Washington, D.C. 20549
Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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.
The number of outstanding shares of the issuer's common stock, $0.001 par value, as of August 13, 2007 was 70,452,880.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited financial statements of Execute Sports, Inc. (“Execute Sports” or the “Company”) as of June 30, 2007 and for the three and six month periods ended June 30, 2007 and 2006 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Form 10-KSB for the fiscal year ended December 31, 2006 filed with the SEC on April 16, 2007. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the interim financial information have been included. The results of operations for any interim period are not necessarily indicative of the results of operations for the entire year.
Organization
Execute Sports was founded in 2002 as Padova International USA, Inc. to produce graphics kits and ancillary soft goods for the motocross, enduro and ATV markets.
In 2003, the Company launched its water sports division under the "Execute Sports" brand to provide wetsuits, vests, rash guards and ancillary products to the wake board and ski markets.
On March 3, 2005 the Company changed its name from Padova International U.S.A., Inc. (DBA Execute Sports) to Execute Sports, Inc.
In January 2006, the Company expanded its product mix by consummating the acquisition of Pacific Sports Group, Inc. (“PSG”), which owned and operated Academy Snowboards, Kampus Wakesk8s, Kampus Wake Shoes and Collective Development Bags and Bindings. In January, 2007, the Company entered into a trademark transfer and assignment agreement whereby all right, title, interest and good will in the Academy brand were transferred to the two former owners of PSG. In connection with the transfer, all of the Company’s account payables and account payables and account receivables relating to the trademark were assigned as well.
Summary of Significant Accounting Principles
Basis of Presentation
The financial statements include the accounts of Execute Sports and its wholly owned subsidiary PSG under the accrual basis of accounting.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounting 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 reporting period. Actual results could differ from those estimates.
Principles of consolidation
The consolidated financial statements include the accounts of Execute Sports and its subsidiary, which is 100% consolidated in the financial statements. All material inter-company accounts and transactions have been eliminated.
Cash and cash equivalents
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Accounts receivable
Accounts receivable are reported at the customers' outstanding balances less any allowance for doubtful accounts. Interest is not accrued on overdue accounts receivable. The Company evaluates receivables on a regular basis for potential reserve. During the three months ended June 30, 2007, the allowance for doubtful accounts decreased $29,000 from $49,000 at March 31, 2007 to $20,000 at June 30, 2007.
The Company has entered into a factoring agreement with JD Factors. Pursuant to the agreement JD Factors’ will provide account receivable financing and factoring to the Company. JD Factors will purchase from the Company the accounts receivable and may pay a portion of the purchase price, or lend money to the Company based upon accounts’ receivable of the Company.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined using the average costing method. Management performs periodic assessments to determine the existence of obsolete, slow moving and non-salable inventories, and records necessary provisions to reduce such inventories to net realizable value.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Property and equipment
Property and equipment are stated at cost. Major renewals and improvements are charged to the asset accounts while replacements, maintenance and repairs, which do not improve or extend the lives of the respective assets, are expensed. At the time property and equipment are retired or otherwise disposed of, the asset and related accumulated depreciation accounts are relieved of the applicable amounts. Gains or losses from retirements or sales are credited or charged to income.
Depreciation is provided using the 200% declining balance method. It is calculated over recovery periods as prescribed by management that range from 5 years for equipment to 7 years for furniture.
Long-lived assets
The Company has adopted Statement of Financial Accounting Standards No. 144 (SFAS 144). The Statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be appropriate. The Company assesses recoverability of the carrying value of an asset by estimating the future net cash flows expected to result from the asset, including eventual disposition. If the future net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset's carrying value and fair value.
Revenue recognition policy
Revenue from the sale of water sports clothing and apparel, and motorcycle accessories are recognized when the earning process is complete and the risk and rewards of ownership have transferred to the customer, which is generally considered to have occurred upon shipment to the customer.
Shipping and handling costs
The Company's policy is to classify shipping and handling costs as selling, general and administrative expenses.
Advertising
The Company expenses all advertising costs as incurred. For the three and six months ended June 30, 2007 and 2006 the Company incurred approximately $8,118 and $8,118 and $17,516 and $52,179, respectively, in advertising expenses.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Loss per common share
The Company adopted Statement of Financial Accounting Standards No. 128, that requires reporting of both basic and diluted earnings (loss) per share. Basic loss per share is calculated using the weighted average number of common shares outstanding in the period. Diluted loss per share includes potentially dilutive securities such as outstanding options and warrants, using the “treasury stock” method and convertible securities using the "if-converted" method. There were no adjustments required to net loss for the period covered in this report in the computation of diluted earnings per share.
Issuance of common stock
The issuance of common stock for other than cash is recorded by the Company at management’s estimate of the fair value of the assets acquired or services rendered.
Comprehensive loss
The Company adopted Financial Accounting Standards Board Statement of Financial Standards No. 130, “Reporting Comprehensive Income,” which establishes standards for the reporting and display of comprehensive income and its components in the financial statements. There were no items of comprehensive income (loss) applicable to the Company during the periods covered in the financial statements included in this report.
Income taxes
On November 1, 2004, the Company amended its Articles of Incorporation to make the transition from an S-Corporation to a C-Corporation. Prior to the transition, the S-Corporation was not a tax paying entity for federal or state income tax purposes and thus no provision for income taxes was recognized. Subsequent to the change, the Company began recognizing the full valuation for deferred tax assets (See Note N).
Impact of accounting standards
In February 2006, the FASB issued SFAS 155 "Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133” and in February 2006, the FASB issued SFAS 155 "Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140. This Statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of statement 133 to Beneficial Interests in Securitized Financial Assets. This Statement:
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Impact of accounting standards (Continued)
a) Permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; b) Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133; c) Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; d) Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and e) Amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.
This Statement is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The fair value election provided for in paragraph 4 of this Statement may also be applied upon adoption of this Statement for hybrid financial instruments that had been bifurcated under paragraph 12 of Statement 133 prior to the adoption of this Statement. Earlier adoption is permitted as of the beginning of an entity's fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. Provisions of this Statement may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis. The Company does not believe that this accounting pronouncement will have a material impact on their financial position or results of operations.
