ITEM 1 - BUSINESS
Corporate History
We were incorporated as Freeze Tag, Inc. in February 2006 in the State of Delaware. In March 2006, Freeze Tag, LLC, our predecessor which was formed in October 2005, was merged with and into Freeze Tag, Inc.
Business Overview
We are in the business of acquiring or developing and publishing casual games. We obtain games through three main sources: licenses, creation of original games, and the use of third-party developers. Most of the games with which we are involved are published in one or more of three platforms, or methods of distribution. These platforms are PC/Mac downloads, mobile, and other emerging platforms like social gaming sites.
Developing Casual Games
We acquire and develop games through licensing arrangements, the creation of our own original games, and through the use of third-party game developers.
Licensed Games
We may develop a game around a well known brand pursuant a license agreement from the owner of that brand. For example, we have a license agreement with the Ohio Art Company that allowed us to develop and distribute a game around their Etch A Sketch® brand. In exchange for the license, we pay a royalty to the Ohio Art Company based on our revenues from that product.
Our cost to develop a “licensed game” is the same as our cost to develop Freeze Tag original game plus royalty payments to the licensor, some of which may be paid in the form of non-refundable up-front royalty advances. The costs involved in developing original content games can range from $25,000 to $150,000 depending on the platform (iPhone vs. PC) and complexity of the game (simple puzzle vs. complex adventure genre). The average cost to develop an iPhone game is $100,000. The average cost to develop a PC/Mac game is $150,000. For a “licensed game” in addition to these development costs we usually have a royalty payment owed to the licensor of the intellectual property, which is usually 10% to 20% of the revenue collected from the game. At times we pay a portion of this royalty in the form of an up-front, non-refundable royalty advance, which typically is in the range of $5,000 to $20,000, but varies by game and is negotiated on a case-by-case basis with the owner of the intellectual property.
Our gross profit margins may be lower on a licensed game compared to an original game because of the royalty payment we pay to the licensor, which is usually 10% to 20% of the revenue from such game, but the sales can be much higher because of the recognition of the licensed title or brand by the casual game consumer. Brand names that are familiar to a casual game consumer create a sense of trust and familiarity that often increases sales.
In the past, our licensed games included Etch a Sketch®, Concentration, Nertz, Can You See What I See?, Can You See What I See? Dream Machine, Amelia Earhart. Going forward (2012), we have a current licensing agreement with Ohio Art Company (Etch A Sketch).
Freeze Tag Original Content
We have created, and will continue to create, original games to put in our portfolio. In the past we hired one or more contract engineers on a “work-for-hire” basis to create the game for us, and we pay that engineer or engineers a fixed fee for their work, known as a development fee. This development fee can range from $15,000 to as much as $75,000, depending on the amount and complexity of the work involved. While we still rely on contract engineers to develop some of our games, during 2011 we also hired in-house software engineers to develop games based on our own content. When we distribute the game, all of the revenues are ours to keep, unless we have negotiated a revenue share (or royalty) with the contract engineer(s). The costs involved in developing Freeze Tag original content games can range from $25,000 to $150,000, depending on the development platform (iPhone vs. PC) and complexity of the game (simple vs. complex). The average cost to develop an iPhone game is $100,000. The average cost to develop a PC/Mac game is $150,000. Generally, iPhone games are less expensive to develop than PC/Mac games because less programming and artwork are required.
Our gross profit margins are usually highest when we distribute our own original content, but we also assume all of the risk because we have paid to develop the game in advance, without knowing whether it will be a success or not. In addition, because there is no existing brand associated with an original game, we have to create the market for the game ourselves.
Our original content games are Victorian Mysteries ™: The Moonstone, Victorian Mysteries: Woman in White, Unsolved Mystery Club™: Amelia Earhart, The Conjurer (rights sold to Real Networks, and Real Detectives (rights sold to Real Networks). We are currently working on the next games in the Victorian Mysteries and Unsolved Mystery Club series. In 2011, we will be launching additional games we hope will become franchises or series in the future.
Publishing Third-Party Developer Titles
We often have a variety of independent developers working with us to build licensed and original titles for us. During the course of our working relationship, these developers sometimes bring a concept or a partially finished game to us for consideration. If we believe the title has merit and the potential to generate significant revenues, then we will contract with the developer to finish the game to our specifications. We will guide them through the development process and, most often, we will own certain intellectual property rights to the finished game. If we don’t own the game code, then we will at least own significant components of the intellectual property such as the name or character likeness.
Third party developers are attracted to working with us because we provide them creative guidance to ensure their game is market-ready, development funds to help them finish their game, and marketing expertise and distribution relationships to get their game to market and create an ongoing revenue stream. These developers often underestimate how much time and money is required in order to complete development of a game. They approach us to help them fund the completion of their game (usually an amount far less than the cost for Freeze Tag to develop an original title), in exchange for a percentage of the revenue generated by the game over a period of time and the transfer of certain intellectual property rights to us.
The risks are lower with third party games because the amount of upfront money required tends to be less than if we were developing the entire game. On occasion, there are games that are 90% finished when they come to us and they only require a small amount of development money to complete. In these circumstances, we can purchase rights in or ownership of a game or portion of the intellectual property (such as the name of the game) in exchange for very little out-of-pocket costs. However, the gross margin is lower than the margin generated by original titles because the developer not only shares in the risk (by having incurred a greater portion of the development costs themselves), but also generally receives a royalty on the back end, usually 20% to 50% of net sales.
Compared to the costs incurred by in-house development projects, our development costs involved in creating games by third party developers are generally low due to the fact that typically when developers bring products to us for publishing consideration, they have already completed or partially completed developing the game. Therefore, we only incur partial development costs in order to acquire distribution rights to publish the third party title. These costs are usually associated with “finishing” final stages of development, which range anywhere from $5,000 to $25,000 per title.
Our third-party developer titles include Xango Tango (we own the Intellectual Property (IP)), Paper Chase (we own the IP), and Letter Lab (we own the IP).
Distributing Casual Games
Once a game is developed, we distribute it through one of three methods. The majority of our games are downloaded onto a PC or Mac computer over the Internet. A smaller but growing percentage of our games are distributed over the iPhone. We do not yet distribute our games through a social networking platform, such as Facebook, however we are currently developing a game for that type of distribution.
Try-before-you-buy
All of our games are available for a limited period of time for free. This is the standard format in the industry, and applies to all three of our methods of distribution. Once required to purchase a game, the purchase price ranges from $2.99 to $19.99. On (industry) average, 1% of the users purchase a game after they try it. Our games are purchased by an average of 4% to 5% of the users who try it.
PC/Mac Downloadable Distribution
All of our games are available for PC or Mac download.
Most of the time, our customers find our games through a game website, such as www.bigfishgames.com or some other retail site such as www.amazon.com. Our distribution partners include, but are not limited, the following: Yahoo!, MSN Games, Amazon.com, Big Fish Games, Steam, Exent/Verizon, Apple, Game House, Shockwave, and Oberon.
Mobile Distribution - High Growth Opportunities.
At the current time, Apple is leading the way in mobile gaming devices with its iPhone (smartphone) and iPad (tablet) products. However, smartphones and tablets based on Google’s Android operating system are proliferating rapidly. Our Etch A Sketch® application was one of the first 500 applications introduced at the same time as the iPhone (2008), so we have been working with Apple since the launch of the iPhone. In 2011, we developed several new applications for mobile devices like iPhone, iPad, and Android devices, including the new “tablet” devices, which we plan to launch in 2012.
The most promising area of growth (for gaming companies) in mobile distribution is the new wave of “tablet” devices that appear to be very popular with consumers. The first tablet, Apple’s iPad, has been wildly successful, selling millions of units. Following Apple, many manufacturers, including Motorola (Xoom), Samsung (Galaxy), and RIM (Playbook) have launched tablet devices. With larger screen sizes, crisp colorful graphics capabilities and speedy processors, these tablets offer tremendous opportunities for games and other entertainment applications (such as electronic books and videos) that consumers enjoy.
In addition to the rapid growth that we believe will continue in the smartphone arena (iOS and Android), we believe that the growth in tablet devices will fuel a whole new wave of increased revenue opportunities in the casual gaming market. We intend to create games that will work on these new smartphone and tablet platforms now and in the future.
Other Emerging Methods of Distribution
We do not currently have a game that is distributed on a social networking site, such as Facebook. However, we are currently working on game designs, and have enabled our Etch A Sketch® iPhone App to be Facebook connected, as well as our Victorian Mysteries™: Moonstone iPhone App. We are also in the process of integrating social networking marketing techniques into our iPhone/iPad games in which players will be able to link to a page on a social networking site, such as Facebook, by clicking on a button within the game.
Business Strategy
Our strategy is to first develop and publish original casual game content on the high growth platforms and devices such as PC/Mac digital downloads and flash HD, smartphone (iPhone and Android), mobile internet devices (such as tablets) and social networking sites. According to a recent NPD report, in 2009, for the first times games sold via digital channels were close to equal the number of units sold through traditional retail outlets. Based on this trend, digital distribution appears to be the wave of the future for the games market. We have been riding that wave since our inception. New, powerful mobile internet devices such as smartphones (Apple iPhone and Android phones) and tablets (iPad) are new platforms that emerged as high growth, legitimate digital distribution channels for games and entertainment. As consumers continue to take up these mobile internet devices and consider them essential tools, the corresponding markets for digital entertainment created specifically for them are positioned to experience rapid adoption and growth.
In addition to attacking the high growth devices and digital distribution channels, we are creating original intellectual property. Wherever possible, we own registered trademark protection for properties we develop. As the digital markets evolve, there are and will continue to be many competitors who will imitate successful game properties. To date, we have received registered trademark approval from the United States Patent and Trademark Office for the following marks: Unsolved Mystery®, Unsolved Mystery Club®, Ancient Astronauts® and Victorian Mysteries® for all gaming platforms; and received preliminary approval on Rocket Weasel. These marks will enable us to defend against copycats who may try to incorporate these keywords into their game titles. We are continuously creating, researching and investigating new intellectual property (names and marks) that will not only provide us with unique and valuable marketing assets but also help us defend against unauthorized use or infringement.
Our Production Process - How Do We Make a Game?
We have learned that establishing and following a rigid process is essential to producing commercially successful products, regardless of the platform. The process all begins with the creative development process. The chart below describes the approach we use to filter ideas and make final decisions on which games we will actually produce. After choosing the game that we will focus on, we write a detailed design document. A thorough design document insures that all of those involved in the creation of the game have a common reference source throughout the production process. Also critical to producing high quality games, a test plan accompanies every design document. Not only do we test for bugs, but also we test the game for usability. Since most casual gamers do not want to read instructions, it is critical that the finished game be easy to play by just pointing and clicking at objects on the screen. This is the way most casual gamers discover games.
As a publisher and developer of games, we have developed expertise in three core aspects of game production. These core competencies help to give us a competitive advantage in the industry. They are listed below, with the resulting benefit also identified.
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Create High Quality Products (including art and sound assets). Benefit: Provides high value to distribution partners and consumers, resulting in increased downloads and purchases.
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Maintain Flexible Engineering Tools and Processes. Benefit: Decreases time-to-market delivery of products.
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Minimize Risk by doing the following: 1) selecting proven genres, 2) keeping development costs low, and 3) modifying designs “on the fly” based on consumer feedback. Benefit: Increases the number of games released per year and decreases reliance on any one title’s success, ultimately improving return on investment for each game.
How Long Does it Take to Develop a Casual Game?
We use a team of development professionals located all over the world, including South America and Europe. We use a development methodology referred to as agile development, which focuses on short development and feedback cycles, leading to shortened development times. Because of this, our costs are reduced, and the availability of an almost unlimited number of engineers and programmers makes our development time approximately 5 months. This is a big competitive advantage.
The Casual Games Market
The Casual Games Association
The Casual Games Association is the international trade association for casual games professionals. The association has more than 4,000 paid members, including gaming executives, publishers, and developers. The association hosts conferences and publishes research reports on the industry. Craig Holland, our CEO, is currently serving as a Founding Advisor to the CGA. This has been extremely beneficial to the company. Mr. Holland’s close ties to the association provides access to information and partnerships, and opportunities that might not otherwise be available. Their website is (http://casualgamesassociation.org/).
The following statistics are published by the Casual Games Association:
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the global market for casual games was $2.25 billion in 2007, and is expected to grow 20% per year in established markets;
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an estimated 200 million people are playing casual games over the Internet each month in 2007;
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in 2007, 49% of casual game players were men, and 51% were women. However, in that year, women accounted for 74% of paying casual game players.
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in 2007, casual game players who paid for a subscription averaged 7 to 15 hours of playing per week. The heaviest times were right after dinner from 7pm - 9pm, and during lunch hours from 11am - 2pm.
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in 2007, the average play time was short, from five minutes to 20 minutes - though it was common for people to play one game after another for many hours.
The Competition
Publishers
Casual game industry publishers typically provide funding, development guidance and distribution for casual games for online, retail and mobile platforms. Some of the largest casual game publishers are:
Rovio (creators of Angry Birds) Esbo, Finland
PopCap Games - acquired by Electronic Arts (creators of Bejeweled) Seattle, Washington
Big Fish Games (creators of Mystery Case Files) Seattle, Washington
Zynga (creators of Farmville), San Francisco, California
Playdom, Mountain View, CA (acquired by Disney)
GameHouse Partners (division of RealNetworks) Seattle, Washington
iWin San Francisco, California
Chillingo, United Kingdom (acquired by Electronic Arts)
Iplay (Oberon Media) Seattle, Washington & NYC
PlayFirst San Francisco, California
Sandlot Games - acquired by Digital Chocolate, Bothell, Washington
Distributors
Casual game industry online, retail and mobile distributors typically provide aggregation services for retail distributors. Some online distributors provide tools and services for online retailers to assist them in interfacing with consumers. According to the CGA's 2007 Market Report, some of the largest casual game distributors and retailers of casual games are:
Online Retailers (Portals)
Big Fish Games Seattle, Washington
RealGames Seattle, Washington
Oberon Media Seattle, Washington & NYC
Amazon.com Seattle, Washington
WildTangent Redmond, Washington
Exent (Verizon Games on Demand) Tel Aviv, Israel
Shockwave San Francisco, California
Yahoo! Games Santa Monica, California
Mobile Distribution
Apple Computer (iTunes), Cupertino, California
Google (Android Market Place), Mountain View, California
Amazon (Android App Store)
Verizon Wireless (Android App Store)
Barnes and Noble (Nook App Store)
Brick and Mortar Distributors
Activision Santa Monica, California
Encore USA Los Angeles, California
Focus Multimedia England, UK
Brick and Mortar Retailers
Gamestop Grapevine, Texas
Wal-Mart Bentonville, Arkansas
Best Buy Minneapolis, Minnesota
Target Minneapolis, Minnesota
Our Intellectual Property
Our intellectual property is an essential element of our business. We use a combination of trademark, patent, copyright, trade secret and other intellectual property laws, confidentiality agreements and license agreements to protect our intellectual property. We have also registered a number of domain names, which we believe will be important to the branding and success of our games. Our employees and independent contractors are required to sign agreements acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership that they may claim in those works. Despite our precautions, it may be possible for third parties to obtain and use without consent intellectual property that we own or license. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.
