May 25, 2006
VIA EDGAR
Mr. Rufus Decker
Accounting Branch Chief
Securities and Exchange Commission
Washington, D.C. 20549-7010
Re: Form 10-KSB for the Year Ended December 31, 2004 Forms 10-QSB
for the quarters ended March 31, 2005, June 30, 2005 and
September 30, 2005 File No. 333-86830
Dear Mr. Decker:
This letter sets forth the responses of Electric Aquagenics Unlimited, Inc. (the
"Company") to the comments made in your February 15, 2006 letter. For your
convenience, we have repeated the staff's comments before each of our responses.
FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 2004.
General
1. Where a comment below requests additional disclosures or other
revisions, please show us your proposed revised disclosure in your
response. With the exception of the comments below that specifically
request an amendment, all revisions may be included in your future
filings.
Mr. Rufus Decker
May 25, 2006
Page 2 of 16
Unless an amendment is specifically requested in your letter, all
revisions requested will be included in the Company's future filings
with the Securities and Exchange Commission (the "SEC").
Item 6 - Management's Discussion and Analysis of Plan of Operation, page 13
Liquidity and Capital Resources, page 16
2. We have reviewed your response to comment 9. Please also discuss in
your liquidity section the changes in your financing cash flows as
depicted in your statement cash flows. See the SEC Interpretive Release
No. 33-8350.
The Company will, in its future filings, discuss in the liquidity
section of its MD&A the changes in its cash flows as suggested in SEC
Interpretive Release No. 33-8350.
Item 8A - Controls and Procedures, page 18
3. We have reviewed your response to comment 10. Your disclosure should
also clarify that disclosure controls and procedures include controls
and procedures designed to ensure that information required to be
disclosed by you in the reports that you file or submit under the
Exchange Act is accumulated and communicated to your management,
including your principal executive and principal financial officers, or
persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.
The Company will, in future filings, make the requested modifications
to its disclosure. An example of the proposed disclosure follows:
Our internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
reporting purposes in accordance with U.S. generally accepted
accounting principles ("GAAP"). Disclosure controls and procedures
include controls and procedures designed to ensure that information
required to be disclosed by us in the reports we submit under the
Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or
persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure. It is management's
responsibility for establishing and maintaining adequate internal
control over financial reporting. Under the supervision and with the
participation of our management, including our Chief Executive Officer
and Chief Financial Officer, management conducted a review, evaluation,
and assessment of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of [Date] pursuant to
Mr. Rufus Decker
May 25, 2006
Page 3 of 16
Exchange Act Rule 15d-15. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are now effective.
Management has made significant changes to internal controls over
financial reporting and has done the following to correct those
weaknesses:
o Engaged a new independent public accounting firm on March 9,
2006;
o Hired a new Chief Financial Officer, H. Warren Jaynes, on
February 15, 2006;
o Management has implemented a regular routine of reconciling
all balance sheet accounts on a regular timely basis to ensure
the accuracy of our records;
o Engaged an accounting firm (separate from it's auditor) to
assist it with complicated accounting issues;
o Our Chief Financial Officer conducts a quarterly meeting with
all senior executives to discuss our Internal Controls over
Financial Reporting and Disclosure and review all pertinent
matters with such senior executives. The first meeting was
held on March 31, 2006; and
o Management intends to purchase and implement a new general
ledger system during the third quarter of 2006 allowing for
better internal accounting controls.
Other than those positive changes indicated above, no
significant changes in internal controls over financial reporting or
other factors have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting that
occurred during the most recently completed fiscal quarter.
4. Your proposed disclosure indicates there were no significant changes in
your internal controls over financial reporting subsequent to the date
of your most recent evaluation. Please disclose whether there have been
any changes in your internal controls and procedures during the most
recently completed quarter. See Item 308 of Regulation S-B.
Please see last paragraph included in our response to comment 3 above.
