ITEM 1. BUSINESS
Hydrodynamic Technology, Inc. was incorporated January 29, 2007 as a California corporation. It is a wholly owned subsidiary of Cavitation Technologies, Inc. (referred to herein, unless otherwise indicated, as “the Company,” “CTi,” “we,” “us,” and “our”) a Nevada corporation originally incorporated under the name Bio Energy, Inc. Cavitation Technologies, Inc. has developed, patented, and commercialized proprietary technology for processing soybean oil through a device called the Nano Neutralization™ Reactor (the “Reactor”). The Reactor is the critical component of the Nano Neutralization System which is designed to reduce operating costs and increase yields in the refining of vegetable oils.
Our investment in research and development (“R&D”) since inception on January 29, 2007 through June 30, 2011 is $5,288,394 including $4,308,803 paid in restricted stock primarily to service providers. This investment in R&D has led to potential commercial products including the NANO Neutralization System and the Bioforce 9000 NANO Reactor System which performs transesterification during the production of crude biodiesel. The NANO Neutralization system accounted for 96% of total annual revenue of $589,926 recorded in fiscal 2011. Both the NANO Neutralization System and the Bioforce 9000 employ our proprietary, patented and patents pending, continuous flow-through, hydrodynamic NANO Technology in the form of our NANO Reactor (the “Reactor”). Our reactor process can create particles smaller than one micron (nano particles) and bonds these particles at the molecular level. The Reactor has no moving parts, operates continuously, and is easily scalable to high volumes.
Vegetable Oil Refining
The NANO Neutralization System™ with our embedded NANO Refining Technology is designed to be used in the vegetable oil refining process to refine crude vegetable oils such as soybean, rapeseed, and canola into high quality refined oils. The finished products derived from the process are used for human consumption and for animal feed. The global demand for vegetable oil has grown consistently at a rate of about 5.6% p.a. from 84.5 million metric tons in 1999 to 146.9 million metric tons in 2010.
We are focused on the soybean oil refining segment of the market. During the soybean oil refining process, there is a certain volume of oil that is lost and remains trapped in gums (impurities), thus reducing the amount of oil produced. The Reactor is designed to improve the efficiency of this process by decreasing the amount of oil that is lost, resulting in a higher oil yield. In addition, traditional refining methods use chemicals to purify oil. The Company’s Reactor requires significantly less chemicals. As a result, the Company’s proprietary technology can both decrease costs and increase oil yield by reducing the use of chemicals and treatment products needed to purify the oil.
Our environmentally friendly Reactor has proven to significantly reduce refining costs, increase oil yield, and limit the amount of chemical additives in certain liquid process applications. The Company’s first pilot test of our NANO Neutralization System was conducted between May and November of 2010 at Carolina Soya, a 200 metric ton/day crude soy oil refining plant in Estill, South Carolina. The system was successful in reducing the amount of chemicals used in the refining process and in increasing oil yield. The system operated 7 months during which we received monthly rental payments totaling $35,000 which is reflected in Revenue for the year ended June 30, 2011. This plant was subsequently sold to another owner who no longer operates the plant as a soybean oil refinery.
In March 2011, the Company completed a second pilot test at a 450 mtpd oil refining plant in Salisbury, Maryland. Again the system demonstrated the ability to significantly reduce the use of chemicals in the refining process. The customer purchased the NANO Neutralization System (with our embedded Reactor) at the conclusion of the test period. The associated revenue was recognized during the year ended June 30, 2011. This customer has agreed to serve as a showcase for the System/Reactor and allow potential customers to tour their facility.
In April 2010 we signed a memorandum of understanding with a vegetable oil refining plant located in Minnesota for pilot testing a 40 GPM NANO System on a production line that processes 200 ton/day of de-gummed oil. As of September 2011, we have completed testing with this prospect, and are awaiting their decision whether or not to buy the system. No revenue has been recognized on this transaction.
Renewable Fuels
Our fully automated Bioforce 9000 NANO Reactor Skid System performs the transesterification process during the production of biodiesel; that is, it converts mono-, di-, and tri-glycerides contained in feedstock (such as animal fats and vegetable oils) into methyl esters (crude biodiesel). Given the conditions of the global biodiesel market as well as the limited resources of our company, we do not intend to focus significant resources to the development of this market in the foreseeable future. Instead, we plan to focus the bulk of our resources on developing our NANO Neutralization System ™ line of business.
Distribution Methods
Based on the results at these two soybean oil refineries in reducing the use of chemicals and improving oil yield, we intend to license our technology globally through a distribution network of strategic partners who are recognized leaders in the markets they serve and who design, build, install and recommend our systems in the markets in which our technology can be applied. On November 1, 2010 after significant joint testing of our Reactor, we signed a global Technology License, Marketing & Collaboration Agreement with the n.v. Desmet Ballestra Group s.a. (Desmet) who is actively marketing the NANO Neutralization System the key component of which is the Company’s Reactor to soybean oil refiners.
The Company and Desmet have worked together to determine the appropriate sales approach and installation process. The Company’s Reactor is designed to be used as an add-on process to an existing neutralization system within soybean and other vegetable oil refineries. Desmet is now focused on marketing the Company’s Reactor to soybean oil refiners to help them increase profits through cost savings and improved oil yields. Desmet purchases the Reactor from the Company and installs it as part of an integrated neutralization system. Based on extensive lab testing and successful commercial implementation, Desmet is guaranteeing the Reactor’s performance and ROI to any facility that purchases and installs it. We are therefore substantially dependent on Desmet to identify prospects, complete sales contracts, install the system and manage relationships with end-users. CTi will focus on developing additional Nano Reactor applications and managing the intellectual property issues associated with new developments.
