IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

Tampa, Florida

CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009





 

CONTENTS

Board of Directors
Ideal Image Development, Inc. and Subsidiaries
Tampa, Florida


We have audited the accompanying consolidated balance sheets of Ideal Image Development, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders' deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ideal Image Development, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

Crowe Horwath LLP

Tampa, Florida

January 13, 2012

IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2010 and 2009

Nature and Organization of Business: Ideal Image Development, Inc. ("IIDI") is involved in the development, management and operation of treatment centers utilizing the IDEAL IMAGE® laser therapy system for the cosmetic services industry.

At December 31, 2010, the Company had 16 franchised centers (18 at December 31, 2009) and 49 company-owned centers (46 at December 31, 2009). In addition, the Company has collected $520,000 for initial franchise fees and deposits in connection with franchise agreements for new centers. Pending the opening of the related centers, the amounts are included in deferred revenue.

Principles of Consolidation: These consolidated financial statements include operating results of Ideal Image Development, Inc. and majority owned subsidiaries, Ideal Image Development, Corporation (100%), Ideal Image of Arizona, LLC (100%), Ideal Image of Georgia, LLC (100%), Ideal Image of Missouri, LLC (100%), Ideal Image Clinics of NC, LLC (75%), Ideal Ventures, Inc. (100%), Ideal Image of Wisconsin, LLC (100%), Ideal Image of Tennessee, LLC (100%), Ideal Image of FL, LLC (100%), Ideal Image of TX, LLC (100%), Ideal Image of NM, LLC (100%), Ideal Image of Idaho, LLC (100%), Ideal Image of Utah, LLC (100%), Ideal Image of Nevada, LLC (100%) and Ideal Image of NC, LLC (100%). All significant inter-company accounts and transactions have been eliminated. The non-controlling interest of Ideal Image Clinics of North Carolina LLC is immaterial and has not been separately presented in these financial statements.

In addition to the entities listed above, the consolidated financial statements include the operating results of Ideal Image Clinics, PLLC, Homansky Health Medical Group of Nevada, PC, Beyond Health Medical Group of North Carolina, Inc., Ideal Health Medical Group of Tennessee, LLC, and Ideal Health Medical Group of Wisconsin, LLC. The Company holds variable interests in, and is the primary beneficiary of expected gains and losses from, these entities. These entities were set up for licensing purposes. The Company bears the benefits and risks of loss from operating these entities through contractual agreements. The assets and liabilities are not material to the financial statements.

Franchise Operations: The Company grants franchises to private operations in exchange for an initial franchise fee and receives royalties based on a percentage of net sales. Franchise fees are deferred and recognized as income when substantial performance of franchisor obligations is complete. The Company typically receives an initial franchise fee ranging from $35,000 to $50,000 and a comprehensive system fee ranging from $160,000 to $215,000 for each location. These initial fees are recognized as revenue, less any amounts associated with royalty holidays (see below), when substantially all the initial services required by the franchise agreement have been performed (typically when the location is opened).

Services provided by the Company under franchise agreements include providing standard construction plans, interior layouts, equipment, furnishings and signage specifications, site selection assistance and review of final construction plans, initial training and planning and developing pre-opening and promotional programs. The Company recognizes site equipment sales revenue upon delivery of the equipment to the franchisee.

Royalties, which are based on monthly sales, are recognized as income on the accrual basis. The Company recognizes ongoing franchise royalty fees under its 10-year franchise agreements of 9% of monthly franchisee sales. Estimates at the end of each period are made based on historical sales reported for each store.

IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition - Clinic Operations: The Company recognizes clinic sales in relation to treatment packages sold at the company-owned clinic locations. The package provides for five initial treatments which occurs at ten week intervals, and allows for up to four additional treatments, as necessary, to obtain the desired results. Clinic sales revenue is recognized evenly over the average number of treatments provided. Remaining contractual revenue relating to unperformed services is included in Deferred Revenue on the balance sheet.

