10-Q 1 form10q.htm BRAINY BRANDS COMPANY, INC. FORM 10-Q form10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

or

o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________________ to __________________________
 
Commission file number: 000-54344

THE BRAINY BRANDS COMPANY, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
 
30-0457914
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

460 Brogdon Road, Suite 400
Suwanee, GA
 
 
30024
(Address of principal executive offices)
 
(Zip Code)

(678) 762-1100
(Registrant's telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
                                                                                                                                                                              Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
 
Accelerated filer o
Non-accelerated filer o
(Do not check if smaller reporting company)
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes o No x
 
Indicated the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date, 32,699,992 shares of common stock are issued and outstanding as of May 9, 2011.
 
 
 
1

 
  
TABLE OF CONTENTS
       
Page No.
PART I. - FINANCIAL INFORMATION
Item 1.
 
Financial Statements (Unaudited).
 
3
   
Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010
  5
   
Consolidated Statements of Income and Comprehensive Income for the Three  Months Ended March 31, 2011 and 2010
  6
   
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010
  7
   
Notes to Unaudited Consolidated Financial Statements
  8
Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
19
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk.
 
24
Item 4T
 
Controls and Procedures.
 
24
PART II - OTHER INFORMATION
Item 1.
 
Legal Proceedings.
 
25
Item 1A.
 
Risk Factors.
 
25
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds.
 
25
Item 3.
 
Defaults Upon Senior Securities.
 
25
Item 4.
 
(Removed and Reserved)
 
25
Item 5.
 
Other Information.
 
25
Item 6.
 
Exhibits.
 
25
 
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION


Statements in this quarterly report may be “forward-looking statements.” Forward-looking statements include, but are not limited to, statements that express our intentions, beliefs, expectations, strategies, predictions or any other statements relating to our future activities or other future events or conditions. These statements are based on current expectations, estimates and projections about our business based, in part, on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may, and are likely to, differ materially from what is expressed or forecasted in the forward-looking statements due to numerous factors, including those those risks discussed from time to time in this report and in other documents which we file with the Securities and Exchange Commission, including the risks described under “Risk Factors,” in our annual report for the year ended December 31, 2010, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report and in other documents which we file with the Securities and Exchange Commission. In addition, such statements could be affected by risks and uncertainties related to our ability to raise any financing which we may require for our operations, competition, government regulations and requirements, pricing and development difficulties, our ability to make acquisitions and successfully integrate those acquisitions with our business, as well as general industry and market conditions and growth rates, and general economic conditions. Any forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of the filing of this quarterly report, except as may be required under applicable securities laws.

 
2

 




PART 1. - FINANCIAL INFORMATION

Item 1. Financial Statements.



 
THE BRAINY BRANDS COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2011 AND 2010



 
3

 


 
 
Page(s)
   
   
Consolidated Balance Sheets as of March 31, 2011and December 31, 2010
5
 
 
Consolidated Statements of Operations For the Three Months  Ended March 31, 2011 and 2010
6
 
        
Consolidated Statements of Cash Flows For the Three Months  Ended March 31, 2011 and 2010 7
   
 
8-18
Notes to Consolidated Financial Statements
 


 
4

 

THE BRAINY BRANDS COMPANY, INC. AND SUBSIDIARY
 
Consolidated Balance Sheets
 
             
             
   
March 31, 2011
   
December 31, 2010
 
   
(unaudited)
       
Assets
           
             
Assets:
           
Cash
  $ 170,394     $ 921,711  
Restricted cash
    566,468       900,000  
Accounts receivable, net of allowance for doubtful accounts of $67 and $1,547, respectively
    31,621       83,706  
Inventory, net
    31,353       52,184  
Prepaid expenses and other
    29,851       86,900  
Total Current Assets
    829,687       2,044,501  
                 
Debt issuance costs, net
    76,075       87,486  
Property and equipment, net
    108,216       90,503  
Intangible assets, net
    600,089       613,029  
                 
Total Assets
  $ 1,614,067     $ 2,835,519  
                 
Liabilities and Shareholders' (Deficit)
               
                 
Liabilities:
               
Accounts payable
  $ 199,610     $ 196,995  
Accrued expenses
    253,451       74,779  
Deferred revenue
    132,396       156,378  
Other current liabilities
    44,599       49,609  
Total  Current Liabilities
    630,056       477,761  
                 
Convertible notes payable
    2,047,465       1,934,178  
Derivative liabilities
    898,316       905,701  
Total Long-Term Liabilities
    2,945,781       2,839,879  
                 
Total Liabilities
    3,575,837       3,317,640  
                 
                 
Shareholders' Deficit
               
Common stock, $0.001 par value, 100,000,000 shares authorized, 32,699,986
         
     shares issued and outstanding
    32,700       32,700  
Additional paid-in capital
    552,587       552,587  
Accumulated deficit
    (2,547,057 )     (1,067,408 )
Total Shareholders' Deficit
    (1,961,770 )     (482,121 )
                 
Total Liabilities and Shareholders' Deficit
  $ 1,614,067     $ 2,835,519  
                 




 
5

 

THE BRAINY BRANDS COMPANY, INC. AND SUBSIDIARY
 
Consolidated Statements of Operations
 
(unaudited)
 
             
   
For the Three Months Ended
 
   
March 31, 2011
   
March 31, 2010
 
             
Revenues
           
     Product sales, net of discounts
  $ 63,474     $ 75,693  
     Licensing income
    33,570       41,758  
Total Revenues
    97,044       117,451  
                 
Cost of Sales
    32,135       37,360  
                 
Gross Profit
    64,909       80,091  
                 
Operating Expenses
               
     Selling, general and administrative expenses
    1,395,346       227,614  
     Depreciation and amortization
    31,717       20,194  
Total Operating Expenses
    1,427,063       247,808  
                 
Loss from Operations
    (1,362,154 )     (167,717 )
                 
Other Income (Expense)
               
   Legal settlement
    60,000       -  
   Change in fair market value of derivative liability
    7,385       -  
   Interest income
    307       1,102  
   Interest expense
    (185,187 )     (10,876 )
                 
     Total Other Income (Expense)
    (117,495 )     (9,774 )
                 
Net Loss
  $ (1,479,649 )   $ (177,491 )
                 
Net Loss per Common Share - Basic and Diluted
  $ (0.05 )   $ (0.02 )
                 
Weighted Average Number of Common Shares Outstanding     32,699,986       11,224,995  
   



 
6

 

THE BRAINY BRANDS COMPANY, INC. AND SUBSIDIARY
 
Consolidated Statements of Cash Flows
 
(unaudited)
 