In March 2006, the FASB issued SFAS No. 156 ("FAS 156"), "Accounting for Servicing of Financial Assets--An Amendment of FASB Statement No. 140." Among other requirements, FAS 156 requires a company to recognize a servicing asset or servicing liability when it undertakes an obligation to service a financial asset by entering into a servicing contract under certain situations. Under FAS 156 an election can also be made for subsequent fair value measurement of servicing assets and servicing liabilities by class, thus simplifying the accounting and provide for income statement recognition of potential offsetting changes in the fair value of servicing assets, servicing liabilities and related derivative instruments. The Statement was effective beginning the first fiscal year that begins after September 15, 2006. The Company does not believe that this accounting pronouncement will have a material impact on its financial position or results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements.” The standard provides guidance for using fair value to measure assets and liabilities. Under the standard, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. The standard clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Impact of accounting standards (Continued)
or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the Statement to determine what impact, if any, it will have on the Company.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132R” (“SFAS 158”). This statement requires balance sheet recognition of the funded status, which is the difference between the fair value of plan assets and the benefit obligation, of pension and postretirement benefit plans as a net asset or liability, with an offsetting adjustment to accumulated other comprehensive income in shareholders’ equity. In addition, the measurement date, the date at which plan assets and the benefit obligation are measured, is required to be the company’s fiscal year end. The Company does not believe that this accounting pronouncement will have a material impact on its financial position or results of operations.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Company’s Board of Directors long-term measurement objectives for accounting for financial instruments. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company does not believe that this recent accounting pronouncement will have a material impact on its financial position or results of operations.
Concentrations of credit risk
The Company performs ongoing credit evaluations of its customers. In the three months ended June 30, 2007, the Company's two largest customers accounted for 90% (79% and 11%) of accounts receivable. In the three months ended June 30, 2006, the Company's largest customer accounted for 44% of accounts receivable.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Concentrations of credit risk (Continued)
For the three and six months ended June 30, 2007, three customers accounted for approximately 93% (45%, 25% and 23%) and 93% (54%, 24% and 15%) of sales, respectively. For the three and six months ended June 30, 2006, two customers accounted for approximately 74% (46% and 28%) and 71% (58% and 13%) of sales, respectively.
For the three months ended June 30, 2007 and 2006, approximately 0% and 3%, respectively, of the Company’s net sales were made to customers outside the United States. For the six months ended June 30, 2007 and 2006, approximately 0% and 6%, respectively, of the Company’s net sales were made to customers outside the United States.
The Company is dependent of third-party manufacturers and distributors for all of its supply of inventory. For the three and six months ended June 30, 2007, the Company's two largest suppliers individually accounted for approximately 100% (67% and 33%) and 97% (71%, and 27%) of product purchases, respectively. For the three and six months ended June 30, 2006, the Company's two and three largest suppliers individually accounted for approximately 83% (47% and 36%) and 81% (54%, 15% and 12%) of product purchases, respectively. The Company is dependent on the ability of its suppliers to provide products and services on a timely basis and on favorable pricing terms. The loss of certain principal suppliers or a significant reduction in product availability from principal suppliers could have a material adverse effect on the Company.
Disclosure about Fair Value of Financial Instruments
The Company estimates that the fair value of all financial instruments at June 30, 2007, as defined in FASB 107, does not differ materially from the aggregate carrying values of its financial instruments recorded in the accompanying balance sheet. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value, and accordingly, the estimates are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
NOTE B - ACCOUNTS RECEIVABLE
On September 12, 2005, the Company entered into a factoring agreement with JD Factor (the “Factor”) subsequent to terminating the factoring agreement with Benefactor Funding Corp. in August 2005. The Factor purchases certain customer accounts receivable on a non-recourse basis with certain broad exceptions. The Factor initially advances 80% of the amount of the invoice with the remainder, less fees, paid to the Company once the customer pays the invoice. The Company performs substantially all collection efforts. Under certain circumstances the Factor has the right to charge back to the Company for specific invoices.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE B - ACCOUNTS RECEIVABLE (Continued)
The interest rate charged to the Company varies depending on the age of the receivable upon customer payment. The factoring agreement is collateralized by substantially all of the Company’s assets.
The Company is reporting the factoring agreement as a secured borrowing in accordance with FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” As of June 30, 2007, the balance due to the Factor was $102,248 which is collateralized by factored receivables of approximately $127,810.
The accounts receivable balance as of June 30, 2007 is reported net of an allowance for doubtful accounts of $20,000.
NOTE C - INVENTORY
Inventories are comprised of finished goods ready for resale and are stated at the lower of cost or market, as determined using the average costing method. The following table represents the major components of inventory at June 30, 2007:
| | | 2007 | |
| Finished goods | | $ | 89,636 | |
| | | | | |
NOTE D - PROPERTY AND EQUIPMENT
Property and equipment at June 30, 2007 consists of the following:
| | | 2007 | |
| Computer and office equipment | | $ | 127,745 | |
| Furniture and fixtures | | | 2,281 | |
| Machinery and equipment | | | 11,262 | |
| | | $ | 141,288 | |
| Less: Accumulated Depreciation | | | (47,714 | ) |
| | | $ | 93,574 | |
Depreciation expense for the three and six months ended June 30, 2007 and 2006 was $2,530 and $5,060 and $1,138 and $2,276, respectively.
NOTE E - LOANS RECEIVABLE
During 2005 and 2006, the Company made strategic loans totaling $396,127 for potential future association to an unaffiliated company that accrues interest at 2% per year and due 12 months from the date of draw.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE E - LOANS RECEIVABLE (Continued)
As of June 30, 2007, the entire balance of the loans were in default. The Company has created a reserve of $250,000 against the loans.
NOTE F - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at June 30, 2007 consist of the following:
| | | 2007 | |
| Payables to vendors | | $ | 42,318 | |
| Payables for inventory | | | 15,476 | |
| Payables for professional services | | | 36,734 | |
| Accrued payroll | | | 39,149 | |
| Accrued interest | | | 11,560 | |
| | | $ | 145,237 | |
NOTE G - CONVERTIBLE DEBENTURE
On May 15, 2006, the Company completed a private placement of convertible debentures generating gross proceeds of $1.9 million, and the issuance of warrants to purchase $475,000 worth of the Company’s common stock. Third party fees totaled $191,000, which were paid in cash.
The terms of the warrants and debentures are substantially the same. The exercise price of the warrants is calculated the same as for the conversion price of the convertible debentures. The warrants and debentures are immediately exercisable. The debentures bear interest at 12% per annum, interest payable monthly at the option of the Holder in cash or common stock. The debenture agreement payment schedule provides for full repayment by September 30, 2011, the maturity date of this debenture, any remaining principle balance automatically converts to the Company’s common stock.
