NOTE 5- BORROWINGS
Short-Term Debt
On August 31, 2012, the Company’s former Chief Financial Officer made an interest free demand advance of $30,000 to provide working capital, which remains outstanding at August 31, 2014. The Note was recorded at its estimated fair value of $27,778 at the acquisition date, and imputed interest was being accreted to non-cash interest expense to the maturity date, using an 8% interest rate. No demand for payment has been made and the note remains unpaid.
On July 13, 2010, March 22, 2012 and October 25, 2012, the Company borrowed $60,000, $50,000 and $10,000, respectively, from a shareholder for use as operating capital. On September 12, 2012, the Company, the shareholder and an external party entered into an Assignment Agreement whereby the external party agreed to assume $30,000 of the $60,000 July 13, 2010 debt in exchange for a 8% convertible note maturing October 24, 2013 (see Short-term Convertible Debt with Ratchet Provisions noted below). The due date on the remaining balance of $30,000 of the $60,000 advance was extended to December 31, 2013 and bears interest at the rate of 15% per annum; the due date of the $50,000 advance was March 7, 2013 and it bears interest at the rates of 15% per annum through March 7, 2013 and 18% per annum interest thereafter if the repayment date is extended; and the $10,000 advance is payable on demand at an interest rate of 15% per annum.
During the nine months ended August 31, 2014, the Company incurred and accrued $10,294 in interest expense, respectively, related to this short-term debt. As of August 31, 2014, the Company has accrued a total of $50,191 of interest expense related to these notes.
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B) | Film Finance Agreement |
On August 11, 2012, the Company entered into an agreement with Coral Ridge Capital Partners, LLC (“CRCP”) under which CRCP agreed to provide $300,000 in equity financing towards the production of the motion picture currently entitled “End of the Gun” (the "Picture"). The initial $100,000 under this agreement was paid on June 12, 2012. While it was the Company’s intent to commence filming of the Picture by September 1, 2012, certain casting delays postponed the commencement date. On January 25, 2013 the Company received a written notice of termination of agreement from CRCP. The termination was detrimental to the funding process; regardless, the Company continued to work diligently over the next 18 months to put the film into production. Ultimately, the Company determined that the film was not able to be financed without the Coral Ridge equity contribution and abandoned the project. Accordingly, the Company has included the $100,000 advance within short-term debt and has accrued interest payable of $23,572 through August 31, 2014. The Company is engaged in settlement discussions regarding any amounts due and the arbitration proceeding originally scheduled for August 2014, has been postponed, with no new date set.
Through August 31, 2014, the Company has paid cumulative expenses totaling $14,688 in connection with the Picture, which have been recorded within operating expenses.
Short-term Convertible Debt with Ratchet Provisions
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(A) | Short-term Convertible Debt |
On March 1, 2012, May 9, 2012, July 9, 2012, September 14, 2012 and September 28, 2012 the Company borrowed $10,000, $32,500, $30,000, $22,500 and $10,000 (for a total of $105,000), from external parties for use as operating capital. See below for additional advances made by this party during the year ended November 30, 2013. The parties entered into convertible notes payable agreements, which make the Company liable for repayment of the principal and 8% annual interest by the various agreements’ expiration dates which range between October 6, 2012 and June 28, 2013. If a default is called by the lender (which occurred as noted below) after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default. A portion of the notes has been converted and, as of August 31, 2014, approximately $13,444 in principal and interest remain outstanding.
On March 18, 2013 the Company received a notice of default from one of the lenders holding a then total of $131,200 of short-term convertible debt. Based upon the foregoing, the Company is now in default under the Notes. Demand was made for the immediate payment of $196,050, representing 150% of the then remaining outstanding principal balance together with default interest of 22% as provided for in the notes as of August 31, 2014. All principal and interest on these notes have been converted as of August 31, 2014.
