Item 1.
DESCRIPTION OF BUSINESS
When used in this Form 10-KSB, the words "expects," "anticipates," "estimates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties, including those set forth below under "Risks and Uncertainties," that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. Wellstone expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. This discussion should be read together with the financial statements and other financial information included in this Form 10-KSB. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-QSB to be filed by the Company subsequent to this Annual Report on Form 10-KSB and any Current Reports on Form 8-K filed by the Company.
GENERAL
Wellstone Filters, LLC ("Wellstone LLC") was founded in February, 1998 by Dr. Carla Cerami Hand at Cerami Consulting Company. Cerami Consulting Corp was investigating the negative health impact of cigarette smoking. As an outgrowth of this work, Cerami Consulting decided to investigate the possibility of developing a filter technology that would remove carcinogens without impacting flavor. As a result of their research, Cerami Consulting filed for U.S. and international patents on the technology and licensed it and related patents to Wellstone LLC for potential commercialization. Two U.S. patents have been issued (1) U.S. Patent 6,119,701: filed - Feb 13, 1998: issued- September 19, 2000: valid until 2018 and (2) U.S. patent 6,615,842: filed-June 26, 2000: issued-September 9, 2003: valid until 2020). International patents are pending. The patents are held by Cerami Consulting, however the Company has the perpetual, exclusive worldwide rights to the use and commercialization of the patents and the technology related to the patents. The Company sublicensed the technology outside the United States in January 2007.
On May 25, 2001, Wellstone LLC was acquired by Farallon Corporation, a publicly registered reporting corporation formed with the intention of making subsequent acquisitions. Farallon Corporation acquired all of the outstanding membership interests of Wellstone LLC in exchange for 8,400,000 shares of common stock of Farallon Corporation. In addition, in connection with the transaction, Farallon Corporation issued 238,728 shares of common stock in cancellation of debt. As a result of the merger, the former members of Wellstone LLC acquired a majority of the outstanding shares of Farallon. Accordingly, the combination has been accounted for as a reverse acquisition, under which, for accounting purposes, Wellstone LLC is the accounting acquiror, and Farallon Corporation is accordingly the accounting acquiree. As is customary in a reverse acquisition, only the historical financial statements of Wellstone LLC, the accounting acquiror, are presented for periods prior to the acquisition. Farallon Corporation, incorporated in 1994, subsequently changed its name to Wellstone Filters, Inc and Wellstone LLC became a wholly-owned subsidiary of Wellstone Filters, Inc. References to Wellstone refer to the combined entity. On January 5, 2005, Wellstone created a wholly-owned subsidiary operating company, Wellstone Tobacco, Inc., a North Carolina corporation. All of the tobacco sales operations have been conducted through Wellstone Tobacco, Inc.
Wellstone tested the filter technology in small manufacturing batches. Wellstone held discussions with several major manufacturers for licensing or supply contracts, but no contracts have been entered into nor are any currently under negotiation. All testing performed on the filter technology prior to and through December 31, 2005 has been for developmental purposes only and in the third quarter of 2005 Wellstone shipped product to Central and South America for promotional and consumer trial purposes only.
Wellstone's original plan was to license its proprietary cigarette filter technology to existing cigarette manufacturers. We believe that our filter compound removes certain carcinogens and the incorporation of our compound into currently marketed brands would be the quickest way to bring Wellstone Filters to the smoking public. After a review of the tobacco marketplace, Management determined to manufacture and produce its own brand, hoping to be a part of an increasing number of small manufacturers who have gained market share in recent years (estimated by some to be 12 billion units of the total 2005 US market) in this multi-billion dollar market. Wellstone's objective is to offer an ultra premium product at a value price. Sales of the Wellstone brand began in the first quarter of calendar 2006. On April 5, 2006, the Company announced that a major supplier to convenience stores in the Southeastern United States agreed to carry all styles of the Wellstone brand and secure orders using its sales organization.
Wellstone has developed packaging materials and tobacco blends for a full line of cigarettes (regular, smooth blue, and menthol) that is consistent with its ultra premium brand positioning. In addition to selling our own brand of Wellstone cigarettes, we will continue to pursue incorporation of our filter into existing cigarette brands. We purchase various ingredients necessary for our filter from suppliers, but do not enter into written agreements with such suppliers; rather we submit purchase orders on an as-needed basis.
The Wellstone brand of cigarettes are lower in toxins, yet, we believe, do not compromise the pleasurable effects of smoking. Wellstone's strategic plan as well as its philosophy is based on two assumptions: first, quitting smoking can be difficult and second, smokers do not appear to focus on cigarette tar levels. In 2002, according to industry reports, 64% of all cigarettes sold in the United States were high in tar. Wellstone believes that part of the reason smokers prefer high tar cigarettes is because of taste. Wellstone's goal is to reduce tar and certain associated carcinogens without affecting the cigarettes' taste. We believe smokers will try Wellstone for its lower price, and come back for its taste.
In the quarter ended September 30, 2006, the Company continued to suffer from a negative gross margin on its cigarettes, which was part of the Company's strategy to obtain market share and entry into the competitive cigarette marketplace. Management reviewed the liquidity position of the Company during the quarter ended September 30, 2006 and sought unsuccessfully for additional debt or equity funding. Although the Company did enter into negotiations for a private placement, the funding group required that the Company carry out a 1-for- 25 reverse split of the common stock as a precondition to such placement. After Wellstone carried out the reverse split, the funding source did not complete funding. Faced with inadequate cash resources to fund the market introduction of its products, management determined to suspend further marketing activity. As a result, sales in the quarter ended September 30, 2006 fell to only $6,475, and Wellstone had no significant sales for the remainder of the year ended December 31, 2006. All employees and officers have been dismissed or have resigned, except for the Company Chief Executive Officer. The Company has negotiated with it suppliers for time to obtain financing and continue its business, but there is not a high probability that financing can be obtained that is not unduly dilutive to the Company shareholders. Currently the Company has no sales and is seeking financing in order to re-enter the market.
THE TOBACCO AND CIGARETTE INDUSTRY
Published industry sources estimate that the annual U.S sales of cigarettes in 2005 were 381 billion. Approximately 44.5 million adult Americans smoke; worldwide, the figure is estimated to be 1.5 billion people. The market share of five major U.S. cigarette manufacturers in 2005 was estimated as follows:
FILTERS
Almost all cigarettes sold are filtered. Worldwide, 93% of the 5.5 trillion cigarettes sold in 2005 were filtered. Four types of material are used in filters: cellulose acetate (68%), polypropylene (21% primarily in China) pure cellulose (less than 1%), and granular additive filters such as activated charcoal (1%). Activated charcoal filters are efficient, having been proven to reduce carcinogenicity. However, activated carbon filters also remove much of the taste and nicotine, and have probably not become more popular due to this reason. In management's opinion, the development of "safe" or "safer" cigarettes has been slow due to three factors. First, the manufacturers had no interest in developing "safer" cigarettes since to do so would be an admission that smoking was prejudicial to health, which would adversely impact sales and lead to liability. We think this is no longer a factor due to overwhelming consensus that smoking is unhealthy, and the 1998 settlement between the state governments and the tobacco companies.
Second, an effective filter (such as activated charcoal) also is likely to remove that substance in tobacco smoke which makes smoking a pleasurable or addictive habit - nicotine.
Third, until Wellstone was introduced, any perceived safer cigarette, or PREP (perceived reduced exposure product) did not lead to a pleasant smoking experience. We believe that the Wellstone filter provides a unique smoothness and rich flavor not found in any other PREP.
Cigarette manufacturers produce their own filters, or purchase from outside manufacturers, principally Filtrona Richmond, Inc.
Another device used to enhance filter performance is to make perforations around the base of the filter for ventilation. The introduction of air dilutes the smoke, but this device can be circumvented by the smoker by covering the perforations with the fingers.
HARMFUL COMPONENTS OF TOBACCO SMOKE
Tobacco smoke is comprised of atmospheric and other gases, particulate matter, and hundreds of chemical compounds. Tar is condensed tobacco smoke. Nicotine is the addictive substance in tobacco smoke. In the doses found in cigarette smoke carbon monoxide reduces the blood's ability to carry oxygen. Known carcinogens include benzene, 2-napthylamine, 4-amino and byphenyl and radioactive polonium-210. Potential carcinogens include N-nitrosodiethylamine, N-nitrosopyrrolidine, benzoapyrene, N-nitrosodieth aholomine and cadmium.
OUR FILTER REMOVES CERTAIN CARCINOGENS
Our filter material works by trapping nucleophiles in tobacco which is produced during combustion and is the subject of U.S. Patent 6,119,701, "Methods, agents and devices for removing nucleophilic toxins from tobacco and tobacco smoke", issued September 19, 2000, to Anthony Cerami, Dr. Carla Cerami Hand M.D./Ph.D. and Dr. Peter Ulrich Ph.D, all shareholders of Wellstone and licensed to Wellstone on September 14, 1999, and of U.S. Patent 6,615,842 "Methods for removing nucleophilic toxins from tobacco smoke" issued September 9, 2003 to Dr. Cerami, and Drs. Cerami Hand and Ulrich and licensed to Wellstone on September 14, 1999. Compounds in the filter material include periodate-oxidated (dialdeyhde) devivaties of the polysaccarides cellulose, starch and agarose.
We intend to sell and market our own cigarette brand and to sell filters directly to manufacturers to be integrated into their own cigarette brands. We also intend to develop our own "make your own" as well as enter into the small cigar market.
RESULTS OF IN-HOUSE TESTING
The patent developers have tested our filter technology in a biopharmaceuticals laboratory, using standard cigarette filter material (cellulose acetate) containing the compound. We have also tested our filter in an FTC testing facility. These tests indicate that our technology removes a measurable level of harmful substances. Variables such as the mix of tobacco used and manufacturing additives may cause variations in the actual percentage of harmful materials removed.
The Ames test is a standard test used to measure mutagenicity by exposing the smoke (filtered and unfiltered) to a strain of Salmonella bacteria. The Ames test demonstrated that our filter removed a majority of mutagens compared to the control cigarette.
The Greiss test measures nitrosamines, which are contained in cigarette smoke and believed to be carcinogenic. With a 250 milligram level of concentration in the Wellstone filter, a majority of the nitrosamines were removed.
MARKETING
The U.S. cigarette market is a mature market in which overall consumer demand is expected to continue to decline over time. On average, domestic consumption has fallen approximately 2 percent per year over the past decade. Numerous factors have contributed to this decline, including health considerations, diminishing social acceptance of smoking, legislative limitations on smoking in public places, and rapidly accelerating costs in the form of increased state tax on cigarettes and settlement cost.
