PART I
ITEM 1. DESCRIPTION OF BUSINESS
As used in this Annual Report, “we”, “us”, “our”, “True Drinks”, “Company” or “our Company” refers to True Drinks, Inc. and all of its subsidiaries, unless the context requires otherwise. We are a holding company and conduct no operating business, except through our subsidiaries. During January 2013, we changed our name from True Drinks, Inc. to True Drinks Holdings, Inc.
Overview
True Drinks, Inc. (the "Company"), is a beverage company that specializes in all-natural, vitamin-enhanced drinks. Our primary business is the development, marketing, sale and distribution of our flagship product, AquaBall
TM
Naturally Flavored Water, a vitamin-enhanced, naturally flavored water drink packaged in our patented stacking spherical bottles. We distribute the AquaBall
TM
nationally through select retail channels, such as grocery stores, mass merchandisers, drug stores and online. We also market and distribute Bazi®
All Natural Energy,
a liquid nutritional supplement drink, which is currently distributed online and through our existing database of customers.
The Company was originally incorporated in the state of Delaware in January 2012.
Our principal place of business is 18552 MacArthur Boulevard, Suite 325, Irvine, California, 92612. Our telephone number is (949) 203-2500. Our corporate website address is
http://www.truedrinks.com
. Our common stock, par value $0.001 (“
Common Stock
”) is currently listed for quotation on the Over-the-Counter Bulletin Board (“
OTCBB
”) under the symbol TRUU.
Recent Developments
Reverse Merger with Bazi International, Inc. ("Bazi Intl.")
On June 7, 2012, the Company, Bazi Acquisition Sub Inc. ("
Merger Sub
"), a Delaware corporation and a wholly-owned subsidiary of the Bazi Intl.
, and True Drinks
entered into an agreement and plan of merger (the “
Merger Agreement
”), wherein Merger Sub merged with and into True Drinks and True Drinks continued as the surviving corporation (the "
Merger
"). As a result of the Merger, True Drinks became a wholly-owned subsidiary of the Company. The Merger closed on October 15, 2012 (the “
Closing Date
”).
The Merger was accounted for as a public company “reverse merger,” and, as such, the consolidated financial statements reported herein reflect the operations of True Drinks, Inc. as the accounting acquiror within the new capital structure of the Company effective on the closing date.
On the Closing Date, the executives and Board of Directors of True Drinks, Inc. were appointed to the same positions within True Drinks Holdings, Inc. Lance Leonard was appointed as our Chief Executive Officer, Daniel Kerker as our Chief Financial Officer, and Kevin Sherman, former President of the Company, as our Vice President of Marketing. We also appointed Timothy Lane, Carl Wistreich, Lou Imbrogno and Lance Leonard to fill the vacancies on our Board of Directors created as a result of the resignation of the former directors of Bazi International, Inc.
Creation of the Series A Preferred
Upon closing the Merger, the Company filed a Certificate of Designation, Preferences, Rights and Limitations of Series A Convertible Preferred Stock (“
Series A Preferred
”) (the “
Certificate of Designation
”), creating 1,544,565 shares of Series A Preferred. On the Closing Date, former True Drinks shareholders exchanged all outstanding capital stock of True Drinks for a total of 1,544,565 Series A Preferred, which shares represent on an as-converted basis at a conversion rate of $0.00610403 per share approximately 95.5% of the total Common Stock outstanding at December 31, 2012. As explained below, the Series A Preferred automatically converted into a total of 2,530,399,062 shares of Common Stock on January 18, 2013.
Financings
In November and December 2012, the Company issued an aggregate principal amount of $725,000 in unsecured convertible promissory notes (the “
Notes
”) to certain purchasers (the “
Purchasers
”). The Notes had a term of 120 days and bore interest at a rate of 9% per annum. At maturity, the holders of the Notes have the right to convert all principal and accrued interest due thereunder into Common Stock at a conversion price equal to $0.01 per share. In addition, each Purchaser received 500,000 shares of Common Stock per $25,000 of principal amount held.
In December 2012, the Company issued $47,000 in unsecured promissory notes to certain purchasers. The notes had a term of 30 days and paid a lender’s fee of 10% of principal. The notes were repaid in January, 2013.
On January 14, 2013, we completed a private placement, wherein we issued an aggregate principal amount of $575,000 in unsecured convertible promissory notes (the “
January Notes
”) to certain purchasers. The January Notes had a term of 120 days and bore interest at a rate of 9% per annum. At maturity, the holders of the January Notes have the right to convert all principal and accrued interest due thereunder into Common Stock at a conversion price equal to $0.01 per share. In addition, each purchaser received 500,000 shares of Common Stock per $25,000 of principal amount held.
Amendment to our Articles of Incorporation and Reverse Stock Split
On January 18, 2013, we filed an amendment to our Articles of Incorporation (the “
Amendment
”) to (i) to change our name to True Drinks Holdings, Inc., and (ii) increase the total number of authorized shares of Common Stock from 200,000,000 to 4,000,000,000 shares. Upon the filing of the Amendment, the shares of Series A Preferred issued to former True Drinks shareholders automatically converted into approximately 2,530,399,062 shares of Common Stock.
In addition, on January 18, 2013, following the Amendment, we affected a reverse split of our authorized, issued and outstanding shares of Common Stock on a 100 for 1 basis. Accordingly, our authorized Common Stock decreased from 4,000,000,000 to 40,000,000 shares and our issued and outstanding shares of Common Stock decreased from 2,649,632,531 to 26,496,325 shares as of January 18, 2013.
The name change and reverse split became effective with the Over−the−Counter Bulletin Board at the opening of trading on January 22, 2013.
Option Agreement
On January 14, 2013, we entered into an Option Agreement (the “Option Agreement”) with Ashworth Holdings, LLC, a Utah limited liability company (“Ashworth”), pursuant to which Ashworth shall have the option to purchase up to 86,008,650 shares of Common Stock for a price of $0.00549 per share and shall expire on April 30, 2013 or upon Ashworth’s exercise of the full allotment of shares thereunder. Upon the 1 for 100 reverse split of the Company’s Common Stock on January 18, 2013, the Option Agreement has been adjusted to cover the purchase of 860,087 shares of Common Stock for a price of $0.549 per share.
Our History
Bazi Intl. Prior to Merger with True Drinks, Inc.
Bazi Intl. was formed in 2001, under the name “Instanet, Inc.” In August 2010, we changed our name to Bazi International, Inc. Until January 18, 2010, our principal channel of distribution was through a multilevel distributor network, which we terminated in January 2010 in favor of a retail and direct-to-consumer, online sales model. Bazi Intl. continued to distribute Bazi® online and through our existing database of customers, but as a result of the termination of our multilevel distributor model, most of our top distributors ended their relationship with the Company during the first quarter of 2010, causing sales of Bazi® to decrease throughout 2011 and into 2012. As a result, Bazi Intl. began suffering from a lack of sufficient capital necessary to adequately market Bazi® and support the Company’s existing retail and distribution partners.
True Drinks, Inc. Prior to Merger with the Bazi Intl.
True Drinks, Inc. (formerly GT Beverage Company, Inc.) was formed on January 19, 2012 to develop, market and sell AquaBall
TM
Naturally Flavored Water. In February and March of 2012, True Drinks, Inc. acquired GT Beverage Company, LLC, the predecessor entity to True Drinks, Inc. GT Beverage Company, LLC was formed in May 2008 to create and commercialize its Sportastic® brand sports drink, sold in round plastic bottles with registered trade dresses such as baseball and soccer designs. However, in January 2012, GT Beverage Company, LLC ceased its sports drink operations. True Drinks began packaging and selling AquaBall
TM
Naturally Flavored Water in its patented interlocking round plastic bottles, with depictions of characters from major entertainment companies, as permitted by licensing agreements with these companies.
Market Overview
Our products are characterized as functional beverages, or drink products with specific health benefits in its formulation of ingredients. Our flagship product,
AquaBall
TM
Naturally Flavored Water is a healthy hydration alternative to current beverages positioned towards children, and
competes in the kids’ food market segment. Functional beverages are growing at an aggressive rate, largely due to consumer demand for healthier alternatives to typical carbonated soft drinks. The shift away from carbonated soft drinks to healthier, functional drinks is reflected in the fact that sales of carbonated soft drinks have been flat since 2004, yet functional beverage sales have grown almost $20.0 billion over the same period to $30.6 billion in annual sales. Market research firm Zenith International estimates that global per capita consumption of functional beverages increased 25% from 2010 to 2013.
The kids foods market segment is projected to grow 40% from $10 billion in 2010 to $14 billion by 2015 according to Packaged Facts, a leading publisher of market research in the food, beverage and consumer packaged good sectors. Beverages are the second highest performing product within the kids foods market segment. In 2010, 40% of the kids food market contained some “better-for-you” element. Packaged Foods forecasts that the next several years will bring tremendous growth in the sales and development of food and beverage products marketed and designed for children. As a result, we are currently positioning
AquaBall
TM
as a healthy, safe, naturally flavored water drink for kids.
Our Products
We market and distribute products that move away from high sugar, high calorie and nutritionally deficient beverages to healthful, natural alternatives. Our mission is to bring integrity back to the beverage industry and that honesty applies to every drop in every bottle. Our goal is to create and deliver beverages for families that encourage improved health, while being clear about what our products contain (and what they don’t).
AquaBall
TM
Naturally Flavored Water
Our flagship product, AquaBall
TM
Naturally Flavored Water, is a naturally flavored water beverage, enhanced with vitamins B3, B5, B6, B12 and C. AquaBall
TM
does not contain high fructose corn syrup, artificial flavors, or artificial colors. Unlike high sugar and high calorie beverages marketed toward children, AquaBall
TM
is sweetened with stevia, an all-natural sweetener, allowing the AquaBall
TM
to provide a zero-sugar, zero-calorie alternative to juice and soda for kids.
The main component of the marketing vision behind the
AquaBall
TM
brand is our licensing agreements with Disney Consumer Products, Inc. (“
Disney
”) and Marvel Entertainment (“
Marvel
”), allowing each
AquaBall
TM
to prominently feature various Disney and Marvel characters. Both Disney and Marvel characters have an established reputation of high retail sales of licensed products, giving each
AquaBall
TM
the presence associated with these brands.
Each AquaBall
TM
is packaged in our patented 12 ounce stackable, spherical PET bottle, and wrapped with colorful, eye-catching labels featuring popular Disney characters and various Marvel Superheros. AquaBall
TM
currently comes in grape, orange and fruit punch flavors, and is sold in mass-market retailers throughout the United States. AquaBall
TM
is also available for purchase online at
http://www.theaquaball.com
. During the year ended December 31, 2012, AquaBall
TM
sales accounted for approximately 99% of the Company’s total revenues.