During December 2012, the Company issued an 8% convertible promissory note to raise $40,000 to pay legal services owed. The Note matured on September 21, 2013, and any unpaid principal or interest at that date accrues interest at the default rate of 22% annually. The note may be converted into common stock, at 41% discount off the average of the lowest three (3) trading prices for the Company’s common stock within the ten (10) days preceding the conversion, at any time after 180 days from the issuance date until the maturity date, or, if later, until paid. A portion of the notes has been converted and, as of August 31, 2014, approximately $41,000 in principal and interest remain outstanding.
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On January 14, 2013, the Company issued an 8% convertible promissory note to raise $55,000 in operating capital. The Note matured on October 17, 2013, and any unpaid principal or interest at that date accrued interest at the default rate of 22% annually. The note may be converted into common stock, at 50% of market price, at any time after 180 days from the issuance date until the maturity date, or, if later, until paid. If a default is called by the lender (which occurred as noted above) after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default. During the three months ended August 31, 2014, this note was fully converted through the issuance of common stock.
On June 12, 2013, the Company issued 8% convertible promissory notes to raise $21,500 in operating capital. This Note matured on March 14, 2014. The note may be converted into common stock, at 45% of the average of the three (3) lowest per share market values during the ten (10) trading days immediately preceding a conversion date at any time after 180 days from the issuance date until the maturity date, or, if later, until paid. . If a default is called by the lender (which occurred as noted above) after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default.
On October 14, 2013, the Company issued an 8% convertible promissory note in the aggregate principal amount of $20,500 to pay payables that were owed. The note has a maturity date of July 14, 2014. The note is convertible into shares of our common stock at a conversion price of forty-five percent (45%) of the average of the lowest trading price per share market values during the thirty (30) trading days immediately preceding a conversion date at any time after 180 days from the issuance date until the maturity date. If a default is called by the lender (which occurred as noted above) after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default.
On February 24, 2014, the Company issued a 10% convertible promissory note in the aggregate principal amount of $25,000. The note has a maturity date of February 24, 2015. The note is convertible into shares of our common stock at a conversion price of the lesser of $0.001 or fifty percent (50%) of the lowest trading day price during the twenty (20) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date. If a default is called by the lender (which occurred as noted above) after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 20% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default. During the three months ended August 31, 2014, the note was partially converted through the issuance of shares of common stock leaving a remaining principal balance of $17,748 as of August 31, 2014.
On March 1, 2014, the Company issued an 8% convertible promissory note in the aggregate principal amount of $30,000 to pay payables that were owed. The note has a maturity date of March 31, 2015. The note is convertible into shares of our common stock at a conversion price of sixty percent (60%) of the average of the lowest closing price per share during the ten (10) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date.
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On March 24, 2014, the Company issued a 10% convertible promissory note in the aggregate principal amount of $26,500. The note has a maturity date of March 24, 2015. The note is convertible into shares of our common stock at a conversion price of fifty percent (50%) of the average of the lowest closing bid during the fifteen (15) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date. If a default is called by the lender after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default.
On May 16, 2014, the Company issued a 10% convertible promissory note in the aggregate principal amount of $50,000. The note has a maturity date of August 16, 2015. The note is convertible into shares of our common stock at a conversion price of fifty percent (50%) of the average of the lowest closing bid during the ten (10) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date. If a default is called by the lender after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default.
On June 1, 2014, the Company issued an 8% convertible promissory note in the aggregate principal amount of $30,000 to pay payables that were owed. The note has a maturity date of June 30, 2015. The note is convertible into shares of our common stock at a conversion price of sixty percent (60%) of the average of the lowest closing price per share during the ten (10) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date.
On August 11, 2014, the Company issued an 8% convertible promissory note in the aggregate principal amount of $103,500. The note has a maturity date of August 13, 2015. The note is convertible into shares of our common stock at a conversion price of fifty percent (50%) of the average of the lowest three (3) trading prices during the thirty (30) trading days immediately preceding a conversion date at any time from the issuance date until the maturity date. If a default is called by the lender after failure to repay principal or interest when due, among other default provisions including untimely filings with the SEC, a default interest rate of 22% per annum is triggered and retrospectively applied from the notes’ inception date on the unpaid amount, as well the principal balance is increased by 50% of the face amount of the note deemed in default.
