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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 0-33519 

 

FITT HIGHWAY PRODUCTS, INC.

 

(Exact name of Registrant as specified in its charter)

 

Nevada 98-0360989
(State of Incorporation) (I.R.S. Employer Identification No.)

 

26381 Crown Valley Parkway, Suite 230, Mission Viejo, CA 92691

(Address of principal executive offices)

 

(949) 582-5933

(Issuer’s telephone number)

 

 

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 ý    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 ý

 

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 (Check one):

 

Large Accelerated Filer o Accelerated Filer o
   
Non-Accelerated Filer (Do not check if smaller reporting company) o Smaller Reporting Company ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o    No ý

 

As of August 19, 2013, there were 3,785,949 shares of our common stock issued and outstanding.

 

 

 
 

 

FITT HIGHWAY PRODUCTS, INC.

FORM 10-Q

JUNE 30, 2013

 

INDEX

 

     
Part I – Financial Information  
     
Item 1. Financial Statements   1
Item 2. Management’s Discussion and Analysis of Financial Condition or Plan of Operation   13
Item 3. Quantitative and Qualitative Disclosures about Market Risk   21
Item 4. Controls and Procedures   21
Item 4T. Controls and Procedures   21
     
Part II – Other Information  
     
Item 1. Legal Proceedings   21
Item 1A. Risk Factors   22
Item 2. Unregistered Sales of Equity Securities   22
Item 3. Defaults Upon Senior Securities   22
Item 4. Submission of Matters to a Vote of Security Holders   22
Item 5. Other Information   22
Item 6. Exhibits   22
     
Signatures   23
     
Certifications  

 

 

 

i
 

 

PART I -- FINANCIAL INFORMATION

ITEM I -- FINANCIAL STATEMENTS

 

FITT HIGHWAY PRODUCTS, INC.

BALANCE SHEETS

(UNAUDITED)

 

   June 30,
2013
   December 31,
2012
 
         
Assets        
Current assets        
Cash and cash equivalents  $    $  
Deferred financing costs   36,000     
Total current assets   36,000     
Property and equipment, net   154    208 
Total assets  $36,154   $208 
           
Liabilities, Redeemable Preferred Stock and Shareholders’ Deficit          
Current liabilities          
Accounts payable  $481,747   $810,560 
Accrued expenses   6,220    78,127 
Accrued compensation   1,476,703    1,280,232 
Notes payable   70,000    302,000 
Advances from related parties   482,601    380,103 
Total current liabilities   2,517,271    2,851,022 
Notes payable – long-term   202,067     
Total liabilities   2,719,338    2,851,022 
           
Redeemable Series A convertible preferred stock, $0.001 par value, 6,300,000 authorized, 105,000 and issued and outstanding, and redemption value of $315,000 at June 30, 2013 and December 31, 2012, respectively   315,000    315,000 
           
Shareholders’ deficit          
Preferred stock, $0.001 par value: 13,700,000 and 20,000,000 shares authorized and no shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively        
Common stock, $0.001 par value: 150,000,000 shares authorized, 2,035,949 and 1,554,249 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively   2,036    1,554 
Additional paid-in capital   29,703,093    29,566,251 
Accumulated deficit   (32,703,313)   (32,733,619)
Total shareholders’ deficit   (2,998,184)   (3,165,814)
Total liabilities, redeemable preferred stock and shareholders’ deficit  $36,154   $208 

 

 

See accompanying Notes to Financial Statements.

 

 

1
 

 

FITT HIGHWAY PRODUCTS, INC.

STATEMENTS OF OPERATIONS

(UNAUDITED)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2013   2012   2013   2012 
                 
Revenue – royalties  $252   $   $317   $ 
                     
Operating expenses:                    
Selling and marketing   848    1,026    2,317    2,127 
General and administrative   218,788    187,913    433,319    417,342 
Total operating expenses   219,636    188,939    435,636    419,469 
Operating loss   (219,384)   (188,939)   (435,319)   (419,469)
                     
Other (income) expense:                    
Interest expense   83,029    5,608    113,570    17,216 
Gain on extinguishment of debt and creditor obligations   (875)   (2,363,291)   (579,995)   (2,363,291)
Other expense, net   400    400    800    800 
Income (loss) before income taxes   (301,938)   2,168,344    30,306    1,925,806 
Income taxes                
Net income (loss)  $(301,938)  $2,168,344   $30,306   $1,925,806 
                     
Income (loss) per common share - basic  $(0.17)  $1.41   $0.02   $1.27 
Income (loss) per common share - diluted  $(0.17)  $1.37   $0.02   $1.25 
                     
Weighted average number of common shares used in basic calculations   1,759,795    1,533,919    1,674,765    1,511,918 
Weighted average number of common shares used in diluted calculations   1,759,795    1,586,996    1,779,765    1,538,457 

 

 

 

See accompanying Notes to Financial Statements.

 

 

2
 

 

FITT HIGHWAY PRODUCTS, INC.

STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Six Months Ended June 30, 
   2013   2012 
Cash flows from operating activities:          
Net income  $30,306   $1,925,806 
Adjustments to reconcile net income to net cash used in operating activities:          
Gain on extinguishment of debt and creditor obligations   (579,995)   (2,363,291)
Common stock issued for services rendered   9,000    24,369 
Depreciation   54    488 
Amortization of debt discount and beneficial conversion feature   102,050     
Changes in operating assets and liabilities:          
Deferred financing costs   (36,000)    
Accounts payable   38,948    109,713 
Accrued expenses   5,920    12,300 
Accrued compensation   196,471    192,686 
Notes payable   130,748     
Net cash used in operating activities   (102,498)   (97,929)
           
Cash flows from financing activities:          
Net advances from related parties   102,498    97,929 
Proceeds from issuance of notes payable, net of fees        
Net cash provided by financing activities   102,498    97,929 
           
Net change in cash and cash equivalents        
Cash and cash equivalents at beginning of period        
Cash and cash equivalents at end of period  $   $ 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $5,600   $4,916 
Cash paid for income taxes  $     
Supplemental disclosure of non-cash investing and financing activities:          
Beneficial conversion feature in convertible promissory notes payable  $18,374   $ 
Issuance of common stock in connection with debt settlement  $37,340   $128,000 
Issuance of preferred stock to reduce advances to related parties  $   $315,000 

 

 

See accompanying Notes to Financial Statements.

 

 

3
 

 

FITT HIGHWAY PRODUCTS, INC.

NOTES TO FINANCIAL STATEMENTS

June 30, 2013

(UNAUDITED)

 

1. Business

 

Business

FITT Highway Products, Inc. (the “Company”) is in the business of the manufacturing (on an outsource basis), distribution and sale of energy drinks. Our current active product is a two-ounce energy shot named “F.I.T.T. Energy for Life” (the “FITT Energy Shot”).

 

We have significant debt that was incurred, for the most part, under previous management. As a result of this significant debt, and other factors, third parties performing marketing, production and fulfillment services have been unwilling to enter into agreements directly with us. In addition, we have been unable to attract necessary investment dollars to conduct operations. Therefore, effective August 12, 2010 we entered into an operating agreement (the “Operating Agreement”) with F.I.T.T. Energy Products, Inc. (“FITT”), a separate entity controlled by certain of our investors and management and whose largest shareholder is our CEO. Under the agreement, FITT is performing a majority of the operating functions for the FITT Energy Shot, and is recording all related results of operations. In exchange, FITT is obligated to pay us a royalty of $0.05 per bottle sold of the FITT Energy Shot.

 

Reverse Stock Split

On November 29, 2012, our Board executed a unanimous written consent authorizing and recommending that our stockholders approve a proposal to institute a one-for-sixty (1:60) reverse stock split. On the same day, holders of a majority of the voting power of all shares of our common and preferred stock entitled to vote, by written consent in lieu of a special meeting of our stockholders, approved the following action: perform a one-for-sixty (1:60) reverse stock split of our issued and outstanding shares of common stock and preferred stock while maintaining the number of authorized shares at 150,000,000 shares of Common Stock and 20,000,000 shares of Preferred Stock (the “Reverse Split”). On January 13, 2013 we filed with the Securities and Exchange Commission (“SEC”) a Schedule 14C Definitive Information Statement notifying our shareholders of the Reverse Split and on January 23, 2013 such notice was mailed to our shareholders. The reverse split became effective February 15, 2013. All references to shares and per share information in these financial statements have been restated to give effect to the Reverse Split.

