UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 2006
or
( ) Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
000-51807
-------------------------------
(Commission File No.)
ELECTRIC AQUAGENICS UNLIMITED, INC.
(name of small business issuer in its charter)
Delaware 87-0654478
- ----------------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1464 W. 40 S. Suite #200, Lindon, Utah 84042-1629
- ----------------------------------------- -----------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (801) 443-1031
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of October 30, 2006, the Registrant had 12,288,341 shares of Common
Stock, $0.0001 par value outstanding.
ELECTRIC AQUAGENICS UNLIMITED, INC.
QUARTERLY REPORT ON FORM 10-QSB
September 30, 2006
INDEX
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Balance Sheets - September 30, 2006 and December 31, 2005 3
Statements of Operations - Three and Nine months ended 5
September 30, 2006 and 2005
Statements of Cash Flows - Nine months ended September 30, 2006 and 2005 7
Notes to Financial Statements 9
ITEM 2. Management's Discussion and Analysis or Plan of Operation 15
ITEM 3. Controls and Procedures 24
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 25
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
ITEM 5. Other Information 25
ITEM 6. Exhibits 26
SIGNATURES 28
2
PART I - FINANCIAL INFORMATION
ELECTRIC AQUAGENICS UNLIMITED, INC.
BALANCE SHEETS
ASSETS
September 30, December 31,
2006 2005
------------------ ------------------
CURRENT ASSETS (Unaudited) (Audited)
Cash and cash equivalents $ 226,367 $ 681,348
Accounts receivable, net 124,127 122,771
Accounts receivable - related party, net 454,434 1,061
Current portion of notes receivable --- 18,834
Current portion of notes receivable - related party --- 63,823
Inventory, net 2,415,838 2,003,902
------------------ ------------------
Total current assets 3,220,766 2,891,739
------------------ ------------------
PROPERTY AND EQUIPMENT, net of
accumulated depreciation of $375,062 and $245,211 722,179 946,702
------------------ ------------------
OTHER ASSETS
Notes receivable --- 72,555
Notes receivable - related party --- 306,829
Deposits 21,737 10,568
Intellectual property 1,225,977 1,207,459
Investments 374,075 374,075
------------------ ------------------
Total other assets 1,621,789 1,971,486
------------------ ------------------
Total assets $ 5,564,734 $ 5,809,927
================== ==================
See notes to financial statements.
3
ELECTRIC AQUAGENICS UNLIMITED, INC.
BALANCE SHEETS (CONTINUED)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
September 30, December 31,
2006 2005
------------------ ------------------
CURRENT LIABILITIES (Unaudited) (Audited)
Accounts payable $ 745,488 $ 1,320,313
Accrued expenses 293,469 346,759
Warranty reserve 102,362 96,800
Advance deposits on machine orders - related party 697,500 ---
Current portion of long-term debt 28,230 38,675
------------------ ------------------
Total current liabilities 1,867,049 1,802,547
------------------ ------------------
LONG TERM LIABILITIES
Long term debt, net of current portion 105,137 157,001
Senior convertible note payable - related party, net of discounts of 1,041,667 291,667
$1,958,333 and $2,708,333
Deferred licensing revenue - related party 791,667 941,667
Derivative liability - related party (See Note 4) 4,665,014 5,353,716
------------------ ------------------
Total long term liabilities 6,603,485 6,744,051
------------------ ------------------
Total Liabilities 8,470,534 8,546,598
------------------ ------------------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.0001 par value; 50,000,000 shares authorized;
11,109,495and 9,322,825 issued and outstanding, respectively 1,111 933
Additional paid in capital 25,300,800 19,838,331
Accumulated deficit (28,207,711) (22,575,935)
------------------ ------------------
Total stockholders' equity (deficit) (2,905,800) (2,736,671)
------------------ ------------------
Total liabilities and stockholders' equity (deficit) $ 5,564,734 $ 5,809,927
================== ==================
See notes to financial statements.
4
ELECTRIC AQUAGENICS UNLIMITED, INC.
UNAUDITED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------- -----------------------------------------
2006 2005 2006 2005
------------------ ------------------- ------------------ ------------------
(Restated) (Restated)
NET SALES - RELATED PARTY $ 490,415 $ 33,556 $ 1,198,634 $ 85,717
NET SALES 288,322 245,211 683,443 404,981
------------------ ------------------- ------------------ ------------------
TOTAL SALES 778,737 278,767 1,882,077 490,698
COST OF GOODS SOLD 512,854 190,848 1,193,907 272,000
------------------ ------------------- ------------------ ------------------
GROSS PROFIT 265,883 87,919 688,170 218,698
------------------ ------------------- ------------------ ------------------
OPERATING EXPENSES
Depreciation and amortization 54,709 26,776 160,559 92,648
Research and development 50,329 79,459 119,665 404,260
General and administrative 1,289,315 1,788,638 5,935,935 6,438,904
------------------ ------------------- ------------------ ------------------
Total operating expenses 1,394,353 1,894,873 6,216,159 6,935,812
------------------ ------------------- ------------------ ------------------
LOSS BEFORE OTHER INCOME (EXPENSE) (1,128,470) (1,806,954) (5,527,989) (6,717,114)
------------------ ------------------- ------------------ ------------------
OTHER INCOME (EXPENSE)
Interest expense (282,909) (65,653) (866,704) (96,281)
Interest income 3,708 1,204 16,942 2,166
Gain (Loss) on derivative liability 29,792 (2,385,194) 688,702 (2,385,194)
Other income (expense) 13,923 27,002 29,075 365,505
------------------ ------------------- ------------------ ------------------
Total other income (expense) (235,486) (2,422,641) (131,985) (2,113,804)
------------------ ------------------- ------------------ ------------------
LOSS BEFORE PROVISION (1,363,956) (4,229,595) (5,659,974) (8,830,918)
FOR INCOME TAXES
PROVISION FOR INCOME TAXES --- --- --- ---
------------------ ------------------- ------------------ ------------------
LOSS FROM CONTINUING OPERATIONS (1,363,956) (4,229,595) (5,659,974) (8,830,918)
DISCONTINUED OPERATIONS:
Income from operations of discontinued
operations (Net of $0 in income taxes) 12,154 11,495 28,248 36,339
(Loss) on disposal of discontinued
operations (Net of $0 in income taxes) (50) --- (50) ---
------------------ ------------------- ------------------ ------------------
GAIN FROM DISCONTINUED OPERATIONS 12,104 11,495 28,198 36,339
------------------ ------------------- ------------------ ------------------
NET LOSS $ (1,351,852) $ (4,218,100) $ (5,631,776) $ (8,794,579)
================== =================== ================== ==================
See notes to financial statements.
5
ELECTRIC AQUAGENICS UNLIMITED, INC.
UNAUDITED STATEMENTS OF OPERATIONS
(CONTINUED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------- ----------------------------------------
2006 2005 2006 2005
------------------ ------------------- ------------------ ------------------
NET LOSS $ (1,351,892) $ (4,218,100) $ (5,631,776) $ (8,794,579)
================== =================== ================== ==================
NET LOSS PER SHARE CONTINUING OPERATIONS $ (0.12) $ (0.48) $ (0.55) $ (1.07)
================== =================== ================== ==================
NET INCOME PER SHARE DISCONTINUED OPERATIONS $ 0.00 $ 0.00 $ 0.00 $ 0.00
------------------ ------------------- ------------------ ------------------
WEIGHTED AVERAGE OF
SHARES OUTSTANDING 11,085,691 8,749,004 10,319,928 8,248,689
================== =================== ================== ==================
See notes to financial statements.
6
ELECTRIC AQUAGENICS UNLIMITED, INC.