Even though our filter technology has proven to be effective, tobacco companies are now prohibited from making any claims around the safety of an ingredient, filter or process utilized in cigarette manufacturing. However, because our test marketing indicates that our package design and product taste is acceptable, management feels that the brand will be successful if we get consumer trial and are able to maintain adequate distribution channels. We believe that our sales in the first half of 2006 justified management’s assessment of the potential success of the brand. Wellstone did not conduct any formal taste tests, but feedback from smokers indicated that Wellstone cigarettes had high taste acceptance. Unfortunately, Wellstone had to suspend marketing in the third quarter of 2006 due to lack of finances. We do not know when, if ever, we will be able to continue marketing and resume sales.
INTERNATIONAL MARKETS; GLYCANEX LICENSE; ACQUISITIONS
Wellstone investigated the international potential of its proprietary compound, especially in Europe, Africa, and Asia where smoking levels are much higher than in the United States and Canada. On January 17, 2007, Wellstone entered into a Patent License Agreement with Glycanex BV, the supplier of the patented filter compound used in Wellstone cigarettes. Under the Patent License Agreement, Wellstone granted to Glycanex an exclusive right to the patent rights for all countries excepting the United States of America and its territories and possessions. Glycanex agreed to pay Wellstone a 3% royalty on net sales which exceed the minimum threshold of Euro 500,000. The consideration for the granting of the license to Glycanex was the cancellation of $120,000 owed to Glycanex for purchases of the filter compound.
Two principal factors led to the decision to license Wellstone's key technology to Glycanex. First, Wellstone lacks cash at this time to pay Glycanex for the $ 120,000 which is owed and likewise lacks cash to defend any collection lawsuit. Wellstone also lacks at this time cash to fund marketing of its Wellstone cigarettes in the United States, but believes that with sufficient funding it can resume marketing. Secondly Wellstone believes that the technology is viable and that the licenses to Glycanex provide a possibility for Wellstone to receive royalty income from the exploitation of the technology outside the United States. Management believes that the Patent License Agreement validates the value of the technology.
We are also considering one or more acquisitions if such can be synergistic with our current business, but no agreements have been reached for any acquisitions.
COMPETITION
Our technology faces competition, but we think that our technology competes favorably because it reduces carcinogens while retaining taste and a significant level of nicotine. We believe that we potentially have five competitors, however additional competitors or new technologies could arise at any time. None of them has any significant level of sales and there has never existed any market for special purpose filters.
Philip Morris test-marketed a new cigarette brand during 2005, Marlboro Ultra Smooth, which contained a new carbon filter that was presumably designed to help filter out certain toxins in cigarette smoke and to therefore reduce exposure to these toxins. However, Philip Morris did not make any reduced risk or reduced exposure health claims. The brand was removed from test market due to a lack of consumer acceptance.
RJ Reynolds introduced its Eclipse cigarette in 1998. Eclipse purports to be safer because it primarily heats rather than burns tobacco, greatly reducing second hand smoke, and leaves no ashes, stains or odor. RJR advertised that smoking Eclipse cigarette might reduce the risk of cancer, chronic bronchitis, and emphysema. The American Lung Association and American Heart Association disagree with those claims. Eclipse is being marketed through the internet and limited retail sales.
INTELLECTUAL PROPERTY
The technology fundamental to Wellstone is protected under U.S. Patent number 6,119,701, entitled "Methods, agents and devices for removing nucleophilic toxins from tobacco and tobacco smoke," by Cerami et al., and issued to the Cerami Consulting Corporation. This patent was filed on February 13, 1998, and approved on September 19, 2000. Based on a licensing agreement with Cerami Consulting Corporation, Wellstone has exclusive rights to the technology on which the patent is based. The patent is protected until February 13, 2018, according to current U.S. Patent law. A second U.S. patent was issued to Cerami Consulting Corporation and licensed to Wellstone: U.S. Patent U.S. Patent number 6,615,842, entitled "Methods for removing nucleophilic toxins from tobacco smoke" by Cerami et al., and issued to Cerami Consulting Corporation. This patent was filed on June 26, 2000 and issued on September 9, 2003. Based on a licensing agreement with Cerami Consulting Corporation, Wellstone has exclusive rights to the technology on which the patent is based. Therefore, Wellstone has controlling rights to the technology on which it is based until June 26, 2020, according to current U.S. Patent law.
The international rights to our technology have been licensed to Glycanex, NL, as set forth under the caption “Marketing.”
EMPLOYEES
As of December 31, 2008, we had only one employee, our Chief Executive Officer, and a part-time controller. Pending resumption of marketing, we do not intend to add additional employees at this time.
GOVERNMENTAL REGULATION
The manufacture and sale of cigarettes and other tobacco products and of pharmaceutical products are subject to extensive federal and state governmental regulation in the United States and by comparable authorities in many foreign countries. These national agencies and other federal, state and local entities regulate, among other things, research and development activities and the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of tobacco products.
There are multiple bills pending before the Congress and in several state legislatures which, if enacted, would significantly change the United States tobacco industry. Some of these federal bills contain provisions which would provide substantial federal government funds for smoking cessation programs and products, as well as incentives to tobacco companies and others to produce less harmful or reduced-risk tobacco products. We are unable to predict what effect, if any, these provisions, if enacted, would have on our technology.
The FDA has promulgated regulations governing the sale and advertising of tobacco products designed primarily to discourage the sale to, and consumption by, adolescents and children. The authority of the FDA to promulgate such regulations was challenged in the federal courts. A federal District Court upheld the FDA's authority to promulgate such regulations but ruled that certain of the regulations restricting advertising were invalid as violative of the constitutional right of free speech. On appeal, the United States Court of Appeals for the Fourth Circuit affirmed portions of the District Court opinion that held the FDA could not regulate tobacco advertising and ruled that the executive branch of the United States government, in particular the FDA, does not have any authority to regulate tobacco products generally. The federal government appealed the Appeals Court's ruling and the matter was heard by the United States Supreme Court in late 1999. On March 21, 2000, the Supreme Court in a five to four decision held that Congress has not given the FDA authority to regulate tobacco products as customarily marketed. Given the decision by the Supreme Court it is unclear whether the Congress will act to grant such authority to the FDA, although legislation that would create such authority has already been introduced in Congress.
The requirements for health warnings on cigarettes are governed by the Federal Cigarette Labeling and Advertising Act ("Labeling Act"). The Labeling Act imposes labeling and advertising requirements on the manufacturers, packagers and importers of cigarettes and requires any company wishing to sell cigarettes within the United States to submit a plan to the Federal Trade Commission explaining how it will comply with the warning label display requirements.
The sale of tobacco products is subject to taxation in all fifty states. In addition, some states permit municipalities to impose an additional sales tax, and many municipalities do so. The state and municipal sales taxes are imposed upon wholesalers and/or retailers but not manufacturers or suppliers of components such as filters and therefore we have no liability for such taxes. In addition, cigarettes are subject to substantial and increasing excise taxes. The federal excise tax on cigarettes has been steadily increasing. Additionally, state excise taxes range from $.07 per pack in South Carolina to $2.46 per pack in Rhode Island. These taxes could adversely affect cigarette sales in the future and our potential revenues.
Tobacco production in the United States is subject to government controls, including the tobacco-price support and production control programs administered by the United States Department of Agriculture (the "USDA"). In October 2004, the Fair and Equitable Tobacco Reform Act of 2004 ("FETRA") was signed into law. FETRA provides for the elimination of the federal tobacco quota and price support program through an industry funded buy-out of tobacco growers and quota-holders. The cost of the buy-out is approximately $9.6 billion and will be paid over 10 years by manufacturers and importers of all tobacco products. The cost will be allocated based on the relative market shares of manufacturers and importers of all tobacco products. Manufacturers and importers of tobacco products are also obligated to cover any losses (up to $500 million) that the government may incur on the disposition of pool stock tobacco accumulated under the previous tobacco price support program. Wellstone's share of tobacco pool stock losses will be minimal.
PRODUCT LIABILITY
In the United States, there have been numerous and well-publicized lawsuits against the largest manufacturers of cigarettes and other tobacco products initiated by state and municipal governmental units, health care providers and insurers, individuals (for themselves and on a class-action basis) and by others. The legal theories underlying such lawsuits are varied, but are generally based upon one or more of the following: (1) manufacturer defendants have deceived consumers about the health risks associated with tobacco product consumption; (2) such defendants knew or should have known about various harmful ingredients of their products and failed to adequately warn consumers about the potential harmful effects of those ingredients; and (3) such defendants knew of the addictive attributes of nicotine and have purposefully manipulated their product ingredients so as to enhance the delivery of nicotine.
We intend to sell cigarettes and to supply filters which we believe could make cigarettes less prejudicial to health, Wellstone could be liable for personal injury to consumers. Even if we believe such lawsuits are without merit, the cost of defense or settlement of lawsuits could be substantial.
AVAILABLE INFORMATION
We file annual, quarterly and current reports, information statements and other information with the Securities and Exchange Commission (the "SEC"). The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.
Item 1A.
Item 1A. RISK FACTORS.
We may be sued and may not be covered by insurance.
There are currently several pending legal actions affecting the tobacco industry, including proceedings and claims arising out of the sale, distribution, manufacture, development, advertising, marketing and claimed health effects of cigarettes. We may be named as a defendant in the future as there has been a noteworthy increase in the number of these cases pending. Punitive damages, often in amounts ranging into the hundreds of millions, or even billions of dollars, are specifically pleaded in a number of these cases in addition to compensatory and other damages. We do not yet have any product liability insurance, and if such insurance can be obtained it probably would be very limited in scope of coverage to any claims that tobacco products manufactured by or for us. Such insurance probably would not cover health-related claims such as those that have been made against the major manufacturers of tobacco products. We do not believe that such insurance currently can be obtained. Accordingly, our inclusion in any of these actions or any future actions would have a material and adverse effect on our financial condition.
We have generated only limited revenues and our marketing operations have been suspended.
Sales and marketing of the Wellstone brand began in the first quarter of calendar 2006. Our sales were limited and were carried out with a negative gross margin in order to obtain market share. Marketing efforts were suspended in the third quarter of 2006. Wellstone may not be able to find an adequate market for its products, achieve a significant level of sales or attain profitability. As a result of the significant operating expenses related to start up operations, Wellstone had a loss of $2,772,581 for the year ended December 31, 2006. We had a loss of $71,193 from operations and a net loss of $77,054 in 2007. Wellstone had a net loss of $131,905 for the year ended December 31, 2008. We do not have financing at this time to resume marketing operations, and we had to write off stale and obsolete inventory during the last quarter of 2006. Wellstone may not be able to resume marketing, or attain profitability. Wellstone may not be able to implement its business plan in accordance with its internal forecasts or at a level that meets the expectations of investors.
The report of our independent registered public accounting firm included in this Annual Report on Form 10-KSB contains an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.
