded to and refuted Artist House's claims. While we are willing to explore resolving this matter without the need for litigation, if this matter ultimately proceeds to a lawsuit, management intends to defend any such suit vigorously.
On January 6, 2006, we issued 16,535 shares of common stock to two individuals for payment due on consulting agreements dating back to 2004. Our responsibility to issue these shares under the agreement was not reported in any prior filings. The shares were issued as exempt from registration under Section 4(2) of the Securities Act of 1933.
On March 27, 2006, we closed a Stock Purchase Agreement with Artist House Holdings, Inc. Under the Stock Purchase Agreement, Artist House has agreed to purchase 283,333 of our “Securities Units,” consisting of 566,667 shares of common stock and a warrant to purchase an additional 283,333 shares of common stock at $4.50 per share exercisable in 24 months, in exchange for $1,700,000 in cash; an effective price of $3.00 per share. Under the terms of the agreement, we were required to file a registration statement for the 566,667 shares of common stock within 45 days. This registration statement was filed on May 11, 2006.
The warrants issued in the above mentioned investment were valued at $275,737 using the Black-Scholes option pricing model and is described as ”Additional paid in capital - warrants” in the stockholders’ equity section of the balance sheet. The following table summarizes the assumptions used in arriving at the valuation:
| Number of warrants issued | 283,333 |
| Stock price at grant date | $ 1.50 |
| Exercise price | $ 4.50 |
| Term | 24 months |
| Volatility | 283,333 warrants at 173% |
| Annual rate of quarterly dividends | 0.00% |
| Discount Rate-Bond Equivalent Yield | 3.50% |
We did not engage in a distribution of this offering in the United States. The purchaser represented its intention to acquire the securities for investment only and not with a view toward distribution. We
requested our stock transfer agent to affix appropriate legends to the stock certificate issued to the purchaser in accordance with Regulation S and the transfer agent affixed the appropriate legends. The purchaser was given adequate access to sufficient information about us to make an informed investment decision. None of the securities were sold through an underwriter and accordingly, there were no underwriting discounts or commissions involved. The purchaser was granted registration rights for the shares they purchased and a registration statement was filed on May 11, 2006 for these shares. The shares were issued as exempt from registration under Section 4(2) of the Securities Act of 1933.
None
No matters have been submitted to our security holders for a vote, through the solicitation of proxies or otherwise, during the quarterly period ended March 31, 2006.
During April, 2006, we received a letter from a third party requesting the exercise of a conversion right attached to a $200,000 note originally due to Ms. Jan Wallace, the former CEO of MW Medical. At this time, the Company does not believe that the note and its rights were assigned under proper conditions and until this matter is resolved, management does not believe it is obligated to grant the conversion. We have responded in the same manner to the third party, and as of yet, has not received a reply. The matter remains under investigation.
On April 18, 2006, Ms. Margaret Robley resigned as our Chief Financial Officer. There was no known disagreement with Ms. Robley on any matter relating to our operations, policies or practices. Effective as of May 11, 2006, one of our directors, Mr. Josh LeVine, agreed to serve as our interim CFO until a permanent replacement was found.
From March 2003 to September 2003, Mr. LeVine worked as an advertising designer with The Territory Ahead in Santa Barbara, California. From June 2002 to March 2003, Mr. LeVine was the president of Nuvo Design.
There are no family relationships between or among Mr. LeVine and any of our other officers or directors.
Mr. LeVine does not have any material interest, direct or indirect, in any transaction over the last two years or in any presently proposed transaction which, in either case, has or will materially affect us.
Exhibit Number | Description of Exhibit |
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SIGNATURES
In accordance with the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | Joseph Spellman |
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| Date: | May 16, 2006 |
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| | By: /s/ Joseph Spellman Joseph Spellman Title: Chief Executive Officer |
