Registration of Securities of a Small-Business Issuer — Form 10-SB Filing Table of Contents
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6: EX-4.1 Instrument Defining the Rights of Security Holders HTML 209K
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Securities
to be registered under Section 12(b) of the Exchange Act: None
Securities
to be registered under Section 12(g) of the Act:
Title
of each class
Name
of Exchange on which to be so
registered
each class is to be registered
Common
Stock, $.001 par value
N/A
ITEM
1. DESCRIPTION OF BUSINESS
Overview
We
are a
development stage company focused on providing free downloaded music legally.
We
provide ad-supported music to registered users through the advertising we sell
on our website. We license the music from record labels, by paying an up-front
licensing fee and paying the record labels a percentage of the ad-generated
revenue. The license agreements with the music industry allows our users to
synchronize their libraries and playlists on their personal computer and up
to
two portable devices, and the users will not be subject to lawsuits for
copyright infringement from the record industry, assuming compliance with the
terms and conditions of our site. Users are required to enter minimal data
about
themselves upon initial registration. This will be used to validate the user
and
to facilitate targeted advertising with age and gender appropriate
messages.Over
time
we will learn more about our users’ tastes and we will be better positioned to
provide even more targeted advertising.
Industry
Background
Evolution
of Music Formats and Effect on Piracy
With
each
new format introduced by the music industry, new piracy issues have arisen.
This
was the case with the cassette tape when it was introduced in the late 70’s, as
it allowed easy duplication, but with a diminished quality. The introduction
of
the compact disc, or CD, or music on a digital format from Sony and Philips
in
the mid-80’s, created an era of huge profits for the industry as users replaced
their aging catalogs for the higher quality CD’s.
With
the
success of the CD format, the music industry gradually phased out tapes and
vinyl as alternative formats. The storage capacity of the CD encouraged the
industry to also phase out singles, once the dominant format, which virtually
disappeared by 2001.
The
digitalization of music created by the CD became the industry’s worst enemy,
however, with the development of the Internet and increased connection speeds
in
the late 1990’s. With the Internet allowing the fast transfer of digital files,
it became the home to illegal music sites that now trade billions of music
files
on a monthly basis.
According
to the Recording Institute Association of America, U.S. CD sales peaked in
2000
at 942.5 million units. CD sales have declined every year since to the
2006 low of 614.9 million units equaling a total decline in sales of
34.8%. Year end 2006, sales were down 12.8% versus the prior year and in
the first quarter of 2007, U.S. CD sales were down 20.5%.
The
music
industry is now scrambling to re-invent itself. Harmed by its dependence on
the
CD distribution format, it is exploring various digital distribution channels
including the sale of music through Internet based music-sites and through
portable handsets such as cell-phones. It is still exploiting the CD format,
which accounted for 85% of sales at the end of 2006.
The
music
industry has struggled to make its music available to legal music sites as
the
majors, artists, and digital distributors have had to re-negotiate distribution
terms and digital rights management policies. It was not until 2004 with the
advent of iTunes that the industry made its deep catalog available.
Advertising
revenue has historically never been a significant source of revenue for the
music industry. While it has had long and deep associations with advertisers
through radio and MTV, the main role of these advertising supported businesses
has been to help promote music sales; they have never contributed meaningful
revenues directly to the music industry. And while concert tours have been
supported by large sponsorship deals for over two decades, the music companies
typically do not share in the revenues of their artists’ touring revenues.
Neither has it known historically how to monetize the high recognition and
brand
value of its star artists.
Online
Music Services
Internet
online music service businesses fall into two categories, legitimate and
illegitimate. Within the legitimate digital music market, the services available
either sell music on an a la carte or subscription basis. A la carte legitimate
music services generally sell songs at a price yielding very small margins
to
the retailer. Online music services that provide a combination of streaming
and
downloading capabilities on a subscription basis allow customers to listen
to as
many songs as they want in a month for a flat fee. Even ringtone downloading
services are facing concerns of hacking, altering of ringtones, and piracy,
with
prices rising for users at the same time. Illegitimate music services generally
make money from the sale of advertising, the sale of information received from
bundles spyware, or the sales of “software upgrades that make piracy more
convenient.
2
Legitimate
Online Music Services
Legal
music service businesses may be standalone enterprises that encompass a
proprietary technology platform and/or include some type of license or file
sharing. Online music services include iTunes, eMusic, Yahoo! Music, AOL Music,
and Wal-Mart to name a few.
Subscription
services charges generally range from $10 to $20 per month. The industry had
high expectations for the subscription services and the response to these
services has disappointed. Recently there have been attempts to create
legitimate Peer-to-Peer services such as Mashboxx and iMesh using fee and/or
subscription revenue models. There have not been many public releases as to
success of such services. Further, the consistency of the content of these
sites
is not favorable, since it’s wholly dependent on the users supplying it, not the
site owner.
The
licensed digital music services also continue to grow due to consumer demand,
but the sustainability at the reseller level is questionable as the current
business of generating revenue on a pure pay-per-track business model is
sustainable as a standalone business>. The mechanical royalties to the
recording industry, performance royalties to the publishers and the cost of
e-commerce leaves little margin at the general dollar per track model that
is in
use today. This leaves services that use this model to make their content
available as loss leaders for the marketing of hardware or general
merchandise.
Pirate
Online Music Services
With
even
the foremost of pirate online enterprises, almost all online music is accessed
and downloaded using unlicensed file sharing. Most of these services are now
designed as Peer-to-Peer services so that songs are swapped from user to user,
unlike the old Napster service that stored songs on a central server. The
distributed design of Peer-to-Peer makes the pirate services much more difficult
to shut down with legal enforcement. In some countries where copyright
enforcement is lax, the central server model is still used, such as the MP3.ru
pirate service in Russia.
With
10.5
million average simultaneous users on Peer-to-Peer services around the world,
DCIA, the trade association that represents the Peer-to-Peer services, reported
that there are 320 million Peer-to-Peer users globally and roughly more than
52
million people illegally downloading music in the U.S. IFPI estimates that
20
billion songs were illegally swapped or downloaded on the internet in 2005.
Several
trends and circumstances precipitated the rise in both licensed and unlicensed
online music services. The first was the proliferation of the Internet, in
particular broadband and high speed capability. Music files are relatively
small
and easy to download. The second was the decline of the singles format, either
in Vinyl or CD. It was a deliberate move by music companies that forced users
to
purchase a full CD even if they only wanted the highlighted, single track.
The
last was the willingness by a large part of the consumer audience to engage
in
an endeavor or practice that, though illegal, they did not consider immoral.
According to the results of a survey on Peer-to-Peer music file-sharing released
by Harris Interactive, the vast majority of Americans believe that downloading
music for personal use should not be prohibited and that the high price of
CD’s
had driven downloading.
3
Harris
Interactive’s 2005 teen survey listed various reasons for teens sharing music on
the Internet:
·
Only
like 1 or 2 songs on an album
(59%);
·
Want
to get music quickly (48%);
·
Music
is too expensive to buy (46%);
·
Music
should be free (44%);
·
Wanting
exclusive songs that are not for sale (40%);
and
·
Think
music should be shared (38%).
Most
Peer-to-Peer downloading occurs between 10 p.m. and 12 p.m. regardless of age.
This makes sense as the most people are on Peer-to-Peer networks during these
hours and the available selection is therefore the greatest at this
time.
According
to the Harris Interactive survey, three out of four (75%) U.S. adults agree
that
"downloading and then selling the music is piracy and should be prohibited,
but
downloading for personal use is an innocent act and should not be
prohibited."
Internet
Advertising
A
2006
McKinsey study showed a steep decline in television viewership for males, 18-34.
This decline was largely attributed to the proliferation of alternative leisure
activities, particularly Internet usage. A number of studies by Nielsen Media
and Research, Jupiter Research, Ipsos-Insight, comScore, Veronis Suhler
Stevenson, TNS Media Intelligence/CMR, McKinsey &Co. and
PricewaterhouseCoopers amongst others analyzed the shift in TV viewership in
the
18-34 male segment and reported the shift as resulting from:
·
A
continued shift from television to other entertainment outlets
(particularly video games and the Internet)
·
A
gravitation towards adult content, music, auctions, sports and consumer
electronics retail
Top
web-sites such as MSN, Google and Yahoo are becoming ubiquitous each with over
480 million unique visitors in March 2006.
As
Internet usage and broadband penetration rises and continues to increase, there
has been a significant increase in online sales and the use of rich media
advertisements. Currently there are 124 million broadband users in 54 million
U.S. homes as of year end 2006 per eMarketer. China had 123 million online
users
as of the end of 2006 per CIA’s World Factbook, up from 56.6 million users in
March 2002 and 22.5 million users in January 2001 per ClickZ. The CIA’s World
Factbook reports online users in Germany at 50.6 million, India at 60.0 million,
Japan at 86.3 million and the U.K. at 37.6 million users. AdAge using Forrester
Research U.S. Commerce 2005-2010 actuals and projections, has total online
retail sales in the U.S. in 2005 at $172.4 billion, with a year on year
2005-2006 projected percentage change of 17% and a projected 2010 retail online
U.S. sales number of $328.6 billion.
The
growth in broadband penetration and online retail have been two of the primary
drivers in the increase in online advertising. While television still commands
by far the biggest portion of ad spending, the increase in spending on Internet
advertising has far outpaced the increase in television advertising spending.
Online advertising in the U.S. is expected to increase from $16.4 billion in
2006 to an expected $19.5 billion in 2007 to over $30 billion by 2010.
The
ANA
and Forrester research companies undertook a study presented in March of 2006
which polled 133 advertisers that control $20 billion in ad spending. The
companies included Charles Schwab, Colgate, Dunkin' Donuts, Johnson &
Johnson, Mattel, Pfizer and Verizon. 80% of the respondents said that they
were
going to increase online advertising. Most were going to move from television
to
online. Forrester predicted that 2007 would be the first full year of TV budget
declines. Perhaps the most pointed example of this is Procter & Gamble,
which has an annual ad budget of $2.5 billion. P&G announced in 2005 that it
would cut back television ad spending. In the first 6 months of 2005, P&G’s
ad spending dropped by 20% to $321 million, compared to the same period the
previous year. During that same period, P&G’s spending on Internet
advertising increased by 55%.
4
Our
Solution
We
plan
to provide a rich user experience that enables users to download music at no
monetary cost. Our goal is to attract and maintain a very large 13-34 year-old
audience that consumes advertising, music and entertainment in an integrated
manner. In addition, our proprietary solution is planned to ensure user privacy
while utilizing the information collected at registration for highly efficient
ad placement. We believe the solution differs from other music and entertainment
download sites in numerous ways. The main features of our solution
include:
·
Broad
catalog of music from all music majors and independents.
We
intend to deliver deep catalogs and new releases from the major record
labels and the independents. This is essential in order to compete
with
online piracy.
·
Target
audience. We
are targeting the 13-34 year-old demographic that represents 75%
of music
downloaders, many who today believe content should be free. The age
traditional 12-17, 18-24 and 18-34 demographic groups are viewed
as
extremely attractive segments of the advertising marketplace, given
high
current (or future) disposable incomes and strong brand loyalties
and
openness to new brands. This brand loyalty is even more pronounced
in the
age 12-17 segment that is being courted in the social media space,
such as
MySpace. This is an important segment for major brands that are
undertaking initiatives to build brand awareness, brand loyalty and
increase sales.
The
18-34
year-old audience has a fundamental belief that online content should be free,
especially music. This group has disposable income but they just choose to
spend
it on things other than online entertainment content. Some members of this
audience are looking for reliable legal alternatives to illegal Peer-to-Peer
services - this is especially true of the younger end of our target demographic.
The 13-24 year-old segment is unlikely to use music sites that charge a fee
for
music downloads, as long as there are alternatives available. Our plan
capitalizes on the desire for ad-supported content and monetizes this
demographic’s interest in music. The industry has been facing the possibility of
losing nearly two generations of users, and we believe our business model is
designed to bring them back and retain them.
The
target audience has become more difficult to reach due to the proliferation
of
leisure activities, the decrease in time spent on traditional media (TV and
print), and the increase in time spent online. This audience is highly receptive
to targeted and contextually relevant commercial messages which acknowledge
who
they are and their desires. Our site is designed to integrate the advertising
and content into a more holistic entertainment experience and in so doing will
attract and keep our audience engaged for more than just a download transaction.
Demographically,
this group falls in the 13-34 age range, allowing us to reach the most
attractive target audience for advertisers. The most prolific downloaders within
this group are aged 16-24. We have done extensive research on the 13-34 year-old
demographic’s lifestyle, entertainment habits and, in particular, online music
behavior. Our site is being designed and built for a user experience that
appeals to this group, which we hope will allow us to deliver this much-coveted
audience to advertisers very efficiently. Our internal research showed that
all
segments of our target audience were open to relevant brands and advertising,
and viewed the ad-supported business model favorably. We believe this will
allow
advertisers to have confidence that the ads they are placing are reaching the
right audience and ultimately allow us to achieve premium ad rates for
delivering this demographic.
·
Ad-supported
legal music.
We will enable users to download music legally on an ad-supported
basis.
We plan to provide ad-supported music to registered users through
the
advertising we sell on our site - hence the phrase “ad-supported” music
downloads. Music companies are endorsing the business model whereby
they
are compensated for the lack of fees charged for the music downloads
by
contractually agreeing to a material percentage of the ad-revenues
and an
allocation of unsold ad inventory for promotional purposes. Ad units
on
the site are intended to include high impact videoads,
rich media units, banners and
buttons.
-
Ad-Supported
Music.
Music is licensed by us from the record companies for ad-supported
downloads. While many in the target audience believe that content
should
be free, they have different opinions on what free means. Our focus
group
research indicates that time spent downloading music is considered
a
valuable use of time. Time and money are currencies and the users
are more
than willing to watch commercial advertising as ”payment” for their
content where ads are an integral and contextually relevant part
of the
experience. Our ad-supported business model was viewed favorably
by all
ages in the target demographic. There is no requirement to provide
any
financial or other information beyond the initial limited registration
information.
-
Legal.
The license agreements with the music industry will allow users to
synchronize their libraries and playlists on their personal computer
and
up to two portable devices. Provided users use the music in the manner
they have agreed to with the site, they will not be subject to lawsuits
from the music industry for infringing copyrights.
·
Privacy.
Upon
a user’s initial visit to our site, he or she must register before
downloading any music - this process is simple and requires minimal
effort. Very limited information is requested at time of sign-up
- email
address, age, gender and zip code or state. Each user selects a unique
ID
by which they are identified each time they return to the site. All
data
will be handled with a high level of sensitivity. We intend to be
a
community that people will not only visit, but come to stay and they
and
their privacy will be treated accordingly. The service will be designed
initially so that if any data is shared with advertisers, marketers
or
vendors, it will be provided at an aggregate level and will not include
information that can identify an individual, unless they have given
their
express consent.
5
·
Targeted
advertising.
The minimal data users provide at registration will be used to validate
the user and to facilitate targeted advertising with age and gender
appropriate messages.Our
proprietary solution enables the behavior of each individual to be
tracked
by their unique ID assigned at registration. This process ensures
that ads
shown to the users are contextually relevant to their appropriate
user
characteristics and privacy is maintained. For example, a 26 year-old
man
may see an ad for beer while a 16 year-old boy would not. We intend
to
enhance our advertising delivery system to direct ads based not only
on
user characteristics, but also on individual behavior on our site.
Over
time we will learn more about our users’ tastes (music genre downloaded,
concerts attended, fan clubs participated in, etc.) and we will be
better
positioned to provide even more targeted advertising.
·
Non-intrusive
advertising.
Our research has indicated that our users are not opposed to advertising;
however they are opposed to intrusive advertising. The business model
is
driven by advertising and the rich user experience has been designed
to
make this advertising part of the experience. The site has been designed
with contextual advertising primarily through rich media and broadband
video commercials in addition to the more traditional banners and
buttons.
It is our intention to not have intrusive advertising such as pop-up
ads.
While users are searching the site or downloading, they are free
to peruse
the ads, visit other areas of the site and/or activate rich media
ads.
·
Site
Design.Our
site is being designed and developed around the user’s experience and not
just for downloading transactions. Our design and development team
is
creating an integrated entertainment experience by incorporating
into the
design extensive target demographic research and insights on how
this
audience lives and consumes its music and other entertainment. The
process
for discovering new content is one that the user is passionate about,
and
one that requires multiple sources and destinations for information.
Over
time, we intend to incorporate important sources for discovery such
as
reviews, lyrics, communications and community (email and playlists),
artist information (bios, event calendars such as concert and tour
information) and metadata thus creating a unique central destination
for
the discovery of new music together with the ability to download
the
music, as well as other entertainment
content.
·
Control
over content.
Virus-free downloads, clean and complete downloads, reliable and
consistent download process, lyrics, categorization by genre, and
metadata
are key content differentiators our site will provide. Unlike Peer-to-Peer
services, we will have control over the content that appears on the
site.
This is very important and attractive to advertisers as they will
not have
to worry about their products being associated with objectionable
content.
Control is especially important with respect to the teen segment
of our
audience, especially for the younger 13-15 year-old subset and their
parents who monitor their online usage. By only including licensed
content
that is controlled at the outset, we have a cost effective model
that will
not require dedicated overhead for people to monitor site content.
This
compares favorably to Myspace.com which currently dedicates more
than 1 in
3 employees to content filtering.
·
Content
and major music label participation. Our
business model plans to monetize the heretofore non-revenue producing
illegal Peer-to-Peer downloads currently estimated to be 20 billion
illegal downloads a year. Record labels will be motivated to see
us
succeed once they see significant positive revenues and the possible
reduction in piracy and the associated costs. A truly successful
music
site must include the artists from major labels and independent labels,
including what young people perceive as the latest acts. This cannot
happen without the support of the record labels and music publishers,
which must license rights to their music. Agreements have been reached
with amongst others Universal Music Group and Independent labels
- Toddler
Records, Tommy Boy Records, MC Records and Koch Records - to have
their
music libraries included in our online catalog. These agreements
allow us
to deliver new releases on the day they are released to the public.
We are
in the midst of negotiating digital rights licensing agreements with
the
other labels for similar agreements. Publishers are also getting
on board
with deals signed or imminent with major holders of publishing rights.
Agreements have been reached with amongst others EMI Music Publishing,
Cherry Lane Music Publishing, Carlin America, Anna Teresa Music/Helene
and
Blue Music.
·
Scalable
business model. Our
business model is intended to be highly scalable because ad-supported,
legal and virus-free content has universal appeal to our target audience
in nearly every market, and global advertisers all seek out this
highly
desirable audience. Our model is intended to provide a highly targeted
environment for advertisers, with virtually no barriers for participation
by the target group because the normal rules of e-commerce (i.e.,
credit
card required) do not apply. Because the value proposition appeals
to our
target demographic, we believe the potential reach and growth rate
is
attractive.
6
·
Strong,
leveragable financial model, with success-based costs.
We
are not a capital intensive business. Our business model of sharing
advertising revenues with the music industry allows our costs to
be
controlled, our gross profit margins to be predictable and our
profitability to be a function of how well we manage our operating
expenses. At the same time, we intend to maintain a focus on the
appropriate advertising and promotional activities which will build
an
audience and then retain this user base. From a cash flow standpoint,
the
major expenditures we anticipate are royalties to the record labels,
publishers and ongoing operating expenses including marketing. We
can also
expand the business to include additional sources of revenue, such
as
selling “permanent” music or selling concert tickets.
·
Quality
product. In
an attempt to diminish the entertainment experience, content owners
have
used a number of technologies to lower the quality of music and film
files
downloaded from pirate online music services. This has been done
with
various degrees of success. We will deliver virus-free digital files
received directly from the record labels. This is a key component
in
convincing potential users to migrate from pirate online music services
due to the variable quality experienced. Music downloaded from us
will be
encoded at 128Kbps, the same quality that users get from popular
paid
sites such as iTunes.