UNAUDITED STATEMENTS OF CASH FLOWS
For the Nine Months
Ended September 30,
2006 2005
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES (Restated)
Net loss $ (5,631,776) $ (8,794,579)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 160,559 92,648
Bad Debt expense 13,197 ---
Common stock issued for services 197,809 72,500
Warrants and options issued for services 1,059,142 1,424,050
Discount of note payable 750,000 41,667
Loss on disposal of discontinued operations 50 ---
Loss on disposal of assets 72,736 ---
Gain on settlement of debt (14,597) ---
Changes in operating assets and liabilities:
(Increase) in accounts receivable (14,553) (109,575)
(Increase) decrease in accounts receivable - related party (453,373) 100,000
(Increase) in inventory (411,936) (1,605,952)
(Increase) decrease in deposits (11,169) 1,500
Increase (decrease) in accounts payable (588,879) 92,015
Increase (decrease) in accrued expenses 151,910 (19,663)
Increase in warranty reserve 5,562 ---
Increase in advance deposits on machine orders - related 697,500 ---
party
(Decrease) in deferred revenue (150,000) 991,667
(Decrease) in derivative liability (688,702) 2,385,194
------------------- -------------------
Net cash used in operating activities (4,856,520) (5,328,528)
------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of property and equipment (46,238) (613,073)
Investments 452,559 55,093
Payments received from notes receivable 13,877 11,498
Payments (Advances to) notes receivable - related party 24,206 (146,848)
Intellectual property disbursements (18,518) (26,584)
------------------- -------------------
Net cash provided (used) in investing activities 425,886 (719,914)
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable (24,844) (93,081)
Proceeds from notes payable - related party --- 3,000,000
Proceeds from issuance of common stock 4,000,497 5,375,402
Proceeds from common stock subscribed --- 2,125
------------------- -------------------
Net cash provided by financing activities 3,975,653 8,284,446
------------------- -------------------
NET INCREASE (DECREASE) IN CASH (454,981) 2,236,004
CASH and cash equivalents, beginning of period 681,348 389,222
------------------- -------------------
CASH and cash equivalents, end of period $ 226,367 $ 2,625,226
=================== ===================
See notes to financial statements.
7
ELECTRIC AQUAGENICS UNLIMITED, INC.
UNAUDITED STATEMENTS OF CASH FLOWS
(CONTINUED)
Nine Months Ended
September 30,
2006 2005
----------- -----------
Supplemental Disclosures of Cash Flow Information: (Restated)
Cash paid during the period for:
Interest $ 49,283 $ 54,614
Income Taxes $ --- $ ---
Supplemental Disclosures of Non-cash Investing and Financing Activities:
Common stock issued for services $ 197,809 $ 72,500
Warrants issued for services $1,059,142 $1,424,050
See notes to financial statements.
8
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed financial statements were prepared by the Company
without audit pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. In management's
opinion all necessary adjustments, which consist primarily of normal recurring
adjustments, to the financial statements have been made to present fairly the
financial position and results of operations and cash flows. The results of
operations for the respective periods presented are not necessarily indicative
of the results for the respective complete years. The financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2005.
NOTE 2 - INVENTORIES
The composition of inventories is as follows at:
September 30, December 31,
2006 2005
------------------ --------------------
Finished goods $ 446,613 $ 531,625
Raw materials 2,285,360 1,792,277
Allowance for obsolete inventory (316,135) (320,000)
------------------ --------------------
$ 2,415,838 $ 2,003,902
================== ====================
NOTE 3 - NOTES RECEIVABLE
The Company provided financing for equipment to Zerorez franchisees, which are
related party entities. These transactions were recorded through Equilease,
Inc., a wholly owned subsidiary of the Company. During September 2006, Equilease
was sold to a related party for the cash value of the notes receivable (See Note
9). The Company had a balance of $0 and $454,689 in Notes Receivable at
September 30, 2006 and 2005, respectively.
NOTE 4 - SENIOR CONVERTIBLE DEBT
In September 2005, the Company entered into a Senior Convertible Note with a
third party in exchange for $3,000,000. Pursuant to the debt agreement, the note
accrues interest at the rate of 3% per annum and is due, principal and interest
together, on September 16, 2008. No principal or interest payments need to be
paid during the loan period. The note may be converted into 1,000,000 shares of
the Company's $0.0001 par value common stock prior to the maturity date, and at
any time, by the holder at a price per share equal to $3.00 per share, subject
to certain other conversion adjustments. In connection with the issuance of the
Note, the Company also granted a three year warrant to purchase up to two (2)
million shares of the Company's $0.0001 par value common stock for a purchase
price of $2.76 per share. The exercise price of these warrants is to be adjusted
if the Company should issue stock for less than the original exercise price.
Because of the feature wherein the conversion price is reset if shares are
issued at a price less than the fixed conversion price, and pursuant to EITF
00-19, the Company has elected to bifurcate the conversion feature from the debt
host and accounts for the feature as a derivative liability with changes in fair
value being recorded in the income statement. The fair value of the derivative
liability is estimated using the Black-Scholes pricing model, with the following
assumptions at September 30, 2006: risk-free interest rate of 4.0%, expected
dividend yield of zero, expected life of 2.96 years and expected volatility of
71.08%. As of September 30, 2006, the value of the derivative liability is
$4,665,014.
9
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 5 - RELATED PARTY TRANSACTIONS
SALES TO AFFILIATES - Water Science, who has exclusive rights to sell our
products in South America and Mexico, is a major shareholder of the Company.
Water Science by agreement may purchase machinery from the Company at cost plus
25 percent. During the nine months ended September 30, 2006, the Company sold
four large water generators, one small water generator and related parts to
Water Science for $1,023,634. Further, the Company has received and recorded
$697,500 in advance deposits from Water Science on machine orders at September
30, 2006. The Company also sold approximately $234,219 in products to an entity
related to Water Science. In connection with the sales of the machines and
products, the Company has recorded approximately $428,634 in accounts receivable
at September 30, 2006. The Company did not have any sales to this party for the
nine months ended September 30, 2005.
During the nine months ended September 30, 2006, the Company sold one of its
small water generators to Zerorez, an affiliate for $25,000. Zerorez is an
affiliated entity having similar shareholders and who was founded by the same
individuals who founded EAU. All of the Company's directors are shareholders of
Zerorez. The Company sold three of its generators to Zerorez for $75,000 and
other product sales of $2,344 during the nine months ended September 30, 2005.
NOTES RECEIVABLE - The Company provided financing for equipment to Zerorez
franchisees, which are related party entities. These transactions were recorded
through Equilease, Inc., a wholly owned subsidiary of the Company. During
September 2006, Equilease was sold to EOWORP, L.L.C. ("EOWORP"), a related
party, for the cash value of the notes receivable (See Note 9). EOWORP is a
shareholder of the Company and its partners are, or were, involved in the
management of the Company, including one who is currently serving on the
Company's board of directors..
SENIOR NOTE PAYABLE - In September 2005, the Company entered into a Senior
Convertible Note with Water Science in exchange for $3,000,000 (see Note 4). Due
to the discount of this note and the beneficial conversion feature, the Company
has recognized $750,000 in interest expense and has recorded a gain of
approximately $688,702 in the change of the derivative liability to fair market
value for the nine months ended September 30, 2006.
LICENSING FEE - In September 2005, the Company received $1,000,000 in exchange
for providing Water Science exclusive licensing and distribution rights for a
five-year term for a specified market area. The agreement provides termination
rights by Water Sciences and a pro rata refund of the fee. The Company
recognizes the fee on a pro rata basis over the life of the agreement. The
Company recognized $150,000 for the nine months ended September 30, 2006.