Prior to maturity, the debentures and warrants are convertible into the Company's common stock at a fixed conversion price equal to the lowest closing bid price of the common stock between the issuance date and the date of the filing the registration statement covering resale of the shares underlying the debenture, or at a conversion price of fifteen cents ($.15). Since the Company’s stock price did not decline below $0.15 prior to the filing of the registration statement, $0.15 is the fixed conversion price for this debenture and associated warrants.
The debentures provide that the Holders may only convert the debenture if the number of shares held by the lender or its affiliates after conversion would not exceed 4.99% of the outstanding shares of the Company's common stock following such conversion.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE G - CONVERTIBLE DEBENTURE (Continued)
In connection with the transaction, the Company entered into a Registration Rights Agreement. Pursuant to the terms of the Registration Rights Agreement, within twenty-one calendar days following the initial closing date, or June 5, 2006, the Company was required to file with the Securities and Exchange Commission a registration statement under the Securities Act of 1933, as amended, covering the resale of all of the common stock underlying the convertible debenture and issuable upon the exercise of the warrants based on a conversion price of $0.15 per share.
The Registration Rights Agreement further provides that if a registration statement is not filed within 21 days from the initial closing date, then in addition to any other rights the Holder may have, and until the registration statement is filed, the Company would be required to pay the Holder an amount in cash, as liquidated damages, equal to an aggregate two percent (2%) of the purchase price of the debentures. In addition, the conversion price would decrease by 10% of the fixed conversion price for each fifteen (15) day calendar period that a registration statement is not filed. The Registration Rights Agreement further provides that if a registration statement is not declared effective within 80 days from the initial closing date, then the Company would be required to pay the Holder an amount in cash, as liquidated damages, equal to an aggregate two percent (2%) of the purchase price of the debentures until the registration statement becomes effective. The Company initially filed the registration statement on May 24, 2006 and it was declared effective on June 15, 2006, or 30 days from the initial close date both within the time frames set forth in the Registration Rights Agreement.
The issuance costs related to the convertible debentures of approximately $191,000 in cash were capitalized to prepaid expenses on the balance sheet and are being amortized over the term of the repayment schedule which is calculated based upon the effective interest method. For the three and six months ended June 30, 2007 and 2006, the Company recognized $36,757 and $72,791 and $17,068 and $17,068, respectively as other expense related to the amortization of the issuance costs with a $31,185 balance remaining in current assets deferred financing costs.
Pursuant to Paragraph 9-32 of EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, the warrants issued in connection with the convertible debentures meet the requirements of and are accounted for as permanent equity since the filing of an effective registration statement within the allotted time frames negated any liquidated damages, settlement is by delivery of shares only and the exercise price is fixed. The initial value of the warrants was treated as a discount to the debenture and recorded as additional paid in capital. The Company calculated the initial value of the warrants on the closing date of the transaction as being $633,333 as determined using a Black-Scholes option pricing model with the following assumptions: expected term 5 years, exercise price $0.15, volatility 7.6%, risk free rate 5.15%, and zero dividend yield. The total value of the warrants and the debenture was $2.53 million of which the warrants represented 25%. Thus, the relative value of the warrants to the total value, or 25% was applied to the debenture value of $1.90 million yielding a warrant discount of $475,000. The discount to the debenture is being amortized over the term of the repayment schedule, or sixteen (16) months, and is calculated based upon the effective interest method. During the three and six months ended June 30, 2007
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE G - CONVERTIBLE DEBENTURE (Continued)
and 2006, the Company recognized $95,390 and $185,771 and $39,015 and $39,015, respectively in non-cash amortization expense related to the warrant discount.
The Company determined that the $1.90 million debenture was issued with a beneficial conversion feature (“BCF”) due to the conversion price ($0.15) being less than the closing stock price ($.32) on the date of issuance, and the conversion feature being in-the-money. Thus, pursuant to EITF 00-27, 27, Application of Issue No. 98-5 to Certain Convertible Instruments, the BCF has been determined based on the gross debenture amount less the portion attributable to the warrants described above, and recorded as a discount to reduce the carry value of the debenture and increase additional-paid-in-capital. The Company calculated the initial BCF on the closing date of the transaction to be $1,615,000 using the intrinsic value method.
Since this amount is greater than the $1,425,000 remaining value of the debenture after deducting for the warrant discount described above, the Company reduced the initial carry value of the debenture to zero effectively recording a BCF of $1,425,000 as additional-paid-in-capital. The BCF discount is being amortized over the debenture repayment term of sixteen (16) months and calculated based upon the effective interest method. During the three and six months ended June 30, 2007, the Company recognized $350,530 and $620,825 and $66,432 and $66,432, respectively in non-cash amortization expense attributable to the amortization of the beneficial conversion feature discount.
In connection with the debenture, the Company entered into a separate Investment Agreement on May 15, 2006 with Dutchess Private Equities Fund, L.P. ("Dutchess"), which provides for the sale and issuance from time to time of up to $10,000,000 in shares of Common Stock for a period of up to 36 months from the date the Registration Statement is declared effective. The maximum number of shares that the Company may put to Dutchess at any one time shall be equal to, at the Company's election, either (a) 200% of the average daily volume in the U.S. market of the Common Stock for the ten trading days prior to the date the Company notifies
Dutchess of its intent to sell shares to Dutchess, multiplied by the average of the three daily closing bid prices immediately preceding the date a Put Notice is delivered, or (b) a number of shares having a value of $100,000. The Company may not submit a Put Notice until after the completion of a previous sale under the Investment Agreement. The purchase price for the Common Stock to be sold shall be equal to 93% of the lowest closing best bid price of the Common Stock during the five-day period following the date the Company delivers a Put Notice. Since the price of the shares put to Dutchess are expected to be below market price at 93% of the market price, there is no added benefit to the Company. Thus, the Company has not recorded an asset related to this agreement. Upon the delivery of shares and receipt of cash related to this Investment Agreement, the Company records the increase in cash or decrease in debenture interest and principle, and an increase in common stock and additional paid in capital. During the six months ended June 30, 2007, the Company placed puts with Dutchess totaling $478,500 resulting in the issuance of 15,432,331 shares of common stock. Of the $478,500, $76,168 was received as cash, $131,009 was applied to advances made to the Company, $54,250 was
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE G - CONVERTIBLE DEBENTURE (Continued)
recognized as a loss due to the conversion discount and $217,073 was applied to accrued interest and principle.