Bazi
®
Bazi® All Natural Energy, is a liquid nutritional drink packed with eight different super fruits, including the Chinese jujube and seven other superfruits, plus 12 vitamins. The proprietary formula contains the following fruits: jujube fruit, blueberry, pomegranate, goji berry, chokeberry, raspberry, acai and sea buckthorn. Additionally, Bazi® contains 12 vitamins including vitamins A, C, E and B-complex. In August, 2011, BioEnergy Ribose was added to Bazi® enhancing the products energy delivery system. Following the Merger, Bazi® sales accounted for approximately 1% of our total revenue from October 15, 2012 through the end of the fiscal year.
Manufacturing and Distribution
Manufacturing
We use a limited number of third parties to supply and manufacture our products. We have co-packing agreements with 7-Up Bottling in Modesto, California and Coats International, Inc. in Dallas, Texas to package up to 2.5 million
AquaBall
TM
cases per year. Bazi® is manufactured by Arizona Packaging and Production under the terms of a five year exclusive manufacturing agreement, which stipulates certain prices, quantities and delivery timelines.
Retail Distribution
We utilize a direct-to-retailer distribution strategy to key national accounts for sales of AquaBall
TM
Naturally Flavored Water, including distribution to Toys R Us, Inc. and stores under the Safeway, Inc. brand nationwide. We also distribute AquaBall
TM
through regional distributors throughout the United States. We are actively seeking additional retail and convenience accounts, and we plan to explore alternative markets for AquaBall
TM
in the upcoming year such as schools, sports venues, fast food restaurants, dollar store and club store channels. Additionally, our licensing agreement with Disney Consumer Products, Inc. and Marvel Entertainment allows us to work with Disney and Marvel’s dedicated sales teams who, in turn, work with top retailers to assist us with securing shelf-space for AquaBall
TM
and accomplishing our long-term sales objectives.
The Company’s ecommerce platform allows current and future consumers to purchase AquaBall
TM
Naturally Flavored Water and Bazi® Energy Shot by visiting our newly redesigned webpages,
http://www.theaquaball.com
and
http://www.drinkbazi.com
. We drive traffic to relevant landing pages and micro sites through digital marketing campaigns and promotions, and a variety of social media marketing efforts.
The Company’s sales and marketing efforts are directed from our corporate offices in Irvine, California, utilizing our own staff, as well as outside resources retained to build market awareness and shelf placement of our products. The Company manages key national accounts through our in-house national sales team. Our sales teams work to secure national distribution with these customers through multiple avenues including joint sales meetings with Disney and Marvel sales personnel dedicated to these national accounts. The Company has hired outside personnel to manage our national broker networks. The networks focus on areas such as regional grocery chains, the convenience store channel, and the food service segment.
The Company is not dependent upon any major customers.
Source and Availability of Raw Materials
We utilize a variety of suppliers to purchase raw materials for the AquaBall
TM
Naturally Flavored Water during the year ended December 31, 2012.
During 2012, we relied significantly on one supplier for 100% of our purchases of raw materials for Bazi®. Bazi, inc. entered into an exclusive manufacturing agreement with this supplier in 2007 to produce the Bazi® product.
We own the formulas for both AquaBall
TM
Naturally Flavored Water and Bazi® Energy Shot, and we believe that our purchasing requirements can be readily met from alternative sources, if necessary.
The industries in which we operate are highly competitive. Not only do we compete with other manufacturers of functional beverages but we also compete with manufacturers of more traditional beverages, such as juice and soda marketed to children.
Our competition in the beverage industry includes products owned by multinational corporations with significant financial resources, including Vitamin Water and Tum-E Yummies, owned by Coca-Cola, and Sobe and Propel, owned by Pepsi Co. Bazi® competitors include Steaz®, Guayaki Yerba Mate, POM Wonderful®, as well as sports and energy drinks including Gatorade®, Red Bull®, 5-Hour Energy®, RockStar®, Monster®, Powerade®, Accelerade® and All Sport®. Indirect competition for the AquaBall
TM
and Bazi® includes soft drinks and juice products, such as Sunny Delight®, CapriSun® and other fruit drinks. These competitors can use their resources and scale to rapidly respond to competitive pressures and changes in consumer preferences by introducing new products, reducing prices or increasing promotional activities. Many of our competitors have longer operating histories and have substantially greater financial and other resources than we do. They therefore have the advantage of established reputations, brand names, track records, back office and managerial support systems and other advantages that we cannot duplicate in the near future. Moreover, many competitors, by virtue of their longevity and capital resources, have established lines of distribution to which we do not have access, and are not likely to duplicate in the near term, if ever.
Intellectual Property
We rely on the AquaBall
TM
patent, AquaBall
TM
and Bazi® trademarks and licensing agreements to market our products and make them standout among out competitors.
We were granted the patent for AquaBall
TM
’s stackable, spherical drink container in 2009, via our predecessor entity GT Beverage Company, LLC, who we purchased on March 31, 2012. We maintain trademark protection for AquaBall
TM
and have federal trademark registration for Bazi®. This trademark registration is protected for a period of ten years and then is renewable thereafter if still in use.
Licensing Agreements
We entered into a three-year licensing agreement with Disney Consumer Products, Inc. (“
Disney
”) and an 18-month licensing agreement with Marvel Characters, B.V. ("
Marvel
") (the “
Licensing Agreements
”) in 2012. Each Licensing Agreement allows us to feature popular Disney and Marvel characters on AquaBall
TM
Naturally Flavored Water, allowing AquaBall
TM
to stand out among other beverages marketed towards children. Under the terms and conditions of the Licensing Agreements, we work with the Disney and Marvel teams to create colorful, eye-catching labels that surround the entire spherical shape of each AquaBall
TM
. Once the label designs are approved, we work with Disney and Marvel to set retail calendars, rotating the placement of different AquaBall
TM
designs over the course of the year.
The terms of the Disney Licensing Agreement stipulates a royalty rate of 4% on the sales of AquaBall Naturally Flavored Water adorned with Disney characters, paid quarterly, with a total royalty guarantee of $231,600 over the term of the agreement which has a term ending date of March 31, 2015. In addition, the Company is required to spend 1% of sales on advertising and promotional opportunities. The Company is required to make common marketing fund contributions totaling $96,188 over the life of the agreement.
The terms of the Marvel Licensing Agreement stipulates a royalty rate of 5% on the sales of AquaBall Naturally Flavored Water adorned with Marvel characters, paid quarterly, with a total royalty guarantee of $150,000 over the term of the agreement which has a term ending date of December 31, 2013.
General
Our operations are affected by extensive laws, governmental regulations, administrative determinations, court decisions and enforcement policies. These requirements exist at the federal, state and local levels in the United States, including laws and regulations pertaining to:
●
|
the formulation, manufacturing, packaging, labeling, holding, storage, distribution, advertising and sale of our products; and
|
●
|
product claims and advertising, including direct claims and advertising by us, as well as claims and advertising by independent distributors, for which we may be held responsible.
|
The formulation, manufacturing, packaging, labeling, holding, storage, distribution, advertising, and sale of our products is subject to regulation by one or more federal agencies, including the Food and Drug Administration (“
FDA
”), the Federal Trade Commission (“
FTC
”), the Consumer Product Safety Commission (“
CPSC
”), the Occupational Safety and Health Administration (“
OSHA
”), the Department of Agriculture (“
USDA
”) and the Environmental Protection Agency (“
EPA
”). These activities are also regulated by various agencies of the states and localities in which our products are sold. Pursuant to the Federal Food, Drug, and Cosmetic Act (“
FDCA
”), the FDA regulates the processing, formulation, safety, manufacture, packaging, labeling, holding, sale, and distribution of foods and nutritional supplements (including vitamins, minerals, amino acids, herbs, and botanicals). The FTC has jurisdiction to regulate the advertising of these products. The CPSC is charged with protecting the public from risks of serious injury or death associated with the use of consumer products. Nutritional supplements are among the over 15,000 types of consumer products under CPSC’s jurisdiction. When consumers complain to the CPSC about alleged harm stemming from ingestion of vitamins and other nutritional supplement, CPSC may contact the entity concerned, inform it of the nature of the complaint, and invite a response. CPSC has conducted several recalls of iron-containing dietary supplements that do not comply with the child-resistant packaging requirement. The OSHA is charged with protecting workplace safety. Nutritional supplement companies must maintain a safe workplace and may from time to time be subject to queries from OSHA if manufacturing methods or procedures raise a question of worker safety. The USDA has jurisdiction over animal food and animal feed, including regulatory control over the harvesting of animal-based source materials, including animal-derived proteins, and animal-derived gelatin capsules, used in the making of dietary supplements. The EPA regulates dietary supplement compliance with standards established under the Clean Air Act, the Clean Water Act, the Occupational Safety and Health Act, and the Pollution Prevention Act as they affect the use, maintenance, and disposal of substances used in and facilities used for the manufacture of nutritional supplements.
The FDCA has been amended several times with respect to nutritional supplements, in particular by the Dietary Supplement Health and Education Act of 1994 (“
DSHEA
”), which established a new framework governing the composition, safety, labeling and marketing of nutritional supplements. Nutritional supplements are defined as vitamins, minerals, herbs, other botanicals, amino acids and other dietary substances for human use to supplement the diet, as well as concentrates, metabolites, constituents, extracts or combinations of such dietary ingredients. Generally, under DSHEA, dietary ingredients that were on the market prior to October 15, 1994, may be used in nutritional supplements without notifying the FDA. New dietary ingredients, consisting of dietary ingredients that were not marketed in the United States before October 15, 1994, are subject to a FDA pre-market new dietary ingredient notification requirement unless the ingredient has been present in the food supply as an article used for food without being chemically altered. A new dietary ingredient notification must provide the FDA with evidence of a history of use or other evidence of safety establishing that use of the dietary ingredient will reasonably be expected to be safe. A new dietary ingredient notification must be submitted to the FDA at least 75 days before the initial marketing of the new dietary ingredient. There is no certainty that the FDA will accept any particular evidence of safety for any new dietary ingredient. The FDA’s refusal to accept such evidence could prevent the marketing of such dietary ingredients.
The FDA issued a consumer warning in 1996, followed by proposed regulations in 1997, covering nutritional supplements that contain ephedra or its active substance, ephedrine alkaloids. We have never produced or sold products containing ephedra. In February 2004, the FDA issued a final regulation declaring nutritional supplements containing ephedra under the FDCA because they present an unreasonable risk of illness or injury under the conditions of use recommended or suggested in labeling, or if no conditions of use are suggested or recommended in labeling, under ordinary conditions of use. The rule took effect on April 12, 2004, and bans the sale of nutritional supplement products containing ephedra. Similarly, the FDA issued a consumer advisory in 2002 with respect to nutritional supplements that contain the ingredient Kava, and the FDA is currently investigating adverse effects associated with ingestion of this ingredient. We have never produced or sold any products containing Kava.