We intend to register ownership of software copyrights in the United States as well as seek registration of various trademarks associated with the Company’s name and casual games that we will develop.
In addition, many of our applications are based on or incorporate intellectual properties that we license from third parties. We have both exclusive and non-exclusive licenses to use these properties for terms of up to three years. Our licensed brands include, among others, Etch A Sketch®, Amelia Earhart, and Nertz. Our licensors include a number of well-established video game publishers and major media companies, including The Ohio Art Company and Nertz Company.
In addition to attacking the high growth devices and digital distribution channels, we are creating original intellectual property. Wherever possible, we own registered trademark protection for properties we develop. As the digital markets evolve, there are and will continue to be many competitors who will imitate successful game properties. We are investing in trademark protection to create game brands and protect them. For example, we have received approval from the United States Patent and Trademark office to register Unsolved Mystery®, Unsolved Mystery Club®, Ancient Astronauts® and Victorian Mysteries® for all gaming platforms and preliminary approval on Rocket Weasel. These marks will enable us to defend against copycats who may try to incorporate these terms into their game titles.
From time to time, we may encounter disputes over rights and obligations concerning intellectual property. While we believe that our product and service offerings do not infringe the intellectual property rights of any third party, we cannot assure you that we will prevail in any intellectual property dispute. If we do not prevail in such disputes, we may lose some or all of our intellectual property protection, be enjoined from further sales of the applications determined to infringe the rights of others, and/or be forced to pay substantial royalties to a third party.
Our Employees
We have 15 employees and/or contractors, 2 of which are our officers, 12 of which are engaged in art production, publishing and development, and 1 of which is engaged in administrative functions. We have a team of over 40 engineers, artists, and developers available to us on an independent contract basis around the world.
Description of Property
Our executive offices are located in Tustin, California, at 228 W. Main Street, 2nd Floor, Tustin, CA 92780. Our office space is approximately 2,000 square feet and the lease is month-to-month at a rate of $2,000 per month.
Available Information
We are a fully reporting issuer, subject to the Securities Exchange Act of 1934. Our Quarterly Reports, Annual Reports, and other filings can be obtained from the SEC’s Public Reference Room at 100 F Street, NE., Washington, DC 20549, on official business days during the hours of 10 a.m. to 3 p.m. You may also obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. The Commission maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the Commission at http://www.sec.gov.
Our Internet website address is http://www.freezetag.com.
ITEM 1A.
ITEM 1A. - RISK FACTORS.
As a smaller reporting company we are not required to provide a statement of risk factors. However, we believe this information may be valuable to our shareholders for this filing. We reserve the right to not provide risk factors in our future filings. We face risks in developing our games and products and eventually bringing them to market. The following risks are material risks that we face. If any of these risks occur, our business, our ability to achieve revenues, our operating results and our financial condition could be seriously harmed. Our primary risk factors and other considerations include:
Risk Factors Related to the Business of the Company
We have a limited operating history and limited historical financial information upon which you may evaluate our performance.
You should consider, among other factors, our prospects for success in light of the risks and uncertainties encountered by companies that, like us, are in their early stages of development. We may not successfully address these risks and uncertainties or successfully implement our existing and new products and services. If we fail to do so, it could materially harm our business and impair the value of our common stock. Even if we accomplish these objectives, we may not generate the positive cash flows or profits we anticipate in the future. We were incorporated in Delaware in February 2006. In March 2006 we merged with Freeze Tag, LLC, our predecessor, which was formed in October 2005. Unanticipated problems, expenses and delays are frequently encountered in establishing a new business and developing new products and services. These include, but are not limited to, inadequate funding, lack of consumer acceptance, competition, product development, and inadequate sales and marketing. The failure by us to meet any of these conditions would have a materially adverse effect upon us and may force us to reduce or curtail operations. No assurance can be given that we can or will ever operate profitably.
If we are unable to meet our future capital needs, we may be required to reduce or curtail operations.
To date we have relied on cash flow from operations, funding from our founders, and debt financing to fund operations. We have extremely limited cash liquidity and capital resources. Our cash on hand as of December 31, 2011, was $26,587, and our monthly cash flow burn rate is approximately $85,000. For the year ended December 31, 2011, our revenue was $732,591.
Our future capital requirements will depend on many factors, including our ability to market our products successfully, cash flow from operations, and competing market developments. Based on our current financial situation we may have difficulty continuing our operations at their current level, or at all, if we do not receive additional financing in the near future. Consequently, although we currently have no specific plans or arrangements for financing, we intend to raise funds through private placements, public offerings or other financings. Any equity financings would result in dilution to our then-existing stockholders. Sources of debt financing may result in higher interest expense. Any financing, if available, may be on unfavorable terms. If adequate funds are not obtained, we may be required to reduce or curtail operations. We anticipate that our existing capital resources will not be adequate to satisfy our operating expenses and capital requirements for any length of time. However, this estimate of expenses and capital requirements may prove to be inaccurate.
Our independent registered public accounting firm has expressed doubts about our ability to continue as a going concern.
As a result of our financial condition, we have received a report from our independent registered public accounting firm for our financial statements for the year ended December 31, 2011 that includes an explanatory paragraph describing the uncertainty as to our ability to continue as a going concern. In order to continue as a going concern we must effectively balance many factors and increase our revenues to a point where we can fund our operations from our sales and revenues. If we are not able to do this we may not be able to continue as an operating company.
Because we face intense competition, we may not be able to operate profitably in our markets.
The market for casual games is highly competitive and is becoming more so, which could hinder our ability to successfully market our products. We may not have the resources, expertise or other competitive factors to compete successfully in the future. We expect to face additional competition from existing competitors and new market entrants in the future. Many of our competitors have greater name recognition and more established relationships in the industry than we do. As a result, these competitors may be able to:
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develop and expand their product offerings more rapidly;
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adapt to new or emerging changes in customer requirements more quickly;
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take advantage of acquisition and other opportunities more readily; and
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devote greater resources to the marketing and sale of their products and adopt more aggressive pricing policies than we can.
If we are unable to maintain brand image or product quality, our business may suffer.
Our success depends on our ability to maintain and build brand image for our existing products, new products and brand extensions. We have no assurance that our advertising, marketing and promotional programs will have the desired impact on our products’ brand image and on consumer preferences.
If we are unable to attract and retain key personnel, we may not be able to compete effectively in our market.
Our success will depend, in part, on our ability to attract and retain key management, including primarily Craig Holland and Mick Donahoo, technical experts, and sales and marketing personnel. We attempt to enhance our management and technical expertise by recruiting qualified individuals who possess desired skills and experience in certain targeted areas. Our inability to retain employees and attract and retain sufficient additional employees, and information technology, engineering and technical support resources, could have a material adverse effect on our business, financial condition, results of operations and cash flows. The loss of key personnel could limit our ability to develop and market our products.
Because our officers and directors control a large percentage of our common stock, they have the ability to influence matters affecting our shareholders.
Our officers and directors beneficially own over 58% of our outstanding common stock. As a result, they have the ability to influence matters affecting our shareholders, including the election of our directors, the acquisition or disposition of our assets, and the future issuance of our shares. Because they control such shares, investors may find it difficult to replace our management if they disagree with the way our business is being operated. Because the influence by these insiders could result in management making decisions that are in the best interest of those insiders and not in the best interest of the investors, you may lose some or all of the value of your investment in our common stock.
Our business may be negatively impacted by a slowing economy or by unfavorable economic conditions or developments in the United States and/or in other countries in which we operate.
A general slowdown in the economy in the United States or unfavorable economic conditions or other developments may result in decreased consumer demand, business disruption, supply constraints, foreign currency devaluation, inflation or deflation. A slowdown in the economy or unstable economic conditions in the United States or in the countries in which we operate could have an adverse impact on our business results or financial condition.
We may not be able to effectively manage our growth and operations, which could materially and adversely affect our business.
We may experience rapid growth and development in a relatively short period of time by aggressively marketing our casual games. The management of this growth will require, among other things, continued development of our financial and management controls and management information systems, stringent control of costs, increased marketing activities, the ability to attract and retain qualified management personnel and the training of new personnel. We intend to hire additional personnel in order to manage our expected growth and expansion. Failure to successfully manage our possible growth and development could have a material adverse effect on our business and the value of our common stock.
Failure to renew our existing licenses or to obtain additional licenses could harm our business.
Some of our game products are or will be based on or incorporate intellectual properties that we license from third parties. Our current licenses to use these properties do not extend beyond terms of two to three years. We may be unable to renew these licenses on terms favorable to us, or at all, and we may be unable to secure alternatives in a timely manner. We expect that licenses we obtain in the future may impose development, distribution and marketing obligations on us. If we breach our obligations, our licensors may have the right to terminate the license or change an exclusive license to a non-exclusive license.
Competition for licenses may also increase the advances, guarantees and royalties that we must pay to the licensor, which could significantly increase our costs. Failure to maintain our existing licenses or obtain additional licenses with significant commercial value could impair our ability to introduce new applications or continue our current game products and applications, which could materially harm our business.
If we fail to develop and introduce new casual games and other applications that achieve market acceptance, our sales could suffer.
Our business depends on providing casual games and applications that consumers want to buy. We must invest significant resources in research and development to enhance our offering of casual games and other applications and introduce new games and other applications. Our operating results would suffer if our games and other applications are not responsive to the preferences of our customers or are not effectively brought to market.
The planned timing or introduction of new casual games is subject to risks and uncertainties. Unexpected technical, operational, deployment, distribution or other problems could delay or prevent the introduction of new casual games, which could result in a loss of, or delay in, revenues or damage to our reputation and brand. If any of our applications is introduced with defects, errors or failures, we could experience decreased sales, loss of customers and damage to our reputation and brand. In addition, new applications may not achieve sufficient market acceptance to offset the costs of development. Our success depends, in part, on unpredictable and volatile factors beyond our control, including customer preferences, competing applications and the availability of other entertainment activities. A shift in Internet or mobile device usage or the entertainment preferences of our customers could cause a decline in our applications' popularity that could materially reduce our revenues and harm our business.
We intend to continuously develop and introduce new games and other applications for use on next-generation Internet and mobile devices. We must make product development decisions and commit significant resources well in advance of the anticipated introduction of new mobile devices. New mobile devices for which we will develop applications may be delayed, may not be commercially successful, may have a shorter life cycle than anticipated or may not be adequately promoted by wireless carriers or the manufacturer. If the mobile devices for which we are developing games and other applications are not released when expected or do not achieve broad market penetration, our potential revenues will be limited and our business will suffer.
If our independent, third-party developers cease development of new applications for us and we are unable to find comparable replacements, our competitive position may be adversely impacted.
We rely on independent third-party developers to develop some of our game products which subjects us to the following risks:
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key developers who work for us may choose to work for or be acquired by our competitors;
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developers currently under contract may try to renegotiate our agreements with them on terms less favorable to us; and
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our developers may be unable or unwilling to allocate sufficient resources to complete our applications on a timely or satisfactory basis or at all.
If our developers terminate their relationships with us or negotiate agreements with terms less favorable to us, we may have to increase our internal development staff, which would be a time consuming and potentially costly process. If we are unable to increase our internal development staff in a cost-effective manner or if our current internal development staff fails to create successful applications, our earnings could be materially diminished.
In addition, although we require our third-party developers to sign agreements acknowledging that all inventions, trade secrets, works of authorship, development and other processes generated by them are our property and to assign to us any ownership they may have in those works, it may still be possible for third parties to obtain and use our intellectual properties without our consent.
Our industry is experiencing consolidation that may cause us to lose key relationships and intensify competition.
The Internet and media distribution industries are undergoing substantial change, which has resulted in increasing consolidation and formation of strategic relationships. We expect this consolidation and strategic partnering to continue. Acquisitions or other consolidating transactions could harm us in a number of ways, including:
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we could lose strategic relationships if our strategic partners are acquired by or enter into relationships with a competitor (which could cause us to lose access to distribution, content, technology and other resources);
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we could lose customers if competitors or users of competing technologies consolidate with our current or potential customers; and
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our current competitors could become stronger, or new competitors could form, from consolidations.
Any of these events could put us at a competitive disadvantage, which could cause us to lose customers, revenue and market share. Consolidation could also force us to expend greater resources to meet new or additional competitive threats, which could also harm our operating results.
We rely on the continued reliable operation of third parties’ systems and networks and, if these systems and networks fail to operate or operate poorly, our business and operating results will be harmed.
Our operations are in part dependent upon the continued reliable operation of the information systems and networks of third parties. If these third parties do not provide reliable operation, our ability to service our customers will be impaired and our business, reputation and operating results could be harmed.
The Internet and our network are subject to security risks that could harm our business and reputation and expose us to litigation or liability.
Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to transmit and store such information and data securely, and any costs associated with preventing or eliminating such problems, could damage our business, hurt our ability to distribute products and services and collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation, and expose us to litigation or liability. We also may be required to expend significant capital or other resources to protect against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks. Any successful attack or breach of our security could hurt consumer demand for our products and services, expose us to consumer class action lawsuits and harm our business.
We may be unable to adequately protect our proprietary rights.
Our ability to compete partly depends on the superiority, uniqueness and value of our intellectual property and technology, including both internally developed technology and technology licensed from third parties. To the extent we are able to do so, in order to protect our proprietary rights, we will rely on a combination of trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions and licensing agreement. Despite these efforts, any of the following occurrences may reduce the value of our intellectual property:
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Our applications for trademarks and copyrights relating to our business may not be granted and, if granted, may be challenged or invalidated;
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Issued trademarks and registered copyrights may not provide us with any competitive advantages;
·
Our efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology;
·
Our efforts may not prevent the development and design by others of products or technologies similar to or competitive with, or superior to those we develop; or
·
Another party may obtain a blocking patent and we would need to either obtain a license or design around the patent in order to continue to offer the contested feature or service in our products.
We may be forced to litigate to defend our intellectual property rights, or to defend against claims by third parties against us relating to intellectual property rights.
We may be forced to litigate to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of other parties’ proprietary rights. Any such litigation could be very costly and could distract our management from focusing on operating our business. The existence and/or outcome of any such litigation could harm our business.
Interpretation of existing laws that did not originally contemplate the Internet could harm our business and operating results.
