CS Diagnostics - 10-Q quarterly report FY

Washington, D.C. 20549

Commission File Number: 000-29611

(Exact name of small business issuer as specified in its charter)

 

(Address of principal executive offices)

(Issuer's telephone number)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock:

As of July 31, 2008, there were 31,373,738 shares of common stock issued and outstanding.

 

 

The Children's Internet, Inc. (the Company) was incorporated under the laws of the State of Nevada on September 25, 1996 under the name D.W.C. Installations. At that date, 2,242,000 shares were issued to a small group of shareholders. The Company was primarily inactive until July 3, 2002 when Shadrack Films, Inc. (Shadrack) purchased 2,333,510 newly-issued shares of the Company’s common stock for $150,000, thereby obtaining a majority ownership interest. The total issued and outstanding shares of the Company was increased to 4,575,510 shares as a result of this sale to Shadrack. On December 27, 2002, the Company’s name was changed from D.W.C. Installations to The Children’s Internet, Inc.

The Company is currently authorized to conduct business in California, and since July 15, 2007 the Company has been located in San Ramon, California. The Company’s primary operations consist of marketing, selling, and administering a secure Internet service and safe online community for children. The system, known as The Children’s Internet®, is not owned by the Company, but is owned by a related party, Two Dog Net, Inc. (“TDN”). The Company’s marketing, selling and administration rights derive from a Wholesale Sales & Marketing Agreement with TDN, through the year 2013 which includes the ability to obtain five-year extensions.

In a Stock Purchase Agreement dated October 11, 2002, twenty-five D.W.C. Installations shareholders sold 2,237,000 of the original 2,242,000 “freely-tradable” shares of common stock to six individuals, two of whom are related to the Company’s former Chief Executive Officer and Chief Financial Officer and current Chairman of the Board, Sholeh Hamedani. Together, the two related individuals purchased 27% of the 2,237,000 shares sold. At the time the shares were issued, the Company believed the shares were "freely tradable" based on the representations made by its attorney at the time, Oswald & Yap, who structured the agreement.  Subsequently the Company determined that the shares were, in fact, not freely tradable and those shares would have to be registered.  The said shares were then registered in a SB-2 Registration Statement which was declared effective on May 5, 2004.

On June 9, 2006, 15,600 shares were issued to two principals of Brazer Communications under a public relations consulting agreement.

On June 29, 2007, 4,500,000 shares (the “Escrowed Shares”) were issued in the name of The Children’s Internet Holding Company, LLC, a Delaware limited liability company (“TCI Holding” or “TCI Holding Company, LLC”), and deposited in escrow on July 3, 2007 in accordance with the Interim Stock Purchase Agreement (“ISPA”) signed on June 15, 2007 between the Company and TCI Holding, thereby increasing the Company’s total issued and outstanding shares of common stock to 31,373,738 at June 30, 2008 for the purposes of financial reporting. The 4,500,000 shares held in escrow have not been deemed to carry voting rights under Nevada law as they are held for the benefit of the Company until released, and currently are subject to cancellation due to the expiration of the Definitive Stock Purchase Agreement as mentioned in the following paragraph.

On October 19, 2007, TCI Holding Company, LLC entered into a Definitive Stock Purchase Agreement (the “DSPA”) with the Company to purchase a controlling interest in the Company. The DSPA expired on March 31, 2008 and was subsequently terminated by action of the Board of Directors on May 9, 2008, as explained in Note 4.

In December 2003, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 104 “Revenue Recognition, corrected copy” to revise and clarify SAB No. 101, “Revenue Recognition in Financial Statements”, issued in 1999 and 2000. Pursuant to these bulletins and the relevant generally accepted accounting principles, the Company recognizes revenue when services are rendered to subscribers under contractual obligation to pay monthly subscription amounts for such services.

The accompanying unaudited interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America pursuant to Regulation S-B of the Securities and Exchange Commission, which contemplates continuation of the Company as a going concern. At present, the Company has not generated any significant revenues from its established sources of revenue and has had net losses and negative cash flow since its inception. These factors raise substantial doubt about the Company's ability to continue as a going concern. Without the realization of additional capital or established revenue sources, it would be unlikely for the Company to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying financial statements, the Company had net losses and negative cash flow from operations for the six-month periods ended June 30, 2008 and 2007, and accumulated net losses and negative cash flow from operations of $5,622,498 and $1,652,144, respectively, from inception through June 30, 2008.

The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. A pending suit against the Company by the Securities and Exchange Commission (the “SEC”), which is further described in Note 4, raises substantial doubt concerning the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on its ability to generate profitable operations in the future by implementing its business plan and/or to obtain the necessary financing to meet its obligations, and to repay its liabilities arising from normal business operations when they come due. The outcome of these matters cannot be predicted with any certainty at this time. Management plans to provide for the Company’s capital needs during the year ended December 31, 2008 through equity financing, including the possible sale of a majority interest in the Company, with the net proceeds to be used to fund continuing operations.

 

 

 

In a letter from Mr. Arnold’s counsel dated November 7, 2007, Mr. Arnold seeks to negotiate an amicable settlement for alleged breach of contract, intentional and negligent misrepresentation arising out of his recruitment, hiring, and employment beginning in December 2005. On or about December 6, 2007, Mr. Arnold filed a lawsuit in the Superior Court of California, County of Alameda Case No. 07-359949 alleging breach of contract, fraud and violation of California Labor Code Section 200 in connection with the dispute surrounding his employment. The Company filed an answer to the Complaint and intends to vigorously defend the claim.