             
   
For the Three Months Ended
 
   
March 31, 2011
   
March 31, 2010
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (1,479,649 )   $ (177,491 )
Adjustments to reconcile net loss to net cash used in operating activities:
         
    Depreciation and amortization
    20,307       20,194  
    Amortization of debt issuance costs
    11,411       -  
    Amortization of debt discount
    113,287       -  
    Change in fair market value derivative liability
    (7,385 )     -  
    Change in allowance for bad debt
    (1,472 )     -  
Changes in operating assets and liabilities:
               
  (Increase) Decrease in:
               
    Accounts receivable
    52,085       16,288  
    Inventory
    20,831       (4,439 )
    Prepaid expenses and other
    57,049       8,971  
  Increase (Decrease) in:
               
    Accounts payable and accrued expenses
    181,287       (338,882 )
    Deferred revenue
    (23,982 )     54,923  
    Credit cards payable
    -       (6,667 )
     Other current liabilties
    (5,010 )     (38,265 )
         Net Cash Used in Operating Activities
    (1,061,241 )     (465,368 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
     Purchase of property and equipment
    (23,608 )     -  
         Net Cash Used in Investing Activities
    (23,608 )     -  
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
     Net proceeds (payments) on lines of credit
    -       330,967  
     Net proceeds (payments) from notes payable
    -       10,336  
    Proceeds from the release of cash restriction
    333,532       -  
     Payments received on amounts due from officer
    -       124,454  
        Net Cash Provided By Financing Activities
    333,532       465,757  
                 
Net Increase (Decrease) in Cash
    (751,317 )     389  
                 
Cash - Beginning of Period
    921,711       276  
                 
Cash - End of Period
  $ 170,394     $ 665  
                 
SUPPLEMENTARY CASH FLOW INFORMATION:
               
Cash Paid During the Period for:
               
    Income Taxes
  $ -     $ -  
    Interest
  $ -     $ -  
                 
SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
None
               



 
7

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

Note 1 Nature of Operations and Basis of Presentation

The Brainy Brands Company, Inc. ( “Holdings” or "Company"), (formerly known as Enter Corp.) is a Delaware corporation incorporated in 2007.  On November 24, 2010, Holdings acquired Brainy Acquisitions, Inc. ( “Acquisitions”), a Delaware corporation incorporated in 2010.  Acquisitions was formed on August 27, 2010 under the laws of the state of Georgia and is headquartered in Suwanee, Georgia.  On September 23, 2010, Acquisitions entered into an Agreement for the Purchase and Sale of Assets of the The Brainy Baby Company, LLC (“LLC”) with Asset Recovery Associates, LLC (“ARA”) as assignee for the benefit of creditors of LLC.  
 
LLC, a limited liability company, was formed on July 30, 2001, (Inception), under the laws of the state of Georgia and was headquartered in Suwanee, Georgia. LLC was engaged in the business of selling educational DVDs, books, games, and toys for babies, toddlers and pre-schoolers both domestically and internationally through retailers under licensing agreements, as well as directly to customers primarily via internet sales.
 
Since Acquisitions had no previous operations and the members of LLC ultimately received the controlling interest in the Company, LLC is considered the accounting acquirer through the corporate recapitalization.

Reverse Acquisition and Recapitalization:

Public Shell Merger – Reverse Merger and Recapitalization

On November 24, 2010, the shareholders of Acquisitions entered into a share exchange with Holdings, such that Acquisitions became a wholly owned subsidiary of Holdings, in a transaction treated as a reverse acquisition. Holdings did not have any operations and majority-voting control was transferred to the prior shareholders of Acquisitions.  The transaction also required a recapitalization of Acquisitions. Since the shareholders of Acquisitions acquired a controlling voting interest, it was deemed the accounting acquirer, while Holdings was deemed the legal acquirer. The historical financial statements of the Company are those of Acquisitions, and of the consolidated entities from the date of merger and subsequent.

Since the transaction is considered a reverse acquisition and recapitalization, the presentation of pro-forma financial was  not required since it was in fact an equity transaction.

In connection with the share exchange, Holdings purchased from the former majority shareholders 40,500,000 shares of common stock for $100,000, the shares were cancelled, and Holdings, concurrently issued 18,749,985 shares of common stock to the shareholders of Acquisitions in exchange for 100% of Acquisitions issued and outstanding stock.  Upon the closing of the reverse acquisition, Acquisitions stockholders held 57% of the issued and outstanding shares of common stock.

 Private Company  – Reverse Merger and Recapitalization

On September 23, 2010, Acquisitions entered into an Agreement for the Purchase and Sale of Assets of  LLC with ARA, as assignee for the benefit of creditors of LLC.

Acquisitions purchased the assets previously assigned by LLC to ARA.  The purchase price was $82,500, which was paid in cash at closing.  Acquisitions did not assume any debt, accounts payable, contracts, agreements, commitments, or other obligations or liabilities of LLC except for certain equipment lease obligations and license agreement .
 
This transaction with ARA is known under Georgia law as an Assignment for the Benefit of Creditors.   In conjunction with this transaction, LLC executed a Deed of Assignment (the “Agreement”) with ARA, whereby all of the assets of LLC, including, but not limited to, all personal property, fixtures, goods, stock, inventory, equipment, furniture, furnishings, accounts receivable, bank deposits, cash, promissory notes, trade names, goodwill, contracts, claims and demands belonging to LLC, books, records, books of account, judgments, liens, and mortgages held or owned by  LLC, were assigned to ARA.
 
 
8

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

This transaction was accounted for as a reverse merger and recapitalization of LLC, deemed the accounting acquirer.  Management determined that this was not an acquisition by Acquisitions despite the cash consideration provided.  Acquisitions (deemed the legal acquirer) did not have any operations prior to this transaction and the majority-voting control was ultimately transferred to the members of LLC.  The transaction also required a recapitalization of the LLC. All equity accounts have been retrospectively recasted to depict share issuances.  The historical financial statements of Acquisitions are those of LLC until September 23, 2010, the date of the transaction, and of the consolidated entities subsequent to that date.  During the year ended December 31, 2010, the Company recorded a gain on extinguishment of debt in the amount of $2,435,463 for all liabilities, including notes payable, accounts payable and accruals, that were not transferred from LLC as part of the ARA transaction.

Basis of Presentation

The accompanying unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the United States Securities and Exchange Commission for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of financial position, results of operations, or cash flows. It is management's opinion, however, that all material adjustments (consisting of normal recurring adjustments) have been made which are necessary for a fair financial statement presentation.