The application of existing laws governing issues such as property ownership, copyright and other intellectual property issues to the Internet is not clear. Many of these laws were adopted before the advent of the Internet and do not address the unique issues associated with the Internet and related technologies. In many cases, the relationship of these laws to the Internet has not yet been interpreted. New interpretations of existing laws may increase our costs, require us to change business practices or otherwise harm our business.
It is not yet clear how laws designed to protect children that use the Internet may be interpreted, and such laws may apply to our business in ways that may harm our business.
The Child Online Protection Act and the Child Online Privacy Protection Act impose civil and criminal penalties on persons distributing material harmful to minors (e.g., obscene material) over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13. We do not knowingly distribute harmful materials to minors or collect personal information from children under the age of 13. The manner in which these Acts may be interpreted and enforced cannot be fully determined, and future legislation similar to these Acts could subject us to potential liability if we were deemed to be non-compliant with such rules and regulations, which in turn could harm our business.
We may be subject to market risk and legal liability in connection with the data collection capabilities of our products and services.
Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate. To provide better consumer experiences and to operate effectively, our products send information to our servers. Many of the services we provide also require that a user provide certain information to us. We post an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client and server products.
Risks Related To Our Common Stock
There is a limited public trading market for our common stock, which may impede our shareholders’ ability to sell our shares.
Currently, there is a limited trading market for our common stock, and there can be no assurance that a more robust market will be achieved in the future. There can be no assurance that an investor will be able to liquidate his or her investment without considerable delay, if at all. If the trading market for our common stock does increase, the price may be highly volatile. Factors discussed herein may have a significant impact on the market price of our shares. Moreover, due to the relatively low price of our securities, many brokerage firms may not effect transactions in our common stock if a market is established. Rules enacted by the SEC increase the likelihood that most brokerage firms will not participate in a potential future market for our common stock. Those rules require, as a condition to brokers effecting transactions in certain defined securities (unless such transaction is subject to one or more exemptions), that the broker obtain from its customer or client a written representation concerning the customer’s financial situation, investment experience and investment objectives. Compliance with these procedures tends to discourage most brokerage firms from participating in the market for certain low-priced securities.
If we are unable to pay the costs associated with being a public, reporting company, we may not be able to continue trading on the OTC Bulletin Board and/or we may be forced to discontinue operations.
We have significant costs associated with being a public, reporting company, which adds to the substantial doubt about our ability to continue trading on the OTC Bulletin Board and/or continue as a going concern. These costs include compliance with the Sarbanes-Oxley Act of 2002, which will be difficult given the limited size of our management, and we will have to rely on outside consultants. Accounting controls, in particular, are difficult and can be expensive to comply with.
Our ability to continue trading on the OTC Bulletin Board and/or continue as a going concern will depend on positive cash flow, if any, from future operations and on our ability to raise additional funds through equity or debt financing. If we are unable to achieve the necessary product sales or raise or obtain needed funding to cover the costs of operating as a public, reporting company, our common stock may be deleted from the OTC Bulletin Board and/or we may be forced to discontinue operations.
We do not intend to pay dividends in the foreseeable future.
We do not intend to pay any dividends in the foreseeable future. We do not plan on making any cash distributions in the manner of a dividend or otherwise. Our Board presently intends to follow a policy of retaining earnings, if any.
We have the right to issue additional common stock and preferred stock without consent of stockholders. This would have the effect of diluting investors’ ownership and could decrease the value of their investment.
We have additional authorized, but unissued shares of our common stock that may be issued by us for any purpose without the consent or vote of our stockholders that would dilute stockholders’ percentage ownership of our company.
In addition, our certificate of incorporation authorizes the issuance of shares of preferred stock, the rights, preferences, designations and limitations of which may be set by the Board of Directors. Our certificate of incorporation has authorized issuance of up to 10,000,000 shares of preferred stock in the discretion of our Board. The shares of authorized but undesignated preferred stock may be issued upon filing of an amended certificate of incorporation and the payment of required fees; no further stockholder action is required. If issued, the rights, preferences, designations and limitations of such preferred stock would be set by our Board and could operate to the disadvantage of the outstanding common stock. Such terms could include, among others, preferences as to dividends and distributions on liquidation.
As of the end of the period covered by this report, we have current outstanding non-affiliate debt obligations totaling approximately $160,725, which are convertible into our common stock. In the event the holder(s) of such instruments convert amounts owed to them into common stock and/or we default on the convertible instruments, significant dilution could occur to the other holders of our common stock and could significantly decrease the value of our common stock.
As of the end of the period covered by this report, we have outstanding non-affiliate debt obligations totaling approximately $160,725, which are convertible into our common stock. Under the terms of these convertible notes, the holders may convert the notes into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 55% multiplied by the Market Price (representing a discount rate of 45%). “Market Price” means the average of the lowest three (3) Trading Prices for the common stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009. Although under the terms of the agreement, the number of shares of common stock issuable upon the conversion of any portion of the notes, cannot exceed an amount that would cause the beneficial ownership of the debt holder and its affiliates to own more than 4.99% of our outstanding shares of Common Stock, the issuance of almost 5% of our outstanding common stock in a short period time, possibly happening multiple times, would cause substantial dilution to our shareholders. In the event the holder(s) of such instruments convert amounts owed to them into common stock and/or we default on the convertible instruments, significant dilution could occur to the other holders of our common stock and could significantly decrease the value of our common stock. We evaluated the convertible notes and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, do not constitute a derivative liability as we have obtained authorization from a majority of our shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be made available or issuable for settlement to occur.
Our common stock is governed under The Securities Enforcement and Penny Stock Reform Act of 1990.
The Securities Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure relating to the market for penny stocks in connection with trades in any stock defined as a penny stock. The Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. Such exceptions include any equity security listed on NASDAQ and any equity security issued by an issuer that has (i) net tangible assets of at least $2,000,000, if such issuer has been in continuous operation for three years, (ii) net tangible assets of at least $5,000,000, if such issuer has been in continuous operation for less than three years, or (iii) average annual revenue of at least $6,000,000, if such issuer has been in continuous operation for less than three years. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated therewith.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
This Item is not applicable to us as we are not an accelerated filer, a large accelerated filer, or a well-seasoned issuer; however, we have not received written comments from the Commission staff regarding our periodic or current reports under the Securities Exchange Act of 1934 within the last 180 days before the end of our last fiscal year.
ITEM 2
ITEM 2 - PROPERTIES
Our executive offices are located in Tustin, California, at 228 W. Main Street, 2nd Floor, Tustin, CA 92780. Our office space is approximately 2,000 square feet and the lease is month-to-month at a rate of $2,000 per month.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
We are not a party to or otherwise involved in any legal proceedings.
In the ordinary course of business, we are from time to time involved in various pending or threatened legal actions. The litigation process is inherently uncertain and it is possible that the resolution of such matters might have a material adverse effect upon our financial condition and/or results of operations. However, in the opinion of our management, other than as set forth herein, matters currently pending or threatened against us are not expected to have a material adverse effect on our financial position or results of operations.
ITEM 4
ITEM 4 - MINE SAFETY DISCLOSURES
There is no information required to be disclosed by this Item.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock has been listed for trading on the OTC Bulletin Board since June 2011. Our current trading symbol is “FRZT.” Since our stock has been listed there have been a limited number of trades of our common stock.
The following table sets forth the high and low bid information for each quarter within the fiscal year ended December 31, 2011, as provided by the Nasdaq Stock Markets, Inc. The information reflects prices between dealers, and does not include retail markup, markdown, or commission, and may not represent actual transactions.
The Securities Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure relating to the market for penny stocks in connection with trades in any stock defined as a penny stock. The Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to a few exceptions which we do not meet. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated therewith.
Holders
As of December 31, 2011, there were 39,275,720 shares of our common stock outstanding held by approximately 115 holders of record of our common stock. As of March 23, 2012, there were 44,082,949 shares of our common stock outstanding held by approximately 115 holders of record of our common stock. Of these 44,082,949 shares outstanding at March 23, 2012, 18,382,549 are held by non-affiliates. On the cover page of this filing we value these shares at $643,390. These shares were valued at $0.035 per share, based on recent trades of our common stock as listed on the OTC Bulletin Board.
Dividends
We have not declared or paid a cash dividend on our capital stock in our last two fiscal years and we do not expect to pay cash dividends on our common stock in the foreseeable future. We currently intend to retain our earnings, if any, for use in our business. Any dividends declared in the future will be at the discretion of our Board of Directors and subject to any restrictions that may be imposed by our lenders.
Securities Authorized for Issuance Under Equity Compensation Plans
There are no outstanding options or warrants to purchase, or securities convertible into, shares of our common stock.
Non-Qualified Stock Option Plan
On March 20, 2006, our Board of Directors and shareholders approved the Freeze Tag, Inc. 2006 Stock Plan. Pursuant to the Plan, we reserved 2,920,500 shares (post-split) of our common stock to be issued to employees and consultants for services rendered to the company. As of December 31, 2008, we had issued options to acquire a total of 1,247,850 shares (post-split) of our common stock to seven of our employees and/or consultants. Effective as of October 15, 2009, all seven of the option holders converted their options into a total of 1,123,065 shares of our common stock. Because of the 5.31-for-one forward stock split of our common stock on October 15, 2009, there are now 1,512,650 shares available for issuance as a part of this stock plan. As of the period ended December 31, 2011, there were 560,000 options outstanding to purchase shares of common stock, and no shares of common stock had been issued pursuant to stock purchase rights under the 2006 Plan.
Under the 2006 Plan, options may be granted to employees, directors, and consultants. Only employees may receive “incentive stock options,” which are intended to qualify for certain tax treatment, and consultants and directors may receive “non-statutory stock options,” which do not qualify for such treatment. A holder of more than 10% of the outstanding voting shares may only be granted options with an exercise price of at least 110% of the fair market value of the underlying stock on the date of the grant, and if such holder has incentive stock options, the term of the options must not exceed five years.
Options and stock purchase rights granted under the 2006 Plan generally vest ratably over a four year period (typically 1⁄4 or 25% of the shares vest after the 1st year and 1/48 of the remaining shares vest each month thereafter); however, alternative vesting schedules may be approved by our Board of Directors in its sole discretion. Any unvested portion of an option or stock purchase right will accelerate and become fully vested if a holder’s service with the company is terminated by us without cause within twelve months following a Change in Control (as defined in the 2006 Plan).
All options must be exercised within ten years after the date of grant. Upon a holder’s termination of service for any reason prior to a Change in Control, we may repurchase any shares issued to such holder upon the exercise of options or stock purchase rights. The Board of Directors may amend the 2006 Plan at any time. The 2006 Plan will terminate in 2016, unless terminated sooner by the Board of Directors.
As of December 31, 2011, we had the following options outstanding:
Plan Category
Number of Securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(a)
(b)
(c)
Equity compensation plans approved by security holders
560,000
0.10
952,650
Equity compensation plans not approved by security holders
- 0 -
- 0 -
- 0 -
Total
560,000
0.10
952,650
Recent Issuance of Unregistered Securities
During the quarter ended December 31, 2011, we issued the following unregistered securities:
On November 29, 2011, we issued 125,000 shares of our common stock, restricted in accordance with Rule 144, to Michael Southworth for consulting services. The issuance was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, and the investor was accredited and sophisticated, familiar with our operations, and there was no solicitation.
If our stock is listed on an exchange we will be subject to the Securities Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure relating to the market for penny stocks in connection with trades in any stock defined as a penny stock. The Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to a few exceptions which we do not meet. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated therewith.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
As a smaller reporting company we are not required to provide the information required by this Item.
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Forward-Looking Statements
This annual report on Form 10-K of Freeze Tag, Inc. for the year ended December 31, 2011 contains forward-looking statements, principally in this Section and “Business.” Generally, you can identify these statements because they use words like “anticipates,” “believes,” “expects,” “future,” “intends,” “plans,” and similar terms. These statements reflect only our current expectations. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy and actual results may differ materially from those we anticipated due to a number of uncertainties, many of which are unforeseen, including, among others, the risks we face as described in this filing. You should not place undue reliance on these forward-looking statements which apply only as of the date of this annual report. These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbors created thereby. To the extent that such statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. In any forward-looking statement where we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation of belief will be accomplished.
We believe it is important to communicate our expectations to our investors. There may be events in the future; however, that we are unable to predict accurately or over which we have no control. The risk factors listed in this filing, as well as any cautionary language in this annual report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Factors that could cause actual results or events to differ materially from those anticipated, include, but are not limited to: distributors not accepting our games; price reductions; unforeseen delays in game production; changes in product strategies; general economic, financial and business conditions; changes in and compliance with governmental regulations; changes in various tax laws; and the availability of key management and other personnel.
Summary Overview
We are a casual online games publisher that develops and markets games across the major digital distribution platforms including PC/Mac downloadable (Web), mobile (including smartphones and tablets), and emerging platforms like social networking sites (including Facebook). We focus on casual games because of our belief that they appeal to a significant portion of the population.
During our most recent fiscal year ended December 31, 2011, we generated revenues of $732,591 from the sales our games compared to $643,518 for the year ended December 31, 2010. During the year ended December 31, 2011, we launched two games for various platforms, compared to four for the year ended December 31, 2010. During 2012, we anticipate we will publish up to eight to ten games for various platforms. In 2012 and going forward we plan to continue the trend we started in 2009 of developing games based on intellectual property we own or purchase from third parties, rather than license intellectual property that belongs to certain third parties, for which we then have to pay royalties to the owner of the intellectual property. We believe this will further enable us to decrease the costs associated with developing and publishing games and increase our gross margins over time.
Critical Accounting Estimates
Revenue Recognition
Our revenues are derived primarily by licensing software products in the form of online and downloadable games for PC, Mac and smartphone platforms. We distribute our products primarily through online games portals and smartphone device manufacturers (“distribution partners”), which market the games to end users. The nature of our business is such that we sell games basically through four distribution outlets - WEB portals, brick and mortar retail distributors, mobile distributors and publishers, and our own web portal, www.freezetag.com.
Product Sales (web and mobile revenues)
We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers, and once any performance obligations have been completed. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.
Licensing Revenues (retail revenues- royalties)
Third-party licensees distribute games under license agreements with us. We receive royalties from the licensees as a result. We recognize these royalties as revenues upon receipt of the monthly or quarterly (varies per distribution partner) revenue reports provided by the partner. Revenue from licensing/royalties is recognized after deducting the estimated allowance for returns and price protection.
Some license agreements require a royalty advance from the licensee/distributor in which case the original advance is recognized as a liability and royalty revenue is deducted from the advance as earned.