As a result of our losses to date and our current lack of revenue, our independent registered public accounting firm has concluded that there is substantial doubt as to our ability to continue as a going concern, and accordingly, our independent registered public accounting firm has included in their report on our December 31, 2007 consolidated financial statements included herein an explanatory paragraph describing the events that have given rise to this uncertainty. The Company will seek additional sources of capital through the issuance of debt or equity financing, but there can be no assurance the Company will be successful in accomplishing its objectives. The ability of the Company to continue as a going concern is dependent on additional sources of capital.
We are dependent on the domestic tobacco business, which is contracting.
Substantially all of our revenues are initially expected to be derived from sales in the United States. The U.S. cigarette market is a mature market and on average, domestic consumption has decreased approximately 2% per year over the past decade. Numerous factors have contributed to this decline, including health considerations, diminishing social acceptance of smoking, legislative limitations on smoking in public places and rapidly accelerating costs in the form of increased state tax on cigarettes and settlement cost. If the U.S. cigarette market continues to contract, it could adversely affect our potential future sales, operating income and cash flows.
Weaknesses in the Company's internal controls and procedures could have a material adverse effect on the Company.
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Management determined that material weaknesses in our internal control over financial reporting existed as of December 31, 2005. A material weakness is a control deficiency, or combination of control deficiencies that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
If we are unable to substantially improve our internal controls, our ability to report our financial results on a timely and accurate basis will continue to be adversely affected, which could have a material adverse effect on our ability to operate our business. Please see Item 8A - Controls and Procedures for more information regarding the measures implemented in 2005, as well as those that we implemented in 2006. Each remedy is designed to remediate the deficiencies in our internal controls. In addition, even after the remedial measures discussed in Item 8A - Controls and Procedures are fully implemented, our internal controls may not prevent all potential errors or fraud, because any control system, no matter how well designed, can only provide reasonable and not absolute assurance that the objectives of the control system will be achieved.
We do not have any production facilities unless we acquire them or contract out production.
Problems in purchasing equipment, establishing manufacturing facilities and meeting demand can be expected. Problems in contracting out production can also be expected. If we cannot produce filter material or outsource production we may not be able to meet market demands of our own brand nor can the filter be used in existing brands unless we license the filer to such existing brands.
Competition could prevent us from meeting our objectives.
The cigarette industry is highly competitive. Our competitors include developers of low-carcinogen tobacco and developers of other filter technology, and these competitors may have a substantially greater financial, manufacturing, marketing and other resources at their disposal. Another company could develop filter technology similar to ours. Competition will affect our ability to market our product and obtain financing. Wellstone brands will be subject to increased competition and this has resulted in additional pressure due to price discounting.
Our cigarettes and the cigarettes using our filter may not be accepted by smokers.
Our filter and the Wellstone brand utilizing it may not be accepted by smokers. Smokers may decide not to purchase our brand or any tobacco product made with our filters due to taste or other preferences, and sales of filters with our technology would be adversely affected.
The cigarette industry is subject to substantial and increasing regulation and taxation and this can only have a negative impact on us.
Various federal, state and local laws limit the advertising, sale and use of cigarettes, and these laws have proliferated in recent years. If, as expected, this trend continues, it may have material and adverse effects on potential sales, operating income and cash flows. In addition, cigarettes are subject to substantial and increasing excise taxes. Increased excise taxes may result in declines in overall sales volume. This result could adversely affect the market for our product.
The U.S. Food and Drug Administration ("FDA") has promulgated regulations governing the sale and advertising of tobacco products. These regulations are designed primarily to discourage the sale to, and consumption by, adolescents and children. The authority of the FDA to promulgate such regulations was challenged in the federal courts. On March 21, 2000, the United States Supreme Court in a five to four decision held that Congress had not given the FDA authority to regulate tobacco products as customarily marketed. Given the decision by the Supreme Court it is unclear whether Congress in the future will act to grant such authority to the FDA, although legislation that would create such authority has already been introduced in Congress. See "Government Regulation."
The cigarette industry is a mature market in which overall consumer demand may continue to decline over time and this may have a negative impact on us.
On average, domestic consumption has fallen approximately 2 percent per year over the past decade. Numerous factors have contributed to this decline, including health considerations, diminishing social acceptance of smoking, legislative limitations on smoking in public places, and rapidly accelerating costs in the form of increased state tax on cigarettes and settlement costs. If this decline in industry-wide consumption continues and Wellstone is unable to capture market share from its competitors, or if the industry as a whole is unable to offset the decline, Wellstone's sales volume, operating income and cash flows could be materially adversely affected, which in turn could negatively affect the value of our common stock.
If we are successful, we might not be able to hire employees and manage a bigger enterprise.
If we are successful in obtaining market acceptance for our products, we will be required to manage increasing, possibly substantial, volume from the resulting customers. To accommodate any such growth and compete effectively, we will be required to attract, integrate, motivate and retain additional highly skilled sales, technical and other employees. We face competition for these people. Our ability to successfully manage such volume also will be dependent on our ability to find a suitable manufacturer for our brand and filters. We or any person contracted with to produce our products in commercial quantities might not be able to overcome the challenge of setting up any production operations, and our personnel, systems, procedures and controls might prove inadequate to support our future operations. Any failure to implement and improve our operational, financial and management systems or to attract, integrate, motivate and retain additional employees required by future growth, if any, could have a material and adverse effect on our business and prospects, financial condition and results of operations.
We may not be able to protect our patents against infringement.
Our success in commercially exploiting our proprietary technology depends in large part on our ability to defend the patents that were licensed to us, to obtain further patent protection for the technology in the United States and other jurisdictions and to operate without infringing upon the patents and proprietary rights of others. Additionally, we must be able to obtain appropriate licenses to patents or proprietary rights held by third parties if infringement would otherwise occur, either in the United States or in foreign countries. The primary patents licensed to us were only issued in the United States and not in foreign jurisdictions. If international patents are not issued, it would diversely affect our competitive advantage, with respect to sales outside the United States.
Patent positions, including our patent positions (owned or licensed) are uncertain and involve complex legal and factual questions for which important legal principles are unresolved. Any conflicts resulting from third party patent applications and patents could significantly reduce the coverage of our patents and limit our ability to obtain meaningful patent protection. If patents are issued to other companies that contain competitive or conflicting claims, we may be required to obtain licenses to these patents or to develop or obtain alternative technology. Such licensing agreements, if required, may be unavailable on acceptable terms or at all. If such licenses are not obtained, we could be delayed in or prevented from pursuing the development or commercialization of our products. It is possible that there exists an issued or pending patent which conflict with or potentially infringe on our patent.
Litigation which could result in substantial cost may also be necessary to enforce any patents to which we have rights, or to determine the scope, validity and unenforceability of other parties' proprietary rights which may affect our rights. U.S. patents carry a presumption of validity and generally can be invalidated only through clear and convincing evidence. We may also have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of an invention, which could result in substantial costs. Our licensed patents might not be held valid by a court or administrative body or that an alleged infringer would be found to be infringing. The mere uncertainty resulting from the institution and continuation of any technology-related litigation or interference proceeding could have a material and adverse effect on our business and prospects.
We may also rely on unpatented trade secrets and know-how to maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with employees, consultants, suppliers and others. These agreements might be breached or terminated, or we might not have adequate remedies for any breach, and our trade secrets might otherwise become known or be independently discovered by competitors.
If we lose our management it would damage our business.
We depend upon the continued services of our senior management for our continued success. The loss of the Company's Chief Executive Officer, Learned Jeremiah Hand, could have a serious negative impact upon our business and operating results. We do not have an employment agreement with Mr. Hand, and we have not obtained "key-man" life insurance with respect to his life.
No cash dividends have been paid and we do not anticipate that we will pay any dividends in the future.
Wellstone has not paid any cash dividends on its capital stock. Wellstone anticipates that its future earnings, if any, will be retained for use in the business, or for other corporate purposes, and it is not anticipated that any cash dividends on its common stock will be paid in the foreseeable future. Investors should not expect to receive any dividends or other periodic income on their investment.
Penny Stock rules could make it hard to resell your shares.
The Penny Stock rules apply to the trading of our stock. Wellstone's common stock does not meet the listing requirements for any trading market other than the OTC Bulletin Board. Consequently, the liquidity of Wellstone's securities could be impaired, not only in the number of securities which could be bought and sold, but also through delays in the timing of transactions, reduction in security analysts' and the news media's coverage of Wellstone, and lower prices for Wellstone's securities than might otherwise be attained.
In addition, the "penny stock" rules limit trading of securities not traded on NASDAQ or a recognized stock exchange, or securities which do not trade at a price of $5.00 or higher, in that brokers making trades in those securities must make a special suitability determination for purchasers of the security, and obtain the purchaser's consent prior to sale. The application of these rules may make it difficult for shareholders to resell their shares.
As the holders of a significant amount of common stock of Wellstone, management and its affiliates have, and will have, substantial influence over Wellstone, and such affiliates may have interests which differ from other holders.
Members of management, and their affiliates, own 71,773 shares of common stock, on a fully diluted basis, or 65.7% of the common stock. As such, such individuals have substantial influence and control over matters voted upon by stockholders (such as the election of the directors to the Board of Directors of Wellstone, mergers and sale of assets involving Wellstone and other matters upon which stockholders of Wellstone vote). This power, in turn, gives them substantial control over the business and operations of Wellstone.
We could change the strategy we outline in this report.
Although we have no current plan to do so, we may change our strategy for the development and marketing of our technology in the future. Our business plan might not be implemented as set forth herein.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
We have no unresolved staff comments.
Item 2.
Item 2.
DESCRIPTION OF PROPERTY
Until September 3, 2003, we rented a minimal amount of office and a lab room of 1,200 square feet space of an affiliate, Kenneth Warren Institute. From October 1, 2003 through November 30, 2004, we used a minimal amount of office space provided by our chief executive officer at no cost. The agreed upon value of the facilities at the Warren Institute was $1,400 per month which was accrued from January 2002 to September 30, 2003. No rent was paid to the Warren Institute; however, Wellstone recorded rent expense for the use of the facilities and a contribution to capital by principal shareholder of $1,400 per month. We also use lab space provided from time to time under agreement with our director of research as part of his compensation. On November 30, 2004, we relocated from New York to North Carolina to avail ourselves of the talent pool and infrastructure already in place in North Carolina. Wellstone leased space in a state-of-the-art cigarette manufacturing facility. In addition to office and plant space, Wellstone also leased, on a non-exclusive basis as needed, certain production assets to produce cigarette samples. Wellstone vacated this space in September, 2006 and now rents a minimal amount of space in Chapel Hill, North Carolina on a month to month basis.
Item 3.
Item 3.
LEGAL PROCEEDINGS
Not Applicable.
Item 4.