 

Merger with FITT

In 2012, FITT proposed negotiating a business combination with us and, on November 5, 2012, our Board of Directors approved commencing formal negotiations with FITT in this regard. On June 12, 2013, the Board, by unanimous written consent, recommended that our stockholders approve the Company entering into a Merger and Reorganization Agreement (the “Merger Agreement”) with FITT and on June 12, 2013, holders of a majority of the voting power of all shares of our common and preferred stock entitled to vote, by written consent in lieu of a special meeting of our stockholders, approved the following action: entry into the Merger Agreement with FITT whereby FITT will be merged into the Company, with the Company being the surviving entity (the “Merger”). The Merger Agreement, which was publicly announced on June 19, 2013, was entered into without having begun or completed an independent valuation of FITT. In order to enter into the Merger Agreement, FITT required that we mitigate our debt to their satisfaction which we have done. Since the beginning of our debt compromise program in early 2010, through the June 30, 2013 we have reduced our balance sheet debt nearly $5.2 million through debt settlement or write-off and through conversion of debt to equity. The Merger Agreement itself requires that FITT be valued at a number at least nine (9) times that of the Company. If the valuation is less than that, FITT has the right to terminate the Merger.

 

On June 27, 2013, FITT retained Aranca US Inc. to perform a business valuation for FITT. On June 27, 2013 we filed with the SEC a Schedule 14C Preliminary Information Statement, which was revised on July 13, 2013, to notify our shareholders of the Merger. If and when approved, we anticipate such notice will be mailed to our shareholders during August 2013 and that the Merger will become effective in September 2013, after the applicable waiting period. However, no assurances can be made that the time-frame indicated will be met or the merger will be completed based on the terms outlined.

 

4
 

Management’s Plan of Operations

Our revenues, and related cash flow, are presently limited to the receipt of royalties from FITT of $0.05 per bottle sold of the FITT Energy Shot. FITT is not obligated to pay us royalties for any additional products it has developed and funded. As such, we are currently dependent upon the success of FITT’s operating capabilities with respect to the FITT Energy Shot. If and when the Merger becomes effective, the Company’s balance sheet, operating results and cash flows will be combined with those of FITT.

 

We have not generated significant revenues for the three- and six-month periods ended June 30, 2013 and 2012, respectively. This was primarily due to a lack of operating capital and our Operating Agreement with FITT.  For the six months ended June 30, 2013 and 2012, we experienced net income of approximately $30,000 and $1,926,000, respectively, principally as a result of gains from our continuing debt compromise program. Excluding said non-cash gains, we continued to incur significant operating losses in the first six months of 2013 and 2012, and continue to have a significant working capital deficit. We intend to continue to attempt to compromise our remaining debt. These factors raise substantial doubt about our ability to continue as a going concern.

 

Management continues to seek capital through various sources. On June 10, 2013 we entered into a Financial Advisory & Investment Banking Agreement with CIM Securities, LLC (“CIM”). Under the agreement, CIM will attempt to raise a maximum of $5.0 million for us on a best efforts basis. Subsequent to June 30, 2013, together with CIM, we completed a private placement memorandum for $1.0 million in bridge loan financing. Once the merger with FITT is finalized, CIM will turn its efforts to the $5.0 million offering. See Note 12 for additional information. In addition, on August 13, 2013, we entered into an agreement with a corporation to sell 1,250,000 shares of our common stock for $250,000. See Note 13.

 

The financial statements have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities in the normal course of business.  The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets and liabilities that might result from the outcome of this uncertainty.

 

2. Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

The financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal year 2012 as reported in our Form 10-K have been omitted.  In the opinion of management, the financial statements include all adjustments, consisting of normal recurring accruals necessary to present fairly our financial position, results of operation and cash flows.  The results of operations for the three- and six-month periods ended June 30, 2013 are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with the financial statements and related notes which are part of our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Net Income Loss per Share

Basic and diluted net income (loss) attributable to common stockholders per share is calculated by dividing the net income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding during the period. At June 30, 2013 and 2012, we had outstanding warrants to purchase zero and 4,319 common shares, respectively. The exercise prices of all warrants were in excess of the average closing price of our common stock during the three- and six-month periods ended June 30, 2013 and 2012. At June 30, 2013 and 2012, we had 105,000 shares of redeemable preferred stock, which were issued in May 2012, convertible into an equal amount of our common shares. The weighted average number of shares of common stock of the convertible preferred stock were included in the calculation of diluted net income for the following periods – three months ended June 30, 2012 (53,077 shares), six months ended June 30, 2013 (105,000 shares), and six months ended June 30, 2012 (26,538 shares) – but excluded from the three months ended June 30, 2013 as the shares would be anti-dilutive due to the net loss in that period.

 

5
 

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. Actual results could materially differ from those estimates.

 

We are not aware of any recently issued, but not yet effective, accounting pronouncements that would have a significant impact on our financial position or results of operations.

 

New Accounting Pronouncements

The Financial Accounting Standards Board issues Accounting Standard Updates (“ASUs”) to amend the authoritative literature in Accounting Standards Codification (“ASC”). There have been a number of ASUs to date that amend the original text of ASC. We believe those issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to our Company or (iv) are not expected to have a significant impact on us.

 

3. Debt Compromise Program

 

As stated in Note 1, we have significant debt that was incurred, for the most part, under previous management, and we are continuing with our program to compromise this debt in a substantial way. Our goal is to settle the debt at an overall rate of no more than $0.10 per one dollar of debt. During the six months ended June 30, 2013, we finalized settlement agreements with certain of our creditors. In addition, we determined that the statute of limitations for certain of our creditors to enforce collection of any amounts they might be owed has now, or will soon elapse. We have written off those accounts for which the statute of limitations has expired. The Company reviewed any claims or liens on these accounts before mitigation. Based on our negotiations and determinations, we have during the six months ended June 30, 2013, or may in the near future, reduce our balance sheet debt as shown below (exclusive of conversion of convertible notes discussed in Note 7):

 

   June 30,
2013
   Future Periods 
Accounts payable  $317,761   $6,809 
Accrued expenses   77,827     
Notes payable   302,000     
   $697,588   $6,809 

 

Debt reductions shown above include $653,406 in settled obligations and $44,182 due to the expiration of statute of limitations on creditor obligations. Amounts expected to be compromised in future periods identified above are dependent on the ability of creditors to enforce collection after certain statute of limitations expire. Management cannot make any assurances that such conditions will be met. As of June 30, 2013, under the condition that the statute of limitations continues to pass on certain creditor balances, we anticipate the future period write-offs of $6,809 will be made during the three months ended September 30, 2013.

 

Our remaining debt totals approximately $2.7 million as of June 30, 2013. Of this, $1,328,958 is owed to our officer and employee for accrued and unpaid salaries and advances (inclusive of accrued payroll taxes), $282,755 is owed for delinquent payroll taxes, and $224,168 is owed to our legal counsel.

 

4. Accounts Payable

 

During the six months ended June 30, 2013, we wrote-off $44,182 in accounts payable as a result of the expiration of the statute of limitation for creditors to enforce collection of their debt. In addition, we finalized and funded agreements to settle certain accounts payable obligations totaling $273,579 for consideration totaling $47,393 ($41,053 in cash and 31,700 shares of common stock valued at $6,340). We also expect to write-off an additional $6,809 in accounts payable in future periods due to the expiration of the statute of limitations to enforce collection. Such write-offs are dependent upon the absence of additional claims on aged balances expected to be written off.

 

6
 

Accounts payable at June 30, 2013 consists of the following:

 

Owed to ongoing vendors  $321,580 
Owed from prior settlements   100,000 
Owed – attempting to settle   53,358 
To be written-off in future periods due to statute of limitations to expire (Note 3)   6,809 
   $481,747 

 

Amounts owed to ongoing vendors are mainly the result of obligations for legal, accounting and outside director fees which are necessary to maintain our status as a fully reporting public company.