Other Revenues
Other revenues primarily include Ad game revenue and work-for-hire game related revenue. We derive our advertising game revenue from certain of our partners that offer our games free of charge to consumers in exchange for the consumers being exposed to advertising embedded in our games. In this way, we do not receive revenue for the sale of our games, but rather a percentage of the “advertising” revenue generated by these player views. This method of generating revenue is essentially the same as traditional radio or television advertising where consumers are allowed to enjoy content for “free” but are forced to watch (or listen) to advertising before, in between and at the end of the programming content.
Additionally, we derive some revenue from “work-for-hire” projects. Some of our partners occasionally ask us to render “work-for-hire” services for them such as preparing packaging materials. For example, a retail game and DVD publisher hired us to create several designs for printed packages that were used for games published by the publisher but not developed by us. For this work, we charge a one-time, fixed fee for each package design.
We recognize this revenue once all performance obligations have been completed. In addition, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.
We recognize revenue in accordance with current accounting standards when an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectability is probable.
Cash and Cash Equivalents
For purposes of the Statement of Cash Flows, we consider liquid investments with an original maturity of three months or less to be cash equivalents. We place our cash and cash equivalents with large commercial banks. The Federal Deposit Insurance Corporation (“FDIC”) insures these balances, up to $250,000. All of our cash balances at December 31, 2011 and 2010 are insured. At December 31, 2011 and 2010 there were no cash equivalents.
Restricted Cash
In February of 2010, as a condition of the private equity offering of common shares of the Company, we entered into an escrow agreement, which governed the receipt and distribution of the funds. At the time of closing, $171,125 (50%) of the funds were placed in to an escrow account, and these funds were used to pay accounting, legal, and consulting fees associated with the public offering of our common stock and the first 12 months of accounting and legal expenses following the successful listing on the OTCBB. As of December 31, 2011, the restrictions placed on the use of that cash had expired and, therefore, we did not have any restricted cash at December 31, 2011, compared to $28,839 as of December 31, 2010.
Allowances for Returns, Price Protection, and Doubtful Accounts
Because the majority of our business is derived through online portals (such as Big Fish Games) and wireless online app stores (such as Apple), there is no physical product, other than the downloadable bits of our games that is involved in the customer purchase. In the digital environment, the customer cannot ‘return’ a digital download product. Therefore, there are no returns. The customer can ask for a refund of a digital product, and if there are any, then they are reconciled or netted out by our distribution partners before we receive the corresponding payments and royalty statements. As such, we do not allow for returns, bad debts or price protection of digital download products.
However, we derive a small portion of our revenues from sales of physical packaged software for personal computers through distribution partners who sell through traditional retail channels. Product revenue is recognized net of allowances for price protection and returns and various customer discounts. Our distribution partners who sell to retailers may allow returns for our packaged personal computer products; these partners may decide to provide price protection or allow returns for personal computer products after they analyze: (1) inventory remaining in the retail channel, (2) the rate of inventory sell-through in the retail channel, and (3) the remaining inventory on hand of our games. To allow for these returns, price protection and various customer discounts, some of our distribution partners who sell to retailers will hold back a percentage of our revenue. These “hold-back” amounts, typically a percentage of revenue, are then reconciled on a quarterly basis and detailed on the statements we receive from our distribution partners.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets. All assets are currently depreciated over 3 years. Maintenance and repairs are charged to expense as incurred. Renewals and improvements of a major nature are capitalized. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are reflected in the statement of operations.
Concentrations of Credit Risk, Major Customers and Major Vendors
Our customers are the end-consumers that purchase its games from the websites where we have our games listed for sale. Therefore, we do not have any individual customers that represent any more than a fraction of our revenue. However, we do have primary distribution partners, which are the owners of the websites where we sell our games. Under our distribution agreements we are not obligated to make, distribute or sell any games. However, for any games we do make and wish to distribute we can list them on one or more of these websites under a revenue sharing arrangement where we share the revenue from any of our games that sell. The sharing arrangement varies greatly depending on the distributor but we generally keep between 35% and 70% of the revenue with the distributor keeping the remainder of the revenue generated by each sale. At times we enter into “exclusivity options” whereby if a distributor wishes to have an exclusive period carrying our games (normally 30-90 days) we will agree to that in exchange for the distributor marketing the game in their newsletter and other marketing programs. Due to the fact we have a number of distribution partners and a variety of different websites where we can sell our games, we are not substantially dependent on any of our distribution partners or agreements. In addition to the distribution agreements, we currently have licensing agreements with Ohio Art Company and CMG Worldwide, which allow us to develop and distribute games around third party intellectual property in exchange for paying royalty payments. We are not substantially dependent on either of those licensing agreements.
At December 31, 2011, our primary distributors that represented 10% or more of our revenues were: Big Fish Games - 37.54% and Exent - 13.07%. At December 31, 2010, our primary distributors that represented 10% or more of our revenues were: Big Fish Games - 48% and Real Networks - 12%.
At December 31, 2011, our primary distributors and partners that represented 10% or more of our accounts receivable were: Exent - 25.17%, Big Fish Games - 18.26%, and Avanquest - 11.06%. At December 31, 2010, our primary distributors and partners that represented 10% or more of our accounts receivable were: Big Fish Games - 39%, Square Enix Ltd - 22%, and Exent Technologies - 17%.
Income Taxes
We account for income taxes using ASC Topic 740, Income Taxes. Under ASC Topic 740, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their 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.
ASC Topic 740 includes accounting guidance which clarifies the accounting for the uncertainty in recognizing income taxes in an organization by providing detailed guidance for financial statement recognition, measurement and disclosure involving uncertain tax positions. This guidance requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective date to be recognized both upon the adoption of the related guidance and in subsequent periods.
We have no uncertain tax positions at any of the dates presented.
Foreign Currency Translation
We derive a portion of our revenue from foreign countries, which report to us in foreign currency, but pay in U.S. Dollars. Because of the fluctuations between the reporting time and the payment period (up to 60 days), it is necessary to make adjustments to our accounting records. These adjustments are recorded under a Foreign Currency Translation expense account, and shown in the Statement of Operations as a General & Administrative expense.
Accounting for Stock-Based Compensation
We account for stock-based compensation in accordance with ASC Topic 718-10, Compensation-Stock Compensation and ASC Subtopic 505-50, Equity-Based Payments to Non-Employees ("ASC stock-based compensation guidance"). Stock-based compensation expense recognized during the requisite services period is based on the value of share-based payment awards after reduction for estimated forfeitures. Forfeitures are estimated at the time of grant and are revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized in our statement of operations for the year ended December 31, 2011 was $16,003, and $39,985 for the year ended December 31, 2010.
Impairment of Long-Lived Assets
We have adopted Accounting Standards Codification subtopic 360-10, Property, Plant and Equipment ("ASC 360-10"). ASC 360-10 requires that long-lived assets and certain identifiable intangibles held and used by us be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We evaluate our long-lived assets for impairment annually or more often if events and circumstances warrant. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses or a forecasted inability to achieve break-even operating results over an extended period. We evaluate the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of long-lived assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. ASC 360-10 also requires assets to be disposed of be reported at the lower of the carrying amount or the fair value less costs to sell.
Fair Value of Financial Instruments
Effective January 1, 2009, we adopted Accounting Standards Codification subtopic 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”) and Accounting Standards Codification subtopic 825-10, Financial Instruments (“ASC 825-10”), which permits entities to choose to measure many financial instruments and certain other items at fair value. Neither of these statements had an impact on our financial position, results of operations or cash flows. The carrying value of cash and cash equivalents, accounts payable, accrued expenses and notes payable, as reflected in the balance sheets, approximate fair value because of the short-term maturity of these instruments.
Inputs used in the valuation to derive fair value are classified based on a fair value hierarchy which distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:
·
Level one - Quoted market prices in active markets for identical assets or liabilities;
·
Level two - Inputs other than level one inputs that are either directly or indirectly observable; and
·
Level three - Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.
Determining the category in which an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each period.
Use of Estimates
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires our management to make judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and these differences may be material.
Research and Development Costs
We charge costs related to research & development of products to general and administrative expense as incurred. The types of costs included in research and development expenses include research materials, salaries, contractor fees, and support materials.
Software Development Costs
Software development costs include direct costs incurred for internally developed products and payments made to independent software developers and/or contract engineers and artists. We account for software development costs in accordance with the FASB guidance for the costs of computer software to be sold, leased, or otherwise marketed ("ASC Subtopic 985-20"). Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation, or the completed and tested product design and working model. Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable against future revenues. For products where proven game engine technology exists (as is the case for most of our products), this may occur early in the development cycle. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established. For most of our PC/Mac products, technological feasibility is established when a detailed game design document containing sufficient technical specifications written for a proven game engine or framework technology has been created and approved by management. However, technological feasibility is evaluated on a product-by-product basis. Amounts related to software development that are not capitalized are charged immediately to the appropriate expense account. Amounts that are considered ‘research and development’ that are not capitalized are immediately charged to general and administrative expense.
Prior to a product's release, we expense, as part of "Cost of Sales-Product Development", capitalized costs when we believe such amounts are not recoverable. Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.
Commencing upon product release, capitalized software development costs are amortized to "Cost of Sales-Product Development" based on the straight-line method over a twenty four month period.
We evaluate the future recoverability of capitalized software development costs and intellectual property licenses on a quarterly basis. For products that have been released in prior periods, the primary evaluation criterion is actual title performance. For products that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific products to which the costs relate or in which the licensed trademark or copyright is to be used. Criteria used to evaluate expected product performance include: historical performance of comparable products developed with comparable technology; orders for the product prior to its release; and, for any sequel product, estimated performance based on the performance of the product on which the sequel is based.
Based on current trends in our business, management has determined the expected shelf life of the majority of a game’s revenue will be realized over a two year period. Therefore, we have determined the appropriate amortization period for expensing capitalized production costs to be two years or twenty four months from date of the initial release, or first sale of the product for a specific technology platform. It is possible that the same game developed on different technology platforms (such as PC and Mac) will be launched on different release dates because product development cycles may differ and distribution partner release policies may differ.
At December 31, 2011, and December 31, 2010, current and long-term capitalized software development costs on the balance sheet were $786,331 and $479,245 respectively.
From time to time, we engage in product development projects for third parties where we do not retain the intellectual property rights to the games it develops. These types of development projects are often referred to as “work-for-hire.” In these instances, all costs associated with developing the games are expensed as they are incurred. We do this because we receive revenue based on project deliverables outlined as milestones in the development agreement executed by the Company and the third party that has engaged us to perform development work. These non-capitalized costs are represented as “Cost of Sales - Development Services” expenses on our financial statements.
For the year ended December 31, 2011, “Cost of Sales - Development Services” was $0. For the year ended December 31, 2010, we recorded “Cost of Sales - Development Services” charges of $141,144.
Intellectual Property Licenses (Prepaid Royalties)
Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of the Company's products. Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology, music or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (prepaid royalties or prepaid licensing fees), and a current liability, (accrued royalties payable) at the contractual amount upon execution of the contract when no significant performance remains with the licensor. Commencing upon the related product's release date, intellectual property licenses costs are amortized to “Cost of Sales - Licensing” based upon the percentage of revenue outlined in the contract with each specific licensor. Generally, our intellectual property licensing contracts call for licensors to be paid a percentage of revenue actually received by us, with allowances for minimum guarantees. Sometimes, the terms of the specific licensing contracts allow for us to re-capture expenses before licensing out royalties are calculated.
Capitalized intellectual property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.
For the year ended December 31, 2011 and the year ended December 31, 2010, prepaid royalties (or prepaid licensing fees) were $12,046, and $21,088 respectively.
Recent Accounting Pronouncements
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”, which is effective for annual reporting periods beginning after December 15, 2011. ASU 2011-05 will become effective for the Company on January 1, 2012. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, items of other comprehensive income that are reclassified to profit or loss are required to be presented separately on the face of the financial statements. This guidance is intended to increase the prominence of other comprehensive income in financial statements by requiring that such amounts be presented either in a single continuous statement of income and comprehensive income or separately in consecutive statements of income and comprehensive income. The adoption of ASU 2011-05 is not expected to have a material impact on our financial position or results of operations.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 will become effective for the Company on January 1, 2012. We are currently evaluating ASU 2011-04 and have not yet determined the impact that adoption will have on our financial statements.
In January 2010, the FASB issued an update to Fair Value Measurements and Disclosures. This update provides amendments to ASC Subtopic 820-10 requiring new disclosures regarding (1) transfers in and out of Levels 1 and 2, in which the Company should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (2) the reconciliation for fair value measurements using significant unobservable inputs (Level 3), in which the Company should present separately information about purchases, sales, issuances, and settlements (on a gross basis rather than as one net number). In addition the update provides clarification of existing disclosures regarding the level of disaggregation and disclosures about inputs and valuation techniques. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchase, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. We do not expect the adoption of this statement to have a material impact on its financial statements.
In December 2010, the FASB issued FASB ASU No. 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts,” which is now codified under FASB ASC Topic 350, “Intangibles - Goodwill and Other.” This ASU provides amendments to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not a goodwill impairment exists. When determining whether it is more likely than not an impairment exists, an entity should consider whether there are any adverse qualitative factors, such as a significant deterioration in market conditions, indicating an impairment may exist. FASB ASU No. 2010-28 is effective for fiscal years (and interim periods within those years) beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, an entity with reporting units having carrying amounts which are zero or negative is required to assess whether is it more likely than not the reporting units’ goodwill is impaired. If the entity determines impairment exists, the entity must perform Step 2 of the goodwill impairment test for that reporting unit or units. Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. This ASU is not expected to have any material impact to our financial statements.
In December 2010, the FASB issued FASB ASU No. 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations,” which is now codified under FASB ASC Topic 805, “Business Combinations.” A public entity is required to disclose pro forma data for business combinations occurring during the current reporting period. This ASU provides amendments to clarify the acquisition date to be used when reporting the pro forma financial information when comparative financial statements are presented and improves the usefulness of the pro forma revenue and earnings disclosures. If a public company presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) which occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The supplemental pro forma disclosures required are also expanded to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. FASB ASU No. 2010-29 is effective on a prospective basis for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The adoption of this ASU will not have a material effect on our financial position, results of operations or cash flows.
Year Ended December 31, 2011 compared to Year Ended December 31, 2010
Results of Operations
Summary of Results of Operations
Operating Loss; Net Loss
Our net loss increased by $67,988, from ($162,195) to ($230,183), from the year ended 2010 compared to 2011. Our operating loss increased by $57,939, from ($150,767) to ($208,706) for the same period. The decrease in operating loss and net loss of 38% and 41%, respectively, compared to the prior year is primarily a result of our increase in expenses, especially our cost of sales related to both product development (increased by $44,521) and licensing (decreased by $11,392), as well as the increase in our general and administrative expenses of $177,927 and the increase in amortization and depreciation of $50,644. These changes are detailed below.
Revenue.