 

From April 1, 2007 through December 31, 2007, Roaya Hamedani-Wooler and Soraiya Hamedani, sisters of the former Chief Executive Officer of the Company, Sholeh Hamedani, and both of whom have twelve years experience with TDN developing and marketing the Children’s Internet®, performed consulting services for the Company. Mrs. Wooler earned $30,181, of which only $19,181 has been paid to date. Soraiya Hamedani earned $27,159, of which only $16,159 has been paid to date. In addition, Lewis Wooler, husband of Roaya Hamedani-Wooler, performed customer service and technical support services during the same period, and earned $24,803, of which only $13,803 has been paid to date. Their consulting services for the Company ended December 31, 2007.

On December 6, 2007, the Company entered into a Services Agreement with TDN, which was made effective as of October 19, 2007. Under the Services Agreement, TDN provided TCI with office space, computer and office equipment, and certain supplies and services until the earlier of January 31, 2007 or the closing of the Definitive Stock Purchase Agreement, explained in Note 4, for which TCI was obligated to pay TDN a monthly charge of $9,961 pro rated based on the actual number of days for any partial months. The monthly payments were guaranteed by TCI Holding Company. Although the Services Agreement expired on January 31, 2008, because the DSPA did not close on January 31, 2008, TDN continued to provide the Company with its San Ramon office space, computers and office equipment, and certain supplies and services. As the Guarantors of the TDN Services Agreement TCI Holding Company signed an agreement with TDN on February 5, 2008 providing that it would guarantee payment of up to $25,000, of unpaid invoices for the monthly service fees. It was in TCI Holding Company’s best interest to ensure a smooth transition and transfer of information so TDN continued to provide uninterrupted services, facilities and equipment which were essential to TCI’s operations as well as to closing the DSPA. Neither TCI Holding nor the Company has paid TDN the outstanding fees.

 

 

In February 2005, the Company owed Shadrack approximately $457,000 for loans made by Shadrack to the Company for funding all of the Company’s operations since entering the development stage on July 3, 2002. On February 15, 2005, the Company's Board of Directors authorized and approved the conversion of debt totaling $456,912 owed by the Company to Shadrack, into 13,054,628 shares of the Company’s restricted common stock at a conversion price of $.035 per share, thereby reducing the amount due to Shadrack.

 

On February 15, 2005, the Company's Board of Directors authorized and approved an amendment to the Wholesale Sales and Marketing Agreement. The amendment reduces the license fee for The Children's Internet® technology payable to TDN from $3.00 to $1.00 per subscriber per month. In consideration for the reduction of the fee, the Company granted TDN or its designees, an option to purchase the Company's currently restricted common stock as described below in the section called “Stock Options Granted”.

 

As noted above, on February 15, 2005, because TDN agreed to reduce their licensing fee, the Company issued an option to TDN to purchase up to 18,000,000 shares of the Company’s restricted common stock at an exercise price of $0.07 per share, and a fair value of $0 (the “TDN Option”). The TDN Option is exercisable, in whole or in part at any time and from time to time, for a period of five years from the date of grant. The TDN Option also provides TDN with “piggyback” registration rights for all shares underlying the TDN Option on any registration statement filed by the Company for a period of one year following any exercise of the TDN Option. This issuance was valued at $0 because as of the date of issuance, the Company was under no obligation for payment to TDN since no sales of the product had occurred and no liability, therefore, had been generated. The TDN Option was granted primarily to induce TDN to reduce its future right to a royalty from sales of the product. 

 

On February 14, 2005, a cross-claim was filed in the Superior Court of California, County of Orange, Case No. 04CC11623 by the Company against O&Y alleging breach of contract, professional negligence, negligent representation, and breach of good faith and fiduciary duty. The basis of the allegations is that O&Y was retained to assist the Company’s predecessor company in the purchase and acquisition of D.W.C. Installations (“D.W.C.”) with the expectation that D.W.C. had available free-trading shares such that the Company could immediately raise capital on the relevant markets and that in advising the Company through the purchase, O&Y failed to properly advise the Company as to the status of D.W.C. and its shares, which in fact were not free-trading. As a result of this conduct, the Company alleges damages in an unspecified amount but including purchase costs, extended operation costs, refiling costs, audit costs, legal fees, loan fees, lost market share, and costs for registration. O&Y has vigorously disputed the claims set forth in the cross-complaint and has indicated its intention, should it prevail in its defense, to institute a malicious prosecution action against the Company, Nasser Hamedani, Sholeh Hamedani and Company counsel. Litigation of this matter is currently stayed pending outcome of the SEC Complaint discussed below. The case was scheduled for a status conference on April 7, 2008 before the Superior Court in Irvine, California, which has been continued to December 15, 2008.

There is a contingent liability in connection with a Stock Purchase Agreement executed on October 11, 2002 between identified shareholders and identified purchasers. Under the terms of the Stock Purchase Agreement, a payment of $150,000 is due to be paid into escrow in part consideration for purchase of the stock of D.W.C. The payment date is designated as 90 days from the date that the Company’s (formerly, D.W.C.) shares of common stock become quoted on the over-the-counter bulletin board system. The shares were approved by NASDAQ OTC:BB to be quoted on the over-the-counter bulletin board system on December 23, 2004. If this payment is not made, there could be exposure in connection with the identified shareholders’ efforts to collect the amounts allegedly due.

 

On June 13, 2006, the Company became subject to an arbitration demand from Stonefield Josephson, Inc., its former accountant, seeking reimbursement costs for legal fees spent in connection with the SEC inquiry of the Company. Stonefield Josephson, Inc.’s claim seeks recovery of $29,412.74. The Company disputes any amounts owed because of a settlement agreement entered into between the respective parties in December 2004 effectively terminating their relationship. This matter was submitted to binding arbitration through AAA in January 2007. The Arbitrator’s decision was issued on February 2, 2007, awarding Stonefield Josephson, Inc. the sum of $19,000 plus costs and fees in the amount of $1,425 due and payable March 15, 2007. The decision also awarded Stonefield Josephson, Inc. interest at the rate of 10% per annum on $19,000 from March 15, 2007. On August 30, 2007, an additional $2,500 in post-arbitration attorney’s fees and costs was awarded by the Los Angeles Superior Court. No amounts have been paid to Stonefield Josephson since the date of the Arbitrator’s decision.

