RICHARDSON & PATEL LLP
10900 Wilshire Boulevard
Suite 500
Los Angeles, California 90024
Telephone (310) 208-1182
Facsimile (310) 208-1154
August 11, 2005
VIA EDGAR AND FEDERAL EXPRESS
Ms. Linda Cvrkel, Branch Chief
United States Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street, N.W.
Washington, D.C. 20548
Re: NuTech Digital, Inc.
Form 10-KSB for the year ended December 31, 2004
Form 10-QSB for the period ended March 31, 2005
Commission File No.: 000-50021
Our File No.: 0622-003
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Dear Ms. Cvrkel:
This law firm is legal counsel to NuTech Digital, Inc. (the "Company"). We
have been asked by the Company to provide assistance in responding to your
letter dated July 8, 2005. In that regard, the Company would like to amend its
Form 10-KSB and 10-QSB once all the comments are addressed and resolved. We have
included proposed amendments to these documents for your review. The proposed
amendments do not have updated certifications. Updated certifications will be
filed when the amendments are approved by you for filing.
Please note that after reviewing your letter the Company determined that
the description of its business was inaccurate because it stated that the
Company was a "distributor" of films. A more accurate description of this aspect
of the Company's business is that it sells DVDs of certain film titles to
distributors for resale to consumers. As you'll see in the discussion to comment
number 2, based on this activity, which the Company believes can be compared to
the activity of a franchisee, the Company believes that it has correctly
accounted for royalty expenses.
Form 10-KSB for the year ended December 31, 2004
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1. MD&A. It appears that significant judgment may be required in
estimating future product sales for purposes of evaluating the realizability of
prepaid advances, prepaid productions costs, and completed masters. Therefore,
please revise your critical accounting estimates to include a detailed
discussion of the judgments involved, your method of making such judgments, how
accurate such judgments have been in the past, and the susceptibility of such
judgments to change in the future. For example, please disclose how you make
reasonably reliable estimates of ultimate revenue expected from your films and
properties for purposes of recognizing periodic costs and estimating fair
values.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 2
In response to this comment, the Company has amended its Form 10-KSB and
Form 10-QSB, and will include in its filings going forward, the following:
Each quarter, we analyze product sales, discuss potential future orders
with customers and review the economic conditions of our industry for the
purpose of analyzing the recovery of completed master costs, production
costs and prepaid royalties. Actual results could vary from the estimates
that we make.
Financial Statements.
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2. Statements of Operations, page F-3. Please revise your statement of
operations to reclassify shipping and handling costs and royalty expenses from
G&A to cost of sales, as these costs are directly associated with the cost of
products sold.
In response to this comment, the Company has amended its Form 10-KSB and
Form 10-QSB, and will include in its filings going forward, a reclassification
of its shipping and handling costs to costs of sales in the statement of
operations and has changed the footnote disclosures to read as follows:
The Company's policy is to classify shipping and handling costs as part of
costs of goods sold in the statement of operations.
While the Company has, in the past, included in its filings that it is
"engaged in the business of licensing and distributing general entertainment
products," a more accurate statement is that the Company is a wholesaler of its
products to distributors and, to a much smaller extent, a retail seller over the
Internet.
In light of the foregoing, the Company believes that it has correctly
accounted for the settlement of royalties because, as to the sale of films to
distributors, it functions much as a franchisee would function. For example, in
a franchise agreement the franchisee acquires a franchise right and amortizes
the franchise right over the franchise agreement term. In the Company's
operations, it acquires a license to make a digital master ("completed master")
and sell replicated DVDs to distributors. The Company amortizes the costs of
making the completed master over the life of its license agreement; as a
franchisee amortizes its costs over the life of the franchise agreement. On a
quarterly basis, the Company reviews the unamortized costs of the completed
masters. If the Company finds that a product is not selling in sufficient
quantities on a prospective basis to recoup the unamortized costs, then it
records an impairment loss of the estimated cost that will not be realized by
revenue. Based on this activity, the Company believes that, like a franchisee,
it should expense realized royalties on a current basis as a selling expense.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 3
For these reasons the Company does not believe that SOP 00-2, "Accounting
by Producers or Distributors of Films" is applicable to its operations, since it
is not a distributor of films, but only a wholesaler of DVDs to distributors. As
noted above, the Company believes that royalty costs are properly presented as
selling expenses.
In accounting for costs related to its production and filming of music
concerts, however, the Company follows the guidelines of SOP 00-2.