Item 7 - Financial Statements
General
5. We have reviewed your response to comment 13. It appears that you have
three operating segments beginning in 2005. Please confirm that you
have determined that these three operating segments are also reportable
segments. If you believe that you meet the criteria discussed in
paragraph 17 of SFAS 131 for aggregation of your operating segments
Mr. Rufus Decker
May 25, 2006
Page 4 of 16
into less than three reportable segments, provide us with the analysis
you performed in reaching this conclusion. In addition, please tell us
why you have not provided the disclosures required by paragraph 33 of
SFAS 131 in your 2005 Forms l0-QSB. If the paragraph 33 information
should have been included, please amend your 2005 Forms 10-QSB
accordingly to include it.
The Company believes that it did not have separate operating segments
as defined in SFAS 131 for 2004 or 2005. The Company only began the
process of differentiating its business very recently (near the end of
2005 and, more specifically, into 2006). As noted in its previous
response, the Company was primarily engaged in research, development
and limited sales of its electrolyzed oxidative water generators and
products. These operations had a majority of similar economic
characteristics for aggregation purposes as further defined in P. 17 of
SFAF 131 due to the nature of its:
o Products and services
o Research and production process
o Types of customers
o Methods of distribution
o Regulatory environment
In addition, the Company's management approach as discussed in
Paragraph 5 of SFAF 131 has been and continues to be to identify and
assess any potential markets and products upon which to focus. While
the Company has identified and decided to focus on the three primary
areas discussed in its 2005 filings, the Company's chief operating
decision maker has not had the financial information available to view
accounting and financial data specifically relating those areas of
focus separately. The Company's current general ledger system is
QuickBooks which does not provide the ability to track manufacturing
costs and to segregate the current three areas of focus. Consequently
the chief decision maker could not regularly review those areas of
focus separately or assess the performance of those areas as the
companies accounting and management information systems were not been
designed to do so during 2005. Therefore, the Companies does not
believe it has had three operating segments as defined in Paragraph 10
(B) & (C) of SFAF 131 during 2005 or 2006 and that it is not subject to
segment reporting.
Mr. Rufus Decker
May 25, 2006
Page 5 of 16
Note 1 - Business Description and Significant Accounting Policies, page F-8
General
6. Please disclose the amounts of your actual costs for shipping and
handling excluded from cost of sales for each period presented as
required by paragraph 6 of EITF 00-10, and the line item these excluded
amounts are included in.
The Company incurred outbound shipping and handling costs of $8,680,
and $1,587 respectively in 2004 and 2003. These amounts were included
in the General and Administrative expense line of the Consolidated
Statement of Operations of the Company for each year indicated. In
accordance with GAAP and EITF 00-10 paragraph 6, the Company will adopt
a policy of including all shipping and handling costs in cost of goods
sold. The Company restated its 2004 financial statements in its Annual
Report on Form 10-KSB, dated December 31, 2005, and it will restate the
Quarterly Reports on Form 10-QSB for the three quarters in 2005 to
reclassify the above amounts from the general and administrative line
items to cost of goods sold.
Earnings Per Share, page F-l0
7. We have reviewed your response to comment 22. You disclose on page 22
that you issued 450,482 shares of restricted stock on April 6, 2004.
Please clarify whether these shares were not outstanding as of December
31, 2004 or whether they were no longer restricted. Please also tell us
what caused the restrictions to be removed.
The 450,482 shares of common stock issued on April 6, 2004 were
restricted only in the sense that they were issued in a transaction
exempt from registration under Section 4(2) of the Securities Act of
1933, as a transaction by an issuer not involving a public offering.
The shares were therefore issued with the standard Rule 144 legend
printed on the certificate to the effect that the shares were not
registered with the Securities and Exchange Commission and were
therefore restricted from being publicly resold. The shares were not
otherwise restricted or subject to vesting or forfeiture provisions.
The shares were outstanding as of December 31, 2004, and remain subject
to the restrictions imposed by federal securities laws.
