UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

 For the quarterly period ended June 30, 2016

OR

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

 For the transition period from                          to                               

Commission File No. 000-25367

(314) 727-3333

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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.

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

The number of shares outstanding of registrant's only class of stock as of August 15, 2016: Common stock, par value $0.01 per share – 203,758,698 shares outstanding.

INDEX

See accompanying Notes to Unaudited Financial Statements.

See accompanying Notes to Unaudited Financial Statements.

FUEL PERFORMANCE SOLUTIONS, INC. 

(formerly known as International Fuel Technology, Inc.)

STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) 

FOR THE THREE-MONTH PERIOD ENDED June 30, 2016 

(Unaudited)

See accompanying Notes to Unaudited Financial Statements.

FUEL PERFORMANCE SOLUTIONS, INC.

(formerly known as International Fuel Technology, Inc.)

STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying Notes to Unaudited Financial Statements.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Basis of Presentation

The interim financial statements included herein have been prepared by Fuel Performance Solutions, Inc. (formerly known as International Fuel Technology, Inc.) (the "Company," "we," "us" or "our") without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to make the information presented not misleading.

These statements reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary for fair presentation of the information contained therein. Interim results are not necessarily indicative of results for a full year. We suggest that these financial statements be read in conjunction with the financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 30, 2016. We follow the same accounting policies in preparation of interim reports as we do in our annual reports.

Note 2 – Substantial Doubt about Ability to Continue as a Going Concern

Our financial statements are presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have incurred significant losses since inception and currently have and previously from time to time have had limited funds with which to operate. These conditions raise substantial doubt as to the Company's ability to continue as a going concern. Management is in the process of executing a strategy based upon marketing technologies that offer enhanced engine performance and greater fuel economy along with pollution control benefits.

We have been funded since inception primarily by unregistered sales of Company restricted stock, generally to existing shareholders. We have also relied on a $1,000,000 equity commitment from one of our Directors, Rex Carr, of which $500,000 remains available (See Note 5. Equity Commitment and Related Party Transactions). Rex Carr passed away on April 27, 2015. On April 30, 2015, the Company elected Glenn Carr as a Director to its Board of Directors (the "Board"). Glenn Carr is the son of Rex Carr. The Company believes that the equity commitment of Rex Carr will be honored by his estate. However, we can make no assurances as to the timing of when the estate may be settled, and how much we may receive once the estate is settled. During the second quarter of 2016, we assigned $12,500 of our claim against the Rex Carr estate pursuant to our $1,000,000 equity commitment, to an interim capital investor (see Note 9. Short term Notes Payable issued in Q2 2016). Subsequent to June 30, 2016, we assigned an additional $300,000 of our claim against the Rex Carr estate to other interim capital investors (see Note 13. Subsequent Events).

In addition, during the third quarter of 2014, we obtained additional funding in the form of a convertible notes payable (see Note 6. Convertible Short-term Notes Payable). During the third quarter of 2015, we obtained additional funding in the form of a subordinated notes payable (see Note 7. Long term Notes Payable). We also obtained funding in the first quarter of 2016 in the form of subordinated notes (see Note 8. Short term Notes Payable issued in Q1 2016) and funding in the second quarter on 2016 in the form of subordinated notes (see Note 9. Short term Notes Payable issued in Q2 2016).

We are currently in discussions with our investment bankers and a number of potential investors to raise additional capital. We believe we will be successful in raising additional capital to fund our operations, but if we are unable to secure additional capital, we will need to curtail operations.

The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.

Note 3 – Significant Accounting Policies

Derivative Financial Instruments

We evaluate our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in our statements of operations. For stock-based derivative financial instruments, we use a Lattice Model option pricing model, assuming maximum value, in accordance with the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") ASC 815-15, "Derivatives and Hedging," to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in our balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Debt Issuance Cost

In accordance with FASB Accounting Standards Update No. 2015-03: Simplifying the Presentation of Debt Issuance Costs, we have reclassified Deferred Financing Costs as a direct deduction from the related debt liability rather than as an asset for the period ending June 30, 2016 and retroactively for the period ending December 31, 2015.

Fair Value of Financial Instruments

We measure our financial assets and liabilities in accordance with the requirements of ASC 820, "Fair Value Measurements and Disclosures," which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 - Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.

Level 2 - Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date and includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.

Level 3 - Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

The following table sets forth by level within the fair value hierarchy the Company's financial assets and liabilities that were accounted for at fair value as of June 30, 2016, and December 31, 2015:

Note 4 – Stockholders' Equity (Deficit)

On March 25, 2016, we filed a certificate of amendment to our Articles of Incorporation increasing the number of our authorized shares from 350,000,000 to 750,000,000 shares with the Nevada Secretary of State.

Non-cash stock-based compensation expense recorded during the three and six months ended June 30, 2016 and June 30, 2015 is as follows:

Employee and Director Awards

During the six months ended June 30, 2016, we did not issue any options to employees or Directors for Director-related services. The $903 of non-cash stock-based compensation expense recognized during the six months ended June 30, 2016 relates to employee options grants made during 2014 that have subsequent vesting terms. These 2014 employee options grants became fully-vested during the six months ended June 30, 2016. $0 of unrecognized non-cash stock-based compensation expense remains as of June 30, 2016.

The following table summarizes information about stock options to employees and Directors that were issued and outstanding during the three months ended June 30, 2016:

Non-employee Awards

During the six months ended June 30, 2016, we did not issue any options to non-employee consultants for services.

The following table summarizes information about stock options to non-employees that were issued and outstanding during the three months ended June 30, 2016:

Sales of Common Stock

We did not receive any proceeds from the sale of common stock during the six months ended June 30, 2016.

Note 5 – Equity Commitment and Related Party Transactions

On June 6, 2016, the Company issued $25,000 of notes payable to David Norris, a Director of our Board and on June 24 $15,000 to Michael Gianino, a Director of our Board. These loans were pursuant to the notes payable transaction discussed in Note 9. Short term Notes Payable issued in Q2 2016.

On March 9, 2016, the Company issued $50,000 of notes payable to Jonathan Burst, our Board chairman and Chief Executive Officer and $50,000 to Michael Gianino, a Director on our Board. These loans were pursuant to the notes payable transaction discussed in Note 8. Short term Notes Payable issued in Q1 2016 below. From the $100,000 notes issued, there is $50,000 cash proceeds from the related party notes payable of $50,000, while the remaining $50,000 is offset with accrued compensation, which is non-cash transaction.

On August 21, 2015, the Company issued $25,000 of notes payable to Jonathan Burst, our Board chairman and Chief Executive Officer, $10,000 to Michael Gianino, a Director on our Board and $10,000 to Stuart D. Beath, our Chief Financial Officer. These loans were pursuant to the notes payable transaction discussed in Note 7. Long term Notes Payable below. Total cash proceeds from the $45,000 of related party notes payable is $10,000, while the remaining $35,000 is offset with accrued compensation.

On August 22, 2014, the Company issued $57,500 ($7,500 OID and $50,000 principal) of notes payable to Jonathan Burst, our Board chairman and Chief Executive Officer. This loan was pursuant to the convertible note payable transaction discussed in Note 6. Convertible Short-term Notes Payable below.