 

5. Accrued Expenses

 

Accrued expenses consist of the following at:

 

   June 30,
2013
   December 31,
2012
 
Accrued interest – convertible promissory notes  $5,920   $ 
Accrued interest – note payable to Distributor       40,327 
Other   300    37,800 
   $6,220   $78,127 

 

During the six months ended June 30, 2013, we finalized and funded a settlement agreement for our Note Payable – Distributor settlement (to which the $40,327 accrued interest relates) and for our Note Payable – Trademark settlement (to which $37,500 of other accrued expenses relates). See Note 7 for additional information.

 

6.

Accrued Compensation

 

Accrued compensation consists of the following at:

 

   June 30,
2013
   December 31,
2012
 
Accrued officers compensation  $790,851   $669,117 
Other accrued compensation   262,383    210,230 
Accrued payroll taxes – delinquent   282,755    277,800 
Accrued payroll taxes on accrued payroll (not yet due)   140,714    123,085 
   $1,476,703   $1,280,232 

 

Due to a continuing lack of capital, we have been unable to pay the majority of the compensation owed to our officers and employees. In addition, in 2007 and 2008, our prior management did not pay certain federal and state payroll tax obligations and they became delinquent. The delinquent tax amounts shown above consist of:

 

   June 30,
2013
   December 31,
2012
 
Federal – trust fund portion  $107,334   $107,334 
Federal – interest and penalties   79,364    75,809 
State – trust fund portion   64,913    64,913 
State – interest and penalties   31,144    29,744 
   $282,755   $277,800 

 

7
 

In October 2010, the IRS filed a federal tax lien against us in the amount of $136,678 related to past-due payroll taxes. Also in October 2010, the IRS served FITT with a Notice of Levy in the amount of $152,974 attaching all royalty payments payable to us by FITT over and above $83,166, which was the amount owed by us to FITT as of October 15, 2010. The amount of the levy represents the amount of the IRS tax lien noted above plus statutory additions. Through our legal counsel, we are actively attempting to work with the IRS and Franchise Tax Board to mitigate these liabilities; however, until such time that formal agreements are in place, penalties and interest will continue to accrue on past due balances.

 

7.

Notes Payable

 

Notes payable consists of the following at:

 

   June 30,
2013
   December 31,
2012
 
Convertible promissory notes – debt acquisition          
Notes payable – at maturity date  $269,002   $ 
Debt discount – remaining on-issuance discount   (62,878)    
Debt discount – beneficial conversion feature (“BCF”)   (4,057)    
Convertible promissory notes – Integrity   20,000     
Convertible promissory note – Legal Counsel   50,000     
Note payable – distributor settlement       202,000 
Note payable – trademark settlement       100,000 
Subtotal   272,067    302,000 
Less current portion   (70,000)   (302,000)
Long-term portion  $202,067   $ 

 

Convertible Promissory Notes – Debt Acquisition

In 2010 we initiated a program to compromise our debt. In furtherance of this program, during the first quarter of 2013 we entered into Debt Acquisition Agreements (“Debt Agreements”) with two parties affiliated with each other (the “Debt Funders”). The Debt Funders agreed to fund a total of $150,000 to an escrow account, which amount was to be used to compromise our debt, either through our direct settlement with particular creditors or through the Debt Funders’ acquisition of certain debt for a compromised amount. In the cases where the Debt Funders acquired debt from creditors, the Debt Funders agreed to provide us with a release from the debt they acquired. Any funds not used to compromise our debt are to be returned to the Debt Funders. During the six months ended June 30, 2013, funds totaling $147,001 had been used to compromise debt and, in connection with the Debt Agreements, we issued convertible promissory notes to the Debt Funders totaling that amount.

 

The notes bear interest at 10% per annum and are repayable at two times the principal amount of the notes. Repayment is to be made by conversion into shares of our common stock based on a 20-day volume weighted average price with the following minimums and maximums, both prior and subsequent to the proposed business combination discussed in Note 1:

 

  Prior to Proposed Business Combination (limited to 20% of note principal)   Subsequent to Proposed Business Combination
Minimum conversion $0.25 per share   Based on $10 million market valuation
Maximum conversion None   Based on $36 million market valuation

 

8
 

If any portion of the notes is not converted into our common shares eight (8) months from the issuance date of each note, the non-converted portion of the notes will be automatically converted as described above. The notes have been classified as long-term debt in the accompanying balance sheet at June 30, 2013 since the method of repayment is conversion into common stock.

 

During the first six months of 2013 the Debt Funders converted a total of $25,000 of the amount of their notes payable at maturity ($12,500 in original funding) into 100,000 shares of our common stock at the minimum conversion rate of $0.25 per share, leaving an original principal balance of $134,501 ($269,002 payable at maturity). As of June 30, 2013, funds totaling $2,999 were still in escrow and had not yet been used.

 

The additional principal of $134,501 is being accreted on a straight-line basis over the eight month terms of the notes. During the three and six months ended June 30, 2013, $63,817 and $84,123, respectively, was charged to interest expense in connection with this accretion.

 

Additionally, we determined that the notes contain a BCF since the effective conversion price, after giving consideration to the repayment terms of two times principal, was less than the market value of our common stock on the measurement dates. The BCF totaling $21,984 was accounted for as debt discount and is being amortized on a straight-line basis over the eight month terms of the notes. During the three and six months ended June 30, 2013, $12,263 and $17,927, respectively, was charged to interest expense in connection with the amortization of the BCF with $4,057 remaining to be amortized.

 

Convertible Promissory Notes – Integrity

During the first quarter of 2013, we became obligated to issue convertible promissory notes totaling $10,000 to Integrity Media under a Service Agreement. See Note 12 for a description of the terms of the agreement.

 

Convertible Promissory Notes – Legal Counsel

On June 14, 2013 our Board of Directors approved the issuance of a $100,000 convertible unsecured note to our legal counsel, Horwitz, Cron & Amrstrong, LLP (“HCA”) in exchange for an accounts payable owed to them in the same amount for legal services they previously performed. The note, which bears no interest unless an event of default occurs, has a term of one year from its effective date of January 15, 2013. Under the terms of the note, at any time prior to the due date of the note, HCA may convert all or a portion of the note at a fixed conversion price of $0.50 per share. If the price of our common stock is over $2.00 per share for five consecutive trading days during the term of the note, the remaining outstanding balance shall be automatically converted into our common shares at $0.50 per share. On June 18, 2013, HCA converted $50,000 of the note into 100,000 shares of our common stock. Subsequent to June 30, 2013, HCA converted the remaining note balance of $50,000 into 100,000 shares of our common stock.

 

Note Payable – Distributor Settlement

This note payable arose from a February 1, 2008 settlement agreement with Christopher Wicks (“Wicks”) and Defiance U.S.A., Inc., under which we agreed to pay Wicks the sum of $252,000 under a payment schedule detailed therein, with the final payment due February 2010. Interest was to accrue at 5% per annum beginning in August 2008. We had made payments totaling $50,000. During the first quarter of 2013, we settled the debt and related accrued interest (see Note 5) for $20,200 resulting in a gain on extinguishment of approximately $222,000. At December 31, 2012, the outstanding balance of $202,000 was classified as a current liability in the accompanying balance sheet.

 

Note Payable – Trademark Settlement

This note payable arose from a March 4, 2009 settlement agreement with Who’s Ya Daddy, Inc. (“Daddy”) concerning an alleged infringement on a trademark of Daddy. The settlement amount totaled $125,000 with no provision for interest and called for $25,000 to be paid immediately with additional payments of $10,000 to be made every 60 days, beginning April 30, 2009, until the obligation was fully paid. Only the initial payment of $25,000 was made. During the first quarter of 2013, we were able to negotiate and fund a settlement of this debt for a total value of $50,000 ($25,000 cash and 100,000 shares of our common stock valued at $0.25 per share). The shares were fully vested on March 5, 2013, the date of issuance. During the six months ended June 30, 2013, we extinguished this debt along with the related accrued expense described in Note 5, and recorded an overall gain on extinguishment of $87,500. As of December 31, 2012, the outstanding balance of $100,000 was classified as a current liability in the accompanying balance sheet.