DSHEA permits statements of nutritional support to be included in labeling for nutritional supplements without FDA premarket approval. These statements must be submitted to the FDA within 30 days of marketing and must bear a label disclosure that “This statement has not been evaluated by the Food and Drug Administration. This product is not intended to diagnose, treat, cure, or prevent any disease.” These statements may describe a benefit related to a nutrient deficiency disease, the role of a nutrient or nutritional ingredient intended to affect the structure or function in humans, the documented mechanism by which a nutrient or dietary ingredient acts to maintain such structure or function, the general well-being from consumption of a nutrient or dietary ingredient, but may not expressly or implicitly represent that a nutritional supplement will diagnose, cure, mitigate, treat or prevent a disease. An entity that uses a statement of nutritional support in labeling must possess scientific evidence substantiating that the statement is truthful and not misleading. If the FDA determines that a particular statement of nutritional support is an unacceptable drug claim or an unauthorized version of a disease claim for a food product, or if the FDA determines that a particular claim is not adequately supported by existing scientific data or is false or misleading, we would be prevented from using the claim.
In addition, DSHEA provides that so-called “third-party literature,” e.g., a reprint of a peer-reviewed scientific publication linking a particular nutritional ingredient with health benefits, may be used in connection with the sale of a nutritional supplement to consumers without the literature being subject to regulation as labeling. Such literature must not be false or misleading; the literature may not promote a particular manufacturer or brand of nutritional supplement; the literature must present a balanced view of the available scientific information on the nutritional supplement; if displayed in an establishment, the literature must be physically separate from the nutritional supplement; and the literature may not have appended to it any information by sticker or any other method. If the literature fails to satisfy each of these requirements, we may be prevented from disseminating it with our products, and any dissemination could subject our products to regulatory action as an illegal drug. Moreover, any written or verbal representation by us that would associate a nutrient in a product that we sell with an effect on a disease will be deemed evidence of an intent to sell the product as an unapproved new drug, a violation of the FDCA.
On August 25, 2007 the FDA adopted the final regulations for large manufactures of a standard originally proposed in March 2003 of the current Good Manufacturing Practices guidelines (“
cGMPs
”) for the manufacturing, packing, holding and distributing dietary ingredients and nutritional supplements. The new regulations will require nutritional supplements to be prepared, packaged, and held in compliance with strict rules, and will require quality control provisions that may mandate redundant testing of product ingredients at each separate stage of manufacture and are intended to ensure that products are accurately labeled and don’t contain adulterants and contaminants. While the rule allowed for medium and small manufacturers to have until 2009 and 2010, respectively, to comply with the cGMPs, most of our contract manufacturers did not qualify as small or medium. As a result, many of our contract manufacturers began following the proposed cGMPs or even pharmaceutical cGMPs well before the final rule was published. We expect to see an increase in our manufacturing costs as a result of the necessary increase in testing of raw ingredients and finished products and compliance with higher quality standards, although we are not certain of the amount of these costs.
The FDA has broad authority to enforce the provisions of the FDCA applicable to nutritional supplements, including powers to issue a public warning letter to an entity, to publicize information about illegal products, to request a recall of illegal products from the market, and to request the Department of Justice to initiate a seizure action, an injunction action, or a criminal prosecution in the United States courts. The regulation of nutritional supplements may increase or become more restrictive in the future.
In 2004, legislation was introduced in both houses of Congress that imposed substantial new regulatory requirements for dietary supplements. These bills did not pass and are no longer pending, but we believe the 2004 proposed legislation evidences a continuing effort to further regulate dietary supplements.
On April 12, 2004, the FDA adopted a new test for determining when a nutritional supplement is adulterated. Under this test, the FDA may declare a nutritional supplement adulterated (i.e., to present an unreasonable risk of illness or injury) if it finds any benefit provided by the supplement outweighed by a risk of illness of injury. The new risk/benefit test is ill-defined and can be interpreted to permit FDA to hold a wide range of nutritional supplements adulterated. It is possible that FDA might hold more nutritional supplements adulterated in the future, reducing the nutritional ingredients available for use in our products.
The FTC exercises jurisdiction over the advertising of nutritional supplements. In recent years, the FTC has instituted numerous enforcement actions against nutritional supplement companies for deceptive advertising based on those companies’ alleged failure to possess competent and reliable scientific evidence in support of claims made in advertising.
The FTC may monitor our advertising and could request all evidence in support of our advertising claims, which evidence is required to be kept by us in advance of advertising. Discerning what constitutes “competent and reliable scientific evidence” involves, to a degree, a subjective assessment of the relative level, degree, quality, and quantity of scientific evidence and its acceptance in the scientific community as proof of the advertising statement. It is therefore possible that we may think evidence we have as sufficient but the FTC may deem the evidence inadequate. We believe we are in material compliance with applicable federal, state and local rules.
On December 9, 2006, President Bush signed the Dietary Supplement & Nonprescription Drug Consumer Protection Act into law. The legislation requires manufacturers of dietary supplement and over-the-counter products to notify the FDA when they receive reports of serious adverse events. We already have an internal adverse event reporting system that has been in place for several years. In December 2008 the FDA submitted Guidance for implementing the regulations for comment, this guidance, when finalized, will represent the current thinking of the Food and Drug Administration on this topic, which we would intend to fully comply with.
We believe that current and reasonably foreseeable governmental regulation will have minimal impact on our business.
Research and Development
No expenses were recorded on research and development for the year ended December 31, 2012. During 2012, we developed our AquaBall
TM
proprietary formula along with Wild Flavors, Inc., an independent third party contracted by the Company. We launched AquaBall
TM
in June 2012. The AquaBall
TM
did not require FDA or other regulatory approval. Following the initial launch of the AquaBall
TM
, we continued research and development efforts to add more flavors to the AquaBall
TM
line, and modify the AquaBall
TM
into a zero sugar, zero calorie product. We launched the zero sugar, zero calorie line in early 2013. We are also planning on introducing new flavors in 2013, such as strawberry lemonade and berry.
During 2006, Bazi® was developed and was launched in January 2007. This product did not require FDA or other regulatory approval. During 2009, new ingredients and productions methods were researched to integrate into existing products or new products. During 2010, Bazi® was repackaged into 2oz shots into two, six and twelve packs to ensure greater retail distribution.
Employees
We had 6 full-time and 2 part-time employees as of December 31, 2012.
Compliance with Environmental Laws
Our business does not require us to comply with any particular environmental regulations.
As a public company, we are required to file our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements on Schedule 14A and other information (including any amendments) with the Securities and Exchange Commission (the “
SEC
”). You may read and copy such material at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549, on official business days during the hours of 10:00 a.m. to 3:00 p.m. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You can also find the Company’s SEC filings at the SEC’s website at http://www.sec.gov.
Our Internet address is www.truedrinks.com. Information contained on our website is not part of this annual report on Form 10-K. Our SEC filings (including any amendments) will be made available free of charge on www.truedrinks.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
ITEM 1A. RISK FACTORS
We are subject to various risks that could have a negative effect on the Company and its financial condition. These risks could cause actual operating results to differ from those expressed in certain “forward looking statements’ contained in this Annual Report on Form 10-K as well as in other communications.
Risks Related to the Company
We have a history of operating losses and are currently experiencing liquidity problems.
We have not been profitable since inception. We had a net loss for the year ending December 31, 2012 of $2,902,155. In addition, we require additional capital to execute our business and marketing plan, and continue as a going concern. Our history of losses may impair our ability to obtain necessary financing on favorable terms or at all. It may also impair our ability to attract investors if we attempt to raise additional capital by selling additional debt or equity securities in a private or public offering.
We will need to raise additional funds to fund operations, which cannot be assured and may result in substantial dilution to our existing shareholders.
To date, our operating funds have been provided primarily from sales of our Common Stock, Preferred Stock (defined below), promissory notes and, to a lesser degree, cash flow provided by sales of our products. We used $4,059,238 of cash for operations in the year ended December 31, 2012. If our business operations do not result in increased product sales, and we are otherwise unable to secure short-term working capital, our business viability, financial position, results of operations and cash flows will be adversely affected. We cannot predict the terms upon which we could raise such capital or if any capital would be available at all, and what dilution will be caused to the existing shareholders.
Our operations are now dependent on the business of True Drinks, and our ability to achieve positive cash flow under our new business plan is uncertain.
As a result of the Merger, our continued operations are now dependent on the business of True Drinks. True Drinks’ ability to achieve positive cash flow resulting from its new business plan is uncertain, as True Drinks only product line, the AquaBall
TM
, was launched less than one year ago. Although True Drinks generated revenues of $1,012,380 from the sale of the AquaBall
TM
in 2012, and we anticipate substantially greater revenues in 2013, there can be no guarantee that the Company will continue to grow revenue or achieve positive cash low in the future.
Our licensing agreements with Disney Consumer Products, Inc. and Marvel Characters, B.V. are critical component of the marketing of the AquaBall
TM
line, and there is no guarantee the licensing agreements will be renewed at the end of each agreement’s term.
We currently have licensing agreement with Disney Consumer Products, Inc. (the “
Disney Agreement
”) and Marvel Characters, B.V. (the “
Marvel Agreement
”) that allow us to place popular Disney and Marvel characters on labels of AquaBall
TM
Naturally Flavored Water. As AquaBall
TM
was launched less than one year ago, the use of these characters, including Disney Princesses and Spider-Man, is critical to making the AquaBall
TM
stand out among our competitors. These licensing agreements have varying terms, with the Disney Agreement expiring in 2015 and the Marvel Agreement expiring in 2013. There is no guarantee we will be able to renew these agreements upon expiration, nor are we able to guarantee that we will have licensing agreements with other companies when the Disney Agreement and Marvel Agreement expire.
Our limited operating history and recent change in marketing strategy make it difficult to evaluate our prospects.
We have a limited operating history on which to evaluate our business and prospects. Our current flagship product, the AquaBall
TM
, was formulated and introduced to the public for sale in 2012. Our other products, including Bazi®, have limited market success. There can be no assurance that we will achieve significant sales as a result of us focusing our sales efforts on the AquaBall
TM
product, or that our new sales model with be successful.
We also may not be successful in addressing our other operating challenges, such as developing brand awareness and expanding our market presence through retail sales and our direct-to-consumer and online sales strategy. Our prospects for profitability must be considered in light of our evolving business model. These factors make it difficult to assess our prospects.
We are affected by extensive laws, governmental regulations, administrative determinations, court decisions and similar constraints, which can make compliance costly and subject us to enforcement actions by governmental agencies.
The formulation, manufacturing, packaging, labeling, holding, storage, distribution, advertising and sale of our products are affected by extensive laws, governmental regulations and policies, administrative determinations, court decisions and similar constraints at the federal, state and local levels, both within the United States and in any country where we conduct business. There can be no assurance that we or our independent distributors will be in compliance with all of these regulations. A failure by us or our distributors to comply with these laws and regulations could lead to governmental investigations, civil and criminal prosecutions, administrative hearings and court proceedings, civil and criminal penalties, injunctions against product sales or advertising, civil and criminal liability for the Company and/or its principals, bad publicity, and tort claims arising out of governmental or judicial findings of fact or conclusions of law adverse to the Company or its principals. In addition, the adoption of new regulations and policies or changes in the interpretations of existing regulations and policies may result in significant new compliance costs or discontinuation of product sales, and may adversely affect the marketing of our products, resulting in decreases in revenues.