Desmet is a global leader in providing engineering services and equipment for oil refining, biofuel, oleochemical, seed crushing, surfactant and detergent markets. Desmet supplies these markets with competitive services based on the latest globally sourced technologies. Desmet generates more than $500 million in annual revenue. Since its founding in 1946, Desmet has built a global network that includes 1,300 employees, 17 global and 8 representative offices, and more than 5,700 lines in a variety of applications. Desmet operates a separate division for each of the above markets and the Desmet Oils & Fats division has supplied small and large plants to approximately 1,700 oil millers in 150 countries, covering over 6,000 process sections. We have developed a relationship with the North American arm of Desmet which operates in each of these markets and provides the Company with other potential opportunities such as palm oil refining.
Desmet has relationships with major refiners and is initially marketing the Reactor to soybean oil refineries in the U.S., South America and Europe with the goal of ultimately making the NANO Neutralization System™ a standard for new refineries. A significant portion of global soybean refineries include major refiners such as Archer Daniels Midland Company, Cargill, Inc. and Bunge Limited. Desmet has several senior sales representatives dedicated to selling the Reactor in North America, South America, and Europe. In order to retain the exclusivity granted to them by our Agreement, Desmet has committed to installing a specified number of Reactors by June 30, 2012, June 30, 2013, and June 30, 2014.
In addition, we believe our proprietary technology is applicable to other segments of the vegetable oil refining market such as rapeseed oil, sunflower seed oil and palm oil which together totaled over half of the world vegetable oil production in 2010. Desmet has begun to market the Reactor to refiners of these oils and has identified pilot plants in North and Latin America, Europe and Asia. The Company expects to install Reactors for testing in these pilot plants during fiscal 2012.
Customers
Four customers generated 100% of our revenue for fiscal 2011. These four customers are not expected to be repeat customers.
We rely exclusively on our strategic partnership with Desmet to market, and distribute our Reactors to new customers.
Sources and availability of raw materials and the names of principal suppliers
We have historically sourced reactor components from various domestic and international suppliers including Canyon Engineering and Strategic IR with whom we have no long term contracts, agreements, or commitments. They provide parts as directed. We believe it would take approximately 60 days to find a new supplier, if necessary.
Competition
Our competitors in the soybean oil refining business are a myriad of companies both large and small that provide equipment and technology to oil refiners. These include 4 or 5 known companies that have longer operating histories and stronger financial capabilities. The soybean oil refining business is a highly competitive commodity market where the low-cost producer has the advantage. We intend to compete by offering solutions that help our clients remain or become a low-cost producer. With limited new technology introduced in the last 50 years, the Reactor provides a unique opportunity for refiners to increase margins. We differentiate ourselves by the designs, processes, and applications described in our issued and allowed patents, and in our patent pending applications. We compete by offering solutions that we believe can reduce operating expenses and increase yield vis-à-vis current technology.
Patents
Our Cavitation Generator patent was issued during fiscal 2011, and is being amortized over an estimated useful life of four years. The patent has a duration through February 27, 2029. We also have an allowed patent for our Multi-State Cavitation Device that was issued August 22, 2011. In addition, we have eight US and five PCT/ international patent applications pending which apply to the design of the Company’s Reactor and the processes related thereto. Based on lab tests, the Company believes its proprietary technology can be applied to other liquid processing industries where there is a need to solve environmental problems, reduce operating costs, and/or improve quality and yield. The Company’s issued and allowed patents and pending patents support potential applications of the Company’s proprietary technology in markets which include, but are not limited to, vegetable oils refining, renewable fuel production, alcoholic beverage enhancement, water purification, and algae oil extraction. In addition, we believe our proprietary technology can also be applied to fuel mixing and crude oil refining. During fiscal 2011, we received the “CE Marking” certification which allows us to market our systems in the European Union.
Our success will depend in part on our ability to obtain patents, maintain trade secrets, and operate without infringing on the proprietary rights of others both in the United States and other countries. There can be no assurances that patents issued to CTi will not be challenged, invalidated, or circumvented, or that the rights granted hereunder will provide proprietary protection or competitive advantage to CTi. We plan to continue to invest in R&D and file for new and improved patents on a regular basis.
Royalty Agreements
On July 1, 2008, our wholly owned subsidiary entered into Patent Assignment Agreements with our President and former CEO, and current CTO, where certain devices and methods involved in the hydrodynamic cavitation processes invented by the President and CTO have been assigned to the Company. In exchange, the Company agreed to pay a royalty of 5% of gross revenues to each of the CTO and President for licensing of the technology and leasing of the related equipment embodying the technology. These agreements were subsequently assigned to Cavitation Technologies on May 13, 2010. The Company’s CTO and President both waived their rights to receive royalty payments that have accrued, or that may accrue, on any gross revenue generated through June 30, 2011.
On April 30, 2008 (as amended November 22, 2010), our wholly owned subsidiary entered into an employment agreement with Varvara Grichko who became a member of the Board of Directors in September 2010. Mrs. Grichko shall receive an amount equal to 5% of actual gross royalties received from the royalty stream in the first year in which the Company receives royalty payments from the patent which Mrs. Grichko was the legally named inventor, and 3% of actual gross royalties received by the Company from the patent in each subsequent year.
Governmental Approval and Regulations and Environmental Compliance
Due to the nature of our products, we have incurred no costs with respect to environmental compliance with federal, state, and local laws.
To our knowledge, our products do not require governmental approval, and we do not foresee that governmental regulations will have a material impact on our business.