 

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8. Related Parties

 

As previously discussed, we have limited capital resources and liquidity.  As a result, during the periods covered by this report, related parties advance funds to us in order for us to pay certain obligations. Advances from related parties consist of the following at:

 

   June 30,
2013
   December 31,
2012
 
Advances from CEO  $135,010   $117,403 
Advances from FITT   332,591    247,700 
Advances from Shareholder   15,000    15,000 
   $482,601   $380,103 

 

Advances from our CEO consist of monies advanced personally by him or through a company he owns. In addition, during the periods covered by this report, we received advances from FITT, an entity controlled by certain of our investors and management and whose largest shareholder is our CEO. The advances from related parties are due upon demand, are expected to be settled within one year, and therefore do not incur interest.

 

Activity in advances from related parties during the six months ended June 30, 2013 and the twelve months ended December 31, 2012 consists of the following:

 

  

Six Months

Ended 2013

  

Twelve Months

Ended 2012

 
Balance beginning of period  $380,103   $480,238 
Increases:          
Net advances   102,498    184,865 
Cancellation of Notes Payable – Bridge Loans       50,000 
Decreases:          
Funds repaid by FITT       (315,000)
Write-off advances from former officer       (20,000)
   $482,601   $380,103 

 

While our Operating Agreement with FITT requires that it makes royalty payments to us based on sales of the FITT Energy Shot, royalties earned to date have been insignificant. Until FITT begins making significant sales of the FITT Energy Shot, any royalty payments we receive will not be large enough to reduce in any meaningful way the amount we owe FITT. Therefore during the 2012 year, FITT requested that we reduce the amount we owe them and on May 15, 2012, we issued 105,000 shares of our preferred stock, valued at $315,000, to FITT as a partial reduction of the debt we owed them. Also during the 2012 year, we extinguished $20,000 in advances from a former officer after determining that the statute of limitations for the enforcement of debt collection had expired

 

9. Litigation

 

Oswald & Yap

On January 13, 2012, a complaint was filed against us in the Superior Court of the State of California, County of Orange, by Oswald & Yap LLP (“Oswald”).  The complaint, which was for unpaid legal services in the amount of $40,734, also named our CEO and FITT as defendants.  Our CEO, as an individual, and FITT, as a company, were never a party to any agreement with Oswald.  Effective October 17, 2012, we entered into an Agreement for Use of Stipulation for Judgment under which we agreed to pay Oswald $25,000 no later than December 17, 2012 and Oswald agreed to release all defendants, but we were unable to make the required payment.

 

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On October 12, 2012, attorneys for our CEO and FITT filed a Motion for Summary Judgment, essentially requesting they be dismissed from the case. On January 30, 2013 we, along with our CEO and FITT, reached a settlement with Oswald whereby Oswald would drop litigation against all defendants and release them from any and all obligations, and the defendants agreed not to attempt to collect from Oswald legal fees and costs related to this matter. In connection with this settlement, during the first quarter of 2013 we recorded a gain on extinguishment of debt in the amount of $32,711.

 

10. Capital Stock

 

Preferred Stock

We have authorized the issuance of a total of 20,000,000 shares of our preferred stock, each share having a par value of $0.001. At December 31, 2011 we had not issued any preferred stock. On May 15, 2012, our Board of Directors agreed to issue 105,000 shares of our preferred stock, designated as Series A, to FITT as a reduction of $315,000 in debt we owed them. We valued the Series A preferred stock at $3.00 per share, which represented a slight premium over the then 30-day volume weighted average price (“VWAP”) for our common shares of $2.70 per share, due to the rights attached to the preferred shares.

 

The Series A preferred stock has been designated with the following rights:

 

  Voting rights – each share has ten votes.
  Conversion – each share is convertible, at the option of the holder, into our common shares on a one for on (1 for 1) basis.
  Redemption – each share is redeemable ten years from the date of issuance, or sooner at the option of the holder, at the rate of $3.00 per share.
  Liquidation – upon liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, each share shall be preferred in order of payment to the holders of the Company’s common stock at a rate of $3.00 per Series A share.
  Dividend rights – none.

 

Since the preferred stock is contingently redeemable by FITT, it has been classified as temporary equity in the accompanying balance sheet as of June 30, 2013 and December 31, 2012.

 

Common Stock

We have authorized the issuance of 150,000,000 shares of our common stock, each share having a par value of $0.001. Following is the activity for our shares of common stock during the six months ended June 30, 2013:

 

   Shares    
Shares outstanding December 31, 2012   1,554,249    
Issuances for settlement of debt:        
Accounts payable   31,700   See Note 4
Notes payable   100,000   See Note 7
Issuances for services:        
Financial advisory and investment banking   100,000   See Note 12
Investor relations   50,000   See Note 12
Conversion of convertible notes payable   200,000   See Note 7
Shares outstanding June 30, 2013   2,035,949    

 

General and administrative expenses include $9,000 for the three and six months ended June 30, 2013 in connection with the issuance of shares for services shown in the table above. During the six months ended June 30, 2012, we recorded general and administrative expense for shares issued for investor relations and litigation support services.

 

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11.       Gain on Extinguishment of Debt and Creditor Obligations

 

The following is a summary of the components of the gain on extinguishment of debt and creditor obligations for the three and six months ended June 30, 2013:

 

  

Three Months

Ended

June 30, 2013

  

Six Months

Ended

June 30, 2013

 
Settlement agreement – Notes Payable – Distributor Settlement (Note 7)  $   $222,127 
Settlement agreement – Notes Payable – Trademark Settlement (Note 7)       87,500 
Settlement agreements – Accounts Payable creditors (Note 4)       226,186 
Write-off Accounts Payable for expiration of statute of limitations (Note 4)   875    44,182 
   $875   $579,995 

 

12. Agreements

 

Integrity Media Agreement

On January 28, 2013, we entered into an agreement with Integrity Media (“Integrity”) to provide investor relations services. Under the agreement, which has a term of twelve (12) months, we agreed to make monthly payments to Integrity of $2,500 cash and a convertible promissory note of $10,000 (total monthly value of $12,500) during the agreement’s first three (3) months. During the final nine (9) months of the agreement, we agreed to pay Integrity a monthly amount of $5,000 cash and $10,000 in a convertible promissory note (total monthly value of $15,000). The convertible promissory notes, which contain no provision for interest, are convertible into our free-trading common shares based on a 20-day volume weighted average price with floor and ceiling conversion prices equal to a $10 million company market valuation and a $36 million company market valuation, respectively. Each note is convertible six months from the date of the note. The agreement is cancelable by either party on 30 days’ written notice. On March 28, 2013, we informed Integrity that we have taken a sabbatical with regard to the agreement and will not accrue any additional fees.

 

During the six months ended June 30, 2013, we recorded a general and administrative expense totaling $25,000 in connection with this agreement ($5,000 in cash and $20,000 in a convertible promissory note).

 

CIM Securities, LLC

On June 10, 2013, we entered into a Financial Advisory & Investment Banking Agreement with CIM Securities, LLC (“CIM”) under which CIM agreed to act as lead investment banker, financial advisor, and lead placement agent for up to $5.0 million in a Reg. D offering on a best effort basis. The agreement which contemplates the merger with FITT discussed in Note 1, has a term of six months. FITT is also a party to the agreement. Subsequent to June 30, 2013, together with CIM, we completed a private placement memorandum for $1.0 million in bridge loan financing. Once the merger with FITT is finalized, CIM will turn its efforts to the $5.0 million offering.