Effective December 11, 2007, we received an investment commitment from Rex Carr, a Director of the Company and a holder of over 5% of our common stock. Pursuant to the terms of the commitment, Mr. Rex Carr agreed to invest up to an aggregate of $1,000,000 in the Company, at such time or times as we may request, in the form of a purchase or purchases of our restricted common stock. We may elect to draw from the commitment at one time or from time to time; provided, however, that the aggregate of such draws may not exceed $1,000,000. We have drawn down $500,000 of the commitment and issued to Mr. Rex Carr that number of our shares of restricted common stock equal to the value of the investment then provided to us. The number of shares to be issued was calculated based on the closing price of our common stock as quoted on OTC Market Group's OTCQB marketplace on the date of the sale. There is no stipulation regarding the duration of this commitment. The total amount available under this commitment is $500,000 as of both June 30, 2016 and December 31, 2015. However, during the second quarter of 2016, we assigned $12,500 of our claim against the Rex Carr estate pursuant to our $1,000,000 equity commitment, to an interim capital investor (see Note 9. Short term Notes Payable issued in Q2 2016). Subsequent to June 30, 2016, we assigned an additional $300,000 of our claim against the Rex Carr estate to other interim capital investors (see Note 13. Subsequent Events).

Rex Carr passed away on April 27, 2015. On April 30, 2015, the Company elected Glenn Carr to its Board. Glenn Carr is the son of Rex Carr, a deceased Director of the Company. The Company believes that the equity commitment of Rex Carr referenced above will be honored by his estate. However, we can make no assurances as to the timing of when the estate may be settled, and how much we may receive once the estate is settled.

Note 6 – Convertible Short-term Notes Payable

On August 22, 2014 (the "2014 Closing Date"), we closed a financing transaction by entering into a Securities Purchase Agreement dated August 22, 2014 (the "2014 Securities Purchase Agreement") with certain funds and investors signatory to such 2014 Securities Purchase Agreement (the "2014 Purchasers") for an aggregate subscription amount of $1,000,000 (the "2014 Purchase Price") of which $50,000 is from a related party. Pursuant to the 2014 Securities Purchase Agreement, we issued the following to the 2014 Purchasers: (i) 10% Convertible Promissory Notes with an aggregate principal amount of $1,150,000 (the "2014 Notes"), and (ii) warrants to purchase an aggregate of 6,666,667 shares of the Company's common stock, par value $0.01 per share, for an exercise price of $0.12 per share for a period of five (5) years from the effective date of the registration statement (the "2014 Warrants").

We recorded $150,000 of original issuance cost related to this transaction, which we have recorded as debt discount.

The terms of the 2014 Notes and the 2014 Warrants are as follows:

10% Convertible Promissory Notes

The total principal amount of the 2014 Notes is issued with a 115% premium to the subscription amount. The 2014 Notes accrue interest at a rate equal to 10% per annum and originally had a maturity date of February 22, 2016. Subsequent to December 31, 2015, the maturity date of the 2014 Notes was extended to April 30, 2016. Subsequent to March 31, 2016, the maturity date of the 2014 Notes was further extended to June 15, 2016. The note is currently in default. We are currently in discussions with The 2014 Note Holders to further extend the maturity date. The 2014 Notes are convertible any time after the issuance date of the 2014 Notes. The 2014 Purchasers have the right to convert the 2014 Notes into shares of the Company's common stock at a conversion price equal to $0.10 per share, subject to standard adjustments for stock dividends, stock splits, subsequent equity sales, subsequent rights offerings and pro rata distributions. While the 2014 Notes are outstanding, in the event of a subsequent equity sale at a price lower than the conversion price of $0.10 per share, the conversion price of the 2014 Notes shall be reduced to the lower conversion price. The 2014 Notes can be redeemed under certain conditions and the Company can force the conversion of the 2014 Notes in the event certain equity conditions are met.

In the event of default, the 2014 Purchasers have the right to require the Company to repay in cash all or a portion of the 2014 Notes at a price equal to 125% of the aggregate principal amount of the 2014 Notes plus all accrued but unpaid interest.

We recorded $29,513 and $30,840 of interest expense related to the issuance of the 2014 Notes during the three months ended June 30, 2016 and June 30, 2015, respectively.

We recorded $62,765 and $60,593 of interest expense related to the issuance of the 2014 Notes during the six months ended June 30, 2016 and June 30, 2015, respectively.

Warrants

The 2014 Warrants are exercisable in whole or in part, at an initial exercise price per share of $0.12, subject to adjustment. The exercise price and number of shares of the Company's common stock issuable under the 2014 Warrants (the "2014 Warrant Shares") are subject to adjustments for stock dividends, splits, combinations, subsequent rights offerings, pro rata distributions and any issuance of securities below the exercise price of the 2014 Warrants. While the 2014 Warrants are outstanding, in the event of a subsequent equity sale including a warrant exercise price lower than the exercise price of $0.12 per share, the exercise price of the 2014 Warrants shall be reduced to the lower exercise price. Any adjustment to the exercise price shall similarly cause the number of 2014 Warrant Shares to be adjusted so that the total value of the 2014 Warrants may increase, provided, that in no event shall the number of 2014 Warrant Shares exceed 200% of the original number of 2014 Warrant Shares originally issued.

In addition to the 2014 Warrants described above, the Company also issued 800,000 warrants to a placement agent assisting with the convertible note transaction. The terms of the placement agent warrants are the same as of the terms of the 2014 Warrants explained above.

Registration Rights Agreement

In connection with the sale of the 2014 Notes and 2014 Warrants pursuant to the 2014 Securities Purchase Agreement, the Company entered into a registration rights agreement (the "2014 Registration Rights Agreement") with the 2014 Purchasers, pursuant to which the Company agreed to register all of the shares of common stock underlying the 2014 Notes and the shares of common stock underlying the 2014 Warrants (together, the "2014 Registrable Securities") on a Form S-1 registration statement (the "2014 Registration Statement") to be filed with the SEC within thirty (30) calendar days following the 2014 Closing Date (the "2014 Filing Deadline") and to use its best efforts to cause the 2014 Registration Statement to be declared effective under the Securities Act within one hundred (100) calendar days following the 2014 Closing Date (the "2014 Effectiveness Deadline"). The 2014 Registration Statement became effective November 26, 2014.

Deferred Financing Cost

In connection with the convertible note transaction explained above, the Company paid $55,000 for legal fees and $80,000 for placement agent fees. In addition, $29,550 was also recorded to deferred financing costs related to the fair value valuation of the placement agent warrants. $0 and $27,189 of deferred financing costs were amortized during the three months ended June 30, 2016 and June 30, 2015, respectively. $17,008 and $53,403 of deferred financing costs were amortized during the six months ended June 30, 2016 and June 30, 2015, respectively. The deferred financing cost balance related to the 2014 Notes is $0 and $17,008 as of June 30, 2016 and December 31, 2015, respectively.

Derivative

Because the above convertible 2014 Notes and 2014 Warrants have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under ASC 815-40-15, "Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock" ("ASC 815-40-15"). ASC 815-40-15 requires as of the date the convertible 2014 Notes and 2014 Warrants are issued, the derivative liability to be measured at the fair value and re-evaluated at the end of each reporting period. See Note 11. Derivative Liability.

