Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
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-K, and notes thereto.
Overview
EAU TECHNOLOGIES, 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 non-toxic cleaning and disinfecting fluids for food safety applications as well as dairy drinking water. These fluids have various commercial applications and may be used in commercial food processing and agricultural products that clean, disinfect, remediate and hydrate. The processes for which these fluids may be used are referred to in this Report (the “Report”) as the “EW Technology.” For example, we believe that our food and agricultural treatment products may be used to systemically treat various facets and phases of the food chain, from grow-out to downstream food, to cleaning and sanitizing food productions equipment, by eliminating dangerous and unhealthy pathogens from the food chain with our highly effective solutions. We make the claim that our products are “non-toxic”. We can do this because at the levels we employ our technology in commercial applications, as well as studies both internal and through third parties shows no toxicity. At the levels employed, the fluids and products are environmentally safe and non-toxic and do not contain or leave harmful residues. The electrolyzed water fluids created by the EW Technology (referred to herein sometimes as the “EW Fluids” or “Empowered Water
TM
”) generated by our specialized equipment can be used in place of many of the traditional products used in commercial, industrial and residential disinfecting and cleaning.
Our focus is on our three core competencies which are, producing high volumes of electrolyzed water, controlling the properties of the water and using our application knowledge. Because of our ability to produce high volumes of water and control the water properties, our target market is in commercial applications where we believe we can add value by generating measurable productivity, employee safety and efficiency gains. We will continue to use a disciplined stage gate development process that drives ideas to commercial test installations that turn into revenues. Once we have developed an application we will attempt to find strategic partners that would be able to assist us with a large scale commercial roll-out of the technology.
We have identified the following industries for early stage sales and marketing focus: 1) food and beverage processing, 2) dairy production and processing, 3) meat and poultry processing and 4) agricultural grow-out and processing (“Primary Markets”). As of the date of this Report, the Company was focused on these markets because we believe that for each of these markets we have a competitive advantage, the potential ability to attract a leading strategic industry partner, or we can provide an attractive value-added proposition. To penetrate these markets, EAU is conducting trials and completing commercial installations that are leading to partnerships with enterprises that can assist in rolling the technology out on a large scale.
Food and Beverage Processing.
In 2008 we installed our equipment to test a clean-in-place (CIP) application with an international beverage bottling company for use with cold beverages. There were three stages of this trial that were conducted simultaneously: 1) Syrup tanks; 2) Bag in box line and; 3) Bottling line. The purpose of the trial was to identify whether EAU’s non-toxic ambient temperature Empowered Waters could replace current 3-5 step CIP processes. In order to become an approved technology for this bottling company, EAU had to show cleaning performance, good antimicrobial efficacy, no negative smell or taste impacts, and improved CIP efficiency.
Results showed Empowered Water™ was able to improve current cleaning and sanitizing efficacy, minimizing the use of commercial chemicals while complying with microbiological integrity and sensory testing requirements. Testing also identified water and energy consumption savings as well as significant timesaving that can increase bottling production line availability.
In August 2010, following the successful tests, the Company received its first purchase orders from the international beverage company. EAU installed its environmentally friendly Empowered Water™ CIP Systems at three of the company’s bottling plants and recorded revenue from the sale of these systems during the first quarter 2011. The Company received an additional order for this same bottling company in 2012 for one of its largest bottling plants. Because of the success we have achieved in this application, we began testing with another International Bottler of soft drinks and have achieved similar success in duplicating results with that company. EAU is now an approved CIP application with both International Bottling companies and is marketing to both companies’ bottling operations in North America.
Upon the successful installations and as part of the Company’s plans to find a strategic industry partner, the Company entered into a non-exclusive commercial relationship with an international manufacturer of food processing equipment. In connection with the agreement the company ordered two Empowered Water Generator systems. We shipped the systems during the fourth quarter of 2011. The systems were used for customer product testing and on-site customer validation. Following the successful tests and validations, the company placed multiple orders for our equipment. During 2013, we shipped six new systems. During the first six months of 2014, we completed 2 new systems. We expect sales to this partner to decrease over the next few months. We have seen interest and successful trials, and will continue to pursue sales through other distributors.
Dairy Production and Processing.
The Company commenced hydration and production tests on dairy cattle in 2006. Multiple on-site trials and University studies were performed. Initial results indicated an increase in milk production and milk fat while maintaining the protein content. We recognized revenues from the sale of this system during 2011. We are no longer receiving revenues from this market.
Meat and Poultry Processing.