The unaudited interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K, which contains the audited financial statements and notes thereto, together with the Management’s Discussion and Analysis, for the years ended December 31, 2010 and 2009.  The interim results for the period ended March 31, 2011 are not necessarily indicative of results for the full fiscal year.
 
Note 2 Summary of Significant Accounting Policies
 
 
Use of estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions impact, among others, the following: allowance for doubtful accounts, inventory obsolescence reserve, the fair value of share-based payments, fair value of derivative liabilities and the valuation allowance for deferred tax assets due to continuing operating losses.

Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the consolidated financial statements, which management considered in formulating its estimate could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from our estimates.

Risks and uncertainties

The Company operates in an industry that is subject to intense competition and change in consumer demand. The Company's operations are subject to significant risk and uncertainties including financial and operational risks including the potential risk of business failure.

Cash

The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.  There were no cash equivalents at March 31, 2011 and December 31, 2010, respectively.
 
The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution. The United States Congress has temporarily increased the Federal Deposit Insurance Corporation (FDIC) deposit insurance from $100,000 to $250,000 per depositor. Cash balance at times may exceed federally insured limits.
 
 
9

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

Accounts receivable and allowance for doubtful accounts
 
Accounts receivable are stated at the amount management expects to collect from outstanding balances. The Company generally does not require collateral to support customer receivables.  The Company provides an allowance for doubtful accounts based upon a review of the outstanding accounts receivable, historical collection information and existing economic conditions. The Company determines if receivables are past due based on days outstanding, and amounts are written off when determined to be uncollectible by management.  The maximum accounting loss from the credit risk associated with accounts receivable is the amount of the receivable recorded, which is the face amount of the receivable net of the allowance for doubtful accounts.

Inventory
 
Inventory is stated at the lower of cost or market using the first-in, first-out (FIFO) valuation method.  Provisions are made for the estimated effect of obsolete and slow-moving inventories.
 
   
March 31, 2011
   
December 31, 2010
 
Finished goods
  $ 128,035     $ 148,866  
Less reserve  for obsolescence and slow moving inventory
    (96,682 )     (96,682 )
    $ 31,353     $ 52,184  

Property and Equipment
 
Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method once placed in service.  Upon retirement or sale, the cost of the assets disposed of and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized. Repairs and maintenance costs are expensed as incurred. The estimated useful lives of assets are as follows:

Computer and office equipment 3 - 5  years
Leasehold improvements Lesser of estimated useful life or life of the lease
Office furniture and fixtures  4 - 7 years
Software  3 - 5  years

Debt Issuance Costs and Debt Discount

These items are amortized over the life of the related debt to interest expense using the straight line method which approximates the interest method.  If a conversion, extinguishment or repayment of the underlying debt occurs, a proportionate share of the unamortized portion of  these amounts will be immediately expensed.

Fair Value of Financial Instruments

The Company’s financial instruments, including cash, accounts receivable, accounts payable and accrued expenses, are carried at cost, which approximates their fair value because of the short-term nature of these financial instruments.

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.
 
 
10

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

Derivative Financial Instruments

Fair value accounting requires bifurcation of embedded derivative instruments such as conversion features in convertible debt or equity instruments, and measurement of their fair value for accounting purposes. In determining the appropriate fair value, the Company uses the binomial option-pricing model. In assessing the convertible debt instruments, management determines if the convertible debt host instrument is conventional convertible debt and further if there is a beneficial conversion feature requiring measurement. If the instrument is not considered conventional convertible debt, the Company will continue its evaluation process of these instruments as derivative financial instruments.
 
Once determined, the derivative liabilities are adjusted to reflect fair value at each reporting period end, with any increase or decrease in the fair value being recorded in results of operations as an adjustment to fair value of derivatives. In addition, the fair value of freestanding derivative instruments such as warrants, are also valued using the binomial option-pricing model. At March 31, 2011 and December 31, 2010, respectively, the Company had derivative liabilities in the amounts of $898,316 and $905,701.

Impairment of Long-Lived Assets

Long-lived assets such as property and equipment and definite-lived intangible assets (DVD or CD master production copies, or "masters") are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.  If the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized in the amount that the carrying amount of the asset exceeds its fair value.  Fair value is determined based on discounted future net cash flows associated with the use of the asset.

Based on the Company's expected future undiscounted cash flows generated by the masters, no impairment was recorded at March 31, 2011 and 2010, respectively.

Indefinite-Lived Intangible Assets

Indefinite-lived intangible assets are recorded at cost and consist of domestic and foreign trademarks.  Trademarks are not amortized since they have indefinite lives, but instead are reviewed annually for impairment. Costs to renew trademarks are expensed as incurred.

Revenue recognition

The Company recognizes revenue when all of the following have occurred: (1) persuasive evidence of an arrangement exists, (2) the product is delivered, (3) the sales price to the customer is fixed or determinable, and (4) collectability of the related customer receivable is reasonably assured.  There is no right of return for products.  Product sales are recognized upon shipment, where risk and title to the Company’s inventory passes to the customer. 

The Company also enters into licensing agreements whereby the licensee agrees to pay a percentage of net sales of the licensed products.  Most of the agreements require the licensee to pay guaranteed minimum royalty payments upon entering into the agreement.  Advanced royalty payments associated with these agreements are recorded as deferred revenue and royalties are recognized as revenue over the period or the agreement based on the greater of the monthly minimums or the licenses’ sales of the licensed products.

Cost of sales

Cost of sales represents costs directly related to the production and manufacturing of the Company’s products. Costs include product development, freight, packaging and print production costs. Cost of sales also represent licensing fees in accordance with a licensing contract with a related party.

Shipping and handling costs
 
The Company classifies shipping and handling amounts billed to customers as product sales and shipping and handling costs as a component of cost of sales.
 
 
11

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

Advertising

Costs incurred for producing and communicating advertising for the Company are charged to operations as incurred as follows:

Three Months Ended
 March 31, 2011
   
Three Months Ended
 March 31, 2010
 
$ 295,258     $ 21,801  

Share-based payments

Generally, all forms of share-based payments, including stock option grants, restricted stock grants and stock appreciation rights are measured at their fair value on the awards’ grant date, based on the estimated number of awards that are ultimately expected to vest. Share-based compensation awards issued to non-employees for services rendered are recorded at either the fair value of the services rendered or the fair value of the share-based payment, whichever is more readily determinable. The expense resulting from share-based payments are recorded in cost of sales or general and administrative expense in the consolidated statements of operations, depending on the nature of the services provided.