3. Statements of Operations, page F-3. We note from your statement of
operations that you have classified the settlement of royalties as non-operating
income. As the underlying costs of the settlement relate to royalty expense, an
operating cost, please reclassify this expense to the operating cost line item
in which you recognize other royalty expenses.
In response to this comment, the Company has amended its Form 10-KSB and
Form 10-QSB, to reclassify the settlement of royalties in the amount of $125,000
to selling expenses.
4. Statement of Stockholders' Equity, page F-5. We note that the statement
of stockholders' equity includes captions related to redeemable common stock,
but this is not described elsewhere in the notes to the financial statements.
Please supplementally explain to us the purpose of this caption and why there
are no shares of common stock associated with this caption. If applicable,
please tell us the circumstances in which the stock is redeemable and how you
have considered the guidance in SFAS 150 in your accounting for this redeemable
common stock. In future filings, disclose the amount of redemption requirements
in the notes to the financial statements as required in paragraph 8 of SFAS 129.
We may have further comment upon receipt of your responses.
In 2002 and 2003, the Company settled two payables by issuing common stock
subject to certain redemption provisions. The common stock was included in
shares issued and outstanding, but the value applicable to the common stock was
included on the financial statements between long-term liabilities and
stockholders' equity. The redemption provisions were terminated in 2004 and the
Company reported $247,500 as part of common stock in stockholders' equity.
5. Statement of Stockholders' Equity, page F-5. We note that in 2003 you
recorded an allocation of offering costs of $499,012 as a reduction of common
stock. Please tell us the nature of these offering costs, including the
issuances of stock they are related to, and your basis for the accounting of the
costs.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 4
The offering costs are legal fees incurred for the preparation of legal
documents required for the private placements (sale) of the Company's common
stock. These costs were allocated against the proceeds received from the sale of
stock from the private placement.
Notes to the Financial Statements
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6. Note 1. Summary of Significant Accounting Policies - Prepaid Royalties,
page F-9. Your accounting policy states royalty advances are stated at cost,
less royalties accrued and less an allowance for obsolescence. SOP 00-2 requires
that unamortized capitalized costs exceeding a film's fair value should be
written off to the income statement, with no subsequent restoration of any
amounts previously written off. As a result, it appears that your policy of
using an allowance for obsolescence for royalty advances does not comply with
SOP 00-2. Please revise your accounting policy accordingly and tell us whether
such modification in your policy affects amounts reported in your financial
statements.
The Company agrees that the terminology in the footnote is incorrect. The
Company wrote-off $15,000 of royalties as impaired.
In response to this comment, the Company has amended its Form 10-KSB and
Form 10-QSB, and will include in its filings going forward, the following
footnote. The Company does not believe that a change is required to the
financial statements.
Royalty advances are stated at cost less the royalties earned by the
licensor on sales from the license agreement. Management periodically
analyzes license agreements and if a product is not selling in sufficient
quantities, then management records an impairment expense in the amount of
the estimated unrecoverable advance royalty as a current period expense.
7. Note 1. Summary of Significant Accounting Policies - Prepaid Royalties,
page F-9. We note that royalty expenses incurred in the last two years were less
than $400,000 per year and the maximum term of the respective license agreements
is through 2010, six years from year-end 2004. We also note from page 8 that
during 2004 you decided to shift the emphasis of your business from selling
general entertainment products to producing and distributing music concerts.
Therefore, it is not clear from your filing how royalty advances are realizable
from the ultimate revenue you expect during the remaining terms of your license
agreements. Please tell us the basis for your conclusion that the prepaid
royalties of $3,273,033 are realizable at December 31, 2004. Please be detailed
in your response and consider providing us with assumptions and information with
respect to the more significant portions of the balance, as appropriate. Include
in your response how you determined the amount of the allowance recorded. In the
alternative, please consider revising your financial statements to write down
prepaid royalties to their fair value based on the guidance in paragraph 43 to
48 of SOP 00-2.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 5
The Company has decided to shift the emphasis of its business from selling
general entertainment products to producing and distributing musical concerts,
however, the Company still holds and sells a film library of over 600 titles.
The Company plans to continue to aggressively sell DVDs from its film library.
In fact, the Company spent $1,800,000 in 2004 to acquire the rights to new
titles. The Company believes that it needs its film library to generate needed
revenue.
Each quarter, the Company reviews its advance royalties on products sold
to verify that it does not have an impairment in these assets. This is done by
analyzing previous sales of products, by discussing future sales with its
customers and by reviewing general economic conditions that impact the Company's
industry. The Company believes that the $3,273,033 of advanced royalties are
properly stated and valued at December 31, 2004.