On August 25, 2006, the Company filed a complaint against its former accountants, Stonefield Josephson, Inc., and its principal Dean Skupen, in the Superior Court of California, County of Alameda, Case No. VG06286054 alleging breach of contract, promissory estoppel, breach of implied covenant of good faith and fair dealing, negligent misrepresentation, fraud, and unfair business practices arising out of defendants’ alleged failure to properly perform contractual obligations. The Company seeks damages resulting from defendants’ actions, including recovering costs expended for a subsequent audit and the resultant loss in stock price following the Company’s inability to file necessary reports with the NASD. The matter was subsequently transferred to Los Angeles Superior Court. Mediation on this matter took place on February 29, 2008 in Los Angeles, California but was unsuccessful. A court hearing is pending.

 

On September 27, 2006, the Securities and Exchange Commission (“SEC”) filed a complaint (the “SEC Complaint”) in the United States District Court, Northern District of California, Case No. C066003CW, against, among others, the Company, and its former Chief Executive Officer, Sholeh Hamedani, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 by one or more defendants; violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, 13a-13 by one or more defendants; violations of Section 13(b)(2)(A) of the Exchange Act by the Company; violations of Section 13(b)(2)(B) of the Exchange Act by the Company; and violations of Section 13(b)(5) of the Exchange Act and Rules 13b2-1, 13b2-2, 13a-14, 16(a) by one or more defendants. The complaint generally alleges that the Company and the individual defendants made false or misleading public statements regarding the Company’s business and operations, made false statements in various filings with the SEC, and in particular, in the June 2005 Annual Report and Restatement and 2005 Current and Quarterly Reports, and that the defendants, or some of them, induced investment in the Company through misrepresentation and omissions. The complaint seeks disgorgement, unspecified monetary damages, injunctive relief and other relief against the defendants. The Company has answered the complaint.

  

A proposed settlement agreement was approved by the SEC Commission and the SEC San Francisco staff had received stand-by authority to accept the settlement offer of the Company if the deal with TCI Holding closed and $2.7 million was made available to transfer to the court’s registry. In order to provide more time to TCI Holding to raise the funds necessary to close the DSPA and settle with the SEC the Company agreed to a bifurcation of the proceedings. Under the agreement, the injunctive relief sought by the Commission will be granted by judgment against the Company, with a remedies hearing which was held in Federal Court on August 14, 2008 (previously scheduled for April 29, 2008 and then June 12, 2008), to resolve the amount of disgorgement, penalties and other monetary issues. The court invited the parties to submit proposals for continuing management and or disposition of corporate assets to be submitted by August 22, 2008. The court has not issued a final order as of the date of this disclosure.

 

In May 2007, Mr. Arnold advised the Company that he disagreed with the Company’s position that his unpaid leave of absence was voluntary. Mr. Arnold informed the Company that he believed his resignation resulted from the Company’s breach of his Executive Employment Agreement. The Company and Mr. Arnold have had discussions in an effort to resolve the dispute between them but, to date, have not reached agreement. The Company believes that Mr. Arnold violated the terms of the Executive Employment Agreement when he voluntarily left his position as President in September of 2006. The Company believes it is only obligated to pay Mr. Arnold for back pay and bonus, plus interest, for the period prior to September 2006. The total compensation that the Company believes it owes Mr. Arnold as of March 31, 2008 is $89,274. This amount is reflected in the Company’s financial statements.

 

In a letter from Mr. Arnold’s counsel dated November 7, 2007, Mr. Arnold indicated that he sought to negotiate an amicable settlement for alleged breach of contract, intentional and negligent misrepresentation arising out of his recruitment, hiring, and employment beginning in December 2005. On or about December 6, 2007, Mr. Arnold filed a lawsuit in the Superior Court of California, County of Alameda Case No. 07-359949 alleging breach of contract, fraud and violation of California Labor Code Section 200 in connection with the dispute surrounding his employment. The Company filed an answer to the Complaint and intends to vigorously defend the claim.

Adverse outcomes in some or all of the claims pending against the Company may result in significant monetary damages or injunctive relief against the Company that could adversely affect the Company’s ability to conduct its business. Although management currently believes that resolving all of these matters, individually, or in the aggregate, will not have a material adverse impact on the Company’s financial position or results of operations, the litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. There exists the possibility of a material adverse impact on the Company’s financial position and the results of operations for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

The Company is not aware of any other pending or threatened litigation that could have a material adverse effect on its business.

The Company entered into two equipment leases with Dell Financial Services L.P. of Round Rock, Texas. The cash value of the equipment leased, including sales tax, is $11,775. The Company entered into these leases in November 2006, however, lease payments commenced in January 2007. The total value of the 48 monthly lease payments is $17,424. At the end of the four-year period in December 2010, each lease has a purchase option at $1. These leases are considered to be operating leases as the period over which payments are to be made exceeds the period over which the assets would be depreciated, if purchased.

 

On January 9, 2007, the Company signed a 12-month co-location agreement with Evocative, Inc. to house the Company’s search engine, servers and related equipment at Evocative’s data center in Emeryville, California. This agreement replaced a similar 13-month agreement which began in October 2003 and was continued on a month-to-month basis. The new agreement added a managed firewall service. The basic annual cost under this agreement was $35,988. The co-location agreement with Evocative was cancelled as of January 31, 2008 by Richard Lewis, who was the acting CEO at the time.

On March 1, 2007, the Company entered into an oral agreement to pay Tim T. Turner, the amount of $13,125 per month as a consultant until such time as Mr. Turner and the Company entered into an employment agreement. On April 2, 2007, the Company entered into an Executive Employment Agreement with Tim T. Turner, whereby Mr. Turner became the Director of Finance and Operations for the Company. This position was not deemed an executive officer position. Upon the Company obtaining Directors and Officers insurance, Mr. Turner would have been appointed an officer of the Company and made a member of the Company’s Board of Directors. Mr. Turner resigned his position with the Company effective on December 15, 2007. The agreement provided that Mr. Turner would receive a yearly salary of $157,500, part of which was to be deferred for a year, and if the Company was not able to pay such deferred compensation, it was to be evidenced by a promissory note and have an attached warrant.

On March 17, 2008, Mr. Turner informed the Company that amounts owed to Mr. Turner included a bonus of $78,750 and severance of $360,937.50, in addition to amounts accrued by the Company for Mr. Turner’s unpaid salary of $110,562 and consulting fees of $13,125.  The Company disputes the bonus and severance amounts claimed by Mr. Turner and intends to legally contest such disputed amounts in the event Mr. Turner further attempts collection.

On April 30, 2007, the Company and the Board of Directors adopted “The Children’s Internet, Inc. 2007 Equity Incentive Plan” (the “Plan”). The purpose of the Plan is to provide incentives to attract retain and motivate eligible persons whose present and potential contributions are important to the success of the Company by offering them an opportunity to participate in the Company’s future performance through awards of Options, Restricted Stock and Stock Bonuses. Under the terms of the Plan, the Company has made available six million (6,000,000) shares of the Company’s stock to be issued to officers, directors, employees, consultants and advisors of the Company with certain restrictions as set forth in the Plan. The Plan will be administered by a Committee of the Board of Directors. The Plan will terminate ten years from the effective date of the Plan unless terminated earlier under terms of the Plan.

 On June 29, 2007, 4,500,000 shares (the “Escrowed Shares”) were issued in the name of The Children’s Internet Holding Company, LLC, a Delaware limited liability company (“TCI Holding” or “TCI Holding Company, LLC”), and deposited in escrow on July 3, 2007 in accordance with the Interim Stock Purchase Agreement (“ISPA”) signed on June 15, 2007 between the Company and TCI Holding, thereby increasing the Company’s total issued and outstanding shares of common stock to 31,373,738 at June 30, 2008 for the purposes of financial reporting. The 4,500,000 shares held in escrow have not been deemed to carry voting rights under Nevada law as they are held for the benefit of the Company until released, and currently are subject to cancellation due to the expiration of the Definitive Stock Purchase Agreement as mentioned in the following paragraph.

On October 19, 2007, the Company and TCI Holding entered into the Definitive Stock Purchase Agreement. The DSPA supersedes the ISPA and constitutes the DSPA that was contemplated by the ISPA. Under the terms of the DSPA, on October 19, 2007 Sholeh Hamedani resigned as Chief Executive Officer and Chief Financial Officer of the Company, but remained Chairman of the Board of Directors. The Board of Directors appointed Richard J. Lewis, III to be the Company’s Acting CEO and CFO.

On March 18, 2008, The Children’s Internet, Inc. (“TCI”) entered into Amendment No. 4 (the “Amendment”) to the DSPA. Under the Amendment, the date upon which the parties are permitted to terminate the DSPA if the closing of the DSPA has not occurred was extended from March 15, 2008 to March 31, 2008.

 

However, TCI Holding was unable to secure the necessary funding in order to close the deal under the terms of the DSPA and the parties were unable to reach a new agreement and, therefore, in the opinion of the Company’s Board of Directors, it was in the best interest of the Company and its shareholders to terminate the DSPA.

On May 9, 2008, the Board of Directors of the Company voted unanimously to terminate the Definitive Stock Purchase Agreement (the “DSPA”) that was entered into on October 19, 2007 between the Company, Shadrack Films, Inc. (currently the Company’s majority shareholder), The Children’s Internet Holding Company, LLC, Richard J. Lewis III, and Sholeh Hamedani.

 

Also, on May 9, 2008, the Board of Directors unanimously voted to remove Richard J. Lewis III as the Company’s Chief Executive Officer and Chief Financial Officer, and subsequently replaced Mr. Lewis with Mr. Tyler Wheeler as acting Chief Executive Officer and Chief Financial Officer.

On February 15, 2005, the Company’s Board of Directors authorized a 2 for 1 forward split of the Company's issued and outstanding common stock to shareholders of record on March 7, 2005, in the form of a 100% stock dividend. The effective date of the forward split on the NASDAQ OTC: BB was March 11, 2005.

No other new shares were issued by the Company during the period from January 1, 2007 through the date of this report.

As explained in Note 3, on February 15, 2005, the Company’s Board of Directors granted an option to TDN, a related party, to purchase up to 18,000,000 shares of the Company’s restricted common stock. This option was valued at $0.

On February 15, 2005, the Company’s Board of Directors granted Tyler Wheeler, the Company’s Chief Software Architect Consultant and a director, an option to purchase up to 1,000,000 shares of the Company’s restricted common stock at an exercise price of $0.07, and a fair value of $315,000. The option is exercisable, in whole or in part at any time and from time to time, for a period of five years from the date of grant. This option to purchase Company shares was based on a fair market value of $0.315 per share. The option was valued using the Black-Scholes option pricing model, which was developed for estimating the fair value of traded options, and taking into account that the exercisable option shares are restricted. The value of $315,000 was recorded as an expense for services when the option was granted.

On June 9, 2006, 15,600 restricted shares were awarded to two principals of Brazer Communications under a six-month contract to perform public relations consulting services for the Company. The fair market value of these shares was $7,800.

On April, 30, 2007, subject to the terms of the 2007 Equity Incentive Plan, the Company granted unqualified stock options to three of the Company’s four Directors, Roger Campos, Jamshid Ghosseiri and Tyler Wheeler. Each Director was granted options to purchase 125,000 shares of the Company’s common stock at the purchase price of $0.081 per share which was the fair market value of the shares at the date of the grant. The options for the three Directors vested immediately upon grant.

The value of the options granted on April 30, 2007 and discussed in the preceding two paragraphs, was based on a fair market value of $0.08 per share at the grant date, which was computed using the Black-Scholes option pricing model. The total value of option shares vested during the three months ended March 31, 2008 was $2,000, which was recorded as an expense of the period.

On May 30, 2008, an agreement entitled “Definitive Agreement in Principle to Merge” was executed between the Company and TCI Holding Company, LLC, under which 100% of TCI Holding’s equity interests would be merged into the Company in exchange for 30 million shares of the Company’s common stock. Two required cash payments totaling $15,000 due within 15 days of the execution of the agreement were not paid by TCI Holding, and other conditions were not met, which resulted in the retraction of the proposed merger agreement, which was reported in a press release on July 17, 2008.

On August 14, 2008, a remedies hearing for the SEC litigation explained in Note 4, was held at the U.S. District Court in Oakland, California. Several matters were taken under submission by the presiding Judge and a decision is expected within approximately two weeks.

The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Report.

The following information contains certain forward-looking statements of management of the Company. Forward-looking statements are statements that estimate the happening of future events and are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as “may," "could," "expect," "estimate," "anticipate," “plan,” "predict," "probable," "possible," "should," "continue," or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.

 

 

 

Our total operating expenses decreased by $288,762 (7.8%) for the six months ended June 30, 2008, as compared to the six months ended June 30, 2007. The major changes were decreases of $163,986 in officer compensation, $35,700 in selling expenses, $30,359 in auditing fees, and $30,000 in stock options granted directors which occurred only in 2007. The decrease in officer compensation is due to the resignation on October 19, 2007 of Sholeh Hamedani, former CEO and CFO, and the resignation on December 15, 2007 of Tim Turner, former Director of Finance & Operations. The decrease in selling expenses corresponds with the Company’s discontinuance of marketing activities until obtaining additional investment capital. The decrease in auditing fees for the six months ended June 30, 2008 is attributable to having conducted an audit of 2006 and a re-audit of 2005 during the six months ended June 30, 2006.

This plan of operation contains forward-looking statements that involve risks, uncertainties, and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those described elsewhere in this report.

 

On September 10, 2002, we entered into a License Agreement with Two Dog Net (‘TDN”) for an exclusive worldwide license to market and sell The Children’s Internet® service. We subsequently replaced the royalty and license agreement with a new Wholesale Sales & Marketing Agreement dated March 3, 2003. The new agreement provides for us to be the exclusive marketers of TDN’s proprietary secure Internet service for children at the pre-school to junior high levels called The Children’s Internet®. We further amended this agreement in February 2005 to decrease the per user fee to TDN from $3.00 to $1.00. In consideration for this decrease of the royalty fee, TDN was granted an option to acquire 18,000,000 shares of the Company’s restricted common stock at an exercise price of $.07 per share for five years from the date of grant. The shares underlying the option have “piggy back” registration rights for a period of one year following any exercise of the option.

 

TDN did not give written notice to terminate the contract one year prior to the expiration of the initial five-year term. Therefore, the licensing agreement was automatically renewed for an additional five years expiring in 2013.

 

The Company released The Children’s Internet®, version 9.0, to the market on March 2, 2006. The Company is the exclusive marketer and distributor of The Children's Internet® membership-based service created just for kids. In the August 2004 issue of PC Magazine, The Children's Internet® was ranked as Editors' Choice in the category of "Kids' Browsers and Services," and was voted number one over AOL, EarthLink and MSN Premium 9. Additionally in August 2006, The Children's Internet® was declared winner of Outstanding Products of 2006 by iParenting Media Awards in the software category. Shortly thereafter in September 2006, The Children's Internet® received the coveted National Parenting Center's Seal of Approval.

We believe The Children's Internet® is the most comprehensive, smart solution to the problems inherent to a child’s unrestricted and unsupervised Internet access. We offer a protected online service and "educational super portal" specifically designed for children, pre-school to junior high, providing them with SAFE, real-time access to the World Wide Web; access to hundreds of thousands of the best pre-selected, pre-approved educational and entertaining web pages accessed through a secure propriety browser and search engine.

During 2007, the technology on which the product is based and the functionality of the service was improved. The Company, through TDN, also substantially upgraded the underlying system infrastructure by increasing redundant servers and improving control procedures which in turn increased the reliability of the service. Additionally, during the first quarter of 2007, where appropriate, the Company contracted with third party companies to outsource administrative support services and effectively put in place the infrastructure to support the marketing initiatives. These outsource providers handle telemarketing and the order taking process and media placement.

 

 

 

The product was being sold for $9.95 per month to the subscriber. The user must already have internet access, either through dial-up, DSL or cable broadband. We utilize both retail and wholesale channels of distribution.

 

The Company will focus on establishing long-term, value-driven relationships with:

 

The product is launched and generated minimal revenues through our grass roots marketing efforts as well as some online marketing initiatives. At the end of the first quarter of 2007, we aired our updated Infomercial on various television stations from New York to California for an initial three week media test which was the first part of an overall three month media campaign. The Company intended to continue to run the media test to identify the markets that met or exceeded our response criteria in order to build the permanent television schedule to ”roll-out” the Infomercial on a national basis. However, due to unforeseen expenses we have not had the anticipated budget in place to continue to run the media test after the first quarter of 2007.

 

Beginning with the third quarter of 2007, the Company focused the majority of the Company’s resources on negotiating and finalizing the Definitive Stock Purchase Agreement and negotiating a proposed settlement with the SEC of the outstanding claims filed by the SEC against the Company.

 

The Company believes that implementation of a broad based sales and marketing plan is essential. With adequate funding, the Company would execute our sales and marketing programs using a number of traditional and some less traditional marketing techniques to generate product awareness and build brand awareness. Among these are;

 

We believe the combined effect of this coordinated marketing program will be to build awareness of our product amongst our target consumer, to establish The Children’s Internet as the premiere product in the minds of consumers and to drive this motivated consumer base to make the purchase decision to subscribe to The Children’s Internet service.

 

The Children's Internet, Inc. will employ both direct and indirect sales channels.

Also, subject to secure financing, we will hire a direct sales force. The primary targets will be the largest Internet Service Providers as well as other national organizations that market to the most appropriate demographic groups for our service. We believe one or more of the largest ISPs in the United States will recognize the first mover advantage opportunity and will use The Children’s Internet to not only offer this much needed product to their existing customers, but also to take a significant market share from their competition. We also believe that almost any company that markets to our demographics will want to seize the public relations goodwill that will accrue to any company offering our service.

The indirect channel, composed of non-salaried independent agents and wholesale distributors, will target a wide range of opportunities, from local charities to national organizations where they may have an influential contact. These sales agents will have the opportunity to employ secondary resellers to work for them, but we will not market using a multi-level marketing plan.

 

In the future, we anticipate generating revenues via advertising sold to the purveyors of children goods and services. As well, we intend to engage in the merchandising of The Children’s Internet® themed products, from clothing to toys to books, but for the foreseeable future we will focus strictly on the successful distribution of our core service.

 

 

Although market data is not exact, and varies depending on the source, our plan is based on the belief that in the United States alone there are an approximately 35 million homes with internet access with children in kindergarten through grade 12 as of June 2007. Our model, with a mix of business generated from the respective channels of distribution, indicates we can be cash flow positive and profitable with less than 0.5% of the market.

 

 

As of June 30, 2008, we had net loss from inception of approximately $5,622,000. Approximately $1,772,000 of the Company’s cumulative net losses are non-cash compensation charges. The cumulative net losses consist of approximately $603,000 which represents the estimated fair market value for the cost of wages, if paid, for services rendered by the Company’s former Chief Executive Officer, Controller and James Lambert, an outside financial consultant (we have recorded these amounts for the cost of wages and, since they did not charge the Company, as additional paid-in capital), $2,307,000 which represents professional fees such as legal and accounting expenses, $575,000 which represents a debt financing fee, $418,000 which represents officers, employees and directors compensation for which options to purchase common stock were issued, $593,000 which represents accrued officers compensation, and the balance of $1,126,000 consists primarily of payroll, occupancy and telecommunications costs including internet costs, net of approximately $2,000 in revenues. To date, Shadrack, the majority shareholder, has funded all of our expended costs, with the exception of short-term advances totaling approximately $436,000 made by other related parties since January 2007.

 

Since inception, the Company has been dependent on funding from Shadrack and other related parties for our current operations and for providing office space and utilities that for the six months ended June 30, 2008, averaged $23,000 per month in operating costs, exclusive of professional fees and officer compensation accrued but unpaid. Through June 30, 2008, the amount funded by Shadrack totaled approximately $1,487,000. On June 30, 2008, the balance due to Shadrack was approximately $1,030,000. The difference of approximately $457,000 was converted to common stock on February 15, 2005, when the Company’s Board of Directors authorized the conversion of all debt owed to Shadrack into 13,054,628 shares of restricted common stock at a conversion price of $0.035 per share. Shadrack has advised the Company that it will no longer continue to fund our operations. The Company received advances from a former pending purchaser of the Company, TCI Holdings, to fund operations during the six months ended June 30, 2008. TCI Holdings is no longer under any obligation to continue to advance funds to the Company, and therefore, the Company will have to obtain debt or equity financing from third parties in order to sustain operations.

 

Where practicable, we plan to contract with third party companies to outsource administrative support services that effectively support the growth of the business. These outsource providers handle technical support, telemarketing and the order taking process and media placement. We believe this strategy will minimize the number of employees required to manage our intended growth in the future.

 

 

 

On January 9, 2007, the Company signed a 12-month co-location agreement with Evocative, Inc. to house the Company’s search engine, servers and related equipment at Evocative’s data center in Emeryville, California. This agreement replaced a similar 13-month agreement which began in October 2003 and was continued on a month-to-month basis. The new agreement added a managed firewall service. The basic annual cost under this agreement was $35,988.

 

As a part of streamlining business operations, under the leadership of the previous CEO, Richard Lewis, in January 2008 the Company closed down its co-location facility and Internet hosting services for the Children’s Internet® provided by Evocative Data Center. Since the product was taken offline, sales efforts have been suspended until additional funds are invested to establish another data center and co-location facility to host the servers that run The Children’s Internet service. Additionally, the Company has terminated the Children’s Internet® support and content staff during this time. Prior to taking the Children’s Internet® service offline, the product was not being aggressively marketed due to the Company’s lack of resources to promote the product.

On March 1, 2007, the Company entered into an oral agreement to pay Tim T. Turner, the amount of $13,125 per month as a consultant until such time as Mr. Turner and the Company entered into an employment agreement. On April 2, 2007, the Company entered into an Executive Employment Agreement with Tim T. Turner, whereby Mr. Turner became the Director of Finance and Operations for the Company. This position was not deemed an executive officer position. Upon the Company obtaining Directors and Officers insurance, Mr. Turner would have been appointed an officer of the Company and made a member of the Company’s Board of Directors. Mr. Turner resigned his position with the Company effective on December 15, 2007. The agreement provided that Mr. Turner would receive a yearly salary of $157,500, part of which was to be deferred for a year, and if the Company was not able to pay such deferred compensation, it was to be evidenced by a promissory note and have an attached warrant.

On March 17, 2008, Mr. Turner informed the Company that amounts owed to Mr. Turner included a bonus of $78,750 and severance of $360,937.50, in addition to amounts accrued by the Company for Mr. Turner’s unpaid salary of $110,562 and consulting fees of $13,125.  The Company disputes the bonus and severance amounts claimed by Mr. Turner and intends to legally contest such disputed amounts in the event Mr. Turner further attempts collection.

 

On April 30, 2007, the Company and the Board of Directors adopted “The Children’s Internet, Inc. 2007 Equity Incentive Plan” (the “Plan”). The purpose of the Plan is to provide incentives to attract retain and motivate eligible persons whose present and potential contributions are important to the success of the Company by offering them an opportunity to participate in the Company's future performance through awards of Options, Restricted Stock and Stock Bonuses. Under the terms of the Plan, the Company has made available six million (6,000,000) Shares of the Company’s stock to be issued to Officers, Directors, Employees, Consultants and Advisors to the Company with certain restrictions as set forth in the Plan. The Plan will be administered by a Committee of the Board of Directors. The Plan will terminate ten years from the effective date of the Plan unless terminated earlier under terms of the Plan.

 

The Company’s office space in Pleasanton, California had been leased by our majority shareholder, Shadrack Films, Inc., which expired on April 30, 2007. From May 1 through July 15, 2007, we rented our office space on a month-to-month basis. The Company and the landlord could not reach an agreement on terms for a new lease and we vacated the premises on July 13, 2007, and moved into office space in San Ramon, California. This office space is leased by Nasser Hamedani, a related party, who we reimburse for the monthly lease payment of $1,762.

 

 

 

Through the date of this report, we have relied primarily on loans from Shadrack to fund all of our expenses. Shadrack has advised the Company that it is no longer able to provide funds to the Company. The Company entered into a Definitive Stock Purchase Agreement with TCI Holdings that, if executed would provide the Company with an infusion of approximately $5.3 million to pay Company debts and fund future operations. As discussed in Note 4 of the Company’s Financial Statements, there can be no assurance that this transaction will be consummated. If the transaction is not consummated, the Company will be required to obtain additional funds through private placements of debt or equity securities or by other borrowing. There is no assurance that such additional financing will be available when required in order to proceed with our business plan. Further, our ability to respond to competition or changes in the market place or to exploit opportunities will be significantly limited by lack of available capital financing. If we are unsuccessful in securing the additional capital needed to continue operations within the time required, we will not be in a position to continue operations. In this event, we would attempt to sell the Company or file for bankruptcy.

None.

Not applicable.

 

As of the end of the year 2007, we carried out an evaluation, under the supervision and with participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act. Based upon that evaluation, we concluded that our disclosure controls and procedures were ineffective to provide reasonable assurance that material 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 SEC rules and forms.

 

In making this evaluation, our Chief Executive Officer and Chief Financial Officer considered the material weaknesses discussed in Management’s Report on Internal Control Over Financial Reporting. Based on this evaluation, we concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of December 31, 2007 because of the identification of material weaknesses in our internal control over financial reporting. There have been no significant changes made in our internal controls or in other factors that could significantly affect our internal controls during the period covered by this report or subsequent to the end of the period covered by this report. Our size and limited financial resources prevent us from employing sufficient personnel currently to enable us to have an adequate segregation of duties within our internal control system.

 

The Company filed a cross-complaint against O&Y alleging breach of contract, professional negligence, negligent representation, and breach of good faith and fiduciary duty. The Company is seeking damages in an unspecified amount for costs, legal fees and losses incurred.

O&Y has vigorously disputed the claims set forth in the cross-complaint and has indicated its intention, should it prevail in its defense, to institute a malicious prosecution action against the Company, Nasser Hamedani, Sholeh Hamedani and Company counsel.

A cross-claim was filed in the Superior Court of California, County of Orange, Case No. 04CC11623 by the Company against O&Y, and the principal allegation is that O&Y was retained to assist its predecessor company in the purchase and acquisition of D.W.C. Installations with the expectation that D.W.C. had available free-trading shares such that the Company could immediately raise capital on the relevant markets and that in advising the Company through the purchase, O&Y failed to properly advise the Company as to the status of D.W.C. Installations and its shares which in fact were not free-trading. As a result of this conduct, the Company alleges damages in an unspecified amount but including purchase costs, extended operation costs, refiling costs, audit costs, legal fees, loan fees, lost market share, and costs for registration.

There is a contingent liability in connection with a Stock Purchase Agreement executed on October 11, 2002 between identified Shareholders and identified Purchasers. Under the terms of Stock Purchase Agreement, a payment of $150,000 is due to be paid into escrow in part consideration for purchase of the stock of D.W.C. Installations, Inc. The payment date is designated as 90 days from the date that the Company’s [D.W.C. Installations, Inc., a Nevada Corporation] shares of common stock become quoted on the over-the-counter bulletin board system. The shares were approved by NASDAQ OTC:BB to be quoted on the over-the-counter bulletin board system and a symbol was assigned on December 23, 2004. If this payment is not made, there could be exposure in connection with the identified shareholders’ efforts to collect the amounts allegedly due.