The Company discounts the notes by the fair market value of the derivative liability upon inception of each note. These discounts are accreted back to the face value of the notes over the note term using the effective interest method.
Former Related Party Debt
At February 28, 2014, the Company had convertible notes totaling $453,061 due to a former affiliate of the Company. The notes were convertible into common shares, based on $40 to $80 share price, most of which is at the higher price. The convertible notes bore interest at 6% per annum and were due August 31, 2015. The Company had accrued $120,921 of interest expense related to these notes. On May 19, 2014, the former related party sold the four notes to an unrelated third party in a private transaction, and the total outstanding principal and interest were restated in a new single note with the new third party for the principal amount of $573,982 due May 16, 2015, convertible at 50 percent of the lowest bid price for the stock during the 10 prior trading days.
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The extinguishment of the original notes and entering into the new note constituted an extinguishment of the old notes due to substantially different terms. Accordingly, the Company recognized a gain on extinguishment of convertible debt of $573,982. The new note is considered fully discounted upon inception and includes a derivative liability due to the variability of the conversion feature. The Company recorded a day one loss on excess fair value of derivative liability of $1,292,470. During the three months ended August 31, 2014, the holder converted approximately $46,000 in principal and interest through the issuance of common stock.
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(B) | Determination of Derivative Liability |
The Company calculated the derivative liabilities using the Black-Scholes pricing model for each note upon inception and recorded the fair market value of the derivative liability as a discount to the note. When a derivative liability associated with a convertible note is in excess of the face value of the convertible note, the excess of fair value of derivative is charged to the statement of operations.
The derivative liabilities associated with these convertible notes were revalued during the period as principal was converted, using the Black-Scholes Model with the below range of inputs. Upon conversion of all or a portion of the convertible notes, the derivative liability associated with the principal converted is valued immediately before conversion using the Black-Scholes model. The change in fair value of the derivative liability associated with the principal converted is recorded as a gain/loss on fair value of derivative liability in the accompanying statement of operation, with the remaining value of that portion of the derivative liability written off with a corresponding credit to additional paid-in capital.
As of August 31, 2014, the Company has outstanding principal amounts on short term convertible debt of $981,490. At the inception of these notes, they were fully discounted due to the associated derivative liabilities. Aggregate remaining discounts on convertible notes to be accreted over the life of each respective note on an effective interest method are $596,478 as of August 31, 2014. For the nine months ended August 31, 2014, interest expense from accretion of the discount, including converted notes, was $336,559.
Aggregate derivative liabilities associated with remaining convertible notes were $1,737,259 as of August 31, 2014. Based on this revaluation at quarter end and the revaluation of derivative liabilities measured during the period immediately before extinguishment of associated convertible notes, the Company recognized a net gain in fair value of derivative liability of $1,561,494 during the nine months ended August 31, 2014.
As of August 31, 2014, the range of inputs used to calculate derivative liabilities noted above were as follows:
| | | | | | | | |
| | August 31, 2014 | | | November 30, 2013 | |
Annual dividend rate | | | 0.0 | % | | | 0.0 | % |
Expected life (years) | | .01 – 1.01 years | | | .01 - .92 years | |
Risk-free interest rate | | | .03% - .16 | % | | | .03% - .13 | % |
Expected volatility | | | 431.20% - 536.5 | % | | | 331.50% - 479.40 | % |
Long-term Convertible Debt
On March 31, 2011, the Company borrowed $200,000 from an external party for use as operating capital. The parties entered into a long-term convertible note agreement, which makes the Company liable for repayment of the principal and 2% annual interest by the agreement’s expiration date of December 28, 2014. Beginning September 27, 2011, the note is convertible into shares of our common stock at a fixed conversion price of $16.00 per share. As a result, the Company will be liable to issue up to 12,500 shares common stock upon conversion. Based on a $22 closing price on the day of note agreement, we recorded a discount of $75,000 as a result of the beneficial conversion feature (“BCF”). As such, the Company discounted the note by the value of the BCF upon inception of the note. During the nine months ended August 31, 2014, interest expense from accretion of the discount was $16,760, leaving a remaining discount of $4,924. The discount being amortized approximates the effective interest method over the term of the note.