Our 2011 revenue increased by $89,073, or 14%, to $732,591 compared to $643,518 for the year ended December 31, 2010, primarily due to the facts we had more games in the market, increased retail distribution, increased European distribution, and because we were able recognize approximately $56,000 of revenue that was recognized as an advance and categorized as unrecognized revenue for the year ended December 31, 2010. Overall our retail revenue increased significantly, by over $130,000 from the prior year, but this increase in retail revenue was offset by the fact we did not derive revenue from our development services (games we developed under a work-for-hire basis for a third party, but did not sell ourselves).
Cost of Sales - Product Development.
Our cost of sales for product development is comprised of the direct costs we incur in creating and publishing a game based on our own or licensed intellectual property. Our 2011 cost of sales for product development increased by $44,521, or 19%, to $276,320, due to the fact we were working on more of our own games, all of which we plan to launch in 2012. We believe our product development costs will continue to increase as we develop and publish more games.
Cost of Sales - Development Services.
Our cost of sales for development services is comprised of the costs we incur to develop games based on third parties’ intellectual property, such as The Conjurer and Real Detectives. Our 2011 cost of sales for product development was $0 due to the fact we shifted to developing games based on intellectual property we own as opposed to intellectual property owned by third parties. Going forward we plan to develop games based on own intellectual property and not develop games based on property owned by third parties, therefore, we believe our development services costs will continue to be low.
Cost of Sales -Licensing.
Our cost of sales for licensing is comprised of royalty payments we make to third parties for the use of their intellectual property and other related costs. Our 2011 cost of sales for licensing increased by $11,392, or 13%, to $96,344, due to the fact we sold more games based on licensing arrangements and therefore had to pay more royalty payments. We believe these costs will decrease as we create our own intellectual property on which our games are based, alleviating the need to pay a royalty payment to the owner of the intellectual property.
General and Administrative Expenses.
General and administrative expenses increased by $177,927, or 54%, to $505,775 for the year ended December 31, 2011, primarily due to an approximately $90,528 increase in accounting, legal, and investor relations/public relations due to us being a public, reporting company, an increase of approximately $19,754 in our employee related expenses (payroll taxes and health insurance, etc.), and a debt discount amortization expense of approximately $49,717 related to convertible debt instruments.
Interest Income/Expense; Net.
Interest income/expense, net increased by $8,123, or 78%, to $18,551, and is primarily attributable to the interest expense on our loans from noteholders and our loan from Sunwest Bank.
Liquidity and Capital Resources
Introduction
During the years ended December 31, 2011 and 2010, because of our operating losses, we did not generate positive operating cash flows. Our cash on hand as of December 31, 2011 was approximately $26,588 and our monthly cash flow burn rate is approximately $85,000. As a result, we have significant short term cash needs. These needs are being satisfied through cash flows from our operations, as well as proceeds from the sales of our securities. We currently do not believe we will be able to satisfy our cash needs from our revenues for some time.
Our cash, current assets, total assets, current liabilities, and total liabilities as of December 31, 2011 and 2010, respectively, are as follows:
Our current assets decreased by $173,385 as of December 31, 2011 as compared to December 31, 2010. The decrease in our total assets between the two periods was primarily attributed to a decrease in our cash on hand of $80,781 and an increase in our accounts receivable of $41,387.
Our current liabilities increased by $247,200, or over 29%, as of December 31, 2011 as compared to December 31, 2010. A large portion of this was an increase in our accrued royalties of $83,430 and our unearned royalties of $45,997, or 20%, with the former being due to royalty payments we could not pay and the latter being due to royalty advances we received in 2011 that have not been earned yet. We also had a significant increase in our current note payable to a related party, $130,000 in 2011 compared to $75,000 in 2010, which is due to an increase in the amount we owe under our note held by The Holland Family Trust, an entity controlled by Craig Holland, one of our officers and directors.
Our total liabilities increased by $204,499, or over 23%, as of December 31, 2011 as compared to December 31, 2010, all due to the increase in our current liabilities as described above.
In order to repay our obligations in full or in part when due, we will be required to raise significant capital from other sources. There is no assurance, however, that we will be successful in these efforts.
Cash Requirements
We had cash available as of December 31, 2011 of $26,588 and $107,369 on December 31, 2010. Based on our revenues, cash on hand and current monthly burn rate, around $85,000 per month, we will need to continue borrowing from our shareholders and other related parties, and/or raise money from the sales of our securities, to fund operations.
Sources and Uses of Cash
Operations
We had net cash provided (used) by operating activities of ($238,081) for the year ended December 31, 2011, as compared to ($124,019) for the year ended December 31, 2010. In 2011, the net cash used in operating activities consisted primarily of our net income (loss) of ($230,183), capitalized production costs of ($571,809), and accounts payable of ($21,796), offset by accounts receivable of $41,385, amortization of production costs of $264,721, unearned royalties of 45,997, stock based compensation of $16,003, prepaid royalties of $9,042, and accrued expenses of $98,407. In 2010, the net cash provided by operating activities consisted primarily of our net income (loss) of ($162,195), capitalized production costs of ($341,285), and accounts receivable of ($43,064), partially offset by amortization of capitalized production costs of $231,167, prepaid royalties of $15,178, accrued expenses of $38,428, unearned royalties of $119,274, and stock based compensation of $39,985.
Investments
We had net cash provided (used) by investing activities of ($12,600) in 2011, compared to ($2,463) in 2010. The amounts in 2011 and 2010 all related to cash used for purchasing fixed assets.
Financing
Our net cash provided (used) by financing activities for the year ended December 31, 2011 was $141,061, compared to $233,786 for the year ended December 31, 2010. For 2011, our financing activities related to payments for private placement memorandum costs of ($6,364), and repayments of debt of ($18,300) offset by borrowings of debt of $165,725. For 2010, our financing activities consisted of ($94,700) in repayments of debt and ($145,914) in payments for the preparation of a private placement memorandum, offset by $344,400 in stock issued in exchange for cash and $130,000 in borrowings of debt.
Contractual Obligations
December 31, 2011:
(1) The interest amount for the contractual obligation for 2012 has been estimated.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company we are not required to provide the information required by this Item.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Shareholders of Freeze Tag, Inc.
We have audited the accompanying balance sheets of Freeze Tag, Inc. (“the “Company”) as of December 31, 2011 and 2010 and the related statements of operations, cash flows and shareholders’ equity for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 audits 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Freeze Tag, Inc. as of December 31, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has insufficient working capital and reoccurring losses from operations, all of which raises substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ M&K CPAS, PLLC
www.mkacpas.com
Houston, Texas
March 30, 2012
FREEZE TAG, INC.
(A DELAWARE CORPORATION) BALANCE SHEETS
The accompanying notes are an integral part of the financial statements
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the financial statements
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
Statement of Shareholders' Equity (Deficit)
The accompanying notes are an integral part of the financial statements
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
STATEMENTS OF CASHFLOWS
The accompanying notes are an integral part of the financial statements
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY
Nature of Business
We are a casual online games publisher that develops and markets games across the major digital distribution platforms including PC/Mac downloadable (Web), mobile, and emerging platforms like social networking sites (including Facebook). We focus on casual games because of our belief that they appeal to a significant portion of the population. Although the primary consumers of downloadable casual games are women over the age of 35, downloadable casual games are enjoyed by people of all ages - ex-gamer dads, pre-teen kids, teenagers, college students and grandparents. Thus, we believe the potential market for our games is very large.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
The Company’s revenues are derived primarily by licensing software products in the form of online and downloadable games for PC, Mac and smartphone platforms. The Company distributes its products primarily through online games portals and smartphone device manufacturers (“distribution partners”), which market the games to end users. The nature of our business is such that we sell games basically through four distribution outlets - WEB portals, brick and mortar retail distributors, mobile distributors and publishers, and our own web portal, www.freezetag.com.
Product Sales (web and mobile revenues)
We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers, and once any performance obligations have been completed. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.
Licensing Revenues (retail revenues- royalties)
Third-party licensees distribute games under license agreements with the Company. We receive royalties from the licensees as a result. We recognize these royalties as revenues upon receipt of the monthly or quarterly (varies per distribution partner) revenue reports provided by the partner. Revenue from licensing/royalties is recognized after deducting the estimated allowance for returns and price protection. Some license agreements require a royalty advance from the licensee/distributor in which case the original advance is recognized as a liability and royalty revenue is deducted from the advance as earned.
Other Revenues
Other revenues primarily include Ad game revenue and work-for-hire game related revenue. We derive our advertising game revenue from certain of our partners that offer our games free of charge to consumers in exchange for the consumers being exposed to advertising embedded in our games. In this way, we do not receive revenue for the sale of our games, but rather a percentage of the “advertising” revenue generated by these player views. This method of generating revenue is essentially the same as traditional radio or television advertising where consumers are allowed to enjoy content for “free” but are forced to watch (or listen) to advertising before, in between and at the end of the programming content.Additionally, we derive some revenue from “work-for-hire” projects. Some of our partners occasionally ask us to render “work-for-hire” services for them such as preparing packaging materials. For example, a retail game and DVD publisher hired us to create several designs for printed packages that were used for games published by the publisher but not developed by us. For this work, we charge a one-time, fixed fee for each package design.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
We recognize this revenue once all performance obligations have been completed. In addition, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.
We recognize revenue in accordance with current accounting standards when an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectability is probable.
Cash and Cash Equivalents
For purposes of the Statement of Cash Flows, the Company considers liquid investments with an original maturity of three months or less to be cash equivalents. The Company places its cash and cash equivalents with large commercial banks. The Federal Deposit Insurance Corporation (“FDIC”) insures these balances, up to $250,000. All of the Company’s cash balances at December 31, 2011 and December 31, 2010 were insured. At December 31, 2011 and December 31, 2010 there were no cash equivalents.
Restricted Cash
In February of 2010, as a condition of the private equity offering of common shares of the Company, we entered into an escrow agreement, which governed the receipt and distribution of the funds. At the time of closing, $171,125 (50%) of the funds were placed in to an escrow account, and these funds are being used to pay accounting, legal, and consulting fees associated with the public offering of common shares of the Company and the first 12 months of accounting and legal expenses following the successful listing on the OTCBB. As of December 31, 2011, the remaining balance was $0 compared to $28,839 as of December 31, 2010.
Releasing the funds required the signatures of both the Company, and a representative from Monarch Bay Management Company.
Because of these restrictions on the use of funds, we have placed them on the balance sheet in a “Restricted Cash” category.
Allowances for Returns, Price Protection, and Doubtful Accounts
Because the majority of our business is derived through online portals (such as Big Fish Games) and wireless online app stores (such as Apple), there is no physical product, other than the downloadable bits of our games that is involved in the customer purchase. In the digital environment, the customer cannot ‘return’ a digital download product. Therefore, there are no returns. The customer can ask for a refund of a digital product, and if there are any, then they are reconciled or netted out by our distribution partners before we receive the corresponding payments and royalty statements. As such, we do not allow for returns, bad debts or price protection of digital download products.
However, we derive a small portion of our revenues from sales of physical packaged software for personal computers through distribution partners who sell through traditional retail channels. Product revenue is recognized net of allowances for price protection and returns and various customer discounts. Our distribution partners who sell to retailers may allow returns for our packaged personal computer products; these partners may decide to provide price protection or allow returns for personal computer products after they analyze: (1) inventory remaining in the retail channel, (2) the rate of inventory sell-through in the retail channel, and (3) the remaining inventory on hand of our games. To allow for these returns, price protection and various customer discounts, some of our distribution partners who sell to retailers will hold back a percentage of our revenue. These “hold-back” amounts, typically a percentage of revenue, are then reconciled on a quarterly basis and detailed on the statements we receive from our distribution partners.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets. All assets are currently depreciated over 3 years. Maintenance and repairs are charged to expense as incurred. Renewals and improvements of a major nature are capitalized. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are reflected in the statement of operations.
Concentrations of Credit Risk, Major Customers and Major Vendors
The Company’s customers are the end-consumers that purchase its games from the websites where the Company has its games listed for sale. Therefore, the Company does not have any individual customers that represent any more than a fraction of its revenue. However, the Company does have primary distribution partners, which are the owners of the websites where it sells its games. Under the Company’s distribution agreements it is not obligated to make, distribute or sell any games. However, for any games the Company does make and wishes to distribute it can list them on one or more of these websites under a revenue sharing arrangement where it shares the revenue from any of its games that sell. The sharing arrangement varies greatly depending on the distributor with the Company generally keeping between 35% and 70% of the revenue and the distributor keeping the remainder of the revenue generated by each sale. At times the Company enters into “exclusivity options” whereby if a distributor wishes to have an exclusive period carrying the Company’s games (normally 30-90 days) it will agree to that in exchange for the distributor marketing the game in their newsletter and other marketing programs. Due to the fact the Company has a number of distribution partners and a variety of different websites where it can sell its games, the Company is not substantially dependent on any of its distribution partners or agreements. In addition to the distribution agreements, the Company currently has licensing agreements with Ohio Art Company and CMG Worldwide, which allow it to develop and distribute games around third party intellectual property in exchange for paying royalty payments. The Company is not substantially dependent on either of those licensing agreements.
At December 31, 2011, the Company’s primary distributors that represented 10% or more of its revenues were: Big Fish Games - 37.54% and Exent - 13.07%. At December 31, 2010, the Company’s primary distributors that represented 10% or more of its revenues were: Big Fish Games - 48% and Real Networks - 12%.
At December 31, 2011, the Company’s primary distributors and partners that represented 10% or more of its accounts receivable were: Exent - 25.17%, Big Fish Games - 18.26%, and Avanquest - 11.06%. At December 31, 2010, the Company’s primary distributors and partners that represented 10% or more of its accounts receivable were: Big Fish Games - 39%, Square Enix Ltd - 22%, and Exent Technologies - 17%.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Income Taxes
We account for income taxes using ASC Topic 740, Income Taxes. Under ASC Topic 740, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their 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.
ASC Topic 740 includes accounting guidance which clarifies the accounting for the uncertainty in recognizing income taxes in an organization by providing detailed guidance for financial statement recognition, measurement and disclosure involving uncertain tax positions. This guidance requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective date to be recognized both upon the adoption of the related guidance and in subsequent periods. The Company has no uncertain tax positions at any of the dates presented.
Foreign Currency Translation
We derive a portion of our revenue from foreign countries, which report to us in foreign currency, but pay in U.S. Dollars. Because of the fluctuations between the reporting time and the payment period (up to 60 days), it is necessary to make adjustments to our accounting records. These adjustments are recorded under a Foreign Currency Translation expense account, and shown in the Statement of Operations as a General & Administrative expense.