 

As compensation for the CIM services, the Company agreed to pay CIM an initial fee of $40,000 and 100,000 restricted shares of the Company’s restricted common stock which CIM agreed to purchase for $200.00. The $40,000 fee is payable as follows: $10,000 upon execution of the agreement, $10,000 upon completion of CIM’s due diligence, $10,000 for the introduction to an investor relations firm retained by us, and $10,000 payable from the proceeds of any funding resulting from CIM’s efforts. The shares were issued to CIM and a designee on June 27, 2013 and were fully vested on issuance. We have accounted for the fees and stock issuance as deferred financing costs which will be amortized in future periods over the term of any financing obtained.

 

For capital raised through the efforts of CIM, the Company agreed to pay CIM the following cash fees:

 

·Placement fee equal to ten percent (10.0%) of the aggregate gross cash proceeds received by the Company from contacts identified by CIM
·Placement fee equal to five percent (5.0%) of the aggregate gross cash proceeds received by the Company from contacts identified by the Company
·Non-accountable expense allowance, due diligence and marketing fee equal to three percent (3.0%) of the aggregate gross cash proceeds received by the Company

 

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The Company also agreed to issue a placement agent warrant to CIM equal valued at ten percent (10.0%) of the gross proceeds of the Reg. D offering. The warrant will contain a “cashless” exercise provision and be exercisable over a five-year period at a price equal to the effective price of the Reg. D offering. The warrants will contain full piggyback registration rights on any future Registration Statement.

 

Acorn Management Partners

On June 20, 2013, we entered into an Investor Relations and Consulting Agreement with Acorn Management Partners, LLC (“Acorn”) to provide us with various investor and public relations services. The term of the agreement is one year, but we may terminate the agreement effective at the end of the first three month period, or any monthly period thereafter, by giving, within the applicable period, no less than seven calendar days’ notice to the end of the period. We agreed to pay Acorn, during the first three-month period of the agreement, cash of totaling $30,000 (payable on a schedule as outlined in the agreement) along with 50,000 shares of our common stock. The shares were issued June 20, 2013 and were vested on issuance.

 

During the three and six months ended June 30, 2013, we recorded a general and administrative expense totaling $33,000 in connection with this agreement consisting of $30,000 in cash obligations and $3,000 in common stock. The common stock was valued based on the market price of the shares on the date of issuance.

 

13. Subsequent Events

 

On August 13, 2013 we entered into an agreement with a corporation to sell 1,250,000 shares of our common stock for $250,000 ($0.20 per share).

 

Concurrent with the stock sale, we entered into an agreement with a second corporation (the “Distributor”) under which the Distributor would have an exclusive right to develop a market in Asia for us. The Distributor has extensive contacts and business relationships in Asia and in Asian communities in the U.S. The initial exclusive right shall be for a six-month period with the understanding that, if results are acceptable to both parties, they will utilize their best efforts to negotiate and execute an additional definitive agreement at the end of this initial six months. As consideration for the Distributor providing services to establish an Asian market for us, we issued 450,000 of our common stock to them which were fully vested on August 13, 2013, the date of issuance, and which will be released to Distributor on an agreed-upon schedule. We expect to record a stock-based marketing expense in 2013 based on the value of the shares issued.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF OPERATION

 

Disclaimer Regarding Forward-Looking Statements

 

Our Management’s Discussion and Analysis contains not only statements that are historical facts, but also statements that are forward-looking (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934).  Forward-looking statements are, by their very nature, uncertain and risky. These risks and uncertainties include international, national and local general economic and market conditions; demographic changes; our ability to sustain, manage, or forecast growth; our ability to successfully make and integrate acquisitions; raw material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other risks that might be detailed from time to time in our filings with the Securities and Exchange Commission.

 

Although the forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by them.  Consequently, and because forward-looking statements are inherently subject to risks and uncertainties, the actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements.  You are urged to carefully review and consider the various disclosures made by us in this report and in our other reports as we attempt to advise interested parties of the risks and factors that may affect our business, financial condition, and results of operations and prospects.

 

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Description of Business

Our business is the manufacturing (on an outsource basis), distribution and sale of energy drinks. Our current active product is a two-ounce energy shot named “F.I.T.T. Energy for Life” (the “FITT Energy Shot”). We have significant debt that was incurred, for the most part, under previous management. As a result of this significant debt, and other factors, third parties performing marketing, production and fulfillment services have been unwilling to enter into agreements directly with us. In addition, we have been unable to attract necessary investment dollars to conduct operations. As more fully discussed in the Operations section below, effective August 12, 2010 we entered into an Operating Agreement with F.I.T.T. Energy Products, Inc. (“FITT”), a separate entity controlled by certain of our investors and management and whose largest shareholder is our Chief Executive Officer (“CEO”). Under the agreement, FITT is performing a majority of the operating functions for the FITT Energy Shot, and is recording all related results of operations. In exchange, FITT is obligated to pay us a royalty of $0.05 per bottle sold of the FITT Energy Shot.

 

Our cash flow is presently limited to receipt of advances and royalty revenue from FITT. As such, we are currently dependent upon the success of FITT’s operating capabilities with respect to the FITT Energy Shot. FITT’s requirement to pay royalties of $0.05 per bottle sold of the FITT Energy Shot is first subject to an IRS Notice of Levy in the amount of $152,974. The Notice of Levy attached all royalty payments payable to us by FITT over and above $83,166, which was the amount owed by us to FITT as of October 15, 2010. Note that FITT is not obligated to pay us royalties for any additional products it has developed and funded. As for advances, FITT has made advances to us, net of repayments, using funds it obtained from its own investors, of $332,591 as of June 30, 2013 to pay our basic operating expenses such as rent, insurance, legal, accounting, public filing and investor relations costs. FITT was not required to make these advances, but elected to do so as we try to mitigate our debt and restructure our business. FITT is not obligated to make any additional advances and there can be no assurance that FITT will advance us additional funds beyond what has already been advanced.

 

As discussed in Note 1 to the accompanying financial statements, on June 12, 2013 we entered into a Merger Agreement with FITT. The completion of the merger is subject to a minimum valuation of FITT and FITT has retained Arcana US Inc. to perform the valuation. If the terms of the merger are met, we expect it will be completed in September 2013 after giving our shareholders appropriate notification and filing required reports with the SEC. Once completed, our operations will be combined with those of FITT.

 

Products

Energy Shots

Our current active product, the FITT Energy Shot, was designed in collaboration with Dr. Rand Scott, a Board Certified Anesthesiologist and Pain Management Specialist.  Dr. Scott incorporated a number of unique ingredients into the product which allows for the use of lower levels of caffeine. We believe that higher levels of caffeine may be unhealthy and potentially dangerous for our consumers, especially for adolescents or people with blood pressure issues. Dr. Scott is on the Speakers board of PriCara Pharmaceutical, a Johnson & Johnson Company, and is currently a consultant to Scisco Group, Inc. as well as an expert in herbal products.  Dr. Scott is also a member of the Speakers Board for Pfizer Pharmaceutical and speaks across the United States on pain management.

 

FITT Energy Shot

Ingredients:

The FITT Energy Shot formula, which was principally based on our previous energy shot’s formula, contains ingredients selected to not only provide energy, but to also enhance mental focus, muscle strength and endurance, and promote cardiovascular health.  The FITT Energy Shot features Resveratrol, a substance found naturally in grapes. Resveratrol may cause the body to act as if it is already on a diet, and change the distribution of fat tissue in the body. In fact, Resveratrol has the scientific world fascinated by its potential to affect age related decline.  Our FITT Energy Shot also contains L-Arginine, an amino acid in dairy, brown rice and nuts which is essential for optimum growth, and regulation of protein metabolism.  L-Arginine can make blood vessels wider, as opposed to the narrowing effect of caffeine. Further, L-Arginine may benefit in the treatment of sports related injuries, as well in building lean muscle and burning fat, since it facilitates the natural release of growth hormone (HGH) and is a building block for creatine. Additionally, the drink features L-Arginine AKG.  L-Arginine AKG has been shown in a University study to help build additional strength when used during training.  Beyond this, the FITT Energy Shot features antioxidant Green Tea extract, and Chromium.  These ingredients have good safety profiles and have support as weight-loss aides.  More than just a caffeine drink, our FITT Energy Shot adds natural energy boosters including Taurine & Guarana, as well as essential Vitamins B3, B5, B6, and B12. To optimize workouts, the FITT Energy Shot has a touch of Fructose, an easily absorbed fuel for the body and brain.  All this is built on a base of healthy pomegranate and orange.