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On February 24, 2014, the holder of the $200,000 note agreed to sell up to $100,000 in principal of the convertible note to an unrelated third party, with $50,000 of principal to be acquired at that time, and an additional $50,000 in principal to be acquired on or before August 14, 2014. The Company agreed to restate that portion of the original note party in a new convertible note due February 25, 2015 with interest due at maturity at 10 percent, and convertible at the election of the holder into common stock at the lower of $0.01 or fifty percent of the lowest trading price of the stock for the previous 20 consecutive trading days. The same third party also invested an additional $25,000 in a new promissory note, on the same terms and both transactions closed in March 2014. Due to the change in the terms of the replacement note, for accounting purposes only, the partial purchase of the note has been treated as the payment of that portion of the old note and the issuance of a new note for the new principal amount. The second installment purchase of an additional $50,000 in principal of the original note was not exercised by May 14, 2014 and by the date of these financial statements.
On March 24, 2014, a second unrelated party agreed with the original note holder of the $200,000 note to purchase up to $100,000 in note principal and $5,000 in accrued interest and also agreed to invest an additional $26,500 in the Company. Under the terms of the agreement, the third party agreed to purchase the $105,000 in principal and accrued interest in three installments, with $42,000 due at signing, $31,500 due 45 days thereafter, and a final $31,500 due 45 days after the second installment payment. The Company agreed to restate the portion of the original note acquired by the third party and to issue a new convertible note in the amounts of $42,000, due March 24, 2015, with interest due at maturity at 10 percent, and convertible at the election of the holder into common stock at fifty percent of the lowest closing bid price of the stock for the previous 15 consecutive trading days. Due to the substantial change in the terms of the replacement note, for accounting purposes only, the partial purchase of the note has been treated as an extinguishment of that portion of the old note and the issuance of a new note for the new principal amount. The actual closing and funding of the initial transaction occurred on May 4, 2014.The second installment purchase of an additional $31,500 in principal of the original note accordingly was due on June 16, 2014, but was not made by the date of these financial statements. The note was partially converted into shares of common stock leaving a remaining principal balance of 38,100 as of August 31, 2014.
As a result of the two purchase transactions, the balance of the $200,000 in original principal amount of the note has been reduced to $108,000 and continues to be held by the original holder along with a remaining discount of $4,924, on the original terms.
Note 6 - STOCKHOLDER'S DEFICIT
During the nine months ended August 31, 2014, approximately $220,294 of convertible debt and related accrued interest thereon was converted into 389,512,136 shares common of stock. In connection with those conversions, approximately $344,370 was recorded to additional paid-in capital for extinguishment of derivative liabilities related to these conversions. See Note 5 relating to outstanding debt and derivative liabilities.
During the nine months ended August 31, 2014, the Company recognized stock compensation expense of $56,000 through the issuance of 12.5 million shares to various parties. In addition, the Company recognized $180,000 in stock-based compensation related to stock options previously issued. On August 8, 2014, the CEO converted $371,429 in accrued salaries into 185,714,250 shares at a price of $0.002 per share.
Note 7 - SUBSEQUENT EVENTS
Subsequent to August 31, 2014, the Company continued to convert its outstanding debt into common shares of the Company through the issuance of approximately 1.2 billion shares of common stock.