Deferred Revenue: Deferred revenue represents franchise fees and deposits of $520,000 and $745,100 at December 31, 2010 and 2009, respectively, as well as remaining clinic contractual treatments of $60,646,245 and $45,451,401 at December 31, 2010 and 2009, respectively, for which payment has been received or a customer financing receivable recorded. Deferred revenues are net of deferred finance fees totaling $4,244,578 and $3,011,768 at December 31, 2010 and 2009, respectively. These fees will be recognized in income as services are performed.

Deferred Customer Acquisition Costs: Commission costs directly related to the acquisition of guest contracts are deferred and recognized over the average number of treatments provided. As of December 31, 2010 and 2009, costs totaling $7,211,116 and $5,541,513, respectively, are deferred and expected to be expensed. The $7,211,116 customer acquisition costs at December 31, 2010 are expected to be expensed during the years ending December 31, 2011 and 2012 at $5,382,262 and $1,828,854, respectively.

Concentration of Credit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable.

Accounts Receivable: Accounts receivable consists of receivables due from franchisees for franchise and royalty fees and customer financing obligations for treatment contracts. For franchise and royalty fees, which totaled $771,019 and $1,168,144 at December 31, 2010 and 2009, respectively, the Company does not require collateral for its receivables; however, in certain instances they are secured by the underlying assets of specific franchises. Receivables related to customer financing obligations, which totaled $6,866,000 and $5,533,998 at December 31, 2010 and 2009, respectively, are typically less than the Company's related deferred revenue obligation with payments scheduled to occur in advance of the related treatments. Management performs ongoing credit evaluations of its franchisees and customer receivables and establishes an allowance for estimated bad debts when the potential for such uncollectible accounts becomes probable. Accounts receivable includes an allowance for doubtful accounts of $1,250,970 in aggregate at December 31, 2010 which includes $406,706 for franchisees and $844,264 for customers. The allowance of $408,281 at December 31, 2009 was related to franchisee receivables. In 2009, specific accounts were written off before year and in 2010 a provision was provided. The provision for bad debts included in cost of revenue and operating expenses was $849,179 and $265,135 for the years ended December 31, 2010 and 2009, respectively.

Property and Equipment: Property and equipment is recorded at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the assets or the shorter of the lease term or useful life for leasehold improvements and assets subject to capital leases.

IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

Goodwill: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment, and any such impairment is recognized in the period identified. Management has determined that there was a goodwill impairment of $1,545,000 in 2009. There was no such impairment in 2010. Goodwill at December 31, 2010 and 2009 includes approximately $445,742 and $18,753,000 resulting from acquisitions in each year, respectively (see Note 3).

The accumulated impairments of goodwill at December 31, 2010 and 2009 were $1,545,000.

Intangibles: Intangibles represents reacquired rights to trade name under franchise agreements measured on the basis of remaining contractual terms of the related contracts and amortized over the remaining contractual period of the contract in which the right was granted. Amortization expense for 2010 and 2009 was $142,851 and $90,438, respectively. Accumulated amortization was $233,413 and $90,438 at December 31, 2010 and 2009, respectively.

Amortization expense for the next five years is as follows:

Advertising: The Company expenses the costs of advertising as incurred. Advertising expense was $10,167,413 and $8,174,640 for the years ended December 31, 2010 and 2009, respectively.

Income Taxes: The Company files a consolidated federal income tax return that includes Ideal Image Development, Inc. and all of its subsidiaries. The Company's method for accounting for income taxes conforms to ASC Section 740, Accounting for Income Taxes. This method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting basis and tax basis of assets and liabilities. Valuation allowances, if any, are provided when a portion or all of a deferred tax asset may not be realized. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The Company adopted guidance issued by the FASB with respect to accounting for uncertainty in income taxes as of January 1, 2009. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The adoption had no affect on the Company's financial statements.