Debt Discount

On issuance date, the fair value of the derivative liability for both the convertible 2014 Notes and 2014 Warrants was $295,773 and $246,905, respectively. Therefore a total of $692,678 (including $150,000 original issuance costs) of debt discount was recorded. $97,688 and $202,568 was recorded as amortization of debt discount during the six months ended June 30, 2016 and June 30, 2015, respectively.

As of June 30, 2016, the convertible 2014 Notes have a balance of $1,092,500, net of $0 of debt discount, and accrued interest of $218,398. As of December 31, 2015, the convertible 2014 Notes have a balance of $982,689, net of $109,811 of debt discount, and accrued interest of $158,997.

As of June 30, 2016, the related party convertible 2014 Note has a balance of $57,500, net of $0 of debt discount, and accrued interest of $11,732. As of December 31, 2015, the related party convertible 2014 Notes have a balance of $52,615, net of $4,885 of debt discount, and accrued interest of $8,368.

Note 7 – Long term Notes Payable

On August 21, 2015 (the "2015 Closing Date"), we closed a financing transaction by entering into a Securities Purchase Agreement dated August 21, 2015 (the "2015 Securities Purchase Agreement") with certain funds and investors signatory to such 2015 Securities Purchase Agreement (the "2015 Purchasers") for an aggregate subscription amount of $415,000 (the "2015 Purchase Price") of which $45,000 is from related parties (see Note 5. Equity Commitment and Related Party Transactions). Pursuant to the 2015 Securities Purchase Agreement, we issued the following to the 2015 Purchasers: (i) 10% Promissory Notes with an aggregate principal amount of $415,000 (the "2015 Notes"), and (ii) warrants to purchase an aggregate of 4,150,000 shares of the Company's common stock, par value $0.01 per share, for an exercise price of $0.12 per share for a period of five (5) years from the Securities Purchase Agreement date (the "2015 Warrants"). The 2015 Notes are subordinated to the 2014 Notes.

In addition, we issued 2,075,000 restricted common shares of our stock to the 2015 Purchasers, previously defined above as the 2015 Affiliate Shares. The 2015 Affiliate Shares have a fair value of $63,787 and were valued based on the closing price of our common stock on August 21, 2015. The 2015 Affiliate Shares were contributed from existing shareholdings of related party Board members and did not increase the total number of our common shares outstanding.

The terms of the 2015 Notes and the 2015 Warrants are as follows:

10% Promissory Notes

The total principal amount of the 2015 Notes is $415,000. The 2015 Notes accrue interest at a rate equal to 10% per annum and have a maturity date of August 21, 2017. The 2015 Notes can be redeemed by the Company at any time without penalty.

In the event of default, the 2015 Purchasers have the right to require the Company to repay in cash all or a portion of the 2015 Notes at a price equal to 125% of the aggregate principal amount of the 2015 Notes plus all accrued but unpaid interest.

We recorded $14,918 and $0 of interest expense related to the issuance of the 2015 Notes during the three months ended June 30, 2016 and June 30, 2015, respectively.

We recorded $25,120 and $0 of interest expense related to the issuance of the 2015 Notes during the six months ended June 30, 2016 and June 30, 2015, respectively

Warrants

The 2015 Warrants are exercisable in whole or in part, at an initial exercise price per share of $0.12, subject to adjustment. The exercise price and number of shares of the Company's common stock issuable under the 2015 Warrants (the "2015 Warrant Shares") are subject to adjustments for stock dividends, splits, combinations, subsequent rights offerings, pro rata distributions and any issuance of securities below the exercise price of the 2015 Warrants. While the 2015 Warrants are outstanding, in the event of a subsequent equity sale including a warrant exercise price lower than the exercise price of $0.12 per share, the exercise price of the 2015 Warrants shall be reduced to the lower exercise price. Any adjustment to the exercise price shall similarly cause the number of 2015 Warrant Shares to be adjusted so that the total value of the 2015 Warrants may increase.

In addition to the 2015 Warrants described above, the Company also issued 296,000 warrants to a placement agent assisting with the 2015 Notes transaction. The terms of the placement agent warrants are the same as of the terms of the 2015 Warrants explained above.

Deferred Financing Cost

In connection with the note transaction explained above, the Company paid $7,500 for legal fees and $29,600 for placement agent fees. In addition, $12,775 was also recorded to deferred financing costs related to the fair value valuation of the placement agent warrants. $6,209 and $0 of deferred financing costs was amortized during the three months ended June 30, 2016 and June 30, 2015, respectively. $12,418 and $0 of deferred financing costs was amortized during the six months ended June 30, 2016 and June 30, 2015, respectively. The deferred financing cost balance related to the 2015 Notes is $28,451 and $40,869 as of June 30, 2016 and December 31, 2015, respectively.

Derivative

Because the above 2015 Notes and 2015 Warrants have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under ASC 815-40-15. ASC 815-40-15 requires as of the date the 2015 Notes and 2015 Warrants are issued, the derivative liability to be measured at the fair value and re-evaluated at the end of each reporting period. See Note 10. Derivative Liability.

Debt Discount

On issuance date, the fair value of the derivative liability for the 2015 Warrants was $179,106. Also, the relative fair value of the 2015 Affiliate Shares was $63,787. Therefore a total of $242,893 of debt discount was recorded. $35,729 and $0 was recorded as amortization of debt discount during the three months ended June 30, 2016 and 2015, respectively.

$71,458 and $0 was recorded as amortization of debt discount during the six months ended June 30, 2016 and 2015, respectively.

As of June 30, 2016, the 2015 Notes have a balance of $237,996, net of $$132,004 of debt discount, and accrued interest of $35,793. As of December 31, 2015, the 2015 Notes have a balance of $153,308, net of $216,692 of debt discount, and accrued interest of $12,874.

As of June 30, 2016, the related party 2015 Notes have a balance of $$28,944, net of $$16,056 of debt discount, and accrued interest of $3,797. As of December 31, 2015, the related party 2015 Notes have a balance of $29,757, net of $15,243 of debt discount, and accrued interest of $1,565.

Note 8 – Short term Notes Payable issued in Q1 2016

On March 9, 2016 (the "2016 Q1 Closing Date"), we closed a financing transaction by entering into a Securities Purchase Agreement dated March 9, 2016 (the "2016 Q1 Securities Purchase Agreement") with certain investors signatory to such 2016 Q1 Securities Purchase Agreement (the "2016 Q1 Purchasers") for an aggregate subscription amount of $373,750 (the "2016 Q1 Purchase Price") of which $100,000 is from related parties, and out of the $100,000, $50,000 is non-cash transaction (see Note 5. Equity Commitment and Related Party Transactions). Pursuant to the 2016 Q1 Securities Purchase Agreement, we issued the following to the 2016 Q1 Purchasers: (i) 10% Promissory Notes with an aggregate principal amount of $373,750 (the "2016 Q1 Notes"), and (ii) warrants to purchase an aggregate of 3,737,500 shares of the Company's common stock, par value $0.01 per share, for an exercise price of $0.05 per share for a period of five (5) years from the Securities Purchase Agreement date (the "2016 Q1 Warrants"). In addition, the 2016 Q1 Notes provide for a return of principal with a 1.5 factor. The 2016 Q1 Notes are subordinated to the 2014 Notes.