Our ability to increase sales is dependent on growing in our existing markets as well as expanding into new markets in other countries. As we expand into foreign markets, we will become subject to different political, cultural, exchange rate, economic, legal and operational risks. We may invest significant amounts in these expansions with little success.
We currently are focusing our marketing efforts in the United States and, to a lesser extent, Canada. We believe that our future growth will come from both the markets that we are currently operating in and other international markets. We do not have any history of international expansion, and therefore have no assurance that any efforts will result in increased revenue. Additionally, we may need to overcome significant regulatory and legal barriers in order to sell our products, and we cannot give assurance as to whether our distribution method will be accepted. These markets may require that we reformulate our product to comply with local customs and laws. However, there is no guarantee that the reformulated product will be approved for sale by these regulatory agencies or attract local distributors.
We face substantial uncertainties in executing our business plan.
Successfully executing our business plan will require us to attain certain objectives to which no assurance can be given that we will be successful in our efforts. We believe that in order to execute our business plan and achieve the sales growth we are anticipating we must, among other things, successfully recruit additional personnel in key positions, develop a larger distribution network and establish a broader customer base and increase awareness of our brand name. In order to implement any of these we will be required to materially increase our operating expenses, which may require additional working capital. If we are unable to secure additional working capital, we will be unable to accomplish our objectives, and if we are unable to accomplish one or more of these objectives, our business may fail.
We are currently dependent on a limited number of independent suppliers and manufacturers of our products, which may affect our ability to deliver our products in a timely manner. If we are not able to ensure timely product deliveries, potential distributors and customers may not order our products, and our revenues may decrease.
We rely entirely on a limited number of third parties to supply and manufacture our product. These third party manufacturers may be unable to satisfy our supply requirements, manufacture our products on a timely basis, fill and ship our orders promptly, provide services at competitive costs or offer reliable products and services. The failure to meet any of these critical needs would delay or reduce product shipment and adversely affect our revenues, as well as jeopardize our relationships with our independent distributors and customers. In the event any of our third party manufacturers were to become unable or unwilling to continue to provide us with products in required volumes and at suitable quality levels, we would be required to identify and obtain acceptable replacement manufacturing sources. There is no assurance that we would be able to obtain alternative manufacturing sources on a timely basis. Additionally, all our third party manufacturers source the raw materials for our products, and if we were to use alternative manufacturers we may not be able to duplicate the exact taste and consistency profile of the product from the original manufacturer. An extended interruption in the supply of our products would result in decreased product sales and our revenues would likely decline. We believe that we can meet our current supply and manufacturing requirements with our current suppliers and manufacturers or with available substitute suppliers and manufacturers.
We are dependent on our third party manufacturers to supply our products in the compositions we require, and we do not independently analyze our products. Any errors in our product manufacturing could result in product recalls, significant legal exposure, and reduced revenues and the loss of distributors.
While we require that our manufacturers verify the accuracy of the contents of our products, we do not have the expertise or personnel to monitor the production of products by these third parties. We rely exclusively, without independent verification, on certificates of analysis regarding product content provided by our third party suppliers and limited safety testing by them. We cannot be assured that these outside manufacturers will continue to supply products to us reliably in the compositions we require. Errors in the manufacture of our products could result in product recalls, significant legal exposure, adverse publicity, decreased revenues, and loss of distributors and endorsers.
We face significant competition from existing suppliers of products similar to ours. If we are not able to compete with these companies effectively, we may not be able to achieve profitability.
We face intense competition from numerous resellers, manufacturers and wholesalers of liquid nutrition drinks similar to ours, including retail, online and mail order providers. We consider the significant competing products in the U.S. market for the AquaBall
TM
to be Tum-E Yummies, Capri-Sun, Bug Juice, and other alternatives marketed towards children, and for Bazi® to be Red Bull®, Monster®, RockStar®, 5 Hour Energy® and Steaz®. Most of our competitors have longer operating histories, established brands in the marketplace, revenues significantly greater than ours and better access to capital than us. We expect that these competitors may use their resources to engage in various business activities that could result in reduced sales of our products. Companies with greater capital and research capabilities could re-formulate existing products or formulate new products that could gain wide marketplace acceptance, which could have a depressive effect on our future sales. In addition, aggressive advertising and promotion by our competitors may require us to compete by lowering prices because we do not have the resources to engage in marketing campaigns against these competitors, and the economic viability of our operations likely would be diminished.
Adverse publicity associated with our products or ingredients, or those of similar companies, could adversely affect our sales and revenues.
Adverse publicity concerning any actual or purported failure of our Company to comply with applicable laws and regulations regarding any aspect of our business could have an adverse effect on the public perception of our Company. This, in turn, could negatively affect our ability to obtain financing, endorsers and attract distributors or retailers for the AquaBall
TM
and/or Bazi®, which would have a material adverse effect on our ability to generate sales and revenues.
Our distributors’ and customers’ perception of the safety and quality of our products or even similar products distributed by others can be significantly influenced by national media attention, publicized scientific research or findings, product liability claims and other publicity concerning our products or similar products distributed by others. Adverse publicity, whether or not accurate, that associates consumption of our products or any similar products with illness or other adverse effects, will likely diminish the public’s perception of our products. Claims that any products are ineffective, inappropriately labeled or have inaccurate instructions as to their use, could have a material adverse effect on the market demand for our products, including reducing our sales and revenues.
The efficiency of nutritional supplement products is supported by limited conclusive clinical studies, which could result in less market acceptance of these products and lower revenues or lower growth rates in revenues.
Our nutritional supplement products are made from vitamins, minerals, amino acids, herbs, botanicals, fruits, berries and other substances for which there is a long history of human consumption. However, there is little long-term experience with human consumption of certain product ingredients or combinations of ingredients in concentrated form. Although we believe all of our products fall within the generally known safe limits for daily doses of each ingredient contained within them, nutrition science is imperfect. Moreover, some people have peculiar sensitivities or reactions to nutrients commonly found in foods, and may have similar sensitivities or reactions to nutrients contained in our products. Furthermore, nutrition science is subject to change based on new research. New scientific evidence may disprove the efficacy of our products or prove our products to have effects not previously known. We could be adversely affected by studies that may assert that our products are ineffective or harmful to consumers, or if adverse effects are associated with a competitor’s similar products.
Our products may not meet health and safety standards or could become contaminated.
We have adopted various quality, environmental, health and safety standards. We do not have control over all of the third parties involved in the manufacturing of our products and their compliance with government health and safety standards. Even if our products meet these standards they could otherwise become contaminated. A failure to meet these standards or contamination could occur in our operations or those of our bottlers, distributors or suppliers. This could result in expensive production interruptions, recalls and liability claims. Moreover, negative publicity could be generated from false, unfounded or nominal liability claims or limited recalls. Any of these failures or occurrences could negatively affect our business and financial performance.
The sale of our products involves product liability and related risks that could expose us to significant insurance and loss expenses.
We face an inherent risk of exposure to product liability claims if the use of our products results in, or is believed to have resulted in, illness or injury. Most of our products contain combinations of ingredients, and there is little long-term experience with the effect of these combinations. In addition, interactions of these products with other products, prescription medicines and over-the-counter drugs have not been fully explored or understood and may have unintended consequences. While our third party manufacturers perform tests in connection with the formulations of our products, these tests are not designed to evaluate the inherent safety of our products.
Although we maintain product liability insurance, it may not be sufficient to cover all product liability claims and such claims that may arise, could have a material adverse effect on our business. The successful assertion or settlement of an uninsured claim, a significant number of insured claims or a claim exceeding the limits of our insurance coverage would harm us by adding further costs to our business and by diverting the attention of our senior management from the operation of our business. Even if we successfully defend a liability claim, the uninsured litigation costs and adverse publicity may be harmful to our business.
Any product liability claim may increase our costs and adversely affect our revenues and operating income. Moreover, liability claims arising from a serious adverse event may increase our costs through higher insurance premiums and deductibles, and may make it more difficult to secure adequate insurance coverage in the future. In addition, our product liability insurance may fail to cover future product liability claims, which, if adversely determined, could subject us to substantial monetary damages.
The success of our business will depend upon our ability to create brand awareness.
The market for functional beverages and nutraceuticals is already highly competitive, with many well-known brands leading the industry. Our ability to compete effectively and generate revenue will be based upon our ability to create awareness of our products distinct from those of our competitors. It is imperative that we are able to convey to consumers the fact that our products are not just functional beverages but are also nutraceuticals. However, advertising and packaging and labeling of such products will be limited by various regulations. Our success will be dependent upon our ability to convey to consumers that our products are superior to those of our competitors.
We must continue to develop and introduce new products to succeed.
The functional beverage and nutritional supplement industry is subject to rapid change. New products are constantly introduced to the market. Our ability to remain competitive depends on our ability to enhance existing products, continue to develop and manufacture new products in a timely and cost effective manner, to accurately predict market transitions, and to effectively market our products. Our future financial results will depend to a great extent on the successful introduction of several new products. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new products or in enhancing existing products.
The success of new product introductions depends on various factors, including the following:
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proper new product selection;
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successful sales and marketing efforts;
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timely delivery of new products;
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availability of raw materials;
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pricing of raw materials;
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regulatory allowance of the products; and
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customer acceptance of new products.
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We may from time to time write off obsolete inventories resulting in higher expenses and consequently greater net losses.
As we sometimes produce product adorned with characters on a promotional schedule, over production of a certain character set could result in write-downs of our inventories. A change in ingredients or labeling requirements could also result in the obsolescence of certain inventory. We did not incur a write-down against inventory for the year ended December 31, 2012. Write-downs of this type could make it more difficult for us to achieve profitability.
Product returns could require us to incur significant additional expenses, which would make it difficult for us to achieve profitability.
We have not established a reserve in our financial statements for product returns. However, we may experience product returns as we shift our focus to the AquaBall
TM
line of products and expand our market presence nationwide. We will continue to analyze our returns to determine if a reserve is necessary. If our reserves prove to be inadequate, we may incur significant expenses for product returns. As we gain more operating experience, we may need to establish a reserve for product returns.
If we are not able to adequately protect our intellectual property, then we may not be able to compete effectively and we may not be profitable.