NOTE 6 - WARRANTY RESERVE
The Company warrants its products against defects in materials and workmanship
for a period of three years. The Company reviews the historical experience of
failure rates and estimates the rate of warranty claims that will be made and
has accrued a warranty reserve for these anticipated future warranty costs. If
actual results differ from the estimates, the Company would adjust the estimated
warranty liability. Changes in the warranty reserve are as follows:
For the Nine Months Ended September 30,
---------------------------------------
2006 2005
--------------- --------------
Warranty reserve at beginning of period $ 96,800 $ 95,160
Costs accrued for additional warranties 24,000 -
Service obligations honored (18,438) -
--------------- ---------------
Warranty reserve at end of period $ 102,362 $ 95,160
================== ===============
10
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 7 - CAPITAL STOCK
In August 2006, the Company issued 50,000 shares of the Company's common stock
to two employees (25,000 shares each) upon their exercising of outstanding stock
options.
In May 2006, the Company sold and issued to Water Science, LLC, a Florida
limited liability company ("Water Science"), a total of 1,600,000 shares of the
Company's $0.0001 par value common stock for a total of $4 million cash, or
$2.50 per share. As part of the transaction, Water Science agreed that this
transaction would not cause an adjustment to the conversion price of the Senior
Convertible Note issued to Water Science in September 2005, nor would it cause
an adjustment to the exercise price of the warrants issued to Water Science in
September 2005. The Company also issued to Water Science warrants to purchase up
to 6,400,000 shares of the Company's $0.0001 par value common stock in exchange
for the payment of $2.76 per share.
In May 2006, the Company issued 500,000 warrants to purchase common stock for
consulting services. The warrants are for a term of five (5) years and have an
exercise price of $2.76 per share. The warrants were valued using the
Black-Scholes model with the following assumptions: risk free rate of 4.99%,
volatility at 59.76% and the stock price at $1.95. The value of each warrant is
approximately $0.92 per warrant. The Company recognized $459,552 in the second
quarter of 2006 as consulting expense.
NOTE 8 - GOING CONCERN
During the current period, the Company incurred significant losses and a
negative cash flow from operations. As a result, at September 30, 2006, the
Company had a high level of equity financing transactions and additional
financing will be required by the Company to fund its future activities and to
support its operations. However, there is no assurance that the Company will be
able to obtain additional financing. Furthermore, there is no assurance that
rapid technological changes, changing customer needs and evolving industry
standards will enable the Company to introduce new products and services on a
continual and timely basis so that profitable operations can be attained. The
Company's ability to achieve and maintain profitability and positive cash flows
is dependent upon its ability to increase sales and profit margins and control
operating expenses. Management plans to mitigate its losses in the near term
through the further development and marketing of its patents, trademarks, brand
and product offerings.
Our auditors have issued their Independent Registered Public Accountants' Report
on the Company's consolidated financial statements for the fiscal year ended
December 31, 2005 with an explanatory paragraph regarding the Company's ability
to continue as a going concern. The consolidated financial statements have been
prepared on a going concern basis, which contemplates continuity of operations,
realization of assets and satisfaction of liabilities in the ordinary course of
business. However, as a result of recurring operating losses, such realization
of assets and satisfaction of liabilities are subject to uncertainty, which
raises substantial doubt about the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
NOTE 9 - DISCONTINUED OPERATIONS
In September 2006, the Company sold our investment in Equilease, Inc.
("Equilease") to EOWORP, L.L.C., ("EOWORP") a related party. Equilease provided
equipment financing for certain Zerorez franchisees, also related parties. The
Company was the sole owner of Equilease and had consolidated the operations of
Equilease into the Company's books. The terms of the agreement called for EOWORP
to pay to the Company the current value of the Notes Receivables held by
Equilease. Further, EOWORP agreed to pay off other certain payables owed to the
Company by Zerorez, a related party. The total cash consideration paid to the
Company was $452,559. The Company recognized income from operations of
discontinued operations in the amount of $28,248 and $36,339 for the nine months
ended September 30, 2006 and 2005, respectively. The Company recorded a loss on
disposal of discontinued operations in the amount of $50.
11
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 10 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Stock Based-Compensation Expense
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payments to employees and directors including employee stock options
and stock purchases related to the Company's employee stock option and award
plans based on estimated fair values. SFAS 123(R) supersedes the Company's
previous accounting under Accounting Principles Board Option No. 25, "Accounting
for Stock Issued to Employees" ("APB25") for periods beginning in fiscal 2006.
In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). The Company has applied
the provisions of SAB 107 in its adoption of SFAS 123(R).
The Company adopted SFAS 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of the Company's fiscal year 2006. The Company's
financial statements as of and for the three and nine month period ended
September 30, 2006 reflect the impact of SFAS 123(R). In accordance with the
modified prospective transition method, the Company's financial statements for
the prior year have not been restated to reflect, and do not include, the impact
of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R)
for the three and nine month period ended September 30, 2006 was $29,950 and
$599,590 respectively, related to employee stock options issued and vesting
during the period. During the three and nine month period ended September 30,
2005, the Company recognized $0 and $951,300, respectively, in compensation
expense related to other stock options.
Basic and Fully Diluted Loss Per Share
Basic and Fully Diluted net loss per share is computed using the
weighted-average number of common shares outstanding during the period.
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------- ------------------ ------------------ ------------------
2006 2005 2006 2005
------------------- ------------------ ------------------ ------------------
(Restated) (Restated)
Loss (numerator) $ (1,351,852) $ 4,218,100) $ (5,631,776) $ 8,794,579)
Shares (denominator) 11,085,691 8,749,004 10,319,928 8,248,689
Per share amount $ (0.12) $ (0.48) $ (0.55) $ (1.07)
The Company's outstanding stock options have been excluded from the basic net
loss per share calculation for the three and nine month period ended September
30, 2006 and 2005, because they are anti-dilutive.
The following table is a summary of the status of the warrants and options
granted for the nine months ended September 30, 2006:
Number Weighted
of Options Average Exercise
and Warrants Price
------------ ----------------
Outstanding at beginning of period 4,653,293 $ 2.78
Granted 7,200,000 2.76
Exercised (50,000) 0.01
Forfeited (402,500) 2.95
Expired - -
------------ ----------------
Outstanding at end of period 11,400,793 $ 2.70
------------ ----------------
12
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 10 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
A summary of the status of the warrants outstanding at September 30, 2006 is
presented below:
Warrants Outstanding Warrants Exercisable
---------------------------------------------------- --------------------------------
Range of Weighted-Average Weighted-Average Weighted-Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
----------- ------------ ----------------- ---------------- ----------- -----------------
$.01-.50 635,000 3.0 years $ 0.10 635,000 $ 0.10
1.00-1.99 290,000 1.9 years 1.48 290,000 1.48
2.00-2.99 8,950,000 2.6 years 2.76 8,950,000 2.76
3.00-3.99 982,417 3.2 years 3.26 982,417 3.26
4.00-4.99 255,000 3.0 years 4.00 255,000 4.00
5.00-5.50 263,376 3.2 years 5.15 263,376 5.15
----------- ------------ ----------------- ---------------- ----------- -----------------
$.01-5.50 11,400,793 2.7 years $ 2.70 11,400,793 $ 2.70
----------- ------------ ----------------- ---------------- ----------- -----------------
The fair value of each warrant granted is estimated on the date granted using
the Black-Scholes pricing model, with the following assumptions for warrants
issued in 2006: risk-free interest rate of between 4.6% and 4.99%, expected
dividend yield of zero, expected lives of 3 and 5 years and expected volatility
of between 59.76 % and 89.54 %.