·
Evolving
landscape for music industry.
Our business model provides a solution for the problems facing the
music
industry, as described below, by providing a viable legal alternative
to
the illegal Peer-to-Peer music sites, an audience for advertisers
and an
attractive music source for young adults. The problems
include:
-
Piracy.
Illegal downloading of music remains the most important issue as
music
industry sales have continued to fall. Over the last five years,
CD units
shipped have fallen 25.1% on a cumulative basis and the resultant
revenue
decrease is 20.3% over the same
period.
-
Lack
of CD sales.
Sales of digital tracks are up 75% for the period January-July 2006
compared with the same period in 2005. In 2005, record company revenues
from digital sales were an estimated $1.1 billion globally. This
is
nowhere close to making up for the loss of physical product sales
which
are down over $9 billion annually and continuing to
fall.
-
Advertisers
and Internet advertising. With
larger overall ad budgets, more companies have shifted advertising
from
other media to the Internet. U.S. online ad spending reached $12.9
billion
in 2005 and is predicted to reach $15.6 billion in 2006 and $22.3
billion
in 2009. The ability to reach the 13-34 demographic through traditional
means has decreased. Advertisers now have new connection points as
Internet advertising has increased significantly, especially with
exploding broadband adoption, the advent of video streaming and the
ability to run TV-style ads on the
Internet.
-
Broadband.
The availability, adoption and speed of in-home broadband connections
have
drawn millions of users to the Internet from other media. Similarly,
it
has opened a new distribution pipeline for entertainment content,
both
legal and illegal.
-
Download
site with value-added related content.We
are not a transaction-based store like iTunes or Napster, but a global
ad-supported personalized music service where registered users can
stay
for a more holistic music related visit. In addition to ad-supported
music
downloads, over time we plan to add concert information, reviews,
lyrics,
news, charts, the ability to purchase albums, digital tracks or relevant
merchandise through strategic partnerships with the music industry
and
e-tailers. In addition to the ability to email album recommendations,
save
the album for later or include it on a favorites list, future releases
could include other programming content as well as social networking
applications with the appropriate controls such as blogs, podcasts,
artist
chat, and chat rooms to name just a few. We also plan to offer sponsor
contests and work with our partners in the advertising and music
industry
to reach and connect with the target audience in new and exciting
ways.
Our
Technology
We
own
and develop our own technology, both for the front-end PCs and the back-end
server systems. Our technology consists of tens of thousands of
lines of proprietary code. The front-end technology is designed in New
York, NY and the backend technology in Seattle, WA by permanent employees
of our company. We believe that our in-house technology know-how is a key
asset for us at launch and moving forward. This is in stark contrast
with several potential competitors who have outsourced either the front-end
or back-end technology of their solution - or in some cases both.
Our
website, www.spiralfrog.com, is accessed via a standard browser
and consists of a server-based web service that includes a relational
database, a file store and a digital rights management (DRM) service.
We will support users who run Windows XP or Windows Vista, running either
the Microsoft Internet Explorer or Firefox browsers.
Unlike
most digital music stores today, we allow users to search and browse for
their favorite songs and videos without first registering for the service,
or
requiring to download client software. Only after the user has confirmed
their favorite track or video exists (including via an audio clip or a
video stream) does the site request the user to register and install the
download manager that permits files to be transferred to the user's hard disk
via the browser interface. We believe this type of unique design will help
us get many more users to try out our site by lowering the upfront
requirements of the typical music sites today. This will also
encourage users to check back often as we build our music and video catalogs
over time - and many users will find other things to do on the site,
helping us build our unique user numbers as all visitors will be consuming
our
sponsors' advertisements.
7
We
rely
on the Microsoft DRM platform to ensure copyright protection of the files,
as
required by content owners. We have developed a sophisticated system to be
able to report actual playcount data for each song and video which forms the
basis of royalty reports to the record labels and publishers. This permits
our revenue and royalty model to be independent of the number of downloads,
allowing for a site design that makes downloading easy and
convenient.
By
marrying the demand for music, entertainment, the marketers’ appetite for
reaching the 13-34 year-old demographic and the music industry’s desire to
reduce piracy and generate revenues, we believe we will offer a unique
win-win-win scenario for all involved in the content supply chain:
·
The
marketers and the advertising industry win
with direct access to this fundamentally important and elusive 13-34
year-old target market;
·
Users
win
with access to a site with an unprecedented combination of music
catalogs,
information for new music discovery and legal music
downloads;
·
The
music industry wins
by
possibly reducing and possibly reversing economic losses suffered
as a
consequence of music piracy by:
-
generating
new revenues; and
-
Potentially
stemming the tide of music piracy, which is estimated to total 20
billion
tracks a year by the RIAA.
In April 2007,
we previewed our site in Canada on an “invitation-only basis”. The purpose
of this first phase is to test the operational and functionality aspects of
the
site, and to receive initial feedback on the user experience. We currently
have over 2,000 members taking part in these previews and have received very
constructive feedback about the site’s viability. In the first month, the
average member has downloaded 16 songs and viewed 15 pages per visit. In
May 2007, we went “live” on our website in Canada.
The
website currently has over 550,000 songs available for download and 1,200 music
videos that can be currently watched on the website or downloaded. As we enter
into additional licensing agreements and as more content becomes available
under
our current licenses, we will be adding them to our database. In connection
with
registration, users need to submit their email address, age, gender, and
Zip/Postal code information, and to create a user name and password. Users
then
download and install our Download Manager, which allows users to download songs
from our site. Users can search for specific songs or artists or browse by
genre. Upon downloading a song, the user is required to type in a randomly
generated visual verification code in order to activate the downloaded song,
which process must be completed within 60 seconds after downloading is
completed. While a song is downloading, users can queue up additional songs
for
downloading and move them up or down the queue list in the order of priority
the
user selects. Once the prior song finishes downloading, users can click to
have
the next song begin downloading.
In
order
to be able to keep downloading songs and playing songs previously downloaded,
users are required to renew their membership at least every 30 days. In order
to
renew, users must enter their user name, email address, randomly generated
code
and answer a few questions about the user and his or her habits. Once the
membership is renewed, the digital rights management, or DRM, program updates
the license. Any songs on the user’s computer will automatically be updated, and
the user must sync their portable music devices to their computer to update
their song licenses.
Future
Opportunities
After
the
initial services have been launched, we plan to leverage our installed base
and
knowledge of user musical preferences to key affiliates and partners who sell
other entertainment products and services. We plan to have a second source
of
revenue produced from these third-party deals, which will encompass related
music products, including ad-free music for permanent ownership, digital videos,
ringtones, lyrics, concert tickets and potentially non-music related products
and music related hardware. We also plan to enter into alliances for online
ticket sales with appropriate companies in each market.
The
success of this model depends upon; 1) getting licenses from the music industry
to distribute songs using this new price model and; 2) negotiating reasonable
revenue splits that are based upon revenue percentages (and not fixed dollar
amounts per download or per play), such as the deal we have been successful
in
negotiating with Universal Music Group. This is necessary since we expect our
revenues to vary by song.
8
Competition
We
face
direct competition from illicit pirate music sites. These Peer-to-Peer sites
distribute free music, in most cases:
·
Without
the consent of the music owners, artists or
publishers;
·
Without
paying for their content;
·
Without
any advertising or marketing costs and a very limited or zero cost
of
goods sold ;
·
From
a company that is often incorporated in countries where intellectual
property laws are barely enforced, or not enforced at
all;
·
Downloads
do not include any DRM and no restrictions are imposed on sharing
or CD
burning;
·
These
services do not impose time-out restrictions on
downloads;
·
Where
spyware, varied file quality and viruses are the
norm;
·
Incorrect
metadata such as labels, descriptions and categorizations result
in poor
search capabilities;
·
Slow
and inaccurate downloads; and
·
Limited
or no information for music
discovery.
We
will
compete with these sites by offering a service that addresses all of the
above-mentioned limitations of the Peer-to-Peer services, namely higher quality
music that is virus-free; accurate metadata (name of the song, artist, composer,
etc.); spyware and virus-free downloads that will not slow down a user’s
computer and; sophisticated discovery tools and search capabilities. Our service
is being built to be more accurate, reliable and faster than anything the
Peer-to-Peer services can offer.
Over
70%
of downloaders are under the age of 35 and many believe that content should
be
free. As such, the Peer-to-Peer services will be our main competition. However,
we do expect to have older segments of our audience who will look to paid and
subscription services as our competition.
Employees
As
of
June 21, 2007, we have 15 full time employees and one consultant. We consider
our relations with our employees to be good. We believe our future will depend
in large part on our ability to attract and retain highly skilled
employees.
Legal
Proceedings
From
time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm our business. We are currently not aware
of any such legal proceedings or claims that we believe will have, individually
or in the aggregate, a material adverse affect on our business, financial
condition or operating results.
9
Risk
Factors
Anyone
considering an investment in our company should consider the following risk
factors.
We
Have a History Of Losses Which May Continue, Which May Negatively Impact Our
Ability to Achieve Our Business Objectives.
We
incurred net losses of $6,743,302 and $1,079,925 for the years ended December31, 2006 and 2005, respectively. For the three months ended March 31, 2007,
we
incurred a net loss of $1,481,713. We cannot assure you that we can achieve
or
sustain profitability on a quarterly or annual basis in the future. Our
operations are subject to the risks and competition inherent in the
establishment of a business enterprise. There can be no assurance that future
operations will be profitable. Revenues and profits, if any, will depend upon
various factors, including whether we will be able to continue expansion of
our
revenue. We may not achieve our business objectives and the failure to achieve
such goals would have an adverse impact on us.
If
We Are Unable to Obtain Additional Funding, Our Business Operations Will be
Harmed and If We Do Obtain Additional Financing, Our Then Existing Shareholders
May Suffer Substantial Dilution.
We
will
require additional funds to complete additional licensing agreements, research
and development and website maintenance. We anticipate that we will require
up
to approximately $18,000,000 to fund our continued operations for the next
twelve months, depending on revenues from operations. Additional capital will
be
required to effectively support the operations and to otherwise implement our
overall business strategy. There can be no assurance that financing will be
available in amounts or on terms acceptable to us, if at all. The inability
to
obtain additional capital will restrict our ability to grow and may reduce
our
ability to continue to conduct business operations. If we are unable to obtain
additional financing, we will likely be required to curtail our marketing and
development plans and possibly cease our operations. Any additional equity
financing may involve substantial dilution to our then existing
shareholders.
Our Independent
Registered Public Accountants Have Expressed Substantial Doubt About Our Ability
to Continue As a Going Concern, Which May Hinder Our Ability to Obtain Future
Financing.
In
their
report dated June 15, 2007, our independent registered public accountants
stated that our financial statements for the year ended December 31, 2006 were
prepared assuming that we would continue as a going concern. Our ability to
continue as a going concern is an issue raised as a result of recurring losses
from operations and a significant working capital deficiency. We continue to
experience net operating losses. Our ability to continue as a going concern
is
subject to our ability to generate a profit and/or obtain necessary funding
from
outside sources, including obtaining additional funding from the sale of our
securities, increasing sales or obtaining loans and grants from various
financial institutions where possible. Our continued net operating losses
increase the difficulty in meeting such goals and there can be no assurances
that such methods will prove successful.
If
we fail to get nearly all the record labels to agree to work with us, our
business model could fail.
There
are
four major record labels, which represent a large majority of the business.
We
have entered into an agreement with Universal Music Group, which is the largest
record label, to distribute the music to our users on an ad-supported basis,
in
return for a percentage of the revenue from the commercials. We believe that
our
approach to licensing music is radically different than anything which has
ever
been done before. It involves a level of risk to the labels, since our unique
business model could take away from their other revenue streams. While the
level
of interest of the other major and independent record labels is encouraging,
there is no guarantee that they will all license us their music on business
terms that we require. In the event that we are unable to enter into agreements
with most of the other major and independent record labels, it is unlikely
that
we will be able to attract and keep users to our site. If we are unable to
offer
a significant portion of all available music, our business model is likely
to
fail and we will need to cease operations or develop a new business
model.
10
If
we fail to get Peer-to-Peer users to switch to our site, we will be unable
to
generate the revenues necessary to continue our
operations.
Even
if
we offer the downloads for free, there is a chance that the people who use
popular file sharing applications such as Limewire, KaZaA and Morpheus will
continue to use those sites and not switch to us in large numbers. In the event
that users do not switch from file sharing applications to our services, we
may
not generate enough revenues and may be unable to convince record labels to
continue making their catalogues available, which would cause us to cease
operations.
The
songs we provide do not play on Apple iPods, which could result in fewer users
of our services.
As
the
first and largest legal music download site, Apple has managed to maintain
their
market share by limiting the playability of music and video content purchased
through iTunes, a closed proprietary interface that does not support any digital
rights management other than the Apple AAC format. Apple is the category leader
for portable digital music players with approximately 76% of the U.S. market
share and 26% share of the worldwide market. Since launch five years ago, more
than 60 million iPods have been sold globally. Over a five year period many
have
been replaced or upgraded and the actual figure of working iPods is estimated
to
be nearer 40 million. Since our music and videos cannot be downloaded to an
iPod, users will need to purchase a portable digital music player that is
compatible with our services if they want to make their music portable. As
a
result, users may be unable or unwilling to spend the additional money and
may
not use our site.
We
distribute songs which have time out restrictions and have other usage
restrictions, any one of which may reduce the size of our audience.
For
the
most part, we are required by the record labels to place restrictions on how
the
ad-supported music is used. For example, the downloads are restricted to
personal use only. While we believe most of our target audience are using this
service for personal reasons only and will accept this timeout for the trade-off
of assured quality music downloads which are fully licensed, legal, and
virus-free, among other added values, some young users may prefer to continue
to
steal music from pirate sites in order to circumvent any of these restrictions,
in particular our timeouts.
The
largest record label has imposed specific restrictions on the music we deliver,
in order to create some differentiation between ad-supported and paid for music.
In other words, the labels want to preserve some market for music that is
actually purchased with money. We do allow users to move the music they download
to their portable music players, their mobile phones, and other portable
devices. However, the major restriction is that we do not allow users to “burn”
CDs in most cases. Therefore, some of the users who obtain music illicitly
from
pirate sites with the explicit intent of burning CDs will continue to use pirate
sites for this purpose. With the rapid growth of digital music players and
music
enabled cell phones, we expect the number of such cases to decline over time,
but there is no guarantee as to how fast this will happen, and what negative
impact this could have on our projected revenues.
It
could take a long time to get our advertising revenues at the level we require
to properly compensate the recording industry.
We
expect
advertisers to migrate to us, but they are by nature conservative and will
require convincing that we are a desirable destination for the age 13-17 and
especially the overall age 18-34 demographic. Although there is a significant
shift of dollars to the Internet, any new publisher is going to have to prove
its place on the advertisers’ schedule and fight for its share of the available
dollars. A new service, no matter how strong the proposition, will come under
additional scrutiny from the advertiser’s advertising agency and media buying
company. They will attempt to exploit our “newness” by demanding test rates that
are below true market value. In the very beginning it may be prudent to take
such deals in order to have the client experience the service and see first
hand
the value that we can deliver.
Mechanical
licenses may not be available for some songs.
Song
writers and music publishers have many protected rights. At least two types
of
rights for their music are implicated by our business plan. The first is the
right to make reproductions of the songs in recorded music; this right is called
the mechanical license. We have been negotiating this mechanical license with
the companies and organizations that grant this license on behalf of the
writers. We believe that we will be able to obtain the necessary rights for
most
of the music that we will distribute on the terms that we seek. However, there
will be some music publishers who might not grant us the necessary rights and
their songs would thus be excluded from our service.
Performance
rights might not be available for all songs.
Song
writers and music publishers also have a right to be paid a royalty whenever
their music is performed (those royalties are payable, for example, when a
song
is performed or played on the radio or on television or streamed on the
Internet). We might be liable for this expense, especially when video is
displayed on our web site or desktop software, such as when a music video or
“television commercial” is streamed, when we show a short film or TV program, or
if we provide games with music playing in the background. Typically, these
licenses are collected by “performing right collecting societies”, such as
ASCAP, BMI, and SESAC in the United States, and other societies in each country
around the world. While we have already signed a license with BMI and SESAC
and
we believe we will conclude a deal with ASCAP, there is no guarantee that we
will, nor is there a guarantee that we will obtain such license on the
percentage terms we seek. We made application to ASCAP for a license, and in
so
doing were advised that they would take no action against the company for
performing songs in the ASCAP repertoire, but the terms of a license agreement
have not yet been concluded. If we are forced to pay a higher percentage than
we
plan, this could adversely affect our operating margins.
11
We
have a limited operating history with which to judge our performance.
We
have
been in existence since October 2003 (date of filing Articles of Organization)
and engaged in developing our business model since February 2004. As a result,
we have only a limited operating history upon which to evaluate our business
and
prospects. Our proposed business operations will be subject to numerous risks
associated with early stage enterprises and the development, production and
sale
of the types of products and services that we offer. These risks apply
particularly to us because the markets for our technology and products are
new
and rapidly evolving. We cannot assure shareholders that our business strategy
will be successful or that we will successfully address these risks. Our failure
to do so could materially adversely affect our business, financial condition
and
operating results.
Our
future success depends on significant growth in our business and we may not
be
able to manage our future growth successfully.
Our
ability to offer broadband entertainment services successfully and implement
our
business plan in a rapidly evolving market requires an effective planning and
management process. Our growth could be limited if our management team is not
able to achieve the effective planning and rapid execution necessary to fully
exploit the market opportunities presented to us. In the future, we plan to
increase the scope of our operations at a rapid rate. Such expansion efforts
could be expensive and may strain our managerial and other resources. To manage
future growth effectively, we must maintain and enhance our financial and
accounting systems and controls, integrate new personnel, manage expanded
operations and our relationships with our customers, suppliers and partners.
If
we do not manage growth properly, it could harm our operating
results.
If
we are unable to retain the services of Messrs. Mohen, Schrieberg and
Suomalainen or if we are unable to successfully recruit skilled personnel,
we
may not be able to continue our operations.
Our
success depends to a significant extent upon the continued services of Mr.
Joe
Mohen, our Chairman and Founder, Mr. Schrieberg, our Chief Executive Officer
and
Mr. Suomalainen, our Chief Technology Officer. Loss of the services of Messrs.
Mohen, Schrieberg or Suomalainen could have a material adverse effect on our
growth, revenues, and prospective business. We do not maintain key-man insurance
on the life of Messrs. Mohen, Schrieberg or Suomalainen. In addition, in order
to successfully implement and manage our business plan, we will be dependent
upon, among other things, successfully recruiting qualified skill personnel.
For
example, we may need to recruit very senior managers who have run major
television networks and there is no guarantee that a young company can attract
such talent. Immigration laws may further restrict our ability to attract or
hire qualified personnel. Competition for qualified individuals is intense.
There can be no assurance that we will be able to find, attract and retain
existing employees or that we will be able to find, attract and retain qualified
personnel on acceptable terms.
We
operate in business climates and industries that change rapidly and in
unexpected ways.
Rapid
technological change and uncertainty due to new and emerging technologies and
shifting consumer preferences characterize the broadband entertainment industry
and the target market industries to which we market and sell our products.
We
may be unable to develop, integrate and market, on a timely basis, the new
and
enhanced products and services necessary to keep pace with competitors. Our
products and services may be rendered obsolete by the offerings of our
competitors or by changes in computing technologies for the fields addressed
by
our software. Failure to anticipate or to respond to changing technologies,
or
significant delays in the development or introduction of products or services,
could cause customers to delay or decide against purchases of our products
or
services.
If
the technology we rely upon becomes obsolete, we may not be able to market
our
services.