Earnings per share

In accordance with accounting guidance now codified as FASB ASC Topic 260, “Earnings per Share,”  basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during each period.  Diluted earnings (loss) per share is computed by dividing net income (loss), adjusted for changes in income or loss that resulted from the assumed conversion of convertible notes, by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period.
   
The Company had the following common stock equivalents at March 31, 2011:

Convertible notes – face amount of $2,806,489, conversion price of $0.40
    7,016,222  
Common stock warrants, conversion price of $0.60 (Series “A”)
    7,016,222  
Common stock warrants, conversion price of $1.20 (Series “B”)
    7,016,222  
Total common stock equivalents
    21,048,666  

The Company had no  common stock equivalents at March 31, 2010.
 
In connection with the reverse acquisition and recapitalization, all share and per share amounts have been retroactively restated.

Reclassification

Certain items in the 2010 consolidated financial statements presentation have been reclassified to confirm to the 2011 presentation.  Such reclassifications have no effect on previously reported net income (loss).

Note 3 Going Concern and Liquidity

As reflected in the accompanying consolidated financial statements, the Company incurred a loss of $1,479,649 and net cash used in operations of $1,061,241 for the three months ended March 31, 2011; and a stockholders’ deficit of $1,961,770 at March 31, 2011.
 
 
12

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

The ability of the Company to continue as a going concern is dependent on Management's plans, which include the raising of capital through debt and/or equity markets with some additional funding from other traditional financing sources, including term notes, until such time that funds provided by operations are sufficient to fund working capital requirements.  The Company may need to incur additional liabilities with certain related parties to sustain the Company’s existence.

The Company will require additional funding to finance the growth of its current and expected future operations as well as to achieve its strategic objectives.  The Company believes its current available cash along with anticipated revenues may be insufficient to meet its cash needs for the near future.  There can be no assurance that financing will be available in amounts or terms acceptable to the Company, if at all.

The Company believes that the utilization of new marketing initiatives, which includes signing up new distributors and a national broker network, and production and distribution of a direct to consumer marketing plan will allow for increased awareness resulting in additional sales that will provide future positive cash flows, however, sales to date have been nominal.

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  These financial statements do not include any adjustments relating to the recovery of the recorded assets or the classification of the liabilities that might be necessary should the Company be unable to continue as a going concern.

Note 4 Property and Equipment

Property and equipment consisted of the following:
 
   
March 31, 2011
   
December 31, 2010
 
Leasehold improvements
 
$
103,195
   
$
103,195
 
Furniture and equipment
   
278,942
     
253,862
 
Vehicle
   
5,700
     
5,700
 
     
387,837
     
362,757
 
Less accumulated depreciation
   
(279,621
)
   
(272,254
)
Property and equipment, net
 
$
108,216
   
$
90,503
 
 
Depreciation expense for the three months ended  March 31, 2011 and 2010 totaled $7,367 and $6,846, respectively.
 
Note 5 Intangible Assets

Intangible assets were comprised of the following at March 31, 2011:
 
 
Estimated life 
 
Gross Amount
   
Accumulated Amortization
   
Net
 
Masters
10 years
 
$
575,209
   
$
425,686
   
$
149,523
 
Trademarks
Indefinite
   
450,566
     
-
     
450,566
 
     
$
1,025,755
   
$
425,686
   
$
600,089
 
 
Intangible assets were comprised of the following at December 31, 2010:
 
 
Estimated life 
 
Gross Amount
   
Accumulated Amortization
   
Net
 
Masters
10 years
 
$
575,209
   
$
412,746
   
$
162,463
 
Trademarks
Indefinite
   
450,566
     
-
     
450,566
 
     
$
1,025,775
   
$
412,746
   
$
613,029
 
 
Amortization expense related to the masters totaled $24,350 and $13,348 for the three months ended March 31, 2011 and 2010, respectively.
 
 
13

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010
Note 6 Debt

(A)  
 2010 Convertible Promissory Notes and Warrants

Terms of Notes

On November 24, 2010, the Company completed a secured convertible notes and warrants offerings (“Notes”).  The Notes are secured by all assets of the Company and mature on November 24, 2012.  The Notes bear interest at a rate of 10% per annum due and are payable semi-annually in arrears commencing March 31, 2011 and upon maturity (as of March 31, 2011, no interest had been paid).  The principal of the Notes was $2,806,489 and the gross proceeds raised were $2,806,489. The Company paid $91,290 in debt issuance costs. The Notes contained the following features:

i.  
Conversion price at issuance:  $0.40 per share of common stock
ii.  
Registration rights – the Company is required to file a registration statement within 60 days of a written request of holders of more than 50% of the conversion shares.  If the Company fails to file such registration statement, the Company will incur liquidated damages of 2% of the aggregate amount raised in the offering for each 30 days of delinquency.  The maximum liquidated damages are capped at 12.0% of the aggregate amount raised in the offering.
iii.  
Warrants -  The Company also issued the Note holders one stock purchase warrant with a maturity of 5 years and a $0.60 exercise price for each convertible share (7,016,222 warrants) and one stock purchase warrant with a maturity of 5 years and a $1.20 exercise price for each convertible share (7,016,222 warrants).
iv.  
Full ratchet provision – The Notes contain a provision in which the conversion price will be reduced in any event the Company issues any security or debt instrument with a lower consideration per share in any future offering.
v.  
$900,000 of the cash proceeds was restricted by the investors and must be utilized for investor relation purposes.  For purposes of cash flow presentation, the restriction was netted with the gross proceeds raised.

Derivative Liabilities

In connection with the ASC 815, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock,” the Company determined that the embedded conversion feature and the warrant issuances (ratchet down of exercise price based upon lower exercise price in future offerings) are not indexed to the Company’s own stock and, therefore, is an embedded derivative financial liability (the “Embedded Derivative”), which requires bifurcation and separate accounting.

The Company measured the fair value of the derivative liabilities using a binomial lattice valuation model.
 
The fair value of the derivative liabilities is summarized as follow:
Fair value at the issuance dates for conversion feature and warrants issued on the 2010 Convertible Promissory Notes and Warrant Offering
  $ 918,885  
Mark to market adjustments for the year ended December 31, 2010:
    (13,184 )
Derivative liabilities balance at December 31, 2010
  $ 905,701  
Mark to market adjustments for the three months ended March 31, 2011:
    (7,385 )
Derivative liabilities balance at March 31, 2011
  $ 898,316  

The Company recorded the fair value of the derivative liabilities as a debt discount and is amortizing the discount over the life of the Notes on a straight-line basis.