Our existing proprietary rights may not afford remedies and protections necessary to prevent infringement, reformulation, theft, misappropriation and other improper use of our products by competitors. We own the formulations contained in our products and the patent for the AquaBall
TM
bottle. We consider this patent and these product formulations our critical proprietary property, which must be protected from competitors. We do not have any patents for our product formulations because we do not believe they are necessary to protect our proprietary rights. Although trade secret, trademark, copyright and patent laws generally provide such protection and we attempt to protect ourselves through contracts with manufacturers of our products, we may not be successful in enforcing our rights. In addition, enforcement of our proprietary rights may require lengthy and expensive litigation. We have attempted to protect some of the trade names and trademarks used for our products by registering them with the U.S. Patent and Trademark Office, but we must rely on common law trademark rights to protect our unregistered trademarks. Common law trademark rights do not provide the same remedies as are granted to federally registered trademarks, and the rights of a common law trademark are limited to the geographic area in which the trademark is actually used. Our inability to protect our intellectual property could have a material adverse impact on our ability to compete and could make it difficult for us to achieve a profit.
Compliance with changing corporate governance regulations and public disclosures may result in additional risks and exposures.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new regulations from the SEC, have created uncertainty for public companies such as ours. These laws, regulations, and standards are subject to varying interpretations in many cases and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. As a result, our efforts to comply with evolving laws, regulations, and standards have resulted in, and are likely to continue to result in, increased expenses and significant management time and attention.
Loss of key personnel could impair our ability to operate.
Our success depends on hiring, retaining and integrating senior management and skilled employees. As a result of the Merger, recent management restructuring, certain members of senior management resigned, and these departures may have negative impact on our business. We are currently dependent on certain current key employees, including Lance Leonard, our Chief Executive Officer, who is vital to our ability to grow our business and achieve profitability. As with all personal service providers, our officers can terminate their relationship with us at will. Our inability to retain these individuals may result in our reduced ability to operate our business.
A limited trading market currently exists for our securities and we cannot assure you that an active market will ever develop, or if developed, will be sustained.
There is currently a limited trading market for our securities on the Over-the-Counter Bulletin Board. An active trading market for the common stock may not develop. Consequently, we cannot assure you when and if an active-trading market in our shares will be established, or whether any such market will be sustained or sufficiently liquid to enable holders of shares of our common stock to liquidate their investment in our company. If an active public market should develop in the future, the sale of unregistered and restricted securities by current shareholders may have a substantial impact on any such market.
The price of our securities could be subject to wide fluctuations and your investment could decline in value.
The market price of the securities of a company such as ours with little name recognition in the financial community and without significant revenues can be subject to wide price swings. The market price of our securities may be subject to wide changes in response to quarterly variations in operating results, announcements of new products by us or our competitors, reports by securities analysts, volume trading, or other events or factors. In addition, the financial markets have experienced significant price and volume fluctuations for a number of reasons, including the failure of certain companies to meet market expectations. These broad market price swings, or any industry-specific market fluctuations, may adversely affect the market price of our securities.
Companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation. If we were to become the subject of securities class action litigation, it could result in substantial costs and a significant diversion of our management’s attention and resources.
Because our common stock may be classified as “penny stock,” trading may be limited, and the share price could decline. Because our common stock may fall under the definition of “penny stock,” trading in the common stock, if any, may be limited because broker-dealers would be required to provide their customers with disclosure documents prior to allowing them to participate in transactions involving the common stock. These disclosure requirements are burdensome to broker-dealers and may discourage them from allowing their customers to participate in transactions involving our common stock.
We may issue preferred stock with rights senior to the common stock, which we may issue in order to consummate a merger or other transaction necessary to continue as a going concern.
Our certificate of incorporation authorizes the issuance of up to 5,000,000 shares of preferred stock, par value $0.001 per share (the “
Preferred Stock
”) without shareholder approval and on terms established by our directors. We may issue shares of preferred stock in order to consummate a financing or other transaction, in lieu of the issuance of common stock. The rights and preferences of any such class or series of preferred stock would be established by our board of directors in its sole discretion and may have dividend, voting, liquidation and other rights and preferences that are senior to the rights of the common stock.
You should not rely on an investment in our common stock for the payment of cash dividends.
Because of our significant operating losses and because we intend to retain future profits, if any, to expand our business, we have never paid cash dividends on our stock and do not anticipate paying any cash dividends in the foreseeable future. You should not make an investment in our common stock if you require dividend income. Any return on investment in our common stock would only come from an increase in the market price of our stock, which is uncertain and unpredictable.
Additional risks may exist since we became public through a “reverse merger.”
Because we became public by means of a “reverse merger,” we may not be able to attract the attention of major brokerage firms. Securities analysts of major brokerage firms may not provide coverage of us since there is little incentive to brokerage firms to recommend the purchase of our common stock. We cannot assure you that brokerage firms will want to conduct any secondary offerings on behalf of the Company in the future.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Facilities
We are headquartered in Irvine, California and lease our office on a one-year lease.
Total rent expense for the year ended December 31, 2012 was approximately $33,000. Total remaining payments on the lease through July 31, 2013 are approximately $27,000.
Insurance
We maintain commercial general liability, including product liability coverage, and property insurance. Our policy provides for a general liability limit of $2.0 million per occurrence, and $10 million annual aggregate umbrella coverage.
ITEM 3. LEGAL PROCEEDINGS
From time to time, claims are made against the Company in the ordinary course of business, which could result in litigation. Claims and associated litigation are subject to inherent uncertainties and unfavorable outcomes could occur. In the opinion of management, the resolution of these matters, if any, will not have a material adverse impact on the Company’s financial position or results of operations.
As of December 31, 2012, we were involved in the following significant legal proceedings:
On July 1, 2011, a lawsuit was filed in the United States District Court, the Southern District of Ohio, Cincinnati Division, against GT Beverage Company, LLC (“GT LLC”) by Dominion Liquid Technologies, LLC. The lawsuit alleges that GT LLC breached terms of a Co-Packing Agreement from 2010, which governed the relationship between the parties. As of February 2013, Dominion amended its complaint to add the Company as a defendant in the case. The Company has not yet filed responsive pleadings. Dominion is seeking monetary damages in an amount exceeding $800,000. GT LLC has filed its answer denying all of Dominion’s claims and expects to vigorously defend the suit. Discovery is ongoing, and the case is currently set for trial in November 2013.
On December 13, 2011, a lawsuit was filed in the 116th District Court of Dallas County, Texas against GT LLC by Quality Logistics Systems, Inc. (“QLS”). The lawsuit alleges that GT LLC is liable for approximately $68,000 in transportation and logistical fees. On May 18, 2012, a judgment was entered in favor of QLS for $68,542.48, along with $4,145 of costs and fees. GT LLC has not satisfied this judgment to date.
ITEM 4. MINE SAFETY DISCLOSURES
None.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business
Overview
True Drinks, Inc. (the "
Company
", "
us
", "
True Drinks
" or "
we
") was formed on January 19, 2012 in Delaware to create and commercialize all-natural, vitamin-enhanced drinks. Our primary business is the development, marketing, sale and distribution of our flagship product, AquaBall
TM
Naturally Flavored Water, a vitamin-enhanced, naturally flavored water drink packaged in our patented stacking spherical bottles. We distribute AquaBall nationally through select retail channels, such as grocery stores, mass merchandisers, drug stores and online. We also market and distribute Bazi®
All Natural Energy,
a liquid nutritional supplement drink, which is currently distributed through select retail channels, online, and through our existing database of customers.
The period from January 19, 2012 through December 31, 2012 is referred to as the year ended December 31, 2012 throughout these consolidated financial statements and notes thereto.
On June 7, 2012, True Drinks, Inc., Bazi Acquisition Sub Inc. ("
Merger Sub
")
, a Delaware corporation and a wholly-owned subsidiary of Bazi International, Inc.,
and Bazi International, Inc.
entered into an agreement and tax-free plan of merger (the “
Merger Agreement
”), wherein Merger Sub merged with and into the Company and True Drinks continued as the surviving corporation (the "
Merger
"). As a result of the Merger, True Drinks became a wholly-owned subsidiary of the Company. The Merger closed on October 15, 2012 (the “
Closing Date
”). As a result of Merger, True Drinks, Inc.’s former shareholders owned approximately 95.5% of the combined post-Merger entity via voting convertible preferred stock issued as part of the merger, on an as-converted basis (See Recent Developments below). The Company subsequently changed its name from “Bazi International, Inc.” to “True Drinks, Inc.”
The Merger was accounted for as a public company “reverse merger,” and, as such, the consolidated financial statements reported herein reflect the operations of True Drinks, Inc. within the capital structure of Bazi International, Inc.
True Drinks, Inc. was formerly named GT Beverage Company, Inc., which was formed in January 2012 and acquired GT Beverage Company, LLC on March 31, 2012 in a business combination primarily to acquire the spherical bottle patent held by GT Beverage Company, LLC. Subsequently as discussed above, GT Beverage Company, Inc. entered into a public company reverse merger with Bazi International, Inc. accounted for as a business combination, since Bazi International, Inc. was not a public shell as defined by rules of the Securities and Exchange Commission. GT Beverage Company, Inc. took over the capital structure of Bazi International, Inc. and was renamed True Drinks, Inc.
GT Beverage Company, LLC is considered the predecessor entity to GT Beverage Company, Inc. under rules of the Securities and Exchange Commission, and accordingly, audited financial statements of GT Beverage Company, LLC as of and for the years ended December 31, 2011 and 2010 are included in Exhibit 10.6. GT Beverage Company, LLC had no operations from January 1, 2012 to March 31, 2012.
Bazi International, Inc. was originally incorporated in the state of Nevada in January 2001. True Drinks, Inc. (“
True Drinks
”),
previously GT Beverage Company, Inc.,
is incorporated in the state of Delaware.
Our principal place of business is 18552 MacArthur Boulevard, Suite 325, Irvine, California, 92612. Our telephone number is (949) 203-2500. Our corporate website address is
http://www.truedrinks.com
. Our common stock, par value $0.001 (“
Common Stock
”) is currently listed for quotation on the Over-the-Counter Bulletin Board (“
OTCBB
”) under the symbol TRUU.
Reverse Stock Split
On January 18, 2013, we amended our Articles of Incorporation to create a 100 to 1 reverse split of our common stock. Accordingly, our authorized common stock decreased from 4,000,000,000 to 40,000,000 shares and our issued and outstanding common stock decreased from 133,733,469 to 1,337,335 shares. As a result of the reverse stock split, all previously reported share amounts, including options in the accompanying consolidated financial statements and related notes have been retrospectively restated back to October 15, 2012 (date of public company reverse merger) to reflect the reverse split.
Recent Developments
On the Closing Date of the Merger, Lance Leonard was appointed as our Chief Executive Officer, Daniel Kerker as our Chief Financial Officer and Kevin Sherman, former President of the Company, as our Vice President of Marketing. We also appointed Timothy Lane, Carl Wistreich, Lou Imbrogno and Lance Leonard to fill the vacancies on our Board of Directors created as a result of the resignation of the former directors of Bazi International, Inc.
Creation of the Series A Preferred.