Note 6 - Acquisition of Business, page F-13
8. We have reviewed your response to comment 24. Per Items 310(c) and (d)
of Regulation S-B, historical financial statements of the acquired
business and pro forma financial information might be required to be
filed, based upon the results of significance tests performed in
Mr. Rufus Decker
May 25, 2006
Page 6 of 16
accordance with Items 310(c)(2) and (3) of Regulation S-B. Please
provide us with your significance tests for each period presented and
file a Form 8-K with the required audited financial statements and pro
forma information.
Upon further review of this matter, the Company believes that Item
310(c) and (d) are not applicable to the Aquagen/Company transaction
(the "Transaction") because the referenced transaction did not involve
the acquisition of a "business". Rule 11-01(d) of Regulation S-X (the
"Rule") provides a list of facts and circumstances to consider in
determining whether an acquisition involved the acquisition of a
"business." The Company's analysis follows.
General/Background
The Transaction was effective December 31, 2004. The Transaction
between the Company and Aquagen utilized an "Asset Purchase Agreement,"
whereby the Company purchased some of Aquagen's assets and assumed
certain of its liabilities. At the conclusion of the Transaction, the
assets purchased from Aquagen became Company property. The Company did
not purchase any of Aquagen's common or preferred stock and Aquagen
continued as a viable public corporation after the Transaction. Aquagen
subsequently changed its name and acquired other assets; and continues
today as the same public entity under a different name, Hoodia Products
International, Inc.
One of the principal reasons for the acquisition of Aquagen assets was
the Company's desire to control Aquagen's proprietary stabilized oxygen
product (marketed as Aquagen) for use in its new consumer drinking
water products, existing products and products it desired to develop,
manufacture and market in the future. The Company believed that the
only way to ensure that its competitors did not use the Aquagen product
was to acquire it.
Application of Rule 11-01(d) to the Transaction
The Rule sets forth a facts and circumstances test that should be
considered in evaluating whether an acquisition of a lesser component
of an entity constitutes a "business."
First Test
The first test is "whether the nature of the revenue-producing activity
of the competent [Aquagen] will remain generally the same as before the
transaction."
In this case, prior to the Transaction, Aquagen sold only its primary
oxygen therapy product (liquid oxygen) solely to health food and
nutritional stores. The Company's strategy in purchasing Aquagen's
Mr. Rufus Decker
May 25, 2006
Page 7 of 16
liquid oxygen product was to use it as a key ingredient in its drinking
water product. This inclusion of the liquid oxygen into the Company's
drinking water differentiated the drinking water from all of the
Company's competition. It also began testing Aquagen's oxygen product
in other, existing products as an ingredient inclusion. The Company,
prior to completing the Transaction, intended to develop other products
that combined the liquid oxygen product with its electrolyzed oxidative
waters products. These included a facial mist spray, a home cleaning
solution, a line of cosmetics and periodontal products.
The Transaction also placed Aquagen's existing products in a different
market sector and channel-the grocery markets. This is an entirely
dissimilar market from health food stores. The brokers and sales
representative are different and the overall approach to marketing is
completely different. Aquagen did not have an independent sales
department prior to or at the time of the Transaction. Virtually all of
its sales (prior to the Transaction) were through brokers-with an
occasional Internet sale. The Company established an in-house sales
department to sell to primarily to the grocery market. New products
were developed using the Aquagen liquid oxygen that were unknown prior
to the Transaction.
The Company believes that these facts and circumstances indicate that
the Company did not acquire a business pursuant to the first test
identified in the Rule.
Second Test
The second test concerns "whether any of the following attributes
remain with the component [Aquagen] after the transaction." There are
eight independent factors that contribute to this analysis, as follows:
1. Physical facilities: Aquagen had offices and a plant in
Salt Lake City. The Company did not assume or use these offices after
the Transaction was completed. The Company built an entirely new
manufacturing facility, including two clean rooms; set up a packaging
facility; built a water bottling facility; and set up an independent
laboratory to test its products. These were all completed at the
Company's corporate office and facility.