On April 9, 2007, the Company issued to Dutchess a promissory note in the face amount of $132,000 for gross proceeds of $110,000 (the “Note”). The Note bears interest at 12% per annum and matures on April 9, 2008 (“Maturity Date”). Pursuant to the Note, the Company is required to make payments to Dutchess in the amount of the greater of a) one hundred percent (100%) of each Put (as defined in the Investment Agreement between the Company and the Investor dated June 28, 2005) given to Dutchess from the Company; or b) eleven thousand seven hundred twenty-one dollars and 39/100 ($11,721.39) (the “Payment Amount”) until the Face Amount is paid in full, minus any fees due. The First Payment will be due on May 1, 2007 and each subsequent Payment will be made at the Closing of each Put until the Note is paid in full, with a minimum amount of eleven thousand seven hundred twenty-one dollars and 39/100 ($11,721.39) per month. In connection with the issuance of the Note, the Company has agreed to provide Collateral to Dutchess in the form of thirty (30) Put Notices. The Put Notices are to be submitted to Dutchess only in the event of default as provided in the Note. In the event that the Company has not repaid the Face Amount by the Maturity Date (the “Residual Amount”), then as liquidated damages (the “Liquidated Damages”), the face amount shall be increased by ten percent (10.0%) as an initial penalty and an additional two and one-half percent (2.5%) per month (pro rata for partial periods), compounded daily, for each month until the face amount is paid in full. Further, if a Residual Amount remains at Maturity, it shall constitute an Event of Default hereunder. Further, in the event of default as provided in the Note, Dutchess may elect to, among other things, either switch the Residual Amount (as defined in the Note) to a three-year, eighteen percent (18%) interest bearing convertible debenture at a twenty-five percent (25%) discount to the market during conversion or increase the Payment Amount (as defined in the Note) to fulfill the repayment of the Residual Amount. In the event that Dutchess elects to switch to a convertible debenture, the Company will be required to file within ten (10) business days a registration statement covering three hundred percent (300%) of the Residual Amount. The Company also issued to Dutchess incentive shares consisting of 600,000 shares of the Company’s restricted common stock.
During the three and six months ended June 30, 2007 and 2006, the Company recognized $0 and $54,250 and $0 and $0, respectively as a non-cash loss due to the conversion discount applied upon the conversion of interest and principle into common stock of the Company pursuant to the Investment Agreement and Debenture Agreement.
During the three and six months ended June 30, 2007 and 2006, the Company recognized $52,512 and $105,561 and $18,829 and $18,829, respectively in interest expense related to the debentures.
As of June 20, 2007, the actual dollar amount due to the Holders of the Company’s debentures was $1,781,894. The following table represents the actual balance due compared to the amount recorded on the balance sheet as of June 30, 2007:
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE G - CONVERTIBLE DEBENTURE (Continued)
| | | June 30, 2007 | |
| Amount borrowed under the convertible debenture | | | 1,900,000 | |
| Accrued interest | | | 117,997 | |
| Payments applied to principle | | | (236,103 | ) |
| Debenture balance | | | 1,781,894 | |
| | | | | |
| Unamortized beneficial conversion feature | | | (369,519 | ) |
| Unamortized Warrant discount | | | (83,441 | ) |
| Recorded debenture balance | | | 1,328,934 | |
NOTE H - NOTES PAYABLE
Notes payable at June 30, 2007 is as follows:
| Unsecured demand note payable to Ron and Dori Arko, bearing interest at 2% per year; currently in default. | $ | 9,539 |
| Unsecured demand note payable to John Helms, bearing interest at 2% per year; currently in default. | $ | 159,828 |
| Unsecured demand note payable to New Heart Ministries, bearing interest at 2% per year; currently in default. | $ | 2,925 |
| Unsecured demand note payable to Pacific Sports Investors LLC, bearing interest at 10% per year; currently in default. | $ | 40,375 |
| Secured demand note payable to Christian Beckas, bearing interest at 12% per year collateralized by 80,000 shares of common stock; currently in default. | $ | 19,300 |
| Secured demand note payable to Hector Peneda, bearing interest at 12% per year collateralized by 40,000 shares of common stock; currently in default. | $ | 8,800 |
| Secured promissory note to Dutchess Private Equities Fund, Ltd., bearing interest at 12% per year and collateralized by however many shares are needed to settle the debt. | $ | 100,990 |
| Total | $ | 341,757 |
Related party Notes payable at June 30, 2007 is as follows:
| Secured demand note payable to Craig Hudson, bearing interest at 12% per year collateralized by 116,000 shares of common stock; currently in default | $ | 32,065 |
| Unsecured note payable to Geno Apicella, Vice-President, non-interest bearing. | $ | 3,023 |
| Unsecured demand note payable to Sheryl Gardner, CFO, bearing interest at 4% per year; currently in default | $ | 47,225 |
| Total | $ | 82,313 |
The interest rate offered on the 2% through 4% loans above is below market rate. The Company has determined the difference between the stated interest rate and the rate available at the date of the loan(s) would be immaterial to these financial statements
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE H - NOTES PAYABLE (Continued)
During the three and six months ended June 30, 2007 and 2006, the Company recognized $32,975 and $37,851 and $15,174 and $28,652, respectively, of interest expense related to the notes above.
During the six months ended June 30, 2007, the Company repaid $120,000 of principle and $9,751 of interest on non related party debt by converting into 5,190,040 shares of common stock.
The Company anticipates entering into debt conversion agreements with certain of the noteholders to convert the principle and interest into shares of common stock.
NOTE I - PURCHASE ORDER FINANCING
During the six months ended June 30, 2007, the Holders of our convertible debentures advanced to the Company $869,425 to be used specifically for production of watersports goods. The advances bear interest of three percent (3%) per month and mature within three months. The advances are secured by the Company’s assets and are convertible into shares of common stock of the Company at the lenders discretion pursuant to the Investment Agreement as described in Note G above. During the six months ended June 30, 2007, the Company repaid $869,425 of principle and incurred $70,192 of interest expense related to the purchase order financing. No debt was converted into common stock.