Accounting for Stock-Based Compensation
We account for stock-based compensation in accordance with ASC Topic 718-10, Compensation-Stock Compensation and ASC Subtopic 505-50, Equity-Based Payments to Non-Employees ("ASC stock-based compensation guidance"). Stock-based compensation expense recognized during the requisite services period is based on the value of share-based payment awards after reduction for estimated forfeitures. Forfeitures are estimated at the time of grant and are revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Stock-based compensation expense recognized in our statement of operations for the year ended December 31, 2011 was $16,003, and $39,985 for the year ended December 31, 2010.
Impairment of Long-Lived Assets
The Company has adopted Accounting Standards Codification subtopic 360-10, Property, Plant and Equipment ("ASC 360-10"). ASC 360-10 requires that long-lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates its long-lived assets for impairment annually or more often if events and circumstances warrant. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of long-lived assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. ASC 360-10 also requires assets to be disposed of be reported at the lower of the carrying amount or the fair value less costs to sell.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Fair Value of Financial Instruments
Effective January 1, 2009, the Company adopted Accounting Standards Codification subtopic 820-10, Fair Value Measurements and Disclosures (“ASC 820- 10”) and Accounting Standards Codification subtopic 825-10, Financial Instruments (“ASC 825-10”), which permits entities to choose to measure many financial instruments and certain other items at fair value. Neither of these statements had an impact on the Company’s financial position, results of operations or cash flows. The carrying value of cash and cash equivalents, accounts payable, accrued expenses and notes payable, as reflected in the balance sheets, approximate fair value because of the short-term maturity of these instruments.
Inputs used in the valuation to derive fair value are classified based on a fair value hierarchy which distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:
·
Level one - Quoted market prices in active markets for identical assets or liabilities;
·
Level two - Inputs other than level one inputs that are either directly or indirectly observable; and
·
Level three - Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.
Determining the category in which an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each period.
Use of Estimates
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires the Company’s management to make judgments, assumptions and estimates that affect the amounts reported in its financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and these differences may be material.
Research and Development Costs
The Company charges costs related to research & development of products to general and administrative expense as incurred. The types of costs included in research and development expenses include research materials, salaries, contractor fees, and support materials.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Software Development Costs
Software development costs include direct costs incurred for internally developed products and payments made to independent software developers and/or contract engineers and artists. We account for software development costs in accordance with the FASB guidance for the costs of computer software to be sold, leased, or otherwise marketed (“ASC Subtopic 985-20”). Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation, or the completed and tested product design and working model. Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable against future revenues. For products where proven game engine technology exists (as is the case for most of our products), this may occur early in the development cycle. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established. For most of our PC/Mac products, technological feasibility is established when a detailed game design document containing sufficient technical specifications written for a proven game engine or framework technology has been created and approved by management. However, technological feasibility is evaluated on a product-by-product basis. Amounts related to software development that are not capitalized are charged immediately to the appropriate expense account. Amounts that are considered ‘research and development’ that are not capitalized are immediately charged to general and administrative expense.
Prior to a product’s release, we expense, as part of “Cost of Sales-Product Development”, capitalized costs when we believe such amounts are not recoverable. Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation. Commencing upon product release, capitalized software development costs are amortized to “Cost of Sales-Product Development” based on the straight-line method over a twenty four month period.
We evaluate the future recoverability of capitalized software development costs and intellectual property licenses on a quarterly basis. For products that have been released in prior periods, the primary evaluation criterion is actual title performance. For products that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific products to which the costs relate or in which the licensed trademark or copyright is to be used. Criteria used to evaluate expected product performance include: historical performance of comparable products developed with comparable technology; orders for the product prior to its release; and, for any sequel product, estimated performance based on the performance of the product on which the sequel is based.
Based on current trends in our business, management has determined the expected shelf life of the majority of a game’s revenue will be realized over a two year period. Therefore, we have determined the appropriate amortization period for expensing capitalized production costs to be two years or twenty four months from date of the initial release, or first sale of the product for a specific technology platform. It is possible that the same game developed on different technology platforms (such as PC and Mac) will be launched on different release dates because product development cycles may differ and distribution partner release policies may differ.
At December 31, 2011, and December 31, 2010, current and long-term capitalized software development costs on the balance sheet were $786,334 and $479,245 respectively.
From time to time, the Company engages in product development projects for third parties where the company does not retain the intellectual property rights to the games it develops. These types of development projects are often referred to as “work-for-hire.” In these instances, all costs associated with developing the games are expensed as they are incurred. We do this because the Company receives revenue based on project deliverables outlined as milestones in the development agreement executed by the Company and the third party that has engaged us to perform development work. These non-capitalized costs are represented as “Cost of Sales - Development Services” expenses on our financial statements.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
For the year ended December 31, 2011, “Cost of Sales - Development Services” was $0. For the year ended December 31, 2010, the Company recorded “Cost of Sales - Development Services” charges of $141,144.
Intellectual Property Licenses (Prepaid Royalties)
Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of the Company’s products. Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology, music or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (prepaid royalties or prepaid licensing fees), and a current liability, (accrued royalties payable) at the contractual amount upon execution of the contract when no significant performance remains with the licensor. Commencing upon the related product’s release date, intellectual property licenses costs are amortized to “Cost of Sales - Licensing” based upon the percentage of revenue outlined in the contract with each specific licensor. Generally, the Company’s intellectual property licensing contracts call for licensors to be paid a percentage of revenue actually received by the Company, with allowances for minimum guarantees. Sometimes, the terms of the specific licensing contracts allow for the Company to re-capture expenses before licensing out royalties are calculated.
Capitalized intellectual property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.
For the year ended December 31, 2011 and the year ended December 31, 2010, prepaid royalties (or prepaid licensing fees) were $12,046, and $21,088 respectively.
Recent Accounting Pronouncements
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”, which is effective for annual reporting periods beginning after December 15, 2011. ASU 2011-05 will become effective for the Company on January 1, 2012. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, items of other comprehensive income that are reclassified to profit or loss are required to be presented separately on the face of the financial statements. This guidance is intended to increase the prominence of other comprehensive income in financial statements by requiring that such amounts be presented either in a single continuous statement of income and comprehensive income or separately in consecutive statements of income and comprehensive income. The adoption of ASU 2011-05 is not expected to have a material impact on the Company’s financial position or results of operations.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 will become effective for the Company on January 1, 2012. The Company is currently evaluating ASU 2011-04 and has not yet determined the impact that adoption will have on its financial statements.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
In January 2010, the FASB issued an update to Fair Value Measurements and Disclosures. This update provides amendments to ASC Subtopic 820-10 requiring new disclosures regarding (1) transfers in and out of Levels 1 and 2, in which the Company should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (2) the reconciliation for fair value measurements using significant unobservable inputs (Level 3), in which the Company should present separately information about purchases, sales, issuances, and settlements (on a gross basis rather than as one net number). In addition the update provides clarification of existing disclosures regarding the level of disaggregation and disclosures about inputs and valuation techniques. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchase, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company does not expect the adoption of this statement to have a material impact on its financial statements.
In December 2010, the FASB issued FASB ASU No. 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts,” which is now codified under FASB ASC Topic 350, “Intangibles - Goodwill and Other.” This ASU provides amendments to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not a goodwill impairment exists. When determining whether it is more likely than not an impairment exists, an entity should consider whether there are any adverse qualitative factors, such as a significant deterioration in market conditions, indicating an impairment may exist. FASB ASU No. 2010-28 is effective for fiscal years (and interim periods within those years) beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, an entity with reporting units having carrying amounts which are zero or negative is required to assess whether is it more likely than not the reporting units’ goodwill is impaired. If the entity determines impairment exists, the entity must perform Step 2 of the goodwill impairment test for that reporting unit or units. Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. This ASU is not expected to have any material impact to our financial statements.
In December 2010, the FASB issued FASB ASU No. 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations,” which is now codified under FASB ASC Topic 805, “Business Combinations.” A public entity is required to disclose pro forma data for business combinations occurring during the current reporting period. This ASU provides amendments to clarify the acquisition date to be used when reporting the pro forma financial information when comparative financial statements are presented and improves the usefulness of the pro forma revenue and earnings disclosures. If a public company presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) which occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The supplemental pro forma disclosures required are also expanded to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. FASB ASU No. 2010-29 is effective on a prospective basis for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The adoption of this ASU will not have a material effect on our financial position, results of operations or cash flows.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 3 - GOING CONCERN
As shown in the accompanying financial statements for the year ending December 31, 2011 and December 31, 2010, we have incurred net losses of $230,182 and $162,196, respectively. As of December 31, 2011 our deficit is $1,222,184. During fiscal 2011, we continued to experience close to neutral cash flows from operations largely due to our continued investment spending for product development of game titles for the PC and other popular gaming platforms that are expected to benefit future periods. Those facts, along with our lack of access to a significant bank credit facility, create an uncertainty about our ability to continue as a going concern. Accordingly, we are currently evaluating our alternatives to secure financing sufficient to support the operating requirements of our current business plan, as well as continuing to execute our business strategy of distributing our game titles to digital distribution outlets, including mobile gaming app stores, online PC and Mac gaming portals, and opportunities for new devices such as tablet (mobile internet device) applications, mobile gaming platforms and international licensing opportunities.
Our ability to continue as a going concern is dependent upon our success in securing sufficient financing and to successfully execute our plans to return to positive cash flows during fiscal 2012. Our financial statements do not include any adjustments that might be necessary if we were unable to continue as a going concern.
NOTE 4 - CAPITALIZED PRODUCTION COSTS
Capitalized Production Costs, Net consists of the following at:
We recognized amortization expense of $264,720 and $231,167 for the year ended December 31, 2011 and 2010, respectively.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 5 - OTHER ASSETS
On June 22, 2011, the Company entered into a technology transfer agreement with an unaffiliated third party, which included a liability in the amount of $36,000 (Note 9) and 96,000 shares of common stock (Note 11) in exchange for the right, title, and interest in the Marishco Game Engine. The liability is payable in 24 installments of $1,500 per installment. The common stock is payable in eight quarterly installments of 12,000 shares per installment. On September 21, 2011, the Company issued 12,000 shares to the unaffiliated third party and reduced common stock payable accordingly.
The game engine will be amortized on a straight-line basis over the useful life of three years. For the year ended December 31, 2011 and 2010 amortization expense was $11,600 and $0 respectively.
NOTE 6 - FIXED ASSETS
Fixed assets, Net, consists of the following at:
Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets. All assets are currently depreciated over three years. For the year ended December 31, 2011 and 2010 depreciation expense was $1,211 and $162, respectively.
NOTE 7 - ACCRUED COMPENSATION
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 8 - ACCRUED ROYALTIES AND UNEARNED ROYALTIES
Accrued Royalties consists of money owed to other parties with whom we have revenue-sharing agreements or from whom we license certain trademarks or copy writes.
Unearned Royalties consists of royalties received from licensees, which have not yet been earned.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Leases
We have been residing in our current building at 228 W. Main Street, Tustin, California since 2006. Since that time, we have paid our rent on a month-to-month basis. As such, we are free to leave our current premises at any time with 30 days courtesy notice but we do not have a lease agreement with the property owner. This is our preference since it is our desire to be able to quickly expand to alternative office space should our growth require additional square footage than our current offices. The Company or Company employees or contractors own all of the computer and office equipment that is used in the course of business. We do not have any lease agreements for any office equipment.
We have a one year contract in place with an Internet service provider (one year contract that expires in March 2012).
Technology Payable
On June 22, 2011, the Company entered into a technology transfer agreement with an unaffiliated third party which included a liability in the amount of $36,000 and 96,000 shares of common stock (Note 11) in exchange for the right, title, and interest in the Marishco Game Engine. The liability is payable in 24 installments of $1,500 per installment and there is no stated interest rate. Therefore the balance of $36,000 was recorded as a liability, net of a discount of $2,834 with the discount to be amortized over the life of the liability using the effective interest method. As of December 31, 2011, the Company recognized a current liability of $18,000, long-term liability of $7,299 and amortization of debt discount of $1,133.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 10 - DEBT
Line of Credit
In October 2006, the Company obtained a $200,000 secured line of credit with Sunwest Bank in Tustin, California. The line of credit was secured with a $50,000 certificate of deposit and liens against the personal property of Craig Holland, CEO, and Mick Donahoo, CFO. The line of credit was renewed each year until 2010 during which year it was not renewed on the maturity date of December 31, 2010; rather, it was re-negotiated between the Company and Sunwest Bank and modified into a “Commercial Term Loan” and continued to bear interest of 7% per annum on amounts advanced prior to the modification.
On August 3, 2010, the Company entered into a Change of Terms Agreement, which modified the terms of its promissory note with Sunwest Bank dated October 20, 2006, as amended. Under the Change of Terms Agreement:
·
The facility changed from a “Commercial Non-Revolving Line-of-Credit” to a “Commercial Term Loan” with the effect being that no further funds would be advanced;
·
Sunwest Bank released a deposit account which was being used to secure the repayment of the amounts owed under promissory note in exchange for Mr. Craig Holland (a guarantor of the promissory note and owner of the deposit account) agreeing $50,000 of the funds in the deposit account would be used to pay down the amount owed under the promissory note;
·
As a result of the $50,000 payment, beginning July 31, 2010, the monthly principal payment was reduced from $5,000 to $1,900; and
·
The date on which the principal and any accrued interest were due under the promissory note, as amended (the Maturity Date), was extended from December 31, 2010 to September 30, 2011.
For the years ended December 31, 2011 and 2010, the balance was $0 and $18,300, respectively. As of December 31, 2011 and 2010, all interest payments were current therefore no accrued interest is recorded. The note matured on September 30, 2011 and the term loan was closed.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Convertible Note Payable
On July 21, 2011, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $62,500 (the “First Asher Note”). The First Asher Note has a maturity date of April 25, 2012, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 55% multiplied by the Market Price (representing a discount rate of 45%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009. The shares of common stock issuable upon conversion of the First Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The purchase and sale of the First Asher Note closed on August 1, 2011, the date that the purchase price was delivered to us. The issuance of the First Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.
The Company evaluated the First Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.1375 below the market price on July 21, 2011 of $0.25 provided a value of $51,136 of which $29,875 was amortized during 2011.
On September 16, 2011, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $40,000 (the “Second Asher Note”). The Second Asher Note has a maturity date of June 20, 2012, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 55% multiplied by the Market Price (representing a discount rate of 45%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009. The shares of common stock issuable upon conversion of the Second Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The purchase and sale of the Second Asher Note closed on September 22, 2011, the date that the purchase price was delivered to us.
The Company evaluated the Second Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.11917 below the market price on September 16, 2011 of $0.30 provided a value of $40,000 of which $15,252 was amortized during 2011.