2. Employee Base: This changed radically. Some Aquagen
employees became Company employees; but the Company hired many new
employees to manufacture and market the newly constituted Company
products and the products that used or included the liquid oxygen
products.
Mr. Rufus Decker
May 25, 2006
Page 8 of 16
3. Market Distribution System: As stated above, this also
changed after the Transaction. The Company's primary focus is on
utilizing the liquid oxygen in its drinking water which is primarily
sold to grocery stores.
4. Sales Force: Prior to the Transaction, Aquagen did not have
a sales force. Its sales were effected through brokers and occasional
Internet sales. Aquagen did not have any designated sales employees in
its organization prior to the Transaction. The Company had an existing
sales force that assumed the sales of the Aquagen products as well as
its products that included the liquid oxygen product as ingredients.
5. Customer Base: As stated above, the Company customer base
post-Transaction is much different that pre-Transaction Aquagen base.
Some of the different markets include: retail grocery stores,
international sales to European countries and agricultural markets.
None of these were available or penetrated by Aquagen prior to the
Transaction.
6. Operating Rights: Aquagen owned its products and sold them
to the Company. Aquagen was not under any license or other agreements.
It sold its assets to the Company free and clear of any liens,
encumbrances or third party rights.
7. Production techniques: After the Transaction, the Company
began using Aquagen's liquid oxygen as an ingredient in many of its
other products, including its consumer drinking water. It also planned
to develop and did develop new products that incorporated the liquid
oxygen technology.
8. Trade name: Aquagen marketed its products under the name
"Aquagen." After the Transaction, the Company changed the Aquagen trade
name to "Perfect Oxygenated Essential" products-incorporating the
liquid oxygen product as an ingredient, but not including it as a trade
name. This marked an entirely new trade name.
The Company believes that these facts and circumstances indicate that
the Company did not acquire a business pursuant to the second test
identified in the Rule. As a result, the Company has concluded that
Item 310(c) and (d) are not applicable to the Transaction because the
Transaction did not involve the acquisition of a "business."
Note 7 - Related Party Transactions, page F-l3
Sales To Affiliate, page F-13
9. We have reviewed your response to comment 25. Please tell us more
regarding the conversion of your accounts receivable to long term notes
receivable. What are the stated maturity dates of the notes receivable?
Is there a minimum payment plan associated with the notes receivable,
Mr. Rufus Decker
May 25, 2006
Page 9 of 16
and if so, have payments been received in accordance with the plan?
What is your basis for believing these amounts will be collected? When
do you think full payment will be received and why has almost nothing
been paid to date? Why do you think this trend is going to change?
The original response to comment 25 of your original letter, dated
December 28, 2005, incorrectly stated the nature of the debt (in the
amount of approximately $319,340) and the actual conversion. Our 2005
audited financial statements reported a Company affiliate receivable in
the amount of $319,340 at year-end 2004 (the "2004 Affiliate
Receivable"). The 2004 Affiliate Receivable stems from a wholly owned
subsidiary, EquiLease. The Company provided financing capital to
EquiLease and EquiLease provided four (4) loans to three (3)
independent franchisees of Zerorez Franchising Systems ("Zerorez") to
purchase equipment to be used in their franchises, pursuant to
long-term promissory notes (the "Notes"). The franchisees are not
shareholders, officers, directors, employees, consultants, etc. of
either Zerorez or the Company. It is questionable as to whether the
Zerorez franchisees are affiliates of the Company. The following is a
breakdown of the amount of each loan:
Loan No. 1:
o Amount of Loan: $106,568.75
o Note Term: 5 years
o Date Executed: 9-25-2004
o Fully amortized monthly payment (including
principal and interest): $2,479.67
o Status: Current
Loan No. 2:
o Amount of Loan: $73,884.32
o Note Term: 5 years
o Date Executed: 10-28-2004
o Fully amortized monthly payment (including
principal and interest): $1,851.90
o Status: Current
Loan No. 3:
o Original Amount of Loan: $77,251.50
o Note Term: 5 years
Mr. Rufus Decker
May 25, 2006
Page 10 of 16
o Date Executed: 9-18-2004
o Note amended on 11-1.05 to include accrued and
unpaid interest. Now loan amount $87,251
o Fully amortized monthly payment on new loan
amount (including principal and interest):
$2,064.32
o Status: Current
Loan No. 4:
o Original Amount of Loan: $60,000
o Original Note Term: 1 year
o Date Executed: 10-5-2004
o Note amended on 11-1.05 to include accrued and
unpaid interest. Now loan amount $67,379.17
o Fully amortized monthly payment on new loan
amount (including principal and interest):
$1,460.50
o Status: Current
All notes are now current. Total principal and interest paid on the
Notes to the date of this letter was $103,537.47. The principal amount
owing under the Notes to the date of this letter was $288,200.84. We
believe that the Notes are viable and will be paid as they normally
accrue on their respective maturity dates.