Upon closing the Merger, the Company filed a Certificate of Designation, Preferences, Rights and Limitations of Series A Convertible Preferred Stock (“
Series A Preferred
”) (the “
Certificate of Designation
”), creating 1,544,565 shares of Series A Preferred Stock. On the Closing Date, former True Drinks shareholders exchanged all outstanding capital stock of True Drinks for a total of 1,544,565 Series A Preferred Stock, which shares represent on an as-converted basis approximately 95.5% of the total common stock outstanding. As explained below, the Series A Preferred automatically converted into a total of 25,303,991 post-split shares of common stock on January 18, 2013.
Financings. I
n November and December, 2012, the Company issued an aggregate principal amount of $725,000 in unsecured convertible promissory notes (the “
Notes
”) to certain purchasers (the “
Purchasers
”). The Notes had a term of 120 days and bore interest at a rate of 9% per annum. At maturity, the holders of the Notes have the right to convert all principal and accrued interest due thereunder into Common Stock at a conversion price equal to $1.00 per share. In addition, each Purchaser received 5,000 post-split shares of Common Stock per $25,000 of principal amount held for a total of 145,000 post-split shares of Common Stock. The Company is currently in discussions regarding the extension of the maturity dates of the Bridge Notes.
In December 2012, the Company issued $47,000 in unsecured promissory notes to certain purchasers. The notes had a term of 30 days and paid a lender’s fee of 10% of principal. The notes were repaid in January, 2013.
On January 14, 2013, we completed a private placement, wherein we issued an aggregate principal amount of $575,000 in unsecured convertible promissory notes (the “
January Notes
”) to certain purchasers. The January Notes had a term of 120 days and bore interest at a rate of 9% per annum. At maturity, the holders of the January Notes have the right to convert all principal and accrued interest due thereunder into Common Stock at a conversion price equal to $1.00 per share. In addition, each purchaser received 5,000 post-split shares of Common Stock per $25,000 of principal amount held.
In February and March 2013, we completed a private placement, wherein we issued an aggregate principal amount of $125,000 in unsecured convertible promissory notes (the “
March Notes
”) to certain purchasers. The March Notes mature 120 days from the date of issuance, and bear interest at a rate of 9% per annum. Pursuant to the terms of the March Notes, the March Notes are convertible into shares of Common Stock at a conversion price equal to $1.00 per share, and each purchaser received 5,000 post-split shares of Common Stock per $25,000 of principal purchased.
Amendment to our Articles of Incorporation and Reverse Stock Split.
On January 18, 2013, we filed an amendment to our Articles of Incorporation (the “
Amendment
”) to (i) to change our name to True Drinks Holdings, Inc., and (ii) increase the total number of authorized shares of Common Stock from 200,000,000 to 4,000,000,000 shares. Upon the filing of the Amendment, the shares of Series A Preferred issued to former True Drinks shareholders automatically converted into approximately 25,303,991 post-split shares of Common Stock.
The loss per common share and all other per-share disclosures in the accompanying financial statements of the Company and the related notes are based on the appropriate number of post-split common shares as adjusted for the aforementioned reverse stock split.
The name change and reverse split became effective with the Over−the−Counter Bulletin Board at the opening of trading on January 22, 2013 under the symbol “BAZID”. The “D” was placed on our ticker symbol for 20 business days. After trading for 20 business days under “BAZID”, on February 20, 2013, our ticker symbol changed from “BAZID” to “TRUU” to better reflect our new name.
Option Agreement
. On January 14, 2013, we entered into an Option Agreement (the “
Option Agreement
”) with Ashworth Holding, LLC, a Utah limited liability company (“
Ashworth
”), pursuant to which we granted Ashworth the option to purchase up to 86,086 shares of Common Stock for a price of $0.549 per share. This option will expire on April 30, 2013 or upon Ashworth’s full exercise of the option.
Basis of Presentation and Going Concern
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. As of and for the year ended December 31, 2012, the Company incurred a net loss of approximately $3.1 million, has negative working capital of approximately $827,000, and an accumulated deficit of approximately $3.1 million. A significant amount of additional capital will be necessary to advance the marketability of the Company's products to the point at which the Company can sustain operations. These conditions, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans are to continue to raise capital through equity and debt offerings, and to expand sales as rapidly as economically viable. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company and its wholly owned subsidiaries True Drinks, Inc., Bazi, Inc. and GT Beverage Company, LLC. All inter-company accounts and transactions have been eliminated in the preparation of these consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management include, among others, provision for losses on accounts receivable, allowances for obsolete and slow moving inventory, stock compensation, deferred tax asset valuation allowances, and the realization of long-lived and intangible assets, including goodwill. Actual results could differ from those estimates.
Revenue Recognition
In accordance with Staff Accounting Bulletin ("
SAB
") No. 104 “
Revenue Recognition in Financial Statements
”, revenue is recognized at the point of shipment, at which time title is passed. Net sales include sales of products, slotting fees, discounts and freight and handling charges. With approved credit, we provide wholesale customers payment terms of up to net 30 days.
Amounts received for unshipped merchandise are recorded as customer deposits and are included in accrued expenses.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less, to be cash equivalents. The Company maintains cash with high credit quality financial institutions. At certain times, such amounts may exceed Federal Deposit Insurance Corporation (“FDIC”) insurance limits. The Company has not experienced any losses on these amounts. At December 31, 2012, the Company had no cash equivalents.
Restricted Cash
The Company has $81,270 in restricted cash with a financial institution securing a letter of credit. The letter of credit matures in August 2015 and was issued as part of contractual obligations related to one of our licensing agreements with Disney Consumer Products, Inc.
Accounts Receivable
We maintain an allowance for doubtful accounts which is analyzed on a periodic basis to ensure that it is adequate to the best of management’s knowledge. Management develops an estimate of the allowance for doubtful accounts receivable based on its own judgment as to the likelihood of ultimate payment. Although the Company expects to collect amounts due, actual collections may differ from these estimated amounts. The allowance was $54,000 at December 31, 2012.
Concentrations
The Company has no significant off-balance sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company maintains the majority of its cash balances with two financial institutions. There are no funds in excess of the federally insured amount of $250,000 through December 31, 2012, or that are subject to credit risk, and the Company believes that the financial institutions are financially sound and the risk of loss is minimal.
During 2012, the Company relied significantly on one supplier for 100% of its purchases of AquaBall
TM
Naturally Flavored Water and Bazi® held for sale. In 2013, the Company has begun production of AquaBall with a second supplier. The Company owns the formula for both the AquaBall
TM
and Bazi®, and management believes that its purchasing requirements can be readily met from alternative sources.
A significant portion of our revenue comes from sales of the AquaBall
TM
Naturally Flavored Water. Following the consummation of the Merger in October 2012, sales of Bazi® accounted for 1% of our total revenue. Before the Merger, the Company’s revenues consisted of sales of AquaBall. For the year ended December 31, 2012, sales of AquaBall accounted for 99% of the Company’s total revenue.
Fair Value Matters
The Company does not have any assets or liabilities carried at fair value on a recurring or non-recurring basis.
The Company’s financial instruments consist of cash, accounts receivable, accounts payable and accrued expenses, and notes payable. Management believes that the carrying amount of these financial instruments approximates their fair values, due to their relatively short-term nature.
Inventory
Inventory is stated at the lower of cost or market on a FIFO (first-in first-out) basis. Provision is made to reduce excess or obsolete inventory to the estimated net realizable value. The Company purchases for resale a vitamin-enhanced flavored water beverage and a liquid dietary supplement.
Management reviews the carrying value of inventory in relation to its sales history and industry trends to determine an estimated net realizable value. Changes in economic conditions or customer demand could result in obsolete or slow moving inventory that cannot be sold or must be sold at reduced prices and could result in an inventory reserve. No inventory reserves were considered necessary as of December 31, 2012.
Inventory is comprised of the following:
Property and Equipment
Property and equipment are stated at cost. The Company provides for depreciation of property and equipment using the straight-line method based on estimated useful lives of between three and ten years. Property and equipment is not significant to the consolidated financial statements as of or for the year ended December 31, 2012.
Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets, the recoverability test is performed using undiscounted net cash flows estimated to be generated by the asset. An impairment was not deemed necessary in 2012.
Intangible Assets
Intangible assets consists of the direct costs incurred for application fees and legal expenses associated with trademarks on the Company’s products, customer list, and the estimated value of GT Beverage Company, LLC’s interlocking spherical bottle patent acquired on March 31, 2012. The Company’s intangible assets, are amortized over their estimated remaining useful lives. The Company evaluates the useful lives of its intangible assets annually and adjusts the lives according to the expected useful life. No impairment was deemed necessary as of December 31, 2012.
Goodwill
Goodwill represents the future economic benefits arising from other assets acquired that are individually identified and separately recognized. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but are tested for impairment at least annually.
Income Taxes
The Company accounts for income taxes in accordance with FASB Accounting Standards Codification 740 (“
ASC Topic 740
”), formerly Statement of Financial Accounting Standards No. 109, “
Accounting for Income Taxes
” (“
SFAS 109
”). Under the asset and liability method of ASC Topic 740, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
The Company adopted the provisions of ASC 740 that provide detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Tax positions must meet a “more-likely-than-not” recognition threshold at the effective date to be recognized. Upon the adoption of ASC 740, the Company had no unrecognized tax positions. For the year ended December 31, 2012, the Company recognized no adjustments for uncertain tax positions.
Stock-Based Compensation
Total stock-based compensation expense, for all of the Company’s stock-based awards recognized for the year ended December 31, 2012, was $163,055.
The Company uses a Black-Scholes option-pricing model (the “
Black-Scholes Model
”) to estimate the fair value of the stock option and warrants. The use of a valuation model requires the Company to make certain assumptions with respect to selected model inputs. Expected volatility is calculated based on the historical volatility of the Company’s stock price over the contractual term of the option. The expected life is based on the contractual term of the option and expected employee exercise and post-vesting employment termination behavior. Currently it is based on the simplified approach provided by SAB 107. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of the grant (see Note 4).
Net Loss Per Share
Earnings per share require presentation of both basic earnings per common share and diluted earnings per common share. Since the Company has a net loss for all periods presented, common stock equivalents are not included in the weighted average calculation since their effect would be anti-dilutive. At December 31, 2012, the Company had 4,755,183 shares of common stock equivalents outstanding.
Research and Development
Research and development costs are expensed as incurred.
Recent Accounting Pronouncements
The Company has reviewed all recently issued, but not yet effective accounting pronouncements and has concluded that there are no recently issued, but not yet effective pronouncements that may have a material impact on the Company’s future financial statements.
NOTE 2 – BUSINESS ACQUISITIONS
During the year ended December 31, 2012, the Company completed two business combinations accounted for under the acquisition (purchase) method pursuant to ASC 805.