Employees
We have four total and full-time employees and have engaged approximately 40 consultants and independent contractors over the past two years. We work closely with employees and consultants comprised of experienced professionals who are chemists, civil, chemical, and mechanical engineers with expertise in hydrodynamic cavitation, nano technology, water treatment, and biotechnology. These individuals hold Ph.Ds in Chemistry and Biology as well as degrees in Civil, Chemical, and Mechanical Engineering.
ITEM 1A.
ITEM 1A. RISK FACTORS
Not applicable for smaller reporting companies.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable for smaller reporting companies.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters is located in Chatsworth, California. This approximate 5,000 square foot facility includes office space and an area to conduct research and development. We extended our lease agreement for office space for a period of two years effective February 1, 2010. We do not anticipate any material difficulties with the renewal of our rental agreement when it expires or in securing replacement facilities on commercially reasonable terms.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We know of no material, existing or pending legal proceeding against our Company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.
ITEM 4.
ITEM 4. (REMOVED AND RESERVED)
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock
Our Common Stock is traded on the Over the Counter Bulletin Board under the symbol CVAT. The following table sets forth the high and low price per share based on the closing price of our Common Stock for the periods indicated.
We became a public company through a share exchange that was effected in October 2008. The first day of public trading of our stock was November 11, 2008. Since our fiscal year end was changed to June 30, public trading of our stock began in the second quarter of fiscal 2009. As of September 20, 2011, there were approximately 1100 holders of record of our Common Stock.
Dividend Policy
We have neither declared nor paid any dividends on our Common Stock in the preceding two fiscal years. We currently intend to retain future earnings to fund ongoing operations and finance the growth and development of our business and, therefore, do not anticipate declaring or paying cash dividends on our Common Stock for the foreseeable future. Any future decision to declare or pay dividends will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements, and such other factors as the Board of Directors deems relevant. In addition, certain of our debt facilities contain restrictions on the declaration and payment of dividends.
Our Series A Preferred Stock bears a 6% cumulative dividend per annum. Dividends may be paid in cash or in additional shares of Series A Preferred Stock, at the Company’s preference. Accumulated dividends at June 30, 2011 amounted to $13,733.
Securities Authorized for Issuance under Equity Compensation Plans
None
Unregistered Sales of Equity Securities and Use of Proceeds
Since our previous disclosure in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011, filed on May 16, 2011, the following is our unregistered security activity.
Issuance of Convertible Notes Payable
On June 6, 2011, the Company issued a convertible promissory note payable to Asher Enterprises, Inc. in the amount of $47,500. The Asher Note bears interest at a rate of 8% per annum and matures on March 8, 2012. The holder of the note may elect to convert principal and accrued interest into shares of common stock at any time at a conversion price equal to 61% of the average lowest three trading prices of the Company’s common stock for the 10 trading days prior to conversion.
We have granted the above securities in reliance on Section 4(2) of the Securities Act of 1933, as amended. These convertible promissory notes were not offered via general solicitation to the public but solely to the aforementioned service provider. No sales commissions or other remuneration was paid in connection with these issuances.
Issuance of Common Stock for Conversion of Indebtedness
On April 4, 2011, we issued 59,829 shares of common stock to Tripod Group, LLC as conversion of $3,500 in principal of outstanding convertible notes payable. On April 5, 2011, we issued an additional 24,376 shares of common stock to Tripod Group, LLC as conversion of $1,217 in principal of outstanding convertible notes payable, along with $209 in accrued interest. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
Issuance of Restricted Common Stock for Services
On April 1, 2011, we issued 101,036 shares of common stock with a value of $10,104 to Michael Psomas for accounting services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 23,341 shares of common stock with a value of $2,334 to Tomer Tal for legal services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 79,435 shares of common stock with a value of $7,944 to Kelly Lowry & Kelley, LLP for legal services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 9,000 shares of common stock with a value of $900 to Shannon Stokes for office services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 200,000 shares of common stock with a value of $20,000 to Sonia Luna for Sarbanes Oxley consulting services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 70,000 shares of common stock with a value of $7,000 to Varvara Grichko for research and development services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On April 1, 2011, we issued 333,333 shares of common stock with a value of $33,333 to Strategic IR for investor relation services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On May 17, 2011, we issued 124,114 shares of common stock with a value of $12,411 to Michael Psomas for accounting services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On May 17, 2011, we issued 64,589 shares of common stock with a value of $6,459 to New Venture Attorneys, PC for legal services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On May 17, 2011, we issued 37,500 shares of common stock with a value of $3,750 to James Fuller for board of director services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On May 17, 2011, we issued 50,000 shares of common stock with a value of $5,000 to Kirk Wiggins for marketing and sales services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 13, 2011, we issued 66,174 shares of common stock with a value of $6,617 to Michael Psomas for accounting services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 13, 2011, we issued 107,750 shares of common stock with a value of $10,775 to New Venture Attorneys, PC for legal services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 13, 2011, we issued 10,000 shares of common stock with a value of $1,000 to Varvara Grichko for board of director services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 13, 2011, we issued 150,000 shares of common stock with a value of $15,000 to Sonia Luna for Sarbanes Oxley consulting services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 14, 2011, we issued 3,000,000 shares of common stock with a value of $254,595 to Bioworld Management Ltd. for research and development services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 14, 2011, we issued 2,000,000 shares of common stock with a value of $169,730 to Strategic IR, Inc. for marketing and investor relation services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
On June 14, 2011, we issued 3,096,990 shares of common stock with a value of $273,375 to Star Funding, Inc. for marketing and investor relation services. These shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were not offered via general solicitation to the public but solely to the aforementioned service provider. The Company issued restricted shares in connection with these issuances. No sales commissions or other remuneration was paid in connection with these issuances.