We began testing of our EW Technology and EW Fluids (the “EW System”) in poultry processing in 2005. Over the course of the next three years, we showed significant results in killing salmonella on the processed poultry. Independent testing analysis revealed pre-chill microbial reduction was significantly below the Food Safety Inspection Services (the enforcement arm of the USDA) allowable limit at that time. From these results we successfully completed Phase I of our USDA Online Reprocessing (“OLR”) Certification. In 2008, we completed the OLR data gathering stage at Fieldale Farms (“Fieldale”) a poultry plant in northern Georgia and submitted our findings to the USDA for OLR approval. EAU received a letter from the USDA approving our fluids for use in the plant for OLR applications.
In 2009 we began receiving revenues of approximately $27,500 per month from Fieldale. 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 II, Item 1 - Legal Proceedings.) We no longer receive revenues from this market.
Agriculture.
In 2006 we made initial sales to Water Science, LLC, a Florida limited liability company (“Water Science”) for the Latin American markets. Water Science is a major shareholder of the Company and its managing member, Peter Ullrich, is a director of our company. We have shipped multiple systems to Ecuador, Mexico, Columbia, Costa Rica and Holland for trials and Water Science internal use, including six new systems in 2012 and one more in the first quarter of 2013. Water Science is utilizing the technology for its own flower and agricultural endeavors. Further studies are being done as each country that has the Empowered Water™ technology ramps up for their own outside sales efforts.
Patents.
We have obtained patent protection on four separate uses of electrolyzed fluids (cleaning and disinfecting eggs, carpet cleaning, mold remediation and poultry processing). The Company received notification that it was granted a process patent in New Zealand for the use of electrolyzed water in the assistance of rumen digestion in dairy cows. The similar process patent is pending in the United States. Those applications are how the fluids are used and how they are stabilized for use in different applications. Additionally, we have a patent pending on the electrolysis equipment and several provisional patent pending applications filed to protect new processes and products, as described herein.
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 $131,286 in cash as of June 30, 2014, compared to $2,654 at December 31, 2013. The Company has received and recorded approximately $790,500 in advance deposits on orders for our equipment as of June 30, 2014. We expect the deposits will be reduced as the Company delivers machines on order to our customers during the second half of 2014. At June 30, 2014 our stockholders’ deficit was $8,274,944, compared to $7,808,794 at December 31, 2013.
Results of Operations for the Three months ended June 30, 2014 and 2013
Revenues and Net Loss -
Net revenues for the three months ended June 30, 2014, decreased by $408,836, to $305,951 compared to revenues of $714,787 for the three months ended June 30, 2013. The majority of the revenues are from the sale of our EW water systems in the Clean-in-Place (“CIP”) market and the agriculture and dairy markets. We expect revenues to continue to fluctuate as we establish our products in the CIP and dairy markets.
Our cost of sales decreased from $589,667 for the three months ended June 30, 2013 to $109,193 for the three months ended June 30, 2014. This decrease is attributable to the decreased sales of our EW water systems.
For the three months ended June 30, 2014, the Company had a net loss of $323,516, compared to a net loss of $765,435 for the three months ended June 30, 2013. This decrease of approximately $440,000 of net losses is primarily due to a loss sustained in 2013 on impaired leased equipment and lower operating expenses.
General and Administrative Expense –
The Company incurred total general and administrative expenses for the three months ended June 30, 2014 of $369,056, a decrease of $77,765 from the $446,821 incurred in 2013. General and administrative expenses for 2014 consist primarily of payroll and labor expense of approximately $223,000, rent expense of $23,000, professional fees of $22,000, and insurance expense of $81,000.
Research and Development -
Our research and development expenses for the three months ended June 30, 2014 and 2013 were $0 and $1,000. We expect to continue to have minimal research and development expenses during 2014.
Interest Expense -
Our interest expense remained largely unchanged from the prior year. Interest expense in 2014 was $153,288 compared to $142,309 in 2013. The Company continues to rely on notes and advances for operating funds and expects to continue to incur significant interest expenses.
Results of Operations for the Six months ended June 30, 2014 and 2013
Revenues and Net Loss -
Net revenues for the six months ended June 30, 2014, decreased by $549,715, to $796,925 compared to revenues of $1,346,640 for the three months ended June 30, 2013. The majority of the revenues are from the sale of our EW water systems in the Clean-in-Place (“CIP”) market and the agriculture and dairy markets. We expect revenues to continue to fluctuate as we establish our products in the CIP and dairy markets.
Our cost of sales decreased from $879,182 for the six months ended June 30, 2013 to $277,912 for the three months ended June 30, 2014. This decrease is attributable to the decreased sales of our EW water systems.
For the six months ended June 30, 2014, the Company had a net loss of $509,580, compared to a net loss of $1,048,241 for the six months ended June 30, 2013. This decrease of approximately $532,000 of net losses is primarily due to lower operating expenses and a loss sustained in 2013 on impaired leased equipment.