NOTE 11 - RESTATEMENT
The Company restated its financial statements for the period ended December 31,
2004 and for the first, second and third quarters ending March 31, 2005, June
30, 2005 and September 30, 2005. The Company determined that generally accepted
accounting principles had not been followed in 2004 and for the stated quarters
of 2005 for the recording of certain types of transactions. See Note
18-Restatement of the Notes to the Consolidated Financial Statements for the
year ended December 31, 2005 and 2004 in the Company's 10-KSB for details of the
restatement of the 2004 financial statements. The impact of the 2004 restatement
of the balance sheet accounts carries forward and the 2004 changes to such
accounts are part of the changes noted below. The type and impact of the changes
to those transactions relating to the first, second and third quarters of 2005
are as follows:
Recognition of common stock and warrant issuances resulting in additional
consulting and compensation expense of $602,100.
Recognition of Licensing Revenue of $1,000,000 over term of agreement.
Recording of the convertible debt and warrants in accordance with EITF
00-19, which resulted in the recognition of a derivative liability in the
amount of $5,388,083 (See Note 4).
13
ELECTRIC AQUAGENICS UNLIMITED, INC.
CONDENSED NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 11 - RESTATEMENT - CONTINUED
The following table highlights the significant areas of change from those
previously reported:
As previously Restated
reported September 30,
September 30, 2005 2005 Change
------------------------ ----------------------- -----------------------
Total Assets $ 8,810,129 $ 5,564,734 $ (3,245,395)
Additional Paid $ (14,842,679) $ (19,044,905) $ (4,202,226)
in Capital
Accumulated deficit $ (9,825,330) $ (18,122,264) $ (8,296,934)
Total Equity $ (5,018,154) $ (923,557) $ 4,094,597
Net Sales $ 1,490,789 $ 490,698 $ (1,000,091)
Net Income (Loss) $ (3,658,990) $ (8,794,579) $ (5,135,589)
Basic Earnings $ (0.50) $ (1.07) $ (0.57)
(Loss) per Share
NOTE 12 - SUBSEQUENT EVENTS
On October 24, 2006, the Company appointed Wade R. Bradley as Chief Executive
Officer and President. In conjunction with the appointment, the Company entered
into an employment agreement with Mr. Bradley which provides a base salary of
$240,000 per year, stock options to purchase up to 500,000 shares of common
stock and other incentives. The term of the contract is for three years with an
automatic renewal for a one year term. As part of the transaction, Water Science
agreed that this transaction would not cause an adjustment to the conversion
price of the Senior Convertible Note issued to Water Science in September 2005,
nor would it cause an adjustment to the exercise price of the warrants issued to
Water Science in September 2005.
On October 27, 2006, the Company entered into a stock purchase agreement with
Peter F. Ullrich, a shareholder of the Company, whereby Mr. Ullrich agreed to
purchase a total of 2,307,692 newly issued shares of $0.0001 par value common
stock of the Company for a purchase price of $1.30 per share in a private
transaction, for total consideration of $2,999,999.60. Under the terms of the
agreement, Mr. Ullrich purchased 1,153,846 shares on October 27, 2006 and will
purchase the remaining 1,153,846 shares on January 2, 2007. As part of the
transaction, Water Science agreed that this transaction would not cause an
adjustment to the conversion price of the Senior Convertible Note issued to
Water Science in September 2005, nor would it cause an adjustment to the
exercise price of the warrants issued to Water Science in September 2005.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis provides information, which management
believes is relevant to an assessment and understanding of the Company's
condensed results of operations and financial condition. The discussion should
be read in conjunction with the financial statements included in our annual
report on Form 10-KSB, and notes thereto.
OVERVIEW
Electric Aquagenics Unlimited, Inc. (referred to herein sometimes as "EAU,"
"we," "us," or the "Company") is in the business of developing, manufacturing
and marketing equipment that uses water electrolysis to create fluids. These
fluids have various commercial applications and may be used in organic,
agricultural and consumer products that clean, disinfect, remediate, hydrate and
moisturize and do not contain or leave harmful residues associated with
chemical-based disinfecting and cleaning agents ("EO Technology"). The
electrolyzed fluids created by the EO Technology (referred to herein sometimes
as the "EO Fluids" or "Empowered Water(TM)") generated by our patented and
specialized equipment currently replace many of the traditional products used in
commercial, industrial and residential disinfecting and cleaning.
We also develop, manufacture and market consumer products that support a healthy
lifestyle, such as our Perfect Empowered Drinking Water(TM) and Perfect
Oxygenated Therapy(TM) products (formerly marketed under the name "Aquagen(R)
Stabilized Oxygen Products"). The fluids that incorporate the EO Technology and
our consumer products are environmentally safe and non toxic at the levels
employed. EAU is continuously looking for ways to improve and enhance our
applications and claims through furthering our studies, solution listings and
registrations with various third party organizations. We plan to expand the
market for our Perfect Empowered Drinking Water(TM) and our Perfect Oxygenated
Therapy(TM) products and to develop other personal use products, such as skin
care products, periodontal products and a foot sanitizer product. We also intend
to continue to develop and market commercial and residential cleaning products,
such as bottled surface cleaning products.
We have identified the following industries for early stage sales and marketing
focus: 1) meat processing, 2) bottled drinking water and consumer products, 3)
grocery and 4) agricultural products. We focus on these markets because we
believe that we have either a competitive advantage in the marketplace or a
leading strategic industry partner for specific products and/or can provide an
attractive value proposition to commercial end users or consumers for products
that use or embody our EO Technology, EO Fluids or Perfect Essentials(TM)
products.
We have successfully completed phase I of our United States Department of
Agriculture ("USDA") Online Reprocessing (OLR) Certification. EAU has recently
completed USDA Phase I Online Reprocessing Certification testing with a
nationally recognized processor on the commercial use of electrolyzed water as
an antimicrobial for salmonella reduction. Both test protocols yielded
successful results. Salmonella reductions were significantly below the FSIS
allowable limit prior to chilling. The EAU Technologies OLR intervention also
tested well showing a statistically significant difference between control and
test groups. EAU is immediately moving forward into the second phase of USDA
testing with two identified processors.
We have shipped four of the nine units ordered from Water Sciences, Inc. Three
of those units have been installed in Ecuador, Costa Rica and Mexico
respectively. The fourth is awaiting site preparation by Water Sciences before
EAU can complete the installation. The remaining five units are in pre-ship
quality assurance testing stage to be completed in the fourth quarter. Shipment
dates and locations have yet to be determined by Water Sciences. Water Sciences
is currently using Empowered Water(TM) fluids in various agricultural channels.
15
We are currently installed in four South Region Whole Foods Market stores (WFM).
We have recently taken over the maintenance and growth of this channel from KES
Science and Technology, Inc. Since we have taken over, we have gone to each of
the stores and have identified other departments that could be using the
Empowered Water(TM). We are currently working with WFM to identify and validate
those other applications. As of now, WFM is using Empowered Water in the produce
and floral departments. We are working to utilize and expand Empowered Water(TM)
throughout the store in each of its departments including, Seafood, Meat &
Poultry, Bakery and Kitchen as well as its general sanitation solution. We will
be proposing this study in the fourth Quarter and expect to commence the study
in January, 2007.
On March 28, 2006, we entered into an agreement with Brand Velocity, Inc.,
whereby Brand Velocity agreed to perform certain strategic planning and
corporate assessment consulting services. Brand Velocity completed its
obligations under this agreement during the second quarter 2006. We are in the
process of completing a brand development and marketing plan that incorporates
Brand Velocity's findings and conclusions.
Past revenues have been generated primarily from equipment sales to agriculture,
grocery, carpet and living surfaces industries, and consumer product sales. We
intend to derive future EO Technology revenues from recurring fees charged to
customers based on per-unit or per-gallon of fluid used after equipment is
installed; and we intend to drive our consumer and EO Technology products to
create greater revenues.