With the exception of Varvara Grichko and James Fuller, who are affiliates of the company, none of the aforementioned service providers are affiliates of the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable for smaller reporting companies.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of should be read in conjunction with the Company’s financial statements and the related notes. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as its plans, objectives, expectations and intentions. Its actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements.
Overview of Our Business
We have developed, patented, and commercialized proprietary technology for processing soybean oil through a device called the Nano Neutralization™ Reactor (the “Reactor”). The Reactor is the critical component of the Nano Neutralization System which is designed to reduce operating costs and increase yields in the refining of vegetable oils. During the year ended June 30, 2011, we recorded revenue of $589,926. Our cumulative loss since inception on January 29, 2007 is $16,669,663, including $11,530,601 in common stock issued for services. Cumulative net cash used in operating activities of $3,421,456was funded largely with $3,822,760 in cash provided from financial activities, including proceeds of $725,000 from the sale of preferred stock, $2,104,688 from the sale of common stock, $386,212 in proceeds from convertible debt, and $486,110 in a bank loan. Our investment in research and development since inception on January 29, 2007 through June 30 2011 is $5,288,394, including $4,308,803 paid in restricted stock primarily to service providers. We have four full-time employees and no part-time employees.
The company is focused on merchandising our NANO Neutralization System - a vegetable oil refining system that employs our proprietary continuous flow-through, hydrodynamic NANO Technology in the form of our multi-stage NANO Series of reactors. The target market for our systems includes refiners who process vegetable oils including soybean oil. The finished product is used for human consumption as well as animal feed. Refer to Part I, Item 1 for a more detailed discussion.
Management’s Plan
We are a development stage entity engaged in merchandising our NANO Neutralization System which is designed to help refine vegetable oils such as soybean, canola, and rapeseed. Our near term goal is to successfully merchandise our systems. We have no significant operating history and, from January 29, 2007, (inception), through June 30, 2011, generated a net loss of $16,669,663. We also have negative cash flow from operations and negative net equity. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles which contemplate continuation of the Company as a going concern.
Management’s plan is to generate income from operations by licensing our technology globally through our strategic partner, the Desmet Ballestra Group. We will also attempt to raise additional debt and/or equity financing to fund future operations and to provide additional working capital. However, there is no assurance that such financing will be consummated or obtained in sufficient amounts necessary to meet the Company’s needs, or that the Company will be able to meet its future contractual obligations. Should management fail to obtain such financing, the Company may curtail its operations.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses. The accounting policies and estimates described below are those CTi considers most critical in preparing its consolidated financial statements. The following is a review of the accounting policies and estimates that include significant judgments made by management using information available at the time the estimates are made. However, these estimates could change materially if different information or assumptions were used instead.
Note 3 to the financial statements includes a summary of the CTi’s significant accounting policies, estimates, and methods used in the preparation of CTi’s financial statements.
Recoverability of Intangible and Long-Lived Assets
Management believes that the accounting estimate related to the recoverability of its intangible and long-lived assets is a “critical accounting estimate” because significant changes in the assumptions used to develop the estimates could materially affect key financial measures, including net income and non-current assets.
Testing intangible and long-lived assets for impairment involves a high degree of judgment due to the assumptions that underlie the undiscounted cash flows analysis. In accordance with ASC 350-30, we evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, we compare the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value based on market value when available or discounted expected cash flows of those assets and is recorded in the period in which the determination is made. Management believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for our products under development will continue. Either of these could result in future impairment of long-lived assets.
Share-Based Compensation
We account for our share-based compensation in accordance ASC 718-20. Stock-based compensation cost is measured at the grant date based on the estimated fair value of the award and is recognized as an expense over the requisite vesting period.
Determining the fair value of share-based awards at the measurement date requires judgment, including estimating the expected term that stock options and warrants will be outstanding prior to exercise, the associated volatility, and the expected dividends. CTi estimates the fair value of options granted using the Black-Scholes valuation model. The expected life of the options used in this calculation is the period of time the options are expected to be outstanding and has been determined based on historical exercise experience. Expected stock price volatility is based on the historical volatility of CTi’s stock for a period approximating the expected life, and the risk-free interest rate is based on the implied yield available on US Treasury zero-coupon issues approximating the expected life. Judgment is also required in estimating the amount of share-based awards that will be forfeited prior to vesting. CTi believes that these assumptions are “critical accounting estimates” because significant changes in the assumptions used to develop the estimates could materially affect key financial measures, including net income.
Income Taxes
Management believes that the accounting estimate related to income taxes is a “critical accounting estimate” because significant judgment is required in interpreting tax regulations in the US, evaluating CTi’s uncertain tax positions, and assessing the likelihood of realizing certain tax benefits. Actual results could differ materially from those judgments, and changes in judgments could materially affect CTi’s consolidated financial statements.
We account for income taxes in accordance with ASC 740-10. We recognize deferred tax assets and liabilities to reflect the estimated future tax effects, calculated at expected future tax rates, of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates on the date of enactment.
ASC 740-10 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. We measure and record uncertain tax positions by establishing a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Only tax positions meeting the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized.
In the normal course of business, CTi may be audited by federal and state tax authorities. The ultimate settlement of any particular issue with the applicable taxing authority could have a material impact on CTi’s financial statements.
Results of Operations
The following is a comparison and analysis of our results of operations for the years ended June 30, 2011 and 2010.