The fair value of the derivative liabilities at issuance and at each mark to market assessment were based upon the following management assumptions:

Exercise price
$0.40 - $1.20
Expected dividends
0%
Expected volatility
93.4% - 99.7%
Expected term: conversion feature
2 years
Expected term: warrants
5 years
Suboptimal exercise factor
1.25
Risk free interest rate 0.53% - 2.24%

 
14

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

(B)  
Debt Issuance Costs

In connection with raising convertible debt during 2010, the Company incurred legal fees in the amount of $91,290.  The Company is expensing the issuance costs over the life of the debt.

During the three months ended March 31, 2011, the Company amortized $11,411 of the debt issuance costs.

Note 7 Fair Value

The Company has categorized its assets and liabilities recorded at fair value based upon the fair value hierarchy specified by Generally Accepted Accounting Principles.

The levels of fair value hierarchy are as follows:
 
·
Level 1 inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access;
 
 
·
Level 2 inputs utilize other-than-quoted prices that are observable, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs such as interest rates and yield curves that are observable at commonly quoted intervals; and
 
 
·
Level 3 inputs are unobservable and are typically based on our own assumptions, including situations where there is little, if any, market activity.
 
 
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the Company categorizes such financial asset or liability based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
 
 
15

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010
 
Both observable and unobservable inputs may be used to determine the fair value of positions that are classified within the Level 3 category. As a result, the unrealized gains and losses for assets within the Level 3 category presented in the tables below may include changes in fair value that were attributable to both observable and unobservable inputs.
 
The following are the major categories of liabilities measured at fair value on a nonrecurring basis during the three months ended March 31, 2011, using quoted prices in active markets for identical liabilities (Level 1); significant other observable inputs (Level 2); and significant unobservable inputs (Level 3):

March 31, 2011:
    Level 1:     Level 2:     Level 3:        
   
Quoted Prices in Active Markets for Identical Liabilities
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
   
Total at
March 31, 2011
 
Derivative Liabilities
  $ -     $ 898,316     $ -     $ 898,316  

December 31, 2010:

    Level 1:     Level 2:     Level 3:        
   
Quoted Prices in Active Markets for Identical Liabilities
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
   
Total at December 31, 2010
 
Derivative Liabilities
  $ -     $ 905,701     $ -     $ 905,701  


Note 8 Stockholders’ Deficit

(A)  
Members’ Deficit

From inception to September 23, 2010, the Company was an LLC and was composed of two members and managed exclusively by its members. A member's percentage interest in the Company is computed as a fraction, the numerator of which is the total of a member's capital account and the denominator of which is the total of all capital accounts of all members.
 
(B)  
Common Stock

There were no stock issuances during the three months ended March 31, 2011 and 2010.

(C)  
Warrants

The following is a summary of the Company’s warrant activity:

   
Warrants
   
Weighted Average Exercise Price
 
             
Outstanding – December 31, 2010
    14,032,444     $ 0.90  
Exercisable – December 31, 2010
    14,032,444     $ 0.90  
Granted
    -     $ -  
Exercised
    -     $ -  
Forfeited/Cancelled
    -     $ -  
Outstanding – March 31, 2011
    14,032,044     $ 0.90  
Exercisable – March 31, 2011
    14,032,044     $ 0.90  

 
16

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

 
Warrants Outstanding Warrants Exercisable
Range of
exercise price
Number
Outstanding
Weighted Average Remaining
Contractual Life (in years)
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
$0.60 - $1.20
14,032,044
4.77 years
$0.90
14,032,044
$0.90

At March 31, 2011 and December 31, 2010, the total intrinsic value of warrants outstanding and exercisable was $0.

Note 9 Commitments and Contingencies

Litigations, Claims and Assessments

From time to time, the Company may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm its business. The Company is currently not aware of any such legal proceedings or claims that they believe will have, individually or in the aggregate, a material adverse affect on its business, financial condition or operating results.
 
On February 8, 2011, the Company settled a legal matter with a licensee and received a $60,000 settlement. The amount has been reflected in the statement of operaions as income.

Note 9 Related Party Transactions

(1)  
Lease-License Agreement

The Company entered into a perpetuity agreement with an entity controlled by the Chief Creative Officer on January 1, 2006.  The Company obtained distribution rights of certain videos created by the counter-party.  The Company has full rights to distribute and sell such product.  The Company agreed to pay $0.50/per unit sold with a minimum monthly payment of $2,750.

During the year ended March 31, 2011 and 2010, the Company accrued $8,250 and $8,250 relating to this agreement.

Note 10 Subsequent Events

On April 4, 2011, The Brainy Brands Company, Inc. filed a certificate of amendment to its certificate of incorporation with the Secretary of State of Delaware, pursuant to which, upon filing, (i) the Company’s number of authorized shares of common stock increased from 100,000,000 to 160,000,000, and (ii) the Company became authorized to issue up to 10,000,000 shares of blank check preferred stock.

On April 18, 2011, The Brainy Brands Company, Inc. entered into a subscription agreement (the “Subscription Agreement”) with accredited investors (the “Investors”). Pursuant to the Subscription Agreement, on April 18, 2011, the Company issued and sold to the Investors, convertible promissory notes (the “Notes”) in the aggregate principal amount of $750,000 (the “Private Placement”). The Notes are secured by all of the assets of the Company. The Notes are convertible into common stock of the Company at an exercise price of $0.40 per share, subject to adjustment in the event of stock splits, stock dividends, or in the event of certain subsequent issuances by the Company of common stock or securities convertible into common stock at a lower price. The Notes will mature two years from the date of issuance and bear interest at the rate of 10% per annum due and payable semi-annually in arrears commencing September 30, 2011 and upon maturity. Pursuant to the Private Placement, the Company issued to the Investors 15 Class A Warrants and 15 Class B Warrants (collectively, the  “Warrants”) to purchase common stock for each $4.00 principal amount of Notes, such that the Company issued an aggregate of 2,812,500 Class A Warrants and 2,812,500 Class B Warrants. The Warrants have a five-year term, may be exercised on a cashless basis, and have an exercise price of $0.60 (with respect to the Class A Warrants) or $1.20 (with respect to the Class B Warrants), subject to adjustment in the event of stock splits, stock dividends, or in the event of certain subsequent issuances of the Company of common stock or securities convertible into common stock at a lower price. The Notes may not be converted, and the Warrants may not be exercised, to the extent such conversion or exercise would cause the holder, together with its affiliates, to beneficially own a number of shares of common stock which would exceed 4.99% of the Company’s then outstanding shares of common stock following such conversion or exercise.
 