The Company was subject to a claim by Stonefield Josephson, Inc., the former accountants for the Company, seeking reimbursement costs for legal fees spent in connection with the Securities and Exchange Commission inquiry of the Company. Stonefield Josephson, Inc.’s claim seeks recovery of $29,412.74. The Company disputes any amounts owed because of a settlement agreement entered into between the respective parties in December 2004 effectively terminating their relationship. This matter was submitted to binding arbitration through AAA in January 2007. The arbitrator’s decision was issued on February 2, 2007, awarding Stonefield Josephson, Inc. the sum of $19,000 plus costs and fees in the amount of $1,425 due and payable March 15, 2007. The decision also awarded Stonefield Josephson, Inc. interest at the rate of 10% per annum from March 15, 2007. On August 30, 2007, an additional $2,500 in post-arbitration attorney’s fees and costs was awarded by the Los Angeles Superior Court. No amounts have been paid to Stonefield Josephson since the date of the Arbitrator’s decision.

On September 27, 2006, the Securities and Exchange Commission (“SEC”) filed a complaint in the United States District Court Northern District of California Case No. C066003CW, against among others the Company, and its CEO, Sholeh Hamedani, alleging against one or more defendants violations of Section 10(b) of the Exchange Act and Rule 10b-5, violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, 13a-13, violations of Section 13(b)(2)(A) of the Exchange Act by the Company, Violations of Section 13(b)(2)(B) of the Exchange Act by the Company, Violations of Section 13(b)(5) of the Exchange Act and Rule 13b2-1, 13b2-2, 13a-14, 16(a).

On February 25, 2005, we entered into a Consulting Agreement with Crosslink Financial Communications, Inc., of which William L. Arnold is the principal shareholder. Crosslink represented the Company in stockholder communications and public relations with existing shareholders, brokers, dealers and other investment professionals as to the Company's current and proposed activities, and in consulting with management. For undertaking this engagement the Company agreed to issue a “Commencement Bonus” payable in the form of 200,000 restricted shares of the Company's common stock. In addition, the Company agreed to a monthly stock compensation of 8,000 shares of common stock every month on the contract anniversary date, and a cash fee of $5,000 per month for the term of the Agreement. Out of this fee, Crosslink paid for complementary services (e.g., other mailing services, email services, database extensions) up to an average of $2,500 per month.

The agreement, which was originally for a term commencing February 25, 2005 and ending twelve months thereafter, was terminated at the end of December 2005 because there was a mutual desire for Mr. Arnold to be involved on a daily basis. Hence, on December 30, 2005, he was hired as the Company’s President. Beginning on September 1, 2006, Mr. Arnold took an unpaid leave of absence.

Subsequent to the filing of our Form 10-KSB on May 18, 2007, Mr. Arnold advised us that he disagreed with our position that his unpaid leave of absence was voluntary. Mr. Arnold informed us that he believed his leave of absence resulted from the Company’s breach of his Executive Employment Agreement. We have had discussions with Mr. Arnold in an effort to resolve the differences between the parties but, to date, have not reached agreement. On August 8, 2007, Mr. Arnold advised us that he intended to take legal action against the Company to enforce the terms of his Employment Agreement. Mr. Arnold claims $520,000 in damages from the Company. We believe that Mr. Arnold violated the terms of his Employment Agreement when he voluntarily left his position as President in September of 2006. We believe that we are only obligated to pay Mr. Arnold for back pay and bonus plus interest, for the period prior to September 2006. The total compensation that we believe is owed to Mr. Arnold as of June 30, 2008 is $89,274, which amount is reflected in our financial statements.

Adverse outcomes in some or all of the claims pending against us may result in significant monetary damages or injunctive relief against us that could adversely affect our ability to conduct our business. Although management currently believes that resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on our financial position or results of operations, the litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. There exists the possibility of a material adverse impact on our financial position and the results of operations for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

We are not aware of any other pending or threatened litigation that could have a material adverse effect on our business.

The Company had no “Unregistered Sales of its securities during the period covered by this report.

The Company has no Senior Securities.

None

On March 29, 2007, the Company entered into an agreement with the firm of Hunter & Renfro, LLP (formerly known as Hunter, Flemmer, Renfro & Whitaker, LLP) of Sacramento, California to replace Marc Lumer & Co. as the Company’s independent accountant. On May 14, 2006, the agreement was replaced with an agreement for Hunter & Renfro, LLP (formerly known as Hunter, Flemmer, Renfro & Whitaker, LLP) to audit the financial statements for the year ended December 31, 2006 and to re-audit the year ended December 31, 2005.

The following documents are filed as part of this Report:

(a)   Exhibits:

(b)   Reports on Form 8-K:

On February 12, 2008, the Company filed a Current Report on Form 8-K extending the closing date for the Definitive Stock Purchase Agreement (DSPA) with TCI Holding Company, LLC from January 31 to February 29, 2008.

On March 6, 2008, the Company filed a Current Report on Form 8-K extending the closing date for the DSPA from February 29 to March 15, 2008.

On March 21, 2008, the Company filed a Current Report on Form 8-K extending the closing date for the DSPA from March 15 to March 31, 2008.

On May 15, 2008, the Company filed a Current Report on Form 8-K to report the termination of the DSPA, the removal of Richard J. Lewis III as Chief Executive Officer and Chief Financial Officer, and the appointment of Tyler Wheeler as Acting Chief Executive Officer and Chief Financial Officer. It is not yet clear what impact the termination of the DSPA will have on the Company.

In accordance with the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.