The
technical features of our site will in large part determine the marketability
of
our product. New market entrants may succeed in developing and introducing
new
or enhanced systems having technologies and features superior to, or more
effective than, any technologies which have been or are being developed
rendering our services obsolete or less marketable. Accordingly, the ability
for
us to compete will be dependent on the timely enhancement of our existing
products as well as the development of future products. There can be no
assurance that we will be able to keep pace with technological developments,
or
that our products will not become obsolete. Technological obsolescence of the
existing technology remains a possibility, which would have a material adverse
affect on our operations.
12
We
face strong competition that could prevent us from adding new customers or
expanding our existing customer relationships.
The
market for broadband entertainment is intensely competitive, subject to rapid
change and significantly affected by new product introductions, pricing
strategies and other market activities of industry participants. Our primary
competitors are the illegal Peer-to-Peer services that have been under fire
from
various international entertainment, legal and governmental organizations for
potentially breaching copyright and intellectual property laws.
We
may not be able to protect adequately the trade secrets and confidential
information that we disclose to our employees.
We
rely
upon trade secrets, technical know-how and continuing technological innovation
to develop and maintain our competitive position. Competitors, through their
independent discovery (or improper means, such as unauthorized disclosure or
industrial espionage), may come to know our proprietary information. We
generally require employees and consultants to execute confidentiality and
assignment-of-inventions agreements.These
agreements typically provide that all materials and confidential information
developed by or made known to the employee or consultant during his, her or
its
relationship with us are to be kept confidential and that all inventions arising
out of the employee’s or consultant’s relationship with us are our exclusive
property. Our employees and consultants may breach these agreements and in
some
instances we may not have an adequate remedy. Additionally, in some instances,
we may have failed to require that employees and consultants execute
confidentiality and assignment-of-inventions agreements.
We
may not be able to adequately defend our intellectual property from third party
infringement, and third party challenges to our intellectual property may
adversely affect our rights and be time consuming and
costly.
Some
of
our competitors have, or are affiliated with companies having substantially
greater resources than we have, and those competitors may be able to sustain
the
costs of complex patent litigation to a greater degree and for longer periods
of
time than us. Uncertainties resulting from the initiation and continuation
of
any intellectual property litigation could have a material adverse effect on
our
ability to compete in the marketplace pending resolution of the disputed
matters. An adverse outcome could subject us to significant liabilities to
third
parties and require us to license disputed rights from third parties or cease
using the technology. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary.
We
may be subject to claims of infringement by third parties that may adversely
affect our rights and may be costly and time consuming to
defend.
Third
parties may claim infringement by us of their intellectual property rights.
Our
products may infringe other intellectual property rights of third parties.
We
may be required to seek licenses for, or otherwise acquire rights to, technology
as a result of claims of infringement. We may not possess proper ownership
or
access rights to the intellectual property we use. Any claims, with or without
merit, could be time consuming to defend, result in costly litigation, divert
management’s attention and resources, cause product development delays or
require us to enter into royalty or licensing agreements. Royalty or licensing
agreements, if required, may not be available on terms acceptable to us, if
at
all. In the event of a successful claim of product infringement against us,
our
failure or inability to license or design around the infringed technology could
have a material adverse effect on our business, financial condition and results
of operations.
13
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION.
Forward-Looking
Statements
The
information in this report contains forward-looking statements. All statements
other than statements of historical fact made in report are forward looking.
In
particular, the statements herein regarding industry prospects and future
results of operations or financial position are forward-looking statements.
These forward-looking statements can be identified by the use of words such
as
“believes,”“estimates,”“could,”“possibly,”“probably,” anticipates,”
“projects,”“expects,”“may,”“will,” or “should” or other variations or similar
words. No assurances can be given that the future results anticipated by the
forward-looking statements will be achieved. Forward-looking statements reflect
management’s current expectations and are inherently uncertain. Our actual
results may differ significantly from management’s
expectations.
The
following discussion and analysis should be read in conjunction with our
financial statements, included herewith. This discussion should not be construed
to imply that the results discussed herein will necessarily continue into the
future, or that any conclusion reached herein will necessarily be indicative
of
actual operating results in the future. Such discussion represents only the
best
present assessment of our management.
Background
We
were
formed in February 5, 2004 as Mohen Entertainment Portals, LLC, which then
merged with and into Mohen, Inc. on May 12, 2005. We are a development stage
company seeking to establish an advertising-funded, free and legal music
download internet site specifically targeted to the age 13-34 market.
Substantially all revenue will be produced from advertising appearing on our
website. We initiated a beta test of our website in Canada in April 2007
and went live in Canada in May 2007. We intend to launch our website in
the United States approximately the start of August 2007. We intend to attract
advertisers who desire to placed targeted advertisements on our website. During
2006, we licensed sound records from Universal Music Group for use on our
website in North America. We are seeking to license additional rights from
other
record labels and music publishers to broaden our offering.
Plan
of Operations
Over
the
next 12 months, we plan to aggressively expand our catalogue of music and videos
available for download to our users. In addition, we hope to attract a
significantly large number of unique users and advertisers wanting to provide
targeted marketing to our users. We anticipate that we will need approximately
$18 million in order to fully implement our business plan over the next 12
months. Our targeted goals and milestones for each of the next four quarters
is
as follows:
July
to September 2007:
●
Sign
additional independent music labels to add one million or more
audio music
tracks to our content
inventory.
●
Expand
United States sales force by adding at least five sales
people.
●
Sign
additional United States publishing
agreements.
Sign
additional United States music publishing
agreements.
●
Execute
marketing campaign in the United States aimed at 13-34 year
olds, through
one or more of the following approaches: hire gorilla marketing
firms for
unconventional promotions; consumer targeted press releases;
advertising
on some of the youth community sites; or hiring “bloggers” to attract
attention to us on the
internet.
●
Conduct
a private placement to raise up to $25
million.
●
Sign
third major music label and increase inventory to three million
audio
tracks.
January
to March 2008:
●
Achieve
at least three million unique monthly
users.
●
Increase
marketing programs.
●
Sign
fourth major music label.
●
Hire
vice president of business development to provide joint marketing
agreements and strategic
alliances.
As
of
December 31, 2006 and March 31, 2007, we had cash on hand of $498,009 and
$45,005, respectively. Development stage net loss for the year ended December31, 2006 was $6,743,302 compared to $1,079,925 for the year ended December31,2005 and $1,481,713 for the three months ended March 31, 2007 compared to
$81,573 for the three months ended March 31, 2006, which was due to a temporary
stall in operations from a lack of capital. The loss for the year ended
December 31, 2006 consisted primarily of selling expenses, costs to develop
our
website and software technology, and legal and accounting expenses incident
to
our development stage activities. For the year ended December 31, 2006, we
used
$137,460 in investing activities in connection with the purchase of property
and
equipment. For the year ended December 31, 2006, we received $8,327,975 from
financing activities, which was comprised primarily of $8,292,456 from the
sale
of Series B Convertible Preferred Stock. For the year ended December 31, 2006,
we used $7,657,023 in operating activities, including $6,743,302 in net losses,
$2,434,560 million for the payment of deferred music licenses and other fees,
$171,356 in prepaid expenses and other current assets, $35,658 in officer loans
and $34,022 in security deposits, which were offset by $1,440,000 in
amortization of deferred licenses, $262,334 in accounts payable and accrued
expenses, $35,658 in bad debts and $21,500 in depreciation.
We
expect
significant capital expenditures during the next 12 months, contingent upon
raising capital. These anticipated expenditures are for music license
acquisitions, website maintenance and development, overhead and working capital
purposes. We have sufficient funds to conduct our operations for a few months,
but not for 12 months or more. There can be no assurance that financing will
be
available in amounts or on terms acceptable to us, if at all. We anticipate
that
we will require up to approximately $18 million to fund our plan of
operations for the next twelve months, depending on revenues, if any, from
operations.
By
adjusting our operations and development to the level of capitalization, we
believe we have sufficient capital resources to meet projected cash flow
deficits. However, if during that period or thereafter, we are not successful
in
generating sufficient liquidity from operations or in raising sufficient capital
resources, on terms acceptable to us, this could have a material adverse effect
on our business, results of operations liquidity and financial
condition.
We
presently do not have any available credit, bank financing or other external
sources of liquidity. Due to our brief history and historical operating losses,
our operations have not been a source of liquidity. We will need to obtain
additional capital in order to expand operations and become profitable. In
order
to obtain capital, we may need to sell additional shares of our common stock
or
borrow funds from private lenders. There can be no assurance that we will be
successful in obtaining additional funding.
We
will
still need additional investments in order to continue operations to cash flow
break even. Additional investments are being sought, but we cannot guarantee
that we will be able to obtain such investments. Financing transactions may
include the issuance of equity or debt securities, obtaining credit facilities,
or other financing mechanisms. However, the lack of a trading price of our
common stock and a downturn in the U.S. stock and debt markets could make it
more difficult to obtain financing through the issuance of equity or debt
securities. Even if we are able to raise the funds required, it is possible
that
we could incur unexpected costs and expenses, fail to collect significant
amounts owed to us, or experience unexpected cash requirements that would force
us to seek alternative financing. Further, if we issue additional equity or
debt
securities, stockholders may experience additional dilution or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of our common stock. If additional financing is not available
or is not available on acceptable terms, we will have to curtail our
operations.
To
date,
we have generated minimal revenues (approximately $2,994 as of June 21, 2007)
and have incurred operating losses in every quarter. Our
independent registered public accountants have stated in their report dated
June 15, 2007, that we are a development stage company. These factors
among others may raise substantial doubt about our ability to continue as a
going concern.
In
April
2006, to obtain funding for our ongoing operations, we entered into a securities
purchase agreement with a 15 accredited investors pursuant to which the
investors purchased 10,414,654 shares of Series B Convertible Preferred Stock
at
a price per share of $0.85, for gross proceeds of approximately $8,852,456,
less
$560,000 in transaction fees.
15
The
holders of our Series B Convertible Preferred Stock may cause us to redeem
their
shares of Series B Convertible Preferred Stock at a price per share equal to
the
then-current liquidation preference as follows: (i) one-third of the initial
number of outstanding shares commencing on the fifth anniversary of closing
of
the initial issuance of Series B Convertible Preferred Stock, two-thirds of
such
shares commencing on the sixth anniversary of closing (less any shares redeemed
on the fifth anniversary), and the remainder of such shares on the seventh
anniversary of closing, and (ii) all of the outstanding shares upon the
consummation of a sale transaction, as defined therein. The holders of the
Series B Convertible Preferred Stock shall have the right to maintain their
pro
rata ownership of our capital stock by participating in certain future issuances
of our capital stock.
The
Series B Convertible Preferred Stock is convertible into our common stock,
at
the option of the holder, at any time into one share of common stock. The Series
B Convertible Preferred Stock will automatically convert into common stock
upon
the occurrence of certain events. The Series B Convertible Preferred Stock
contains anti-dilution provisions in the event of a consolidation, merger or
sale; subdivision or combination; or if we issue discounted stock. Each share
of
Series B Convertible Preferred Stock shall be entitled to cast that number
of
votes per share as is equal to the number of votes that holder would be entitled
to cast had such holder converted his shares into shares of Common Stock on
the
record date for such vote, and will vote together with the holders of our common
stock, and not as a separate class.
The
shares of Series B Convertible Preferred Stock receive preference over all
other
classes of our capital stock in the event of our liquidation to the extent
of
the liquidation preference, which is defined as the conversion price for
the
Series B Convertible Preferred Stock, subject to anti-dilution and other
adjustments. In the event that our Common Stock is not registered under Section
12(b) or 12(g) of the Securities Exchange Act of 1934 or listed for trading
on
the AIM branch of the London Stock Exchange by July 31, 2007, we will be
required to pay liquidated damages to the holders of Series B Convertible
Preferred Stock of 2% per month, subject to a maximum of 4%, for each share
outstanding for each month we are not publicly listed. We do not expect that
the
effective date of this filing to occur until after July 31, 2007 (see Note
11 to
our December 31, 2006 financial statements). In addition, if such
registration or listing has not occurred by September 30, 2007, the holders
could cause us to redeem their shares of Series B Convertible Preferred Stock
at
a redemption price of two times the then-current liquidation preference.
During
March and April 2007, we entered into securities purchase agreements with nine
accredited investors for the sale of an aggregate of $5,000,000 in senior
secured exchangeable notes, of which we received net proceeds of approximately
$4,500,000 after expenses and closing costs.
The
senior secured exchangeable notes bear interest at 12% per annum, payable
monthly commencing October 1, 2007, maturing on April 19, 2008, and are
exchangeable into our common stock, at the investor’s option, at a rate of $0.86
per share, subject to adjustment. Based on this conversion price, the $5,000,000
in senior secured exchangeable notes are exchangeable into approximately
5,813,953 shares of our common stock. The investor cannot exchange the senior
secured convertible notes into shares of our common stock until our common
stock
has been registered with the Securities and Exchange Commission under Section
12(b) or 12(g) of the Securities Exchange Act of 1934. In addition, so long
as
any shares of our Series B Convertible Preferred Stock is outstanding, the
investors are prohibited from exchanging their senior secured exchangeable
notes
into shares of our common stock. The investors have contractually agreed to
restrict their ability to exchange the senior secured exchangeable notes and
receive shares of our common stock such that the number of shares of common
stock held by it and its affiliates after such exchange does not exceed 9.99%
of
the then issued and outstanding shares of our common stock.
In
connection with the securities purchase agreements, we also entered into a
registration rights agreement providing for the filing, within 30 days after
the
senior secured exchangeable notes become exchangeable into shares of our common
stock, of a registration statement with the Securities and Exchange Commission
registering the common stock issuable upon exchange of the senior secured
exchangeable notes. We are obligated to use our best efforts to cause the
registration statement to be declared effective no later than 90 days after
such
registration statement is filed and to insure that the registration statement
remains in effect until the earlier of (i) all of the shares of common stock
issuable upon conversion of the secured exchangeable debentures have been sold
or (ii) such shares may be sold without restriction pursuant to Rule 144(k).
In
the event of a default of our obligations under the registration rights
agreement, we are required to pay to the investors, as liquidated damages,
(i) a
cash amount equal to 1.5% of the aggregate purchase of the senior secured
convertible notes, and (ii) for each 30 day period that the registration
statement has not been filed or declared effective, as the case may be, a cash
amount equal to 2% of the aggregate purchase of the senior secured convertible
notes.
The
senior secured exchangeable notes are collateralized by 3,581,000 shares of
Series A Convertible Preferred Stock and 490,000 shares of common stock of
six
of our shareholders and directors. In addition, we executed a security agreement
in favor of the investors granting them a first priority security interest
in
all of our goods, inventory, contractual rights and general intangibles,
receivables, documents, instruments, chattel paper, and intellectual property.
The security agreement states that if an event of default occurs under the
secured convertible debentures or security agreements, the investor has the
right to take possession of the collateral, to operate our business using the
collateral, and have the right to assign, sell, lease or otherwise dispose
of
and deliver all or any part of the collateral, at public or private sale or
otherwise to satisfy our obligations under these agreements.
16
Off-Balance
Sheet Arrangements
We
do not
have any off balance sheet arrangements that are reasonably likely to have
a
current or future effect on our financial condition, revenues, results of
operations, liquidity or capital expenditures.
Critical
Accounting Policies
Income
Taxes
We
account for our income taxes in accordance with SFAS No. 109, “Accounting for
Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities
and
their tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets or liabilities of a change in tax rates is recognized in
the
period that the tax change occurs. SFAS No. 109 also requires that deferred
tax
assets be reduced by a valuation allowance if it is more likely than not that
some or all of the deferred tax asset will not be realized. We have established
a valuation allowance related to the benefits of net operating losses for which
utilization in future periods is uncertain. We believe it is more likely than
not that we will not realize the benefits of these deductible differences in
the
near future and, therefore, a valuation allowance has been recorded to offset
such future tax benefits.
Revenue
Recognition
We
expect
that we will derive substantially all of our revenue from the sale of
advertising on our website. We anticipate to have four major advertising
revenues streams: Click Ad revenues will be recognized when an ad that is
placed in our website is successfully ‘Clicked’ and linked to another website or
area; Video revenues will be recognized when ads are played within the website;
Banner revenues will be recognized when an ad is displayed in our website;
and
Imprint revenues will be recognized once the established number of times an
ad
is to be shown is displayed. Any prepaid advertising payments received
will be treated as deferred revenues.
Research
and Development
In
accordance with SFAS No. 2, "Accounting for Research and Development Costs,"
all
research and development costs are expensed when they are incurred. Research
and
development expenses consist primarily of research and development activities
associated with the development of our technology. Since inception through
December 31, 2006, we have expended $886,729 for research and development
activities.
Software
Development
We
expense all costs incurred in the preliminary project stage for software
developed for internal use and capitalizes all external direct costs of
materials and services consumed in developing or obtaining internal-use computer
software in accordance with Statement of Position (“SOP”) 98-1, “Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use.” In
addition, for employees who are directly associated with and who devote time
to
internal-use computer software projects, to the extent of the time spent
directly on the project, we capitalize payroll and payroll-related costs
of such
employees incurred once the development has reached the applications development
stage. All costs incurred for upgrades, maintenance and enhancements that
do not result in additional functionality are expensed. To date, we did not
capitalize any software development costs as such technology has not
reached any definitive stage of functionality. These costs once capitalized
will be amortized to expense over the estimated life of
the software technology. We will periodically perform reviews of
the recoverability of capitalized software costs.
Web
Site Development Costs
We
adopted Emerging Issues Task Force Abstract (“EITF”) Issue number 00-2,
“Accounting for Web Site Development Costs.” EITF 00-2 provides guidance on the
accounting for the costs of development of company web sites, dividing the
web
site development costs into five stages: (1) the planning stage, during which
the business and/or project plan is formulated and functionalities,
necessary hardware and technology are determined, (2) the web site application
and infrastructure development stage, which involves acquiring or developing
hardware and software to operate the web site, (3) the graphics development
stage, during which the initial graphics and layout of each page are designed
and coded, (4) the content development stage, during which the information
to be
presented on the web site, which may be either textual or graphical in nature,
is developed, and (5) the operating stage, during which training,
administration, maintenance and other costs to operate the existing web site
are
incurred. The costs incurred in the web site application and infrastructure
stage, the graphics development stage and the content development stage are
capitalized; all other costs are expensed as incurred. To date, we did not
capitalize any web site development costs. Such costs once capitalized
will amortized to expense over the estimated life of the website
technology. We will periodically perform reviews of the recoverability of
capitalized web site costs.
17
Stock-Based
Compensation
Effective
January 1, 2006, we adopted SFAS No. 123(R), "Share Based Payment," using the
modified prospective transition method. There was no effect to the accompanying
financial statements pursuant to the adoption of SFAS No. 123R. SFAS No. 123R
is
a revision of SFAS No. 123, and supersedes APB Opinion No. 25, and its related
implementation guidance. SFAS No. 123(R) addresses all forms of share-based
payment awards including shares issued under employee stock purchase plans,
stock options, restricted stock and stock appreciation rights. Under SFAS No.
123(R), stock-based awards result in a cost that will be measured at fair value
on the award's grant date, based on the estimated number of awards that are
expected to vest that will result in a charge to operations.
Prior
to
January 1, 2006, we accounted for employee stock transactions in accordance
with
Accounting Principle Board ("APB") Opinion No. 25. "Accounting for Stock Issued
to Employees." We had adopted the pro forma disclosure requirements of SFAS
No.
123, "Accounting for Stock-Based Compensation."
Prior
to
our adoption of SFAS No. 123(R), SFAS No. 123 required that we provide pro-forma
information regarding net earnings and net earnings per share as if our
stock-based awards had been determined in accordance with the fair value method
prescribed therein. We previously adopted the disclosure portion of SFAS No.
148
"Accounting for Stock-based Compensation - Transition and Disclosure," requiring
quarterly SFAS No. 123 pro-forma disclosures. The pro-forma charge for
compensation cost related to stock-based awards granted was recognized over
the
service period. For stock options, the service period represents the period
of
time between the date of grant and the date each option becomes exercisable
without consideration of acceleration provisions (e.g., retirement, change
of
control, etc.).