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2008.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCK­HOLDER MATTERS
(a) Market Information
The Company's Common Stock has traded on the OTC Bulletin Board under the symbol WLSF.OB from May, 2003 to June 29, 2006, when the symbol was changed to WFLT.OB in connection with a 1-for-25 reverse stock split, and under the symbol WFLR.PK on the Pink Sheets LLC from June 7, 2007, when a 1-for-100 reverse stock split was effected. The high and low sales prices for the common stock were as follows:
All share information is adjusted for stock splits and stock dividends. The above information was supplied by the OTC Bulletin Board or Pink Sheets, LLC and these prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
(b) Holders
As of December 31, 2008, there were approximately 140 record holders of Company common stock.
(c) Dividends
The Company has not paid any dividends on its common stock. The Company currently intends to retain any earnings for use in its business, and therefore does not anticipate paying cash dividends in the foreseeable future.
(d)
Equity Compensation Plans
Equity Compensation Plans
Equity Compensation Plan Information as of December 31,
Number of Securities
remaining available
(a) (b) for future issuance
Number of Securities Weighted Average under equity
To be issued upon
exercise price of
compensation plans
exercise of existing outstanding options, (excluding Securities
Options, warrants warrants and
reflected in
Plan Category and rights rights column (a)
Equity compensation 7,200 $250 9,600
approved by
Security holders
Equity compensation -
-
-
Plans not approved
By Security holders
Total 7,200 9,600
(e)
Sales of Unregistered Securities during the year ended December 31, 2008
None.
(f) Company repurchases of common stock during the years ended December 31, 2008 and 2007.
None
Item 6.
Item 6. SELECTED FINANCIAL DATA
As a smaller reporting company we are not required to respond to this item.
Item 7.
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
SUSPENSION OF MARKETING PROGRAM
In the quarter ended September 30, 2006, the Company continued to suffer from a negative gross margin on its cigarettes; which was part of the Company's strategy to obtain market share and entry into the competitive cigarette marketplace. Management reviewed the liquidity position of the Company during the quarter ended September 30, 2006 and sought unsuccessfully for additional debt or equity funding. Although the Company did enter into negotiations for a private placement, the funding group required that the Company carry out a 1-for- 25 reverse split of the common stock as a precondition to such placement. After Wellstone carried out the reverse split, the funding source did not complete funding. Faced with inadequate cash resources to fund the market introduction of its products, management determined to suspend further marketing activity. As a result, sales in the quarter ended September 30, 2006 fell to only $6,475, and Wellstone had no significant sales for the fourth quarter, and does not expect to be able to have any further sales until such time as Wellstone obtains financing. All full time employees and officers have been dismissed or have resigned except for the Company Chief Executive Officer. The Company is in negotiations with its suppliers for time to obtain financing and continue its business, but there is not a high probability that financing can be obtained that is not unduly dilutive to the Company shareholders.
WELLSTONE'S STRATEGIC DIRECTION
Following a review of the tobacco market and cigarette industry, Wellstone determined to manufacture and produce its own brand of cigarettes. In connection with such plan, Wellstone has developed packaging materials and tobacco blends for a full line of cigarettes, including regular, smooth blue and menthol. Our strategy and objective is to offer an ultra-premium product at a value price.
Wellstone has received approval from the Federal Trade Commission (FTC) and the National Association of Attorneys Generals (NAAG) and has been added to the list of approved brands in thirty one states. We have initiated the process for approval in the remaining states but are not actively prosecuting approval due to lack of funds and uncertainty about the Company’s future marketing. Wellstone has signed a multi-year manufacturing contract with US Flue-Cured Tobacco for production. With the exception of filters, US Flue- Cured will procure all materials, manufacture, package, and ship to order. The Company believes US Flue-Cured's annual manufacturing capacity is sufficient to meet its short and long-term needs. Filters will be sourced from the largest domestic filter manufacturer, as well as several European alternatives. Tobacco leaves and filter compound material is readily available through a variety of sources.
Subject to regulatory approval, we intend to offer what we consider to be a "Potentially Reduced Exposure Product" or "PREP" or products within the price value segment of the market. The Company launched its Wellstone brand of cigarettes in the United States during the first quarter of 2006 and has shipped all brand styles to Arizona, Louisiana, North Carolina, Virginia and California. Wellstone is investigating the international potential of its proprietary compound, especially in Europe, Africa, and Asia where smoking levels are much higher than in the United States and Canada. The Company continues to consider one or more acquisitions if such can be synergistic with our current business, but no agreements have been reached for any acquisitions.
We believe that our brand of cigarettes are lower in toxins and do not compromise the pleasurable effects of smoking. Wellstone's strategic plan as well as its philosophy is based on two assumptions: first, quitting smoking can be difficult and second, many smokers do not concentrate on cigarette tar levels. In 2002, according to industry reports, 64% of all cigarettes sold in the United States were high (more than 10 mg) in tar. Wellstone believes that part of the reason smokers prefer high tar cigarettes is because of taste. Wellstone's goal is to reduce toxins and certain associated carcinogens without affecting the cigarettes' taste. We believe smokers will try Wellstone for its lower price, and come back for its taste.
We believe that Wellstone is the only small (less than $50 million in sales) US cigarette manufacturer that is publicly traded. We believe that the remainder of the small manufacturers in the industry are privately held or foreign. Management believes Wellstone's access to the US capital markets will assist Wellstone in its goal to become the largest company in the growing discount cigarette market. However, there can be no assurance that Wellstone's access to US capital markets will provide the necessary financing to build and grow the business.
We intend to sell and market our own cigarette brand and to sell filters directly to manufacturers to be integrated into their own cigarette brands. Management has determined that manufacturing and distributing a Wellstone line of cigarettes will be in the best interests of its stockholders, particularly if Wellstone is able to successfully market its brand. The successful launch of a Wellstone brand should add significant value to the Company. More importantly, the success of a Wellstone brand will, it is anticipated, lead the way for other manufacturers to utilize the filter in their own cigarettes under a Wellstone license. We also intend to develop our own "make your own" as well as enter into the small cigar market.
OVERVIEW
Wellstone has relocated from New York to North Carolina to avail itself of the talent pool and infrastructure already in place in North Carolina. Wellstone has leased space in a state-of-the-art cigarette manufacturing facility. In addition to office and plant space, Wellstone also leases, on a non-exclusive basis as needed, certain production assets to produce cigarette samples. The office space and plant are located at 250 Crown Boulevard in Timberlake, North Carolina, approximately 20 miles from Durham. This space was vacated in September, 2006, and now rents a minimal amount of space in Chapel Hill, North Carolina on a month to month basis. In furtherance of its marketing plans, the Company:
- Designed packaging to reflect the benefits of the Wellstone filter.
- Retained Signal Design, Inc. of Durham, North Carolina to assist in developing a comprehensive brand strategy and marketing campaign.
- Has received results from an independent FTC testing facility that confirm the Company's expectations for their patented filter technology.
- Hired independent sales consultants and are negotiating with several more.
- Entered into an agreement with U.S. Flue-Cured Tobacco Growers, Inc. to manufacture Wellstone's product line.
- Received FTC advertising approval and rotation warning approval
- Wellstone brand approved by Settling States under the Master Settlement Agreement
- Has formulated distribution plans and begun shipping cigarettes.
RESULTS OF OPERATIONS
On January 5, 2006, the Company announced that it launched its Wellstone brand in the United States with shipments to several states resulting in revenue of $258,194 for the year ended December 31, 2006, of which $215,741 represented sales for the six months ended June 30, 2006 before marketing efforts were suspended in the third quarter. On April 5, 2006, the Company announced that a major supplier to convenience stores in the Southeastern United States had agreed to carry all styles of the Wellstone brand and secure orders using its sales organization. Wellstone had been able to secure additional suppliers to carry all styles of the Wellstone brand family and anticipated that it would ship to additional states during the third quarter of 2006 with sales to most states by the end of the year. However, due to cessation of marketing, there was only limited sales after June 30, 2006. Wellstone shipped product to Central and South America during the third quarter of 2005 for promotional and consumer trial purposes only. Prior to January 2006 Wellstone had received no revenue. Our operations primarily consisted of developing and refining our proprietary filter formulation, obtaining a US and international patent on that formulation, and on seeking to market the filter technology and the Wellstone brand of cigarettes.
Wellstone had a loss from operations of $6,044 in the year ended December 31, 2008. These expenses reflect sales of $0, and operating expenses associated with the inactivity of the company. Interest expenses of $125,861 related to the outstanding debt to debenture holders and management. The Company had a loss of $ 77,054 for the year ended December 31, 2007 that included a gain of $120,000 from the forgiveness of debt associated with the international license of the technology to a supplier for the year ended December 31, 2007. The loss is primarily the result of interest expense of $125,861
.
Substantially all of our losses for the year ended December 31, 2005 were the result of general operating expense, legal fees, and stock-based compensation expense for the issuance of stock and stock options. Options to purchase 180,000 shares with exercise prices of $.08325 per share were issued to two officer employees resulting in an expense of approximately $1,920,000. Because these stock options were issued to employees, the expense was calculated in accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees. Under APB No. 25, the difference between the fair value of the Company's common stock on the grant date and the exercise price of the stock option, multiplied by the number of options granted, is recorded as compensation expense. In addition, the Company issued 160,000 shares of stock to an unrelated individual as certain compensation for consulting services that he provided to the Company and 20,000 shares of common stock to the brother of the Company's Chief Executive Officer for legal services that he provided to the Company. These shares were valued at $25.50 per share based on the closing price of the Company's common stock on the date of issuance and resulted in a non-cash expense of $4,590,000. The Company issued 65,000 shares of common stock upon the exercise of stock options at an exercise price of $.25 and 24,000 shares of common stock upon the exercise of stock options at an exercise price of $.08325.
LIQUIDITY AND CAPITAL RESOURCES
We began shipping cigarettes in the US during January 2006 with shipments to several states resulting in revenue of $258,194 for the year ended December 31, 2006. We currently have no sales and no cash to fund operations. An officer and director is advancing funds to Wellstone for its cash requirements.
Wellstone Filters, Inc. received $250,000 from the Carlson Group, Ltd., pursuant to a promissory note, dated May 17, 2006. This Note is not associated with the prior promissory notes which had been issued in 2006 and 2004. The Company borrowed the principal amount of $250,000, at an interest rate of 8% per annum, due in full on December 31, 2007. In addition to the stated interest rate, the Company shall also pay to the Lender an amount equal to the lesser of (a) $25,000 or (b) 3% of the net profits after taxes as of September 30, 2007, to be payable simultaneously with the principal and interest due on December 31, 2007. If a portion of the principal or interest is paid prior to December 31, 2007, the calculation of the additional amount shall be adjusted pro-rata. In the event of a default under the note when due, then the Lender, at its election, may declare the entire unpaid principal, and all accrued but unpaid interest, immediately due and payable. The maximum additional amount that the Company shall pay is $25,000, and such amount is due on the maturity of the Note. This note has not been paid as of December 31, 2008, and the Company lacks funds to pay the note. Wellstone is in discussions with Carlson Group, Ltd. regarding repayment options.
