NOTES TO FINANCIAL STATEMENTS
NOTE 1 - BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES
Business Description
–
EAU Technologies, Inc. (the “Company” or “EAU”), was incorporated on March 6, 2000, under the laws of the state of Delaware and commenced operations in September, 2000 as Primacide, Inc. On May 10, 2001, the Company changed its name from Primacide, Inc., to Electric Aquagenics Unlimited, Inc. On January 17, 2007 the Company changed its name from Electric Aquagenics Unlimited, Inc. to EAU Technologies, Inc. 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 commercial food processing organic or non-organic agricultural and consumer products that clean, disinfect, remediate, hydrate and moisturize. These products, which the Company intends to market nationally and internationally, are for commercial and residential use. The Company’s financial statements are presented in accordance with accounting principles generally accepted in the United States of America.
Cash and Cash Equivalents
- For purposes of the balance sheet and statement of cash flows, the Company considers all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents.
Receivables
– Receivables represent valid claims against debtors for sales or other charges arising on or before the balance-sheet date and are reduced to their estimated net realizable value. The Company estimates allowances for doubtful accounts based on the aged receivable balances and historical losses. The Company charges off uncollectible accounts receivable when management estimates no possibility of collecting the related receivable.
Inventory
– Inventory, consisting primarily of finished goods, is stated at the lower of cost or market; cost is determined on first-in, first-out (FIFO) method.
Property and Equipment, and Depreciation
– Property and equipment are recorded at historical cost. Expenditures for additions and major improvements that extend the life of the asset are capitalized, whereas the cost of maintenance and repairs are expensed as incurred. The Company is currently testing its system in multiple locations. Upon completion of the tests, and once the lease for the system has started, the cost of the system will be transferred from inventory to property and equipment. Depreciation is computed on the straight-line method over the estimated useful lives of the assets ranging from three to seven years. Depreciation expense for the years ended December 31, 2012 and 2011 was $2,366 and $8,043, respectively. In September 2005, the Company pledged all the assets of the Company as collateral for the Senior Convertible Note, payable to Water Science, a related party. In December 2011, the Senior Convertible Note was extended to November 2013.
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.
Fair Value of Financial Instruments
–
The carrying values of cash on hand, receivables, payables and accrued expenses approximate their fair value due to the short period to maturity of these instruments.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES (continued)
Recognition of Sales and Costs of Goods Sold
– The Company records sales of its products based upon the terms of the contract; when title passes to its customers; and, when collectability is reasonably assured. The Company provides an allowance for sales returns based on current and historical experience. Cost of goods sold consists of the purchase price of products sold including inbound shipping charges.
Sales Taxes
-
In accordance with FASB ASC 605-45, formerly EITF Issue No. 06-3,
How Taxes Collected From Customers and Remitted to Government Authorities Should be Presented in the Income Statement
, the Company accounts for sales taxes imposed on its good and services on a gross basis in the statements of operations. For the years ended December 31, 2012 and 2011, respectively, $2,665 and $10,825 of sales taxes has been reported in revenues.
Warranties
–
The Company warrants its products against defects in materials and workmanship for a period of up to three years. The Company has accrued a reserve for these anticipated future warranty costs.
Income Taxes
–
Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.
Accounting Estimates
- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Research and Development –
Research and development costs are expensed as incurred. Research and development expenses for the years ended December 31, 2012 and 2011 were approximately $7,500 and $37,500, respectively.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES (continued)
Patents, Trademarks and Intellectual Property
–
Patents, trademarks and intellectual property, consisting of trade secrets and formulas are recorded in accordance with Accounting Standards Codification 350,
Intangibles – Goodwill and Other
(ASC 350), (formerly Statement of Financial Accounting Standards “SFAS” No. 142, "Goodwill and Other Intangible Assets"). As such, patents and trademarks are initially measured based on their fair values.
Loss Per Share
–
The Company follows the provisions of ASC Topic 260 "Earnings Per Share". Earnings per share (EPS) are computed based on the weighted average number of shares actually outstanding. No changes in the computation of diluted earnings per share amounts are presented because warrants granted would have been anti-dilutive due to the Company’s net reported loss.
Stock Based Compensation
-
Stock-based compensation is calculated according to FASB ASC Topic 718,
Compensation — Stock Compensation
, which requires a fair-value-based measurement method to account for stock-based compensation. The Company has modified the price of stock options to employees and directors. The Company accounts for the incremental value of the modified options based on the excess of the fair value of the modified award based on current circumstances. The modifications made to the Company’s equity awards did not result in significant incremental compensation costs, either individually or in the aggregate.
Recently Enacted Accounting Standards
In February 2013, the FASB issued guidance that requires an entity to present information about reclassification adjustments from accumulated other comprehensive income in their financial statements or footnotes. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2012. We do not expect the adoption will have a material impact on our financial statements.
In July 2012, the FASB issued guidance that will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for indefinite-lived intangible assets. If entities determine, based on qualitative factors, the fair value of the asset is more likely than not less than the carrying value, the two-step impairment test would be required. This guidance is effective for fiscal years beginning after September 15, 2012, with early adoption permitted. We do not expect the adoption will have a material impact on our financial position, results of operations or cash flows.
NOTE 2 - CONCENTRATIONS OF CREDIT RISK
The Company occasionally maintains cash balances in excess of the $250,000 federally insured limit. As of December 31, 2012 the Company had a total of $433,619 in cash in excess of this limit. To date, the Company has not incurred, and the Company’s management does not currently expect to incur, any losses associated with its cash balances.
The Company extends unsecured credit to its customers in the normal course of business. Periodically, the Company performs credit evaluations of its customers’ financial condition for determination of doubtful accounts.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 3 - TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable consist of the following at December 31:
|
|
2012
|
|
|
2011
|
|
Trade accounts receivable
|
|
$
|
2,500
|
|
|
$
|
83,378
|
|
Trade accounts receivable – related party
|
|
|
5,500
|
|
|
|
5,500
|
|
Less allowance for doubtful accounts
|
|
|
-
|
|
|
|
-
|
|
|
|
$
|
8,000
|
|
|
$
|
88,878
|
|
During 2012, sales to three customers represented 58%, 14% and 11% of our revenues, for a total of 83% of total revenues. During 2011, sales to three customers represented approximately 87% of our revenues. Bad debt expense for the years ended December 31, 2012 and 2011 was $0 and $0, respectively.
NOTE 4 - INVENTORIES
The composition of inventories is as follows at December 31:
|
|
2012
|
|
|
2011
|
|
Finished goods
|
|
$
|
645,604
|
|
|
$
|
550,197
|
|
Raw materials
|
|
|
829,362
|
|
|
|
1,023,716
|
|
Allowance for obsolete inventory
|
|
|
(305,000
|
)
|
|
|
(400,000
|
)
|
|
|
$
|
1,169,966
|
|
|
$
|
1,173,913
|
|
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
|
|
2012
|
|
|
2011
|
|
Machinery and equipment
|
|
$
|
41,301
|
|
|
$
|
41,301
|
|
Furniture and fixtures
|
|
|
47,284
|
|
|
|
47,284
|
|
Leasehold improvements
|
|
|
32,136
|
|
|
|
32,136
|
|
Total property and equipment
|
|
|
120,721
|
|
|
|
120,721
|
|
Less: accumulated depreciation
|
|
|
(120,721
|
)
|
|
|
(119,712
|
)
|
Property and equipment, net
|
|
$
|
-
|
|
|
$
|
1,009
|
|
Depreciation expense for the year ended December 31, 2012 and 2011 was $1,009 and $8,043, respectively.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 6 - LEASED EQUIPMENT
At December 31, 2012, leased assets consisted of equipment that had been placed in service and were under operating lease agreements with two customers. Each system is custom designed for the size and fluid requirements of the application with each lessee. We recorded $0 and $168,000 in revenues from the lease of these systems for the year ended December 31, 2012 and 2011, respectively.
In December 2009, the Company received notice from one of the lease customers of its intent to cancel the lease. At that time the Company recognized impairment in the value of those related leased assets in the amount of $248,478. The Company is currently involved in legal action with that lease customer (see Note 13).
In January 2012, we received notice that the other customer who had been leasing our system, completed their bankruptcy proceedings. The new owner informed us that they would not be renewing the lease and has discontinued the use of our system. It was determined that no additional impairment of the related leased equipment would be necessary beyond depreciation already recognized.
|
|
2012
|
|
|
2011
|
|
Leased equipment
|
|
|
1,105,809
|
|
|
|
1,105,809
|
|
Less: accumulated depreciation
|
|
|
(254,383
|
)
|
|
|
(254,383
|
)
|
Less: accumulated impairment of equipment
|
|
|
(248,478
|
)
|
|
|
(248,478
|
)
|
Leased equipment, net
|
|
$
|
602,948
|
|
|
$
|
602,948
|
|
Depreciation expense on leased equipment for the year ended December 31, 2012 and 2011 was $0 and $53,173, respectively, all of which has been included in cost of goods sold.
NOTE 7 - INTANGIBLE ASSETS
Patents, trademarks and intellectual property, consisting of trade secrets and formulas are recorded in accordance with Accounting Standards Codification 350,
Intangibles – Goodwill and Other
(ASC 350), (formerly Statement of Financial Accounting Standards “SFAS” No. 142, "Goodwill and Other Intangible Assets"). As such, patents are initially measured based on their fair values. The patents which have been granted are being amortized over a period of 20 years. Patents which are pending or are being developed are not amortized until a patent has been issued. The amount of intangible assets, consisting of patents, as of December 31, 2012 is as follows:
|
|
2012
|
|
|
2011
|
|
Gross amount of patents
|
|
$
|
141,945
|
|
|
$
|
126,106
|
|
Less amount of accumulated amortization
|
|
|
(4,714
|
)
|
|
|
(3,357
|
)
|
Net value of patents
|
|
$
|
137,231
|
|
|
$
|
122,749
|
|
Amortization expense for the fiscal years ended December 31, 2012 and 2011 was $1,357 and $1,357, respectively.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 7 - INTANGIBLE ASSETS – (Continued)
The estimated amortization expense, based on current intangible balances, for the next fiscal years beginning January 1, 2013 is as follows:
2013
|
|
$
|
1,357
|
|
2014
|
|
$
|
1,357
|
|
2015
|
|
$
|
1,357
|
|
2016
|
|
$
|
1,357
|
|
2017
|
|
$
|
1,357
|
|
NOTE 8 - RELATED PARTY TRANSACTIONS
Sales to Affiliates –
In September 2005, Water Science, a related party, paid to the Company $1,000,000 for the exclusive rights to sell our products in South America and Mexico. The agreement allows for a pro-rated refund during the first 5 years under certain circumstances. The Company recognizes income from this agreement over the first 5 years of the agreement. The Company fully recognized the exclusivity rights during 2010. This agreement also gives Water Science the rights to purchase machinery from the Company at cost plus 25 percent. T
he Company had sales of $273,011 and $3,192 during the years ended December 31, 2012 and 2011, respectively. T
he Company has received and recorded $515,383 and $763,393 in advance deposits from Water Science on machine orders at
December 31, 2012 and 2011, respectively
.
Convertible Note Payable –
See Note 10 for disclosure of related party Convertible Notes Payable.
Advances
– Periodically throughout the year, the Company advances officers and employees cash for certain reimbursable expenses. As of December 31, 2012 and 2011, the Company had advances to employees or officers in the amount of $5,500.
Employee Options
– In December 2007, the Company granted 480,260 options to various employees. The options are for a term of ten (10) years and have an exercise price of $1.30 per share. The options vested over a period of four (4) years. The options were valued using the Binomial model with the following assumptions: risk free rate of 4.64%, volatility at 87.06% and the stock price at $1.30. The value of each option was approximately $1.13. In May 2009, 36,000 options were cancelled due to the departure of an employee. The exercise price per option was adjusted to $0.31 by the Company in September 2010. The options were fully vested as of December 31, 2012. The Company recognized $0 and $74,709 in expenses related to the vesting of these options during the years ended December 31, 2012 and 2011, respectively.
In November 2007, the Company granted 530,000 options to Douglas Kindred, in connection with the appointment of Mr. Kindred as Chief Technology Officer. The options are for a term of ten (10) years and have an exercise price of $1.30 per share. The options vested over a period of four (4) years. The options were valued using the Binomial model with the following assumptions: risk free rate of 4.28%, volatility at 85.99% and the stock price at $1.01. The exercise price per option was adjusted to $0.31 by the Company in September 2010. The options were fully vested as of December 31, 2012. The Company recognized $0 and $44,690 in expenses related to the vesting of these options during the years ended December 31, 2012 and 2011.
Director Options
– See Note 11 for disclosure about grants of director stock options.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 9 - 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 Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Warranty reserve at beginning of period
|
|
|
120,000
|
|
|
$
|
72,796
|
|
Costs accrued for additional warranties
|
|
|
25,894
|
|
|
|
51,193
|
|
Service obligations honored
|
|
|
(894
|
)
|
|
|
(3,989
|
)
|
Warranty reserve at end of period
|
|
$
|
145,000
|
|
|
$
|
120,000
|
|
NOTE 10 - CONVERTIBLE NOTES PAYABLE – RELATED PARTY
In January 2013, the Company entered into a loan agreement with a related party. The principal amount of the Note is $1,325,000. The funds had been advanced to the Company at various times throughout 2012. The Loan Agreement provides for interest at a rate of 10% annually and will mature on November 30, 2013. The outstanding balance under the Loan Agreement is convertible into shares of the Company’s common stock at $0.31 per share and no principal or interest payments are due until maturity. The Loan Agreement provides that accrued interest and the outstanding principal balance can be prepaid, in whole or in part, at any time without premium or penalty. In connection with the negotiation of the Loan Agreement, the Company also granted a warrant to purchase up to 1,325,000 shares of the Company’s common stock at an exercise of $0.31 per share. The warrant expires on January 31, 2018.
In September 2005, the Company entered into a Senior Convertible Note (the “Note”) with Water Science, a related party, in exchange for $3,000,000. Pursuant to the debt agreement, the Note accrues interest at the rate of 3% per annum and was initially due, principal and interest together, on September 16, 2008. In June 2008, Water Science agreed to extend the maturity date of the Note to March 16, 2009. In March 2009, the Company and Water Science agreed to extend the maturity date to September 16, 2009 and increase the interest rate to 10%. No principal or interest payments need to be paid during the loan period. In October 2008, as part of a new financing agreement, the Company amended the Note and changed the conversion rate from $3.00 per share to $1.00 per share. The Note may be converted into 3,000,000 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 $1.00 per share, subject to certain other conversion adjustments. The Company granted a security interest in all of the Company’s assets as collateral for the loan. In connection with the original issuance of the Note, the Company granted a three year warrant to purchase up to two million shares of the Company’s $0.0001 par value common stock with an exercise price of $2.76 per share.
In August 2009 and October 2010, the Company entered into agreements with Water Science, a related party, to extend the maturity dates of the Promissory Note from September 16, 2009 to November 1, 2010 and to December 1, 2011, respectively.
In December 2011, the Company and Water Science agreed to again extend the maturity date of the Promissory Note this time to November 30, 2013.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 10 - CONVERTIBLE NOTES PAYABLE – RELATED PARTY – (Continued)
In December 2011, the Company entered into an agreement to convert $358,527 of accrued interest into a new convertible note. Simple interest will accrue at a rate of 10% per annum on the unpaid principal amount outstanding and the loan will mature on November 30, 2013, at which time accrued interest and the outstanding principal balance shall be due. The agreement contains an optional conversion right, whereby the Lender may convert all or any portion of the outstanding principal and interest due into shares of the Company’s common stock at a price per share equal to $1.00 per share. In connection with the issuance of the convertible note, the Company granted a five year warrant to purchase up to 358,527 shares of the Company’s $0.0001 par value common stock with an exercise price of $0.31 per share.
NOTE 11 - COMMON STOCK
In January 2013, the Compensation Committee of the Board of Directors of the Company authorized the Company to grant each director 96,775 warrants for the purchase of common stock at $0.31 per share for the current year compensation for the year of service the director will serve as a member of the Board of Directors, pursuant to the Company’s Board of Directors compensation plan. The option will vest ratably over a period of two years from the date of when the option was granted. These grants were made pursuant to the annual directors’ compensation program approved by the Board in December 2007.
In December 2011, the Compensation Committee of the Board of Directors of the Company authorized the Company to grant to each board member 96,775 options to purchase shares of the Company’s common stock at an exercise price of $0.31 per share for each director for the years of service 2010, 2011 and 2012 for a total of 290,325 options each, effective on January 1, 2012. A portion of the options vested immediately while some will vest over a period of two years from the date of grant as follows: 145,163 immediately, 96,775 on January 1, 2013 and 48,387 on January 1, 2014. The grants were made in March 2012 and were granted pursuant to the annual directors’ compensation program approved by the Board in December 2007. The Board also granted 48,388 options to Karl Hellman for his year of service in 2009.
In December 2011, Theodore Jacoby, a director of the Company, purchased 161,291 shares of common stock of the Company for $50,000 at a price of $0.31 per share.
In December 2011, Peter Ullrich, a director of the Company, agreed to exercise 5,806,452 shares of common stock of the Company for $1,800,000, or $0.31 per share. The principle amount of two loans with total value of $1,800,000 was used as consideration for the exercise price. Mr. Ullrich also agreed to purchase 2,593,549 shares of the Company’s common stock for $804,000, or $0.31 per share, which Mr. Ullrich had advanced to the Company during 2011.
A summary of the status of common stock options and warrants outstanding at December 31, 2012 and 2011, and changes during the years then ended is presented below.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 11 - COMMON STOCK - (Continued)
|
|
For the years ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
Shares
|
|
|
Weighted Average Exercise Price
|
|
|
Shares
|
|
|
Weighted Average Exercise Price
|
|
Outstanding at beginning of period
|
|
|
3,688,066
|
|
|
$
|
0.31
|
|
|
|
9,185,991
|
|
|
$
|
0.32
|
|
Granted
|
|
|
1,209,688
|
|
|
|
0.31
|
|
|
|
358,527
|
|
|
|
0.31
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,806,452
|
)
|
|
|
0.31
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
(50,000
|
)
|
|
|
1.88
|
|
Outstanding at end of period
|
|
|
4,897,754
|
|
|
$
|
0.31
|
|
|
|
3,688,066
|
|
|
$
|
0.31
|
|
Weighted average fair value of options and warrants exercisable
|
|
|
4,897,754
|
|
|
$
|
0.31
|
|
|
|
3,688,066
|
|
|
$
|
0.31
|
|
A summary of the status of the options and warrants outstanding at December 31, 2012 is presented below:
|
|
|
Warrants Outstanding
|
|
|
Warrants Exercisable
|
|
Range of
Exercise
Prices
|
|
|
Number
Outstanding
|
|
|
Weighted-Average
Remaining
Contra Life
|
|
|
Weighted-Average
Exercise Price
|
|
|
Number
Exercisable
|
|
|
Weighted Average
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
.01-.50
|
|
|
|
4,897,754
|
|
|
|
5.0 years
|
|
|
$
|
0.31
|
|
|
|
4,317,106
|
|
|
$
|
0.31
|
|
The fair value of each option and warrant granted is estimated on the date granted using the Binomial pricing model, with the following assumptions used for the grants: risk-free interest rate of 1.15%, expected dividend yield of zero, expected lives of five years and expected volatility of 246%.
NOTE 12 - INCOME TAXES
The Company accounts for income taxes in accordance with ASC 740,
Income Taxes
. ASC 740 requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carryforwards. At December 31, 2012 and 2011, the total of all deferred tax assets was approximately $16,436,000 and $15,247,000, respectively, and the total of the deferred tax liabilities was approximately $0 and $0, respectively. The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company’s future earnings, and other future events, the effects of which cannot be determined. Because of the uncertainty surrounding the realization of the deferred tax assets, the Company established a valuation allowance of approximately $16,436,000 and $15,247,000 as of December 31, 2012 and 2011, respectively, which has been offset against the deferred tax assets. The net change in the valuation allowance during the year ended December 31, 2012, was approximately $1,189,000.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 12 - INCOME TAXES – (Continued)
The Company has available at December 31, 2012, unused tax operating loss carryforwards of approximately $41,940,000, which may be applied against future taxable income and expire in various years through 2032.
The components of income tax expense from continuing operations for the years ended December 31, 2012 and 2011 consist of the following:
|
|
Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Current income tax expense:
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Net current tax expense
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense (benefit) arising from:
|
|
|
|
|
|
|
|
|
Net operating income (loss)
|
|
$
|
(757,900
|
)
|
|
$
|
(
1,135,900
|
)
|
Excess of tax over financial accounting depreciation
|
|
|
(43,900
|
)
|
|
|
(25,400
|
)
|
Stock for services
|
|
|
44,800
|
|
|
|
116,400
|
|
Accrued interest
|
|
|
150,000
|
|
|
|
63,900
|
|
Reserve for bad debts
|
|
|
-
|
|
|
|
(10,300
|
)
|
Warranty reserve
|
|
|
9,300
|
|
|
|
17,600
|
|
Amortization of debt discounts
|
|
|
16,700
|
|
|
|
236,400
|
|
Section 263(A)
|
|
|
1,800
|
|
|
|
11,800
|
|
Other – meals & entertainment, change in allowance for Obsolete
|
|
|
|
|
|
|
|
|
inventory, gain on settlement of accrued contingent liability
|
|
|
(128,200
|
)
|
|
|
1,900
|
|
Valuation allowance
|
|
|
707,400
|
|
|
|
723,600
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax expense
|
|
$
|
-
|
|
|
$
|
-
|
|
Deferred income tax expense results primarily from the reversal of temporary timing differences between tax and financial statement income.
The temporary differences gave rise to the following deferred tax asset (liability) at December 31, 2012 and 2011:
|
|
|
December 31,
|
|
|
|
|
2012
|
|
|
|
2011
|
|
Excess of book accounting depreciation over tax
|
|
$
|
10,200
|
|
|
$
|
54,100
|
|
Obsolete inventory
|
|
|
113,800
|
|
|
|
149,200
|
|
Accrued interest – related party
|
|
|
586,700
|
|
|
|
341,300
|
|
Warranty reserve
|
|
|
54,100
|
|
|
|
44,800
|
|
Contribution carryover
|
|
|
-
|
|
|
|
7,100
|
|
263A capitalization
|
|
|
27,500
|
|
|
|
29,400
|
|
NOL carryforwards
|
|
|
15,643,600
|
|
|
|
14,621,500
|
|
Valuation allowance
|
|
|
(16,435,900
|
)
|
|
|
(15,247,400
|
)
|
|
|
$
|
-
|
|
|
$
|
-
|
|
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 12 - INCOME TAXES – (Continued)
The Company files income tax returns in the U.S. federal jurisdiction, and North Carolina, Georgia, and Utah. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2009. The statute of limitations remains open on all years from 2009 going forward.
The company operates at a loss and will only be liable for minimum state tax payments once returns are filed. No unrecognized liability will be added to the Company’s balance sheet for the un-filed returns as the amounts reported are an immaterial amount.
At December 31, 2012, there are no
tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
NOTE
13 - COMMITMENTS AND CONTINGENCIES
In 2008, EAU signed a lease agreement with Fieldale Farms, a large poultry producer in northern Georgia, to install our equipment at their facility. We began receiving revenues of approximately $27,500 per month from this facility in February 2009. Per the terms of the agreement, we were to help the plant achieve Category 1 compliance for post-chill microbial performance. The plant completed a USDA test set October 2009 with the result that it met the Category 1 requirements for that test set. Fieldale indicated that it was suspending the agreement as of November 23, 2009 and ceased making payments. In February 2011, the Company filed a complaint in the Superior Court of Cobb County Georgia against Fieldale for breaching the agreement. (See Part I, Item 3 - Legal Proceedings)
In December 2010, the Company entered into a Second Amended and Restated License Agreement with Zerorez Franchising Systems, Inc. (“Zerorez”). The agreement amended the previous agreements with Zerorez by expanding the license granted to Zerorez by allowing Zerorez to acquire and use commercial Electrolyzed Water Generators in connection with their performance of franchise services other than the Primacide Generators manufactured or sold by the Company. The term of the agreement is for five years.
In September 2005, Water Science, a related party, paid to the Company $1,000,000 for the exclusive rights to sell our products in South America and Mexico. This agreement also gives Water Science the rights to purchase machinery from the Company at cost plus 25 percent.
The Company has incurred significant losses and has had negative cash flows from operations. As a result, at December 31, 2012, the Company has 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. We currently do not have sufficient funds on hand to fund all of our operational needs for the next 12 months. We will have sufficient funds to operate our business provided we receive expected payments from our customers or if we are able to secure additional funding. We do not have any agreements in place for additional funding. Management will continue to seek to obtain sufficient funding for its operations through either debt or equity financing. 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 achieve positive sales and profit margins and control operating expenses.
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 14 - GOING CONCERN
At December 31, 2012 the Company had deficit working capital, deficit equity and has sustained recurring losses from operations, all of which raise substantial doubt about the Company’s ability to continue as a going concern. The 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 financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Company estimates that it will need up to $1,500,000 for the upcoming twelve months to execute our business plan. Management plans to mitigate its losses in the near term through the further development and marketing of its trademarks, brand and product offerings.
NOTE 15 - LOSS PER SHARE
Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing net income by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding.
At December 31, 2012 and 2011, the Company had outstanding warrants and notes payable convertible into shares of common stock, which were not used in the computation of income (loss) per share because their effect would be anti-dilutive either due to the net loss or due to the exercise price of the warrants and options or conversion rate of the convertible notes relative to the current stock price.
The following data shows the amounts used in computing loss per share:
|
|
For the Year Ended
|
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Net (loss) (numerator)
|
|
$
|
(2,031,881
|
)
|
|
$
|
(3,045,429
|
)
|
Shares (denominator)
|
|
|
|
|
|
|
|
|
Basic
|
|
|
28,575,371
|
|
|
|
20,007,494
|
|
Per share amount
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.07
|
)
|
|
$
|
(0.15
|
)
|
EAU TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 16 - SUBSEQUENT EVENTS
On January 31, 2013, the Board of Directors of the Company approved a loan agreement with Peter Ullrich, a member of the Board. The principal amount of the Note is $1,325,000. The funds had been advanced to the Company at various times throughout 2012. The loan agreement provides for interest at a rate of 10% annually and will mature on November 30, 2013. The outstanding balance under the loan agreement is convertible into shares of the Company’s common stock at $0.31 per share and no principal or interest payments are due until maturity. The loan agreement provides that accrued interest and the outstanding principal balance can be prepaid, in whole or in part, at any time without premium or penalty. In connection with the negotiation of the loan agreement, the Company also granted to Mr. Ullrich a warrant to purchase up to 1,325,000 shares of the Company’s common stock at an exercise of $0.31 per share. The warrant expires on January 31, 2018.
In accordance with ASC 855, management evaluated events subsequent to December 31, 2012 and concluded there were no other events or transactions during this period that required recognition or disclosure in its financial statements.