There
were no stock options granted to employees during the year ended 2005.
The
cost
of stock-based compensation awards issued to non-employees for services are
recorded at either the fair value of the services rendered or the fair value
of
the stock-based award, whichever is more readily determinable, using the
measurement date guidelines enumerated in Emerging Issues Task Force ("EITF")
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services."
18
Recent
Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155 "Accounting for Certain Hybrid
Financial Instruments-an amendment of FASB Statements No. 133 and 140" ("FAS
155"). FAS 155 addresses the following: a) permits fair value re-measurement
for
any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation; b) clarifies which interest-only strips
and
principal-only strips are not subject to the requirements of Statement 133;
c)
establishes a requirement to evaluate interests in securitized financial assets
to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation;
d) clarifies that concentrations of credit risk in the form of subordination
are
not embedded derivatives; and e) amends Statement 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 financial instrument. FAS 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. We have not yet completed our
evaluation of the impact of adopting SFAS 155 on our results of operations
or
financial position, but do not expect the adoption to have a material
impact.
In
March
2006, the FASB issued SFAS 156 - "Accounting for Servicing of Financial Assets
-
an amendment of FASB Statement No. 140" ("SFAS 156"). SFAS 156 is effective
for
the first fiscal year beginning after September 15, 2006. SFAS 156 changes
the
way entities account for servicing assets and obligations associated with
financial assets acquired or disposed of. We have not yet completed our
evaluation of the impact of adopting SFAS 156 on our results of operations
or
financial position, but do not expect that the adoption of SFAS 156 will have
a
material impact.
In
July
2006, the Financial Accounting Standards Board issued Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109" (the "Interpretation"). The Interpretation establishes for
all entities a minimum threshold for financial statement recognition of the
benefit of tax positions, and requires certain expanded disclosures. The
Interpretation is effective for fiscal years beginning after December 31, 2006,
and is to be applied to all open tax years as of the date of effectiveness.
We
are in the process of evaluating the impact of the adoption of this
Interpretation. We do not expect this Interpretation to have a material impact
on our financial position or results of operations.
In
September 2006, the FASB issued Statement of Financial Accounting Standard
No.
157, "Fair Value Measurements" (“SFAS 157”). This statement defines fair value,
establishes a fair value hierarchy to be used in generally accepted accounting
principles and expands disclosures about fair value measurements. Although
this
statement does not require any new fair value measurements, the application
could change current practice. The statement is effective for fiscal years
beginning after November 15, 2007. We are currently evaluating the impact of
this statement and do not expect the adoption of this pronouncement to have
a
material impact on our financial position or results of operations.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Liabilities" ("SFAS No. 159"). SFAS No. 159 provides
companies with an option to report selected financial assets and liabilities
at
fair value, and establishes presentation and disclosure requirements designed
to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. The new guidance is
effective for fiscal years beginning after November 15, 2007. We are currently
evaluating the potential impact of this statement and do not expect the adoption
of this pronouncement to have a material impact on our financial position or
results of operations.
In
September 2006, the staff of the Securities and Exchange Commission issued
SAB
No. 108 which provides interpretive guidance on how the effects of the carryover
or reversal of prior year misstatements should be considered in quantifying
a
current year misstatement. SAB 108 becomes effective in fiscal 2007. The
adoption of this pronouncement is not expected to have an impact on our
financial position, results of operation or cash flows.
In
December 2006, the FASB approved FASB Staff Position (FSP) No. EITF 00-19-2,
"Accounting for Registration Payment Arrangements" ("FSP EITF 00-19-2"), which
specifies that the contingent obligation to make future payments or otherwise
transfer consideration under a registration payment arrangement, whether issued
as a separate agreement or included as a provision of a financial instrument
or
other agreement, should be separately recognized and measured in accordance
with
SFAS No. 5, "Accounting for Contingencies". FSP EITF 00-19-2 also requires
additional disclosure regarding the nature of any registration payment
arrangements, alternative settlement methods, the maximum potential amount
of
consideration and the current carrying amount of the liability, if any. The
guidance in FSP EITF 00-19-2 amends FASB Statements No. 133, "Accounting for
Derivative Instruments and Hedging Activities", and No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity", and FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of
Others", to include scope exceptions for registration payment arrangements.
FSP
EITF
00-19-2 is effective immediately for registration payment arrangements and
the
financial instruments subject to those arrangements that are entered into or
modified subsequent to the issuance date of this FSP, or for financial
statements issued for fiscal years beginning after December 15, 2006, and
interim periods within those fiscal years, for registration payment arrangements
entered into prior to the issuance date of this FSP. The adoption of this
pronouncement is not expected to have a material impact on our financial
position, results of operations or cash flows. However, we will be required
to
pay the holders of our Series B Convertible Preferred Stock liquidated damages
of 2% per month for each share outstanding for each month after July 31, 2007
and through September 30, 2007 that we are not publicly listed.
(1)
Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to options
or
warrants currently exercisable or convertible, or exercisable or convertible
within 60 days of June 21, 2007 are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person.
(2)
For
purposes of calculating the percentage beneficially owned, the number of
shares
of each class of stock deemed outstanding include 13,437,200 common shares;
9,440,200 Series A Convertible Preferred Shares and 10,414,654 Series B
Convertible Preferred Shares outstanding as of June 21, 2007.
(3)
Represents shares of common stock issuable upon conversion of Series A
Convertible Preferred Stock.
(4)
Includes 800,000 shares of common stock issuable upon conversion of Series
A
Convertible Preferred Stock.
(5)
Includes 400,000 shares of common stock issuable upon conversion of Series
A
Convertible Preferred Stock.
(6)
Includes 245,000 shares of common stock issuable upon conversion of Series
A
Convertible Preferred Stock.
(7)
Includes 5,938,153 shares of common stock issuable upon conversion of Series
A
Convertible Preferred Stock.
(8)
Represents shares of common stock issuable upon conversion of Series B
Convertible Preferred Stock.
22
ITEM
5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS.
A.
Identification
of Directors and Executive Officers. The current officers and directors
will serve for one year or until their respective successors are
elected
and qualified. They are:
Name
Age
Position
Joe
Mohen
50
Chairman
Mel
Schrieberg
64
Chief
Executive Officer
Vesa
Suomalainen
44
Chief
Technology Officer
James
Campbell
34
Chief
Information Officer
George
Hayes
55
Senior
VP Sales and Marketing
Roger
Munford
50
General
Manager
Orville
Hagler
50
Secretary
Jordan
Levin
39
Director
Frances
Preston
71
Director
Jerome
N. Gold
61
Director
Mark
Hutchens
52
Director
Steve
Norcia
66
Director
Robert
N. Gordon
58
Director
Albert
Hughes
43
Director
Mark
Strama
39
Director
Scott
Stagg
44
Director
Amir
Khan
39
Director
Thomas
J. Mackell, Jr.
64
Director
Joe
Mohen, Chairman
Mr.
Mohen
has been our Chairman since founding our company. Between founding our company
and May 2006, Mr. Mohen was President. Previously, between July 2001 and July
2003, Mr. Mohen was the founder and Chairman of ParishPay, a New York, New
York
online payment company that provides automated handling of donations for the
Catholic Church in the United States, by making direct deductions of monthly
offerings from parishioners checking or credit card accounts. Mr. Mohen was
a
co-founder and Chief Executive Officer of Election.com, where he worked from
1999 through 2001. Mr. Mohen was CEO of Proginet Corporation from 1991 thru
1996, which he founded in 1986.
Mel
Schrieberg, Chief
Executive Officer
Mr.
Schrieberg has been our Chief Executive Officer since December 2006. Between
2002 and 2007, Mr. Schrieberg was the Chairman and Chief Executive Officer
of
Election Services Corporation, a Garden City, New York based election services
company. Mr. Schrieberg was a co-founder, President and Chief Operating Officer
of Election.com and held management positions with Xerox Corporation, ROLM
Systems, Inc., IBM and Automatic Data Processing. Mr. Schrieberg received his
Bachelor of Science degree in industrial management from the University of
Rhode
Island in 1968, his Masters in Business Administration from Fairleigh Dickinson
University in 1973 and attended the Executive Entrepreneurial Program at Harvard
University in 2005.
Vesa
Suomalainen, Chief
Technology Officer
Mr.
Suomalainen has been our Chief Technology Officer since September 2004. Between
2000 and August 2004, Mr. Suomalainen was retired. Between 1988 and 2000, Mr.
Suomalainen worked for Microsoft Corporation, holding, among others, titles
of
general manager, director of product strategy and product unit manager. Mr.
Suomalainen received his Bachelor of Science degree in computer engineering
from
the University of New Mexico in 1987.
James
Campbell, Chief
Information Officer
Mr.
Campbell has been our Chief Information Officer since June 2006. Between
December 2001 and May 2006, Mr. Campbell worked for the New York State Office
of
Homeland Security, as the Deputy Assistant Director from December 2001 until
September 2003 and the Chief Information Officer from September 2003 until
May
2006. Between January 1996 and December 2001, Mr. Campbell was a software
engineer for Proginet Corporation. Mr. Campbell received his Bachelor of Science
degree in computer information systems from the Long Island University, C.W.
Post in 1996.
23
George
Hayes, Senior
VP Sales and Marketing
Mr.
Hayes
has been our Senior VP Sales and Marketing since June 2007. Between February
2006 and June 2007, Mr. Hayes worked as an independent media and marketing
consultant. Between September 1975 and February 2006, Mr. Hayes worked for
McCann Worldgroup, an international advertising company. During that time,
Mr.
Hayes worked in several positions, including Executive Vice President of
Universal McCann, which he held for the last several years working at McCann.
Mr. Hayes also worked for J. Walter Thompson as a media planner. Mr. Hayes
received his Bachelors degree from Georgetown University in 1973.
Roger
Munford, General
Manager
Mr.
Munford has been our General Manager since May 2006. Between June 2000 and
May
2006, Mr. Munford was the General Manager, Online, for Dennis Publishing, Inc.,
based in New York, New York.
Orville
Hagler, Secretary
Mr.
Hagler has been our Secretary and Vice President Entertainment Programming
since
November 2003. Between January 2002 and November 2003, Mr. Hagler was the data
administrator and DBA of New Technology, Financial Services for TIAA-CREF in
New
York.
Jordan
Levin, Director
Mr.
Levin
has been a director since January 2007. Since February 2006, Mr. Levin has
been
the co-founder of Generate LLC, a Los Angeles, California based management
and
production company. Between January and December 2005, Mr. Levin was
self-employed as a strategic consultant. In October 2004, Mr. Levin was a
Freelance Director for the television show, Everwood. Between September 2003
and
June 2004, Mr. Levin was the Chief Executive Officer of The WB Network. Between
June 2001 and September 2003, Mr. Levin was the President of Entertainment
at
The WB Network. Between August 1994 and June 2001, Mr. Levin worked for The
WB
Television Network, as the VP of Programming, the Sr. VP of Programming and
EVP
of Programming. Mr. Levin graduated from the University of Texas at Austin
in
1989 with a degree in television and film theory.
Frances
Preston, Director
Ms.
Preston has been a director since April 2005. Between 1986 and 2004, Ms. Preston
was the President and CEO of Broadcast Music Inc. (BMI). Since retiring as
President and CEO, Ms. Preston has served as an advisor to BMI and continues
to
serve as a member of their board of directors. Ms. Preston serves on the
Recording Academy’s President’s Advisory Council and on the board of directors
for the Grammy Foundation. She is a member of the Board of Directors of the
National Academy of Popular Music/Songwriters Hall of Fame, a Board Member
of
the Rhythm & Blues Foundation, the Rock & Roll Hall of Fame, the
National Music Museum (DC) and a past member of the National Advisory Board
of
the George Foster Peabody Awards.
Jerome
N. Gold, Director
Mr.
Gold
has been a director since January 2007. Mr. Gold is the Chief Financial Officer
for RP Realty Partners LLC, a position he has held since March 2006. Between
August 2005 and March 2006, Mr. Gold was the Senior Managing Director of
Corporate Finance/Restructuring at FTI Consulting Inc. within FTI's Transaction
Advisory Services group, residing in the Los Angeles office. Between May 2004
and June 2005, Mr. Gold was the chief financial officer at Platinum Equity
LLC,
a private equity firm specializing in leveraged buyouts and operating acquired
portfolio companies. Between March 2001 and May 2004, Mr. Gold was managing
director of his own consulting firm, Gold International, which specialized
in
advisory and M&A services for media, entertainment and communications.
Between 1992 and 2001, Mr. Gold served as Chief Financial Officer of Warner
Music Group. Prior to Warner Music, Mr. Gold was a partner at Ernst & Young.
Mr. Gold attended Baruch College at City University New York and is a Certified
Public Accountant.
Mark
Hutchens, Director
Mr.
Hutchens has been a director since January 2007. Between January 2003 and
December 2006, Mr. Hutchens was retired. Between January 2001 and December
2002,
Mr. Hutchens was the CEO of Radiant Data, a systems software company. Between
August 1988 and May 1999, Mr. Hutchens was the CEO of Insession, a systems
software company.
24
Steve
Norcia, Director
Mr.
Norcia has been a director since January 2007. Mr. Norcia is the principal
and
founder of Topsail Group LLC, an Old Saybrook, Connecticut based consulting
company, a position he has held since December 2002. Between September 2000
and
January 2002, Mr. Norcia was the VP Business Development for Agency.com, a
New
York, New York based interactive agency. Between 1996 and August 2000, Mr.
Norcia was the Managing Director of the New York office of DDB, a New York,
New
York based advertising agency. Mr. Norcia received Bachelor of Arts degree
from
the University of Connecticut in 1962.
Robert
N. Gordon, Director
Mr.
Gordon has been a director since November 2003. Mr. Gordon is a Principal in
Strategic Horizons, Inc., a position he has held since 1996.
Albert
Hughes, Director
Mr.
Hughes has been a director since January 2007. Mr. Hughes is the President
of
Axis Group, LLC, a Berkley Heights, New Jersey based computer consulting
company, a position he has held since August 1996. Mr. Hughes received Bachelor
of Arts degrees in both Computer Science and Economics from Rutgers University
in 1985. Prior to founding Axis Group, Mr. Hughes was a partner at Strategic
Network Designs. Mr. Hughes also worked for Eicon Technology and Booz Allen
Hamilton.
Mark
Strama, Director
Mr.
Strama has been a director since January 2007. Mr. Strama has been a member
of
the Texas House of Representatives since 2004. From 2000 through December 2003,
Mr. Strama served as a Senior Vice President at Election.com, after Election.com
acquired NewVoter.com, a company Mr. Strama founded in 1999 and served as Chief
Executive Officer. Previously, Mr. Strama was Director of Programs at Rock
the
Vote, a non-profit voter registration campaign sponsored by the music industry
and MTV. Mr. Strama served as chief of staff to Texas State Senator Rodney
Ellis
from 1991 through 1995, and also served on the staff of Ann Richards' 1990
campaign for Governor of Texas.
Scott
Stagg, Director
Mr.
Stagg
has been a director since April 18, 2007. Mr. Stagg is the managing member
of 3V
Capital Management, a Greenwich, Connecticut based hedge fund, a position he
has
held since July 2003. Between April 2003 and December 2005, Mr. Stagg was the
director of research for Libertas Partners, a Greenwich, Connecticut based
broker-dealer. Between February 2002 and February 2003, Mr. Stagg was an
executive director at UBS Asset Management. Mr. Stagg received his Bachelor
of
Arts from the State University of New York in 1984 and his Masters of Business
Administration from the University of Chicago in 1993.
Amir
Khan, Director
Mr.
Khan
has been a director since April 18, 2007. Mr. Stagg is the portfolio member
of
3V Capital Management, a Greenwich, Connecticut based hedge fund, a position
he
has held since March 2007. Between August 2004 and March 2007, Mr. Khan was
the
chief operating officer for Libertas Partners, a Greenwich, Connecticut based
broker-dealer. Between February 2001 and August 2004, Mr. Khan was the chief
operating officer for Debttraders, Inc., a New York, New York based
broker-dealer. Mr. Khan holds a Bachelors degree in chemical engineering, a
Masters of Business Administration and is a Certified Financial
Analyst.
Thomas
J. Mackell, Jr., Director
Mr.
Mackell has served as a director since February 2007. Mr. Mackell has been
a
Director of the Federal Reserve Bank of Richmond since January 2003, the Deputy
Chairman between June 2003 and December 2004, and the is the President and
Chairman of the Board of Directors since January 2005. Mr. Mackell is the
President of the Association of Benefit Administrators, Inc., a position he
has
held since 1981. Between September 2000 and January 2005, Mr. Mackell worked
for
The Kamber Group, Inc., in various positions, including Group and Vice Chair,
Executive Vice President and President and Chief Operating Officer. Mr. Mackell
earned a bachelor’s degree from Seton Hall University and attended St. John’s
University School of Law. Mr. Mackell earned a master’s degree from Long
Island University and a doctorate from Rutgers University. Mr. Mackell
holds Series 6 and 63 securities licenses.
25
The
following is a summary of the committees on which our directors
serve.
Audit
Committee
Our
Audit
Committee currently consists of Albert Hughes, Bob Gordon and Frances
Preston, with Mr. Hughes elected as Chairman of the Committee. Mr. Hughes is
our
audit committee financial expert.
Our
Audit
Committee’s responsibilities include: (i) reviewing the independence,
qualifications, services, fees, and performance of the independent auditors,
(ii) appointing, replacing and discharging the independent auditor, (iii)
pre-approving the professional services provided by the independent auditor,
(iv) reviewing the scope of the annual audit and reports and recommendations
submitted by the independent auditor, and (v) reviewing our financial reporting
and accounting policies, including any significant changes, with management
and
the independent auditor.
Compensation
Committee
Our
Compensation Committee currently consists of Steve Norcia, Frances Preston,
Mark
Hutchens, Mel Schrieberg and Thomas Mackell, with Mr. Norcia elected as Chairman
of the Committee. Our Compensation Committee has responsibility for assisting
the Board of Directors in, among other things, evaluating and making
recommendations regarding the compensation of our executive officers and
directors, assuring that the executive officers are compensated effectively
in a
manner consistent with our stated compensation strategy and periodically
evaluating the terms and administration of our incentive plans and benefit
programs.
Nominating
Committee
Our
Nominating Committee currently consists of Mel Schrieberg, Steve Norcia, Mark
Strama and Jordan Levin, with Mr. Schrieberg elected as Chairman of the
Committee. Our Nominating Committee has responsibility for assisting the Board
in, among other things, effecting the organization, membership and function
of
the Board and its committees. The Nominating Committee shall identify and
evaluate the qualifications of all candidates for nomination for election as
directors.
Technology
Committee
Our
Technology Committee currently consists of Mark Hutchens, Albert Hughes and
Jerry Gold, with Mr. Hutchens elected as Chairman of the Committee. Our
Technology Committee is responsible for reviewing, evaluating and making
recommendations to the Board on major strategies and other subjects relating
to
our approach to technical and commercial innovation; the innovation development,
technology acquisition and decision-making process to assure ongoing growth;
and
the effectiveness of our technological efforts and investments in developing
new
products and businesses.
(c)
Family
Relationships.
None.
(d)
Involvement
in Certain Legal
Proceedings.
None.
26
ITEM
6. EXECUTIVE COMPENSATION.
Director
Compensation
Directors
do not currently receive any cash compensation in connection with their
services. Outside directors are entitled to receive grants of common stock
or
options to purchase common stock through our stock option plan at the discretion
of the board of directors. We reimburse all directors for certain expenses
in
connection with attendance at board meetings.