8. Note 1. Summary of Significant Accounting Policies - Inventories, page
F-9. Please revise future filings to disclose the amount of your allowance of
obsolete inventory, if any.
In response to this comment, the Company agrees that in future filings it
will disclose the amount of its allowance for obsolete inventory.
9. Note 1. Summary of Significant Accounting Policies - Prepaid Production
Costs, page F-9; Property and Equipment, page F-9. We note that you amortize
prepaid production costs over the estimated life of the contracts and you
amortize completed masters over seven years. Please explain to us the basis for
your method of amortization and the reason you do not use the
individual-film-forecast-computation method outlined in paragraph 34 of SOP
00-2. Additionally, tell us and revise to explain in detail in the notes to your
financial statements in future filings your basis for your conclusion that
prepaid production costs aggregating $679,890 and completed masters are
realizable at December 31, 2004. As part of your response and your revised
disclosure, please explain in further detail how you evaluated these capitalized
costs for impairment. See paragraph 43-47 of SOP 00-2. We may have further
comment upon receipt of your response.
Please see the Company's response to comment 2, which explains the basis
for its method of amortizing prepaid production costs and completed masters.
The Company has also revised footnote Number 1 and the MD&A to detail its
methods of amortization. The new note is as follows:
Amortization of Completed Masters
The Company amortizes its completed masters over the life of its licensing
agreements, which is generally 7 years. If a product is not selling in
sufficient quantities, then management writes down the asset to its
estimated fair value and records the impairment as a current period
expense.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 6
Prepaid Production Costs
The Company amortizes production costs using the individual
film-forecast-computation method as required by SOP 00-2, "Accounting by
Producers or Distributors of Films." Under this method, amortization is computed
in the ratio that current period actual revenue (numerator) bears to estimated
remaining unrecognized ultimate revenue as of the beginning of the current
fiscal year (denominator).
10. Note 1. Summary of Significant Accounting Policies - Net Earnings
(Loss) Per Share, page F-10. We note that you have included a disclosure for
proforma net (loss) from continuing operations and proforma earnings per share
below your discussion on the computation of basic and diluted net loss per
shares. Please tell us the purpose of these proforma amounts, especially
considering your disclosure elsewhere in Note 1 that states that no proforma
disclosures have been made related to stock options.
The Company agrees that Note 1 was incorrect and that proforma disclosure
is required. In response to this comment, the Company has amended its Form
10-KSB and Form 10-QSB, and will include in its filings going forward, a revised
footnote. Please see comment 12 below.
11. Note 1. Summary of Significant Accounting Policies - Common Stock
Issued for Non-Cash Transactions, page F-11. We note from your Statement of
Stockholders' Equity that during 2003 and 2004 you issued stock for services,
prepaids and accounts payable. Please list for us, and disclose in the notes to
the financial statements in future filings, each separate transaction, the per
share value of the stock associated with each transaction and how you calculated
or determined that stock value. We may have further comment upon receipt of your
response.
In response to this comment, the Company issued common stock in exchange
for the following services:
Services Under 2003 Consultant Stock Plan
-----------------------------------------
June 2003 - 550,000 shares of common stock at $0.18 in exchange for legal
services rendered with an aggregate fair value of $99,000.
July 2003 - 150,000 shares of common stock at $0.16 in exchange for
consulting services rendered with an aggregate fair value of $24,000.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 7
August 2003 - 100,000 shares of common stock at $0.12 in exchange for
consulting services rendered with an aggregate fair value of $12,000.
August 2003 - 100,000 shares of common stock at $0.12 in exchange for
consulting services rendered with an aggregate fair value of $12,000.
August 2003 - 150,000 shares of common stock at $0.102 in exchange for
consulting services rendered with an aggregate fair value of $15,300.
September 2003 - 125,000 shares of common stock at $0.12 in exchange for
legal services rendered with an aggregate fair value of $15,000.
September 2003 - 40,000 shares of common stock at $0.15 in exchange for
consulting services rendered with an aggregate fair value of $6,000.
October 2003 - 100,000 shares of common stock at $0.12 in exchange for
consulting services rendered with an aggregate fair value of $12,000.
Other Services
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July 2003 - 250,000 shares of common stock at $0.096 in exchange for
consulting services rendered with an aggregate fair value of $24,000.