General and Administrative Expense –
The Company incurred total general and administrative expenses for the six months ended June 30, 2014 of $745,982, a decrease of $181,690 from the $927,672 incurred in 2013. General and administrative expenses for 2014 consist primarily of payroll and labor expense of approximately $447,000, rent expense of $45,000, professional fees of $50,000, and insurance expense of $139,000.
Research and Development -
Our research and development expenses for the three months ended June 30, 2014 and 2013 were $0 and $9,838. We expect to continue to have minimal research and development expenses during 2014.
Interest Expense -
Our interest expense remained largely unchanged from the prior year. Interest expense in 2014 was $286,767 compared to $276,183 in 2013. The Company continues to rely on notes and advances for operating funds and expects to continue to incur significant interest expenses.
Liquidity and Capital Resources
We do not receive sufficient revenues to fund all of our operational needs. The majority of our additional funding has come from a single shareholder. 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 only if we receive expected orders from our customers and we are able to secure additional funding. We do not have any agreements in place for additional funding. We may not have enough funding for operations to fund our business until it is developed enough to bring the business plan to maturity. 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 project $1,500,000 is required over the next twelve months to execute our business plan. Moreover, if we able to expand our sale of EW machines as anticipated, we may need significant additional working capital to fund that expansion. We do not have arrangements in place to provide us with this funding or any additional funding. In light of these circumstances, the ability of the Company to continue as a going concern is in substantial doubt.
The Company had $131,286 in cash as of June 30, 2014, compared to $2,654 at December 31, 2013. We have had continuing losses of $509,580 for the six months ended June 30, 2014, compared with losses of $1,048,241 for the six months ended June 30, 2013. The net loss per share for the first six months of 2014 and 2013 was $0.02 and $0.04 per share, respectively.
Net cash used in operating activities in the three month period ended June 30, 2014 was $426,901 compared to $609,852 for the same period in 2013. The majority of the change in cash used for the current period was related to the decrease in the advance deposits for machine orders in 2014 as compared to 2013. At June 30, 2014 we had total deposits outstanding of $790,500.
At June 30, 2014, the Company’s net inventory was $594,712, representing a decrease of approximately $60,000, from the $653,967 on hand at December 31, 2013.
The Company’s only cash flows from investing activities were from expenditures related to intellectual property of $4,467 and $5,436 during the periods ended June 30, 2014 and 2013, respectively.
Cash flows from financing activities provided the Company $560,000 for the period ended June 30, 2014, which consisted of unsecured short term advances. The Company received proceeds of $130,000 from unsecured advances during the six months ended June 30, 2013.
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 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-K, dated December 31, 2013, 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. There were no material changes in our judgments or estimates during the second quarter of 2014.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, “
Revenue from Contracts with Customers.
” ASU 2014-09 supersedes the revenue recognition requirements in “
Accounting Standard Codification 605 - Revenue Recognition
” and most industry-specific guidance. The standard requires that entities recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. This ASU is effective for fiscal years beginning after December 15, 2016. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. The Company is currently assessing the impact ASU 2014-09 will have on its financial position and results of operations.
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU requires companies to present an unrecognized tax benefit, or a portion thereof, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss or a tax credit carryforward, is not available at the reporting date under the applicable tax law or an entity does not intend to use its deferred tax asset for such purpose, the unrecognized tax benefit should be presented as a liability and not a reduction to deferred tax assets. This ASU is effective for fiscal years and interim periods beginning after December 15, 2013 with early adoption permitted. During the three months ended March 31, 2014, the Company adopted ASU 2013-11 and the adoption did not have a significant impact on its consolidated financial statements.
Other recently issued ASUs were assessed and determined to be either not applicable or are expected to have a minimal impact on the Company’s consolidated financial position and 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 EW 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 EW 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. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements include our expectations regarding working capital requirements and future funding, our expectations regarding our internal controls, expectations regarding funding commitments, our expectations regarding reductions in deposits from Water Science, future revenues, future inventory levels, future orders, future test results, and plans and objectives of management for future operations, including plans and objectives relating to the products and the future economic performance of the Company. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, future business decisions, and the time and money required to successfully complete development projects, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of those assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in any of the forward-looking statements contained herein will be realized. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risks associated with successfully developing our business in evolving markets, our need for additional capital, our continuing operating losses, the ability of our management to conduct distribution activities and sell products, possible failure to successfully develop new products, risks associated with litigation, risks associated with international transactions, vulnerability to competitors due to lack of patents on our products, and other risk factors listed in our annual report on Form 10-K for the year ended December 31, 2013 and our other SEC reports. Based on actual experience and business development, the Company may alter its marketing, capital expenditure plans or other budgets, which may in turn affect the results of operations. In light of the significant uncertainties inherent in the forward-looking statements included therein, the inclusion of any such statement should not be regarded as a representation by the Company or any other person that the objectives or plans will be achieved
.