Executive
Compensation
Summary
Compensation Table (1)
Name
& Principal Position
Year
Salary
($)
All
Other Compensation ($)
Total
($)
Joseph
Mohen, Chairman and Former President (2)
2006
2005
2004
—
—
—
421,240
(3)
—
—
421,240
—
—
Robin
Kent, Former Chief Executive Officer (4)
2006
2005
340,000
—
—
—
340,000
—
Eric
McClean, Former Chief European Operations (5)
2006
196,155
—
196,155
Orville
Hagler, Secretary
2006
2005
2004
87,459
—
—
69,500
(6)
—
—
156,959
—
—
(1)
As
permitted under the rules promulgated by the Securities and Exchange Commission,
this table omits columns that are not applicable.
(2)
Mr.
Mohen was our President until May 2006.
(3)
Represents consulting fees of $241,240 in 2006 pursuant to his consulting
agreement and $180,000 in settlement of consulting fees owed from prior
years.
(4)
Mr.
Kent was our Chief Executive Officer between May 2006 and December 2006.
(5)
Mr.
McClean was our Chief of European Operations from May 2006 until December
2006.
(6)
Represents settlement of salary owed from prior years.
27
Employment/Consulting
Agreements
Mel
Schrieberg
Effective
March 6, 2007, we entered into an employment agreement with Mel Schrieberg
to
serve as our Chief Executive Officer for a term of three years, which shall
automatically renew for additional one year periods unless either party gives
90
days prior written notice. Pursuant to the agreement, until such time as we
receive financing and revenues, Mr. Schrieberg will not receive a salary. Prior
to achieving United States based revenue, Mr. Schrieberg receives an annual
salary of $198,000. Upon achieving United States based revenue, Mr. Schrieberg
receives an annual salary of $265,000 and upon our company achieving a cash
flow
positive run rate, Mr. Schrieberg receives an annual salary of $350,000. In
addition, Mr. Schrieberg shall receive incentive compensation at an annual
rate
of 50% of the base salary. In addition, Mr. Schrieberg is entitled to
participate in any and all benefit plans, from time to time, in effect for
our
employees, along with vacation, sick and holiday pay in accordance with our
policies established and in effect from time to time. Mr. Schrieberg is also
entitled to receive a monthly automobile allowance, up to $1,000 per month,
and
we will reimburse Mr. Schrieberg for all maintenance, gasoline and other normal
expenses associated with the use of the automobile. In addition, we will
purchase disability and life insurance policies for Mr. Schrieberg.
Vesa
Suomalainen
Effective
December 11, 2005, we entered into an employment agreement with Vesa Suomalainen
to serve as our Chief Technology Officer. Pursuant to the agreement, receives
an
annual salary of $175,000. In addition, Mr. Suomalainen received 240,000 shares
of common stock, subject to buy-back in the event that Mr. Suomalainen resigns
prior to September 1, 2007. In addition, Mr. Suomalainen is entitled to
participate in any and all benefit plans, from time to time, in effect for
our
employees, along with vacation, sick and holiday pay in accordance with our
policies established and in effect from time to time. Mr. Suomalainen will
also
receive up to an additional 240,00 shares of restricted stock if remains
employed through January 2010.
George
Hayes
Effective
June 7, 2007, we entered into an employment agreement with George Hayes to
serve
as our Senior Vice President of Marketing and Sales for a term of three years,
which shall automatically renew for additional one year periods unless either
party gives 90 days prior written notice. Pursuant to the agreement, until
such
time as we launch our music services and are receiving United States based
revenue, Mr. Hayes receives an annual salary of $175,000. Upon achieving United
States based revenue for a period of three months, Mr. Hayes receives an annual
salary of $225,000. In addition, Mr. Hayes shall receive incentive compensation
at an annual rate of 35% of the base salary. In addition, Mr. Hayes is entitled
to participate in any and all benefit plans, from time to time, in effect for
our employees, along with vacation, sick and holiday pay in accordance with
our
policies established and in effect from time to time. Mr. Hayes also received
250,000 shares of restricted common stock upon execution of the employment
agreement.
Orville
Hagler
Effective
February 4, 2004, we entered into an employment agreement with Orville Hagler
to
serve as our Vice President, Internet Properties for a term of three years,
which shall automatically renew for additional one year periods unless either
party gives 30 days prior written notice. Pursuant to the agreement, Mr. Hagler
receives an annual salary of $139,000. In addition, Mr. Hagler is entitled
to
participate in any and all benefit plans, from time to time, in effect for
our
employees, along with vacation, sick and holiday pay in accordance with our
policies established and in effect from time to time. Mr. Hagler will also
receive an additional 240,000 shares of restricted stock if he remains employed
through January 2010.
Joseph
Mohen
Effective
January 15, 2004, we entered into a consulting agreement, which was amended
on
April 27, 2006, with Joseph Mohen, our Chairman, for a term until June 30,2011,
which shall automatically renew for additional one year periods unless either
party gives 30 days prior written notice. Pursuant to the agreement, Mr. Mohen
receives annual consulting fees of $360,000.
28
ITEM
7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Other
than as disclosed below, there have been no transactions, or proposed
transactions, which have materially affected or will materially affect us in
which any director, executive officer or beneficial holder of more than 10%
of
the outstanding common stock, or any of their respective relatives, spouses,
associates or affiliates, has had or will have any direct or material indirect
interest. We have no policy regarding entering into transactions with affiliated
parties.
We
have
obtained our directors & officers and errors and omissions insurance
policies from Arden Financial Services. Brian Mohen, the brother of our
Chairman, Joseph Mohen, owns a portion of Arden Financial Services.
During
March 2007, we borrowed $63,000 from Vesa Suomalainen, our Chief Technology
Officer, with interest at 10%, maturing on April 1, 2007. The loan was
collateralized by certain of our computer equipment. The loan was repaid in
full
on April 27, 2007, including default charges of approximately
$3,300.
ITEM
8. DESCRIPTION OF SECURITIES.
COMMON
STOCK
We
are
authorized to issue up to 48,000,000 shares of common stock, par value
$.001. As
of June 21, 2007, there were 13,437,200 shares of common stock outstanding.
Such
number includes 473,147 and 5,456,853 shares of common stock that are vested
and
unvested, respectively, granted to officers, directors and employees pursuant
to
our stock option plan. When a restricted stock grant recipient no longer
works
for us (or serves on our board for directors) for any reason, (i) all unvested
shares of common stock granted pursuant to our stock option plan are forfeited,
and (ii) all vested shares of common stock granted pursuant to our stock
option
plan are subject to repurchase.
Holders of our common stock are entitled to one vote per share on all matters
to
be voted upon by the stockholders. The election of directors requires a
plurality of votes cast by our stockholders. All other actions by our
stockholders requires a majority of votes cast. Holders of common stock are
entitled to receive ratably such dividends, if any, as may be declared by
the
Board of Directors out of funds legally available therefor. Upon the
liquidation, dissolution, or winding up of our company, the holders of common
stock are entitled to share ratably in all of our assets which are legally
available for distribution after payment of all debts and other liabilities
and
liquidation preference of any outstanding common stock. Holders of common
stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of common stock are validly issued, fully paid and
nonassessable. The rights, preferences and privileges of holders of our common
stock are subject to, and may be adversely affected by, the rights of holders
of
shares of any series of preferred stock which we may designate and issue
in the
future without further stockholder approval.
PREFERRED
STOCK
We
are
authorized to issue up to 36,000,000 shares of preferred stock, $.01 par value.
The shares of preferred stock may be issued in series, and shall have such
voting powers, full or limited, or no voting powers, and such designations,
preferences and relative participating, optional or other special rights, and
qualifications, limitations or restrictions thereof, as shall be stated and
expressed in the resolution or resolutions providing for the issuance of such
stock adopted from time to time by the Board of Directors. The Board of
Directors is expressly vested with the authority to determine and fix in the
resolution or resolutions providing for the issuances of preferred stock the
voting powers, designations, preferences and rights, and the qualifications,
limitations or restrictions thereof, of each such series to the full extent
now
or hereafter permitted by the laws of the State of Delaware.
Series
A Convertible Preferred Stock
In
July
2005, our Board of Directors adopted and created a series of preferred stock
consisting of 12,000,000 shares designated as Series A Convertible Preferred
Stock. The Series A Convertible Preferred Stock is convertible into our common
stock, at the option of the holder, at any time into one share of common stock.
The Series A Convertible Preferred Stock will automatically convert into common
stock upon the occurrence of certain events. The Series A Convertible Preferred
Stock contains anti-dilution provisions in the event of a consolidation, merger
or sale; subdivision or combination; or if we issue discounted stock. The Series
A Convertible Preferred Stock is entitled to one vote per share of all matters
requiring shareholder vote, and will vote together with the holders of our
common stock, and not as a separate class. As of June 21, 2007, there were
9,440,200 shares of Series A Preferred Stock outstanding.
Series
B Convertible Preferred Stock
On
April21, 2006, our Board of Directors adopted and created a series of preferred
stock
consisting of 24,000,000 shares designated as Series B Convertible Preferred
Stock. The holders of our Series B Convertible Preferred Stock may cause us
to
redeem their shares of Series B Convertible Preferred Stock at a price per
share
equal to the then-current liquidation preference as follows: (i) one-third
of
the initial number of outstanding shares commencing on the fifth anniversary
of
closing of the initial issuance of Series B Convertible Preferred Stock,
two-thirds of such shares commencing on the sixth anniversary of closing (less
any shares redeemed on the fifth anniversary), and the remainder of such shares
on the seventh anniversary of closing, and (ii) all of the outstanding shares
upon the consummation of a sale transaction, as defined therein. The holders
of
the Series B Convertible Preferred Stock shall have the right to maintain their
pro rata ownership of our capital stock by participating in certain future
issuances of our capital stock.
The
Series B Convertible Preferred Stock is convertible into our common stock,
at
the option of the holder, at any time into one share of common stock. The Series
B Convertible Preferred Stock will automatically convert into common stock
upon
the occurrence of certain events. The Series B Convertible Preferred Stock
contains anti-dilution provisions in the event of a consolidation, merger or
sale; subdivision or combination; or if we issue discounted stock. Each share
of
Series B Convertible Preferred Stock shall be entitled to cast that number
of
votes per share as is equal to the number of votes that holder would be entitled
to cast had such holder converted his shares into shares of Common Stock on
the
record date for such vote, and will vote together with the holders of our common
stock, and not as a separate class.
29
The
shares of Series B Convertible Preferred Stock receive preference over all
other
classes of our capital stock in the event of our liquidation to the extent
of
the liquidation preference, which is defined as the conversion price for the
Series B Convertible Preferred Stock, subject to anti-dilution and other
adjustments. In the event that our Common Stock is not registered under Section
12(b) or 12(g) of the Securities Exchange Act of 1934 or listed for trading
on
the AIM branch of the London Stock Exchange by July 31, 2007, we may be required
to pay liquidated damages to the holders of Series B Convertible Preferred
Stock
of up to 6% of the liquidation preference for each share, and if such
registration or listing has not occurred by September 30, 2007, the holders
could cause us to redeem their shares of Series B Convertible Preferred Stock
at
a redemption price of two times the then-current liquidation
preference.
As
of
June 21, 2007, there were 10,414,654 shares of Series B Preferred Stock
outstanding.
OPTIONS
As
of
June 21, 2007, we had 670,000 options issued and outstanding pursuant to our
Employee Stock Option Plan, exercisable at $0.11 per share.
WARRANTS
We
have
warrants outstanding to purchase 460,000 shares of our common stock, exercisable
at $0.85 per share expiring June 30, 2011.
CONVERTIBLE
SECURITIES
During
March and April 2007, we entered into securities purchase agreements with nine
accredited investors for the sale of an aggregate of $5,000,000 in senior
secured exchangeable notes, of which we received net proceeds of approximately
$4,500,000 after expenses and closing costs.
The
senior secured exchangeable notes bear interest at 12% per annum, payable
monthly commencing October 1, 2007, maturing on April 19, 2008, and are
exchangeable into our common stock, at the investor’s option, at a rate of $0.86
per share, subject to adjustment. Based on this exchange price, the $5,000,000
in senior secured exchangeable notes are exchangeable into approximately
5,813,953 shares of our common stock. The investor cannot exchange the senior
secured exchangeable notes into shares of our common stock until our common
stock has been registered with the Securities and Exchange Commission under
Section 12(b) or 12(g) of the Securities Exchange Act of 1934. In addition,
so
long as any shares of our Series B Convertible Preferred Stock is outstanding,
the investors are prohibited from exchanging their senior secured exchangeable
notes into shares of our common stock. The investors have contractually agreed
to restrict their ability to exchange the senior secured exchangeable notes
and
receive shares of our common stock such that the number of shares of common
stock held by it and its affiliates after such exchange does not exceed 9.99%
of
the then issued and outstanding shares of our common stock.
The
exchange price of the senior secured exchangeable notes will be adjusted in
the
following circumstances:
·
If
we pay a stock dividend, engage in a stock split, reclassify our
shares of
common stock or engage in a similar transaction, the exchange price
of the
senior secured exchangeable notes will be adjusted
proportionately;
·
If
we issue rights, options or warrants to all holders of our common
stock
entitling them to subscribe for or purchase shares of common stock
at a
price per share less than $0.86 per share, then the exchange price
of the
senior secured exchangeable notes will be adjusted on a weighted-average
basis;
·
If
we issue shares, rights, warrants, options or other securities or
debt
that are convertible into or exchangeable for shares of our common
stock,
at a price per share less than $0.86 per share, then the exchange
price
will be adjusted to such lower price on a full-ratchet
basis;
·
If
we distribute to all holders of our common stock evidences of indebtedness
or assets or rights or warrants to subscribe for or purchase any
security,
then the exchange price of the senior secured exchangeable notes
will be
adjusted based upon the value of the distribution as a percentage
of the
market value of our common stock on the record date for such distribution;
and
·
If
we engage in a merger, consolidation or sale of more than one-half
of our
assets, then the investors will have the right to (i) demand that
we
prepay the senior secured exchangeable notes, (ii) exchange the senior
secured exchangeable notes into the shares of stock and other securities,
cash and property receivable by holders of our common stock following
such
transaction, or (iii) in the case of a merger or consolidation, require
the surviving entity to issue senior secured exchangeable notes with
similar terms.
30
In
connection with the securities purchase agreements, we also entered into a
registration rights agreement providing for the filing, within 30 days after
the
senior secured exchangeable notes become exchangeable into shares of our common
stock, of a registration statement with the Securities and Exchange Commission
registering the common stock issuable upon exchange of the senior secured
exchangeable notes. We are obligated to use our best efforts to cause the
registration statement to be declared effective no later than 90 days after
such
registration statement is filed and to insure that the registration statement
remains in effect until the earlier of (i) all of the shares of common stock
issuable upon exchange of the senior secured exchangeable notes have been sold
or (ii) such shares may be sold without restriction pursuant to Rule 144(k).
In
the event of a default of our obligations under the registration rights
agreement, we are required to pay to the investors, as liquidated damages,
(i) a
cash amount equal to 1.5% of the aggregate purchase price of the senior secured
exchangeable notes, and (ii) for each 30 day period that the registration
statement has not been filed or declared effective, as the case may be, a cash
amount equal to 2% of the aggregate purchase price of the senior secured
exchangeable notes.
The
senior secured exchangeable notes are collateralized by 3,581,000 shares of
Series A Convertible Preferred Stock and 490,000 shares of common stock of
six
of our shareholders and directors. In addition, we executed a security agreement
in favor of the investors granting them a first priority security interest
in
all of our goods, inventory, contractual rights and general intangibles,
receivables, documents, instruments, chattel paper, and intellectual property.
The security agreement states that if an event of default occurs under the
senior secured exchangeable notes or security agreements, the investor has
the
right to take possession of the collateral, to operate our business using the
collateral, and have the right to assign, sell, lease or otherwise dispose
of
and deliver all or any part of the collateral, at public or private sale or
otherwise to satisfy our obligations under these agreements.
31
PART
II
ITEM
1. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
(a)
Market
Information. Our Common Stock is not trading on any stock exchange
or
market. We are not aware of any market activity in our
stock.
(b)
Holders.
As of June 21, 2007, there were 48 record holders of 13,437,200 shares
of
our Common Stock.
(c)
Dividends.
We have not paid any cash dividends to date and do not anticipate
or
contemplate paying dividends in the foreseeable future. It is the
present
intention of management to utilize all available funds for execution
of
the Registrant’s business, as set forth
herein.
ITEM
2. LEGAL PROCEEDINGS.
From
time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm our business. We are currently not aware
of any such legal proceedings or claims that we believe will have, individually
or in the aggregate, a material adverse affect on our business, financial
condition or operating results.
ITEM
3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
There
are
not and have not been any disagreements between us and our accountants on any
matter of accounting principles, practices or financial statement
disclosure.
ITEM
4. RECENT SALES OF UNREGISTERED SECURITIES.
On
July8, 2004, we sold 240,000 shares of Series A Convertible Preferred Stock for
gross proceeds of $10,000.
On
September 29, 2004, we sold 24,000 shares of Series A Convertible Preferred
Stock for gross proceeds of $1,000.
On
January 18, 2005, we sold 38,000 shares of Series A Convertible Preferred Stock
for gross proceeds of $6,115.
On
February 28, 2005, we sold 30,000 shares of Series A Convertible Preferred
Stock
for gross proceeds of $10,000.
On
March23, 2005, we sold 120,000 shares of Series A Convertible Preferred Stock for
gross proceeds of $60,000.
During
the quarter ended March 31, 2005, we issued 200,000 shares of common stock,
valued at $0.05 per share, to a consultant for services rendered.
On
April8, 2005, we sold 70,000 shares of Series A Convertible Preferred Stock for
gross
proceeds of $35,000.
On
May16, 2005, we sold 85,000 shares of Series A Convertible Preferred Stock for
gross proceeds of $39,197.
During
the quarter ended June 30, 2005, we issued 6,460,000 shares of common stock,
valued at $0.05 per share, to employees, board members and consultants for
compensation and services rendered.
On
July19, 2005, we sold 2,133 shares of Series A Convertible Preferred Stock for
gross
proceeds of $2,000.
On
August9, 2005, we sold 30,000 shares of Series A Convertible Preferred Stock for
gross
proceeds of $15,000.
On
October 1, 2005, we sold 1,067 shares of Series A Convertible Preferred Stock
for gross proceeds of $1,000.
In
April
2006, we issued 10,414,654 shares of Series B Preferred stock for $0.85 per
share, or $8,852,456, through a private placement offering. In connection with
the private placement, we paid $560,000 in transaction fees and also issued
a
warrant to purchase 460,000 shares of Series B Preferred Stock, which may be
converted into common stock at the same conversion rate of one-for-one, to
the
financial advisers who brokered the transaction. The warrant expires in June
2011 and has an exercise price of $0.85.
During
the year ended December 31, 2006, we issued 387,000 common stock options to
employees.
During
the year ended December 31, 2006, we issued 270,000 shares of restricted common
stock to employees and consultants.
During
March and April 2007, we entered into securities purchase agreements with nine
accredited investors for the sale of an aggregate of $5,000,000 in senior
secured exchangeable notes, of which we received net proceeds of approximately
$4,500,000 after expenses and closing costs.
The
senior secured exchangeable notes bear interest at 12% per annum, payable
monthly commencing October 1, 2007, maturing on April 19, 2008, and are
exchangeable into our common stock, at the investor’s option, at a rate of $0.86
per share, subject to adjustment. Based on this conversion price, the $5,000,000
in senior secured exchangeable notes are exchangeable into approximately
5,813,953 shares of our common stock. The investor cannot exchange the senior
secured convertible notes into shares of our common stock until our common
stock
has been registered with the Securities and Exchange Commission under Section
12(b) or 12(g) of the Securities Exchange Act of 1934. In addition, so long
as
any shares of our Series B Convertible Preferred Stock is outstanding, the
investors are prohibited from exchanging their senior secured exchangeable
notes
into shares of our common stock. The investors have contractually agreed to
restrict their ability to exchange the senior secured exchangeable notes and
receive shares of our common stock such that the number of shares of common
stock held by it and its affiliates after such exchange does not exceed 9.99%
of
the then issued and outstanding shares of our common stock.