The Company is in the process of amending its Articles of Incorporation to increase the authorized common shares so there are sufficient shares for conversions of outstanding convertible promissory notes and to use as collateral for planned film financings. A Preliminary Schedule 14C Information Statement regarding the change was filed on October 17, 2014 (effective October 20, 2014 and, assuming no SEC comments, will be mailed to shareholders on or after October 31, 214. The amendment will be effective 20 days after the mailing to shareholders.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CERTAIN STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q (THIS “FORM 10-Q”), CONSTITUTE “FORWARD LOOKING STATEMENTS” WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1934, AS AMENDED, AND THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 (COLLECTIVELY, THE “REFORM ACT”). CERTAIN, BUT NOT NECESSARILY ALL, OF SUCH FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS “BELIEVES”, “EXPECTS”, “MAY”, “SHOULD”, OR “ANTICIPATES”, OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY, OR BY DISCUSSIONS OF STRATEGY THAT INVOLVE RISKS AND UNCERTAINTIES. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF MASS HYSTERIA ENTERTAINMENT COMPANY, INC. (“THE COMPANY”, “WE”, “US” OR “OUR”) TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. REFERENCES IN THIS FORM 10-Q, UNLESS ANOTHER DATE IS STATED, ARE TO MAY 31, 2014.
General
We were incorporated in Nevada on November 2, 2005 under the name “Michael Lambert, Inc.”. Until August 5, 2009 we manufactured handbags. On August 5, 2009 (the “Effective Date”), pursuant to the terms of a Stock Purchase Agreement, Daniel Grodnik (our Chief Executive Officer) and affiliated parties purchased a total of 7,985 shares of our issued and outstanding common stock (the “Change of Control”). This constituted a majority control of the Company. In addition to the shares purchased, the Company also issued 42,015 shares to Daniel Grodnik and certain affiliated parties in connection with the Change of Control. The total of 50,000 shares issued to Daniel Grodnik and the affiliated parties represented 74.6% of the shares of outstanding common stock of the Company as of the Effective Date. In connection with the Change of Control, we changed our name to Mass Hysteria Entertainment Company, Inc. (“we”, “us“, the “Company”, or “Mass Hysteria”) and also changed our business plan. We are now a multi-media entertainment company created to produce feature films for theatrical, DVD, video on demand (VOD) and television distribution with an interactive component for commercial, documentary and educational film market. Our plan has been to create original interactive theatrical films and second screen (mobile app) experience for non-Mass Hysteria films. In addition, we intend to continue creating traditional film and television projects.
Plan of Operations
We are a company without significant sources of revenue and require additional capital to operate; and consequently we are subject to the risks associated with such companies, including the uncertainty of the Company’s technology and intellectual property resulting in successful commercial products or services as well as the marketing and customer acceptance of such products or services; competition from larger organizations and dependence on key personnel. To achieve successful operations, the Company will require additional capital to finance the acquisition of film properties and their attendant costs, further development of our interactive technology, marketing and the creation and rendering of second screen content for original and repurposed movies for interactivity. No assurance can be given as to the timing or ultimate success of obtaining future funding.
As we reported earlier in the quarter, the Company has changed its mandate to concentrate on film financing and producing. To that end, the Company has committed resources and off-balance sheet funding to co-finance Daughter Of God, a film starring Keanu Reeves that commences photography October 27th in New York. The Company’s new direction includes reviewing numerous projects to co-finance and produce. Our goal is to create a portfolio and to invest in a slate of interesting, commercial and star driven projects over the next 12 months.
Currently, we are in development with Lionsgate on a reality series entitled, Ball and Chain. We recently closed a development deal with Sony Picture’s faith based label, Affirm Pictures, to develop a script from a novel
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Affirm has acquired the rights to entitled, The Devil In Pew Number Seven. The Company will be putting up the funding to pay a screenwriter to do an adaptation of the novel. Should the film be produced based on the script we fund, the Company’s CEO, Daniel Grodnik will produce the picture. Mr. Grodnik is also an Executive Producer on a new movie that commenced photography October 13, 2014 in Mobile, Alabama starring Robert DeNiro and Dave Batista. The picture is being produced by the Emmett/Furla Company.