GT Beverage Company, LLC
On March 31, 2012, the Company completed the acquisition of GT Beverage Company, LLC (“GT Beverage”), a Nevada limited liability company, by issuing 292,690 shares of common stock in exchange for all of the oustanding membership interests of GT Beverage. The primary purpose of the acquisition was to take advantage of GT Beverages’ patented spherical bottle for use in the Company's product AquaBall
TM
Naturally Flavored Water. These 292,690 shares of common stock were exchanged for 292,690 shares of the Company Series A Preferred Stock upon the merger with Bazi International, Inc. GT Beverage had no sales or significant operations from January 1, 2012 through March 31, 2012, and, accordingly, as a predecessor entity, GT Beverage has not provided audited financial statements for the three-months ended March 31, 2012. Audited financial statements of GT Beverage as of and for the years ended December 31, 2011 and 2010 are contained in Exhibit 10.6.
The acquisition date fair value was $2,926,900 for the purchase of GT Beverage’s outstanding member interests. The $2,926,900 consisted of 292,690 shares of the Company’s common stock with an estimated fair value of $2,926,900. The acquisition of GT Beverage has been accounted for using the acquisition method. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The allocation of the purchase price is based upon a valuation of certain assets acquired and liabilities assumed. The purchase price allocation was as follows:
|
|
Amount
|
|
Property and equipment
|
|
$
|
26,396
|
|
Patent for spherical bottle (useful life of 11.3 years)
|
|
|
1,600,000
|
|
Goodwill
|
|
|
2,414,642
|
|
Total assets acquired
|
|
|
4,041,038
|
|
Accounts payable, accrued expenses and other current liabilities
|
|
|
(1,114,138
|
)
|
Total liabilities assumed
|
|
|
(1,114,138
|
)
|
Total allocation of purchase price consideration
|
|
$
|
2,926,900
|
|
The useful life of the intangible asset was based upon the patterns in which the economic benefits related to the patent are expected to be realized, and the patent will be amortized on a basis reflecting those economic patterns.
The Company incurred $107,000 of legal costs related to this transaction, which has been recorded as general and administrative expense during the year ended December 31, 2012.
As noted above, there were no significant operations of GT Beverage from January 1, 2012 through March 31, 2012 and, accordingly, the pro forma financial information required by ASC 805 is not applicable.
Bazi International, Inc.
On October 15, 2012, the Company completed the acquisition of 100% of Bazi International, Inc. (“Bazi Intl.”), by exchanging shares of Company common stock for Bazi Intl. shares of voting convertible preferred stock. Bazi Intl.’s results of operations are reflected in the Company’s consolidated statements of operations from the acquisition date of October 15, 2012 through December 31, 2012.
The Company is considered the accounting acquiror due to its majority ownership, control of the board of directors, and officer positions held post acquisition. Accordingly, the acquisition has been acounted for as a public company reverse merger. Bazi Intl. was not a public company shell, as defined by the SEC, therefore the acquisition (purchase) method of accounting under ASC 805 has been used and the Company's capital structure has been restated to reflect the capital structure of Bazi Intl at the acquisition date.
The acquisition date estimated fair value was $727,805, consisting of 1,192,335 shares of the Company’s common stock with an estimated fair value of $727,805. The acquisition of Bazi Intl. has been accounted for using the acquisition method. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The allocation of the purchase price is based upon a valuation of certain assets acquired and liabilities assumed. The purchase price allocation was as follows:
|
|
Amount
|
|
Cash
|
|
$
|
5,646
|
|
Inventory
|
|
|
47,000
|
|
Customer List (useful life of 2 years)
|
|
|
100,000
|
|
Goodwill
|
|
|
1,059,860
|
|
Total assets acquired
|
|
|
1,212,506
|
|
Accounts payable, accrued expenses and other current liabilities
|
|
|
(484,701
|
)
|
Total liabilities assumed
|
|
|
(484,701
|
)
|
Total allocation of purchase price consideration
|
|
$
|
727,805
|
|
The useful life of the intangible asset (customer list) was based upon the patterns in which the economic benefits related to the customer list are expected to be realized, and the customer list will be amortized on a basis reflecting those economic patterns.
The Company incurred $138,000 of legal costs related to this transaction, which has been recorded as general and administrative expense during the year ended December 31, 2012.
The unaudited pro forma information presented in the following table summarizes the Company’s consolidated results of operations for the year ended December 31, 2012, as if the acquisition of Bazi Intl. had occurred on January 1, 2012. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisition had taken place at the beginning of 2012, nor is it intended to be a projection of future results.
Pro Forma (Unaudited)
|
Year Ended December 31, 2012
|
Revenues
|
|
$
|
1,488,515
|
|
Net loss
|
|
$
|
(5,001,653
|
)
|
Basic net loss per share
|
|
$
|
(0.22
|
)
|
NOTE 3 — SHAREHOLDERS’ EQUITY
As of December 31, 2012, the authorized capital stock of the Company consisted of 40,000,000 shares of Common Stock (par value $0.001) and 5,000,000 shares of Series A Preferred Stock (par value $0.001). The holders of Common Stock are entitled to receive, when and as declared by the Board of Directors, dividends payable either in cash, in property or in shares of common stock of the Company. Dividends have no cumulative rights and dividends will not accumulate if the Board of Directors does not declare such dividends.
The holders of Preferred Stock are entitled to receive, when and as declared by the Board of Directors, dividends payable either in cash, in property or in shares of the common stock of the Company, in an amount equal to the aggregate amount of the dividend to which such shares of Preferred Stock would have been entitled had such share been converted into shares of Common Stock. The holders of Preferred Stock will vote together with holders of Common Stock on an as-converted basis. Each share of Preferred Stock is convertible into 1638.28 shares of Common Stock of the Company. As of the merger date of October 15, 2012, the holders of Preferred Stock held approximately 95.5% of the total outstanding Common Stock of the Company as on as-converted basis.
Through December 31, 2012, no dividends have been declared or paid by the Company.
In January 2012, the Company formed and issued founders shares of its Common Stock to certain individuals and entities totaling 854,500 shares. As of the merger with Bazi Intl. on October 15, 2012, these shares were converted into 854,500 shares of the Company’s Series A Preferred shares.
In February and March 2012, the Company issued 163,000 shares of its Common Stock to certain accredited investors pursuant to subscription agreements in exchange for a total of $1,625,000. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 163,000 shares of the Company’s Series A Preferred shares.
On April 1, 2012, the Company completed the acquisition of the ownership interest in GT Beverage Company, LLC in exchange for 292,690 shares of its Common Stock. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 292,690 shares of the Company’s Series A Preferred shares.
Between April and June 2012, the Company issued 186,875 shares of its Common Stock to certain accredited investors pursuant to subscription agreements in exchange for a total of $1,574,982 in cash. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 186,875 shares of the Company’s Series A Preferred shares.
In June 2012, the Company issued 15,000 shares of its Common Stock for services provided to the Company valued at $150,000 based on the fair value of the Company’s stock. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 15,000 shares of the Company’s Series A Preferred shares.
In July 2012, the Company issued 17,500 shares of its Common Stock to certain accredited investors pursuant to subscription agreements in exchange for a total of $175,000 in cash. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 17,500 shares of the Company’s Series A Preferred shares.
In October 2012 (pre-merger), the Company issued 15,000 shares of its Common Stock for services provided to the Company valued at $15,000 based on the fair value of the Company’s stock. As of the merger with Bazi Intl. on October 15, 2012, these shares were exchanged for 15,000 shares of the Company’s Series A Preferred shares.
On October 15, 2012, the Company issued 1,192,335 shares of its Common Stock to the holders of 100% of the outstanding shares of Bazi International, Inc. pursuant to the Merger with Bazi Intl.
Between October and December 2012 (post-merger), the Company issued 145,000 shares of its Common Stock to certain accredited investors in connection with bridge loans made to the Company. Such loans have short-term maturities of approximately 4 months. The Company expensed the fair value of the common stock issued of approximately $108,000 to interest expense immediately. (See Note 7).
NOTE 4 — STOCK OPTIONS AND WARRANTS
As of the completion of the merger with Bazi International, Inc. on October 15, 2012, the Company assumed warrants and two stock option plans, including the current grants under those plans and the plans themselves. The two plans are the 2003 Stock Incentive Plan and the 2006 Distributor Option Plan. The Company will not grant new options under either of these plans. In 2012, the Company also issued certain Non-Qualified Options to board members, executives and other employees. A summary of these plans is presented below.
Warrants
A summary of the Company
’s warrant activity for the year ended December 31, 2012 is presented below:
|
|
Warrants
Outstanding
|
|
|
Weighted
Average
Exercise Price
|
Outstanding, January 19, 2012
|
|
|
-
|
|
|
|
|
|
Outstanding Warrants Assumed with Merger on October 15, 2012
|
|
|
145,185
|
|
|
$
|
52.00
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
(12,845
|
)
|
|
|
154.00
|
|
Outstanding, December 31, 2012
|
|
|
132,340
|
|
|
$
|
43.00
|
|
As of December 31, 2012, the Company had the following outstanding warrants to purchase its common stock:
Warrants Outstanding
|
|
|
Exercise Price Per Share
|
|
|
Remaining Life (Yrs)
|
|
|
118,950
|
|
|
$
|
28.00
|
|
|
|
2.31
|
|
|
1,000
|
|
|
$
|
30.00
|
|
|
|
2.92
|
|
|
3,200
|
|
|
$
|
150.00
|
|
|
|
0.13
|
|
|
9,190
|
|
|
$
|
200.00
|
|
|
|
0.13
|
|
|
132,340
|
|
|
$
|
42.53
|
|
|
|
2.11
|
|
Non-Qualified Stock Options
In 2012, the Company issued stock options pursuant to certain employment agreements, board resolutions and option agreements with employees. The grant date fair values of options granted during the year ended December 31, 2012 was between $0.274 and $0.457 per share for a total of $1,195,575 to be expensed over the vesting periods of the options. Such fair values were estimated using the Black-Scholes stock option pricing model and the following weighted average assumptions.
|
|
2012
|
|
Expected life
|
|
2.5 years
|
|
Estimated volatility
|
|
75.0%
|
|
Risk-free interest rate
|
|
0.30% – 0.43%
|
|
Dividends
|
|
None
|
|
The weighted average estimated fair value per share of the stock options at grant date was $0.309 during the year ended December 31, 2012. The expected life of options granted is based on the “simplified method” described in ASC 718-10 due to changes in the vesting terms and the contractual life of current option grants. Assumed volatility is based on the historical volatility of companies within the similar industry. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding to the expected term of the options.