On May 1, 2006, we entered into a consulting agreement with JL Montgomery
Consulting, LLC, a Florida limited liability company. By the terms of this
agreement, JL Montgomery Consulting agreed to assist the Company in locating and
structuring equity and long-term debt financing; to help establish financial
policies and procedures; to offer strategic financial assistance; to provide
strategic business planning; to offer financial advice to the Company and its
Board of Directors on financial matters; and to introduce the Company to third
parties, including independent companies, governmental contacts, and/or third
party individuals interested in purchasing our products or forming a business
relationship with us. As compensation, we granted to JL Montgomery Consulting a
five-year, fully vested warrant to purchase up to 500,000 of our $.0001 common
stock at the price of $2.76 per share.
On May 26, 2006, our Chief Executive Officer and chairman of our board of
directors, Gaylord Karren, resigned from all positions with EAU for health
reasons. Mr. Karren committed, as his health permits, to assist the Company in
any way he can during the transition and in the future.
In connection with Mr. Karren's resignation, the Company and Mr. Karren executed
a Separation Agreement. This agreement provides, in part, that Mr. Karren
receive severance in the amount of $11,500 per month for six months and a lump
sum of $69,000 on December 1, 2006, the grant of options to acquire 25,000
shares of the Company's common stock at an exercise price equal to the close
price of the Company's common stock as reported on the OTCBB as of the effective
time, health benefit coverage for up to six months and other miscellaneous terms
together with an indemnification from liability with respect to services Mr.
Karren provided for the benefit of the Company. In addition, the agreement
provides for a mutual general release by and between the Company and Mr. Karren.
The Company retained Mr. Jay S. Potter, a member of the Board of Directors to
act as interim Chief Executive Officer until a permanent Chief Executive Officer
is retained. Mr. Potter agreed to spend approximately 70% of his business time
working for the Company. Mr. Potter agreed to continue as a member of the Board
of Directors. The Company has agreed to compensate Mr. Potter $10,000 per month
for each month the Company utilizes his services as an interim officer.
On July 27, 2006 the Company entered into an agreement with Egon Zehnder
International Inc., management consultants to assist the Company in recruiting,
evaluating and hiring a new Chief Executive Officer.
16
On August 31, 2006, H. Warren Jaynes resigned as the Company's Chief Financial
Officer, effective September 8, 2006. Our Company's controller has assumed the
duties of the CFO until a replacement CFO is hired.
On October 24, 2006, the Company appointed Wade R. Bradley as Chief Executive
Officer and President. In conjunction with the appointment, the Company entered
into an employment agreement with Mr. Bradley which provides a base salary of
$240,000 per year, stock options to purchase up to 500,000 shares of common
stock and other incentives. The term of the contract is for three years with an
automatic renewal for a one year term.
On October 27, 2006, the Company entered into a stock purchase agreement with
Peter F. Ullrich, a shareholder of the Company, whereby Mr. Ullrich agreed to
purchase a total of 2,307,692 newly issued shares of $0.0001 par value common
stock of the Company for a purchase price of $1.30 per share in a private
transaction, for total consideration of $2,999,999.60. Under the terms of the
agreement, Mr. Ullrich purchased 1,153,846 shares on October 27, 2006 and will
purchase the remaining 1,153,846 shares on January 2, 2007.
Our operations are currently funded by a combination of revenues and capital
funding.
Financial Position and Results of Operations
The following discussion should be read in conjunction with selected financial
data and the financial statements and notes to financial statements.
Financial Position
The Company had $226,367 in cash as of September 30, 2006, compared to $681,348
at December 31, 2005. Our working capital as of September 30, 2006 was
$1,353,717 compared to $1,089,192 at December 31, 2005. The primary reason for
the increase in our working capital for the nine months ended September 30,
2006, was a decrease in cash of $454,981, or 66%, which was offset by an
increase in accounts receivable of $453,373, or 367%, and from an increase in
inventory of $411,936, or 21%. The Company has received and recorded $697,500 in
advance deposits from Water Science on machine orders at September 30, 2006.
This will be reduced as the Company delivers machines on order to Water Science,
a related party. Water Science, who has exclusive rights to sell our products in
South America and Mexico is also an affiliate of the Company, by agreement may
purchase machinery from us at cost plus 25 percent. These deliveries are
targeted to occur during the fourth quarter of 2006. Long term debt increased
102%, from $448,668 at December 31, 2005 to $1,146,804 at September 30, 2006, or
$698,136. The primary increase is a result of the discount of the Senior Note
Payable, which was $750,000 for the nine months ended September 30, 2006. At
September 30, 2006, our stockholders' deficit was $2,905,800.
Summary of select balance sheet information follows:
September 30, December 31,
2006 2005
------------------- --------------------
Balance Sheet Data: (Unaudited)
------------------
Cash and Cash Equivalents $ 226,367 $ 681,348
Total Current Assets 3,220,776 2,891,739
Total Assets 5,564,734 5,809,927
Total Current Liabilities 1,867,049 1,802,547
Long Term Debt 1,146,804 448,668
Total liabilities and stockholders' equity $ 5,564,734 $ 5,809,927
17
Results of Operations for the three months ended September 30, 2006 and 2005
Revenues and Net Income
The Company had total revenues of $778,737 for the three months ended September
30, 2006, which represents an increase of 179% from the $278,767 in total
revenues for the same period one year earlier. A majority of this increase came
from consumer products sales of approximately $297,000 and EO Machine sales of
approximately $440,000 in the current three month period versus approximately
$313,000 consumer product sales and $0 EO Machine sales in the three months
ended September 30, 2005. Management believes that we will continue generating
revenues from both its consumer and EO Machine sales during the rest of 2006 as
it has received deposits on nine machines from Water Science, LLC, a related
party, a company that holds a license agreement with the Company to distribute
its products in South America, of which we have shipped four machines with the
remaining machines scheduled to be delivered during the upcoming quarter.
Net loss for the three months ended September 30, 2006 was $1,351,852, or a loss
of $0.12 per share, compared with a net loss of $4,218,100, or $0.42 per share
for the same period in 2005. The majority of the decrease in the loss per share
over the comparable period in 2005 was due to the recording of the derivative
liability loss at September 30, 2005 of $2,385,194, compared to a gain in the
fair market value of the derivative liability of $29,792 at September 30, 2006.
The current quarter net loss includes an increase of $217,296 in interest
expense, from $65,653 in 2005 to $282,909 in 2006, or an increase of 331%. This
is due to interest expense related to the senior note payable entered into in
September 2005.
General and Administrative Expenses
The Company's general and administrative expenses totaled $1,289,315 during the
three months ended September 30, 2006, compared to $1,788,638 during the three
months ended September 30, 2005, for a decrease of $499,323, or 28%. General and
administrative expense for 2006 consists primarily payroll expense ($612,142),
professional fees ($388,503) and travel related expenses ($68,224). The Company
has implemented tighter controls to reduce its general and administrative
expenses by reducing any unnecessary expenses, reducing payroll expense and is
challenging all of its expenditures.
Research and Development
Research and development expenses incurred during the three month period ended
September 30, 2006 decreased $29,130 or 37%, from $79,459 in 2005 to $50,329 in
2006. It is anticipated that the Company's research and development expenditures
will continue at approximately this same level or a little higher due to
research it intends to continue in the agriculture markets. While the Company
will continue to conduct research to improve its products and their performance,
it believes it has developed proven products that have commercial value in its
targeted markets.