NOTE J - STOCKHOLDERS’ EQUITY
On August 18, 2004, the Company entered into a service contract valued at $100,000 in exchange for 400,000 shares of common stock, which represents the fair market value of the common stock as of that date. The contract term is 24 months. During the three and six months ended June 30, 2006, the Company recognized $12,465 and $24,795, respectively, of expense in connection with this contract, which has been fully expensed as of December 31, 2006.
On March 1, 2004, the Company entered into a service contract valued at $62,500 in exchange for 250,000 shares of common stock, which represents the fair market value of the stock as of that date. The contract term is 24 months. For the three and six months ended June 30, 2007 and 2006, the Company recognized $0 and $5,137 and $7,791 and $15,497, respectively, of expense in connection with this contract, which has been fully expensed as of June 30, 2007.
During the six months ended June 30, 2007, the Company issued 1,634,616 shares of common stock valued at the closing price of the stock on the date of issuance, or $77,885 to two of its directors as payment in lieu of cash.
During the six months ended June 30, 2007, the Company issued 1,546,154 shares of common stock valued at the closing price of the stock on the date of issuance, or $67,846 to two of its employees as payment in lieu of cash.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE J - STOCKHOLDERS’ EQUITY (Continued)
During the six months ended June 30, 2007, the Company issued 1,400,000 shares of common stock valued at the closing price of the stock on the date of issuance, or $28,600 to the Holders of our convertible debentures as an inducement to make short term loans to the Company for the purpose of financing production and working capital.
During the six months ended June 30, 2007, the Company issued 5,190,040 shares of common stock in exchange for the retirement of $120,000 of principle and $9,751 of accrued interest. The stock valued at the closing price of the stock on the date of issuance and resulted in an increase to shareholders equity of $102,244 and a gain of $27,507.
During the six months ended June 30, 2007, the Company issued 15,432,331 shares to Dutchess pursuant to the Investment Agreement (See NOTE G). The total value of the shares on the dates of issuance was $478,500. Of this amount $76,168 was received in cash, $348,082 was applied as a reduction of principle and interest on the Company’s debenture and other short term financing provided by Dutchess, and $54,250 was recognized as a loss due to a conversion discount.
NOTE K - WARRANTS
At June 30, 2007, the Company had 3,440,238 Warrants outstanding entitling the holder thereof the right to purchase one share of common stock for each warrant held as follows:
| | | | | Exercise | | | | | |
| Warrant | | Number of | | Price Per | | Issue | | Expiration | |
| Class | | Warrants | | Warrant | | Date | | Date | |
| A | | | 500,000 | | $ | 0.35 | | | 3/3/2006 | | | 3/31/08 | |
| A | | | 28,571 | | $ | 0.35 | | | 3/29/2006 | | | 9/30/07 | |
| Debenture | | | 2,911,667 | | $ | 0.15 | | | 5/15/2006 | | | 5/15/11 | |
| | | | | | | | | | | | | | |
| Total | | | 3,440,238 | | | | | | | | | | |
During the six months ended June 30, 2007, no warrants were issued or exercised.
Stock Warrants Issued to Third Parties
The Company accounts for stock-based compensation issued to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force consensus in Issue No. 96-18 ("EITF 96-18"), "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services."
In addition, the Company evaluates each derivative issued to determine whether treatment as either equity or a liability is warranted for that derivative pursuant to EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in a Company's Own Stock of that derivative.
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE L - STOCK INCENTIVE PLAN
On December 13, 2005, pursuant to an Employment Agreement and in anticipation of approval of the Stock Incentive Plan, the Company awarded its then Product Manager, Duane Pacha a non-qualified stock option to purchase 300,000 shares of common stock of the Company at an exercise price of $.35 per share with an expiration date of December 12, 2015. The option vests and become exercisable at a rate of 12,500 per month over a twenty-four month period. On December 31, 2006, the Company terminated Mr. Pacha’s position as Product Manager due to the disposition of the Academy business. At the time of departure from the Company, options to purchase 150,000 shares had vested. The remaining options to purchase 150,000 shares were canceled. As of June 30, 2007, the vested options were canceled due to non exercise.
On December 13, 2005, pursuant to an Employment Agreement and in anticipation of approval of the Stock Incentive Plan, the Company awarded its then Marketing Director, Jeff Baughn a non-qualified stock option to purchase 300,000 shares of common stock of the Company at an exercise price of $.35 per share with an expiration date of December 12, 2015. The option vests and become exercisable at a rate of 12,500 per month over a twenty-four month period. On December 15, 2006, the Company terminated Jeff Baughn’s position as Marketing Director due to the disposition of the Academy business. At the time of departure from the Company, options to purchase 150,000 shares had vested. The remaining options to purchase 150,000 shares were canceled. As of June 30, 2007, the vested options were canceled due to non exercise.
On December 15, 2005, pursuant to an Employment Agreement and in anticipation of approval of the Stock Incentive Plan, the Company awarded its President, Todd Pitcher a non-qualified stock option to purchase 300,000 shares of common stock of the Company at an exercise price of $.35 per share with an expiration date of December 14, 2015. The option vests and become exercisable at a rate of 12,500 per month over a twenty-four month period. On December 22, 2006, the Company and Todd Pitcher mutually agreed to terminate Mr. Pitcher as President in order to improve operational cash flow. At the time of departure from the Company, options to purchase 150,000 shares had vested. The remaining options to purchase 150,000 shares were canceled. As of June 30, 2007, the vested options were canceled due to non exercise.
The following table summarizes the Company's stock option activity for the six months ended June 30, 2007:
| | | 2007 | |
| | | | | Weighted Average | |
| | | Shares | | Exercise Price | |
| Outstanding at beginning of period | | | 450,000 | | $ | 0.35 | |
| Granted | | | - | | | | |
| Forfeited | | | (450,000 | ) | | 0.35 | |
| Exercised | | | - | | | | |
| Outstanding at end of period | | | - | | $ | 0.35 | |
| | | | | | | | |
| Options exerciseable at end of period | | | - | | | | |
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE L - STOCK INCENTIVE PLAN (Continued)
The Company accounts for stock options pursuant to Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment. The Company values each option grant utilizing the grant date fair value for fixed awards based on the Black-Scholes Option Pricing Model. Compensation cost is amortized over the vesting period.
During the six months ended June 30, 2007, no compensation expense related to options was recognized. To date, the Company has recognized compensation expense of $85,313.