On November 17, 2011, for value received, we gave a convertible promissory note to The Lebrecht Group, APLC, in the original principal amount of $13,225 (the “Lebrecht Note”). The Lebrecht Note has a maturity date of November 18, 2012, and principle and accrued interest at the rate of ten percent (10%) are due at that time. The note holder has an option to convert the note into Common Stock to be issued upon each conversion of the Lebrecht Note and shall be determined by dividing the Conversion Amount by the Conversion Price, which shall be equal to the greater of (i) the Fixed Conversion Price, which is $0.001 per share, and (ii) the Variable Conversion Price, which is seventy five percent (75%) of the closing bid price for the Common Stock on the trading day immediately preceding the conversion, (the Fixed Conversion Price and the Variable Conversion Price, as applicable, shall be referred to as the “Conversion Price”).
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
The Company evaluated the Lebrecht Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.10125 below the market price on November 17, 2011 of $0.135 provided a value of $4,408 of which $529 was amortized during 2011.
On December 6, 2011, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $45,000 (the “Third Asher Note”). The Third Asher Note has a maturity date of September 8, 2012, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 55% multiplied by the Market Price (representing a discount rate of 45%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009. The shares of common stock issuable upon conversion of the Third Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The purchase and sale of the Third Asher Note closed on December 8, 2011, the date that the purchase price was delivered to us.
The Company evaluated the Third Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.0605 below the market price on December 6, 2011 of $0.14 provided a value of $45,000 of which $4,061 was amortized during 2011.
Total Accrued interest for the above convertible notes is $3,436 as of December 31, 2011.
Convertible Note Payable - Related Party
On July 2, 2010, a convertible note loan from Holland Family Trust, (whose sole trustee is Franklena Holland, mother of Company president Craig Holland), was secured for $100,000. The Company has received $75,000 of the purchase price, with the remaining $25,000 to be paid at a later date. The promissory note is convertible into the Company’s common stock at a rate of $0.10 per share. The convertible promissory note bears interest at the rate of 10% per annum and matures 12 months from the date each purchase installment was received. Interest on the notes is paid each month at the first of the month as such there is no accrued interest as of December 31, 2011. The Company had a convertible note payable balance of $75,000 for period ended December 31, 2011 and December 31, 2010.
The Company evaluated this related party convertible note for derivative liability treatment noting that if the shares were converted at a fixed price of $0.10 per share, and the principal value of $75,000, this would result in 750,000 additional shares which is less than 1% of the authorized share count; therefore, the number of shares is determinate and in conclusion, the note is not considered a derivative liability. In addition, the Company evaluated this related party convertible note for a beneficial conversion feature noting that the conversion price of $0.10 which was exactly the same as the market price of $0.10 during the 2009-2010 fiscal years when the common shares were being sold to private purchasers consistently at this price; therefore, no beneficial conversion feature was created during issuance of this note.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Note Payable- Related Party
As of July 1, 2010, there is a note payable to Craig Holland and Mick Donahoo for $25,000 each (a total of $50,000 notes payable) for money that was loaned to the company to secure the Sunwest Bank debt. The money was loaned to the company at a rate of 10% interest compounded annually and matures on June 30, 2012.
As of October 19, 2011, there is a note payable to Mick Donahoo for $5,000 for money that was loaned to the company to secure equipment. The money was loaned to the company at a rate of 10% interest compounded annually and matures on October 19, 2013.
The Company had a note payable balance of $55,000 for the period ended December 31, 2011 and 50,000 for December 31, 2010. For the period ended December 31, 2011, and year ended December 31, 2010, the Company recorded accrued interest of $8,167 and $2,580, respectively.
The Company recorded total interest expense, including beneficial conversion feature amortization, for all debt of $68,268 and $10,921 for the year ended December 31, 2011 and 2010, respectively. However, the amortization expense related to the beneficial conversion features of $49,717 is not included in interest expense on the financial statements; rather it is included in amortization expense.
NOTE 11 - STOCKHOLDERS’ EQUITY
Stock Issuance
The Company is authorized to issue up to 100,000,000 shares of its $.001 par value common stock, and up to 10,000,000 shares of its $.001 par value preferred stock.
On January 31, 2010, the Private Placement Offering closed, and the Company entered into and closed a stock purchase agreement with multiple accredited investors for the sale of 3,444,000 shares of its common stock at a purchase price of $0.10 per share totaling $344,400. See discussion of 2010 Private Placement Offering below.
As of June 30, 2010, the Company issued 3,326,121 shares of its common stock to consultants in exchange for legal, financial, and marketing consulting related to the 2010 Private Placement Offering.
On June 22, 2011, the Company entered into a technology transfer agreement with an unaffiliated third party included a liability in the amount of $36,000 (Note 9) and 96,000 shares of common stock. The liability of $36,000 was recorded net of a debt discount of $2,834 which was included in additional paid in capital at June 30, 2011. The common stock is payable in eight quarterly installments of 12,000 shares per installment. The first installment was delivered effective September 16, 2011. As the third party has no future performance obligation, the Company valued the 96,000 shares at $33,600 based on the closing price of $0.35 per share on the measurement date. The amount is recorded in common stock payable as of June 30, 2011. As of December 31, 2011, stock payable was $29,400 due to issuance of 12,000 shares of common stock on September 21, 2011. The Company considered ASC 718-10-25-20 concluding that June 22, 2011 is the appropriate measurement date as the Company has received the goods, there is no significant disincentive to perform, and there is no future performance/service obligation on the part of the third party.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
On September 21, 2011, we issued 100,000 shares of our common stock, restricted in accordance with Rule 144, to Empire Relations Group, Inc. as consideration under a consulting agreement dated September 16, 2011 for public and financial relations services. The fair value was $30,000 based on the closing stock price of $0.30 per share on the measurement date as the shares are non-refundable and no future performance obligation exists. The issuance of the shares was exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(2) thereof. The consultant was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.
On September 21, 2011, we issued 12,000 shares of our common stock, restricted in accordance with Rule 144, to an unaffiliated thirty party as consideration under the Technology Transfer Agreement entered into on June 22, 2011. This is the first of eight identical quarterly installments of shares to be issued. The fair value of $4,200 based on the closing price of $0.35 per share on the measurement date was deducted from common stock payable. The issuance of the shares was exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(2) thereof. The shareholder was a sophisticated investor, familiar with our operations, and there was no solicitation.
On November 29, 2011, we issued 125,000 shares of our common stock, restricted in accordance with Rule 144, to Michael Southworth as additional consideration under a consulting agreement dated November 29, 2011 for public and financial relations services. The fair value was $17,500 based on the closing stock price of $0.14 per share on the measurement date of November 29, 2011. The issuance of the shares was exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(2) thereof. The consultant was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.
Capitalized Private Placement Costs
In October of 2009, the Company created a Private Placement Memorandum to raise funds primarily for our upcoming public stock listing, working capital and general corporate purposes. Through the Memorandum, we offered to qualified accredited investors a maximum of 12,500,000 shares of our common stock. The subscription price per Share was $0.10 and the minimum purchase was Fifteen Thousand (15,000) Shares ($1,500). We reserved the right to accept subscriptions for fewer Shares at our sole discretion.
We agreed to pay Monarch Bay Associates, LLC, a licensed FINRA broker dealer (the “placement agent”), a commission of 5% of the gross proceeds of the Offering. In addition, we agreed to indemnify the Placement Agent against certain liabilities under the Securities Act of 1933, as amended.
Each Investor must qualify as an “Accredited Investor” under Regulation D of the Securities Act of 1933, as amended.
The Shares offered and sold pursuant hereto were not registered under the 1933 Act or under the securities laws of any state and were offered and sold in reliance upon exemptions from such registration requirements for non-public offerings pursuant to Regulation D under the Securities Act and applicable state securities laws, and therefore, are considered “restricted securities” as such is defined in Rule 144 promulgated under the 1933 Act.
The private placement offering closed on January 31, 2010, and $344,400 in funds were received and we issued 3,444,000 shares to those investors ($0.10/share). At this time, the Company issued 1,108,707 shares of its common stock to each of the following for legal and consulting services: The Lebrecht Group, Michael Southworth and Cardiff Partners. A total of $19,656 was paid to Monarch Bay Associates for the placement agent commission.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
For the year ended December 31, 2011 and the year ended December 31, 2010 we capitalized $6,364 and $145,914, respectively, of costs associated with the offering as a charge to Additional Paid in Capital.
Discussion of 2006 Stock Option plan
The 2006 Stock Option Plan was adopted by our Board of Directors in March of 2006. A total of 550,000 shares of Common Stock have been reserved for issuance to employees, consultants and directors upon exercise of incentive and non-statutory options and stock purchase rights which may be granted under the Company’s 2006 Stock Plan (the “2006 Plan”). On October 15, 2009, 235,000 of those options were exercised, leaving 315,000 shares available for issuance to employees. Because of the 5.31-for-one forward stock split of the Company’s common stock on October 15, 2009, there are now 1,512,650 shares available for issuance as a part of this stock plan. As of the period ended December 31, 2011, there were 560,000 options outstanding to purchase shares of Common Stock, and no shares of Common Stock had been issued pursuant to stock purchase rights under the 2006 Plan.
Under the 2006 Plan, options may be granted to employees, directors, and consultants. Only employees may receive “incentive stock options,” which are intended to qualify for certain tax treatment, and consultants and directors may receive “non-statutory stock options,” which do not qualify for such treatment. A holder of more than 10% of the outstanding voting shares may only be granted options with an exercise price of at least 110% of the fair market value of the underlying stock on the date of the grant, and if such holder has incentive stock options, the term of the options must not exceed five years.
Options and stock purchase rights granted under the 2006 Plan generally vest ratably over a four year period (typically 1⁄4 or 25% of the shares vest after the 1st year and 1/48 of the remaining shares vest each month thereafter); however, alternative vesting schedules may be approved by the Board of Directors in its sole discretion. Any unvested portion of an option or stock purchase right will accelerate and become fully vested if a holder’s service with the Company is terminated by the Company without cause within twelve months following a Change in Control (as defined in the 2006 Plan).
All options must be exercised within ten years after the date of grant. Upon a holder’s termination of service for any reason prior to a Change in Control, the Company may repurchase any shares issued to such holder upon the exercise of options or stock purchase rights. The Board of Directors may amend the 2006 Plan at any time. The 2006 Plan will terminate in 2016, unless terminated sooner by the Board of Directors.
The Company granted 560,000 stock options during the year ended December 31, 2010. As of December 31, 2011, the stock options became fully vested and expensed accordingly. The Company did not grant any stock options for the period ended December 31, 2011. The weighted average assumptions used in the model are outlined in the following table:
Stock-based compensation expense recognized in our statement of operations for the year ended December 31, 2011 and 2010 was $16,003 and $39,985, respectively.
The Company did not grant any warrants during year ended December 31, 2010 or the year ended December 31, 2011.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
Exercising of Stock Warrants and Options
For the year ended December 31, 2011, and the year ended December 31, 2010, no shares of common stock were issued on the cashless exercise of warrants or options.
A summary of the status of the warrants and options issued by the Company as of December 31, 2011 and 2010 are as follows:
NOTE 12 - INCOME TAXES
The Company accounts for income taxes in accordance with standards of disclosure propounded by the FASB, and any related interpretations of those standards sanctioned by the FASB. Accordingly, deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities, as well as a consideration of net operating loss and credit carry forwards, using enacted tax rates in effect for the period in which the differences are expected to impact taxable income. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized. Due to the uncertainty as to the utilization of net operating loss carry forwards, a valuation allowance has been made to the extent of any tax benefit that net operating losses may generate.
Income tax expense consists of California minimum franchise taxes of $1,600, Delaware state taxes of $489, and back taxes owed of $837. For Federal and California income tax purposes, the Company has net operating loss carry forwards that expire through 2027. The net operating loss as of December 31, 2011 was approximately $149,529. The net operating loss as of December 31, 2010 was approximately $311,000. No tax benefit has been reported in the financial statements because after evaluating our own potential tax uncertainties, the Company has determined that there are no material uncertain tax positions that have a greater than 50% likelihood of reversal if the Company were to be audited.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 13 - EARNINGS (LOSS) PER COMMON SHARE
Basic loss per share is calculated based on the weighted-average number of outstanding common shares. Diluted loss per share is calculated based on the weighted-average number of outstanding common shares plus the effect of dilutive potential common shares.
Net loss per share for the year ending:
NOTE 14 - RELATED PARTY TRANSACTIONS
On August 2, 2010, we granted Craig Holland, our President, Chief Executive Officer, and a Director, options to purchase up to 115,000 shares of our common stock at an exercise price of $0.11 per share. The options were granted under the Freeze Tag, Inc. 2006 Stock Plan. As of December 31, 2011, the stock options are fully expensed and included in stock based compensation of $16,003.
As of July 1, 2010, there are notes payable to Craig Holland and Mick Donahoo for $25,000 each (a total of $50,000 notes payable) for money that was loaned to the company to secure the Sunwest Bank loan. The money was loaned to us at a rate of 10% interest compounded annually. In addition, as of October 19, 2011, there is a note payable to Mick Donahoo for $5,000 for money that was loaned to the company to secure equipment. The money was loaned to the company at a rate of 10% interest compounded annually and matures on October 19, 2013. The Company had a note payable balance of $55,000 for the period ended December 31, 2011 and a balance of $50,000 for the period ended December 31, 2010. For the period ended December 31, 2011, and year ended December 31, 2010, the Company recorded accrued interest of $6,646 and $2,580, respectively.
On July 1, 2010, we entered into one (1) $100,000 principal amount convertible promissory note, which is convertible any time at $0.10 per share. The holder of this note is the Holland Family Trust, which is not controlled by any of our officers and directors, but is controlled by Franklena E. Holland, the mother of one of our officers and directors. Under the note we have received $75,000 of the purchase price, with the remaining $25,000 to be paid at a later date. The note matured on July 1, 2011, and was renewed for another 1 year term. Interest on the notes is paid each month at the first of the month as such there is no accrued interest as of December 31, 2011. The Company had a convertible note payable balance of $75,000 for period ended December 31, 2011 and December 31, 2010.
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company adopted FASB ASC 820 on October 1, 2008. Under this FASB, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under GAAP, certain assets and liabilities must be measured at fair value, and FASB ASC 820-10-50 details the disclosures that are required for items measured at fair value.
The Company has various financial instruments that must be measured under the new fair value standard including: cash and debt. The Company currently does not have non-financial assets or non-financial liabilities that are required to be measured at fair value on a recurring basis. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels are as follows:
Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. The fair value of the Company’s cash is based on quoted prices and therefore classified as Level 1.
Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 - Unobservable inputs that reflect our assumptions about the assumptions that market participants would use in pricing the asset or liability.
Cash, accounts receivable, capitalized production costs, prepaid royalties, prepaid expenses, accounts payable, accrued compensation, accrued royalties, accrued interest, accrued expenses, unearned royalties, notes payable - related party and technology payables reported on the balance sheet are estimated by management to approximate fair market value due to their short term nature.