Summary of select income statement information follows:
Three months ended
September 30,
---------------------------
Percent
2006 2005 Better (Worse) Change
------------ ------------- --------------- -------------
Revenue, net $ 778,737 $ 278,767 $ 499,970 179%
Gross profit 265,883 87,919 177,964 202%
Operating loss 1,128,470 1,806,954 678,484 38%
Net loss 1,351,852 4,218,100 2,866,248 68%
Loss per share 0.12 0.48 0.36 75%
18
Results of Operations for the nine months ended September 30, 2006 and 2005
Revenues and Net Income
The Company had total revenues of $1,882,077 for the nine months ended September
30, 2006, which represents an increase of 284% from the $490,698 in total
revenues for the nine months ended September 30, 2005. A majority of this
increase came from consumer products sales of approximately $651,000 and
agriculture enhancement products of approximately $1,024,000 in the current nine
month period versus approximately $321,000 consumer product sales and no
agriculture enhancement product sales in the nine months ended September 30,
2005.
Net loss for the nine months ended September 30, 2006 was $5,631,776, or a loss
of $0.55 per share, compared with a net loss of $8,794,579, or $1.07 per share
for the same period in 2005. The current period net loss includes an increase of
$770,423 in interest expense, from $96,281 in 2005 to $866,704 in 2006, or an
increase of 800%. This is due to interest expense related to the senior note
payable entered into in September 2005. The improved results were also due to
the recording of the derivative liability to fair market value of a gain of
$688,702 during the nine months ended in 2006 compared to a $2,385,194 loss
realized in the recording of the derivative liability to fair market value
during the same period in 2005.
General and Administrative Expenses
The Company's general and administrative expenses totaled $5,935,935 during the
nine months ended September 30, 2006, compared to $6,438,904 during the nine
months ended September 30, 2006, for a decrease of $502,969, or 8%. General and
administrative expense for 2006 consists primarily of payroll expense
($2,070,871), compensation expense ($1,185,642), professional fees ($1,200,344),
capital funding fees ($237,763), travel related expenses ($308,157) and rent
($132,441). The Company has implemented tighter controls to reduce its general
and administrative expenses by reducing any unnecessary expenses, reducing
payroll expense and is challenging all of its expenditures.
Research and Development
Research and development expenses incurred during the period ended September 30,
2006 decreased $284,595 or 70% compared to R&D expenses incurred during the same
period one year earlier, due to the Company beginning to move from the
development stage to the sale of its developed products.
Summary income statement information follows:
Nine months ended
September 30
---------------------------
Percent
2006 2005 Better (Worse) Change
------------ ------------- --------------- -------------
Revenue, net $ 1,882,077 $ 490,698 $ 1,391,379 284%
Gross profit (loss) 688,170 218,698 469,472 215%
Operating loss 5,527,989 6,717,114 1,189,125 18%
Net loss 5,631,776 8,794,579 3,162,803 36%
Loss per share $ 0.55 $ 1.07 $ 0.52 49%
19
Related Party Transactions
Sales to Affiliates - Water Science, who has exclusive rights to sell our
products in South America and Mexico is an affiliate of the Company. Water
Science by agreement may purchase machinery from the Company at cost plus 25
percent. During the nine months ended September 30, 2006, the Company sold four
large water generators, one small water generator and related parts to Water
Science for $1,023,634. Further, the Company has received and recorded $697,500
in advance deposits from Water Science on machine orders at September 30, 2006.
The Company also sold approximately $234,219 in products to an entity related to
Water Science. In connection with the sales of the machines and products, the
Company has recorded approximately $428,634 in accounts receivable at September
30, 2006. The Company did not have any sales to this party for the nine months
ended September 30, 2005.
During the nine months ended September 30, 2006, the Company sold one of its
small water generators to Zerorez, an affiliate for $25,000. The Company sold
three of its generators to Zerorez for $75,000 and other product sales of $2,344
during the nine months ended September 30, 2005.
Notes Receivable - The Company provided financing for equipment to Zerorez
franchisees, which are related party entities. These transactions were recorded
through Equilease, Inc., a wholly owned subsidiary of the Company. During
September 2006, Equilease was sold to a related party for the cash value of the
notes receivable (See Note 9).
Senior Note Payable - In September 2005, the Company entered into a Senior
Convertible Note with Water Science in exchange for $3,000,000 (see Note 4). Due
to the discount of this note and the beneficial conversion feature, the Company
has recognized $750,000 in interest expense and has recorded a gain of
approximately $688,705 in the change of the derivative liability to fair market
value for the nine months ended September 30, 2006.
Licensing Fee - In September 2005, the Company received $1,000,000 in exchange
for providing Water Science exclusive licensing and distribution rights for a
five-year term for a specified market area. The agreement provides termination
rights by Water Sciences and a pro rata refund of the fee. The Company
recognizes the fee on a pro rata basis over the life of the agreement. The
Company recognized $150,000 for the nine months ended September 30, 2006.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2006, we had cash and cash equivalents of $226,367, compared to
$681,348 at December 31, 2005. We have had continuing operating losses of
$1,128,470 and $5,527,989 for the three and nine months ended September 30,
2006, respectively, compared with operating losses of $1,806,954 and $6,717,114
for the three and nine months ended September 30, 2005, respectively. The net
loss per share for the second quarter of 2006 was $0.55 compared to a loss of
$1.07 per share for the same period in 2005. The decrease is attributable to
increased gross profits, reduced operating expenses and a higher
weighted-average of shares outstanding during 2006. Our working capital as of
September 30, 2006 was $1,353,717 for reasons discussed above under financial
position.
Net cash used in operating activities in the nine month period ended September
30, 2006 was $4,856,520, a 9% decrease, compared to $5,328,528 for the same
period in 2005. The primary uses of cash were an increase in inventory of
$411,936, an increase of accounts receivable of $453,373 and a decrease in
accounts payable of $588,879. Advances on machine orders increased $697,500
during the period which reduced the operating cash requirements for the Company.
Sales have increased during the quarter resulting in a corresponding increase in
accounts receivable.
At September 30, 2006, the Company's inventory was $2,415,838, representing an
increase of 21% from the $2,003,902 on hand at December 31, 2005. The Company is
in the process of building machines for Water Science, LLC, a related party, and
other customers for expected deliveries in the second half of 2006 and has
increased its inventory over the December 31, 2005 inventory levels due to
ordering components for these machines.
The operating outflow of cash was reduced by the Company issuing warrants and
stock options in lieu of cash during the quarter of $1,059,142. The Company
adopted SFAS 123(R), effective January 1, 2006, and now expenses stock options
given to employees. The Company recognized a non-cash increase from the
20
discounting of the Company's note payable to Water Science, LLC of $750,000.
(See Note 4 to the Company's unaudited financial statements.) Further, the
Company recognized a non-cash decrease in the derivative liability of $688,702,
due to changes in the Black-Scholes value of the liability.
Cash flows from investing activities provided the Company $425,886 during the
period ended September 30, 2006 as compared $719,914 used for the same period in
2005. During 2006, the cash flows consisted of net cash receipts of $452,559
from the sale of our investment in Equilease (See Note 9 to the Company's
unaudited financial statements), investments in intellectual property and
patents of $18,518 and purchase of equipment of $46,238. This compares to
$613,073 used to purchase equipment, $135,350 net cash used to purchase notes
receivables, $55,093 used to purchase investments and $26,584 used to invest in
intellectual property and patents for the comparable period in 2005.
Cash flows from financing activities provided the Company $3,975,653 and
$8,284,446 for the nine months ended September 30, 2006 and 2005, respectively.
This is primarily a result of the Company's continued sales of its common stock
to fund operations. The Company raised $4,000,497 and $5,375,402 from the sale
of stock and $0 and $3,000,000 from the issuance of a note payable for the nine
months ended September 30, 2006 and 2005, respectively. This amount was offset
by payments made on notes payable in the amount of $24,844 and $93,081 in 2006
and 2005, respectively.