The terms of the 2016 Q1 Notes and the 2016 Q1 Warrants are as follows:

10% Promissory Notes

The total principal amount of the 2016 Q1 Notes is $373,750. The 2016 Q1 Notes will not accrue interest unless they are not repaid by the April 30, 2016 maturity date. Subsequent to the April 30, 2016 maturity date, simple interest shall accrue at an annual rate of 10% on a principal amount calculated by taking the original investment amount multiplied by the 1.5 factor. Subsequent to March 31, 2016 the maturity date of the 2016 Q1 Notes was extended to June 30, 2016. The note is currently in default. We are currently in discussions with the 2016 Q1 Note Holders to further extend the maturity date. The 2016 Q1 Notes can be redeemed by the Company at any time without penalty.

In the event of default, the outstanding principal amount of the 2016 Q1 Note plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the 2016 Q1 Purchasers election, immediately due and payable in cash.

We recorded $6,249 and $0 of interest expense related to the issuance of the 2016 Q1 Notes during the three months ended June 30, 2016 and June 30, 2015, respectively.

We recorded $6,249 and $0 of interest expense related to the issuance of the 2016 Q1 Notes during the six months ended June 30, 2016 and June 30, 2015, respectively.

Warrants

The 2016 Q1 Warrants are exercisable in whole or in part, at an initial exercise price per share of $0.05, subject to adjustment. The exercise price and number of shares of the Company's common stock issuable under the 2016 Q1 Warrants (the "2016 Q1 Warrant Shares") are subject to adjustments for stock dividends, splits, combinations, subsequent rights offerings, pro rata distributions and any issuance of securities below the exercise price of the 2016 Q1 Warrants. While the 2016 Q1 Warrants are outstanding, in the event of a subsequent equity sale including a warrant exercise price lower than the exercise price of $0.05 per share, the exercise price of the 2016 Q1 Warrants shall be reduced to the lower exercise price. Any adjustment to the exercise price shall similarly cause the number of 2016 Q1 Warrant Shares to be adjusted so that the total value of the 2016 Q1 Warrants may increase.

Derivative

Because the above 2016 Q1 Notes and 2016 Q1 Warrants have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under ASC 815-40-15. ASC 815-40-15 requires as of the date the 2016 Q1 Notes and 2016 Q1 Warrants are issued, the derivative liability to be measured at the fair value and re-evaluated at the end of each reporting period. See Note 11. Derivative Liability.

Debt Discount

On issuance date, the fair value of the derivative liability for the 2016 Q1 Warrants was $25,879. Therefore a total of $25,879 of debt discount was recorded. $0 was recorded as amortization of debt discount during the six months ended June 30, 2016 and 2015, respectively.

As of June 30, 2016, the 2016 Q1 Notes have a balance of $254,796, net of discount $18,954, and accrued interest of $4,575.

As of June 30, 2016, the related party 2016 Q1 Notes have a balance of $93,075, net of discount $6,925 and accrued interest of $1,674.

Note 9 – Short term Notes Payable issued in Q2 2016

On June 24, 2016 (the "2016 Q2 Closing Date"), we closed a financing transaction by entering into a Securities Purchase Agreement dated June 24, 2016 (the "2016 Q2 Securities Purchase Agreement") with certain investors signatory to such 2016 Q2 Securities Purchase Agreement (the "2016 Q2 Purchasers") for an aggregate subscription amount of $52,500 (the "2016 Q2 Purchase Price") of which $40,000 is from related parties (see Note 5. Equity Commitment and Related Party Transactions). Pursuant to the 2016 Q2 Securities Purchase Agreement, we issued the following to the 2016 Q2 Purchasers: (i) 10% Promissory Notes with an aggregate principal amount of $52,500 (the "2016 Q2 Notes"), and (ii) warrants to purchase an aggregate of 525,000 shares of the Company's common stock, par value $0.01 per share, for an exercise price of $0.05 per share for a period of five (5) years from the Securities Purchase Agreement date (the "2016 Q2 Warrants"). In addition, the 2016 Q2 Notes provide for a return of principal with a 1.5 factor. The 2016 Q2 Notes are subordinated to the 2014 Notes. The $12,500 of the 2016 Q2 Notes Payable to a non-affiliated party received as collateral for his investment, an assignment of $12,500 of our claim against the Rex Carr estate pursuant to our $1,000,000 equity commitment. The remaining $40,000 to related parties, did not receive any collateral for their investments.

The terms of the 2016 Q2 Notes and the 2016 Q2 Warrants are as follows:

10% Promissory Notes

The total principal amount of the 2016 Q2 Notes is $52,500. The 2016 Q2 Notes will not accrue interest unless they are not repaid by the September 30, 2016 maturity date. Subsequent to the September 30, 2016 maturity date, simple interest shall accrue at an annual rate of 10% on a principal amount calculated by taking the original investment amount multiplied by the 1.5 factor. The 2016 Q2 Notes can be redeemed by the Company at any time without penalty.

In the event of default, the outstanding principal amount of the 2016 Q2 Notes plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the 2016 Q2 Purchasers election, immediately due and payable in cash.

Warrants

The 2016 Q2 Warrants are exercisable in whole or in part, at an initial exercise price per share of $0.05, subject to adjustment. The exercise price and number of shares of the Company's common stock issuable under the 2016 Q2 Warrants (the "2016 Q2 Warrant Shares") are subject to adjustments for stock dividends, splits, combinations, subsequent rights offerings, pro rata distributions and any issuance of securities below the exercise price of the 2016 Q2 Warrants. While the 2016 Q2 Warrants are outstanding, in the event of a subsequent equity sale including a warrant exercise price lower than the exercise price of $0.05 per share, the exercise price of the 2016 Q2 Warrants shall be reduced to the lower exercise price. Any adjustment to the exercise price shall similarly cause the number of 2016 Q2 Warrant Shares to be adjusted so that the total value of the 2016 Q2 Warrants may increase.

Derivative

Because the above 2016 Q2 Notes and 2016 Q2 Warrants have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under ASC 815-40-15. ASC 815-40-15 requires as of the date the 2016 Q2 Notes and 2016 Q2 Warrants are issued, the derivative liability to be measured at the fair value and re-evaluated at the end of each reporting period. See Note 11. Derivative Liability.

Debt Discount

On issuance date, the fair value of the derivative liability for the 2016 Q2 Warrants was $5,300. Therefore a total of $5,300 of debt discount was recorded. $0 was recorded as amortization of debt discount during the three and six months ended June 30, 2016 and 2015, respectively.

As of June 30, 2016, the 2016 Q2 Notes have a balance of $11,238, net of $1,262 of debt discount, and accrued interest of $0.

As of June 30, 2016, the related party 2016 Q2 Notes have a balance of $35,962, net of $4,038 of debt discount, and accrued interest of $0.

Note 10 – Blencathia Merger

Effective October 27, 1999, we merged with Blencathia Acquisition Corporation ("Blencathia"). Blencathia was a public shell company with immaterial assets and liabilities and 312,000 shares outstanding at the time of the merger, which it redeemed and cancelled upon the merger. In exchange, we issued 312,000 of our common shares to the prior Blencathia owner with the contractual understanding that such shares were to be sold by that owner to achieve gross cash proceeds of $500,000. Any excess proceeds were to be returned to us and any deficiency was to be made up by us issuing additional shares or paying the difference in cash. As we believed that we controlled the ultimate timing of the sale of these 312,000 shares by the prior Blencathia owner, we did not consider these shares as issued or outstanding for purposes of computing earnings per share prior to 2006.