The following tables provide a summary of the fair values of assets and liabilities measured on a non-recurring basis:
FREEZE TAG, INC.
(A DELAWARE CORPORATION)
NOTES TO THE FINANCIAL STATEMENTS
The Company believes that the market rate of interest as of December 31, 2011 and 2010 was not materially different to the rate of interest at which the convertible notes payable were issued. Accordingly, the Company believes that the fair value of the convertible notes payable approximated their carrying value at December 31, 2011 and 2010.
NOTE 16 - SUBSEQUENT EVENTS
On January 26, 2012, a convertible note loan from Holland Family Trust, (whose sole trustee is Franklena Holland, mother of Company president Craig Holland), was secured for $100,000 in cash. The promissory note is convertible into the Company’s common stock at a rate of $0.05 per share. The convertible promissory note bears interest at the rate of 10% per annum and matures 12 months from the date the purchase installment was received. Interest on the notes is paid each month at the first of the month as such there is no accrued interest as of December 31, 2011.
On March 2, 2012, we issued 3,000,000 shares of our common stock, restricted in accordance with Rule 144, to Crucible Capital Group, Inc. for services pursuant to a letter agreement dated February 29, 2012. The issuance was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, and the investor was accredited and sophisticated, familiar with our operations, and there was no solicitation.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There are no items required to be reported under this Item.
ITEM 9A
ITEM 9A - CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
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 our disclosure controls and procedures (as defined) in Exchange Act Rules 13a - 15(c) and 15d - 15(e)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer, who are our principal executive officer and principal financial officers, respectively, concluded that, as of the end of the period ended December 31, 2011, our disclosure controls and procedures were not effective (1) to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to us, including our chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.
Our Chief Executive Officer and Chief Financial Officer do not expect that our disclosure controls or internal controls will prevent all error and all fraud. No matter how well conceived and operated, our disclosure controls and procedures can provide only a reasonable level of assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented if there exists in an individual a desire to do so. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Furthermore, smaller reporting companies face additional limitations. Smaller reporting companies employ fewer individuals and find it difficult to properly segregate duties. Often, one or two individuals control every aspect of the company's operation and are in a position to override any system of internal control. Additionally, smaller reporting companies tend to utilize general accounting software packages that lack a rigorous set of software controls.
(b) Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act, as amended, as a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States and includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and any disposition of our assets;
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, Management has identified the following four material weaknesses that have caused management to conclude that, as of December 31, 2011, our disclosure controls and procedures, and our internal control over financial reporting, were not effective at the reasonable assurance level:
1. We do not have sufficient segregation of duties within accounting functions, which is a basic internal control. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.
2. We have not documented our internal controls. We have limited policies and procedures that cover the recording and reporting of financial transactions and accounting provisions. As a result we may be delayed in our ability to calculate certain accounting provisions. While we believe these provisions are accounted for correctly in the attached audited financial statements our lack of internal controls could lead to a delay in our reporting obligations. We were required to provide written documentation of key internal controls over financial reporting beginning with our fiscal year ending December 31, 2009. Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.
3. Effective controls over the control environment were not maintained. Specifically, a formally adopted written code of business conduct and ethics that governs our employees, officers, and directors was not in place. Additionally, management has not developed and effectively communicated to our employees its accounting policies and procedures. This has resulted in inconsistent practices. Further, our Board of Directors does not currently have any independent members and no director qualifies as an audit committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K. Since these entity level programs have a pervasive effect across the organization, management has determined that these circumstances constitute a material weakness.
4. Effective controls over transactions were not maintained. Specifically, controls were not designed and in place to ensure that contingencies were properly reflected. Accordingly, management has determined that this control deficiency constitutes a material weakness.
To address these material weaknesses, management performed additional analyses and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented. Accordingly, we believe that the consolidated financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.
(c) Remediation of Material Weaknesses
To remediate the material weakness in our documentation, evaluation and testing of internal controls we hope to engage a third-party firm to assist us in remedying this material weakness.
(d) Changes in Internal Control over Financial Reporting
There are no changes to report during our fiscal quarter ended December 31, 2011.
ITEM 9B
ITEM 9B - OTHER INFORMATION
There are no events required to be disclosed by the Item.
PART III
ITEM 10
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers
The following table sets forth the names, ages, and biographical information of each of our current directors and executive officers, and the positions with the Company held by each person, and the date such person became a director or executive officer of the Company. Our executive officers are elected annually by the Board of Directors. The directors serve one-year terms until their successors are elected. The executive officers serve terms of one year or until their death, resignation or removal by the Board of Directors. Family relationships among any of the directors and officers are described below.
Craig Holland co-founded Freeze Tag in October 2005. Prior to founding Freeze Tag, Craig founded Thumbworks, a publisher of mobile gaming applications, in January 2002 and served as the CEO of Thumbworks from its formation until its acquisition by In-Fusio, a mobile game publisher and mobile entertainment platform provider in January 2005. As CEO of Thumbworks, Mr. Holland drove the organization's strategic direction, overseeing carrier relations, business development and licensing initiatives which led to partnerships with some of the world's leading brands such as Etch A Sketch®, Nickelodeon, Suzuki, Paramount Pictures, and Honda. Prior to founding Thumbworks, Mr. Holland founded Nine Dots, an interactive marketing firm in North America whose clients included a number of high profile consumer brands such as Nestle, Quaker Oats, Qualcomm and General Motors, in 1992. Mr. Holland served as the CEO of Nine Dots from its formation until its sale to CyberSight, a Canadian-based interactive marketing company, in September 2000. Mr. Holland holds an MBA with an emphasis in Marketing from the University of Southern California (USC) and a Bachelor of Arts in English Literature from the University of California at Los Angeles (UCLA).
Mick Donahoo co-founded Freeze Tag in October 2005 and in his role as COO, Mr. Donahoo oversees product planning, design, and software development of all games and technology. With over 15 years of technology experience, Mr. Donahoo has produced over 25 mobile games distributed via 20 worldwide wireless carriers. Prior to founding Freeze Tag, Mr. Donahoo led North American development for Thumbworks and following its acquisition, In-Fusio, and oversaw overseas engineering teams located in Taiwan, Thailand, India, Russia, and Korea. Prior to In-Fusio, Mick was a consulting executive at Ernst & Young, LLP in the Financial Services and Aerospace and Defense industries architecting and developing large-scale, three-tiered client/server applications. Mick holds a Bachelor of Science degree in Business and Management Information Systems from Brigham Young University.
Family Relationships
There are no family relationships among any of our officers, directors, or shareholders.
Historical Compensation of Directors
Other than as set forth herein no compensation has been given to any of the directors, although they may be reimbursed for any pre-approved out-of-pocket expenses.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s directors and executive officers and persons who own more than ten percent of a registered class of the Company’s equity securities to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
During the most recent fiscal year, to the Company’s knowledge, the following delinquencies occurred:
Name
No. of Late Reports
No. of Transactions Reported Late
No. of
Failures to File
Craig Holland
Mick Donahoo
Board Meetings and Committees
During the 2011 fiscal year to date, the Board of Directors met on a regular basis and took written action on numerous other occasions. All the members of the Board attended the meetings. The written actions were by unanimous consent.
Code of Ethics
We have not adopted a written code of ethics, because we believe and understand that our officers and directors adhere to and follow ethical standards without the necessity of a written policy.
Audit Committee
We do not currently have an audit committee.
Compensation Committee
We do not currently have a compensation committee.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Executive Officers and Directors
We do not currently have written employment agreements with our executives, Craig Holland and Mick Donahoo. Both are at-will employees whose compensation is set forth in the Summary Compensation Table below.
Summary Compensation Table
The following table sets forth information with respect to compensation earned by our Chief Executive Officer and Chief Financial Officer for the fiscal years ended December 31, 2011, 2010 and 2009.
(1) On August 2, 2010, Mr. Holland was issued options to purchase 115,000 shares of our common stock with an exercise price of $0.11 per share, valued at $11,494 of which the Company has recognized a total stock based compensation expense of $9,579 as of December 31, 2010. The remaining stock based compensation expense of $1,916 was recognized during the first quarter of the year ended December 31, 2011.
Director Compensation
The following table sets forth director compensation as of for the fiscal year ended December 31, 2011:
Name
Fees Earned or Paid in Cash
($)
Stock Awards
($)
Option Awards
($)
Non-Equity Incentive Plan Compensation
($)
Nonqualified Deferred Compensation Earnings
($)
All Other
Compensation
($)
Total
($)
Craig Holland
Mick Donahoo
Outstanding Equity Awards at Fiscal Year-End
On March 20, 2006, our Board of Directors and shareholders approved the Freeze Tag, Inc. 2006 Stock Plan. Pursuant to the Plan, we reserved 2,920,500 shares (post-split) of our common stock to be issued to employees and consultants for services rendered to the company. As of December 31, 2008, we had issued options to acquire a total of 1,247,850 shares (post-split) of our common stock to seven of our employees and/or consultants. Effective as of October 15, 2009, all seven of the option holders converted their options into a total of 1,123,065 shares of our common stock.
The following table sets forth certain information concerning outstanding stock awards held by the Named Executive Officers as of December 31, 2011:
Option Awards
Stock Awards
Name
Number of Securities Underlying Unexercised Options
(#)
Exercisable
Number of Securities Underlying Unexercised Options
(#)
Unexercisable
Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options
(#)
Option Exercise Price
($)
Option Expiration Date
Number of Shares or Units of Stock That Have Not Vested
(#)
Market Value of Shares or Units of Stock That Have Not Vested
($)
Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested
(#)
Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested
($)
Craig Holland
- 0 -
115,000
- 0 -
0.11
8/02/20
- 0 -
- 0 -
- 0 -
- 0 -
Mick Donahoo
- 0 -
- 0 -
- 0 -
- 0 -
- 0 -
- 0 -
- 0 -
- 0 -
- 0 -
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 23, 2012, certain information with respect to the Company’s equity securities owned of record or beneficially by (i) each Officer and Director of the Company; (ii) each person who owns beneficially more than 5% of each class of the Company’s outstanding equity securities; and (iii) all Directors and Executive Officers as a group.
Common Stock
(1)
Unless otherwise indicated, based on 44,082,949 shares of common stock issued and outstanding. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants, but are not deemed outstanding for the purposes of computing the percentage of any other person.
(2)
Indicates one of our officers or directors.
(3)
Unless indicated otherwise, the address of the shareholder is Freeze Tag, Inc., 228 W. Main Street, 2nd Floor, Tustin, California 92780.
(4)
Includes options to purchase 115,000 shares of common stock that are exercisable on February 2, 2011.
We are not aware of any person who owns of record, or is known to own beneficially, five percent or more of the outstanding securities of any class of the issuer, other than as set forth above. We are not aware of any person who controls the issuer as specified in Section 2(a)(1) of the 1940 Act. There are no classes of stock other than common stock issued or outstanding. We do not have an investment advisor.
There are no current arrangements which will result in a change in control.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
As of October 19, 2011, there is a note payable to Mick Donahoo for $5,000 for money that was loaned to us to secure equipment. The money was loaned to us at a rate of 10% interest compounded annually and matures on October 19, 2013.
On August 2, 2010, we granted Craig Holland, our President, Chief Executive Officer, and a Director, options to purchase up to 115,000 shares of our common stock at an exercise price of $0.11 per share. The options were granted under the Freeze Tag, Inc. 2006 Stock Plan.
As of July 1, 2010, there are notes payable to Craig Holland and Mick Donahoo for $25,000 each (a total of $50,000 notes payable) for money that was loaned to the company to secure the Sunwest Bank loan. The money was loaned to us at a rate of 10% interest compounded annually. As of December 31, 2011, Mr. Holland and Mr. Donahoo were each owed interest of $1,290 (for a total interest owed of $2,580) under these notes. This brings the combined amount owed to Mr. Donahoo and Mr. Holland on these notes to a total amount of $52,580, as of December 31, 2011. No principal or interest has been paid back to Mr. Donahoo or Mr. Holland as of December 31, 2011.
On July 1, 2010, we entered into one (1) $100,000 principal amount convertible promissory note, which is convertible any time at $0.10 per share. The holder of this note is the Holland Family Trust, which is not controlled by any of our officers and directors, but is controlled by Franklina E. Holland, the mother of one of our officers and directors. Under the note we have received $75,000 of the purchase price, with the remaining $25,000 to be paid at a later date. The note matures on July 1, 2011, at least to the first $50,000 installment, with interest at 10% payable starting August 1, 2010.
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit and Related Fees
During the year ended December 31, 2011, M&K CPAS, PLLC charged us $24,650, in fees for professional services for the audit of our financial statements included in our annual report and for reviews of our quarterly reports. During the year ended December 31, 2010, M&K CPAS, PLLC charged us $48,750, in fees for professional services for the audit of our financial statements included in our Form S-1.
Tax Fees
During the year ended December 31, 2011, M&K CPAS, PLLC charged $0 for professional services for tax preparation. This was the same as for the year ended December 31, 2010.
All Other Fees
During the year ended December 31, 2011, M&K CPAS, PLLC charged $0 for any other fees. This was the same for the year ended December 31, 2010.
Of the fees described above for the year ended December 31, 2011, 100% were approved by the entire Board of Directors.
PART IV
ITEM 15
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following financial statements are filed as part of this report:
(a)(2) Financial Statement Schedules
We do not have any financial statement schedules required to be supplied under this Item.
(a)(3) Exhibits
Refer to (b) below.
(b) Exhibits
*
Filed herewith.
**
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Act of 1934 and otherwise are not subject to liability.
(1) Incorporated by reference from our Registration Statement on Form S-1, filed with the Commission on August 16, 2010.
(2) Incorporated by reference from Amendment No. 2 to our Registration Statement on Form S-1/A2, filed with the Commission on October 25, 2010.
(3) Incorporated by reference from Current Report on Form 8-K filed with the Commission on August 3, 2011.
(4) Incorporated by reference from Quarterly Report on Form 10-Q for the period ended June 30, 2011 filed with the Commission on August 15, 2011.
(5) Incorporated by reference from Current Report on Form 8-K filed with the Commission on September 21, 2011.
(6) Incorporated by reference from Current Report on Form 8-K filed with the Commission on December 23, 2011.
(7) Incorporated by reference from Current Report on Form 8-K filed with the Commission on March 8, 2012.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Dated: March 30, 2012
/s/ Craig Holland
By:
Craig Holland
Its:
Director, President and Chief Executive Officer
Dated: March 30, 2012
/s/ Mick Donahoo
By:
Mick Donahoo
Its:
Director, Chief Financial Officer, Chief Accounting
Officer, Chief Operating Officer