July 2003 - 125,000 shares of common stock at $0.16 in exchange for
consulting services rendered with an aggregate fair value of $20,000
October 2003 - 23,809 shares of common stock at $0.42 in exchange for
consulting services rendered with an aggregate fair value of $10,000.
October 2003 - 150,000 shares of common stock at $0.13 in exchange for
consulting services rendered with an aggregate fair value of $19,500.
November 2003 - 25,000 shares of common stock at $0.60 in exchange for
consulting services rendered with an aggregate fair value of $15,000.
November 2003 - 29,270 shares of common stock at $0.585 in exchange for
consulting services rendered with an aggregate fair value of $17,000.
Accounts Payable
----------------
September 2003 - 210,000 shares of common stock at $0.395 in exchange for
accounts payable with an aggregate fair value of $83,125.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 8
During the year ended December 31, 2004, the Company issued the following
shares of common stock:
Services and Prepaid Expenses Under 2003 Consultant Stock Plan
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February 2004 - 35,000 shares of common stock at $1.05 per share in
exchange for legal services rendered with an aggregate fair value of
$36,750.
February 2004 - 15,000 shares of common stock at $1.00 per share in
exchange for consulting services rendered with an aggregate fair value of
$15,000.
March 2004 - 250,000 shares of common stock at $1.20 per share in exchange
for legal services rendered with an aggregate fair value of $356,380.
August 2004 - 237,500 shares of common stock at $0.27 per share in
exchange for concert consulting services rendered with an aggregate fair
value of $64,125.
September 2004 - 150,000 shares of common stock at $0.24 per share in
exchange for a one year prepaid consulting agreement with an aggregate
fair value of $36,000.
September 2004 - 100,000 shares of common stock at $0.27 per share in
exchange for filming services rendered with an aggregate fair value of
$27,000.
October 2004 - 44,273 shares of common stock at $0.25 per share in
exchange for consulting services rendered with an aggregate fair value of
$11,068.
December 2004 - 125,000 shares of common stock at $0.27 per share in
exchange for prepaid consulting services with an aggregate fair value of
$33,750.
December 2004 - 25,000 shares of common stock at $0.25 per share in
exchange for consulting services rendered with an aggregate fair value of
$7,250.
Other Services and Prepaid Expenses
-----------------------------------
January 2004 - 50,000 shares of common stock at $1.06 per share in
exchange for consulting services rendered with an aggregate fair value of
$49,500.
February 2004 - 110,000 shares of common stock at $1.05 per share in
exchange for prepaid consulting services with an aggregate fair value of
$115,500.
February 2004 - 75,000 shares of common stock at $0.87 per share in
exchange for prepaid consulting services with an aggregate fair value of
$65,250.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 9
March 2004 - 15,000 shares of common stock at $0.87 per share in exchange
for consulting services rendered with an aggregate fair value of $13,050.
March 2004 - 230,473 shares of common stock at $0.40 per share in exchange
for legal services rendered with an aggregate fair value of $92,189.
March 2004 - 160,000 shares of common stock at $0.99 per share in exchange
for consulting services rendered with an aggregate fair value of $158,400.
March 2004 - 600,000 shares of common stock at $0.87 per share in exchange
for consulting services rendered with an aggregate fair value of $522,000.
April 2004 - 45,000 shares of common stock at $0.50 per share in exchange
for consulting services rendered with an aggregate fair value of $22,500.
May 2004 - 45,000 shares of common stock at $0.41 per share in exchange
for consulting services rendered with an aggregate fair value of $18,450.
June 2004 - 45,000 shares of common stock at $0.40 per share in exchange
for consulting services rendered with an aggregate fair value of $18,000.
July 2004 - 45,000 shares of common stock at $0.39 per share in exchange
for consulting services rendered with an aggregate fair value of $17,550.
August 2004 - 25,000 shares of common stock at $0.27 per share in exchange
for consulting services rendered with an aggregate fair value of $6,750.
October 2004 - 45,000 shares of common stock at $0.25 per share in
exchange for website development with an aggregate fair value of $11,250.
November 2004 - 35,000 shares of common stock at $0.35 per share in
exchange for consulting services rendered with an aggregate fair value of
$12,075.
The value of the common stock represented the fair market value of the
common stock on the date of grant, as reported by the OTCBB or was otherwise
determined by negotiation between the Company and the service provider. In
future filings the Company will continue its disclosure in this manner.