Our working capital requirements for the foreseeable future will vary based upon
a number of factors, including, our timing in the implementation of our business
plan, our growth rate and the level of our revenues. We have no commitments to
fund any future capital expenditures. Our current assets, along with cash
generated from anticipated revenues, will not provide us with sufficient funding
for the next twelve months. On October 27, 2006, the Company entered into a
stock purchase agreement with Peter F. Ullrich, a shareholder of the Company,
whereby Mr. Ullrich agreed to purchase a total of 2,307,692 newly issued shares
of $0.0001 par value common stock of the Company for a purchase price of $1.30
per share in a private transaction, for total consideration of $2,999,999.60.
Under the terms of the agreement, Mr. Ullrich will purchase 1,153,846 shares on
October 25, 2006 and the remaining 1,153,846 shares on January 2, 2007. We
anticipate that we may need an additional $5,000,000 or more in future funding
to execute our business plan over the next twelve months. Moreover, if we able
to expand our sale of EO machines as anticipated, we will need significant
additional working capital to fund that expansion. We do not have arrangements
in place to provide us with this funding or any additional funding. In light of
these circumstances, the ability of the Company to continue as a going concern
is in substantial doubt.
If the Company does not raise sufficient funds in the future, we may not be able
to fund expansion, take advantage of future opportunities, meet our existing
debt obligations or respond to competitive pressures or unanticipated
requirements. Without additional financing, management believes that the Company
will be able to fund its operations for at least an additional 6 months..
Future financing transactions may include the issuance of equity or debt
securities, obtaining credit facilities, or other financing mechanisms. However,
a subsequent decline in the trading price of our common stock and the downturn
in the U.S. stock and debt markets could make it more difficult for us to obtain
financing through the issuance of equity or debt securities. Even if we are able
to raise the funds required, it is possible that we could incur unexpected costs
and expenses, fail to collect significant amounts owed to us, or experience
unexpected cash requirements that would force us to seek alternative financing.
Further, if we issue additional equity or debt securities, stockholders may
experience additional dilution, or the new equity securities may have rights,
preferences or privileges senior to those of existing holders of our common
stock.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
21
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with U.S. generally accepted accounting principles and our discussion and
analysis of our financial condition and results of operations require us to make
judgments, assumptions and estimates that affect the amounts reported in our
financial statements and accompanying notes. Note 1 of the notes to consolidated
financial statements in Part II, Item 7 of the Company's Annual Report on Form
10-KSB, dated December 31, 2005, describes the significant accounting policies
and methods used in preparation of our consolidated financial statements. We
base our estimates on historical experience, current trends, future projections,
and on various other assumptions we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates. We believe the following to be our critical accounting
estimates because they are both important to the portrayal of our financial
condition and results and they require us to make judgments and estimates about
matters that are inherently uncertain.
Our critical accounting policies and estimates include the following:
Revenue recognition;
Impairment of long-lived assets; and
Allowances for doubtful accounts.
Revenue Recognition. We recognize revenue when goods are shipped and title
passes to the customer or when services are performed in accordance with
contract terms. The Company provides an allowance for sales returns based on
current and historical experience. We also recognize revenue from a licensing
agreement pro-rated over the term of the agreement.
Impairment of long-lived assets. Long-lived assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. Determination of recoverability is based on
an estimate of undiscounted future cash flows resulting from the use of the
asset and its eventual disposition. Measurement of an impairment loss for
long-lived assets that management expects to hold and use is based on the fair
value of the asset. Long-lived assets are reported at the lower of carrying or
fair value less costs to sell.
Allowance for doubtful accounts. The Company sells its products to large grocery
and commercial customers, as well as smaller independent customers. It regularly
reviews its aging and reserves for amounts that may be at risk in collection.
The Company has historically had very few uncollectible amounts.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payments to employees and directors including employee stock options
and stock purchases related to the Company's employee stock option and award
plans based on estimated fair values. SFAS 123(R) supersedes the Company's
previous accounting under Accounting Principles Board Option No. 25, "Accounting
for Stock Issued to Employees" ("APB25") for periods beginning in fiscal 2006.
In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). The Company has applied
the provisions of SAB 107 in its adoption of SFAS 123(R).
The Company adopted SFAS 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of the Company's fiscal year 2006. The Company's
financial statements as of and for the three and six month period ended June 30,
2006 reflect the impact of SFAS 123(R). In accordance with the modified
22
prospective transition method, the Company's financial statements for the prior
year have not been restated to reflect, and do not include, the impact of SFAS
123(R). Stock-based compensation expense recognized under SFAS 123(R) for the
three and nine month period ended September 30, 2006 was $29,950 and $599,590,
respectively, related to employee stock options issued and vesting during the
period. During the three and nine month period ended September 30, 2005, the
Company recognized $0 and $951,300, respectively, in compensation expense
related to other stock options.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of ARB No. 43, Chapter 3," which clarifies the accounting for abnormal amounts
of idle facility expense, freight, handling costs, and waste material. This
statement is effective for inventory cost incurred during fiscal years beginning
after June 15, 2005. SFAS No. 151 is not currently applicable to the company,
and we believe that the adoption of SFAS No. 151 will not have a material impact
on our results of operations. In December 2004, the FASB issued SFAS No. 153,
"Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29," which
replaces the exception from fair value measurement in APB Opinion No. 29 with a
general exception for exchanges of non-monetary assets that do not have
commercial substance. This statement is effective for non-monetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. SFAS No.
153 is not currently applicable to the company, and we believe that the adoption
of SFAS No. 153 will not have a material impact on our results of operations.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154
"Accounting Changes and Error Corrections, an amendment of APB Opinion 20 and
FASB Statement No. 3," which changes the requirements for accounting for and
reporting on a change in accounting principle. This statement is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. We believe that the adoption of SFAS No. 154 will not
have a material impact on our results of operations.
In March 2006, the FASB issued SFAS No. 156 "Accounting for Servicing of
Financial Assets, an amendment of FASB No. 140," which modifies the accounting
for and reporting of servicing asset and servicing liabilities. This statement
is effective as of the beginning of our first fiscal year that begins after
September 15, 2006. SFAS No. 156 is not currently applicable to the company and,
we believe that the adoption of SFAS No. 156 will not have a material impact on
our results of operations.
In June 2006, the FASB issued Financial Interpretation No. (FIN) 48, "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement 109." FIN
48 prescribes a recognition threshold and a measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. This interpretation also provides guidance
on de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. This interpretation is effective for fiscal
years beginning after December 15, 2006. The Company is currently evaluating the
impact of applying the various provisions of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," that
provides guidance for using fair value to measure assets and liabilities. Under
SFAS 157, fair value refers to the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants in the market in which the reporting entity transacts. SFAS 157
establishes a fair value hierarchy that prioritizes the information used to
develop the assumptions that market participants would use when pricing the
asset or liability. The fair value hierarchy gives the highest priority to
quoted prices in active markets and the lowest priority to unobservable data. In
addition, SFAS 157 requires that fair value measurements be separately disclosed
by level within the fair value hierarchy. This standard will be effective for
financial statements issued for fiscal periods beginning after November 15, 2007
and interim periods within those fiscal years. The Company is currently
evaluating the impact of applying the various provisions of SFAS 157.
INFLATION
We do not expect the impact of inflation on operations to be significant.
23
PRECIOUS METALS
Raw materials used by the Company in the EO Machines include a number of
precious metals and minerals. Prices of these materials can be volatile and the
Company has no fixed price contracts or arrangements. The Company ordinarily
does not attempt to hedge the price risk of its raw materials. Commercial
deposits of certain metals that are required for the alloys used in the EO
Machines are found in only a few parts of the world, and for certain materials
only single sources are readily available. The availability and prices of these
metals and other materials may be influenced by private or governmental cartels,
changes in world politics, unstable governments in exporting nations, production
interruptions, inflation and other factors. Although the Company has not
experienced significant shortages of its supplies and raw materials, there can
be no assurance that such shortages will not occur in the future. Any such
shortages or prices fluctuations could have a material adverse effect on the
Company.