 
17

 
The Brainy Brands Company, Inc. and Subsidiary
Notes to Consolidated Financial Statements - unaudited
March 31, 2011 and 2010

In connection with the Subscription Agreement, on April 18, 2011, the Company entered into a pledge and escrow agreement (the “Pledge Agreement”) with the shareholders identified on Schedule A thereto (consisting of John Benfield (the Company’s chief executive officer), Dennis Fedoruk (the Company’s president and chief creative officer) Ronda Bush (the Company’s chief operations officer) and Jerry Bush (an employee of the Company and the husband of Ronda Bush) (the “Shareholders”), and Grushko & Mittman, P.C. , as escrow agent (the “Escrow Agent”). Pursuant to the Pledge Agreement, the Shareholders placed the aggregate 14,724,994 shares of common stock of the Company held by the Shareholders (the “Shares”) in escrow with the Escrow Agent. The Shares will be returned to the Shareholders if the Company meets the Revenue Target set forth in the Pledge Agreement, or released to the Investors if and in the proportion that the Company fails to meet the Revenue Target. The Revenue Target is defined under the Pledge Agreement as $2,000,000 gross cash revenues from sales in the ordinary course of business, net of returns and refunds, as recognized in accordance with generally accepted accounting principles (“GAAP”), and the gross cash receipts from long-term licensing fees received during the year ended December 31, 2011, even if such entire licensing fees are not included in revenues pursuant to GAAP, during the year ended December 31, 2011.

A second closing under the Subscription Agreement may occur (the “Additional Closing”), subject to certain conditions including the consent of the Investors, within 45 days after the initial closing of the Private Placement, for additional principal amount of $750,000 in notes.  If such Additional Closing occurs, the Company will issue notes and warrants on the same terms and conditions as the Private Placement. 

Pursuant to an escrow agreement entered into between the Company, the Investors, and Grushko & Mittman, P.C., as escrow agent, $250,000 from the sale of the Notes (or $500,000, if the additional closing occurs) will continue to be held in escrow following the closing of the Private Placement in a non-interest bearing account and released to the Company or on the Company’s behalf not more frequently than one time each ten days.  A request for release must be made in writing to the Escrow Agent and Collateral Agent.  The request must include a copy of unanimously adopted resolutions of the board of directors of the Company certified by the secretary of the Company and the Company’s chief financial officer that (i) the Company is requesting a release of funds and the details thereof including the amount, purposes, and wire delivery instructions, (ii) that such requested funds are for reimbursement of funds which were timely employed in conformity in all material respects with the use of proceeds set forth on Schedule 9(e) to the Subscription Agreement, and (iii) an Event of Default, or an event that with the giving of notice or the passage of time could become an Event of Default, has not occurred.  The Company must provide to Collateral Agent reasonably satisfactory proof that the funds for which reimbursement is sought had been used for the purposes described in part (ii) of the previous sentence.  The Escrow Agent may not release any funds if an objection to such release has been made by Collateral Agent.  Deviations from Schedule 9(e) to the Subscription Agreement may be made subject to the written approval of the Collateral Agent.  Schedule 9(e) contemplates that $500,000 will be used for public relations and investor relations services rendered by a direct marketing firm under the Company’s direction to implement and manage a direct mail correspondence program.  The Company believes that this program will be beneficial for its business and keeping its shareholders apprised of its progress.  Unless postponed by the Company and Collateral Agent, any funds retained in escrow on the one year anniversary of the Closing Date will be released to Investors requesting such release in proportion to the relative amount of Note principal held by all Investors as of such one year anniversary date.  Upon release to the Investors, such sums shall be applied against amounts outstanding on the Notes in the manner set forth in the Notes.




 
18

 


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

We make forward-looking statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information currently available to us. Forward-looking statements include information about our possible or assumed future results of operations which follow under the headings “Business and Overview,” “Liquidity and Capital Resources,” and other statements throughout this report preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates” or similar expressions. We generally use words such as “believe,” “may,” “could,” “will,” “intend,” “expect,” “anticipate,” “plan,” and similar expressions to identify forward-looking statements, including statements regarding our ability to continue to create innovative technology products, our ability to continue to generate new business based on our sales and marketing efforts, referrals and existing relationships, our financing strategy and ability to access the capital markets and other risks discussed in our Risk Factor section included in our Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission.
 
Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in these forward-looking statements, including the risks and uncertainties described below and other factors we describe from time to time in our periodic filings with the U.S. Securities and Exchange Commission (the “SEC”). We therefore caution you not to rely unduly on any forward-looking statements. The forward-looking statements in this report speak only as of the date of this report, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
 
Plan of Operation

Brainy Acquisitions, Inc., the operating subsidiary of The Brainy Brands Company Inc. (the "Company") was formed on August 27, 2010 under the laws of the state of Georgia and is headquartered in Suwanee, Georgia. The Company, through its operating subsidiary, engages in the business of selling educational DVDs, books, games, and toys for babies, toddlers and pre-schoolers both domestically and internationally through retailers under licensing agreements, as well as directly to customers primarily via internet sales.

We sell over 200 education and entertainment products aimed at children ages 9 months to 5 years including DVD’s, CD’s, books, toys, games, puzzles, and flash cards.

With a global operation and sales through an international network of licensees in 60 countries, licensed broadcasting in 110 countries, distribution channels in China, Asia and Europe, our goal is to become a market leader in preschool education and early childhood development products.

Results of Operation

Summary Income Statement for the Three Months Ended March 31, 2011 and 2010
   
Three months ended
 
   
March 31, 2011
   
March 31, 2010
 
Revenue – net discounts
 
$
97,044
   
$
       117,451
 
Gross Profit
 
$
64,909
   
$
80,091
 
Operating Expense
 
$
1,427,063
   
$
    247,808
 
Other Expense
 
$
(117,495
)
 
$
      (9,774
)
Net Loss
 
$
(1,479,649
)
 
$
(177,491
)
Loss per Share – Basic and Diluted
 
$
(0.05
)
 
$
         (0.02
 
 
 
19

 

 
For the three months ended March 31, 2011 and 2010, the Company reported a net loss of $(1,479,649), or $(0.05) per share and net loss of $(177,491) or $(0.02) per share, respectively. The change in net loss between the three months ended March 31, 2011 and 2010 was primarily attributable to following significant events:  
 
During the year ended December 31, 2010 the Company’s management team was focused on a capital raise which included recapitalizing the Company with a public shell corporation.  Due to the small number of management personnel, considerable time and effort was shifted from the selling process toward reverse merger and recapitalization process.  The transaction closed in November 2010.  As a result, the Company experienced limited sales during the three months ended March 31, 2011.