32
On
May 7,2007, we issued options to purchase an aggregate of 170,000 shares of our common
stock pursuant to our stock incentive plan to five employees for employment
services.
On
June7, 2007, we issued 250,000 shares of our common stock to one employee pursuant
to an employment agreement.
*
All of
the above offerings and sales were deemed to be exempt under rule 506 of
Regulation D and Section 4(2) of the Securities Act of 1933, as amended. No
advertising or general solicitation was employed in offering the securities.
The
offerings and sales were made to a limited number of persons, all of whom were
accredited investors, business associates of Mohen, Inc. or executive officers
of Mohen, Inc., and transfer was restricted by Mohen, Inc. in accordance with
the requirements of the Securities Act of 1933. In addition to representations
by the above-referenced persons, we have made independent determinations that
all of the above-referenced persons were accredited or sophisticated investors,
and that they were capable of analyzing the merits and risks of their
investment, and that they understood the speculative nature of their
investment.
ITEM
5. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section
145 (“Section 145”) of the Delaware General Corporation Law, as amended (the
“DGCL”), permits indemnification of directors, officers, agents and controlling
persons of a corporation under certain conditions and subject to certain
limitations. Section 145 empowers a corporation to indemnify any person who
was
or is a party or is threatened to be made a party to any threatened, pending
or
completed action, suit or proceeding whether civil, criminal, administrative
or
investigative, by reason of the fact that he or she is or was a director,
officer or agent of the corporation or another enterprise if serving at the
request of the corporation. Depending on the character of the proceeding, a
corporation may indemnify against expenses (including attorneys’ fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
in connection with such action, suit or proceeding if the person indemnified
acted in good faith and in a manner he or she reasonably believed to be in
or
not opposed to, the best interests of the corporation, and, with respect to
any
criminal action or proceeding, had no reasonable cause to believe his or her
conduct was unlawful. In the case of an action by or in the right of the
corporation, no indemnification may be made with respect to any claim, issue
or
matter as to which such person shall have been adjudged to be liable to the
corporation unless and only to the extent that the Court of Chancery or the
court in which such action or suit was brought shall determine that despite
the
adjudication of liability such person is fairly and reasonably entitled to
indemnity for such expenses which the court shall deem proper. Section 145
further provides that to the extent a present or former director or officer
of a
corporation has been successful in the defense of any action, suit or proceeding
referred to above or in the defense of any claim, issue or matter therein,
such
person shall be indemnified against expenses (including attorneys’ fees)
actually and reasonably incurred by such person in connection therewith.
Our
Certificate of Incorporation (the “Charter”), provides that no current or former
director of the Registrant shall be personally liable to the Registrant or
its
stockholders for monetary damages for breach of fiduciary duty as a director,
except for liability: (a) for any breach of the director’s duty of loyalty to
the Registrant or its stockholders; (b) for acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of law; (c)
under
Section 174 of the DGCL; or (d) for any transaction from which the director
derived any improper personal benefit. The Registrant’s Charter also authorizes
the Registrant, to the fullest extent permitted by applicable law, to provide
indemnification of, and advanced expenses to, the Registrant’s agents and any
other persons to which the DGCL permits.
In
accordance with Section 145, the Registrant’s Bylaws provide that the Registrant
shall indemnify its officers and directors, and any employee who serves as
an
officer or director of any corporation at the Registrant’s request. According to
Article XIV of the Bylaws, directors and officers as well as employees and
individuals may be indemnified against expenses (including attorneys’ fees),
judgments, fines and amounts paid in settlement in connection with specified
actions, suits or proceedings, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation as
a
derivative action) if they acted in good faith and in a manner they reasonably
believed to be in or not opposed to the best interests of the corporation,
and
with respect to any criminal action or proceeding, had no reasonable cause
to
believe their conduct was unlawful.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Audit Committee of the
Board
of
Directors and Stockholders
of
Mohen,
Inc.
We
have
audited the accompanying balance sheet of Mohen, Inc. (A Development Stage
Enterprise) (the “Company”) as of December 31, 2006, and the related statements
of operations, changes in stockholders’ deficiency and cash flows for the years
ended December 31, 2006 and 2005 and for the period from February 5, 2004
(Inception) to December 31, 2006. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
the
financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of
its
internal control over financial reporting. Our audit included consideration
of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion.
An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Mohen, Inc. (A Development Stage
Enterprise), as of December 31, 2006, and the results of its operations and
its
cash flows for the years ended December 31, 2006 and 2005 and for the period
from February 5, 2004 (Inception) to December 31, 2006 in conformity with
accounting principles generally accepted in the United States of America.
As
discussed in Note 1 to the financial statements, the Company continues to
generate operating losses and has a significant working capital deficiency
as of
December 31, 2006. The Company has yet to generate revenues. These conditions
raise substantial doubt about the Company’s ability to continue as a going
concern. Management’s plans regarding these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
Stock
based compensation expense related to employee stock
options
1,188
--
1,188
Stock
based compensation expense related to issuance of restricted
stock
units
1,650
--
1,650
Changes
in operating assets:
Prepaid
expenses and other current assets
(171,356
)
--
(171,356
)
Deferred
licenses and other fees
(2,434,560
)
--
(2,434,560
)
Security
deposits
(34,022
)
--
(34,022
)
Officer
loans
(35,658
)
--
(35,658
)
Changes
in operating liabilites:
Accounts
payable and accrued expenses
262,334
685,737
1,311,328
Other
current liabilites
(455
)
455
--
TOTAL ADJUSTMENTS
(913,721
)
1,019,192
593,658
NET CASH USED IN OPERATING ACTIVITIES
(7,657,023
)
(60,733
)
(7,692,480
)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment
(137,460
)
--
(137,460
)
Net
cash used in investing activities
(137,460
)
--
(137,460
)
CASH
FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Series A Convertible Preferred
stock
--
168,312
304,312
Distributions to Series A stockholders
--
(107,543
)
(268,819
)
Proceeds from issuance of Series B Redeemable Convertible Preferred
stock
8,852,456
--
8,852,456
Costs associated wiith private placement offering of Series B
Preferred
Stock
(560,000
)
--
(560,000
)
Net cash provided by financing activities
8,292,456
60,769
8,327,949
NET INCREASE IN CASH
497,973
36
498,009
CASH
-
BEGINNING
36
--
--
CASH
-
END
$
498,009
$
36
$
498,009
NON-CASH
INVESTING AND FINANCING TRANSACTIONS:
Contributed
capital from waiver of accrued compensation and consulting
fees
$
166,332
$
110,500
$
636,832
Minimum
royalty obligations
$
3,065,440
$
--
$
3,065,440
The
accompanying notes are an integral part of these financial
statements.
F-6
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(1)Organization
Nature
of Business
Mohen,
Inc. (the “Company”) commenced operations as a development stage company on
February 5, 2004. While
the
Company filed its Articles of Organization in October 2003, operations did
not
commence until February 2004. Mohen, Inc. is the surviving entity from a
common control merger between Mohen Entertainment Portals, LLC and Mohen
Entertainment Portals, Inc., which changed its name to Mohen, Inc. The merger
was consummated on May 12, 2005. The accompanying financial statements reflect
the merger of the two entities for all periods presented since the majority
shareholders and management of both entities are the same. The Company is
seeking to establish an advertising-funded, free and legal music download
internet site. In
2004
and 2005, the Company had limited business operations, whereby the primary
focus
was the development of its business model. In 2006, with the hiring of its
technology team, the Company accelerated its technological development
activities.
Going
Concern and Management’s Plans
While
there can be no assurance, management believes the Company has the ability
to
raise adequate capital to keep the Company operational for the next twelve
months. In March and April 2007, the Company raised approximately $5 million
(Note 11) to finance its operations, however, no assurance can be given that
such funds will be sufficient. If the Company is unable to raise additional
funds, it may be forced to change or delay its contemplated marketing and
business plans.
The
Company's principal business activity consists of the development of its
in-house music technology. The Company is developing a music technology-internet
based service, which, when available, will provide consumers the ability at
no
charge to download music files. This free service will allow a consumer to
play
the ad-supported music files only on the computer such consumer uses to download
music files as well as a portable playback device. In addition, the website
will
be able to offer online e-tailers, advertising, media and marketing companies
the ability to provide highly targeted advertising, promotional and other
marketing information to consumers who may have a strong interest in such
advertisers' products.
To
date,
the Company has entered into license agreements with UMG Recording Inc. and
other music companies. As of December 31, 2006, the technology has not yet
been
launched as additional technological development activities and various
collaborative agreements still need to be completed. There is no assurance
that
the development activities will continue and, if so, there is no assurance
that
the Company will be commercially successful.
Being
a
development stage company, the Company is subject to all the risks inherent
in
the establishment of a new enterprise and the marketing and design of a new
product, many of which risks are beyond the control of the Company.
The
Company’s principal activities, to date, have been in the research and
development of its website technology. The accompanying financial statements
have been prepared in accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 7, “Development Stage Enterprises.”
F-7
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(1)Organization,
continued
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. The Company is currently a development stage
enterprise and the Company’s continued existence is dependent upon its ability
to obtain additional debt and/or equity financing. The Company has yet to
generate a positive cash flow from operations, and until commercially viable
products are developed and revenue generated, the Company is totally dependent
upon debt and equity funding to finance the Company’s operations. The Company
does not have any patents or copyrights protecting its intellectual
property.
These
factors raise substantial doubt about the Company’s continued existence as a
going concern. These financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
(2)
Summary
of Significant Accounting Policies
Use
of Estimates
The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date
of financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
Fair
Value of Financial Instruments
The
Company has estimated the fair value of financial instruments using available
market information and other valuation methodologies in accordance with SFAS
No.
107, "Disclosures about Fair Value of Financial Instruments." Management of
the
Company believes that the fair value of financial instruments, consisting of
cash, prepaid expenses and other current assets, accounts payable and accrued
liabilities, approximates their carrying value due to the immediate or
short-term maturity associated with these instruments.
Cash
and Cash Equivalents
For
purposes of the statement of cash flows, the Company considers all short-term
investments with original maturities of three months or less when purchased
to
be cash equivalents. The Company had no cash equivalents as of December 31,2006.
Concentration
of Credit Risks
The
Company places its cash in what it believes to be creditworthy financial
institutions. However, cash balances may exceed FDIC insured levels at various
times during the year. As of December 31, 2006, the Company has cash balances
of
approximately $400,000 in excess of the maximum amount insured by the FDIC.
F-8
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(2)
Summary
of Significant Accounting Policies, continued
Property
and Equipment
Property
and equipment are stated at cost less accumulated depreciation. Depreciation
expense is determined using the straight-line method over the estimated useful
lives of the respective assets, which are generally three to five years for
computers, equipment and furniture. Depreciation on leasehold improvements
is
provided using the straight-line method over the shorter of the estimated useful
lives of the improvements or the lease term. Expenditures for maintenance and
repairs are charged to operating expense as incurred. Upon retirement or sale,
the original cost and related accumulated depreciation are removed from the
respective accounts, and the gains and losses are included in other income
or
expense.
Impairment
of Long-Lived Assets
In
accordance with FASB Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, the Company evaluates its long-lived assets,
including property and equipment, for impairment whenever events or changes
in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If circumstances require a long-lived asset to be tested for
possible impairment, the Company first compares undiscounted cash flows expected
to be generated by an asset to the carrying value of the asset. If the carrying
value of the long-lived asset is not recoverable on an undiscounted cash flow
basis, impairment is recognized to the extent that the carrying value exceeds
its fair value. Fair value is determined through various valuation techniques
including discounted cash flow models, quoted market values and third-party
independent appraisals, as considered necessary.
Income
Taxes
The
Company accounts for its income taxes in accordance with SFAS No. 109,
“Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets or liabilities of a change in tax
rates is recognized in the period that the tax change occurs. SFAS No. 109
also
requires that deferred tax assets be reduced by a valuation allowance if it
is
more likely than not that some or all of the deferred tax asset will not be
realized. We have established a valuation allowance related to the benefits
of
net operating losses for which utilization in future periods is uncertain.
The
Company believes it is more likely than not that it will not realize the
benefits of these deductible differences in the near future and, therefore,
a
valuation allowance has been recorded to offset such future tax
benefits.
Revenue
Recognition
The
Company expects that it will derive substantially all of its revenue from the
sale of advertising on its website. The Company anticipates to have four major
advertising revenues streams: Click Ad revenues will be recognized when an
ad
that is placed in its website is successfully ‘Clicked’ and linked to another
website or area; Video revenues will be recognized when ads are played within
the website; Banner revenues will be recognized when an ad is displayed in
the
Company’s website; and Imprint revenues will be recognized once the established
number of times an ad is to be shown is displayed. Any prepaid advertising
payments received will be treated as deferred revenues.
Research
and Development
In
accordance with SFAS No. 2, "Accounting for Research and Development Costs,"
all
research and development costs are expensed when they are incurred. Research
and
development expenses consist primarily of research and development activities
associated with the development of the Company’s technology. Since inception
through December 31, 2006, the Company has expended $886,729 for research and
development activities.
Software
Development
The
Company expenses all costs incurred in the preliminary project stage for
software developed for internal use and capitalizes all external direct costs
of
materials and services consumed in developing or obtaining internal-use computer
software in accordance with Statement of Position (“SOP”) 98-1, “Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use.” In
addition, for employees who are directly associated with and who devote time
to
internal-use computer software projects, to the extent of the time spent
directly on the project, the Company capitalizes payroll and payroll-related
costs of such employees incurred once the development has reached the
applications development stage. All costs incurred for upgrades,
maintenance and enhancements that do not result in additional functionality
are
expensed. To date, the Company did not capitalize any software development
costs as such technology has not reached any definitive stage of
functionality. These costs once capitalized will be amortized to expense over
the estimated life of the software technology. The Company
will periodically perform reviews of the recoverability of
capitalized software costs.
Web
Site Development Costs
The
Company adopted Emerging Issues Task Force Abstract (“EITF”) Issue number 00-2,
“Accounting for Web Site Development Costs.” EITF 00-2 provides guidance on the
accounting for the costs of development of company Web sites, dividing the
Web
site development costs into five stages: (1) the planning stage, during which
the business and/or project plan is formulated and functionalities,
necessary hardware and technology are determined, (2) the Web site application
and infrastructure development stage, which involves acquiring or developing
hardware and software to operate the Web site, (3) the graphics development
stage, during which the initial graphics and layout of each page are designed
and coded, (4) the content development stage, during which the information
to be
presented on the Web site, which may be either textual or graphical in nature,
is developed, and (5) the operating stage, during which training,
administration, maintenance and other costs to operate the existing Web site
are
incurred. The costs incurred in the Web site application and infrastructure
stage, the graphics development stage and the content development stage are
capitalized; all other costs are expensed as incurred. To date, the Company
did not capitalize any Web site development costs. Such costs once
capitalized will amortized to expense over the estimated life of the website
technology. The Company will periodically perform reviews of the
recoverability of capitalized website costs.
F-9
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(2)
Summary
of Significant Accounting Policies, continued
Net
Income/Loss Per Common Share
Basic
net
income (loss) per share of common stock are computed by dividing net income
(loss) available to common stockholders by the weighted average number of shares
of common stock outstanding during the periods presented.
Diluted
net income (loss) per share reflects per share amounts that result if dilutive
common stock equivalents are converted to common stock.
Common
stock equivalents, consisting of convertible preferred stock, options and
warrants were not included in the calculation of diluted loss per share for
2006
and 2005 because their inclusion would have had been anti-dilutive.
Total
common stock equivalents outstanding related to stock options, warrants and
convertible preferred stock were 20,972,000 as of December 31,2006.
Stock-Based
Compensation
Effective
January 1, 2006, the Company adopted SFAS No. 123(R), "Share Based Payment,"
using the modified prospective transition method. There was no effect to the
accompanying financial statements pursuant to the adoption of SFAS No. 123R.
SFAS No. 123R is a revision of SFAS No. 123, and supersedes APB Opinion No.
25,
and its related implementation guidance. SFAS No. 123(R) addresses all forms
of
share-based payment awards including shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation rights. Under
SFAS
No. 123(R), stock-based awards result in a cost that will be measured at fair
value on the award's grant date, based on the estimated number of awards that
are expected to vest that will result in a charge to operations.
Prior
to
January 1, 2006, the Company accounted for employee stock transactions in
accordance with Accounting Principle Board ("APB") Opinion No. 25. "Accounting
for Stock Issued to Employees."The Company had adopted the pro forma disclosure
requirements of SFAS No. 123, "Accounting for Stock-Based Compensation."
Prior
to
the Company's adoption of SFAS No. 123(R), SFAS No. 123 required that the
Company provide pro-forma information regarding net earnings and net earnings
per share as if the Company's stock-based awards had been determined in
accordance with the fair value method prescribed therein. The Company had
previously adopted the disclosure portion of SFAS No. 148 "Accounting for
Stock-based Compensation - Transition and Disclosure," requiring quarterly
SFAS
No. 123 pro-forma disclosures. The pro-forma charge for compensation cost
related to stock-based awards granted was recognized over the service period.
For stock options, the service period represents the period of time between
the
date of grant and the date each option becomes exercisable without consideration
of acceleration provisions (e.g., retirement, change of control, etc.).
(2)
Summary
of Significant Accounting Policies, continued
Stock-Based
Compensation, continued
The
cost
of stock-based compensation awards issued to non-employees for services are
recorded at either the fair value of the services rendered or the fair value
of
the stock-based award, whichever is more readily determinable, using the
measurement date guidelines enumerated in Emerging Issues Task Force ("EITF")
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services."
Recent
Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155 "Accounting for Certain Hybrid
Financial Instruments-an amendment of FASB Statements No. 133 and 140" ("FAS
155"). FAS 155 addresses the following: a) permits fair value re-measurement
for
any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation; b) clarifies which interest-only strips
and
principal-only strips are not subject to the requirements of Statement 133;
c)
establishes a requirement to evaluate interests in securitized financial assets
to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation;
d) clarifies that concentrations of credit risk in the form of subordination
are
not embedded derivatives; and e) amends Statement 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 financial instrument. FAS 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. The Company has not yet completed
its
evaluation of the impact of adopting SFAS 155 on its results of operations
or
financial position, but does not expect the adoption to have a material
impact.
In
March
2006, the FASB issued SFAS 156 - "Accounting for Servicing of Financial Assets
-
an amendment of FASB Statement No. 140" ("SFAS 156"). SFAS 156 is effective
for
the first fiscal year beginning after September 15, 2006. SFAS 156 changes
the
way entities account for servicing assets and obligations associated with
financial assets acquired or disposed of. The Company has not yet completed
its
evaluation of the impact of adopting SFAS 156 on its results of operations
or
financial position, but does not expect that the adoption of SFAS 156 will
have
a material impact.
In
July
2006, the Financial Accounting Standards Board issued Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109" (the "Interpretation"). The Interpretation establishes for
all entities a minimum threshold for financial statement recognition of the
benefit of tax positions, and requires certain expanded disclosures. The
Interpretation is effective for fiscal years beginning after December 31, 2006,
and is to be applied to all open tax years as of the date of effectiveness.
The
Company is in the process of evaluating the impact of the adoption of this
Interpretation. This Company does not expect this Interpretation to have a
material impact on the Company’s financial position or results of
operations.
F-11
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(2)
Summary
of Significant Accounting Policies, continued
Recent
Accounting Pronouncements, continued
In
September 2006, the FASB issued Statement of Financial Accounting Standard
No.