 

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Caffeine Concerns:

As reported in an August 28, 2012 article in the Wall Street Journal, “New York’s attorney general is investigating whether the multi-billion dollar energy-drink industry is deceiving consumers with misstatements about the ingredients and health value of its products.” The article goes on to say “Investigators are examining whether the companies overstated the benefits of exotic-sounding ingredients while understating the role of caffeine, a common stimulant that industry critics believe to be the main active ingredient,” and also that “the products’ labels often don’t say how much caffeine is contained in the drink” but instead relates the caffeine content to that of a cup of coffee. In addition, the article reports that “Investigators are looking into whether the addition of ingredients like guarana—another source of caffeine—violates laws that ban putting multiple sources of caffeine in one beverage without disclosing the overall amount.” The entire article can be seen at the following link: http://online.wsj.com/article/SB10000872396390444230504577615690249123150.html.

 

On October 31, 2012, San Francisco City Attorney Dennis J. Herrera sent a letter to Monster Beverage (see link http://graphics8.nytimes.com/packages/pdf/business/Monster-Energy.PDF) asking the company to prove its advertised claim that large daily quantities of Monster Energy were safe for adults and adolescents. Recently, the energy drink industry and Monster Beverage in particular has been the subject of increasing scrutiny as a result of disclosures that the Food and Drug Administration had received reports that the deaths of five people since 2009 may be linked to Monster Energy drinks (see link http://topics.nytimes.com/top/reference/timestopics/organizations/f/food_and_drug_administration/index.html?inline=nyt-org). We believe we are at the opposite end of that spectrum from those being examined by San Francisco in numerous ways. F.I.T.T. Energy was born of the same concern exhibited by San Francisco’s city attorney and the FDA. If you read Mr. Herrera’s letter to Monster it addresses among other issues the levels of caffeine in the product. We have created a product that avoids what we felt were potentially dangerous and unhealthy levels of caffeine while uniquely adding the proven health benefits of Resveratrol. F.I.T.T.’s use of vasodilators to increase blood flow also helps mitigate health concerns that we presume are at the heart of San Francisco’s inquiry.”

 

Blood Pressure Study:

In June 2011, our operating partner, FITT, completed a randomized, single center, double-blind, crossover trial which evaluated the impact on resting blood pressure of the ingestion of the FITT Energy Shot and two leading competitors’ products. In a July 11, 2011 press release, we announced that “preliminary results showed that the competitors’ energy shots caused average increases in patients’ systolic blood pressure in amounts 240% to 280% greater than when taking F.I.T.T. Energy”. In September 2011, FITT received the final results from the clinical trial, which were very favorable, in a report prepared by Mandava Associates LLC (http://www.mandava.com). Mandava Associates, established in 1986, is a Washington D.C. based scientific consulting firm that is well qualified to offer a diversity of services that are keyed towards the necessities of various industries. With over 100 years combined experience in product development, product approvals and regulatory services, Mandava Associate’s expertise is extensive and always current. They have a successful track record in handling registration applications and other submissions for approvals, authorizations, and marketing to regulatory authorities worldwide. Mandava Associates is affiliated through teaming agreements with various organizations and institutions to provide research, laboratory management, clinical trials, and international regulatory services. Below are two statements taken directly from the trial’s final report:

 

“FITT had no more effect than placebo (fruit juice) on average blood pressure” as this includes both systolic and diastolic blood pressures”.

 

“FITT did not cause any BP (blood pressure) change after dosing in comparison to other leading products”.

 

In its marketing materials, FITT is differentiating the FITT Energy Shot from competitive products using the results of the clinical trial.

 

Prior Energy Shot

Our prior energy shot, called The Sports Energy Shot, was designed to provide a zero calorie, sugar free, rapid and lasting energy boost, enhancing muscle strength and endurance. The Sports Energy Shot formula, which contains a number of the same ingredients as the FITT Energy Shot (L-Arginine, Niacinamide, B vitamins, etc.) was the basis for the FITT Energy Shot’s formulation.

 

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Prior Canned Energy Drinks

We previously distributed canned energy drinks in two flavors, Cranberry-Pineapple and Green Tea, with a Regular and Sugar-Free version of each.  Shipments began in 2005 with the Cranberry-Pineapple flavor.  During 2009, we stopped selling the canned energy drinks to focus on our energy shots, but we may elect to resume sales of these products in the future, under the FITT brand, in those situations where marketing, shipping, and product placement costs are advantageous.

 

Operations

Since 2005, when we completed a merger with Snocone Systems, Inc., we have been unable to generate operating income and have become burdened with substantial debt. As of June 30, 2013, we have less than $200 in assets (zero in cash) and in excess of $2.7 million in debt. Included in the debt amount is $1,328,958 is owed to our officer and employee for accrued and unpaid salaries and advances (inclusive of accrued payroll taxes, $282,755 is owed for delinquent payroll taxes, and $224,168 is owed to our legal counsel.

 

Due to a number of factors, including our substantial debt, we have been unable to attract necessary investment dollars to produce and market our product. In addition, third parties performing marketing, production and fulfillment services have been unwilling to enter into agreements directly with us due to our poor financial condition, among other reasons. These factors raise substantial doubt about our ability to continue as a going concern unless we can substantially mitigate our debt and raise capital.

 

In order to conduct operations, we were forced to pursue a partner to produce and market the FITT Energy Shot.  Under the terms of the August 12, 2010 Operating Agreement with FITT, they are performing the majority of our operating functions, including among other things, selling, marketing, producing and distributing the FITT Energy Shot, and they pay all costs and expenses involved with performing these services. FITT processes and records in its books all sales, costs and operating expenses connected with its performance of services in connection with the Operating Agreement, and all cash, inventory and other assets resulting from either the invested dollars or from FITT’s operations are the property of FITT, including any new products financed and developed by FITT. For its part, FITT pays us a royalty of $0.05 for each bottle sold of the FITT Energy Shot, but is not required to pay us royalties on any new products it develops. Also as noted under “Description of Business” above, FITT has advanced funds to us to pay basic operating expenses, but has no obligation to make any future advances. While FITT enjoys the benefit of any profits earned through its performance of the operating services, it also bears the responsibility of any losses as well as raising capital.

 

Management believes the merger with FITT discussed elsewhere in this report will be finalized on or about August 31, 2013. If so, our operations will be combined with FITT.

 

Marketing

Marketing functions, which are currently being performed by FITT, are being directed mainly to the retail market segment. But FITT also anticipates directing some future efforts to the use of electronic media such as the internet and social media.

 

Test Marketing

FITT previously performed test marketing of The FITT Energy Shot using both a Direct Response TV (“DRTV”) campaign and through email broadcasts. The DRTV campaign was directed by Havas Edge, LLC (“Havas”) (formerly Euro RSCG Edge) under FITT’s July 2010 agreement with them, and included a 60 second television commercial (the “FITT Commercial”) about the FITT Energy Shot. Havas is a member of Havas Worldwide, a global advertising and communications services group with 316 offices in 75 countries.

 

Based on the results of FITT’s test marketing, Havas recommended FITT pursue a strategy to clearly differentiate the FITT Energy Shot from similar products in the marketplace, and to develop new marketing materials, including a new FITT Commercial, to support a drive-to-retail for the product. As a result, as discussed above in “Products – FITT Energy Shot”, our operating partner, FITT, funded a clinical trial testing the impact of the FITT Energy Shot and two competitive products on participants’ blood pressure. Given the positive results of this blood pressure study, Havas suggested FITT reshoot the FITT Commercial to include the unique benefits of the product and focus any media on driving traffic to retail outlets verses a DRTV campaign. FITT’s website, which can be seen at www.throwafitt.com, has been updated to support the drive-to-retail and to highlight the unique benefits of the product.

 

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Marketing Plan – Retail

The retail market space for our product includes convenience stores, grocery chains, drug stores, and health and fitness centers to name a few. FITT believes sales into the retail market will provide the most stable method for marketing the FITT Energy Shot, as well as FITT’s other products.