Revenue
During the year ended June 30, 2011, revenue of $589,926 was related largely to our vegetable oil refining line of business. This consisted primarily of a transaction completed in March 2011 with a customer located in Maryland for a NANO Neutralization System for $341,326 as well as a licensing agreement that we completed in December 2010 with a customer located in North Carolina for a 10 gallons/minute NANO Neutralization System for $187,600. In addition, we recognized revenue of $35,000 associated with the rental of a NANO Neutralization System and $26,000 related to the sale of a Bioforce 9000 Reactor Skid System. We recognized no revenue during the year ended June 30, 2010.
Cost of Revenue
During the year ended June 30, 2011, our cost of revenue amounted to $91,144 which was the result of the revenue transactions described above. We had no cost of revenue during the year ended June 30, 2010 as we recognized no revenue during that period.
Operating Expenses
Our operating expenses for the year ended June 30, 2011 amounted to $3,694,906 compared with $7,860,529 in 2010, a decrease of $4,165,623 or 53.0%. The decrease in general and administrative expenses in 2011 of $2,645,715, or 46.6%, was due largely to a one-time issuance of 5,000,000 shares valued at $1,050,000 for marketing consulting services in February 2010. The decrease in research and development expenses of $1,519,908, or 69.6%, was primarily due to a one-time issuance of restricted common stock to three consultants in July 2009 as compensation for research and development activities performed on the design and development of our NANO Neutralization System used for refining vegetable oil.
Interest Expense and Other
Interest expense and other consists of interest expense and change in value of derivatives.
Our interest expense for the year ended June 30, 2011 decreased by $236,629 as compared to 2010. The decrease was primarily attributable to two charges in fiscal 2010 which did not occur in fiscal 2011: a beneficial conversion feature of $63,601 resulting from the modification of convertible notes payable as well as $223,137 associated with the issuance of convertible debt. Specifically, on June 1, 2010, Snapshot, Ltd., a holder of Company debt securities agreed to convert an outstanding note payable into shares of the Company’s common stock at a conversion rate of $0.10 per share. As a result, the Company issued 2,789,217 shares of common stock as payment of the note payable of $278,922. A resulting charge on the conversion of the note payable of $223,137 was recorded, representing the difference between the market value of the stock issued and the book value of the note payable. These two transactions resulted in $286,738 of interest expense in fiscal 2010 that did not occur in fiscal 2011. Interest expense in fiscal 2011 consisted largely of $39,973 for the bank loan, $34,724 for the amortization of discounts on the issuance of convertible notes payable as well as $19,197 associated with the change in the value of derivatives.
During the year ended June 30, 2011, we issued convertible notes payable amounting to a gross face value of $151,212. By virtue of the variable conversion ratios contained in the provisions of the agreements, the conversion features of the notes are a derivative under ASC 815-40, Derivatives and Hedging. Accordingly, the value of the beneficial conversion feature has been classified as a derivative liability on the accompanying balance sheet. On a quarterly basis, the value of the beneficial conversion feature is adjusted and reflected in derivative liability on the balance sheet. As of June 30, 2011, the aggregate value of the Derivative Liability associated with the above notes amounted to $121,679. The initial aggregate Derivative Liability value upon the issuance dates amounted to $102,482. The increase of $19,197 is recorded in Interest Expense and Other for the year ended June 30, 2011. There was no such expense in 2010.
Liquidity and Capital Resources
CTi’s primary sources of liquidity have been issuances of restricted common stock and warrants to service providers, sale of common stock for cash, issuances of convertible promissory notes, and short-term loans from related parties and a strategic partner.
See Note 7, “Convertible Notes Payable,” Note 8 “Related Party Short-Term Loans,” Note 9, “Short-Term Loans,” and Note 10, “Stockholder’s Equity” for more information.
CTi’s ability to continue to issue restricted common stock and warrants in exchange for services may be adversely affected by the performance of our stock price. Additionally, CTi’s ability to issue long-term debt and obtain short-term loans may be negatively impacted by domestic economic conditions that create a tight credit environment, particularly for development stage companies.
It is our intention to rely less on the issuance of stock as payment to service providers, and more on cash generated from operations by licensing our technology globally through our strategic partner, Desmet. The Company received advances from Desmet to assist with funding the production of specific CTi Systems. The Company has agreed to pay these amounts at the time the systems are sold or licensed. These amounts are reflected as advances on the accompanying consolidated balance sheets as of June 30, 2011 and 2010. As of June 30, 2011 and 2010, the Company had $36,533 and $17,262, respectively, of advances outstanding.
Sources and Uses of Cash
During fiscal 2011, we generated a gross profit of $498,782 compared with $0 in fiscal 2010. During fiscal 2011, our net loss amounted to $3,295,428 including non-cash operating expenses of $2,711,135 arising primarily from common stock and warrants issued for services. Net cash used in operating activities in 2011 of $614,188 was used largely to pay salary and related expenses of $377,037, professional fees to attorneys and accountants of $124,721, R&D of $111,267, consultant fees of $88,100, as well as interest on bank debt of $39,973.
During fiscal 2010, our net loss amounted to $8,196,462 including non-cash operating expenses of $6,924,014 arising primarily from common stock and warrants issued for services. We generated no revenue, and our net cash used in operating activities of $1,025,761 was used largely to pay salary related expenses of $436,853, professional service fees such as attorneys and accountants of $262,909, as well as interest on bank debt of $46,701.
Net cash used in investing activities during fiscal 2011 amounted to $123,366 including $81,038 for the customization of demonstration systems and $42,328 for patent filing costs. This was comparable to fiscal 2010 when we invested $187,787 including $23,820 for property and equipment, $71,683 for the customization of systems, and $92,284 in patent filing costs.