Note 9 - Common Stock, page F-14
10. We have reviewed your response to comment 26. In addition to disclosing
in future filings, please show us in your response the fair value of
the warrants at the date of issuance and the reason for issuance.
Please also tell us whether you used the Black-Scholes model for your
issuances of warrants to non-employees, including the assumptions you
used.
The fair value of warrants issued during 2004 was not recorded using
the Black-Scholes model for valuing such warrants. We have subsequently
utilized the Black-Scholes model for determining the fair value of
those warrants and restated the financial statements for the year ended
December 31, 2004 that are included in our Annual Report on Form 10-KSB
for 2005 making the following adjusting entries:
1. To record the fair value of 380,000 warrants issued to non-employee
consultants who performed services and received warrants for those
services from the company:
Mr. Rufus Decker
May 25, 2006
Page 11 of 16
Debit Credit
----- ------
Consulting Expense $1,013,940
Additional Paid In Capital $1,013,940
The fair value of the warrants was calculated using the Black-Scholes model with
the following assumptions:
Term Risk Free Black-Scholes
Number (Years) Strike Price Stock Price Volatility Rate Value Fair Value
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
250,000 5 $4.00 $4.00 86.40 3.31 2.771 692,750
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
50,000 3 $1.50 $3.35 73.90 3.10 2.332 116,600
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
30,000 3 $2.50 $3.35 73.90 3.12 1.933 57,990
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
50,000 3 $1.50 $4.00 73.90 3.17 2.932 146,600
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
2. To record the fair value of 105,481 warrants issued to placement
agents who performed services in connection with stock placements. The
value of these warrants is treated as a stock offering cost and is
recorded as a reduction to additional paid in capital (with an
offsetting increase to additional paid in capital for the warrant
issuance).
Debit Credit
----- ------
Additional Paid In Capital $284,381
Additional Paid In Capital $284,381
The fair value of the warrants was calculated using the Black-Scholes model with
the following assumptions:
Term Risk Free Black-Scholes Fair Value
Number (Years) Strike Price Stock Price Volatility Rate Value
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
30,000 2 $3.00 $4.60 75.07% 2.54% 2.515 75,450
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
75,481 2 $5.00 $4.10 88.50% 3.63% 2.768 208,931
- --------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------
Mr. Rufus Decker
May 25, 2006
Page 12 of 16
PIPE Shares - 100,000 warrants were issued in connection with a private
placement offering. The above warrants were disclosed as part of the offering
and only a memo entry is made to additional paid in capital for these warrants.
Exhibit 31 - Certifications
11. We have reviewed your response to comment 27. Item 601 (b)(31) of
Regulation S-B requires certifications to be provided exactly as stated
therein. Your proposed certification contains numerous differences from
that presented in Item 60l (b)(31). Please file an amendment to your
Form l0-KSB to include certifications that conform to the format
provided in Item 60l (b) (31) of Regulation S-B and refer to the
appropriate locations for the definitions. Please also amend your 2005
Forms 10-QSB accordingly. In doing so, please refile the Forms 10-KSB
and l0-QSB in their entirety, along with the updated certifications.