Stock option activity during the year ended December 31, 2012 is summarized as follows:
|
|
Number of
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
Options outstanding at January 19, 2012
|
|
|
–
|
|
|
$
|
–
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Granted
|
|
|
3,870,387
|
|
|
|
0.69
|
|
Forfeited
|
|
|
–
|
|
|
|
–
|
|
Expired
|
|
|
–
|
|
|
|
–
|
|
Options outstanding at December 31, 2012
|
|
|
3,870,387
|
|
|
$
|
0.69
|
|
The following table summarizes information about the Company’s stock options outstanding as of December 31, 2012:
|
|
|
Oustanding Options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
Exercisable Options
|
|
|
|
|
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
Aggregate
|
|
Range of
|
|
|
|
|
|
Contractual Life
|
|
|
Intrinsic
|
|
|
|
|
|
Intrinsic
|
|
Exercise Prices
|
|
|
Number
|
|
|
(Years)
|
|
|
Value
|
|
|
Number
|
|
|
Value
|
|
$
|
0.01
|
|
|
|
3,133,172
|
|
|
|
2.54
|
|
|
$
|
4,355,109
|
|
|
|
982,950
|
|
|
$
|
1,366,309
|
|
$
|
1.017
|
|
|
|
737,217
|
|
|
|
2.69
|
|
|
$
|
724,684
|
|
|
|
-
|
|
|
$
|
-
|
|
Totals
|
|
|
|
3,870,389
|
|
|
|
2.57
|
|
|
$
|
5,079,793
|
|
|
|
982,950
|
|
|
$
|
1,366,309
|
|
Bazi Intl. Stock Incentive Plans
As a result of the October 15, 2012 reverse merger, the Company assumed two stock option plans of Bazi Intl. known as the 2003 Stock Incentive Plan and the 2006 Distributor Stock Incentive Plan. Both plans are no longer issuing any stock options. Information concerning each plan is summarized below:
2003 Stock Incentive Plan
The 2003 Stock Incentive Plan has a total of 20,806 options to purchase Company common stock outstanding at December 31, 2012, with exercise prices ranging from $15.00 per share to $50.00 per share. The weighted average contractual life of these options is less than two years.
2006 Distributor Stock Incentive Plan
The 2006 Distributor Stock Incentive Plan has a total of 6,650 options to purchase Company common stock outstanding at December 31, 2012, with exercise prices ranging from $15.00 per share to $118.00 per share. The weighted average contractual life of these options is approximately two years.
NOTE 5 — INTANGIBLE ASSETS
The Company has incurred costs to trademark eight of its current products and marketing nomenclatures. During the year, the Company purchased a patent in relation to the purchase of GT Beverage Company, LLC and also assumed the trademarks of Bazi International, Inc. Patents and trademarks are being amortized over the lesser of their remaining life or 15 years.
Intangible assets are:
Amortization expense for the year ended December 31, 2012, was $114,216. For these assets, amortization expense over the next five years is expected to be as follows:
|
|
Patent and trademark amortization
|
|
2013
|
|
$
|
193,328
|
|
2014
|
|
|
168,042
|
|
2015
|
|
|
145,172
|
|
2016
|
|
|
141,177
|
|
2017
|
|
|
141,177
|
|
2018 and thereafter
|
|
|
803,737
|
|
|
|
$
|
1,592,633
|
|
NOTE 6 — INCOME TAXES
The Company does not have significant income tax expense or benefit for the year ended December 31, 2012. Tax net operating loss carryforwards have resulted in a net deferred tax asset with a 100% valuation allowance applied against such asset at December 31, 2012. Such tax net operating loss carryforwards (“NOL”) approximated $3.1 million at December 31, 2012. Some or all of such NOL may be limited by Section 382 of the Internal Revenue Code.
The income tax effect of temporary differences between financial and tax reporting and net operating loss carryforwards gives rise to a deferred tax asset at December 31, 2012 as follows:
|
|
2012
|
|
Deferred tax asset –NOL’s
|
|
$
|
1,160,000
|
|
Less valuation allowance
|
|
$
|
(1,160,000
|
)
|
Net deferred tax asset
|
|
$
|
-
|
|
At December 31, 2012 approximately $3,000,000 of net operating loss carryforwards for federal and state income tax purposes were available to offset future taxable income through the year 2032, of which these net operating losses will begin to expire in the year 2032. In assessing the realizability of 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 realizable. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the history of the Company and projections for future taxable income over the periods in which the deferred tax assets are realizable, management believes it is not more likely than not that the Company will realize the benefits of these deductible differences and therefore a full valuation allowance against the deferred tax assets has been established.
As a result of the Merger with Bazi International, Inc. on October 15, 2012, the Company may have access to utilize a portion of the net operating loss carryforwards of Bazi International, Inc. which, in total, were approximately $25 million at the time of the Merger. The Company is uncertain as of the timing of this filing as to the portion of the Bazi net operating loss carryforwards that may be limited by Section 382 of the Internal Revenue Code.
The Tax Reform Act of 1986 contains provisions that limit the utilization of net operating loss and tax credit carryforwards if there has been a change of ownership as described in Section 382 of the Internal Revenue Code. Such an analysis has not been performed by the Company to determine the impact of these provisions on the Company’s net operating losses, though management believes the impact would be minimal, if any. A limitation under these provisions would reduce the amount of losses available to offset future taxable income of the Company.
In June 2006, the Financial Accounting Standards Board (“
FASB
”) issued ASC Topic 740 (formerly Interpretation No. 48, “
Accounting for Uncertainties in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes
”. ASC 740 prescribes a recognition threshold and measurement attribute for the recognition and measurement of tax positions taken or expected to be taken on income tax returns. ASC Topic 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with tax positions.
Based on management’s assessment of ASC Topic 740, management concluded that the Company does not have any uncertain tax positions as of December 31, 2012. There have been no income tax related interest or penalties assessed or recorded and if interest and penalties were to be assessed, the Company would charge interest and penalties to income tax expense. It is not anticipated that unrecognized tax benefits would significantly increase or decrease within 12 months of the reporting date. The Company and its subsidiaries file income tax returns in the U.S. and various state jurisdictions and there are open statutes of limitations for taxing authorities to audit the Company’s tax returns from 2008 through the current period.
NOTE 7 — CONVERTIBLE NOTES
Between October and December 2012, the Company consummated the sale of senior secured convertible notes (“Bridge Notes”) to a limited number of accredited investors. The purchase price of the Bridge Notes consisted of $725,000 of net proceeds. The Bridge Notes carried a term of 120 days, accrued interest at 9% per annum, earned a lender’s fee of 10% which was added to the principal of the note, earned a common stock award of 5,000 shares of Common Stock per $25,000 unit purchased, and the principal, interest and lender’s fee was convertible, at the option of the holder, into shares of the Company’s Common Stock at a price of $0.01 per share.
Certain notes have matured through the date of this report, have not been repaid and are now considered past due. The remaining notes mature at various dates through April 30, 2013. The Company is currently in discussion regarding the extension of the maturity dates of the notes.
In December 2012, the Company issued promissory notes to certain investors. The purchase price of the notes consisted of $47,000 in net proceeds. The promissory notes carried a term of 30 days and earned a lender’s fee of 10%. The promissory notes were repaid in January 2013.
NOTE 8 — COMMITMENTS AND CONTINGENCIES
The Company has entered in a number of consulting agreements with various consultants. Termination of any of these agreements could result in termination fees.
The Company leases its office in Irvine, California on a one-year lease. Total rent expense related to operating leases for the year ended December 31, 2012 was approximately $33,000. Total remaining payments on the lease through July 31, 2013 are approximately $19,000.
The Company maintains employment agreements with certain key management. The agreements provide for minimum base salaries, eligibility for stock options, performance bonuses and severance payments.
Legal Proceedings
From time to time, claims are made against the Company in the ordinary course of business, which could result in litigation. Claims and associated litigation are subject to inherent uncertainties and unfavorable outcomes could occur. In the opinion of management, the resolution of these matters, if any, will not have a material adverse impact on the Company’s financial position or results of operations.
As of December 31, 2012, the Company was involved in the following significant legal proceedings:
On July 1, 2011, a lawsuit was filed in the United States District Court, the Southern District of Ohio, Cincinnati Division, against GT Beverage Company, LLC (“GT LLC”) by Dominion Liquid Technologies, LLC. The lawsuit alleges that GT LLC breached terms of a Co-Packing Agreement from 2010, which governed the relationship between the parties. As of February 2013, Dominion amended its complaint to add the Company as a defendant in the case. The Company has not yet filed responsive pleadings. Dominion is seeking monetary damages in an amount exceeding $800,000. GT LLC has filed its answer denying all of Dominion’s claims and expects to vigorously defend the suit. Discovery is ongoing, and the case is currently set for trial in November 2013.
On December 13, 2011, a lawsuit was filed in the 116th District Court of Dallas County, Texas against GT LLC by Quality Logistics Systems, Inc. (“QLS”). The lawsuit alleges that GT LLC is liable for approximately $68,000 in transportation and logistical fees. On May 18, 2012, a judgment was entered in favor of QLS for $68,542.48, along with $4,145 of costs and fees. GT LLC has not satisfied this judgment to date.
NOTE 9 — RELATED PARTY TRANSACTIONS
On May 11, 2012, the Company loaned Environmental Packaging Technologies, Inc. (“EPT”) the sum of $150,000 in exchange for a 50-day promissory note. The promissory note accrues interest at ten percent (10%) per annum and included a ten percent (10%) of principal fee payable to the Company. The Company sent EPT a notice of default on October 18, 2012 demanding payment of the original principal amount of $150,000, accrued interest of $6,575 and the ten percent fee in the amount of $15,000. True Drinks’ former chairman and current investor is the chairman for EPT.
Our Board of Directors approved each of these arrangements.
NOTE 10 – LICENSING AGREEMENTS
We entered into a three-year licensing agreement with Disney Consumer Products, Inc. (“Disney”) and an 18-month licensing agreement with Marvel Characters, B.V. ("Marvel") (the “Licensing Agreements”) in 2012. Each Licensing Agreement allows us to feature popular Disney and Marvel characters on AquaBall
TM
Naturally Flavored Water, allowing AquaBall
TM
to stand out among other beverages marketed towards children. Under the terms and conditions of the Licensing Agreements, we work with the Disney and Marvel teams to create colorful, eye-catching labels that surround the entire spherical shape of each AquaBall
TM
. Once the label designs are approved, we work with Disney and Marvel to set retail calendars, rotating the placement of different AquaBall
TM
designs over the course of the year.
The terms of the Disney Licensing Agreement stipulates a royalty rate of 4% on the sales of AquaBall Naturally Flavored Water adorned with Disney characters, paid quarterly, with a total royalty guarantee of $231,600 over the term of the agreement which has a term ending date of March 31, 2015. In addition, the Company is required to spend 1% of sales on advertising and promotional opportunities. The Company is required to make common marketing fund contributions totaling $96,188 over the life of the agreement.
The terms of the Marvel Licensing Agreement stipulate a royalty rate of 5% on the sales of AquaBall Naturally Flavored Water adorned with Marvel characters, paid quarterly, with a total royalty guarantee of $150,000 over the term of the agreement which has a term ending date of December 31, 2013.
NOTE 11 — SUBSEQUENT EVENTS
Management has evaluated subsequent events through the date the accompanying consolidated financial statements were filed with the Securities and Exchange Commission, and noted no other significant subsequent events not elsewhere disclosed in these notes to consolidated financial statements.