NOTE M - NET OPERATING LOSS CARRY FORWARD
In assessing the ability to realize deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
At December 31, 2006, a valuation allowance for the full amount of the net deferred tax asset was recorded because of uncertainties as to the amount of taxable income that would be generated in future years.
United States Corporation Income Taxes
| Period of Loss | | Amount | | Expiration Date | |
| December 31, 2006 | | $ | 5,602,753 | | | December 31, 2026 | |
| December 31, 2005 | | $ | 3,559,866 | | | December 31, 2025 | |
| December 31, 2004 | | $ | 420,421 | | | December 31, 2024 | |
Prior to November 2004 the Company was organized as an S-Corporation and all losses were distributed and recognized through the tax returns of the owners. The loss for the fiscal year ended December 31, 2006, was $5,608,910. As of December 31, 2006, a valuation allowance for the full amount of the net deferred tax asset has been recognized over the period for $2,243,564, based on an anticipated tax rate of 40%.
NOTE N - GOING CONCERN AND MANAGEMENT’S PLANS
The Company has suffered recurring losses from operations since inception. In addition, the Company has yet to generate an internal cash flow from its business operations. These factors raise substantial doubt about its ability to continue as a going concern.
Management’s plans with regard to these matters encompass the following actions: 1) obtain funding from new investors to alleviate the Company’s working capital deficiency; and 2) implement a plan to generate additional sales. The Company’s continued existence is dependent
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE N - GOING CONCERN AND MANAGEMENT’S PLANS
upon its ability to resolve its liquidity problems and increase profitability in its current business operations. However, the outcome of management’s plans cannot be ascertained with any degree of certainty. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of these risks and uncertainty.
NOTE O - RELATED PARTY TRANSACTIONS
As of December 31, 2006, Mr. Apicella was owed $54,700. During the three months ended March 31, 2007, the Company incurred $11,800 of expenses paid on its behalf by Geno Apicella, CEO. In addition, during the three months ended March 31, 2007, the Company repaid $62,300 to Mr. Apicella leaving a balance due to Mr. Apicella of $4,223 as of March 31, 2007. During the three months ended June 30, 2007, the Company repaid an additional $1,200 bringing the balance due Mr. Apicella’s to $3,023.
NOTE P - DISPOSITION OF ACADEMY LINE
On February 5, 2007 the Company filed a current report on Form 8-k with the United States Securities and Exchange Commission relating to the January 31, 2007, Trademark Transfer and Assignment Agreement (the “Agreement”) with Duane Pacha (“Duane”) and Jeff Baughn (“Jeff”, with Duane, the “Buyers”) pursuant to which the Company transferred all right, title, interest and good will in the ACADEMY SNOWBOARD CO. and ACADEMY trademarks, and the associated ACADEMY logo and their goodwill, and all associated domain names, in particular the domain www.academysnowboards.com, trades secrets and copyrights and their goodwill (collectively, the “Brand”). Moreover, as per the Agreement, there was no cash component relating to the transfer and assignment of the Brand and the Company shall assign to Buyers certain of the Company’s accounts payable and accounts receivable relating to the Brand. Specifically, the accounts receivable in the amount of $107,761.52 were transferred to the Buyers resulting in a decrease to accounts receivable. Accounts payable in the amount of $345,321.50 were transferred to the Buyers resulting in a decrease to accounts payable.
NOTE Q - SUBSEQUENT EVENTS
From July 1, 2007 through August 4, 2007, the Company issued 794,117 and 882,352 shares of common stock to two officers and two directors, respectively, with a combined value of $33,529 based on the closing stock price on the date of issuance..
From July 1, 2007 through August 4, 2007, the Company issued 1,163,400 shares of common stock to Dutchess in exchange for the reduction of $17,759 of short term loans.
On July 31, 2007, the Company entered into an Addendum to Promissory Note (“Addendum”) with John Helms (“Helms”), as more fully described herein, amending the repayment provisions of certain debt obligations of the Company to Helms. On August 4, 2004, Execute Sports issued a promissory note to Helms bearing interest at two percent (2%) per annum (the “2004 Note”).
EXECUTE SPORTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
NOTE Q - SUBSEQUENT EVENTS
On February 28, 2005, Execute Sports entered into a certain Promissory Note Cancellation and Reissuance Agreement with Helms providing for, among other things, the cancellation of the 2004 Note and the issuance of a new Payment in Kind Promissory Note in the principal face amount of $210,000, bearing interest at two percent (2%) per annum (the “2005 Note”). On March 15, 2006, Execute Sports entered into a new Promissory Note Cancellation and Reissuance Agreement with Helms, providing for, among other things, the cancellation of the 2005 Note and the issuance of a new Payment in Kind Promissory Note in the principle amount of $174,824.26, bearing interest at four percent (4%) per annum (the “Note”).
According to the Addendum, Helms and the Company agreed that the amount owed under the Note, or approximately $164,221.45 (the “Amount Owed”) shall be paid in the following manner: (a) 3,000,000 shares of restricted common stock of the Company to be issued and forwarded to Helms within seven (7) business days from the date of the Addendum (the “Initial Payment”), representing repayment of seventy-five thousand dollars ($75,000) towards the accrued interest to date due under the Note, with the remaining amount to be applied to the principal. After the Initial Payment, the principal amount owed by the Company to Helms shall be eighty-nine thousand two hundred twenty-one and 45/100 dollars ($89,221.45) (the “Remaining Amount”). The Remaining Amount due under the Note is to be paid over the next consecutive six (6) quarters, in equal installments of approximately fourteen thousand eight hundred seventy and 24/100 dollars ($14,870.24 ), plus accrued interest to date, worth of the Company’s common stock. The amount of shares to be issued to Helms shall be based on the closing price of the Company’s common stock on the last trading day of each calendar quarter, beginning on September 28, 2007, and shall be paid within seven (7) business days from said date. The payments shall be applied first to accrued interest and then principal. The Company’s Board of Directors has the discretion to issue a greater amount of shares pursuant to this Section in order to pay off the Note sooner and any such amounts paid shall be without penalty.