We will revise the certifications in our future filings to conform to
the stated requirements. We will also amend our 2005 Forms 10-QSB as
requested.
FORM 10-QSB FOR THE PERIOD ENDED SEPTEMBER 30, 2005
Financial Statements
Consolidated Statements of Operations
12. We have reviewed your response to comment 30. Where are the marketing
and promotion expenses for the nine months ended September 30, 2004
classified? Marketing and promotion expenses for current and prior year
should be classified consistently, in order to enable comparisons of
the amounts. Please amend your filings to make the appropriate
revisions to your prior period financial statements so that your
presentation is the same for all periods presented.
We agree with your assessment and our original response inadequately
explained the appropriate resolution to the original comment. Further
review of the marketing and promotion line item in the 3rd Quarter 2005
10-QSB revealed this as an obvious oversight in the filing and is a
classification error between the marketing and promotion line item and
the general and administrative line item of the 10-QSB. Prior to the
2004 10-KSB reporting, such amounts were included in the general and
administrative line item of the Consolidated Statement of Operations.
Mr. Rufus Decker
May 25, 2006
Page 13 of 16
We have determined that these expenses are not material and will in the
future consistently include them in the general and administrative line
item.
The Company will be restating its Form 10-QSBs for all three quarterly
reports filed in 2005 and will properly classify and report the
marketing and promotion expense items as part of the general and
administrative line item for the above amounts and periods as
indicated.
Note 6 - Senior Convertible Debt
13. We have reviewed your response to comment 31. You state that you
recorded the issuance of your convertible debt at its face amount since
it cannot be converted immediately. Please tell us why you believe this
treatment is appropriate, including the accounting literature that you
used to support your conclusion. In addition, you state that your
convertible debt does not have any non-detachable conversion features
that would be deemed to be beneficial. Provide us with detailed
computations which support your conclusion that you did not have any
beneficial conversion features related to your convertible debt.
Paragraph 5 of EITF 98-5 states that embedded beneficial conversion
features are calculated at the commitment date as the difference
between the conversion price and the fair value of the common stock,
multiplied by the number of shares into which the security is
convertible. See Case 1(b) at the end of EITF 98-5 for an example on
how to perform this calculation. Note, however, that paragraph 5 of
EITF 00-27 states that the effective conversion price, instead of the
specified conversion price, should be used to compute the intrinsic
value of the embedded beneficial conversion feature. See paragraphs 6-7
of EITF 00-27 for an example on how to perform this calculation.
The Company has re-evaluated its original response to the staff with
respect to this issue and has determined that its initial response was
not accurate. The debt was convertible immediately and does have a
beneficial conversion feature. Accordingly, in our 2005 10-KSB we
recorded the transaction as follows and we will restate the financial
statements included in the Quarterly Report on Form 10-QSB for the
third quarter of 2005 to properly reflect this transaction in
accordance with EITF 98-5 and EITF 00-27. The entries that were made to
properly account for the transaction in the 2005 10-KSB financial
statements are as follows:
Mr. Rufus Decker
May 25, 2006
Page 14 of 16
1. To record the detachable warrants on September 16, 2005:
Debit Credit
----- ------
Cash $3,000,000
Discount to Note Payable $3,000,000
Loss on Derivative Liability $2,388,083
Derivative Liability $5,388,083
Notes Payable $3,000,000
The Discount to Note Payable, in the amount of $3,000,000, will be amortized
over the stated term of the Note (36 Months). This results in monthly
amortization of $83,333, which will be charged to interest expense. For the year
ended December 31, 2005 and the quarter ended March 31, 2006, the Company
recognized $291,666 and $249,999 in interest expense, respectively.