The decrease in total revenues for the three months ended March 31, 2011 as compared to the comparable three months ended March 31, 2010 was a result of both a decrease in product sales as well as a decrease in licensing income.   

Gross profit percentage for the three months ended March 31, 2011 as compared to the comparable three months ended March 31, 2010 remained flat.

Operating expenses increased considerably from $247,808 for the three months ended March 31, 2010 to $1,427,063 for the comparable three months ended March 31, 2011.  The increase is primarily attributable to the company exhausting resources marketing the product line, increased costs associated with running a public company, and considerable expenses were incurred developing an investor relations campaign.

Other income (expenses)  – net increased significantly, primarily due to the increase in interest expense associated with the convertible notes issued during November of 2010, offset by legal settlement income.

Going Concern:  As shown in the accompanying financial statements, the Company incurred a net loss of $(1,479,649) during the three months ended March 31, 2011, and as of that date, the Company had a shareholders’ deficit of $1,961,770. Those factors raise substantial doubt about the Company’s ability to continue as a going concern. Management of the Company plans to address this concern by doing the following:

·  
Raising additional capital through convertible note offerings or other equity financing
·  
Launch of new marketing and awareness campaign

The ability of the Company to continue as a going concern is dependent on its ability to do all or most of the above listed steps.
 
Liquidity and Capital Resources
 
The following table summarizes total current assets, liabilities and working capital at March 31, 2011 compared to December 31, 2010.
   
March 31, 2011
   
December 31, 2010
   
Increase/Decrease
 
Current Assets
 
$
829,687
   
$
2,044,501
   
$
(1,214,814
Current Liabilities
 
$
630,056
   
$
477,761
   
$
(152,295
Working Capital
 
$
199,631
 
 
$
1,566,740
   
$
(1,367,109
)

As March 31, 2011, we had working capital  of $199,631 as compared to working capital of $1,566,740 at December 31, 2010, a decrease of $(1,367,109). The decrease is primarily attributable to the Company raising capital in November 2010 through a convertible note.  The Company used a majority of the capital raise to retool the product line and to begin to market the retooled product line.
 
 
20

 
 
Net cash used for operating activities for the three months ended March 31 2011 and 2010 was $(1,061,241) and $(465,368), respectively. The Net Loss for the three months ended March 31, 2011 and 2010 was $(1,479,649) and $(177,491), respectively.
 
Net cash used for investing activities for the three months ended March 31 2011 and 2010 was $(23,608) and $(-), respectively. The Company purchased trade booth equipment during the three months ended March 31, 2011.

Net cash obtained through all financing activities for the three months ended March 31, 2011 was $333,532  as compared to $465,757 for the three months ended March 31, 2010.
 
The Company continues to explore potential expansion opportunities in the industry in order to boost sales, while leveraging distribution systems to consolidate lower costs.  The Company needs to continue to raise money in order execute the business plan.

Financing

On April 18, 2011, The Brainy Brands Company, Inc. entered into a subscription agreement (the “Subscription Agreement”) with accredited investors (the “Investors”). Pursuant to the Subscription Agreement, on April 18, 2011, the Company issued and sold to the Investors, convertible promissory notes (the “Notes”) in the aggregate principal amount of $750,000 (the “Private Placement”). The Notes are secured by all of the assets of the Company. The Notes are convertible into common stock of the Company at an exercise price of $0.40 per share, subject to adjustment in the event of stock splits, stock dividends, or in the event of certain subsequent issuances by the Company of common stock or securities convertible into common stock at a lower price. The Notes will mature two years from the date of issuance and bear interest at the rate of 10% per annum due and payable semi-annually in arrears commencing September 30, 2011 and upon maturity. Pursuant to the Private Placement, the Company issued to the Investors 15 Class A Warrants and 15 Class B Warrants (collectively, the  “Warrants”) to purchase common stock for each $4.00 principal amount of Notes, such that the Company issued an aggregate of 2,812,500 Class A Warrants and 2,812,500 Class B Warrants. The Warrants have a five-year term, may be exercised on a cashless basis, and have an exercise price of $0.60 (with respect to the Class A Warrants) or $1.20 (with respect to the Class B Warrants), subject to adjustment in the event of stock splits, stock dividends, or in the event of certain subsequent issuances of the Company of common stock or securities convertible into common stock at a lower price. The Notes may not be converted, and the Warrants may not be exercised, to the extent such conversion or exercise would cause the holder, together with its affiliates, to beneficially own a number of shares of common stock which would exceed 4.99% of the Company’s then outstanding shares of common stock following such conversion or exercise.

In connection with the Subscription Agreement, on April 18, 2011, the Company entered into a pledge and escrow agreement (the “Pledge Agreement”) with the shareholders identified on Schedule A thereto (consisting of John Benfield (the Company’s chief executive officer), Dennis Fedoruk (the Company’s president and chief creative officer) Ronda Bush (the Company’s chief operations officer) and Jerry Bush (an employee of the Company and the husband of Ronda Bush) (the “Shareholders”)), and Grushko & Mittman, P.C. , as escrow agent (the “Escrow Agent”). Pursuant to the Pledge Agreement, the Shareholders placed the aggregate 14,724,994 shares of common stock of the Company held by the Shareholders (the “Shares”) in escrow with the Escrow Agent. The Shares will be returned to the Shareholders if the Company meets the Revenue Target set forth in the Pledge Agreement, or released to the Investors if and in the proportion that the Company fails to meet the Revenue Target. The Revenue Target is defined under the Pledge Agreement as $2,000,000 gross cash revenues from sales in the ordinary course of business, net of returns and refunds, as recognized in accordance with generally accepted accounting principles (“GAAP”), and the gross cash receipts from long-term licensing fees received during the year ended December 31, 2011, even if such entire licensing fees are not included in revenues pursuant to GAAP, during the year ended December 31, 2011.

A second closing under the Subscription Agreement may occur (the “Additional Closing”), subject to certain conditions including the consent of the Investors, within 45 days after the initial closing of the Private Placement, for additional principal amount of $750,000 in notes.  If such Additional Closing occurs, the Company will issue notes and warrants on the same terms and conditions as the Private Placement. 
 