FORWARD-LOOKING STATEMENTS
All forward-looking statements contained herein are deemed by the Company to be
covered by and to qualify for the safe harbor protection provided by the Private
Securities Litigation Reform Act of 1995. Prospective shareholders should
understand that several factors govern whether any forward-looking statement
contained herein will be or can be achieved. Any one of those factors could
cause actual results to differ materially from those projected herein. These
forward-looking statements include plans and objectives of management for future
operations, including plans and objectives relating to the products and the
future economic performance of the Company. Assumptions relating to the
foregoing involve judgments with respect to, among other things, future
economic, competitive and market conditions, future business decisions, and the
time and money required to successfully complete development projects, all of
which are difficult or impossible to predict accurately and many of which are
beyond the control of the Company. Although the Company believes that the
assumptions underlying the forward-looking statements contained herein are
reasonable, any of those assumptions could prove inaccurate and, therefore,
there can be no assurance that the results contemplated in any of the
forward-looking statements contained herein will be realized. . Forward-looking
information is inherently subject to risks and uncertainties, and actual results
could differ materially from those currently anticipated due to a number of
factors, which include, but are not limited to, risks associated with
successfully developing our business in evolving markets, our need for
additional capital, our continuing operating losses, the ability of our
management to conduct distribution activities and sell products, possible
failure to successfully develop new products, vulnerability to competitors due
to lack of patents on our products, and other risk factors listed in our annual
report on Form 10-KSB for the year ended December 31, 2005 and our other SEC
reports. Based on actual experience and business development, the Company may
alter its marketing, capital expenditure plans or other budgets, which may in
turn affect the results of operations. In light of the significant uncertainties
inherent in the forward-looking statements included therein, the inclusion of
any such statement should not be regarded as a representation by the Company or
any other person that the objectives or plans will be achieved.
ITEM 3. CONTROLS AND PROCEDURES
The Company has evaluated, with the participation of the Company's principal
executive and principal financial officers, the effectiveness of the issuer's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of September 30, 2006, pursuant to
Exchange Act Rule 15d-15. Based upon that evaluation, the principal executive
and financial officers concluded that the Company's disclosure controls and
procedures were effective at the reasonable assurance level.
The Company's management does not expect that its disclosure controls will
prevent all error and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. The design of any system of controls
is based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions. Further, the design of a
24
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been or will be detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdown can occur because of simple error or mistake.
There have been no significant changes in our internal control over financial
reporting that occurred during our most recently completed fiscal quarter that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting, or other factors that could
significantly affect internal controls subsequent to the date of our most recent
evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In August 2006, the Company issued 50,000 shares of the Company's common stock
to two employees (25,000 shares each) upon their exercising of outstanding stock
options.
The sale of the above referenced securities was exempt from registration with
the Securities and Exchange Commission under Section 4(2) of the Securities Act
of 1933 and Rule 506 of Regulation D promulgated there under.
ITEM 5. OTHER INFORMATION
On June 15, 2006, we entered into a Termination Agreement with Coating Systems
Laboratories ("CSL"), whereby both parties agreed to terminate the License and
Distribution Agreement, entered into during February 2005 and the Joint Venture
Agreement, entered into during August 2005. Included in the termination
agreement the companies agreed to enter into a future agreement subject to
further testing of the CSL products, whereby the Company will have exclusive
rights to purchase and market certain CSL products within a certain territory
mutually agreed upon by both parties. In September 2006, the parties agreed to a
new License and Distribution Agreement, whereby the Company will have the
exclusive right to distribute and sell certain products in North and South
America.
On July 31, 2006, we entered into a Termination Agreement with KES Science and
Technology, Inc. ("KES"), whereby both parties agreed to terminate the Exclusive
Distributor Agreement, entered into during May 2004. Included in the termination
agreement KES agreed to pay to the Company all amounts currently owed.
Additionally, the companies agreed that the Company would sell one more EO Water
machine to KES. No additional future sales are anticipated.
In September 2006, the Company sold our investment in Equilease, Inc.
("Equilease") to EOWORP, L.L.C., ("EOWORP") a related party. Equilease provided
equipment financing for certain Zerorez franchisees, also related parties. The
Company was the sole owner of Equilease and had consolidated the operations of
Equilease into the Company's books. The terms of the agreement called for EOWORP
to pay to the Company the current value of the Notes Receivables held by
Equilease. Further, EOWORP agreed to pay off other certain payables owed to the
Company by Zerorez, a related party. The total cash consideration paid to the
Company was $452,559.
In November 2005, we entered into a joint venture agreement with Dr. William
Jackson to market certain of the products he owns and controls that are used in
the agriculture industry (the "Dr. Jackson JV Agreement"). By the terms of the
Dr. Jackson JV Agreement, we agreed to market and sell certain of his currently
marketed products, and he agreed to market and sell our EOW Technology and EOW
Systems into the agriculture industry. In August of 2006, the Company and Dr.
Jackson mutually agreed to change the nature of the relationship from a joint
venture to joint marketing effort of each others products. Dr. Jackson has an
25
EOW water generator that he is continuing to test with his products. Both
parties believe their respective products have great synergy in green
agriculture applications. The two parties are continuing to negotiate incentives
and or product costs to each other in the joint marketing effort.
On October 24, 2006, the Company appointed Wade R. Bradley as Chief Executive
Officer and President. In conjunction with the appointment, the Company entered
into an employment agreement with Mr. Bradley which provides a base salary of
$240,000 per year, stock options to purchase up to 500,000 shares of common
stock and other incentives. The term of the contract is for three years with an
automatic renewal for a one year term.
On October 27, 2006, the Company entered into a stock purchase agreement with
Peter F. Ullrich, a shareholder of the Company, whereby Mr. Ullrich agreed to
purchase a total of 2,307,692 newly issued shares of $0.0001 par value common
stock of the Company for a purchase price of $1.30 per share in a private
transaction, for total consideration of $2,999,999.60. Under the terms of the
agreement, Mr. Ullrich will purchase 1,153,846 shares on October 27, 2006 and
will purchase the remaining 1,153,846 shares on January 2, 2007.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3(i).1 Articles of Incorporation (Incorporated by reference from
registration statement on Form SB-2 filed with the SEC on July
29, 2002 (File No. 333-86830)
3(i).2 Certificate of Amendment of Certificate of Incorporation
(Incorporated by reference from registration statement on Form
SB-2 filed with the Securities and Exchange Commission on July
29, 2002 (File No. 333-86830)
3(ii).1 Bylaws (Incorporated by reference from registration statement on
Form SB-2 filed with the Securities and Exchange Commission on
April 24, 2002 (File No. 333-86830).
10.1 Termination Agreement by and between the Company and KES Science
and Technology, Inc., dated July 31, 2006. (Incorporated by
reference to Exhibit 10.13 of the Company's Form 10-QSB for the
quarter ended June 30, 2006).
10.2 Equilease Stock Purchase Agreement by and between the Company and
EOWORP, L.L.C. dated September 13, 2006.
10.3 Employment Agreement by and between the Company and Wade R.
Bradley dated October 24, 2006. (Incorporated by reference to
Exhibit 10.1 of the Company's Form 8-K dated October 30, 2006.)
31.1 Certification by Jay S. Potter under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by Brian D. Heinhold under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Jay S. Potter pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Brian D. Heinhold pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
26
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant cause
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated: November 3, 2006
ELECTRIC AQUAGENICS UNLIMITED, INC.
By: /s/ Jay S. Potter
---------------------------------
Jay S. Potter
Interim Chief Executive Officer
(Principal Executive Officer)
By: /s/ Brian D. Heinhold
---------------------------------
Interim Chief Financial Officer
(Principal Financial Officer)
27