157, "Fair Value Measurements" (“SFAS 157”). This statement defines fair value,
establishes a fair value hierarchy to be used in generally accepted accounting
principles and expands disclosures about fair value measurements. Although
this
statement does not require any new fair value measurements, the application
could change current practice. The statement is effective for fiscal years
beginning after November 15, 2007. The Company is currently evaluating the
impact of this statement and does not expect the adoption of this pronouncement
to have a material impact on the Company’s financial position or results of
operations.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Liabilities" ("SFAS No. 159"). SFAS No. 159 provides
companies with an option to report selected financial assets and liabilities
at
fair value, and establishes presentation and disclosure requirements designed
to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. The new guidance is
effective for fiscal years beginning after November 15, 2007. The Company is
currently evaluating the potential impact of this statement and does not expect
the adoption of this pronouncement to have a material impact on the Company’s
financial position or results of operations.
In
September 2006, the staff of the Securities and Exchange Commission issued
SAB
No. 108 which provides interpretive guidance on how the effects of the carryover
or reversal of prior year misstatements should be considered in quantifying
a
current year misstatement. SAB 108 becomes effective in fiscal 2007. The
adoption of this pronouncement is not expected to have an impact on the
Company's financial position, results of operation or cash flows.
In
December 2006, the FASB approved FASB Staff Position (FSP) No. EITF 00-19-2,
"Accounting for Registration Payment Arrangements" ("FSP EITF 00-19-2"), which
specifies that the contingent obligation to make future payments or otherwise
transfer consideration under a registration payment arrangement, whether issued
as a separate agreement or included as a provision of a financial instrument
or
other agreement, should be separately recognized and measured in accordance
with
SFAS No. 5, "Accounting for Contingencies". FSP EITF 00-19-2 also requires
additional disclosure regarding the nature of any registration payment
arrangements, alternative settlement methods, the maximum potential amount
of
consideration and the current carrying amount of the liability, if any. The
guidance in FSP EITF 00-19-2 amends FASB Statements No. 133, "Accounting for
Derivative Instruments and Hedging Activities", and No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity", and FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of
Others", to include scope exceptions for registration payment arrangements.
FSP
EITF
00-19-2 is effective immediately for registration payment arrangements and
the
financial instruments subject to those arrangements that are entered into or
modified subsequent to the issuance date of this FSP, or for financial
statements issued for fiscal years beginning after December 15, 2006, and
interim periods within those fiscal years, for registration payment arrangements
entered into prior to the issuance date of this FSP. The adoption of this
pronouncement is not expected to have a material impact on the Company's
financial position, results of operations or cash flows. However, the Company
will be required to pay a liquidated damage penalty (see Note 11).
The
Company entered into three (3) Royalty and License Agreements. The Company
has
made various payments and is obligated to make additional non-refundable
recoupable prepayments. At December 31, 2006 such fees aggregated as
follows:
Amount
Deferred
license and other fees
$5,500,000
Less,
accumulated amortization
(1,440,000)
$4,060,000
Royalty/license
payments are accounted for in accordance with statement of Financial Accounting
Standard ("SFAS") No. 50 "Financial Reporting for the Record and Music
Industry". The Company reports such minimum guaranteed license
payments as
an
asset and amortizes such cost to expense in accordance with the terms of the
license agreements.
The
Company entered into an agreement with UMG Recordings, Inc. (“Universal”),
effective May 20, 2006 through November 15, 2008, for certain limited,
non-exclusive, non-transferable rights to Universal’s active digital catalog of
music and video recordings for the United States and Canada. The agreement
includes varying rights for streaming, downloading and related
artwork.
In
consideration of these rights, the Company paid a $2 million recoupable advance
(non-refundable) to Universal for the US rights and $184,560 for the Canadian
rights. The Company will pay Universal royalties based on a percentage of
revenues in connection with its service, including advertising, net sales of
products and services, access to the use of the service, banners or
click-through royalties and other web site programs. However, the aforementioned
royalty advances to Universal are first recoupable before any additional
payments are due for the first contract year ending November 15, 2007, at which
time further advances of identical amounts are required under the Universal
contract.
The
Company entered into a similar agreement with EMI Entertainment, Inc. for the
US
music and video rights effective April 1, 2006 through March 31, 2008. The
Company paid a $100,000 recoupable advance (non-refundable) in consideration
of
the rights, which are similar to the Universal Agreement.
The
Company also entered into an agreement with The Orchard Enterprises, Inc.,
effective November 15, 2006 through December 2008, for worldwide music and
music
video rights. The Company has not yet advanced any funds under this
agreement.
At
December 31, 2006, the Company is obligated to make minimum license and other
payments in connection with various music label and music publishing contracts
totaling $3,065,440 payable over the next nine months.
F-13
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(4)
Property and Equipment
Property
and equipment at December 31, 2006 consists of the following:
Amount
Computer
equipment
$137,460
Less,
accumulated depreciation
21,500
Property
and equipment, net
$115,960
Estimated
useful lives for such assets are three years. Depreciation expense for the
year
ended December 31, 2006 and 2005 amounted to $21,500 and $-0- respectively.
Depreciation expense for the period since February 5, 2004 (inception) totals
$21,500.
(5)
Related Party Transactions
In
2006,
the Company advanced funds in the form of a loan to an officer in the amount
of
$35,658. The loan was to be repaid from bonuses, or in the absence thereof,
in
equal monthly installments with simple interest at prime commencing September
2006. The officer resigned in December 2006 and no payments have been made
to
date. Accordingly, the Company has provided an uncollectible allowance for
the
full amount of this loan.
The
Company paid insurance commissions amounting to approximately $21,750 for the
year ended December 31, 2006 to an insurance broker, who is related to the
Company’s Chairman of the Board.
(6)
Equity Transactions
Common
Stock - par value $0.001
During
the quarter ended March 31, 2004, the Company issued 2,567,200 shares of common
stock, valued at $0.01 per share, to its founders for compensation and services
rendered.
During
the quarter ended June 30, 2004, the Company issued 120,000 shares of common
stock, valued at $0.01 per share (representative of the fair value of such
services), to a consultant for services rendered.
During
the quarter ended March 31, 2005, the Company issued 200,000 shares of common
stock, valued at $0.05 per share (representative of the fair value of such
services), to a consultant for services rendered.
During
the quarter ended June 30, 2005, the Company issued 6,460,000 shares of common
stock, valued at $0.05 per share ($323,000 representative of the fair value
of
such services), to employees, board members and consultants for compensation
and
services rendered.
During
the year ended December 31, 2006, the Company issued 270,000 restricted stock
units to employees and consultants.
Convertible
Preferred Stock - Series A - par value $0.01
In
February, 2004, the Board of Directors authorized the issuance of up to
12,000,000 shares of Series A Convertible Preferred Stock which may be converted
into common stock at a rate of one share of common stock for each share of
Series A Convertible Preferred stock. The Company issued 8,650,000 shares to
its
founders upon the formation of the Company. The Series A Preferred Stock
provides certain rights to its holders which include dividends (if declared),
optional conversion rights, anti-dilution protection and voting rights. The
Series A Preferred stock is not redeemable.
During
2004, the Company issued 414,000 shares of Series A Convertible Preferred stock
for prices ranging between $.04 and $1.00 per share, or $136,000.
During
2004, the Company distributed (pre-incorporation distributions) $161,277 to
preferred Series A shareholders.
During
2005, the Company issued 376,200 shares of preferred stock for prices ranging
between $.16 and $0.94 per share, or $76,115.
During
2005, the Company distributed (pre-incorporation distributions) $107,543 to
preferred Series A shareholders.
Redeemable
Convertible Preferred Stock - Series B - par value $0.01
On
April19, 2006, the Board of Directors authorized the issuance of up to 24,000,000
shares of Series B Redeemable Convertible Preferred Stock (“Series B Preferred
Stock”), which may be converted into common stock at a rate of one share of
common stock for each share of Series B Preferred stock. In April 2006, the
Company issued 10,414,654 shares of Series B Preferred stock for $0.85 per
share, or $8,852,456, through a private placement offering. In connection with
the private placement, the Company paid $560,000 in transaction fees and also
issued a warrant to purchase 460,000 shares of Series B Preferred Stock, which
may be converted into common stock at the same conversion rate of one-for-one,
to the financial advisers who brokered the transaction. The warrant expires
in
June 2011 and has an exercise price of $0.85.
The
warrant was valued at $112,000 and is included as a component of the value
of
the Series B Redeemable Convertible Preferred stock.
F-15
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(6)
Equity Transactions, continued
Redeemable
Convertible Preferred Stock - Series B - par value $0.01,
continued
The
Series B shares are automatically converted into shares of common stock upon
the
earlier of (i) the completion of a public offering raising gross proceeds of
at
least $20 million or an offering price greater than 200% of the applicable
conversion price, (ii) common stock becoming Publicly listed, as defined below,
or (iii) written consent of two-thirds (2/3rd) of Series B holders. In addition,
the Series B carries preferential liquidation rights ahead of common shares,
at
a specified conversion price, subject to certain adjustments. Holders of Series
B shares are also entitled to liquidated damages of 2% of the liquidating
preference, for each share outstanding, for the months of August through
September 2007, if by July 31, 2007, common shares are (i) not registered under
Regulation 12 (b) or (g) of the Securities and Exchange Act of 1934 or (ii)
the
Company is not listed on the AIM Branch of the London Exchange (“Publicly
Listed”). The liquidated damages continue to accrue each month for August
through September 30, 2007. After such date the Series B holders are entitled
to
mandatory redemption at two (2) times the liquidation price, as specified.
The
Series B shares carry certain anti-dilution provisions and are only entitled
to
dividends if common shareholders receive dividends.
In
accordance with EITF-D-98, “Classification and Measurement of Redeemable
Securities”, the Company has classified the Series B Preferred Stock outside of
permanent equity since the securities contain contingent redemption features
that are not solely within the control of the Company. As of December 31, 2006,
the securities are carried at their face value since the contingency has not
been met and it is not currently probable. At such time the redemption is
considered likely to occur, the carrying value will be adjusted to its
liquidation value.
(7)Share
Based Arrangements- Stock Award Plan
At
December 31, 2006, the Company has a Stock Award Plan (the “Plan”) which
provides for the issuance of common stock options and restricted stock units
for
certain employees, directors and outside consultants as further described below.
The
Plan,
approved by the board of directors, permits the grant of options and restricted
stock up to a maximum of 4,500,000 shares. As of December 31, 2006, there were
3,843,000 options and shares available for future awards. The options and
restricted shares vest annually, based on employee anniversary, over four (4)
years and three (3) years, respectively. As of December 31, 2006, there were
approximately $13,697 and $28,050 of total unrecognized compensation costs
related to non-vested options and restricted stock, respectively to be expensed
ratably over the period January 2007 through June 2010. No options have been
exercised under the Plan.
F-16
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(7)Share
Based Arrangements- Stock Award Plan, continued
A
summary
of the activity of the Stock Option Plan is as follows:
(7)Share
Based Arrangements- Stock Award Plan, continued
A
summary
of the status of the Company’s unvested share-based payment awards (restricted
stock awards) as of December 31, 2006 and changes in the year then ended is
as follows:
At
December 31, 2006, the total fair value of share-based awards vested was
$1,650.
For
the
years ended December 31, 2006 and 2005 and for the period February 5, 2004
(inception) to December 31, 2006, total compensation costs recognized in the
statement of operations for share-based payment awards were $2,838, $-0- and
$2,838, respectively.
The
Company recognizes stock-based compensation costs on a straight-line basis
over
the requisite service period of the award, which is generally the vesting term
of the award. As of December 31, 2006, the Company had $67,251 of unvested
stock-based compensation at fair value remaining to be expensed ratably over
the
period January 2007 through June 2010.
The
fair
value of the stock options and restricted stock units granted is estimated
on
the date of grant using the Black-Scholes option valuation model. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. Option valuation models require the input of highly subjective
assumptions, including expected life (using the plain vanilla method) and stock
price volatility. The following assumptions were used:
The
weighted average grant date fair value of options granted in 2006 calculated
using the Black-Scholes pricing model was $0.04 per option. In August 2006,
the
Company obtained an independent appraisal of its common stock which was
determined to have a fair value of $.11.
F-18
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(8)Income
Taxes
A
reconciliation of U.S. statutory federal income tax rate to the effective rate
follows:
Net
operating loss (NOL) for which no tax benefit is currently
available
(40.69)
(40.69)
0.00%
0.00%
At
December 31, 2006, the deferred tax asset and benefit consisted of a tax asset
of approximately $3,100,000, due to operating loss carry-forwards of
approximately $7.7 million, which was fully reserved for by providing a
valuation allowance of $3,100,000. The valuation allowance offsets the deferred
tax asset for which it is more likely than not that the deferred tax assets
will
not be realized. The net operating loss carry-forward expires at various times
through the year 2026.
The
valuation allowance will be evaluated at the end of each year, considering
positive and negative evidence about whether the deferred tax asset will be
realized. At that time, the allowance will either be increased or reduced.
A
reduction could result in the complete elimination of the allowance if positive
evidence indicates that the value of the deferred tax asset is no longer
impaired and the allowance is no longer required.
Should
the Company undergo an ownership change as defined in Section 382 of the
Internal Revenue Code, the Company’s tax net operating loss carry-forwards
generated prior to the ownership change will be subject to an annual limitation,
which could reduce or defer the utilization of these losses.
(9)Commitments
and Contingencies
The
Company is obligated under seven (7) employment contracts with officers and
employees aggregating approximately $1,000,000 with terms ranging from one
to
three years. The Company also issued stock options and restricted stock units
to
these individuals covered by their contracts.
The
Company rents office space on a month to month basis for $10,000. Rent expense
for the years ended December 31, 2006 and 2005 and the period February 5, 2004
(inception) to December 31, 2006 was approximately $170,000, $-0- and $170,000,
respectively.
Under
the
terms of employment agreements the Company has had with its Chairman and Chief
Executive Officer and with its Corporate Secretary, during the period from
February 5, 2004 (inception) to December 31, 2004 and a portion of 2005 and
2006, the Company did not pay these officers a salary, as a result of the lack
of available resources. The Company recorded compensation expense and a capital
contribution of $360,000, $110,500 and $166,332 for the period from February5,2004 (inception) to December 31, 2004 and the years ended December 31, 2005
and
2006, respectively. These amounts are equal to the salaries that would have
been
paid during that period, representing an imputed compensation expense for the
minimum base salary amount under the agreement with them, as if the Company
had
paid their salaries.
F-19
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Financial Statements
(10)Legal
Matters
In
February 2007, a Series B shareholder provided the Company with a draft
complaint purporting to assert claims for breach of fiduciary duty, intentional
interference with a prospective contract. The Company is not aware of any
further action that the shareholder has taken with respect to this matter.
On
January 26, 2007, Robin Kent (“Kent”), the former Chief Executive Officer of the
Company (May through December 26, 2006), through his attorney, provided a letter
to the Company raising a complaint in connection with his termination as CEO
of
the Company on December 26, 2006. The Company is not aware of any further action
that Kent has taken with respect to this matter. According to the Company’s
records, Kent resigned on December 26, 2006 which he confirmed in
writing.
In
the
event that any litigation occurs with respect to either or both of the
aforementioned matters, the Company intends to defend any such action
vigorously, and believes that
any
such claims asserted against it would be without merit.
Accordingly, the Company has not made any adjustment to the accompanying
financial statements.
(11)Subsequent
Events
During
March 2007, the Company borrowed $63,000 from an Officer/Shareholder of the
Company, with interest at 10%, maturing on April 1, 2007. The loans were
collateralized by certain computer equipment of the Company. The loan was repaid
in full on April 27, 2007, including default interest, from the proceeds of
the
Senior Note, as described below.
During
March and April 2007, the Company entered into a $5.0 million Senior Secured
Exchangeable Note (the “Note”) with an investor group which will provide
financing up to a maximum of approximately $4.5 million, net of expenses and
closing costs. The Note bears interest at 12% per annum, with interest payable
monthly, commencing October 1, 2007. The entire principal amount is due on
April19, 2008. The Note is collateralized by 3,581,000 million shares of Series
A
exchangeable (convertible) preferred stock and 490,000 common shares owned
by
six (6) shareholders and directors of the Company and all assets of the
Company. The
note
is exchangeable into 5,813,953 common shares upon the registration of the
Company’s common shares under Section 12(b) or 12(g) of the Securities Exchange
Act of 1934, but cannot be exchanged while any preferred Series B shares are
outstanding. The
investors have contractually agreed to restrict their ability to exchange the
senior secured exchangeable notes and receive shares of our common stock such
that the number of shares of common stock held by it and its affiliates after
such exchange does not exceed 9.99% of the then issued and outstanding shares
of
our common stock. The Company received advances under this Note in
March 2007 amounting to $202,000.
The
Company expects to file a Form 10-SB with the Securities and Exchange Commission
by the end of June, 2007. The effective date of this filing is not expected
to
occur until after July 31, 2007 (the “required listing date”). Therefore,
in accordance with the Series B preferred certificate of designation, it is
probable that the Company will be required to pay the Series B shareholders
liquidated damages of 2% per month for each share outstanding for each month
the
Company is not publicly listed, as defined therein. As a result, the Company
will record a charge (in accordance with the accounting requirements of EITF
00-19-2) in May 2007 for such damages of $208,000, which will be payable in
August 2007.
On
May 7,2007, the Company issued options to purchase an aggregate of 170,000 shares
of
its common stock pursuant to its stock incentive plan to five employees for
employment services.
On
June7, 2007, the Company issued 250,000 shares of its common stock to one employee
pursuant to an employment agreement.
net
cash (used in) provided by operating activities:
Depreciation
11,454
--
32,954
Amortization
of deferred financing cost
2,753
--
2,753
Amortization
of deferred licenses and other fees
577,500
--
2,017,500
Bad
debts
--
--
35,658
Common
stock issued for compensation and services
--
--
457,930
Stock
based compensation expense related to employee stock
options
1,197
--
2,385
Stock
based compensation expense related to issuance of restricted
stock
units
51,007
--
52,657
Changes
in operating assets:
Prepaid
expenses and other current assets
90,332
--
(81,024
)
Deferred
licenses and other fees
--
--
(2,434,561
)
Deferred
financing costs
(60,000
)
--
(60,000
)
Security
deposits
5,022
--
(29,000
)
Officer
loan
--
--
(35,658
)
Changes
in operating liabilities:
Accounts
payable and accrued expenses
104,010
81,656
1,415,338
TOTAL ADJUSTMENTS
783,275
81,656
1,376,932
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
(698,438
)
83
(8,390,918
)
CASH
FLOWS FROM INVESTING ACTIVITIES:
Purchases
of property and equipment
(19,566
)
(157,026
)
Net
cash used in investing activities
(19,566
)
(157,026
)
CASH
FLOWS FROM FINANCING ACTIVITIES:
Senior
secured exchangeable note
202,000
202,000
Due
to shareholder
63,000
63,000
Proceeds
from issuance of Series A preferred stock
--
304,312
Distributions
to Series A stockholders
--
(268,819
)
Proceeds
from issuance of Series B preferred stock
--
8,852,456
Costs
associated with private placement offering
--
(560,000
)
Net cash provided by financing activities
265,000
8,592,949
NET
(DECREASE) INCREASE IN CASH
(453,004
)
83
45,005
CASH
-
BEGINNING
498,009
36
--
CASH
-
END
$
45,005
$
119
$
45,005
NON-CASH
INVESTING AND FINANCING TRANSACTIONS:
Contributed
capital from waiver of accrued compensation and consulting
fees
$
--
$
--
$
636,832
Minimum
royalty obligations
$
--
$
--
$
3,065,440
The
accompanying notes are an integral part of these condensed financial
statements.