The mobile app we have been developing will allow audiences to interact with theatrical movies and will provide a unique immersive quality that can offer each audience member a customizable and sharable experience. We recently agreed to end our relationship with a software development group to develop the app under the name SideKick™ and instead expect to retain a new software developer to assist in developing the software under our own trade name in the near future. Due to our change in focus, the app is no longer our main focus, although we intend to continue our development activities.
COMPARISON OF OPERATING RESULTS
RESULTS OF OPERATION FOR THE THREE AND NINE MONTHS ENDED AUGUST 31, 2014 COMPARED TO THE THREE AND NINE MONTHS ENDEDAUGUST 31, 2013
We had no revenue for the three and nine months ended August 31, 2014 and 2013. The lack of revenue in both periods is due to the establishing and operationalization of our business plan. As we begin to meet our business plan goals, we expect to generate revenue in the future. In the period from August 5, 2009 to date, we have assembled our management team, developed its intellectual property, and are continuing to implement our marketing strategies. Mass Hysteria intends to create movies that take advantage of traditional revenue streams that are still viable, and at the same time, identifying those revenue streams that will define new media's involvement in the film business such as downloading applications to smart phones that will allow the theater-goer to "participate" with the on-screen experience. Our plan is to combine these entertainment experiences into an alternative theatrical experience for young adults. We expect to license and further develop our own mobile applications in the future, depending on our ability to raise capital and/or generate additional sources of revenues.
For the three months ended August 31, 2014, we had general and administrative expenses of $251,945; interest expense of $216,531, excess fair value of derivative of $54,311, gain in fair value of derivative liability of $141,697. For the three months ended August 31, 2013, we had general and administrative expenses of $223,829; interest expense of $36,986, excess fair value of derivative of $13,842, and gain on fair value of derivative liability of $52,283. Whereas general and administrative expenses are relatively consistent period over period, interest expense is a function of debt issued and accretion of discounts recognized that are unique to the period based on borrowings. In addition, the change in fair value of derivative liabilities changes period to period based on changing variables included in the Black Scholes option pricing model including the stock price on the day of valuation and the related effective conversion price.
We had a net loss of $381,090, for the three months ended August 31, 2014, as compared to a net loss from of $222,374, for the three months ended August 31, 2013. The primary reasons for the increased net loss are due to the loss on excess fair value of derivative liability noted above and increased interest expense due to accretion of debt discounts.
For the nine months ended August 31, 2014, we had general and administrative expenses of $717,722; interest expense of $371,895, excess fair value of derivative of $3,083,417, gain in fair value of derivative liability of $1,561,494, and gain on extinguishment of convertible notes of $665,983. For the nine months ended August 31, 2013, we had general and administrative expenses of $661,681; interest expense of $241,422, excess fair value of derivative of $40,680, and gain on stand ready guarantee of $125,817. Whereas general and administrative expenses are relatively consistent period over period, interest expense is a function of debt issued and accretion of discounts recognized that are unique to the period based on borrowings. In addition, the change in fair value of derivative liabilities changes period to period based on changing variables included in the Black Scholes option pricing model including the stock price on the day of valuation and the related effective conversion price.
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We had a net loss of $1,945,557, for the nine months ended August 31, 2014, as compared to a net loss from of $883,316, for the nine months ended August 31, 2013. The primary reason for the increased net loss is due to the loss on excess fair value of derivative liabilities noted above.
LIQUIDITY AND CAPITAL RESOURCES
We had total assets of $72,252 as of August 31, 2014, consisting of $60,902 in cash, $1,200 in lease deposits, $5,000 in prepaid expenses, and $5,150 in capitalized film costs. We had a working capital deficit of $3,721,098.
We had total liabilities of $3,885,076 of August 31, 2014, consisting of current liabilities, which included $171,470 of accounts payable; accrued liabilities of $378,934; accrued payroll of $609,829; short-term debt of $243,572; short-term convertible debt, net of discount of $389,936; a stand ready obligation of $250,000; derivative liability of $1,737,259; and convertible long-term debt of $103,076 net of discount.