On January 25, 2006, Wellstone Filters, Inc. received $500,000 from the Carlson Group, Ltd., pursuant to a promissory note, dated January 25, 2006. This Note is not associated with the prior promissory note which had been issued in 2004. The Company borrowed the principal amount of $500,000, at an interest rate of 8% per annum, due in full on December 31, 2007. In addition to the stated interest rate, the Company shall also pay to the Lender an amount equal to the lesser of (a) $25,000 or (b) 3% of the net profits after taxes as of September 30, 2007, to be payable simultaneously with the principal and interest due on December 31, 2007. If a portion of the principal or interest is paid prior to December 31, 2007, the calculation of the additional amount shall be adjusted pro-rata. In the event of a default under the note when due, then the Lender, at its election, may declare the entire unpaid principal, and all accrued but unpaid interest, immediately due and payable. The maximum additional amount that the Company shall pay is $25,000, and such amount is due on the maturity of the Note. This note has not been paid as of December 31, 2008, and the Company lacks funds to pay the note. Wellstone is in discussions with Carlson Group, Ltd. regarding repayment options.
During 2004, the Company received $1,500,000 in exchange for a $1,500,000 convertible promissory note, due December 31, 2006, that it issued to the Carlson Group, Ltd. The note bears interest at a rate of 4% per annum (effective interest rate of 38%), which accrues and is payable on maturity. This note has not been paid as of December 31, 2008, and the Company lacks funds to pay the note. Wellstone is in discussions with Carlson Group, Ltd. regarding repayment options.
Wellstone has sourced suppliers to manufacture its patented formulation in commercial quantities. These sources of supply will enable Wellstone to meet all foreseeable market demand for the Wellstone line as well as to supply other manufacturers who may choose to license the product. Because the formulation is unique to Wellstone's product, Wellstone has been required to specially source manufacturing to ensure that strict specifications can be met. Wellstone intends to use multiple suppliers to ensure a reliable supply.
Our activities to date have been limited to seeking capital; seeking sources of supply and development of a business plan. We do not believe that conventional financing, such as bank loans, is available to us due to these factors. The Company will be required to engage in debt or equity transactions to satisfy cash needs over the next twelve months, and Management believes that it will be able to raise the required funds for operations from one or more future offerings and to affect our business plan. However, there can be no assurances to that effect because our ability to raise significant amounts of financing will be dependent on favorable capital markets and obtaining a market for our products, and other risks inherent in the business as discussed under the caption "Risk Factors" may affect the outcome of Management's plans.
Item 8.
Item 8. FINANCIAL STATEMENTS
Wellstone's financial statements are appended to the end of this reportreport and include the following:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statement of Income for the years ended December 31, 2008 and 2007 and the period inception (February 17, 1998)) to December 31, 2008
Consolidated Statement of Cash Flows for the years ended December 31, 2008 and 2007 and the period inception (February 17, 1998) to December 31, 2008
Consolidated Statement of Stockholders’ Deficit for the period inception (February 17, 1998)) to December 31, 2008
Notes to Consolidated Financial Statements.
.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNT­ING AND FINANCIAL DISCLOSURE
On January 12, 2008, Wellstone Filters, Inc. (the “Company”) terminated its relationship with De Joya Griffith & Company, LLC (“De Joya Griffith”), the principal accountant previously engaged to audit the Company’s financial statements. The Company’s board of directors approved the dismissal of De Joya Griffith. The audit reports of De Joya Griffith on the Company’s financial statements for the fiscal years ending December 31, 2006 and 2005 did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles, except such report was modified to include an explanatory paragraph for a going concern uncertainty. In connection with the audits of the fiscal year ending December 31, 2007 and 2006 including the subsequent interim periods since engagement through January 12, 2008, the date of termination, the Company had no disagreements with De Joya Griffith with respect to accounting or auditing issues of the type discussed in Item 304(a)(iv) of Regulation S-B. Had there been any disagreements that were not resolved to their satisfaction, such disagreements would have caused De Joya Griffith to make reference in connection with their opinion to the subject matter of the disagreement. In addition, during that time there were no reportable events (as defined in Item 304(a)(1)(iv) of Regulation S-B).
During the fiscal year ending December 31, 2006, including the subsequent interim periods since engagement through January 12, 2008, the date of De Joya Griffith’s termination, the Company (or anyone on its behalf) did not consult with any other accounting firm regarding any of the accounting or auditing concerns stated in Item 304(a)(2) of Regulation S-B. Since there were no disagreements or reportable events (as defined in Item 304(a)(2) of Regulation S-B), the Company did not consult any other firm in respect to these matters during the time periods detailed herein.
The Company provided De Joya Griffith with a copy of the Form 8-K reporting this change. The Company requested that De Joya Griffith furnish the Company with a letter to the Securities and Exchange Commission stating whether De Joya Griffith agreed with the above statements. A copy of that letter dated January 12, 2008 is filed as an Exhibit to the Form 8-K.
On January 12, 2008 the Registrant engaged Black Wing Group,,LLC as its new independent. Prior to the engagement of Black Wing Group. LLC, the Registrant did not consult with Black Wing Group, LLC on the application of accounting principles to any specific transaction nor the type of audit opinion that might be rendered on the Registrant's financial statements.
Item 9T. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized, and reported accurately, in accordance with U.S. Generally Accepted Accounting Principles and within the required time periods, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding disclosure.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this Annual Report on Form 10-K our disclosure controls and procedures were effective to enable us to accurately record, process, summarize and report certain information required to be included in the Company’s periodic SEC filings within the required time periods, and to accumulate and communicate to our management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This annual report does not include an attestation report of the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
Item 9B.
Item 9B. OTHER INFORMATION
Not applicable
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The members of the Board of Directors of Wellstone serve until the next annual meeting of stockholders, or until their successors have been elected. The officers serve at the pleasure of the Board of Directors. The following are the directors, executive officers and key employees of Wellstone.
Learned Jeremiah Han
Learned Jeremiah Hand, Chief Executive Officer
Mr. Hand, age 50, joined Wellstone in March, 2000. He has been Chief Executive Officer and a director since March 2000 and Acting Chief Financial Officer since September, 2006. From March 2000 to December 2003 he was employed by Warren Pharmaceuticals, Inc. as its Vice President - Chief Operating Officer. From January 2000 to December 2003 he was Executive Director of the Kenneth S. Warren Institute, a non-profit medical research facility. In 1999 he founded HFC, a private seed venture capital corporation, which has made many internet and biotechnology related investments and is a founder of Medibuy.com. In March 2000, Mr. Hand began to devote a significant portion of his time to Wellstone. He now dedicates 30% of his time to Wellstone. From 1994 to 1999, he served as Vice President at Morgan Stanley Dean Witter. He has a BA cum laude from Amherst College.
Code of Ethics
Wellstone has not adopted a code of ethics which applies to the chief executive officer, or principal financial and accounting officer, because of our level of operations at this time. Wellstone intends to adopt a code of ethics during calendar 2008.
Audit Committee Financial Expert
Wellstone does not have either an Audit Committee or a financial expert on the Board of Directors. The Board of Directors believes that obtaining the services of an audit committee financial expert is not economically rational at this time in light of the costs associated with identifying and retaining an individual who would qualify as an audit committee financial expert, the limited scope of our operations and the relative simplicity of our financial statements and accounting procedures .
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires Wellstone's officers, directors and persons who own more than ten percent of a registered class of our equity securities to file reports of ownership and changes in ownership with the SEC. Officers, directors and ten percent stockholders are required by regulation to furnish Wellstone with copies of all Section 16(a) forms they file. During the year ended December 31, 2007, Wellstone believes that Learned Jeremiah Hand and Samuel M. Veasey failed to file the reports required by Section 16(a) of the Exchange Act, including Forms 3, 4 and 5. Based on representations submitted by such people. Wellstone does not believe that such individuals purchased or sold any Wellstone Common Stock during 2008.
Item 11.
Item 11. EXECUTIVE COMPENSATION
No compensation or benefits have been paid to the sole executive officer and director for the years ended December 31, 2008 and 2007.
In September 2004 Mr. Hand was granted options to purchase 7,200 shares at $250.00 per share. The above options were granted under Wellstone's 1994 Stock Option Plan, as such plan was amended and restated in 2004. There were no options granted or exercised in the years ended December 31, 2008 and 2007. The options held by Mr. Hand are not in the money and have no value.
Wellstone has no long term incentive plans other than the plans described above.
Item 12.
Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information relating to the beneficial ownership of Company common stock as of the date of this report by (i) each person known by Wellstone to be the beneficial owner of more than 5% of the outstanding shares of common stock (ii) each of Wellstone's directors and executive officers, and (iii) all officers and directors as a group. Unless otherwise noted below, Wellstone believes that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. For purposes hereof, a person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof upon the exercise of warrants or options or the conversion of convertible securities. Each beneficial owner's percentage ownership is determined by assuming that any warrants, options or convertible securities that are held by such person (but not those held by any other person) and which are exercisable within 60 days from the date hereof, have been exercised.
Name and Address Common Stock Percentage
Learned Jeremiah Hand(1)(2) 71,773 66.3%
Chief Executive Officer
Carla Cerami Hand, MD,PhD(1)(2)
71,773 66.3%
Anthony Cerami, PhD(1)(3) 11,574 11.5%
All officers and directors
as a group (1 person) 71,773 66.3%
* less than 1%
(1)The business address of each of these persons is300 Market Street, Suite 130-13, Chapel Hill, North Carolina
(2)Ms. Cerami Hand and Mr. Learned Jeremiah Hand are wife and husband. The 71,773 shares listed as beneficially owned by Mr. Learned Jeremiah Hand include 55333 shares which are controlled by Carla Cerami Hand, as stated below; 7,200 shares issuable upon exercise of stock options, and 9,240 shares held through a family limited partnership controlled by him. Mr. Hand disclaims beneficial ownership of such 55,333 shares. Ms. Cerami is the sole limited partner of a partnership which holds 46,093 shares and also controls 9,240 shares held via a trust, and may be deemed to beneficially own the 16,440 shares controlled by Learned Jeremiah Hand. She disclaims beneficial ownership of the 16,440 shares controlled by Learned Jeremiah Hand.
(3)Dr. Anthony Cerami is the father of Carla Cerami Hand. Shares are held in a trust.
Item 13.
Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Mr. Learned Hand, an officer and director, advanced $28,940 to Wellstone for expenses which had not been reimbursed as of December 31, 2008. Mr. Learned Hand advanced an additional $15,000 to Wellstone for operating expenses in September 2006 that has not been reimbursed as of December 31, 2008. A law firm controlled by a brother of Learned Hand advanced funds on behalf of Wellstone from time to time prior to calendar 2006, and as of December 31, 2007 and 2008 the amount unreimbursed to the law firm was $16,286. The highest amount owing to the law firm during 2007 or 2008 was $16,286.
Mr. Learned J. Hand has advanced the Company additional funds during 2007 in the amount of $61,144. Mr. Hand is under no commitment to continue to advance funds to the Company.
Carla Cerami Hand or Cerami Consulting Corporation and an entity controlled by Learned Hand loaned various amounts to Wellstone for its capital requirements prior to the year ended December 31, 2006. The loans are due on demand, bear interest at 8% per annum and are represented by promissory notes. As of December 31, 2008, $34,671 had accrued as interest on these notes, none of which had been paid. These related party notes payable totaled $59,200 as of December 31, 2008.
The Company has a licensing agreement with Cerami Consulting Corporation, an entity owned and controlled by the spouse of the Company's Chief Executive Officer. The licensing agreement grants the Company the exclusive worldwide exploitation rights to practice and utilize the inventions, technology, know- how, and patent, including the rights to manufacture and market the filters which are the subject of the licensing agreement, that are held by Cerami Consulting Corporation. In exchange for the license rights, the Company agreed to pay all future costs for development, manufacture, and commercialization of the technology, including all other future fees and costs in connection with the patents.
Item 14
Item 14 Principal Accountant Fees and Services.
Audit Fees
Item 14 Principal Accountant Fees and Services.
During the period covering the fiscal years ended December 31, 2007 our principal accounting firm Blackwing Group was paid audit fees of $2,000 for audit services performed in 2008. In fiscal 2007 we paid DeJoya Griffith & Co. $9,000 for reviews of our Quarterly Reports on Form 10-QSB. We paid DeJoya Griffith $24,000 in audit fees and $1,345 for EDGAR filing fees for $2006.
Audit Committees pre-approval policies and procedures
We do not have an audit committee. Our engagement of Blackwing Group LLC, as our independent registered public accounting firm, was approved by the Board of Directors. No services described in Item 9(e)(2) through 9(e)(4) of Schedule 14A were performed by our auditors.
PART IV
Item 15.
Item 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits. The following exhibits of the Company are included herein.No schedules are required.
2. Plan of acquisition, reorganization, arrange­ment, li­quidation or succession.
2.1. Agreement and Plan of Reorganization, dated February, May 25, 2001, be­tween the Reg­istrant and Wellstone LLC.(2)
3. Certificate of Incorporation and Bylaws
3.1. Articles of Incorporation(1)
3.2 Articles of Amendment(2)
3.3 Bylaws(1)
3.4 Articles of Amendment increasing authorized common stock to 300,000,000 shares (5)
3.5 Articles of Amendment for reverse stock split. (10)
10. Material Contracts
10.1 Stock Option Plan(1)
102 Amended and Restated Stock Option Plan(5)
10.3 Funding Agreement with Arrakis Select Fund,(5)
10.4 Schedule of Details, options granted as of December 31, 2004 under Stock Option Plan(5)
10.5 $1,500,000 Promissory Note (4)
10.6 Warrants, exercisable for 3,240,000 shares of common stock (4)
10.7 Lease Agreement, with U.S. Flue-Cured Tobacco Growers Inc., dated as of September 1, 2004. (5)
10.8 Marketing Agreement, with H&S Marketing, dated as of December 28, 2004 (5)
10.9 License Agreement, by and between Cerami Consulting Corporation and Wellstone Filters, LLC, dated as of September 14, 1999 (5)
10.10 Lease Extension Agreement with U.S. Flue-Cured Tobacco Growers Inc., dated May 2, 2005 (5)
10.11 $500,000 Promissory Note between Wellstone Filters, Inc. and Carlson Group, Ltd., dated January 25, 2006 (6)
10.12 Summary of Employment Agreement with Learned Jeremiah Hand (7)
10.13 Summary of Employment Agreement with Samuel M. Veasey (7)
10.14. Patent License Agreement dated January 17, 2007 between Wellstone and Glycanex BV.(8)
21.1 Wellstone Tobacco Company is incorporated in North Carolina. Trade names used include Wellstone and Silverton. Wellstone Filters LLC is incorporated in Delaware.
31.1 Certification of Chief Executive and Financial Officer Pursuant to Exchange Act Rule 13a-14(a)(10).
32.1 Certification of Chief Executive and Financial Officer pursuant to 18 U.S.C. Section 1350(10).
(1) Incorporated by reference to the Company's Registration Statement on Form 10-SB, file no. 0-28161.
(2) Incorporated by reference to the Company's Current Report on Form 8-K, dated May 25, 2001.
(3) Incorporated by reference to the Company's Current Report on Form 8-K dated August 6, 2001.
(4) Incorporated by reference to the Company's Current Report on Form 8-K, dated December 3, 2004.
(5) Incorporated by reference to the Company's amended Annual Report on Form 10-KSB/A, dated December 31, 2004.
(6) Incorporated by reference to the Company's Current Report on Form 8-K, dated December 25, 2005.
(7) Incorporated by reference to the Company's Annual Report on Form 10-KSB, dated December 31, 2004.
(8) Incorporated by reference to the Company's Current Report on Form 8-K, dated January 22, 2007.
(9) (7) Incorporated by reference to the Company's Annual Report on Form 10-KSB, dated December 31, 2006.
(10) Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 18, 2009.
WELLSTONE FILTERS, INC.
By:/s/ Learned Jeremiah Hand
Learned Jeremiah Hand
CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on March 18, 2009.
By:/s/Learned Jeremiah Hand CEO and Director
Learned Jeremiah Hand (principal executive officer and acting
accounting and financial officer)
THE BLACKWING GROUP, LLC 18921G E VALLEY VIEW PARKWAY #325
INDEPENDENCE, MO 64055
816-813-0098
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Wellstone Filters, inc. (A Development Stage Company)
3887 Pacific Street
Las Vegas, NV 89121
We have audited the accompanying balance sheets of Wellstone filters, inc. (A Development Stage Company) as of December 31, 2007 and 2008, and the related statements of income and changes in member’s equity, and cash flows for the periods then ended and the period from February 17, 1998 to December 31, 2008. 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 audit 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 audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the prior auditor, these financial statements referred to above present fairly, in all material respects, the financial position of Wellstone filters, inc. (A Development Stage Company) as of December 31, 2007 and 2008, and the results of its operations and its cash flows for the periods then ended and the period from February 17, 1998 to December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note C to the financial statements, the Company faces competition from existing companies with considerably more financial resources and business connections. In the event that Company fails to meet the anticipated levels of performance there is significant doubt that the Company will be able to meet the debt obligations related to the non public offering. These conditions raise substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note C. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Blackwing Group, LLC
Issuing Office: Independence, MO
March 17, 2009
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of this financial statement.
The accompanying notes are an integral part of these financial statements.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of significant accounting policies of Wellstone Filters, Inc. (A Development Stage Company) (the Company) is presented to assist in understanding the Company’s financial statements. The accounting policies presented in these footnotes conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the accompanying financial statements. These financial statements and notes are representations of the Company’s management who are responsible for their integrity and objectivity. The Company has not realized revenues from its planned principal business purpose and is considered to be in its development state in accordance with SFAS 7, “Accounting and Reporting by Development State Enterprises.”
Organization, Nature of Business and Trade Name
Wellstone Filters, LLC (Wellstone) was organized as a Delaware limited liability company on February 17, 1998 (date of inception). On May 25, 2001, Wellstone Filters, Inc. (formerly Farallon Corporation) (the "Registrant") acquired Wellstone pursuant to an Agreement and Plan of Reorganization (the Agreement), dated as of May 25, 2001. The Registrant acquired all of the outstanding membership interest of Wellstone, in exchange for 8,400,000 shares of the Registrant's Common Stock. In addition, the Company issued 238,728 shares of common stock for cancellation of debt.
The stockholders of Wellstone, after the acquisition, owned the majority of the combined company. Accordingly, the combination has been accounted for as a reverse acquisition whereby, for accounting purposes, Wellstone is the accounting acquirer and Registrant is the accounting acquiree. Registrant and Wellstone are collectively referred to as (the Company). The Company has adopted a December 31 yearend. The financial statements from inception through May 25, 2001, are those of Wellstone, LLC, and the accounting acquirer. Subsequent to May 25, 2001, the financial statements reflect the consolidated position and operations of Registrant and Wellstone. All share amounts are after giving effect to a 5-for-1 forward stock split effected in July 2003, a .40 for one stock dividend effected in October 2003 and a 3-for-1 forward stock split effected in September 2004, a 1-for-25 reverse split effective June 2006 and a 1-for-100 reverse stock split effective June of 2007.
The Company is engaged in the development and marketing of a proprietary cigarette filter technology and the Wellstone brand of cigarettes utilizing its patented reduced risk filter. On January 5, 2006, Wellstone announced that it had launched its brand in the United States with shipments to Phoenix, Arizona. The Company subsequently announced that it had shipped the Wellstone brand to Chapel Hill, NC and Richmond, Virginia and has partnered with a major supplier of convenience stores in the Southeastern United States to carry the Wellstone brand family. The Company is not currently generating any revenues from planned principal operations and is considered a development stage company as defined in Statement of Financial Accounting Standards No. 7.
These Consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
Organization, Nature of Business and Trade Name (continued)
Basis of Presentation
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates. Management further acknowledges that it is solely responsible for adopting sound accounting practices, establishing and maintaining a system of internal accounting control and preventing and detecting fraud. The Company’s system of internal accounting control is designed to assure, among other items, that (1) recorded transactions are valid; (2) all valid transactions are recorded and (3) transactions are recorded in the period in a timely manner to produce financial statements which present fairly the financial condition, results of operations and cash flows of the company for the respective periods being presented.
Property and Equipment
Property and equipment are carried at cost, less accumulated depreciation and amortization. Expenditures for maintenance and repairs are charged against operations. Renewals and betterments that materially extend the life of the assets are capitalized. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income for the period.
Depreciation is computed for financial statement purposes on a straight-line basis over estimated useful lives of the related assets of 3 to 5 years.
For federal income tax purposes, depreciation is computed under the modified accelerated cost recovery system. For audit purposes, depreciation is computed under the straight-line method.
Income Taxes
Income taxes are recorded using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to difference between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. 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 and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all short-term debt securities purchased with maturity of three months or less to be cash equivalents.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock based Compensation
On January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), Accounting for Stock-Based Compensation, to account for compensation costs under our stock option plans. We previously utilized the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (as amended).