In 2006, we learned that the prior Blencathia owner had, in fact, sold the 312,000 shares for aggregate proceeds of approximately $150,000, without our consent. Accordingly, in the fourth quarter of 2006, we recorded $500,000 of general expenses (representing the cost of the 1999 merger) and the deemed issuance of approximately $150,000 of common stock. The remaining $350,000 obligation was reflected as a current accrued expense. Beginning in 2006, the 312,000 shares have been reflected as outstanding for earnings per share computations. During 2009 and 2010, we made payments totaling $160,000 to the prior Blencathia owner. We have not made any payments to the prior Blencathia owner since 2010. The related current accrued expense balance remains at $190,000 at June 30, 2016. We are in negotiations with the prior Blencathia owner to resolve this obligation and may ultimately settle the obligation with either cash or equity securities with a lower market value.

Note 11 – Derivative Liability

During 2009, we granted a warrant to purchase 2,000,000 shares of the Company's common stock to an accredited investor in conjunction with equity raise efforts. On April 12, 2013, our Board authorized and approved the extension of the expiration date and a change of exercise price for this warrant. The outstanding share purchase warrant originally had a March 23, 2014 expiration date and an exercise price of $0.25. The new modified terms extended the warrant expiration date to April 11, 2018 and reduced the exercise price to $0.226. The exercise price is also subject to dilutive adjustments for share issuances (full ratchet reset features). As of both June 30, 2016 and December 31, 2015, the exercise price has been reduced to approximately $0.14 and an additional 1,620,015 and 1,430,134 warrants as of June 30, 2016 and December 31, 2015, respectively, are to be issued to the investor due to the reset features.

On August 21, 2015, we issued 4,150,000 warrants to investors and 296,000 warrants to a placement agent. The exercise price of these warrants is also subject to dilutive adjustments for share issuance (full ratchet reset features). During Q1 2016, an additional 5,810,000 warrants were issued to the 2015 Notes Payable holders and an additional 414,400 warrants were issued to the placement agent because of the reset provision. See Note 7. 2015 Notes Payable.

On August 22, 2014, we issued 6,666,667 warrants to investors and 800,000 warrants to a placement agent. The exercise price of these warrants is also subject to dilutive adjustments for share issuance (full ratchet reset features). During Q1 2016, an additional 9,333,334 warrants were issued to the 2014 Notes Payable holders and an additional 1,120,000 warrants were issued to the placement agent because of this reset provision. See Note 6. Convertible Short-term Notes Payable.

In the first quarter of 2016 we issued 3,737,500 warrants to investors (see note 8). The exercise price of these warrants is subject to dilutive adjustments for share issuance (full ratchet reset features).

In the second quarter of 2016 we 525,000 warrants to investors (see note 9). The exercise price of these warrants is subject to dilutive adjustments for share issuance (full ratchet reset features).

Because the convertible 2014 Notes, 2014 Warrants and 2015 Warrants and 2016 Warrants all have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under ASC 815-40-15, which requires as of the date the convertible 2014 Notes, 2014 Warrants and 2015 Warrants are issued, the derivative liability to be measured at fair value and re-evaluated at the end of each reporting period.

Key assumptions used to determine the fair value of the convertible 2014 Notes are as follows:

Key assumptions used to determine the fair value of the 2014 Warrants and 2015 Warrants are as follows:

As of June 30, 2016, the fair value of the total convertible 2014 Notes, 2014 Warrants, 2015 Warrants and 2016 Warrants' derivative liability is $134,984 and we recognized a gain on derivative liability of $321,230 and $65,166 for the six months ended June 30, 2016 and June 30, 2015, respectively.

The following table summarizes the derivative liability included in the balance sheet:

The following table summarizes information about warrants outstanding as of June 30, 2016:

Note 12 – Legal Proceedings

We are periodically subject to various lawsuits and claims with respect to matters arising out of the normal course of business. While the impact on future financial results is not subject to reasonable estimation because considerable uncertainty exists, management believes, after consulting with counsel, that it is more likely than not that the ultimate liabilities resulting from such lawsuits and claims will not materially affect our financial position, results of operations or liquidity.

On July 31, 2006, we received notice from the American Arbitration Association ("AAA") of a Demand for Arbitration dated July 27, 2006 received by the AAA naming the Company as Respondent and TPG Capital Partners ("TPG"), the prior Blencathia owner, as the Claimant. The arbitration had been requested by TPG to resolve an alleged aggregate proceeds shortfall from the sale of our securities issued in the Blencathia merger. TPG has claimed they sold some or all of the 312,000 shares and the sales have not generated at least $500,000 of proceeds, as guaranteed in the merger documents.

In an effort to resolve this matter prior to submission to binding arbitration, both TPG and the Company participated in a non-binding mediation conference on January 30, 2007, which did not resolve the matter. Informal discussions are ongoing. It is not expected that the ultimate settlement of this matter, considering we have recorded a liability for the shortfall amount, will have an additional adverse material effect on the Company. Since 2009, the Company has made payments to TPG totaling $160,000 to reduce the recorded liability. The remaining recorded liability balance is $190,000 at both June 30, 2016 and December 31, 2015, respectively.

We are a defendant in litigation with a former employee regarding accrued but unpaid salary. We are in discussions for settlement of this claim and have accrued an amount that we believe will resolve this matter.

Note 13 – Subsequent Events

On July 7, 2016, July 20, 2016 and July 27 2016, the Company issued $42,000, $42,000 and $41,000, respectively, of notes payable to non-affiliated individual investors. A total of 1,250,000 five-year warrants with an exercise price of $0.05 per share were issued pursuant to these investments.The terms of these loans were the same as the terms of the 2016 Q2 Notes Payable (see Note 9.). In addition, a total of $300,000 of collateral, in the form of an assignment of our claim against the Rex Carr estate, was assigned to these investors.

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

The following is management's discussion and analysis of certain significant factors that have affected the financial condition, results of operations and cash flows of Fuel Performance Solutions, Inc. (formerly known as International Fuel Technology, Inc.) (the "Company," "we," "us" or "our") during the periods included in the accompanying financial statements. This discussion should be read in conjunction with the financial statements and notes included in our annual report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission ("SEC") on March 30, 2016 (the "Annual Report").

Forward-looking Statements and Associated Risks

This quarterly report on Form 10-Q contains forward-looking statements that are based largely on our expectations and are subject to a number of risks, uncertainties and assumptions, many of which are beyond our control, including, but not limited to, economic, competitive and other factors affecting our operations, markets, products and services, expansion strategies, our ability to raise additional capital and other factors described elsewhere in this report and documents filed by us with the SEC, including in our Annual Report under the "Risk Factors" section. Words such as "expects," "anticipates," "intends," "plans," "believes," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. Actual results could differ materially from these forward-looking statements. In light of these risks, uncertainties and assumptions, there can be no assurance that the forward-looking information contained in this report will, in fact, prove accurate. We do not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances.

Overview

We are a fuel performance enhancement technology company transitioning to a commercial enterprise. We believe the macroeconomic environment for our technology and products is excellent now and will continue to be so for the foreseeable future. We believe ever-increasing fuel environmental regulations will likely result in increased demand for additive products to help offset adverse fuel performance and engine impacts resulting from these regulations. We believe our products and technology are uniquely positioned to benefit from this macro environment by offering fuel performance enhancement solutions that specifically address these macro developments and trends.