We had a total stockholders’ deficit of 3,812,824 as of August 31, 2014, and an accumulated deficit as of August 31, 2014 of $12,382,483.
We had $140,957 in net cash used in operating activities for the nine months ended August 31, 2014, which included $1,945,557 in net loss, offset by $236,000 in share-based compensation, $387,339 in amortization of discount on short-term debt, and changes in operating assets and liabilities totaling $325,321. We also had a $1,561,494 change in fair value of derivative liability, gain on extinguishment of convertible notes of $665,983, and a loss on excess of derivatives of $3,083,417. We had $3,150 used by financing activities for film costs. We had $205,000 provided by financing activities from proceeds from convertible debt.
Since we have no liquidity and have suffered losses, we depend to a great degree on the ability to attract external financing in order to conduct our business activities and expand our operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. If we are unable to raise additional capital from conventional sources, including increases in related party and non-related party loans and/or additional sales of stock, we may be forced to curtail or cease our operations. Even if we are able to continue our operations, the failure to obtain financing could have a substantial adverse effect on our business and financial results. We have no commitments to provide us with financing in the future, other than described above. Our independent registered public accounting firm included an explanatory paragraph raising substantial doubt about the Company’s ability to continue as a going concern in our most recent annual filing.
In the future, we may be required to seek additional capital by selling debt or equity securities, selling assets, or otherwise be required to bring cash flows in balance when it approaches a condition of cash insufficiency. The sale of additional equity securities, if accomplished, and the conversion of convertible debt, if converted, may result in dilution to our shareholders. We cannot provide assure, however, that financing will be available in amounts or on terms acceptable to us, or at all.
Off-Balance Sheet Arrangements
None.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Principal Financial Officer, after evaluating the effectiveness of our "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q (the "Evaluation Date"), have concluded that as of the Evaluation Date, our disclosure controls and procedures were not effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the 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 Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. They were deemed not effective due to adjustment and disclosure omissions. The Company will continue to take steps to identify matters of accounting and disclosure.
(b) Changes in internal control over financial reporting. During the quarter ended August 31, 2014 we retained the services of an outside services firm to assist with closing of our books and records, and prepare our quarterly and annual filings with the SEC. This firm was not engaged for enough time during the period ended August 31, 2014 to have a material effect on our internal controls over financial reporting.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
INHERENT LIMITATIONS OF INTERNAL CONTROLS
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that:
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● | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; |
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● | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
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● | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. |
Management does not expect that our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed 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 internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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PART II: OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
None during the quarter ended August 31, 2014 except for the referenced arbitration proceeding regarding the Coral Ridge agreement, originally scheduled for August, 2014, but postponed to a date still to be determined due to on-going settlement discussions.
ITEM 1A – RISK FACTORS
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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1. | See Item 5 of our Annual Report on Form 10-K for the year ended November 30, 2013 filed March 13, 2014 and amended by filing on April 14, 2014.
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2. | During the quarter ended August 31, 2014, we issued 365,564,132 shares of common stock upon conversion of convertible notes. The aggregate principal and interest amount of this note that was converted was $164,410. The issuances were exempt pursuant to Section 3(a)(9) of the Securities Act of 1933 as well as Section 4(2) of the Securities Act of 1933. |
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None during the quarter.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5 - OTHER INFORMATION
None
The following exhibits are filed as part of this quarterly report on Form 10-Q:
31.1
Rule 13a-14(a)/15d-a4(a) Certification of Chief Executive and Chief Financial Officer
31.2
Section 1350 Certification of Chief Executive and Chief Financial Officer
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Dated: October 20, 2014 | | Mass Hysteria Entertainment Company, Inc. |
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| | By: | /s/ Daniel Grodnik |
| | Daniel Grodnik, Chief Executive and Financial Officer |
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