Item 2 - Management's Discussion and Analysis or Plan of Operations
This management’s discussion and analysis of results of operations and financial condition contains forward-looking statements that involve risks and uncertainties. In some cases, you can identify these statements by forward-looking words such as "may," "might," "will," "should," "expect(s)," "plan(s)," "anticipate(s)," "believe(s)," "estimate(s)," "predict(s)," "intend(s)," "potential" and similar expressions. All of the forward-looking statements contained in this registration statement are based on estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market and other factors. Although we believe such estimates and assumptions are reasonable, they are inherently uncertain and involve risks and uncertainties. In addition, management’s assumptions about future events may prove to be inaccurate. We caution you that the forward-looking statements contained in this registration statement are not guarantees of future performance and we cannot assure you that such statements will be realized. In all likelihood, actual results will differ from those contemplated by such forward-looking statements as a result of a variety of factors, including, but not limited to, those factors discussed in "Risk Factors" and included in our on Form 10-KSB for the fiscal year ended December 31, 2006. Except as required by law, we undertake no obligation to update any of these forward-looking statements.
Critical Accounting Policies
The Company's discussion and analysis of its results of operations, financial condition and liquidity are based upon the Company's financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments 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 period. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. Actual results may materially differ from these estimates under different assumptions or conditions. On an on-going basis, the Company reviews its estimates to ensure that the estimates appropriately reflect changes in its business.
Inventories
Inventories are valued at the lower of cost or market and primarily consist of wetsuits, sticker kits and related accessories. Cost is determined using the average cost method. The inventory balance reflects management’s estimate of net realizable value. Management performs periodic assessments based on our understanding of market conditions and forecasts of future product demand to determine the existence of obsolete, slow moving and non-salable inventories, and records the necessary adjustment at the time of assessment directly to the statement of operations to reduce such inventories to their net realizable value. If the actual amount of obsolete inventory significantly exceeds the inventory balance, the Company's costs of goods sold and gross profit and resulting net income or loss would be significantly adversely affected.
Revenue recognition
The Company recognizes revenue when the product is shipped to the customer. At that time, the title and risk of loss transfer to the customer, and collectability is reasonably assured. Collectability is evaluated on an individual customer basis taking into consideration historical payment trends, current financial position, results of independent credit evaluations and payment terms. Additionally, an estimate of product returns are recorded when revenue is recognized. Estimates are based on historical trends taking into consideration current market conditions, customer demands and product sell through. If actual sales returns significantly exceed the recorded estimated expense, the Company's sales would be adversely affected.
Allowance for doubtful accounts
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. An estimate of uncollectible amounts is made by management based upon historical bad debts, current customer receivable balances and aging, the customer's financial condition and current economic conditions. If a significant number of customers with significant receivable balances in excess of the allowance fail to make required payments, the Company's operating results would be significantly adversely affected. Based on management's assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to the valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. The Company generally does not require collateral.
Product Warranty
The Company's Watersports products carry a ninety-day warranty. Warranty costs are charged against sales in the period products are sold as a reduction in the selling price. Historically, warranty costs have been less than 1% of sales. In estimating its warranty obligations, the Company considers various relevant factors, including the Company's stated warranty policies, the historical frequency of claims, and the cost to replace or repair the product. If the actual amount of warranty claims significantly exceeds the estimated expense, the Company's costs of goods sold and gross profit and resulting net income or loss would be significantly adversely affected.
Income taxes
On November 1, 2004, the Company amended its Articles of Incorporation to make the transition from an S-Corporation to a C-Corporation. Prior to the transition the S Corporation was not a tax paying entity for federal or state income tax purposes and thus no provision for income taxes was recognized. The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted rates recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In assessing the realizability of deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. SFAS No. 109 requires a valuation allowance to be recorded when it is more likely than not that some or all of the deferred tax assets will not be realized. The Company has recorded a valuation allowance for the full amount of the net deferred tax asset because of uncertainties as to the amount of taxable income that would be generated in future years.
Overview
Results of Operations
THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
Net Sales for the three months ended June 30, 2007 and 2006 were $798,037 and $506,990, respectively, representing a $291,047, or 57% increase. The three month year-over-year increase is due primarily to the increase in sales with existing customers and the increase in sales with our internet partners. We also increased our volume with small domestic dealers and international distributors.
Net Sales for the six months ended June 30, 2007 and 2006 were $1,351,519 and $1,102,524, respectively, representing a $248,995, or 23% increase. The six month year-over-year increase is primarily due to the increase in sales with existing customers and the increase in sales with our internet partners. We also increased our volume with small domestic dealers and international distributors.
Gross margin for the three months ended June 30, 2007 and 2006 was $420,997, or 53% and $152,898, or 30%, respectively. The $268,099 increase in gross margin over the previous year was primarily due to a $161,933 credit taken by the Company for past due amounts to a former supplier of motocross sticker kits.
Gross margin for the six months ended June 30, 2007 and 2006 was $633,532, or 47% and $270,490, or 25%, respectively. The $363,042 increase in gross margin over the previous year was due to an improved product mix towards higher margin products, a $161,933 credit taken by the Company for past due amounts to a former supplier, more favorable materials prices for rubber products and lower shipping rates.
Selling, General and Administrative expenses for the three months ended June 30, 2007 and 2006 was $369,329 and $1,035,392, respectively, representing a $666,063 or 64% decrease. Selling, General and Administrative expenses for the six months ended June 30, 2007 and 2006 was $733,157 and $1,968,368, respectively, representing a $1,235,211 or 63% decrease. The three and six month year-over-year decrease was the result of no acquisition costs, significantly less stock based compensation expense, lower selling and advertising costs and lower personnel and professional service costs compared to the same periods in the prior year.
Net loss from continuing operations and net loss for the three months ended June 30, 2007 and 2006 was $527,017 and $1,037,323, respectively. Net loss from continuing operations for the six months ended June 30, 2007 and 2006 was $1,199,219 and $1,861,944, respectively. The net loss from continuing operations decreased for the three and six month periods by $510,306, or 49% and $662,725 or 36%, respectively. The improvement in net loss is due primarily to decreased operating costs described above offset by higher, non-cash convertible debenture related amortization and interest expense.
Net loss for the six months ended June 30, 2007 and 2006 was $992,528 and $1,861,944, respectively, representing an $869,416, or 47% decrease in net loss compared to the same period last year. The improvement in the net loss compared to the net loss from continuing operations is due to the $206,691 net gain recognized by the Company upon the disposition of the Academy brand.
Financial Condition
From inception to June 30, 2007, we Incurred an accumulated deficit of $11,147,527, and we expect to incur additional losses through the fiscal year ending December 31, 2007 and for the foreseeable future. This loss has been incurred through a combination of selling and operating expenses related to expensing of stock, as well as in support of our plans to expand sales and distribution channels, as well as to develop new products.