Commercial Update

During fiscal year 2015 and continuing into the first half of 2016, our three primary distribution partners, Unipart, Brenntag and Nordmann Rassmann ("NRC"), reorganized their efforts on our behalf and committed additional resources to better capitalize on the growing opportunities they foresee with our proprietary fuel additive formulations. These additional efforts by our distribution partners have resulted in more commercial opportunities for us that should come to fruition in 2016.

This repositioning by our distribution partners in 2015 and into the first half of 2016 had a negative effect on our revenues in the short term, but has provided us with a greater platform to succeed going forward.

The second quarter of 2016 was not a great quarter in terms of revenues. However, it was a productive quarter as a number of high profile projects with numerous rail and road transport operators in Europe continued to move forward. We are close to finalizing a number of these projects which should result in revenues beginning in the third quarter of 2016.

Our distribution partners will continue to account for the vast majority of our commercial opportunities and progress.

Unipart: Since the third quarter of 2014, our commercial efforts have been focused on the development of, preparation for, and the launch of the Fuel Efficiency Management ("FEM") program in conjunction with Unipart.

Since that time period, in consultation with Unipart, we put all of our DiesoLiFT^TM sales and marketing efforts in the United Kingdom and Europe on hold pending the proper development of the FEM program. Equipment vendors for all aspects of the FEM program have now been sourced and vetted and the deliberate pace to ensure the FEM program was ready for proper deployment has reached the launch point. Unipart now has a group set up for the specific purpose of commercializing DiesoLiFT^TM. Unipart continues to commit more time, effort and resources toward making the FEM program a success.

In the third quarter of 2015, we expanded our marketing and distribution agreement with Unipart. The revised marketing and distribution agreement with Unipart provides Unipart exclusive distribution rights for DiesoLiFT^TM for the rail industry worldwide; exclusive distribution rights for DiesoLiFT^TM for commercial and public service vehicle and retail markets in the United Kingdom and the Republic of Ireland, Australia, South Africa and theMiddle East; exclusive distribution rights for GasoLift^TM for all sectors in the United Kingdom and The Republic of Ireland; and non-exclusive distribution rights for DiesoLiFT^TM and GasoLiFT^TM worldwide.

In addition, Unipart has been granted exclusive distribution rights for PerfoClean in the United Kingdom and the Republic of Ireland and non-exclusive distribution rights worldwide. PerfoClean is our proprietary formulation specifically designed to clean bulk fuel storage tanks.

Unipart adopted the FEM program in its own fleet of distribution vehicles in 2015 and is actively involved in commercial projects with numerous road transport operators (both private and public sector), rail operators (both passenger and freight) and fuel wholesalers. We expect additional deployments of the FEM program in the third quarter of 2016.

The FEM program is our primary business focus and will be the primary driver of our future revenues and profits.

Brenntag: In 2015, Brenntag made the decision to re-evaluate their efforts on our behalf. After extensive analysis, and as part of their strategic fuel business planning, Brenntag decided there was a compelling opportunity to put in place a more organized and concerted marketing and sales approach to our product line. Brenntag has completed its market by market studies and will roll-out their revised marketing and sales plan for distribution of our products across Europe in the third quarter of 2016.

Brenntag will also continue to sell our products to Bardahl, Lubrichim, ETSP, Lubro and Eurol, who all repackage the products and sell to retail customers under their own brand name.

Going forward, we expect Brenntag to execute on their revised plan and ramp up their selling efforts of our products to: the road transport industry (fleets); refineries and fuel distributors; bio-diesel manufacturers; and the marine industry.

NRC: In 2015, NRC decided to re-evaluate their efforts on our behalf. After extensive review, NRC concluded there was a compelling opportunity to more aggressively market and sell our unique fuel additives formulations. As a result, the entire Company product line was moved out of NRC's new business division and into their Oleochemicals, Lubes & Growth division. This transition provides NRC with more resources to market and sell our products.

We are in the process of updating and expanding our distribution agreement with NRC to reflect the increased resources that NRC is now dedicating to the marketing and sales of our proprietary fuel additive formulations.

The primary thrust of NRC efforts will continue to be with our PerfoLiFT^TM line of bio-diesel stabilization additives used to stabilize and prolong the shelf life of bio-diesel fuels or all underlying sources. NRC continues to receive orders from and sell our products to some of the largest bio-diesel manufacturers in Europe.

Despite the fact that sales of our PerfoLiFT^TM BD-Series product line to NRC decreased during 2015 and in the first half of 2016 compared to prior periods, we expect NRC to increase its sales of our PerfoLiFT^TM BD-Series of bio-diesel stability additives in 2016 and beyond through increased sales to existing accounts and sales to new accounts.

NRC has also begun to market our products to the marine industry and to some road transport fleets.

Results of Operations

Three and Six Months Ended June 30, 2016 Compared to Three and Six Months Ended June 30, 2015

Net Revenues

Net revenues for the three months ended June 30, 2016 were $9,045, as compared to $91,295 for the three-month period ended June 30, 2015. This decrease is primarily attributable to decreased sales of the PerfoLiFT^TM BD-Series and DiesoLiFT^TM through our distributor network during the three months ended June 30, 2016.

During the three months ended June 30, 2016, all of our sales were to one of our distribution partners. During the three months ended June 30, 2015, 100% of our sales were concentrated among three customers. Sales revenue generated during the three months ended June 30, 2016 and June 30, 2015 was primarily generated from the sale of the PerfoLiFT^TM BD-Series and DiesoLiFT^TM.

Net revenues for the six months ended June 30, 2016 were $56,667, as compared to $225,368 for the six month period ended June 30, 2015. This decrease is primarily attributable to decreased sales of the PerfoLiFT^TM BD-Series and DiesoLiFT^TM through our distributor network during the six months ended June 30, 2016.

During the six months ended June 30, 2016, 100% of our sales were concentrated among two customers. During the six months ended June 30, 2015, 100% of our sales were concentrated among four customers. Sales revenue generated during the three months ended June 30, 2016 and June 30, 2015 was primarily generated from the sale of the PerfoLiFT^TM BD-Series and DiesoLiFT^TM.

Operating Expenses

Total operating expenses were $224,851 for the three months ended June 30, 2016, as compared to $456,831 for the three-month period ended June 30, 2015. This $231,980 decrease from the prior period was primarily attributable to reductions in: the cost of operations due to decreased sales; salaries and wages; non-cash stock-based compensation expense; employee expenses; and professional services, which are more fully described below.

Total operating expenses were $574,708 for the six months ended June 30, 2016, as compared to $949,783 for the six-month period ended June 30, 2015. This $375,075 decrease from the prior period was primarily attributable to reductions in: the cost of operations due to decreased sales; salaries and wages; non-cash stock-based compensation expense; employee expenses; and professional services, which are more fully described below.

Cost of Operations

Cost of operations was $0 for the three months ended June 30, 2016, as compared to $71,598 for the three-month period ended June 30, 2015. This decrease was due to decreased sales for the three months ended June 30, 2016, compared to the three months ended June 30, 2015.

Cost of operations was $34,470 for the six months ended June 30, 2016, as compared to $173,070 for the six-month period ended June 30, 2015. This decrease was due to decreased sales for the six months ended June 30, 2016, compared to the six months ended June 30, 2015.