We use the fair value method for equity instruments granted to employees and non-employees and use the Black Scholes model for measuring the fair value of options, if issued. The stock based fair value compensation is determined as of the date of the grant or the date at which the performance of the services is completed (measurement date) and is recognized over the vesting period.
For the twelve months ended December 31, 2008, the Company did not have any stock based compensation expenses.
Revenue and Cost Recognition
The Company provides custom solutions for business management needs. The Company reports income and expenses on the accrual basis of accounting, whereby income is recorded when it is earned and expenses recorded when they are incurred. In this specific industry revenue from jobs is recognized as stipulated in each contract for services. The Company currently has not met any contract terms for recognition of revenue.
Cost of Goods Sold
Job costs include all direct materials, and labor costs and those indirect costs related to contracted services. Selling, general and administrative costs are charged to expense as incurred.
Advertising
Advertising expenses related to specific jobs are allocated and classified as costs of goods sold. Advertising expenses not related to specific jobs are recorded as general and administrative expenses.
Use of Estimates
The preparation of financial statements in accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
A change in managements’ estimates or assumptions could have a material impact on Wellstone Filters, Inc.’s financial condition and results of operations during the period in which such changes occurred. Actual results could differ from those estimates. Wellstone Filters, Inc.’s financial statements reflect all adjustments that management believes are necessary for the fair presentation of their financial condition and results of operations for the periods presented.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Research and Development
The Company expenses research and development costs as incurred.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
Principles of Consolidation
The consolidated financial statements include the accounts of the Registrant and its wholly owned subsidiaries, Wellstone Filters, LLC and Wellstone Tobacco, Inc. All significant inter-company transactions have been eliminated in consolidation.
Recently Issued Accounting Pronouncements
Recently Enacted Accounting Standards - In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (FAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of FAS 157 became effective as of the beginning of our 2008 fiscal year. The adoption of FAS 157 did not have a significant impact on our financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), which addresses how to quantify the effect of financial statement errors. The provisions of SAB 108 became effective as of the end of our 2007 fiscal year. The adoption of SAB 108 did not have a significant impact on our financial statements.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparison between companies that choose different measurement attributes for similar types of assets and liabilities. The provisions of FAS 159 become effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact that FAS 159 will have on our financial statements.
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” which applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recently Issued Accounting Pronouncements (continued)
noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. The statement is effective for annual periods beginning after December 15, 2008.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133,” (SFAS “161”) as amended and interpreted, which requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. Disclosing the fair values of derivative instruments and their gains and losses in a tabular format provides a more complete picture of the location in an entity’s financial statements of both the derivative positions existing at period end and the effect of using derivatives during the reporting period. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early adoption is permitted. We are currently evaluating the impact that FAS 161 will have on our financial statements.
In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60.” SFAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Those clarifications will increase comparability in financial reporting of financial guarantee insurance contracts by insurance enterprises. This Statement requires expanded disclosures about financial guarantee insurance contracts. The accounting and disclosure requirements of the Statement will improve the quality of information provided to users of financial statements. SFAS 163 will be effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of SFAS 163 will have a material impact on its financial condition or results of operation.
None of the above new pronouncements has current application to the Company, but may be applicable to the Company’s future financial reporting.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE B - STOCK SPLITS AND STOCK DIVIDENDS
The Company has declared and affected the following stock splits and dividends:
- A five for one stock split in July
- A four-tenths for one stock dividend in September 2003
- A three for one stock split in September
- A one for 25 reverse stock split in June
- A one for 100 reverse stock split in January 2007
All share amounts in the consolidated financial statements have been retroactively restated to reflect these stock splits and dividend.
NOTE C - GOING CONCERN
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading, or seeking protection from creditors pursuant to laws or regulations.
Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business.
The Company incurred a net loss of $31,715 and $32,788 for the three months ended December 31, 2008 and 2007 and $131,905 and $77,054 for the twelve months ended December 31, 2008 and 2007. The Company's liabilities exceed its assets by $4,340,096 as of December 31, 2008. The Company's sole operations have been discontinued with no other source of operating revenues. These factors create substantial doubt about the Company's ability to continue as a going concern. The Company's management plans to continue as a going concern revolves around its ability to develop and/or acquire new business operations, as well as raise necessary capital to pay ongoing general and administrative expenses of the Company.
The ability of the Company to continue as a going concern is dependent on securing additional sources of capital and the success of the Company's plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
NOTE D - INCOME TAXES
The Company accounts for income taxes using the liability method; under which deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE D - INCOME TAXES - Continued
As of December 31, 2008, the Company had net operating loss carryforwards of approximately $32,604,542, which expire in varying amounts between 2016 and 2026. Realization of this potential future tax benefit is dependent on generating sufficient taxable income prior to expiration of the loss carryforward. The deferred tax asset related to this potential future tax benefit has been offset by a valuation allowance in the same amount. The amount of the deferred tax asset ultimately realizable could be increased in the near term if estimates of future taxable income during the carryforward period are revised.
Deferred income tax assets of $6,045,049 and $5,987,407 at December 31, 2008 and 2007, respectively were offset in full by a valuation allowance.
The components of the Company's net deferred tax assets, including a valuation allowance, are as follows:
Deferred Tax Assets
As of December 31, 2008
As of December 31, 2007
Net operating loss carryforwards
$3,766,549
$3,708,907
Stock based compensation
2,278,500
2,278,500
Net deferred tax assets before valuation allowance
$6,045,049
$5,987,407
Less: Valuation Allowance
(6,045,049)
(5,987,407)
Net deferred tax assets
--
--
A reconciliation between the amounts of income tax benefit determined by applying the applicable U.S. and State statutory income tax rate to pre-tax loss is as follows:
As of December 31, 2008
As of December 31, 2007
Statutory federal income tax
(35%)
(35%)
Statutory state income tax
(8.7%)
(8.7%)
Change in valuation allowance on deferred tax assets
(43.7%)
(43.7%)
Due to the inherent uncertainty in forecasts and future events and operating results, the Company has provided for a valuation allowance in an amount equal to gross deferred tax assets resulting in the above figures for the periods audited.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE E - NET LOSS PER COMMON SHARE
Net loss per share is calculated in accordance with SFAS No. 128, “Earnings Per Share” using the weighted average number of common shares outstanding during the year.
The computation of diluted loss per common share is based on the weighted average number of shares outstanding during the year, plus common stock equivalents calculated under the treasury stock method. The Company has issued equity instruments convertible into common stock such as stock options and warrants issued to employees, consultants and creditors that can be exercised for approximately 1,462,600 shares of common stock at December 31, 2006 with conversion process of $2.50 per share as of December 31, 2006. Common stock equivalents have not been included in the diluted loss per share calculation for the year December 31, 2008 or 2007 because the effect would be antidilutive.
NOTE F - PROPERTY AND EQUIPMENT
The carrying values of fixed assets as of December 31, 2008 and 2007, were as follows:
Equipment
$ 19, 421
19,421
Furniture and Fixtures
-
-
19,421
19,421
Accumulated Depreciation
(19,421)
(18,127)
$ -
$ 1,294
Depreciation for the periods ended December 31, 2008 and 2007 is $1,294 and $6,178.
NOTE G - ACCRUED EXPENSES
The Company has accrued expenses for years ended 2008 and 2007 of $1,356,224 and $1,230,363 , respectively. The amounts for 2008 and 2007 were primarily the result of deferred salaries of Company executives and interest on notes payable.
NOTE H - LONG-TERM DEBT
Long-Term debt consist of the following at December 31, 2007 and 2008:
Note payable to an entity bearing interest at 4%, with principal and interest due on November 30, 2006. The note holder also received a warrant to purchase 129,600 shares of the Company’s common stock for $12.50 per share
$2,250,000
$2,250,000
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE I - RELATED PARTY TRANSACTIONS
Mr. Learned Hand, an officer and director, advanced $28,942 to the Company for expenses, which had not been reimbursed as of December 31, 2008. Mr. Learned Hand advanced an additional $15,000 to Wellstone for operating expenses in September 2006. The unreimbursed amount as of December 31, 2006 was $43,942. A law firm controlled by a brother of Learned Hand advanced funds on behalf of the Company from time to time in calendar 2004, and as of December 31, 2006 the amount unreimbursed to the law firm was $16,286.
Pacific Coast Distributors, a distributor owned and operated by Adam Hand, a brother of the Company's CEO, accounted for $ 39,311, or 15% of the Company's sales in 2006. The sales terms to this distributor were the same as any other distributor. As of December 31, 2006, this distributor owed the Company $39,311, which was 15% of the Company's accounts receivable as of that date. However, in connection with its cessation of sales, the Company has written off all of its accounts receivables as uncollectible.
Pursuant to an Agreement and Plan of Reorganization dated May 25, 2001, Wellstone Filters, Inc., a Delaware corporation formerly known as Farallon Corporation ("Wellstone") acquired all of the outstanding membership interests of Wellstone LLC in exchange for 210,000,000 shares of Wellstone's Common Stock. In addition, Wellstone issued 5,968,200 shares of common stock to a stockholder of Farallon in cancellation of debt of $2,842. The terms of the acquisition were determined between the parties, who are related in that Learned Jeremiah Hand, the CEO of Wellstone, LLC, is the brother of Jehu Hand, the founder and president of Farallon. Prior to the acquisition, Wellstone LLC
and Farallon had no affiliation or relationship.
Carla Cerami Hand or Cerami Consulting Corporation and an entity controlled by Learned Hand have loaned various amounts to the Company for its capital requirements, as follows. The loans are due on demand; bear interest at 8% per annum and are represented by promissory notes. As of December 31, 2008, $34,671 had accrued as interest on these notes, none of which had been paid. These related party notes payable totaled $59,200 as of December 31, 2005.
During 2005 Wellstone issued 20,000 shares of common stock, valued at $510,000, to the brother of the Company's Chief Executive Officer for legal services that he provided to the Company.
In 2004, we issued to Jehu Hand, a brother of our Chief Executive Officer, 600,000 shares of common stock as compensation for legal services, which he provided to the Company. The Company's issuance of shares of its common stock to Mr. Hand resulted in an expense of approximately $6,270,000. On January 2, 2004, Arrakis Select, Inc., a company controlled by Jehu Hand, a brother of our Chief Executive Officer, entered into a Funding Agreement whereby Arrakis provided $195,000 to Wellstone between January and October 2004 in exchange for 22,992 shares of common stock. The Company issued common stock to Arrakis monthly at a price per share equal to the closing bid price of common stock as of the 15th day of the month in which Arrakis invested the money.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE I - RELATED PARTY TRANSACTIONS (continued)
The Company has a licensing agreement with Cerami Consulting Corporation, an entity owned and controlled by the spouse of the Company's Chief Executive Officer. The licensing agreement grants the Company the exclusive worldwide exploitation rights to practice and utilize the inventions, technology, know how, and patent, including the rights to manufacture and market the filters which are the subject of the licensing agreement, that are held by Cerami Consulting Corporation. In exchange for the license rights, the Company agreed to pay all future costs for development, manufacture, and commercialization of the technology, including all other future fees and costs in connection with the patents.