The Company and its subsidiaries are subject to U.S. federal income tax, as well as state income taxes in the respective states in which it operates in. The Company is no longer subject to examination by taxing authorities for years before December 31, 2007. The Company does not expect the total amount of unrecognized tax benefits to significantly change in the next 12 months.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company did not have any amounts accrued for interest and penalties at December 31, 2010 and 2009.

Stock Based Compensation: The Company recognizes the cost of employee services received in exchange for awards of equity instruments based on the fair value of those awards. Compensation expense in future periods is based on managements' determination of the equity instruments' fair value at the grant date and allocated to expense ratably over the applicable vesting periods.

Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles 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 income and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates used in preparing these financial statements include those assumed in determining the allowance for doubtful accounts, the estimated useful lives of property and equipment, the deferred tax valuation allowance and the fair value assessment used for goodwill impairment testing.

In order to facilitate the consistent operation and image of the Ideal Image brand, the Company has acquired a number of franchises from the franchisees. In 2010, the Company acquired three clinics due to defaults by the franchisees. In 2009, the Company acquired 6 clinics due to defaults by the franchisees. As provided for in the applicable Franchise agreement, these clinics were acquired by the Company from the franchisee by assuming the franchisee's obligations for deferred revenue, debt, lease and other commitments while also taking ownership of the clinic's assets. Any unpaid royalties or other obligations of the franchisee to the Company were written-off and are included in bad debts expense in the accompanying Consolidated Statements of Operations. In addition, in 2009 the Company acquired 23 clinics for total consideration of $8,366,000 by issuing subordinated promissory notes to the seller.

Each of these acquisitions has been accounted for as a purchase and, accordingly, the center's results of operations have been included in the accompanying consolidated financial statements since the respective acquisition dates. The purchase price for each acquisition was allocated to the fair value of assets acquired and liabilities assumed as follows:

The goodwill resulting from these acquisitions is associated primarily with the Company's market presence and leading position, growth opportunities in the markets which the Company operates, as well as the Company's experienced work forces and established operating infrastructures. Goodwill from these acquisitions is deductible for tax purposes.

The Company had losses in the previous three years which resulted in a shareholders' deficit position as of December 31, 2010. The 2009 losses were funded primarily through positive operating cash flow mainly from guest prepayments, as well as royalties from franchises. Management anticipates continued improvements in operations during fiscal year 2011 and beyond. Management acknowledges that improvement over the historical operating results is dependent upon the Company executing on their growth plan for additional clinic locations, as well as the Company owned clinics acquired in 2010 and 2009 achieving expected sales volumes in 2011. Management currently expects that cash flows from operations will be sufficient to fund working capital required for operations and clinic expansions.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's net deferred income taxes at December 31, 2010 and 2009 are as follows:

The components of the deferred tax assets and liabilities are as stated below:

NOTE 4 - INCOME TAXES (Continued)

A valuation allowance is required to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, management has determined that a valuation allowance of $5,110,108 and $6,754,888 at December 31, 2010 and 2009, respectively, is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. In addition, at December 31, 2010, the Company has a deferred tax liability of $436,536 due to tax amortization for goodwill (naked credit) that cannot be used to offset the net deferred tax assets in assessing the amount of valuation allowance. Therefore, the Company had a change in its valuation allowance of approximately $1,644,780 and $2,797,619, respectively, for the years ending December 31, 2010 and 2009. At December 31, 2010, the Company had federal and state net operating loss carry-forwards of $20,447,211 and $19,128,832, respectively, which will begin to expire in 2025. The difference between the Company's effective tax rate and the statutory tax rate primarily relates to the valuation allowance, state taxes, and non-deductible items.

The income tax expense is comprised of the following:

Property and equipment consisted of the following:

Depreciation expense for the years ended December 31, 2010 and 2009 was $1,857,719 and $2,404,212, respectively.

Long-term debt consists of the following as of December 31:

IDEAL IMAGE DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

NOTE 6 - LONG-TERM DEBT AND CREDIT FACILITY (Continued)

Long-term debt maturities are as follows: