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
June 30, 2006
or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
333-86830
---------------------
(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
incorporation or organization) Identification No.)
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 August 9, 2006, the Registrant had 10,972,825 shares of Common
Stock, $0.0001 par value outstanding.
Electric Aquagenics Unlimited, Inc.
QUARTERLY REPORT ON FORM 10-QSB
June 30, 2006
INDEX
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets - June 30, 2006 and 3
December 31, 2005
Consolidated Statements of Operations - Three and Six months 5
ended June 30, 2006 and 2005
Consolidated Statements of Cash Flows - Six months ended 6
June 30, 2006 and 2005
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis or Plan of Operation 13
ITEM 3. Controls and Procedures 21
PART II. OTHER INFORMATION
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 21
ITEM 5. Other Information 22
ITEM 6. Exhibits 22
SIGNATURES 25
2
PART I - FINANCIAL INFORMATION
Electric Aquagenics Unlimited, Inc.
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, December 31,
2006 2005
------------------ ------------------
CURRENT ASSETS (Unaudited) (Audited)
Cash and cash equivalents $ 882,279 $ 681,348
Accounts receivable, net 147,276 122,771
Accounts receivable - related party, net 266,418 1,061
Current portion of notes receivable 23,564 18,834
Current portion of notes receivable - related party 48,977 63,823
Inventory, net 2,555,496 2,003,902
------------------ ------------------
Total current assets 3,924,010 2,891,739
------------------ ------------------
PROPERTY AND EQUIPMENT, net of
accumulated depreciation of $321,567 and $245,211 741,749 946,702
------------------ ------------------
OTHER ASSETS
Notes receivable 55,335 72,555
Notes receivable - related party 304,178 306,829
Deposits 21,737 10,568
Intellectual property 1,222,546 1,207,459
Investments 374,075 374,075
------------------ ------------------
Total other assets 1,977,871 1,971,486
------------------ ------------------
Total assets $ 6,643,630 $ 5,809,927
================== ==================
See notes to consolidated financial statements.
3
Electric Aquagenics Unlimited, Inc.
CONSOLIDATED BALANCE SHEETS (Continued)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
June 30, December 31,
2006 2005
------------------ ------------------
Current liabilities (Unaudited) (Audited)
Accounts payable $ 929,833 $ 1,320,313
Accrued expenses 546,558 346,759
Warranty reserve 108,800 96,800
Advance deposits on machine orders - related party 577,000 ---
Current portion of long-term debt 27,738 38,675
------------------ ------------------
Total current liabilities 2,189,929 1,802,547
------------------ ------------------
LONG TERM LIABILITIES
Long term debt, net of current portion 112,716 157,001
Senior convertible note payable - related party,
net of discounts of $2,208,333 and $2,708,333 791,667 291,667
Deferred licensing revenue - related party 841,667 941,667
Derivative liability - related party (See Note 4) 4,694,807 5,353,716
------------------ ------------------
Total long term liabilities 6,440,857 6,744,051
------------------ ------------------
Total Liabilities 8,630,786 8,546,598
------------------ ------------------
STOCKHOLDERs' EQUITY (DEFICIT)
Common stock, $.0001 par value; 50,000,000 shares authorized;
10,947,825 and 9,322,825 issued and outstanding, respectively 1,095 933
Additional paid in capital 24,867,608 19,838,331
Accumulated deficit (26,855,859) (22,575,935)
------------------ ------------------
Total stockholders' equity (deficit) (1,987,156) (2,736,671)
------------------ ------------------
Total liabilities and stockholders' equity (deficit) $ 6,643,630 $ 5,809,927
================== ==================
See notes to consolidated financial statements.
4
Electric Aquagenics Unlimited, Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------------------ ------------------- ------------------ ------------------
(Restated) (Restated)
NET SALES - RELATED PARTY $ 309,619 $ 52,161 $ 708,219 $ 52,161
NET SALES 276,330 67,988 395,121 159,770
------------------ ------------------- ------------------ ------------------
TOTAL SALES 585,949 120,149 1,103,340 211,931
Cost of goods sold 361,307 47,358 681,053 81,152
------------------ ------------------- ------------------ ------------------
Gross profit 224,642 72,791 422,287 130,779
------------------ ------------------- ------------------ ------------------
OPERATING EXPENSES
Depreciation and amortization 50,970 33,372 105,850 65,872
Research and development 34,557 45,115 69,336 324,801
General and administrative 2,679,217 2,827,355 4,646,620 4,650,266
------------------ ------------------- ------------------ ------------------
Total operating expenses 2,764,744 2,905,842 4,821,806 5,040,939
------------------ ------------------- ------------------ ------------------
LOSS FROM OPERATIONS (2,540,102) (2,833,051) (4,399,519) (4,910,160)
------------------ ------------------- ------------------ ------------------
OTHER INCOME (EXPENSE)
Interest expense (294,688) (16,712) (583,794) (30,628)
Interest income 15,226 10,107 29,327 25,806
Gain (Loss) on derivative liability 636,503 --- 658,910 ---
Other income (expense) 15,152 364,505 15,152 338,503
------------------ ------------------- ------------------ ------------------
Total other income (expense) 372,193 357,900 119,595 333,681
------------------ ------------------- ------------------ ------------------
LOSS BEFORE PROVISION FOR INCOME TAXES (2,167,909) (2,475,151) (4,279,924) (4,576,479)
PROVISION FOR INCOME TAXES --- --- --- ---
------------------ ------------------- ------------------ ------------------
NET LOSS $ (2,167,909) $ (2,475,151) $ (4,279,924) $ (4,576,479)
================== =================== ================== ==================
NET LOSS PER SHARE $ (0.21) $ (0.29) $ (0.43) $ (0.56)
================== =================== ================== ==================
WEIGHTED AVERAGE OF SHARES OUTSTANDING 10,380,243 8,455,716 9,854,455 8,138,925
================== =================== ================== ==================
See notes to consolidated financial statements.
5
Electric Aquagenics Unlimited, Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months
Ended June 30,
2006 2005
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES (Restated)
Net loss $ (4,279,924) $ (4,576,479)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 105,850 65,872
Bad Debt expense 3,669 ---
Common stock issued for services --- 72,500
Warrants and options issued for services 1,029,192 1,424,050
Discount of note payable 500,000 ---
Loss on disposal of assets 72,736 ---
Gain on settlement of debt (14,597) ---
Changes in operating assets and liabilities:
(Increase) in accounts receivable (28,174) (82,008)
(Increase) decrease in accounts receivable - related party (265,357) 100,000
(Increase) in inventory (551,594) (1,404,359)
(Increase) in deposits (11,169) ---
Increase (decrease) in accounts payable (375,883) 1,195,202
Increase (decrease) in accrued expenses 199,799 (23,148)
Increase in warranty reserve 12,000 ---
Increase in advance deposits on machine orders - related party 577,000 ---
(Decrease) in deferred revenue (100,000) ---
(Decrease) in derivative liability (658,909) ---
------------------- -------------------
Net cash used in operating activities (3,785,361) (3,228,370)
------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of property and equipment (11,098) (595,461)
Investments --- 105,093
Payments received from notes receivable 12,490 11,661
Payments (Advances to) notes receivable - related party 17,497 (111,711)
Intellectual property disbursements (15,087) (12,631)
------------------- -------------------
Net cash provided (used) in investing activities 3,802 (603,049)
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable (17,757) (77,337)
Proceeds from notes payable - related party --- 163,000
Proceeds from issuance of common stock 4,000,247 3,524,452
Proceeds from common stock subscribed --- 2,125
------------------- -------------------
Net cash provided by financing activities 3,982,490 3,612,240
------------------- -------------------
NET INCREASE (DECREASE) IN CASH 200,931 (219,179)
CASH and cash equivalents, beginning of period 681,348 389,222
------------------- -------------------
CASH and cash equivalents, end of period $ 882,279 $ 170,043
=================== ===================
See notes to consolidated financial statements.
6
Electric Aquagenics Unlimited, Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Six Months Ended
June 30,
2006 2005
------------------- -------------------
(Restated)
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 33,522 $ 30,628
Income Taxes $ --- $ ---
Supplemental Disclosures of Non-cash Investing
and Financing Activities:
Common stock issued for services $ --- $ 72,500
Warrants issued for services $ 1,029,192 $ 1,424,050
See notes to consolidated financial statements.
7
Electric Aquagenics Unlimited, Inc.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed consolidated 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 consolidated
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 - PRINCIPLES OF CONSOLIDATION
The accompanying condensed consolidated financial statements include the
accounts of Electric Aquagenics Unlimited, Inc. and its wholly owned subsidiary
Equilease, Inc. (collectively, the "Company"). All significant intercompany
accounts and transactions have been eliminated.
NOTE 3 - INVENTORIES
The composition of inventories is as follows at:
June 30, December 31,
2006 2005
-------------- ----------------
Finished goods $ 249,693 $ 531,625
Raw materials 2,645,803 1,792,277
Allowance for obsolete inventory (340,000) (320,000)
-------------- ----------------
$ 2,555,496 $ 2,003,902
============== ================
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.
8
Electric Aquagenics Unlimited, Inc.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SENIOR CONVERTIBLE DEBT - continued
Because of this 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. As of June 30, 2006, the value of
the derivative liability is $4,694,807.
NOTE 5 - 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 six months ended June 30, 2006, the Company sold two large
water generators and related parts to Water Science for $349,500. Further, the
Company has received and recorded $577,000 in advance deposits from Water
Science on machine orders at June 30, 2006. The Company also sold approximately
$233,719 in products to an entity related to Water Science. In connection with
the sales of the machines and products, the Company has recorded approximately
$266,000 in accounts receivable at June 30, 2006. The Company did not have any
sales to this party for the six months ended June 30, 2005.
During the six months ended June 30, 2006, the Company sold one of its small
water generators to Zerorez, an affiliate for $25,000. The Company sold two of
its generators to Zerorez for $50,000 and other product sales of $2,121 during
the six months ended June 30, 2005
Notes Receivable - The Company provided financing for equipment to Zerorez
franchisees, which are related party entities. As of June 30, 2006 and 2005, the
Company had notes receivables of $353,155 and $370,652, respectively.
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 $500,000 in interest expense and has recorded a gain of
approximately $659,000 in the change of the derivative liability to fair market
value for the six months ended June 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 $100,000 for the six months ended June 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 Six Months Ended June 30,
---------------------------------
2006 2005
--------------- --------------
Warranty reserve at beginning of period $ 96,800 $ -
Costs accrued for additional warranties 12,000 -
Service obligations honored - -
--------------- ---------------
Warranty reserve at end of period $ 108,800 $ -
=============== ===============
9
Electric Aquagenics Unlimited, Inc.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - CAPITAL STOCK
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 June 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.
NOTE 9 - 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 six month period ended June 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 six month period ended June 30, 2006 was $254,854 and $569,640,
respectively, related to employee stock options issued and vesting during the
period. During the three and six month period ended June 30, 2005, the Company
recognized $0 and $602,100, respectively, in compensation expense related to
stock options.
10
Electric Aquagenics Unlimited, Inc.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 Six Months Ended
June 30, June 30,
------------------- ------------------ ------------------ ------------------
2006 2005 2006 2005
------------------- ------------------ ------------------ ------------------
Loss (numerator) $ (2,167,909) $ (2,475,151) $ (4,279,924) $ (4,576,479)
Shares (denominator) 10,380,243 8,455,716 9,854,455 8,138,925
Per share amount $ (0.21) $ (0.29) $ (0.43) $ (0.56)
The Company's outstanding stock options have been excluded from the basic net
loss per share calculation for the three and six month period ended June 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 six months ended June 30, 2006:
Number Weighted
of Options Average Exercise
and Warrants Price
------------ ----------------
Outstanding at beginning of period 4,653,292 $ 2.78
Granted 7,200,000 2.76
Exercised (25,000) .01
Forfeited - -
Expired - -
---------- -----------
Outstanding at end of period 11,828,292 $ 2.78
---------- -----------
A summary of the status of the warrants outstanding at June 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-.50 684,999 3.2 years $ 0.10 684,999 $ 0.10
1.00 - 1.99 290,000 2.2 years 1.48 290,000 1.48
2.00 - 2.99 9,250,000 2.8 years 2.76 9,250,000 2.76
3.00 - 3.99 1,084,917 3.9 years 3.29 1,084,917 3.29
4.00 - 4.99 255,000 3.3 years 4.00 255,000 4.00
5.00 - 5.50 263,376 3.4 years 5.15 263,376 5.15
----------- ----------- -------------- -------------- --------- --------------
$.01-5.50 11,828,292 2.7 years $ 2.78 11,828,292 $ 2.78
----------- ----------- -------------- -------------- --------- --------------
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%.
11
Electric Aquagenics Unlimited, Inc.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - RESTATEMENT
The Company restated its financial statements for the period ended December 31,
2004 and for the first and second quarters ending March 31, 2005 and June 30,
2005. The Company determined that generally accepted accounting principles had
not been followed in 2004 and for the second quarter 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 and second quarters quarter of 2005 are as follows:
Recognition of common stock and warrant issuances resulting in
additional consulting and compensation expense of $602,100.
The following table highlights the significant areas of change from those
previously reported:
Restated
As previously June 30,
reported June 30, 2005 2005 Change
------------------------ ----------------------- -----------------------
Total Assets $ 5,977,898 $ 5,809,927 $ (167,971)
Additional Paid $ (11,436,566) $ (19,838,331) $ (8,401,765)
in Capital
Accumulated deficit $ (8,702,789) $ (22,575,935) $ (13,873,146)
Total Equity $ (3,859,508) $ (2,736,671) $ 1,122,837
Net Sales $ 216,347 $ 211,931 $ (4,416)
Net Income (Loss) $ (2,536,449) $ (4,576,479) $ (2,040,030)
Basic Earnings $ (0.37) $ (0.56) $ (0.19)
(Loss) per Share
12
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"). For example,
our agricultural treatment products systemically treat all facets and phases of
the food chain, from soil to animal grain, by eliminating dangerous and
unhealthy pathogens and augmenting the same with natural organic growth
stimulating substances which are highly effective in increasing the growth in
plants and weight gain and production in animals. 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), Perfect Oxygenated
Therapy(TM) products (formerly marketed under the name "Aquagen(R) Stabilized
Oxygen Products") and our Perfect Hand Sanitizer and Protectant(TM). The fluids
that incorporate the EO Technology and our consumer products are environmentally
safe and non toxic. 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, and
3) 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. We believe if
further testing continues to be successful that our technology will be the only
non-toxic meat processing process available approved by the USDA.
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,
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.
13
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. 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 $882,279 in cash as of June 30, 2006, compared to $681,348 at
December 31, 2005. Our working capital as of June 30, 2006 was $1,734,081
compared to $1,089,192 at December 31, 2005. The primary reason for the increase
in our working capital for the six months ended June 30, 2006 was an increase in
cash from the sale of stock and warrants during the second quarter of 2006, an
increase in accounts receivable of $289,862, or 234%, and from an increase in
inventory of $551,594, or 28%. The Company has received and recorded $577,000 in
advance deposits from Water Science on machine orders at June 30, 2006. 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. This will be reduced as the Company delivers
machines on order to Water Science, a related party. The majority of these
14
deliveries are targeted to occur during the third quarter of 2006. Long term
debt increased 102%, from $448,668 at December 31, 2005 to $904,383 at June 30,
2006, or $455,715. The primary increase is a result of the discount of the
Senior Note Payable, which was $500,000 for the six months ended June 30, 2006.
At June 30, 2006, our stockholders' deficit was $1,987,156.
Summary of select balance sheet information follows:
June 30, December 31,
2006 2005
------------ -------------
Balance Sheet Data:
Cash and Cash Equivalents $ 882,279 $ 681,348
Total Current Assets 3,924,010 2,891,739
Total Assets 6,643,630 5,809,927
Total Current Liabilities 2,189,929 1,802,547
Long Term Debt 904,383 448,668
Total liabilities and stockholders' equity $ 6,643,630 $ 5,809,927
Results of Operations for the three months ended June 30, 2006 and 2005
Revenues and Net Income
The Company had total revenues of $585,949 for the three months ended June 30,
2006, which represents an increase of 388% from the $120,149 in total revenues
for the same period one year earlier. A majority of this increase came from
consumer products sales of approximately $149,000 and EO Machine sales of
approximately $349,000 in the current three month period versus approximately
$74,000 consumer product sales and $0 EO Machine sales in the three months ended
June 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 eight 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.
Net loss for the three months ended June 30, 2006 was $2,167,909, or a loss of
$0.21 per share, compared with a net loss of $2,475,151, or $0.29 per share for
the same period in 2005. Part of the decrease in the loss per share over the
comparable period in 2005 was due to 1,924,527 additional outstanding shares in
2006 versus the prior year. The current quarter net loss includes an increase of
$277,976 in interest expense, from $16,712 in 2005 to $294,688 in 2006, or an
increase of 1,663%. This is due to interest expense related to the senior note
payable entered into in September 2005. This expense was offset by a gain
realized in the recording of the derivative liability to fair market value of
$636,503 and interest income of $15,226. This compares to $0 gain realized in
the recording of the derivative liability to fair market value and $10,107 in
interest income during the same period in 2005.
General and Administrative Expenses
The Company's general and administrative expenses totaled $2,679,217 during the
three months ended June 30, 2006, compared to $2,827,355 during the three months
ended June 30, 2005, for a decrease of $148,138, or 5%. General and
administrative expense for 2006 consists primarily of compensation expense
($831,906), payroll expense ($745,700), professional fees ($453,395), capital
funding fees ($225,058) and travel related expenses ($84,141). 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.
15
Research and Development
Research and development expenses incurred during the three month period ended
June 30, 2006 decreased $10,558 or 23% compared to those 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. 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
June 30,
--------------------------- Percent
2006 2005 Better (Worse) Change
------------ ------------- --------------- ---------
Revenue, net $ 585,949 $ 120,149 $ 465,800 388%
Gross profit 224,642 72,791 151,851 209%
Operating loss 2,540,102 2,833,051 292,949 10%
Net loss 2,167,909 2,475,151 307,242 12%
Loss per share $ 0.21 $ 0.29 $ 0.08 28%
Results of Operations for the six months ended June 30, 2006 and 2005
Revenues and Net Income
The Company had total revenues of $1,103,340 for the six months ended June 30,
2006, which represents an increase of 421% from the $211,931 in total revenues
for the six months ended June 30, 2005. A majority of this increase came from
consumer products sales of approximately $355,000 and agriculture enhancement
products of approximately $583,000 in the current six month period versus
approximately $146,000 consumer product sales and no agriculture enhancement
product sales in the six months ended June 30, 2005.
Net loss for the six months ended June 30, 2006 was $4,279,924, or a loss of
$0.43 per share, compared with a net loss of $4,576,479, or $0.56 per share for
the same period in 2005. The current quarter net loss includes an increase of
$553,166 in interest expense, from $30,628 in 2005 to $583,794 in 2006, or an
increase of 1,806%. This is due to interest expense related to the senior note
payable entered into in September 2005. This expense was offset primarily by a
gain realized in the recording of the derivative liability to fair market value
of $658,910 compared to $0 gain 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 $4,520,120 during the
six months ended June 30, 2006, compared to $4,650,266 during the six months
ended June 30, 2005, for a decrease of $130,146, or 3%. General and
administrative expense for 2006 consists primarily of payroll expense
16
($1,458,730), compensation expense ($1,155,692), professional fees ($811,840),
capital funding fees ($234,667) and travel related expenses ($216,073). 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 June 30, 2006
decreased $255,465 or 79% 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:
Six months ended
June 30,
--------------------------- Percent
2006 2005 Better (Worse) Change
------------ ------------- --------------- ---------
Revenue, net $ 1,103,340 $ 211,931 $ 891,409 421%
Gross profit (loss) 422,287 130,779 291,508 223%
Operating loss 4,399,519 4,910,160 510,641 10%
Net loss 4,279,924 4,576,479 296,555 6%
Loss per share $ 0.43 $ 0.56 0.13 23%
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 six months ended June 30, 2006, the Company sold two large
water generators and related parts to Water Science for $349,500. Further, the
Company has received and recorded $577,000 in advance deposits from Water
Science on machine orders at June 30, 2006. The Company also sold approximately
$233,719 in products to an entity related to Water Science. In connection with
the sales of the machines and products, the Company has recorded approximately
$266,000 in accounts receivable at June 30, 2006. The Company did not have any
sales to this party for the six months ended June 30, 2005.
During the six months ended June 30, 2006, the Company sold one of its small
water generators to Zerorez, an affiliate for $25,000. The Company sold two of
its generators to Zerorez for $50,000 and other product sales of $2,121 during
the six months ended June 30, 2005
Notes Receivable - The Company provided financing for equipment to Zerorez
franchisees, which are related party entities. As of June 30, 2006 and 2005, the
Company had notes receivables of $353,155 and $370,652, respectively.
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 $500,000 in interest expense and has recorded a gain of
approximately $659,000 in the change of the derivative liability to fair market
value for the six months ended June 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 $100,000 for the six months ended June 30, 2006.
17
Liquidity and Capital Resources
At June 30, 2006, we had cash and cash equivalents of $882,279, compared to
$681,348 at December 31, 2005. We have had continuing operating losses of
$2,540,102 and $4,399,519 for the three and six months ended June 30, 2006,
respectively, compared with operating losses of $2,833,051 and $4,910,160 for
the three and six months ended June 30, 2005, respectively. The net loss per
share for the second quarter of 2006 was $(0.42) per share compared to a $(0.56)
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 June 30, 2006 was
$1,860,581 for reasons discussed above under financial position.
Net cash used in operating activities in the six month period ended June 30,
2006 was $3,785,361, a 15% increase, compared to $3,228,370 for the same period
in 2005. The primary uses of cash were an increase in inventory of $551,594, an
increase of accounts receivable of $293,531 and a decrease in accounts payable
of $375,883. Advances on machine orders increased $577,000 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 June 30, 2006, the Company's inventory was $2,555,496, representing an
increase of 28% 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 $1,029,192. 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
discounting of the Company's note payable to Water Science, LLC of $500,000. See
Note 4 to the Company's unaudited consolidated financial statements. Further,
the Company recognized a non-cash decrease in the derivative liability of
$658,909, due to changes in the Black-Scholes value of the liability.
Cash flows from investing activities provided the Company $3,802 during the
period ended June 30, 2006 as compared $603,049 used for the same period in
2005. During 2006, the cash flows consisted of cash receipts of $29,987 from
notes receivable, investments in intellectual property and patents of $15,087
and purchase of equipment of $11,098. This compares to $595,461 used to purchase
equipment, $100,050 net cash used to purchase notes receivables, $105,093 used
to purchase investments and $12,631 used to invest in intellectual property and
patents for the comparable period in 2005.
Cash flows from financing activities provided the Company $3,982,490 and
$3,612,240 for the six months ended June 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 $4,000,247 and $3,524,452 from the sale of
stock for the six months ended June 30, 2006 and 2005, respectively. This amount
was offset by payments made on notes payable in the amount of $17,757 and
$77,337 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. We anticipate that we will need approximately two to
three million dollars in funding to execute our business plan over the next
twelve months and at least an additional $5,000,000 or more in funding
thereafter. Moreover, if we able to expand our sale of EO machines as
anticipated, we will need significant additional working capital to fund that
18
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
Proceeds from the private sale of our common stock to Water Science, LLC should
be sufficient to fund our continuing operations at our current level through at
least August 2006 or later depending on the ability of the Company to generate
sales. Management recognizes that additional funding will be required to finance
growth and to achieve our strategic objectives. Management is actively pursuing
additional sources of funding. We have no contractual arrangements that will
provide us with funds and there can be no assurance that we will obtain the
necessary funding, or that such funding, if obtained, will be on terms that are
favorable to the Company or its shareholders. Failure to raise the required
capital could prevent us from achieving our business objectives and may result
in substantially reducing or even terminating operations.
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. Financing transactions in the future may include the issuance of
equity or debt securities, obtaining credit facilities, or other financing
mechanisms.
Management recognizes that we will likely need to raise additional capital
during 2006 in order to continue operations and is currently attempting to do
so. If we are unable to raise such additional capital, 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,
which could have a material adverse impact on our business.
Future financing transactions may include the issuance of equity or debt
securities, obtaining credit facilities, or other financing mechanisms. However,
inability to establish a public market for our common stock, or once we have a
market for our common stock, 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.
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
consolidated 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
19
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.
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
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 six month period ended June 30, 2006 was $254,854 and $569,640,
respectively, related to employee stock options issued and vesting during the
period. During the three and six month period ended June 30, 2005, the Company
recognized $0 and $602,100, respectively, in compensation expense related to
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
20
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.
Inflation
We do not expect the impact of inflation on operations to be significant.
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
21
forward-looking statements contained herein will be realized. 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 of March 31, 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 are effective.
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 2. Unregistered Sales of Equity Securities and Use of Proceeds
On May 1, 2006, we entered into a Subscription Agreement, a Warrant Agreement, a
Registration Rights Agreement and an Amended and Restated Exclusive License and
Distribution Agreement with Water Science, LLC, a Florida limited liability
company ("Water Science") an accredited and sophisticated investor and our
senior lender and a major customer. Pursuant to the Subscription Agreement, we
sold and issued to Water Science 1,600,000 shares of our $0.0001 par value
common stock for an aggregate purchase price of $4 million, or $2.50 per share.
Pursuant to the Warrant Agreement, we granted to Water Science a three-year
warrant to purchase up to a total of 6,400,000 shares of our $0.0001 par value
common stock for a purchase price of $2.76 per share.
Pursuant to the Registration Rights Agreement, we agreed to register with the
Securities and Exchange Commission all of the shares purchased by the
Subscription Agreement and all of the shares underlying the Warrant Agreement
during the period between the one year anniversary and the two year anniversary
of the date of the Registration Rights Agreement.
Pursuant to the Amended and Restated Exclusive License and Distribution
Agreement, certain terms in the original Exclusive License and Distribution
Agreement entered into between Water Science and us on or about September 19,
2005, were clarified, specifically with respect to what products and technology
is intended to be covered by the License Agreement, and to specify the initial
pricing with respect to such products.
We paid a placement fee of $240,000 to SunTrust Robinson Humphrey Capital
Markets Division ("SunTrust") in connection with the placement of the 1,600,000
shares of common stock. The placement fee was paid to SunTrust pursuant to the
terms of an Engagement Letter dated October 31, 2005 (the "Engagement Letter")
whereby SunTrust was appointed as our exclusive placement agent in connection
with the sale of securities. Pursuant to the terms of the Engagement Letter,
which may be terminated by either party at any time, SunTrust is entitled to a
placement fee of 6.0% of the gross proceeds received by the Company from any
sale by the Company of its securities.
22
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.
On May 1, 2006, a part of the consulting agreement with JL Montgomery
Consulting, LLC, a Florida limited liability company and an accredited and
sophisticated investor, for services to be rendered in the future, 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. The sale of the 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. The parties are currently negotiating the
future terms of the current agreement.
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 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
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.
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).
23
10.1 Senior Convertible Note by and between the Company and Water
Science, LLC, in the principal amount of $3,000,000, dated
September 16, 2005 (Incorporated by reference to Exhibit 10.2
of the Company's Form 8-K/A, dated October 12, 2005)
10.2 Registration Rights Agreement by and between the Company and
Water Science, LLC, dated May 1, 2006 (Incorporated by
reference to Exhibit 10.3 of the Company's Form 8-K, dated May
4, 2006)
10.3 Amended and Restated Exclusive License and Distribution
Agreement, by and between the Company and Water Science, LLC,
dated May 1, 2006. (Incorporated by reference to Exhibit 10.4
of the Company's Form 8-K, dated May 4, 2006)
10.4 Warrant Agreement by and between the Company and Water
Science, LLC, dated May 1, 2006. (Incorporated by reference to
Exhibit 10.2 of the Company's Form 8-K, dated May 4, 2006)
10.5 Subscription Agreement by and between the Company and Water
Science, LLC, dated May 1, 2006. (Incorporated by reference to
Exhibit 10.1 of the Company's Form 8-K, dated May 4, 2006)
10.6 Consulting Agreement by and between the Company and JL
Montgomery Consulting, LLC, dated May 1, 2006 (Incorporated by
reference to Exhibit 10.13 of the Company's Form 10-QSB, dated
May 15, 2006)
10.7 Separation Agreement by and between the Company and Gaylord
Karren, dated May 26, 2006 (Incorporated by reference to
Exhibit 10.1 of the Company's Form 8-K, dated June 2, 2006)
10.8 Termination Agreement by and between the Company and Coating
Systems Laboratories, dated June 15, 2006.
10.9 Agreement by and between the Company and Coating Systems
Laboratories, dated June 20, 2006.
10.10 Termination Agreement by and between the Company and KES
Science and Technology, Inc., dated July 31, 2006.
31.1 Certification by Jay S. Potter under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by H. Warren Jaynes 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 H. Warren Jaynes pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
24
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: August 11, 2006 ELECTRIC AQUAGENICS UNLIMITED, INC.
By: /s/ Jay S. Potter
--------------------------------------
Jay S. Potter
Interim Chief Executive Officer
(Principal Executive Officer)
By: /s/ H. Warren Jaynes
--------------------------------------
H. Warren Jaynes
Chief Financial Officer
(Principal Financial Officer)
25