In the fiscal years ended December 31, 2003 and 2002, Ms. Cerami Hand and/or Mr. Learned Hand advanced $8,899 and $16,072, respectively, on behalf of the Company for its corporate expenses. The Warren Institute, affiliated with the above officers, provided from time to time office space and occasional use of a 1,200 square foot lab to the Company at a cost of $1,400 per month from January 2002 to September 30, 2003, all of which has been accounted for as a contribution to capital by the controlling stockholders. Such amounts are not represented by any promissory note and bear no interest.
The notes payable - related party consist of loans from officers of the Company. The amounts are unsecured, bearing interest rates between 5% to 8% and are due on demand. Accrued interest on the notes was $37,109 and $31,248 as of December 31, 2008 and December 31, 2007, respectively.
Accounts payable - related party includes amounts due to an officer of the Company and the brother of an officer of the Company.
NOTE J - SUPPLEMENTAL CASH FLOW INFORMATION
No cash amounts were paid for interest or income taxes during the period from February 17, 1998, (date of inception) to December 31, 2008.
During the year ended December 31, 2004, the Company issued warrants with debt. The warrants were valued at $1,020,000, which amount was recorded as a discount on long-term debt. During 2005 and 2004, $510,000 and $42,500, respectively, of the debt discount was accreted as interest expense.
During the years ended December 31, 2003 and 2002, the Company recorded a contribution of capital of $12,600 and $16,800, respectively, for the use of office space provided by an officer and board member of the Company. The arrangement for the use of office space was mutually terminated on September 30, 2003.
During the year ended December 31, 2003, the Company purchased furniture and equipment through an increase in the related party accounts payable totaling $67,705.
During the year ended December 31, 2002, the Company acquired furniture and equipment in exchange for an increase in related party accounts payable of $11,167.
During the year ended December 31, 2001 the Company issued 238,728 shares of common stock in settlement of $2,842 of debt.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE K - CAPITAL STOCK
Preferred Stock
The Company has authorized 1,000,000 shares of preferred stock, $.001 par value, with such rights, preferences and designation and to be issued in such series as determined by the Board of Directors. No shares of preferred stock are issued and outstanding at December 31, 2008.
Common Stock
The Company has authorized common stock. A three for one stock split was approved on September 27, 2004 and subsequently effected on October 6, 2004. The stock split resulted in the issuance of an additional 157,978,800 shares of common stock. On September 15, 2003 a four tenths for one stock dividend was declared and subsequently issued on September 30, 2003. The stock dividend resulted in the issuance of an additional 45,136,800 shares of common stock.
On December 1, 2006 a one for one-hundred reverse stock split was approved and effected on January 31, 2007. The reverse stock split resulted in a reclassification of common stock from 10,433,720 to 105,989
, including 1,652 shares issued to shareholders in rounding off the reverse stock split. .
On May 17, 2006 a one for twenty-five reverse stock split was approved and effected on June 19, 2006. The reverse stock split resulted in a reclassification of common stock from 280,842,991 to 10,433,720.
There was only one issuance of common stock in 2006. On March 6, 2006, an employee exercised stock options to purchase 24,000 shares of common stock for $2,000.
During 2005, the Company issued to Jehu Hand, a brother of our Chief Executive Officer, 600,000 shares of common stock as compensation for legal services, which he provided to the company. The Company’s issuance of shares of its common stock to Mr. Hand resulted in an expense of approximately $6,270,000.
During 2004, Arrakis Select, Inc., a company controlled by Jehu Hand, a brother of our Chief Executive Officer, entered into a Funding Agreement whereby Arrakis provided $195,000 to Wellstone between January and October 2004 in exchange for 22,992 shares of common stock. The Company issued common stock to Arrakis monthly at a price per share equal to the closing bid price of common stock as of the 15th day of the month in which Arrakis invested the money.
Issuance of Stock Options Resulting in Expense
During 2005, the Company granted stock options to purchase 180,000 shares of common stock to employees with exercise prices below the market price on the measurement date. Because the options vested immediately, they resulted in compensation expense of $1,920,000 in 2005. No options were granted in 2006 or 2007.
During 2004, options to purchase 26,500,000 shares with exercise prices ranging from $.003 to $.01 per share were issued to three officers of the Company, resulting in an expense of approximately $13,555,000. Also, during the year, options were issued to a scientific advisor to purchase 4,800,000 shares at an exercise price of $.0007 per share resulting in expense of approximately $655,000. The expense for the issuance of these stock options to the advisor was calculated based on the Black-Scholes option-pricing model.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2008
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company’s financial instruments consist of cash, accounts payable, and notes payable. The carrying amount of cash and accounts payable approximates fair-value because of the short-term nature of these items. The carrying amount of notes payable approximates fair value as the individual borrowings bear interest at market interest rates.
NOTE M - PATENT LICENSE AGREEMENT
On January 17, 2007, Wellstone entered into a Patent License Agreement with Glycanex, BV, the supplier of the patented filter compound used in Wellstone cigarettes. Under the Patent License Agreement, Wellstone granted to Glycanex an exclusive right to the patent rights for all countries excepting the United States of America and its territories and possessions. Glycanex agreed to pay Wellstone a 3% royalty on net sales which exceed the minimum threshold of Euro 500,000. The consideration for the granting of the license to Glycanex was the cancellation of $120,000 owed to Glycanex for purchase of the filter compound. There was no activity with respect to this agreement in 2008.
NOTE N - LIQUIDITY
The Company launched its Wellstone brand of cigarettes in the United States during the first quarter of 2006 and has shipped all brand styles to Arizona, Louisiana, North Carolina, Virginia and California. Additionally, the Company has partnered with several suppliers of convenience stores in the Southeastern and the West Coast to carry the Wellstone brand family. Even though the Company’s net revenue increased 241% for the second quarter over the first quarter it continued to have a deficit in working capital and stockholders' deficit, and continued to incur losses. Although sales were increasing, the Company continued to suffer from a negative gross margin on its cigarettes; which was part of the Company’s strategy to obtain market share and entry into the competitive cigarette marketplace. Management reviewed the liquidity position of the Company during the quarter ended September 30, 2006 and sought unsuccessfully for additional debt or equity funding. Although the Company did enter into negotiations for a private placement, the funding group required that the Company carry out a 1-for- 25 reverse split of the common stock as a precondition to such placement. After Wellstone carried out the reverse split, the funding source did not complete funding. Faced with inadequate cash resources to fund the market introduction of its products; management determined to suspend further marketing activity.
NOTE O - NOTE PAYABLE
Wellstone Filters, Inc. received $250,000 from the Carlson Group, Ltd., pursuant to a promissory note, dated May 17, 2006. This Note is not associated with the prior promissory notes which had been issued in 2006 and 2004. The Company borrowed the principal amount of $250,000, at an interest rate of 8% per annum, due in full on December 31, 2007. In addition to the stated interest rate, the Company shall also pay to the Lender an amount equal to the lesser of (a) $25,000 or (b) 3% of the net profits after taxes as of September 30, 2007, to be payable simultaneously with the principal and interest due on December 31, 2007. If a portion of the principal or interest is paid prior to December 31, 2007, the calculation of the additional amount shall be adjusted pro-rata. In the event of a default under the note when due, then the Lender, at its election, may declare the entire unpaid principal and all accrued but unpaid interest, immediately due and payable. The maximum additional amount that the Company shall pay is $25,000, and such mount is due on the maturity of the Note. No further arrangements have been made with respect to these agreements in 2008.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2007
NOTE O - NOTE PAYABLE (continued)
On January 25, 2006, Wellstone Filters, Inc. received $500,000 from the Carlson Group, Ltd., pursuant to a promissory note, dated January 25, 2006. This Note is not associated with the prior promissory note which had been issued in 2004. The Company borrowed the principal amount of $500,000, at an interest rate of 8% per annum, due in full on December 31, 2007. In addition to the stated interest rate, the Company shall also pay to the Lender an amount equal to the lesser of (a) $25,000 or (b) 3% of the net profits after taxes as of September 30, 2007, to be payable simultaneously with the principal and interest due on December 31, 2007. If a portion of the principal or interest is paid prior to December 31, 2007, the calculation of the additional amount shall be adjusted pro-rata.
In the event of a default under the note when due, then the Lender, at its election, may declare the entire unpaid principal and all accrued but unpaid interest, immediately due and payable. The maximum additional amount that the Company shall pay is $25,000, and such amount is due on the maturity of the Note. In October 2004 the Company entered into an agreement with another fund under which it received $1.5 million in debt financing plus warrants. The Company has dismissed or accepted the resignation of all employees and officers except for its Chief Executive Officer, has vacated its corporate offices and otherwise drastically reduced its general and administrative costs pending a resolution of its liquidity problems. The Company is funding its cash needs from funds lent by its officer and director.
NOTE P - STOCK OPTION PLAN
On April 1, 1994, the Company adopted the 1994 Stock Option Plan. The plan provides for the granting of awards of up to 1,680,000 shares of common stock to officers, directors, employees, advisors, and employees of other companies that do business with the Company as non-qualified stock options. The Stock Option Committee for the Board of Directors determines the option price, which cannot be less that the fair market value at the date of the grant or 110% of the fair market value if the recipient of the grant holds 10% or more of the Company’s common stock. The exercise price per share of shares subject to a NON-Qualified option cannot be less than 85% of the fair market value. Options granted under the plan will typically expire ten years from the date of the grant (five years if the recipient of the grant holds 10% or more of the Company’s common stock on the date of the grant) or three months after termination of employment. The plan was amended and restated in 2003 for technical updates to confirm with law.
On December 31, 2008, the Company had 960,000 shares available for grant under the Option Plan.
During 2004, the Company issued warrants to purchase 129,600 shares of common stock with an exercise price of $12.50 per share in connection with a note payable. See Note H.
WELLSTONE FILTERS, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDING DECEMBER 31, 2007
NOTE P - STOCK OPTION PLAN (continued)
A schedule of the options is as follows:
Exercise
Number of
Price
Options
Per Share
Outstanding at December 31, 2004
1,273,000
.17 - .25
Granted
180,000
0.08325
Exercised
128,000
.08325 - .25
Outstanding at December 31, 2005
1,325,000
.17 - .25
Granted
- -
- -
Exercised
24,000
.08333
Lapsed
581,000
- -
Outstanding at December 31, 2006
720,000
2.50
Granted
- -
- -
Exercised
- -
- -
Outstanding at December 31, 2007
720,000
2.50
Granted
- -
- -
Exercised
- -
- -
Outstanding at December 31, 2008
720,000
2.50