 

In October 2011, FITT entered into an exclusive Master Marketing Agreement with GRIPS Marketing Corporation (“GRIPS”). GRIPS is managed by an individual with over 40 years’ experience marketing a variety of products to convenience stores and other retail outlets, and who has long-term relationships with some major distributors that service those outlets. In April 2012, with the assistance of GRIPS, FITT received a letter from Core-Mark International, a major national distributor, in which Core-Mark agreed to team up with FITT to distribute FITT’s energy products, including the FITT Energy Shot, to Core-Mark’s customer base. See the section below titled “Distribution” for more information.

 

In March 2013, FITT entered into a Brokerage Agreement with SummitHill Sales & Marketing, Inc. (“Summit”) under which Summit agreed to become FITT’s exclusive sales representative for customers in Southern California and Clark County Nevada. Summit, which was formed in 1999 by two individuals with long histories in food and beverage brokerage businesses, currently brokers products to well over 1,500 convenience and retail outlets.

 

Marketing Plan – Representation

In April 2010, we entered into an agreement with Sports 1 Marketing LLC, an entity whose principal owner is Warren Moon, NFL Hall of Fame quarterback. As part of the agreement, Mr. Moon agreed to endorse the FITT Energy Shot and has been featured in a number of the advertising campaigns for the product including several of our test-marketing email broadcasts. In March 2013, FITT entered into an agreement with Anna Rawson for product representation services including product endorsement. Ms. Rawson is a former member of the Ladies Professional Golf Association and is a well-known model and fitness expert with a large social media following. Relationships with high-profile personalities and athletes provide an opportunity to achieve much broader brand recognition.

 

Distribution

As noted above, in April 2012, with the assistance of GRIPS, FITT received a letter from Core-Mark International, a major national distributor, in which Core-Mark agreed to team up with FITT to distribute FITT’s energy products, including the FITT Energy Shot, to Core-Mark’s customer base. Core-Mark is one of the largest broad-line, full-service marketers and distributors of packaged consumer products in North America. Founded in 1888, Core-Mark provides distribution and logistics services as well as marketing programs to over 29,000 retail locations across the United States and Canada through its 28 distribution centers. Core-Mark services traditional convenience retailers, grocers, mass merchandisers, drug, liquor and specialty stores, and other stores that carry consumer packaged goods. Core-Mark’s plan was to launch FITT’s products in California, Nevada and Arizona, then move across the country to other divisions. During the second quarter of 2012, FITT began shipping the FITT Energy Shot, along with other products it has developed, to Core-Mark who then shipped the products to certain of its convenience store customers. FITT’s marketing program for sales into this market include in-store display racks and signage, and also include support by field sales reps and by various forms of media designed to drive the consumer to purchase the product at the retail outlets.

 

For purchases made through FITT’s website and other electronic media, product was initially shipped to customers by one of the nation’s leading fulfillment resources. FITT is in the process of reviewing its plans for sales to customers through electronic media, including its website, and what is the most efficient method to ship product to those customers.

 

Production

Under the FITT Operating Agreement, FITT is responsible for the production and distribution of the FITT Energy Shot. The FITT Energy Shot is produced at Wellington Foods Incorporated, a contract manufacturer of liquid and powder nutritional supplements since 1974. In addition to its manufacturing facilities, Wellington has the in-house capabilities to develop products from concept for flavoring ingredient content to production, or to take an existing formula and extend the product line with new flavors or innovative ingredients. Dr. Rand Scott, one of our medical experts and a shareholder, researched and recommended the ingredients for the FITT Energy Shot and Wellington provided the final flavoring and formulation. Wellington owns the formula for the FITT Energy Shot, but there is no barrier to its recreation and there are numerous manufacturers within the U.S. capable of manufacturing the product.

 

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The principal raw materials used to manufacture the energy shot are plastic bottles, nutritional supplements, flavoring agents, and concentrates as well as other ingredients from independent suppliers. These raw materials are readily available from any number of sources in the United States.

 

The Industry

Energy drinks, including two-ounce shots and canned drinks, are beverages with legal stimulants, vitamins, and minerals that give users a lift of energy.  Common ingredients are caffeine, taurine, ginseng, sugars, and various amounts of vitamins and minerals.  The products are consumed by individuals who are explicitly looking for the extra boost in energy.  While canned energy drinks are most commonly consumed by individuals in the 18-to-34 age group, energy shots have been appealing to a more expanded demographic. In an article discussing energy drinks published in the August 2011 issue of Beverage Industry, Garima Goel-lal, beverage analyst with Mintel International, a global leading market research company, states that “a lot of adults in the older age [group] who don’t want sugar in their beverages, but want the same benefit of an energy boost, are going toward energy shots”. In the same article, Jared Koerten, U.S. research associate for Euromonitor International, states “The appeal and benefits that energy shots offer consumers has driven sales in recent years. These products have capitalized on many consumer demands in the fast-paced global economy of today. First, these products offer extended energy to consumers who need to stay alert for long work hours. In addition, by promising ‘no crash later’, energy shots can provide a boost of energy without the accompanying loss in productivity that often stems from drinking coffee or other sugary drinks”.

 

In its June 2012 Executive Summary Report on energy drinks and energy shots, Mintel reports that sales of energy shots were nearly $1.6 billion in 2011, an increase of nearly $330 million over 2010 sales. Mintel also forecasts continued growth in energy shot sales to in excess of $3.4 billion by 2016. In this report, Ms. Goel-lal states “Energy drinks and shots continue to grow unabated, especially after the recession. In order to enjoy uninterrupted growth, the category needs to add new customers, engage in innovation, broaden its functional platform, and allay product safety concerns.” Mintel also reports that Living Essential’s 5-Hour Energy “continues to account for the lion’s share in the segment.”

 

Results of Operations for the Three Months Ended June 30, 2013 and 2012

 

As discussed above, since August 12, 2010, FITT has been responsible for performing the majority of the operating functions for the Company. Accordingly, since that date, FITT has processed and recorded in its books all sales, costs and operating expenses connected with its performance of those services and the Company has earned a royalty of $0.05 for each bottle sold of the FITT Energy Shot. To date, royalty earnings have been insignificant.

 

Revenue – Royalties

Royalties earned during the second quarter of 2013 were $252. No royalties were earned during the same period of 2012.

 

Selling and Marketing Expenses

Selling and marketing expenses of $848 and $1,026 in the three months ended 2013 and 2012, respectively, include costs for press releases and other minor items.

 

General and Administrative Expenses

General and administrative expenses include personnel costs for management, operations and finance functions, along with legal, accounting costs, insurance and investor relations costs. General and administrative expenses for the second quarter of 2013 were $218,788 compared to $187,913 for the comparable period in 2012. In 2013, our investor relations expenses were $33,000 ($30,000 in cash and $3,000 in common stock) while the 2012 period had no investor relations expense.

 

 

 

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Interest Expense

Interest expense the six months ended June 30, 2013 was $83,029 compared to $5,608 for the same period in 2012. The 2013 amount included accretion of principal balance and amortization of beneficial conversion feature discount related to the convertible promissory notes totaling $76,080. The 2012 period included interest of $3,525 related to debt which has been settled or extinguished.

 

Gain on the Extinguishment of Debt and Creditor Obligations

During the second quarter of 2013, we determined that the statute of limitations for certain of our creditors to enforce collection of $875 they might be owed has elapsed. As a result, we recorded a gain on extinguishment of debt totaling $875.

 

Results of Operations for the Six Months Ended June 30, 2013 and 2012

 

Revenue – Royalties

Royalties earned during the first half of 2013 were $317. No royalties were earned during the same period of 2012.

 

Selling and Marketing Expenses

Selling and marketing expenses of $2,317 and $2,127 in the six months ended 2013 and 2012, respectively, include costs for press releases and other minor items.