We have financed our operations since inception primarily through debt and equity financing. During the six months ended June 30, 2007, we had a net decrease in cash of $36,868. Total cash resources as of June 30, 2007 was $37,518, compared with $74,386 at December 31, 2006.
Our available working capital and capital requirements will depend on numerous factors, including progress in our distribution and sales of our products, the timing and cost of expanding into new markets, the cost of developing new products, changes in our existing collaborative and licensing relationships, the resources that we devote to developing new products and commercializing capabilities, the status of our competitors, our ability to establish collaborative arrangements with other organizations, our ability to attract and retain key employees, our management of inventory and our need to purchase additional capital equipment.
The Company’s Liquidity Plan
Recent operating results give rise to concerns about the Company’s ability to generate cash flow from operations sufficient to sustain ongoing viability. During 2006 and the latter half of 2005, the Company’s cost control strategies focused on managing general and administrative expenses through keeping headcount to a minimum, amongst other things, and maintaining a focused marketing and sales strategy that leverages existing channel partnerships.
The Company’s need to raise additional equity or debt financing and the Company’s ability to generate cash flow from operations will depend on its future performance and the Company’s ability to successfully implement business and growth strategies. The Company’s performance will also be affected by prevailing economic conditions. Many of these factors are beyond the Company’s control. If future cash flows and capital resources are insufficient to meet the Company’s commitments, the Company may be forced to reduce or delay activities and capital expenditures or obtain additional equity capital. In the event that the Company is unable to do so, the Company may be left without sufficient liquidity.
In September 2004, we commenced a private placement to sell up to 7,000,000 shares of our common stock at a per share cost of $.25. We closed the financing on May 27, 2005, accepting no further subscription agreements pursuant to the September 2004 private placement offering, and have received proceeds of $729,500 in connection with the financing.
On December 26, 2005, the Company’s SB-2 registration statement was declared effective by the Securities and Exchange Commission. Pursuant to the terms of the Offering, the Company offered to certain investors up to 3,571,428 shares of the Company’s common stock for consideration of $0.35 per share. As of December 31, 2005, the Company has received $1,246,550 in proceeds $70,000 of which was received on January 3, 2006.
On June 15, 2006, pursuant to the filing of an effective SB-2 registration statement, we finalized a private placement and received $1,900,000 of convertible debentures with a $10,000,000 equity line of credit whereby the company places stock puts with the creditor in exchange for cash or repayment of debt. During the six months ended June 30, 2007, the Company recognized $478,500 from the stock puts (See Footnote J to the financial statements)
Management is currently in the process of seeking additional equity financing with potential investors. Management is also working with the holders of our convertible debentures to finance production and provide working capital when needed. There can be no assurance that such additional financing will be obtained. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
ITEM 3. CONTROLS AND PROCEDURES
(a) As of December 31, 2006, we conducted an evaluation, under the supervision and participation of our management, including the Company’s President and Chief Executive Officer (who is the principal accounting officer) of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report, as required by Rule 13a-15(b) under the Exchange Act of 1934, as amended (the “Exchange Act”)
In connection with the audit of our Consolidated Financial Statements for the fiscal year ended December 31, 2006, our independent registered public accounting firm informed us that we had significant deficiency constituting material weaknesses as defined by the standards of the Public Company Accounting Oversight Board, which had been identified in connection with the audit of our Consolidated Financial Statements for the fiscal year ended December 31, 2006
The significant deficiency in internal control identified consisted of inadequate segregation of duties affecting initiating, recording and processing financial data.
Based on the evaluation, which disclosed a deficiency in the segregation of financial duties, the Company’s President and Chief Executive Officer (who is the principal accounting officer) concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
The Company has taken, and will continue to take, steps to address the specific problems identified by the auditors including, but not limited to, emphasizing enhancement of the segregation of duties based on the limited resources the Company has, and, where practical, the Company will continue to assess the cost versus benefit of adding additional resources that would mitigate the situation. Our President and Chief Executive Officer will monitor our accounting policies to assure proper accounting on an ongoing basis.
(b) There were no changes in the Company’s internal controls over financial reporting identified in connection with the evaluation by management described above that occurred during the period covered by this report that has materially effected, or is reasonably likely to materially effect the Company’s internal control over financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
No change since previous filing.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no unregistered sales of equity securities during the period ended June 30, 2007.
Item 3. Defaults Upon Senior Notes.
Due to our inability to pay, the Company is currently in default on the following Notes:
Item 4. Submission of Matters to A Vote of Security Holders.
None.
Item 5. Other Information.
There were no matters required to be disclosed on a current report on Form 8-K during the period covered by this report that were not so disclosed.
There were no changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors since the Company last disclosed these procedures.
| Unsecured demand note payable to Ron and Dori Arko, bearing interest at 2% per year; currently in default. | | $ | 9,539 | |
| Unsecured demand note payable to John Helms, bearing interest at 2% per year; currently in default. | | $ | 159,828 | |
| Unsecured demand note payable to New Heart Ministries, bearing interest at 2% per year; currently in default. | | $ | 2,925 | |
| Unsecured demand note payable to Pacific Sports Investors LLC, bearing interest at 10% per year; currently in default. | | $ | 40,375 | |
| Secured demand note payable to Christian Beckas, bearing interest at 12% per year collateralized by 80,000 shares of common stock; currently in default. | | $ | 19,300 | |
| Secured demand note payable to Hector Peneda, bearing interest at 12% per year collateralized by 40,000 shares of common stock; currently in default. | | $ | 8,800 | |
| Total | | $ | 240,767 | |
Due to our inability to pay, the Company is currently in default on the following related party Notes:
| Secured demand note payable to Craig Hudson, bearing interest at 12% per year collateralized by 116,000 shares of common stock; currently in default | | | 32,065 | |
| Unsecured demand note payable to Sheryl Gardner, CFO, bearing interest at 4% per year; currently in default | | | 47,225 | |
| Total | | | 79,290 | |
Total interest due on the above Notes is $11,560, bringing the total amount in default to $331,617.
Item 6. Exhibits
Exhibit Number | Description | By Reference from Document |
| | | |
| 31.1 | Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act | * |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | * |
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Signature | | Title | | Date |
| | | | | |
| /s/ Geno M. Apicella | | Chief Executive Officer and Principle Accounting Officer | | August 10, 2007 |
| Name: Geno M. Apicella | | | | |