Fiscal 2011 net cash provided by financing activities of $752,063 included proceeds from the sale of common stock of $572,741, convertible notes payable of $151,212, and short-term loans of $90,750. These proceeds were offset by $38,640 in payments on borrowings from our bank loan as well as a repayment of $24,000 for short term loans. Fiscal 2010 net cash provided by financing activities of $1,208,780 included proceeds from the sale of common stock of $1,231,947 and short-term loans of $109,000. These proceeds were offset by $112,167 in payments on borrowings from our bank loan as well as repayment of $20,000 in convertible notes payable.
Off-balance Sheet Arrangements
The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable for smaller reporting companies.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Cavitation Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Cavitation Technologies, Inc. (a development stage company) as of June 30, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ deficit, and cash flows for the years ended June 30, 2011 and 2010, and the period from January 29, 2007 (inception date) through June 30, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cavitation Technologies, Inc. as of June 30, 2011 and 2010, and the results of its operations and its cash flows for the years ended June 30, 2011 and 2010 and the period from January 29, 2007 (inception date) through June 30, 2011, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has incurred losses in developing its business and further losses are anticipated. The Company requires additional funds to meet its obligations and the costs of operations. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in this regard are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Rose, Snyder & Jacobs
Rose, Snyder & Jacobs
A Corporation of Certified Public Accountants
Encino, California
September 26, 2011
Cavitation Technologies, Inc
(A Development Stage Company)
Consolidated Balance Sheets
See accompanying notes, which are an integral part of these financial statements
Cavitation Technologies, Inc
(A Development Stage Company)
Consolidated Statements of Operations
See accompanying notes, which are an integral part of these financial statements
Cavitation Technologies, Inc
(A Development Stage Company)
Consolidated Statements of Changes in Stockholders' Deficit
Cavitation Technologies, Inc
(A Development Stage Company)
Consolidated Statements of Changes in Stockholders' Deficit (Continued)
Cavitation Technologies, Inc
(A Development Stage Company)
Consolidated Statements of Cash Flows
See accompanying notes, which are an integral part of these financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization
Hydrodynamic Technology, Inc. was incorporated January 29, 2007 as a California corporation. It is a wholly owned subsidiary of Cavitation Technologies, Inc. (referred to herein, unless otherwise indicated, as “the Company,” “CTi,” “we,” “us,” and “our”) a Nevada corporation originally incorporated under the name Bio Energy, Inc. Cavitation Technologies, Inc. has developed, patented, and commercialized proprietary technology for processing soybean oil through a device called the Nano Neutralization™ Reactor (the “Reactor”). The Reactor is the critical component of the Nano Neutralization System which is designed to reduce operating costs and increase yields in refining vegetable oils.
Note 2 - Basis of Presentation and Going Concern
Management’s Plan Regarding Going Concern
The accompanying financial statements have been prepared in conformity with generally accepted accounting principles which contemplate continuation of the Company as a going concern. The Company has no significant operating history and, from January 29, 2007, (inception), through June 30, 2011, generated a net loss of $16,669,663. The Company also has negative cash flow from operations and negative net equity. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern.
Management’s plan is to generate income from operations by licensing our technology globally through our strategic partner, the Desmet Ballestra Group. We will also attempt to raise additional debt and/or equity financing to fund operations and to provide additional working capital. However, there is no assurance that such financing will be consummated or obtained in sufficient amounts necessary to meet the Company’s needs, or that the Company will be able to meet its future contractual obligations. Should management fail to obtain such financing, the Company may curtail its operations.
The accompanying consolidated financial statements do not include adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from an inability of the Company to continue as a going concern.
Basis of Presentation
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) as promulgated in the United States of America (“U.S.”).
On October 7, 2009, the Company filed an amendment to its Articles of Incorporation with the Secretary of State of the State of Nevada to authorize and increase the number of authorized shares of common stock to 1,000,000,000 (par value $0.001) and to effect a 3 for 1 forward split of all outstanding shares. The effective date for the forward split was October 29, 2009. All references to the number of shares in the consolidated financial statements have been retroactively adjusted and are presented on a post-split basis.
Note 3 - Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Cavitation Technologies, Inc. and its wholly owned subsidiary Hydrodynamic Technology, Inc. All significant inter-company transactions and balances have been eliminated through consolidation.
Fair Value Measurement
FASB Accounting Standards Codification (“ASC”) 820-10 requires entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet for which it is practicable to estimate fair value. ASC 820-10 defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. As of June 30, 2011 and 2010, the carrying value of certain accounts such as inventory, accounts payable, accrued expenses, accrued payroll and short-term loans approximates fair value due to the short-term nature of such instruments.
The following table presents information about the Company’s assets and liabilities measured and reported in the financial statements at fair value on a recurring basis as of June 30, 2011 and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. The three levels of the fair value hierarchy are as follows:
·
Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
·
Level 2 - Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
·
Level 3 - Valuations based on inputs that are unobservable, supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The derivative liability attributed to the convertible notes’ conversion feature is measured using the Black-Sholes option valuation model.
The following tables provide a reconciliation of the beginning and ending balances of our financial liabilities classified as Level 3:
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. Significant estimates are used in valuing our stock options, warrants, convertible notes, and common stock issued for services, among other items. Actual results could differ from these estimates.
Revenue Recognition
Revenue is recognized when persuasive evidence of an agreement exists; delivery has occurred, including transfer of title and risk of loss for product sales, or services have been rendered for service revenues; the price to the buyer is fixed or determinable; and collectability is reasonably assured.