 
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Pursuant to an escrow agreement entered into between the Company, the Investors, and Grushko & Mittman, P.C., as escrow agent, $250,000 from the sale of the Notes (or $500,000, if the additional closing occurs) will continue to be held in escrow following the closing of the Private Placement in a non-interest bearing account and released to the Company or on the Company’s behalf not more frequently than one time each ten days.  A request for release must be made in writing to the Escrow Agent and Collateral Agent.  The request must include a copy of unanimously adopted resolutions of the board of directors of the Company certified by the secretary of the Company and the Company’s chief financial officer that (i) the Company is requesting a release of funds and the details thereof including the amount, purposes, and wire delivery instructions, (ii) that such requested funds are for reimbursement of funds which were timely employed in conformity in all material respects with the use of proceeds set forth on Schedule 9(e) to the Subscription Agreement, and (iii) an Event of Default, or an event that with the giving of notice or the passage of time could become an Event of Default, has not occurred.  The Company must provide to Collateral Agent reasonably satisfactory proof that the funds for which reimbursement is sought had been used for the purposes described in part (ii) of the previous sentence.  The Escrow Agent may not release any funds if an objection to such release has been made by Collateral Agent.  Deviations from Schedule 9(e) to the Subscription Agreement may be made subject to the written approval of the Collateral Agent.  Schedule 9(e) contemplates that $500,000 will be used for public relations and investor relations services rendered by a direct marketing firm under the Company’s direction to implement and manage a direct mail correspondence program.  The Company believes that this program will be beneficial for its business and keeping its shareholders apprised of its progress.  Unless postponed by the Company and Collateral Agent, any funds retained in escrow on the one year anniversary of the Closing Date will be released to Investors requesting such release in proportion to the relative amount of Note principal held by all Investors as of such one year anniversary date.  Upon release to the Investors, such sums shall be applied against amounts outstanding on the Notes in the manner set forth in the Notes.

Recent Accounting Pronouncements
 
In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2010-06, “Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 amends ASC 820, “Fair Value Measurements” ("ASC 820") to require a number of additional disclosures regarding fair value measurements. The amended guidance requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfers in or out of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. The ASU also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The amended guidance was effective for financial periods beginning after December 15, 2009, except the requirement to disclose Level 3 transactions on a gross basis, which becomes effective for financial periods beginning after December 15, 2010. ASU 2010-06 did not have a significant effect on the Company’s consolidated financial position or results of operations.

In July 2010, the FASB issued ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 is to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The disclosures about activity that occurs during the reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The Company does not expect the provisions of ASU 2010-20 to have a material effect on its financial position, results of operations or cash flows.
 
Critical Accounting Policies
 
Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.  
 
 
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Our significant accounting policies are summarized in Note 2 of our consolidated financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would have any effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.
 
We believe the following critical accounting policies and procedures, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
 
Use of Estimates, Going Concern Consideration – The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.  Among the estimates we have made in the preparation of the financial statements is an estimate of our projected revenues, expenses and cash flows in making the disclosures about our liquidity in this report.  As an early stage company, many variables may affect our estimates of cash flows that could materially alter our view of our liquidity and capital requirements as our business develops.  Our consolidated financial statements have been prepared assuming we are a “going concern”.  No adjustment has been made in the consolidated financial statements which could result should we be unable to continue as a going concern.
 
Share-Based Compensation - US GAAP requires public companies to expense employee share-based payments (including options, warrants, restricted stock units and performance stock units) based on fair value.  We must use our judgment to determine key factors in determining the fair value of the share-based payment, such as volatility, forfeiture rates and the expected term in which the award will be outstanding.
 
Derivative Financial Instruments - Fair value accounting requires bifurcation of embedded derivative instruments such as conversion features in convertible debt or equity instruments, and measurement of their fair value for accounting purposes. In determining the appropriate fair value, the Company uses binomial option-pricing model. In assessing the convertible debt instruments, management determines if the convertible debt host instrument is conventional convertible debt and further if there is a beneficial conversion feature requiring measurement. If the instrument is not considered conventional convertible debt, the Company will continue its evaluation process of these instruments as derivative financial instruments.
 
Once determined, derivative liabilities are adjusted to reflect fair value at each reporting period end, with any increase or decrease in the fair value being recorded in results of operations as an adjustment to fair value of derivatives. In addition, the fair value of freestanding derivative instruments such as warrants, are also valued using the binomial option-pricing model.
 
Debt Issuance Costs and Debt Discount -These items are amortized over the life of the debt to interest expense using the straight line method which approximates the interest method..  If a conversion, extinguishment or repayment of the underlying debt occurs, a proportionate share of these amounts is immediately expensed.
 
Revenue recognition - The Company recognizes revenue when all of the following have occurred: (1) persuasive evidence of an arrangement exists, (2) the product is delivered, (3) the sales price to the customer is fixed or determinable, and (4) collectability of the related customer receivable is reasonably assured.  There is no right of return for products.  Product sales are recognized upon shipment, where risk and title to the Company’s inventory passes to the customer. 
 
The Company also enters into licensing agreements whereby the licensee agrees to pay a percentage of net sales of the licensed products.  Most of the agreements require the licensee to pay guaranteed minimum royalty payments upon entering into the agreement.  Advanced royalty payments associated with these agreements are recorded as deferred revenue and royalties are recognized as revenue over the period of the agreement based on the greater of the monthly minimums of the licensees’ sales of the licensed products.
 
 
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OFF-BALANCE SHEET ARRANGEMENTS:

We do not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable for a smaller reporting company.

Item 4. Controls and Procedures.

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in the reports we file pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our Chief Executive Officer (“CEO”), who also serves as the Company’s Principal Financial Officer (“PFO”), to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide a reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Management designed the disclosure controls and procedures to provide reasonable assurance of achieving the desired control objectives. 
 
We carried out an evaluation, under the supervision and with the participation of our management, including our CEO and PFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based upon that evaluation, the Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Changes in Internal Control over Financial Reporting
 
There have been no changes in our internal controls over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings.
 
There are no legal proceedings to which the Company or any of its property is the subject.
 
Item 1A. Risk Factors.
 
Not applicable to a smaller reporting company.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.
 
None.
 
Item 4. (Removed and Reserved)

 
Item 5. Other Information.
 
None.
 
Item 6. Exhibits.

No.
 
Description
31.1
 
Rule 13a-14(a)/ 15d-14(a) Certification of Principal Executive Officer and Principal Financial Officer
     
32.1
 
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
     



 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

       
 
The Brainy Brands Company, Inc.
 
       
Date:  May 16, 2011
By:  
/s/ John Benfield   
 
John Benfield
Chief Executive Officer (principal executive officer, principal financial officer, and principal accounting officer)
 
     
 
     
 

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