 

General and Administrative Expenses

General and administrative expenses include personnel costs for management, operations and finance functions, along with legal, accounting costs, insurance and investor relations costs. General and administrative expenses for the first half of 2013 were $433,319 compared to $417,342 for the comparable period in 2012. In 2013, our investor relations expenses were $58,000 ($35,000 in cash, $20,000 in notes payable and $3,000 in common stock) while the 2012 period included a stock-based investor relations expense of $4,769. In addition, expenses that were higher in 2013 than 2012 include accrued wages and benefits ($13,000) and stock transfer and filing fees ($7,000). Offsetting these increases were expenses that were lower in 2013 than in 2012 including consulting ($20,000) and legal ($39,000).

 

Interest Expense

Interest expense the six months ended June 30, 2013 was $113,570 compared to $17,216 for the same period in 2012. The 2013 amount included accretion of principal balance and amortization of beneficial conversion feature discount related to the convertible promissory notes totaling $102,050. The 2012 period included interest of $12,300 related to debt which has been settled or extinguished.

 

Gain on the Extinguishment of Debt and Creditor Obligations

During the first half of 2013, we entered into settlement agreements with various debt holders. We also determined that the statute of limitations for certain of our creditors to enforce collection of amounts they might be owed has elapsed. As a result, we reduced our balance sheet debt by $697,588 and recorded gains on extinguishment of debt totaling $579,995. For additional information, see Notes 3 and 11 to the accompanying financial statements.

 

Liquidity and Capital Resources

 

The report of our independent registered public accounting firm on the financial statements for the year ended December 31, 2011 contains an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern as a result of recurring losses, a working capital deficiency, and negative cash flows. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that would be necessary if we are unable to continue as a going concern.

 

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At June 30, 2012, our principal sources of liquidity result from advances of funds from FITT, officers and shareholders.  Our principal short-term and long-term liquidity needs have been, and are expected to be, funding operating losses until we achieve profitability, servicing and compromising debt, and making expenditures for general corporate purposes.

 

Management continues to seek capital through various sources. On June 10, 2013 we entered into a Financial Advisory & Investment Banking Agreement with CIM Securities, LLC (“CIM”). Under the agreement, CIM will attempt to raise a maximum of $5.0 million for us on a best efforts basis. The Banking Agreement contemplates the merger with FITT discussed in Note 1 to the accompanying financial statements. Subsequent to June 30, 2013, together with CIM, we completed a private placement memorandum for $1.0 million in bridge loan financing. Once the merger with FITT is finalized, CIM will turn its efforts to the $5.0 million offering. For further information, see Note 12 to the accompanying financial statements.

 

We currently have no cash and management cannot be certain that future royalties FITT is obligated to pay us under the provisions of the Operating Agreement, subject to the satisfaction of the IRS Notice of Levy, will be sufficient to pay our basic operating expenses, let alone compromise debt in any substantial way. Management continues to actively seek capital through various sources but, given the present economic environment and our current financial condition, management is not confident we can attract any capital without first significantly compromising our debt. If we cannot obtain additional financing, we will be forced to curtail our operations even further or may not be able to continue as a going concern, and we may become unable to satisfy our obligations to our creditors.

 

DEBT

Convertible Promissory Notes – Debt Acquisition

In 2010 we initiated a program to compromise our significant debt and during the first half of 2013, we entered into Debt Acquisition Agreements and used funds of $147,001 to settle debt of $653,406 and to repay other amounts due. The terms of the convertible promissory notes issued in accordance with these agreements are described in Note 7 to the accompanying financial statements. In addition, see Note 3 for a summary of the compromised debt.

 

During the six months ended June 30, 2013, the holders of the convertible promissory notes converted a total of $25,000 of the amount of their notes payable at maturity ($12,500 in original funding) into 100,000 shares of our common stock at the minimum conversion rate of $0.25 per share.

 

EQUITY

Sales of Equity Securities

There were no sales of equity securities during the six-month periods ended June 30, 2013 and 2012. Due to a lack of capital, in the six months ended June 30, 2013 we issued 150,000 shares of common stock for services (value of $9,000). In the comparable 2012 period, we issued 20,000 shares of common stock in payment for services related to investor relations, marketing, strategic alliance coordination, and legal fees (value of $24,369).

 

Subsequent to June 30, 2013, we sold 1,250,000 shares of our common stock to a corporation for $250,000. Also subsequent to June 30, 2013, we issued 450,000 shares of our common stock to another corporation for services. See Note 13 to the accompanying financial statements.

 

At June 30, 2013, our cash and cash equivalents were zero, and we had negative working capital in excess of $2.5 million.  

 

The following table sets forth our cash flows for the six months ended June 30:

 

   2013   2012   Change 
Operating activities  $(102,498)  $(97,929)  $(4,569)
Investing activities            
Financing activities   102,498    97,929    4,569 
Total  $   $   $ 

 

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Operating Activities

Operating cash flows for the six months ended June 30, 2013 reflect our net income of $30,306 and a change in working capital items of $336,087, offset by a change in non-cash items (gain on extinguishment of debt and creditor obligations, common stock issued for services, depreciation, accretion of debt and amortization of debt discount) of $468,891. The change in working capital is primarily related to increases in accounts payable, accrued expenses / compensation and notes payable.  The increases in the working capital components are due to the lack of operating capital to pay vendors and the deferral of payment of a significant percentage of wages to our employees.

 

Investing Activities

There was no cash used in investing activities for the six months ended June 30, 2013 or 2012.

 

Financing Activities

There was $102,498 and $97,929 cash provided from related parties for the six months ended June 30, 2013 and 2012, respectively.

 

Off Balance Sheet Arrangements

 

We have no off balance sheet arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Our President and Chief Financial Officer (the “Certifying Officer”) has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of period covered by this report.  Based upon such evaluation, the Certifying Officer concluded that our disclosure controls and procedures were effective as of June 30, 2013.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 4T. CONTROLS AND PROCEDURES

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Oswald & Yap

On January 13, 2012, a complaint was filed against us in the Superior Court of the State of California, County of Orange, by Oswald & Yap LLP (“Oswald”).  The complaint, which was for unpaid legal services in the amount of $40,734, also named our CEO and FITT as defendants.  Our CEO, as an individual, and FITT, as a company, were never a party to any agreement with Oswald.  Effective October 17, 2012, we entered into an Agreement for Use of Stipulation for Judgment under which we agreed to pay Oswald $25,000 no later than December 17, 2012 and Oswald agreed to release all defendants, but we were unable to make the required payment.

 

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On October 12, 2012, attorneys for our CEO and FITT filed a Motion for Summary Judgment, essentially requesting they be dismissed from the case. The judge heard the motion on January 17, 2013 and indicated he was likely to rule in favor of the motion which would have allowed for the collection from Oswald of legal fees and costs associated with the defense of our CEO and FITT. On January 30, 2013 we, along with our CEO and FITT, reached a settlement with Oswald whereby Oswald would drop litigation against all defendants and release them from any and all obligations, and the defendants agreed not to attempt to collect from Oswald legal fees and costs related to this matter. In connection with this settlement, during the first quarter of 2013 we recorded a gain on extinguishment of debt in the amount of $32,711.

 

ITEM 1A. RISK FACTORS

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES

 

There have been no events which are required to be reported under this item.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

There have been no events which are required to be reported under this item.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None

 

ITEM 5. OTHER INFORMATION

 

None

 

ITEM 6. EXHIBITS
   
31.1 Certification of Chief Executive Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2 Certification of Chief Financial Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
32 Certifications Pursuant to 18 U.S.C., Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS XBRL Instance Document*
   
101.SCH XBRL Schema Document*
   
101.CAL XBRL Calculation Linkbase Document*
   
101.DEF XBRL Definition Linkbase Document*
   
101.LAB XBRL Label Linkbase Document*
   
101.PRE XBRL Presentation Linkbase Document*

 

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SIGNATURES

 

In accordance with 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, duly authorized.

 

 

FITT HIGHWAY PRODUCTS, INC.
(Registrant)

   
Dated: August 19, 2013  
  By: /s/ Michael R. Dunn  
  Michael R. Dunn
  Its:  Chief Executive Officer and Chief Financial Officer (Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer)

 

 

 

 

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