Selling, General and Administrative Expense

Selling, general and administrative expense for the three months ended June 30, 2016 was $224,851, as compared to $385,233 (including non-cash stock-based compensation of $35,507) for the three-month period ended June 30, 2015. This decrease of $160,382 was primarily attributable to the following activities:

Selling, general and administrative expense for the six months ended June 30, 2016 was $540,238, as compared to $776,713 (including non-cash stock-based compensation of $72,783) for the six-month period ended June 30, 2015. This decrease of $236,475 was primarily attributable to the following activities:

Interest Expense, Net

Interest expense, net was $92,605 and $167,519 for the three months ended June 30, 2016 and June 30, 2015, respectively. The decrease in interest expense, net is primarily attributable to interest expense recorded relating to the third quarter of 2015 Notes financing.

Interest expense, net was $292,709 and $316,475 for the six months ended June 30, 2016 and June 30, 2015, respectively. The increase in interest expense, net is primarily attributable to interest expense recorded relating to the third quarter of 2015 Notes financing.

Gain (Loss) on Derivative Liability

Gain on derivative liability was $258,793 and $27,860 for the three months ended June 30, 2016 and June 30, 2015, respectively.

The gain on derivative liability recorded during the three months ended June 30, 2016 and June 30, 2015 was primarily attributable to certain warrants issued during 2009 and during 2014, 2015 and the first and second quartersof 2016 (see Note 11 – Derivative Liability) that are subject to dilutive adjustments for share issuances (full ratchet reset features) tied to future issuances of our equity securities. Because of these characteristics, our derivative liability must be measured at fair value and re-evaluated at the end of each reporting period. The mark-to-market of the derivative liability at June 30, 2016 and June 30, 2015 caused such gain.

Gain on derivative liability was $321,230 and $65,166 for the six months ended June 30, 2016 and June 30, 2015, respectively.

The gain on derivative liability recorded during the six months ended June 30, 2016 and June 30, 2015 was primarily attributable to certain warrants issued during 2009 and during 2014, 2015 and the first and second quarters of 2016 (see Note 11 – Derivative Liability) that are subject to dilutive adjustments for share issuances (full ratchet reset features) tied to future issuances of our equity securities. Because of these characteristics, our derivative liability must be measured at fair value and re-evaluated at the end of each reporting period. The mark-to-market of the derivative liability at June 30, 2016 and June 30, 2015 caused such gain.

As of June 30, 2016 and December 31, 2015, the fair value of both components of our derivative liability was $134,484 and $425,035, respectively.

Income Tax Provision

We have operated at a net loss since inception and have not recorded or paid any income taxes, other than for non-cash deferred tax expense related to a basis difference between financial reporting and tax reporting goodwill. We have significant net operating loss ("NOL") carry-forwards that would be recognized at such time as we demonstrate the ability to operate on a profitable basis for an extended period of time. The deferred income tax asset resulting primarily from the NOL carry-forwards has been fully reserved with a valuation allowance. Because goodwill is not depreciated and has an indefinite life for book purposes, the deferred tax liability related to the book to tax basis difference is not offset against the deferred tax assets when establishing our valuation allowance. We did not record any expense during the six months ended June 30, 2016 and June 30, 2015, respectively, as we deemed the valuation allowance to be sufficient.

Net Loss

Net loss for the three months ended June 30, 2016 was $(49,618), as compared to $(505,195) for the three months ended June 30, 2015. The decrease in net loss was primarily due to: an increase in gain on derivative liability of $230,933; and decreases in net interest expense ($74,914), salaries and wages ($56,542), employee expenses ($38,685, non-cash stock-based compensation expense ($35,507), and professional services ($29,887). described above. The basic and diluted net loss per common share for both the three months ended June 30, 2016 and June 30, 2015 was $(0.00), respectively.

Net loss for the six months ended June 30, 2016 was $(489,520), as compared to $(975,724) for the six months ended June 30, 2015. The decrease in net loss was primarily due to: an increase in gain on derivative liability ($256,064); and decreases in employee expenses ($79,626, non-cash stock-based compensation expense ($71,880), , professional services ($45,404) and salary and wages ($38,592) as described above. The basic and diluted net loss per common share for both the six months ended June 30, 2016 and June 30, 2015 was $(0.00), respectively.

Recently Issued Accounting Pronouncements

Management does not believe that any recently issued, but not effective, accounting standards, if currently adopted, would have a material effect on the Company's financial statements.

Critical Accounting Policies and Estimates

Derivative Financial Instruments

We evaluate our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in our statements of operations. For stock-based derivative financial instruments, we use a Lattice Model option pricing model, in accordance with the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") ASC 815-15, "Derivatives and Hedging," to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in our balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve (12) months of the balance sheet date.

Revenue Recognition

We recognize revenue from the sale of our products when the price is fixed and determinable, persuasive evidence of an arrangement exists, the products are shipped, and title and risk of loss has passed to the buyer and collectability of the resulting receivable is reasonably assured. The majority of our revenues is from sales to product distributors. Product distributors do not have the option to return product that is not immediately sold to an end-user. Therefore, our revenue recognition is not conditional on whether a distributor is able to sell product to an ultimate product end-user. Our sales policies for end-users are consistent with product distributor sales policies.

Beginning in May 2013, as an effort to address our outstanding payable balance with and at the request of our product manufacturer, our non-United States customers began remitting receivable payments directly to our product manufacturer in lieu of remitting payment directly to us. Under this arrangement, we still maintained the risks and benefits related to sending the product to each customer and thus recorded sales revenues (and associated cost of sales) applying the gross reporting treatment for each transaction pursuant to ASC 605-45, "Principal Agent Considerations." During the first quarter of 2014, we once again began collecting payments directly from our non-United States customers and paying our product manufacturer separately for the corresponding cost of manufactured goods.

Investor Warrant Modifications

The Company and the Board from time to time have authorized the modification to the terms of certain prior warrant issuances. We analyze such modifications under ASC 718 "Compensation-Stock Compensation" ("ASC 718") and ASC 505, "Equity Based Payments to Non-Employees" ("ASC 505") and have historically determined that no gain or loss is recognized upon the modification due to the warrants having been issued to an investor and investor awards not being subject to either ASC 718 or ASC 505.

Valuation of Goodwill

We account for goodwill and intangible assets in accordance with ASC 350 "Intangibles-Goodwill and Other" ("ASC 350"). ASC 350 requires that goodwill and other intangibles with indefinite lives be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value. In addition, ASC 350 requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions or the occurrence of one or more confirming events in future periods could cause the actual results or outcomes to materially differ from such estimates and could also affect the determination of fair value and/or goodwill impairment at future reporting dates.

We employed a qualitative analysis for goodwill at both June 30, 2016 and December 31, 2015 and determined there was no impairment.

Liquidity and Capital Resources

A critical component of our operating plan affecting our ability to execute the product commercialization process is the cash resources needed to pursue our marketing and sales objectives. Until we are able to generate positive and sustainable operating cash flow, our ability to attract additional capital resources in the future will be critical to continue the funding of our operations.