Concentrations
Four customers generated 100% of our revenue for fiscal 2011. These four customers are not expected to be repeat customers.
Deferred Revenue
As of June 30, 2011, the Company had received total deposits of $16,951 relating to the fabrication of the Company’s NANO Neutralization System. Because this transaction does not yet fulfill the requirements of revenue recognition, this amount has been reflected in Deferred Revenue on the accompanying consolidated balance sheet as of June 30, 2011.
Cash
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates market value. The Company maintains its cash and cash equivalents in bank deposit accounts which, at times, may exceed federally insured limits. The Company has never experienced losses in such accounts and believes it is not exposed to significant credit risk on cash and cash equivalents.
Inventory
Inventory, net of an allowance for excess quantities and obsolescence, are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Inventory is composed of finished goods, and represents costs incurred to manufacture our NANO Reactors.
Property and Equipment
Property and equipment is presented at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets. Betterments, renewals, and extraordinary repairs that extend the life of the assets are capitalized; other repairs and maintenance charges are expensed as incurred. The cost and related accumulated depreciation and amortization applicable to retired assets are removed from the Company's accounts, and the gain or loss on dispositions, if any, is recognized in the consolidated statements of operations.
Property and equipment are recorded at cost and depreciated using the straight-line method over the following estimated useful lives.
Leasehold improvements
Shorter of life of asset or lease
Furniture
5-7 Years
Office equipment
5-7 Years
Equipment
4-7 Years
Patents
Capitalized patent costs represent legal fees associated with procuring and filing patent applications. The Company accounts for patents in accordance with ASC 350-30, General Intangibles Other Than Goodwill. As of June 30, 2011, the Company had incurred $121,112 in gross patent costs which are capitalized in the accompanying consolidated balance sheet. The Company had one patent issued during the year ended June 30, 2011, which is being amortized over an estimated useful life of 4 years. The patent has a duration through February 27, 2029. For the year ended June 30, 2011, amortization amounted to $2,959.
At June 30, 2011, future amortization of patent costs is estimated as follows:
Amortizable Intangibles and Long-Lived Assets
In accordance with ASC 350-30, the Company evaluates amortizable intangibles and long-lived assets for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. The Company’s management believes there is no impairment of its intangibles and long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company’s products under development will continue. Either of these could result in future impairment of intangibles and long-lived assets.
Stock-Based Compensation
The Company accounts for its share-based compensation in accordance ASC 718-20, Share-Based Payment. Stock-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite vesting period. There were no stock options granted during the years ended June 30, 2011 or 2010. Warrants granted during the year ended June 30, 2011 and 2010 were valued using the following assumptions.
The assumptions used in the Black Scholes models referred to above are based upon the following data: (1) The contractual life of the underlying non-employee warrants as the expected life; The expected life of the option is estimated by considering the contractual term of the option, the vesting period of the option, the employees’ expected exercise behavior and the post-vesting employee turnover rate. (2) The expected stock price volatility of the underlying shares over the expected term of the option or warrant is based upon historical share price data of the Company. (3) The risk free interest rate is based on published U.S. Treasury Department interest rates for the expected terms of the underlying options. (4) Expected dividends are based on historical dividend data and expected future dividend activity. (5) The expected forfeiture rate is based on historical forfeiture activity and assumptions regarding future forfeitures based on the composition of current grantees.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10, Income Taxes. The Company recognizes deferred tax assets and liabilities to reflect the estimated future tax effects, calculated at anticipated future tax rates, of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset 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.
ASC 740-10 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. The Company classifies interest and penalties as a component of interest and other expenses. To date, there have been no interest or penalties assessed or paid.
The Company measures and records uncertain tax positions by establishing a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Only tax positions meeting the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized.
Deferred Costs
Deferred costs as of June 30, 2010 represent costs associated with customizing specific units of the NANO Neutralization System and Reactor products. During 2011 direct costs associated with the Nano Neutralization Systems and Reactors have been reclassified to property, plant and equipment and inventory, respectively. This reclassification aligns with CTi’s intention under its current sales and distribution strategy to use the Systems as demonstration units, and license the Reactors to a strategic partner.
Advertising costs
Advertising costs (including marketing expense) incurred in the normal course of operations are expensed as incurred. Advertising expenses amounted to $97,135, $46,719, and $236,438 for the years ended June 30, 2011 and 2010, and the period from January 29, 2007 (date of inception) through June 30, 2011, respectively.
Research and Development Costs
Research and development expenses relate primarily to the development, design, testing of preproduction prototypes and models, compensation, and consulting fees, and are expensed as incurred.
Recent Accounting Pronouncements
Accounting standards promulgated by the FASB change periodically. Changes in such standards may have an impact on the Company’s future financial position. The following are a summary of recent relevant accounting developments.
In May 2011, the Financial Accounting Standard Board (“FASB”) issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 clarifies some existing concepts, eliminates wording differences between U.S. GAAP and International Financial Reporting Standards (“IFRS”), and in some limited cases, changes some principles to achieve convergence between U.S. GAAP and IFRS. ASU 2011-04 results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. ASU 2011-04 will be effective for Cavitation beginning after December 15, 2011. Cavitation does not expect the adoption of ASU 2011-04 to have a material effect on its operating results or financial position.
Note 4 - Net Loss Per Share - Basic and Diluted
The Company computes the loss per common share using ASC 260, Earnings per Share. The net loss per common share, both basic and diluted, is computed based on the weighted average number of shares outstanding for the period. The diluted loss per common share is computed by dividing the net loss attributable to common stockholders by the weighted average shares outstanding assuming all potential dilutive common shares were issued.