The calculations and assumptions used to calculate the derivative liability are
as follows:
The value of the 2,000,000 warrants and the 1,000,000 convertible shares upon
issuance was computed using the following assumptions:
Term Stock Strike Risk-free
Security (years) Price Price Volatility Rate Black-Scholes FMV
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Warrants 3 $3.35 $2.76 70.60 4.00 1.820745 3,641,490
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Convertible 3 $3.35 $3.00 70.60 4.00 1.746593 1,746,593
shares
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
Total FMV of liability at issuance 5,388,083
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
The value of the warrants and the conversion feature at December 31, 2005 was
computed using the following assumptions:
Term Stock Strike Risk-free
Security (years) Price Price Volatility Rate Black-Scholes FMV
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Warrants 2.7 $3.35 $2.76 74.21 4.00 1.809348 3,618,696
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Convertible 2.7 $3.35 $3.00 74.21 4.00 1.735020 1,735,020
shares
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
Total FMV of liability at 12/31/05 5,353,716
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
The change in the derivative liability from issuance to December 31, 2005 was a
decrease of $34,367, which was recorded as a gain on derivative liability.
Mr. Rufus Decker
May 25, 2006
Page 15 of 16
The value of the warrants and the conversion feature at March 31, 2006 was
computed using the following assumptions:
Term Stock Strike Risk-free
Security (years) Price Price Volatility Rate Black-Scholes FMV
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Warrants 2.47 $3.35 $2.76 77.92 4.00 1.801885 3,603,770
- ------------------ ----------- ---------- ----------- ------------- ---------- ------------ -----------------
Convertible 2.47 $3.35 $3.00 77.92 4.00 1.727539 1,727,539
shares
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
Total FMV of liability at 3/31/06 5,331,309
- ------------------ ----------- ---------- ------------------------------------------------- -----------------
The change in the derivative liability from December 31, 2005 to March 31, 2006
was a decrease of $22,407, which was recorded as a gain on derivative liability.
Note 7 - Commitments and Contingencies
14. We have reviewed your response to comment 32. Based upon review of the
license agreement, it appears that the licensee may terminate the
agreement for various causes. If termination of the agreement occurs at
any time within five years after the effective date, the licensee shall
be entitled to a refund of the license fee on a pro-rated basis. As
such, please tell us what consideration you gave to the agreement
having a five year term, which would require the license fee to be
recognized ratably over five years.
Under the "Exclusive License and Distribution Agreement" between the
Company (as licensor) and Water Sciences (as licensee), Water Sciences
can terminate the license agreement, on written notice, if the Company
materially defaults in performing any of its obligations under the
license or if any of the standard bankruptcy events occur. Water
Science can also terminate for "convenience" reasons. The license
further states that licensee can only receive back a pro rata portion
of the license fee if it terminates the license agreement based upon
the Company's default or upon the invocation of a voluntary or
involuntary bankruptcy proceeding. If licensee terminates the license
agreement for "convenience" purposes, no portion of the license fee is
subject to pro-rated forfeiture.
Mr. Rufus Decker
May 25, 2006
Page 16 of 16
After further review, the Company agrees with the reviewer's assessment
as the licensee may terminate the agreement if the Company fails to
perform its obligations under the agreement or declares bankruptcy.
Based upon these requirements, the Company will restate its net loss
for the Three and Nine Months Ended September 30, 2005 by increasing in
these periods its net loss by $991,667. The Company will then recognize
ratably $50,000 in each quarter over the 5-year life of the agreement.
This change in the accounting for the transaction was made and reported
accordingly in our Annual Report on Form 10-KSB filed on April 17,
2006.
In connection with our responses, the Company acknowledges:
o The Company is responsible for the adequacy and accuracy of
the disclosure in their filings;
o Staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission form taking any
action with respect to the filing; and
o The Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Please address any future correspondence to our Chief Financial Officer, H.
Warren Jaynes at 1464 West 40 South, Suite 200, Lindon, Utah 84042; telephone:
(801) 443-1031; fax: (801) 443-1029; e-mail: wjaynes@eau-x.com.
Very truly yours,
Electric Aquagenics Unlimited, Inc.
/s/ Gaylord M. Karren
Gaylord M. Karren
Chief Executive Officer