In its audit report dated June 30, 2016, our independent registered public accounting firm expressed substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We have been funded since inception primarily by unregistered sales of Company restricted stock, generally to existing shareholders. We have also relied on a $1,000,000 equity commitment from one of our Directors, Rex Carr, of which $500,000 remains available (See Note 5. Equity Commitment and Related Party Transactions.) Rex Carr passed away on April 27, 2015. On April 30, 2015, the Company elected Glenn Carr as a Director to its Board. Glenn Carr is the son of Rex Carr. The Company believes that the equity commitment of Rex Carr will be honored by his estate. However, we can make no assurances as to the timing of when the estate may be settled, and how much we may receive once the estate is settled. During the second quarter of 2016, we assigned $12,500 of our claim against the Rex Carr estate pursuant to our $1,000,000 equity commitment, to an interim capital investor (see Note 9. 2016 Q2 Notes Payable). Subsequent to June 30, 2016, we assigned an additional $300,000 of our claim against the Rex Carr estate to other interim capital investors (see Note 13. Subsequent Events).

In addition, during the third quarter of 2014, we obtained additional funding in the form of a convertible notes payable (see Note 6. Convertible Short-term Notes Payable) and during the third quarter of 2015, we obtained additional funding in the form of a subordinated notes payable (see Note 7. 2015 Notes Payable). We also obtained funding in the first and second quarters of 2016 in the form of subordinated notes (see Note 8. 2016 Q1 Notes Payable and Note 9. 2016 Q2 Notes Payable).

While we cannot make any assurances as to the accuracy of our projections of future capital needs, based on our current cash available as of August 15, 2016 (approximately $70,000) and additional capital commitments from Directors, we have adequate cash and cash equivalents balances and commitments to fund operations through the end of September 2016. Management implemented a salary deferral program for all employees during 2011 to conserve our cash position. This salary deferral program has continued.

We are currently working with two U.K.-based investment banks. Based on recent discussions with them, we believe they will be successful in raising long term capital in the fourth quarter of 2016.

However, if we are unable to secure additional capital, we will need to curtail operations.

Cash used in operating activities was $383,121 for the six months ended June 30, 2016, as compared to cash used in operating activities of $498,353 for the six months ended June 30, 2015. The decrease in cash flow used in operating activities was due primarily to a decrease in our accounts receivable balance ($282,211) due to timing of customer cash collections and a $256,064 gain on derivative liability, partially offset by a decrease in our accounts payable balance ($201,218) due to timing of vendor payments.

Cash provided by financing activities was $376,250 for the six months ended June 30, 2016, as compared to $0 for the six months ended June 30, 2015. During the six months ended June 30, 2016, we received gross proceeds of $376,250 from the issuance of notes payable.

Net cash increased (decreased) by ($11,871) and $(498,353) for the six months ended June 30, 2016 and June 30, 2015, respectively.

During the six months ended June 30, 2016 and June 30, 2015, we did not make significant investments in property and equipment and do not anticipate doing so in the immediate future.

Working capital deficit at June 30, 2016 was $(3,338,696), as compared to $(3,126,013) at December 31, 2015. The negative working capital balance for June 30, 2016 is negatively impacted by continued operational cash burn to fund ongoing operations during the six months ended June 30, 2016, the issuance of the 2016 Notes payable and the reclassification of the 2014 Notes payable and associated accrued interest payable from a long term liability to a current liability at December 31, 2015. The negative working capital balance for December 31, 2015 is negatively impacted by continued operational cash burn to fund ongoing operations during the twelve months ended December 31, 2015 and the reclassification of the 2014 Notes payable and associated accrued interest payable from a long term liability to a current liability at December 31, 2015.

Effective October 27, 1999, we merged with Blencathia Acquisition Corporation ("Blencathia"). Blencathia was a public shell company with immaterial assets and liabilities and 312,000 shares outstanding at the time of the merger, which it redeemed and cancelled upon the merger. In exchange, we issued 312,000 of our common shares to the prior Blencathia owner with the contractual understanding that such shares were to be sold by that owner to achieve gross cash proceeds of $500,000. Any excess proceeds were to be returned to us and any deficiency was to be made up by us issuing additional shares or paying the difference in cash. As we believed that we controlled the ultimate timing of the sale of these 312,000 shares by the prior Blencathia owner, we did not consider these shares as issued or outstanding for purposes of computing loss per share.

In 2006, we learned that the prior Blencathia owner had, in fact, sold the 312,000 shares for aggregate proceeds of approximately $150,000, without our consent. Accordingly, in the fourth quarter of 2006, we recorded $500,000 of general expenses (representing the cost of the 1999 merger) and the deemed issuance of approximately $150,000 of common stock. Since 2009, we have made payments to the prior Blencathia owner in the aggregate of $160,000 reducing this obligation. The remaining $190,000 obligation has been reflected as a current accrued expense. We are in negotiations with the prior Blencathia owner to resolve this obligation and may ultimately settle the obligation with either cash or equity securities with a lower market value. Beginning in 2006, the 312,000 shares have been reflected as outstanding for earnings per share computations.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Not applicable.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our management has evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2016. Based on this evaluation, the principal executive officer and principal financial officer have identified a material weakness in our internal control over financial reporting. Because of the material weakness, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective at June 30, 2016.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

This quarterly report does not include an attestation report of our independent auditors regarding internal control over financial reporting. Management's report was not subject to attestation by our independent auditors pursuant to temporary rules of the SEC that permit our company to provide only management's report in this quarterly report.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are periodically subject to various lawsuits and claims with respect to matters arising out of the normal course of business. While the impact on future financial results is not subject to reasonable estimation because considerable uncertainty exists, management believes, after consulting with counsel, that it is more likely than not that the ultimate liabilities resulting from such lawsuits and claims will not materially affect our financial position, results of operations or liquidity.

On July 31, 2006, we received notice from the American Arbitration Association ("AAA") of a Demand for Arbitration dated July 27, 2006 received by the AAA naming us as Respondent and TPG Capital Partners ("TPG"), the prior Blencathia owner, as the Claimant. The arbitration had been requested by TPG to resolve an alleged aggregate proceeds shortfall from the sale of Company securities issued in the Blencathia merger. TPG has claimed they sold some or all of the 312,000 shares and the sales have not generated at least $500,000 of proceeds, as guaranteed in the merger documents.

In an effort to resolve this matter prior to submission to binding arbitration, both TPG and the Company participated in a non-binding mediation conference on January 30, 2007, which did not resolve the matter. Informal discussions are ongoing. It is not expected that the ultimate settlement of this matter, considering we have recorded a liability for the shortfall amount, will have an additional adverse material effect on the Company. Since 2009, we have made payments to TPG totaling $160,000 to reduce the recorded liability. The remaining liability balance is $190,000 at June 30, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the second quarter of 2016, the Company received a cumulative total of $52,500 in the form of subordinated notes; $12,500 from external investors and $40,000 from two Directors of the Company (see Note 9. 2016 Q2 Notes Payable above). The subordinated 2016 Q2 Notes included warrants to purchase 525,000 shares of our common stock with a five year term and an exercise price of $0.05, subject to adjustments for stock dividends, splits, combinations, subsequent rights offerings, pro rata distributions and any issuance of securities below the $0.05 exercise price. We used the proceeds for general corporate purposes.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

There have been no material changes to the procedures by which security holders may recommend nominees to our Board of Directors since the filing of our Annual Report.

Item 6. Exhibits

(a) The following exhibits are filed as part of this report:

SIGNATURES

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