F-24
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(1)Organization
Nature
of Business
Mohen,
Inc. (the “Company”) commenced operations as a development stage company on
February 5, 2004. While
the
Company filed its Articles of Organization in October 2003, operations did
not
commence until February 2004. Mohen, Inc. is the surviving entity from a
common control merger between Mohen Entertainment Portals, LLC and Mohen
Entertainment Portals, Inc., which changed its name to Mohen, Inc. The merger
was consummated on May 12, 2005. The accompanying financial statements reflect
the merger of the two entities for all periods presented since the majority
shareholders and management of both entities are the same. The Company is
seeking to establish an advertising-funded, free and legal music download
internet site. In
2004
and 2005, the Company had limited business operations, whereby the primary
focus
was the development of its business model. In 2006, with the hiring of its
technology team, the Company accelerated its technological development
activities.
Going
Concern and Management’s Plans
While
there can be no assurance, management believes the Company has the ability
to
raise adequate capital to keep the Company operational for the next twelve
months. In March and April 2007 the Company raised approximately $5 million
(Note 8) to finance its operations, however, no assurance can be given that
such
funds will be sufficient. If the Company is unable to raise additional funds,
it
may be forced to change or delay its contemplated marketing and business plans.
The
Company's principal business activity consists of the development of its
in-house music technology. The Company is developing a music technology-internet
based service, which, when available, will provide consumers the ability at
no
charge to download music files. This free service will allow a consumer to
play
the ad-supported music files only on the computer such consumer uses to download
music files as well as a portable playback device. In addition, the website
will
be able to offer online e-tailers, advertising, media and marketing companies
the ability to provide highly targeted advertising, promotional and other
marketing information to consumers who may have a strong interest in such
advertisers' products.
To
date,
the Company has entered into license agreements with UMG Recording Inc. and
other music companies. As of March 31, 2007, the technology has not yet been
launched as additional technological development activities and various
collaborative agreements still need to be completed. There is no assurance
that
the development activities will continue and, if so, there is no assurance
that
the Company will be commercially successful.
Being
a
development stage company, the Company is subject to all the risks inherent
in
the establishment of a new enterprise and the marketing and design of a new
product, many of which risks are beyond the control of the Company.
The
Company’s principal activities, to date, have been in the research and
development of its website technology. The accompanying financial statements
have been prepared in accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 7, “Development Stage Enterprises.”
F-25
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(1)Organization,
continued
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. The Company is currently a development stage
enterprise and the Company’s continued existence is dependent upon its ability
to obtain additional debt and/or equity financing. The Company has yet to
generate a positive cash flow from operations, and until commercially viable
products are developed and revenue generated, the Company is totally dependent
upon debt and equity funding to finance the Company’s operations. The Company
does not have any patents or copyrights protecting its intellectual
property.
These
factors raise substantial doubt about the Company’s continued existence as a
going concern. These financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
(2)
Summary
of Significant Accounting Policies
Basis
of Presentation
These
unaudited condensed financial statements have been prepared in accordance with
accounting principles generally accepted for interim financial information.
Accordingly, they do not include all the information and footnotes required
by
accounting principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position, results of operations and cash flows for all periods
presented have been made. The results of operations for the three-month period
ended March 31, 2007 are not necessarily indicative of the operating results
that may be expected for the year ending December 31, 2007. These condensed
financial statements should be read in conjunction with the financial statements
and related footnotes for the year ended December 31, 2006 included elsewhere
herein in this Registration Statement.
Use
of Estimates
The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Net
Income/Loss Per Common Share
Basic
net
income (loss) per share of common stock are computed by dividing net income
(loss) available to common stockholders by the weighted average number of shares
of common stock outstanding during the periods presented.
Diluted
net income (loss) per share reflects per share amounts that result if dilutive
common stock equivalents are converted to common stock.
F-26
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(2)
Summary
of Significant Accounting Policies, continued
Net
Income/Loss Per Common Share, continued
Common
stock equivalents, consisting of convertible preferred stock, options and
warrants were not included in the calculation of diluted loss per share for
2006
and 2005 because their inclusion would have had been anti-dilutive.
Total
common stock equivalents outstanding related to stock options, warrants and
convertible preferred stock were 26,495,000 as of March 31, 2007.
Income
Taxes
Effective
January 1, 2007, the company adopted the provisions of FASB Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of
FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement of tax positions taken or expected to be taken in a tax return.
For those benefits to be recognized, a tax position must be more-likely-than-not
to be sustained upon examination by taxing authorities. Differences between
tax
positions taken or expected to be taken in a tax return and the benefit
recognized and measured pursuant to the interpretation are referred to as
“unrecognized benefits”. No liability was required to be recorded (or amount of
net operating loss carry forward or amount of tax refundable is reduced) for
any
unrecognized tax benefits for potential future obligations to the taxing
authority for tax positions as a result of applying the provisions of FIN 48.
In
accordance with FIN 48, interest costs related to unrecognized tax benefits
are
required to be calculated (if applicable) and would be classified as “Interest
expense, net” in the consolidated statements of operations. Penalties would be
recognized as a component of “General and administrative expenses”. No penalties
or interest costs were recognized during the three months ended March 31,2007.
The
Company files income tax returns in the United States (federal) and in various
state and local jurisdictions. The Company is still subject to federal, state
and local income tax examinations by tax authorities for years since inception
to December 31, 2006.
The
adoption of the provisions of FIN 48 did not have a material impact on the
company’s consolidated financial position and results of operations. At January1, 2007 and March 31, 2007, no liability for unrecognized tax benefits was
required to be recorded.
The
Company recognized a deferred tax asset of approximately $3.7 million as of
March 31, 2007, primarily relating to net operating loss carryforwards of
approximately $9.2 million, available to offset future taxable income through
2026.
The
ultimate realization of deferred tax assets is dependent upon the generation
of
future taxable income during the periods in which those temporary differences
become deductible. The Company considers projected future taxable income and
tax
planning strategies in making this assessment. At present, the Company does
not
have a sufficient history of income to conclude that it is more likely than
not
that the Company will be able to realize all of its tax benefits in the near
future and therefore a valuation allowance was established in the full value
of
the deferred tax asset.
F-27
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(2)
Summary
of Significant Accounting Policies, continued
Recent
Accounting Pronouncements, continued
A
valuation allowance will be maintained until sufficient positive evidence exists
to support the reversal of any portion or all of the valuation allowance net
of
appropriate reserves. Should the Company continue to be profitable in future
periods with supportable trends, the valuation allowance will be reversed
accordingly.
(3)Royalty/License
Agreements
The
Company entered into three (3) Royalty and License Agreements. The Company
has
made various payments and is obligated to make additional non-refundable
recoupable prepayments. At March 31, 2007 such fees aggregated as
follows:
Amount
Deferred
license and other fees
$
5,500,000
Less,
accumulated amortization
(2,017,500
)
$
3,482,500
Royalty/license
payments are accounted for in accordance with statement of Financial Accounting
Standard ("SFAS") No. 50 "Financial Reporting for the Record and Music
Industry". The Company reports such minimum guaranteed license
payments as
an
asset and amortizes such cost to expense in accordance with the terms of the
license agreements.
The
Company entered into an agreement with UMG Recordings, Inc. (“Universal”),
effective May 20, 2006 through November 15, 2008, for certain limited,
non-exclusive, non-transferable rights to Universal’s active digital catalog of
music and video recordings for the United States and Canada. The agreement
includes varying rights for streaming, downloading and related
artwork.
In
consideration of these rights, the Company paid a $2 million recoupable advance
(non-refundable) to Universal for the US rights and $184,560 for the Canadian
rights. The Company will pay Universal royalties based on a percentage of
revenues in connection with its service, including advertising, net sales of
products and services, access to the use of the service, banners or
click-through royalties and other web site programs. However, the aforementioned
royalty advances to Universal are first recoupable before any additional
payments are due for the first contract year ending November 15, 2007, at which
time further advances of identical amounts are required under the Universal
contract.
The
Company entered into a similar agreement with EMI Entertainment, Inc. for the
US
music and video rights effective April 1, 2006 through March 31, 2008. The
Company paid a $100,000 recoupable advance (non-refundable) in consideration
of
the rights, which are similar to the Universal Agreement.
The
Company also entered into an agreement with The Orchard Enterprises, Inc.,
effective November 15, 2006 through December 2008, for worldwide music and
music
video rights. The Company has not yet advanced any funds under this
agreement.
F-28
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(3)Royalty/License
Agreements, continued
At
March31, 2007, the Company is obligated to make minimum license and other payments
in
connection with various music label and music publishing contracts totaling
$3,065,440 payable over the next nine months.
(4)
Equity and Treasury Stock Transactions
Common
Stock - par value $0.001
During
the quarter ended March 31, 2004, the Company issued 2,567,200 shares of common
stock, valued at $0.01 per share, to its founders for compensation and services
rendered.
During
the quarter ended June 30, 2004, the Company issued 120,000 shares of common
stock, valued at $0.01 (representative of the fair value of such services)
per
share, to a consultant for services rendered.
During
the quarter ended March 31, 2005, the Company issued 200,000 shares of common
stock, valued at $0.05 (representative of the fair value of such services)
per
share, to a consultant for services rendered.
During
the quarter ended June 30, 2005, the Company issued 6,460,000 shares of common
stock, valued at $0.05 per share ($323,000 representative of the fair value
of
such services), to employees, board members and consultants for compensation
and
services rendered.
During
the year ended December 31, 2006, the Company issued 270,000 restricted stock
units to employees and consultants.
Convertible
Preferred Stock - Series A - Par Value $0.01
In
February, 2004, the Board of Directors authorized the issuance of up to
12,000,000 shares of Series A Convertible Preferred Stock at a conversion rate
of one share of common stock for each share of Series A Convertible Preferred
stock. The Company issued 8,650,000 shares to its founders upon the formation
of
the Company. The Series A Preferred Stock provides certain rights to its holders
which include dividends (if declared), optional conversion rights, anti-dilution
protection and voting rights. The Series A Preferred stock is not
redeemable.
During
2004, the Company issued 414,000 shares of Series A Convertible Preferred stock
for prices ranging between $.04 and $1.00 per share, or $136,000.
During
2004, the Company distributed (pre-incorporation distributions) $161,277 to
preferred Series A shareholders.
During
2005, the Company issued 376,200 shares of preferred stock for prices ranging
between $.16 and $.94 per share, or $76,115.
F-29
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(4)
Equity Transactions, continued
Convertible
Preferred Stock - Series A - Par Value $0.01,
continued
During
2005, the Company distributed (pre-incorporation distributions) $107,543 to
preferred Series A shareholders.
Redeemable
Convertible Preferred Stock - Series B - par value $0.01
On
April19, 2006, the Board of Directors authorized the issuance of up to 24,000,000
shares of Series B Redeemable Convertible Preferred Stock (“Series B Preferred
Stock”), which may be converted into common stock at a rate of one share of
common stock for each share of Series B Preferred stock. In April 2006, the
Company issued 10,414,654 shares of Series B Preferred stock for $0.85 per
share, or $8,852,456, through a private placement offering. In connection with
the private placement, the Company paid $560,000 in transaction fees and also
issued a warrant to purchase 460,000 shares of Series B Preferred Stock, which
may be converted into common stock at the same conversion rate of one-for-one,
to the financial advisers who brokered the transaction. The warrant expires
in
June 2011 and has an exercise price of $0.85.
The
warrant was valued at $112,000 and is included as a component of the value
of
the Series B Redeemable Convertible Preferred stock.
The
Series B shares are automatically converted into shares of common stock upon
the
earlier of (i) the completion of a public offering raising gross proceeds of
at
least $20 million or an offering price greater than 200% of the applicable
conversion price, (ii) common stock becoming Publicly listed, as defined below,
or (iii) written consent of two-thirds (2/3rd) of Series B holders. In addition,
the Series B carries preferential liquidation rights ahead of common shares,
at
a specified conversion price, subject to certain adjustments. Holders of Series
B shares are also entitled to liquidated damages of 2% of the liquidating
preference, for each share outstanding, for the months of August through
September 2007, if by July 31, 2007, common shares are (i) not registered under
Regulation 12 (b) or (g) of the Securities and Exchange Act of 1934 or (ii)
the
Company is not listed on the AIM Branch of the London Exchange (“Publicly
Listed”). The liquidated damages continue to accrue each month for August
through September 30, 2007. After such date the Series B holders are entitled
to
mandatory redemption at two (2) times the liquidation price, as specified.
The
Series B shares carry certain anti-dilution provisions and are only entitled
to
dividends if common shareholders receive dividends.
In
accordance with EITF-D-98, “Classification and Measurement of Redeemable
Securities”, the Company has classified the Series B Preferred Stock outside of
permanent equity since the securities contain contingent redemption features
that are not solely within the control of the Company. As of March 31, 2007,
the
securities are carried at their face value since the contingency has not been
met and it is not currently probable. At such time the redemption is considered
likely to occur, the carrying value will be adjusted to its liquidation
value.
F-30
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(5)Share
Based Arrangements- Stock Award Plan
At
March31, 2007, the Company has a Stock Award Plan (the “Plan”) which provides for the
issuance of common stock options and restricted stock units for certain
employees, directors and outside consultants as further described below.
The
Plan,
approved by the board of directors and amended in January 2007, permits the
grant of options and restricted stock up to a maximum of 7,449,308 shares.
As of
March 31, 2007, there were 1,269,308 options and shares available for future
awards. The options and restricted shares vest annually, based on employee
anniversary, over four (4) years and three (3) years, respectively,
for
those granted through December 31, 2006 and vest quarterly for those granted
after January 1, 2007. As of March 31, 2007, there were approximately
$17,287 and $572,754 of total unrecognized compensation costs related to
non-vested options and restricted stock, respectively to be expensed ratably
over the period January 2007 through June 2010. No options have been exercised
under the Plan.
A
summary
of the activity of the Stock Option Plan is as follows:
(5)Share
Based Arrangements- Stock Award Plan, continued
A
summary
of the status of the Company’s unvested share-based payment awards (restricted
stock awards) as of March 31, 2007 and changes in the year then ended is as
follows:
At
March31, 2007, the total fair value of share-based awards vested was
$51,000.
The
Company recognizes stock-based compensation costs on a straight-line basis
over
the requisite service period of the award, which is generally the vesting term
of the award. Total stock-based compensation expense included in the statements
of operations was $52,204 and $-0- for the period ended March 31, 2007 and
2006,
respectively.
The
fair
value of the stock options and restricted stock units granted is estimated
on
the date of grant using the Black-Scholes option valuation model. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. Option valuation models require the input of highly subjective
assumptions, including expected life (using the plain vanilla method) and stock
price volatility. The following weighted-average assumptions were used:
The
weighted average grant date fair value of options granted in 2007 calculated
using the Black-Scholes pricing model was $0.04 per option. In August 2006,
the
Company obtained an independent appraisal of its common stock which was
determined to have a fair average value of $.11.
(6)Commitments
and Contingencies
The
Company is obligated under seven (7) employment contracts with officers and
employees aggregating approximately $1,000,000 with terms ranging from one
to
three years. The Company also issued stock options and restricted stock units
to
these individuals covered by their contracts.
F-32
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(6)Commitments
and Contingencies, continued
The
Company rents office space on a month to month basis for $10,000. Rent expense
for the three months ended March 31, 2007 and 2006 was approximately $30,000
and
$0, respectively.
Under
the
terms of employment agreements the Company has had with its Chairman and Chief
Executive Officer and with its Corporate Secretary, during the period from
February 5, 2004 (inception) to December 31, 2004 and a portion of 2005 and
2006, the Company did not pay these officers a salary, as a result of the lack
of available resources. The Company recorded compensation expense and a capital
contribution of $360,000, $110,500 and $166,332 for the period from February5,2004 (inception) to December 31, 2004 and the years ended December 31, 2005
and
2006, respectively. These amounts are equal to the salaries that would have
been
paid during that period, representing an imputed compensation expense for the
minimum base salary amount under the agreement with them, as if the Company
had
paid their salaries.
(7)Legal
Matters
In
February 2007, a Series B shareholder provided the Company with a draft
complaint purporting to assert claims for breach of fiduciary duty, intentional
interference with a prospective contract. The Company is not aware of any
further action that the shareholder has taken with respect to this matter.
On
January 26, 2007, Robin Kent (“Kent”), the former Chief Executive Officer of the
Company (May through December 26, 2006), through his attorney, provided a letter
to the Company raising a complaint in connection with his termination as CEO
of
the Company on December 26, 2006. The Company is not aware of any further action
that Kent has taken with respect to this matter. According to the Company’s
records, Kent resigned on December 26, 2006 which he confirmed in
writing.
In
the
event that any litigation occurs with respect to either or both of the
aforementioned matters, the Company intends to defend any such action
vigorously, and believes that
any
such claims asserted against it would be without merit.
Accordingly, the Company has not made any adjustment to the accompanying
financial statements.
F-33
Mohen,
Inc.
(A
Development Stage Company)
Notes
to Condensed Financial Statements
(Unaudited)
(8)Subsequent
Events
During
March 2007, the Company borrowed $63,000 from an Officer/Shareholder of the
Company, with interest at 10%, maturing on April 1, 2007. The loan was
collateralized by certain computer equipment of the Company. The loan was repaid
in full on April 27, 2007, including default interest, from the proceeds of
the
Senior Note, as described below.
During
March and April 2007, the Company entered into a $5.0 million Senior Secured
Exchangeable Note (the “Note”) with an investor group which will provide
financing up to a maximum of approximately $4.5 million, net of expenses and
closing costs. The Note bears interest at 12% per annum, with interest payable
monthly, commencing October 1, 2007. The entire principal amount is due on
April19, 2008. The Note is collateralized by 3,581,000 million shares of Series
A
exchangeable (convertible) preferred stock and 490,000 common shares owned
by
six (6) shareholders and directors of the Company and all assets of the
Company. The
Note
is exchangeable into 5,813,953 common shares upon the registration of the
Company’s common shares under Section 12(b) or 12(g) of the Securities Exchange
Act of 1934, but cannot be exchanged while any preferred Series B shares are
outstanding. The
investors have contractually agreed to restrict their ability to exchange the
senior secured exchangeable notes and receive shares of our common stock such
that the number of shares of common stock held by it and its affiliates after
such exchange does not exceed 9.99% of the then issued and outstanding shares
of
our common stock. The Company received advances under this Note in
March 2007 amounting to $202,000.
During
May 2007, the Company reacquired 1,840,000 shares of common stock of Mr. Kent,
its former Chief Executive Officer, (see note 7 above) as a result of violations
of his non-compete agreement with the Company.
The
Company’s expects to file a Form 10-SB with the Securities and Exchange
Commission by the end of June, 2007. The effective date of this filing is not
expected to occur until after July 31, 2007 (the “required listing date”).
Therefore, in accordance with the series B preferred certificate of designation,
the Company determined in May 2007, it is probable that the Company will be
required to pay the Series B shareholders liquidated damages of 2% per month
for
each share outstanding for each month the Company is not publicly listed, as
defined therein. As a result, the Company will record a charge (in accordance
with the accounting requirements of EITF 00-19-2) for such damages of $208,000,
which will be payable in August 2007.
On
May 7,2007, the Company issued options to purchase an aggregate of 170,000 shares
of
its common stock pursuant to its stock incentive plan to five employees for
employment services.
On
June7, 2007, the Company issued 250,000 shares of its common stock to one employee
pursuant to an employment agreement.
Employment
Agreement between the Company and Mel Schrieberg
10.2
Employment
Agreement between the Company and Vesa Suomalainen
10.3
Employment
Agreement between the Company and Orville Hagler
10.4
Consulting
Agreement between the Company and Joe Mohen
10.5
Agreement
for the Inclusion of Universal Sound Recordings and Universal Videos
in
Online, On-Demand Ad-Supported Services between the Company and UMG
Recordings, Inc. *
10.6
EMI
Music Publishing Agreement
10.7
Employment
Agreement between the Company and George Hayes
14.1
2006
Stock Award Plan
*
To be
filed by amendment
34
SIGNATURES
In
accordance with Section 12 of the Securities Exchange Act of 1934, the
registrant caused this registration statement to be signed on its behalf by
the
undersigned, thereunto duly authorized.