12. Note 1. Summary of Significant Accounting Policies - Stock Based
Compensation, page F-11. We note from your disclosure in Note 1 that you use the
fair value based method of accounting for stock based compensation, under which
compensation expense has been recognized for stock option awards granted and no
pro forma disclosures have been made due to the use of the fair value based
method. This disclosure appears to conflict with that in Note 17 which states
that you have elected to continue to account for stock-based compensation under
the "intrinsic value" method of APB 25, under which no compensation expense has
been recognized for stock options granted to employees at fair market value.
Please clarify for us which of the methods you use to account for stock based
compensation. If you continue to follow APB 25, please include in your response
and in future filings, the appropriately captioned pro forma disclosure required
by paragraph 2(e) of SFAS 148. Additionally, because you disclose in Note 1 that
you do not believe the existing option pricing models provide a reliable single
measure of the fair value of the options, please tell us how you determine fair
value of the stock options issued, considering also non-employee compensation,
including the significant assumptions. See paragraph 47(d) of SFAS 123. We may
have further comment upon receipt of your response.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 10
We will change the footnote disclosure in the amended for 10-KSB and
10-QSB to read as follows:
As permitted by FAS 123, as amended, the Company accounts for stock
options issued to employees using the intrinsic value method as prescribed
by APB 25. Under this method no expense is recognized for options issued
with an exercise price equal to or greater than the market price of the
stock on the date of grant. Expense for options or warrants issued to
non-employees is recorded in the financial statements at estimated fair
value. For options issued to employees the Company is subject to proforma
disclosures based on the estimated fair value of options issued.
The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and
are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock options and warrants have
characteristics different from those of traded options, and because
changes in the subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of such
stock options.
13. Note 1. Summary of Significant Accounting Policies - Recently Issued
Accounting Pronouncements, page F-12. We note that you have disclosed several
recently issued pronouncements. In future filings, please include whether you
expect the applicable pronouncement to materially effect the financial position
or results of operations of the company for all pronouncements that have not
been adopted as of the latest year end. See SAB Topic 11M.
In response to this comment, the Company agrees to include this
information in its future filings.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 11
14. Note 14. Convertible Promissory Notes, page F-20. We note that you
have issued two convertible promissory notes that have a conversion price of $
..25 per share. Please tell us the date at which the notes were issued and the
trading price that was used to determine the existence of a beneficial
conversion feature. If a beneficial conversion feature existed at the date of
issuance, please tell us if you have recorded the fair value of this feature.
Please see the guidance outlined in EITF 98-5 and 00-27, as applicable.
The Company issued two convertible promissory notes totaling $137,566. The
notes can be converted after July 7, 2004 into the Company's common stock at a
conversion price of $0.25 per share (550,264 total shares). The notes are
unsecured and bear interest at the minimum rate permitted by the IRS (4.0% at
December 31, 2004).
The notes were issued on July 7, 2003 when the Company's stock was trading
at $0.15 per share. The conversion price was negotiated by the Company and the
note holders, who were unrelated to the Company. Because the conversion price is
higher than the fair market value on the date the notes were issued, there is no
beneficial conversion expense attributable to this debt.
15. Note 19. Common Stock Purchase Warrants, page F-23. We note that in
2004 you issued a series of three warrants for consulting fees. Please tell us
how the fair value of the warrants was determined and if any expense was
recognized during 2004. Additionally, tell us the terms of the warrant
cancellation and whether you currently have a liability for the consulting fees
as a result of the cancellation.
The value of the warrants was negotiated by the Company and the warrant
holder, who was unrelated to the Company. The Company did not recognize any
expense in the year ended December 31, 2004 because the parties to the
transaction mutually agreed to its termination. Because of this, the Company
does not have liability for the consulting fees related to the warrants.
Form 10-QSB for the quarter ended March 31, 2005
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16. Note 21. Subsequent Event. We note from Part II Item 5 - Other
Information that Dimension DVD is claiming in its lawsuit that you owe it
$70,620. In future filings, please disclose the amount of the lawsuit in the
notes to the financial statements. See paragraph 11 of SFAS No. 5.
In response to this comment, the Company will include this information in
future filings.
Ms. Linda Cvrkel, Branch Chief
August 11, 2005
Page 12
17. Comply with the comments on the Form 10-KSB for the year ended
December 31, 2004 as they apply to filings on Form 10-QSB.
The Company agrees to comply with this comment.
We have also included a statement from the Company making the
acknowledgements you requested in your letter.
We look forward to hearing from you regarding the Company's response at
your earliest convenience.
Very truly yours,
RICHARDSON & PATEL LLP
By: /s/ Mary Ann Sapone
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MARY ANN SAPONE