As of June 30, 2011, the Company had 1,810,957 stock options and 13,145,618 warrants outstanding to purchase common stock that were not included in the diluted net loss per common share because their effect would be anti-dilutive. In addition, the Company had 111,111 shares of Series A Preferred Stock outstanding which are convertible into approximately 333,333 shares of common stock. The Company also had $120,610 of outstanding convertible notes payable, before any discounts, which are convertible into 2,202,626 shares of common stock as of June 30, 2011. These items were also not included in the calculation of diluted net loss per common share because their effect would be anti-dilutive.
Note 5 - Property and Equipment
Property and equipment consisted of the following as of June 30, 2011 and June 30, 2010:
Depreciation and amortization expense for the years ended June 30, 2011, 2010, and for the period from January 29, 2007 (inception) through June 30, 2011, amounted to $18,164, $16,968 and $47,751, respectively.
Note 6 - Bank Loan
On August 1, 2010 the Company renewed its loan with National Bank of California until November 1, 2010. The amount outstanding was $520,516. The terms and conditions remain the same with monthly payments of $7,396 and an interest rate of prime plus 2.75%. On November 1, 2010, the loan was extended until November 1, 2011 with 11 regular monthly payment of $6,000 and a final payment of $474,171. The interest rate floor was increased from 7.0% to 7.5%. As of June 30, 2011, the outstanding balance on the loan was $486,110. We provided the National Bank of California a security interest in the assets of the Company as collateral for a loan.
Note 7 - Convertible Notes Payable
On February 1, 2011, the Company issued convertible promissory notes to the Tripod Group, LLC, (the “Tripod Notes”) for an aggregate total amount of $61,212. The Tripod Notes bear interest at a rate of 6% per annum and have a maturity date of February 1, 2012. The holder of the notes may elect to convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price equal to 65% of the lowest closing bid price of any of the four trading days prior to the conversion. The issuance of the Tripod Notes amounted in a beneficial conversion feature of $32,960 on the issue date, which was recorded as a discount to the carrying value of the notes. As of June 30, 2011, the remaining discount balance amounted to $16,482. During the year ended June 30, 2011, $30,602 of the Tripod Notes principal was converted into 513,364 shares of common stock. As a result, the carrying value of the Tripod Notes as of June 30, 2011 amounted to $14,128 consisting of outstanding principal of $30,610 less the discount of $16,482. The beneficial conversion feature is measured using the Black-Sholes option valuation model. Refer to the table below for the inputs used in the Black-Scholes option valuation model
On February 8, 2011, the Company issued a convertible promissory note payable to Asher Enterprises, Inc., (the “Asher Note”), in the amount of $42,500. The Asher Note bears interest at a rate of 8% per annum and matures on November 10, 2011. The holder of the note may elect to convert principal and accrued interest into shares of common stock at any time at a conversion price equal to 58% of the average lowest closing bid prices of the Company’s common stock for 3 of any 10 trading days prior to conversion. The issuance of the Asher Note amounted in a beneficial conversion feature of $28,412 on the issue date, which has been recorded as a discount to the carrying value of the note. As of June 30, 2011, the remaining discount balance amounted to $13,741. As a result, the carrying value of the Asher Note as of June 30, 2011 amounted to $28,759 consisting of outstanding principal of $42,500 less the discount of $13,741. The beneficial conversion feature is measured using the Black-Sholes option valuation model. Refer to the table below for the inputs used in the Black-Scholes option valuation model.
On June 6, 2011, the Company issued a convertible promissory note payable to Asher Enterprises, Inc., (the “Second Asher Note”), in the amount of $47,500. The Asher Note bears interest at a rate of 8% per annum and matures on March 8, 2012. The holder of the note may elect to convert principal and accrued interest into shares of common stock at any time at a conversion price equal to 61% of the average lowest closing bid prices of the Company’s common stock for 3 of any 10 trading days prior to conversion. The issuance of the Second Asher Note amounted in a beneficial conversion feature of $41,109 on the issue date, which has been recorded as a discount to the carrying value of the note. As of June 30, 2011, the remaining discount balance amounted to $29,724. As a result, the carrying value of the Second Asher Note as of June 30, 2011 amounted to $17,776 consisting of outstanding principal of $47,500 less the discount of $29,724. The beneficial conversion feature is measured using the Black-Sholes option valuation model. Refer to the table below for the inputs used in the Black-Scholes option valuation model.
By virtue of the variable conversion ratios of the Tripod Notes, the Asher Note and the Second Asher Note, the conversion feature of the above notes is a derivative under ASC 815-40, Derivatives and Hedging. Accordingly, the value of the conversion feature has been classified as a derivative liability on the accompanying balance sheet. As of June 30, 2011, the aggregate value of the conversion features associated with the above notes amounted to $121,679.
The inputs used for the Black-Scholes option valuation model were as follows:
Note 8 - Related Party Short-Term Loans
In June 2011, the Company borrowed $6,000 from our Chief Financial Officer. The borrowing bears no interest and is payable on demand. The outstanding balance as of June 30, 2011 was $6,000.
In June 2011, the Company borrowed $9,750 from 3240 Huntington, LLC, a company owned by our President. The borrowing bears no interest and is payable on demand. The outstanding balance as of June 30, 2011 was $9,750.
Note 9 - Short-Term Loans
In January 2010, the Company borrowed $9,000 from a shareholder as a short-term loan. The borrowing bears no interest and is due on demand. As of June 30, 2010, the total outstanding amount related to this short-term loan amounted to $9,000. On July 6, 2010, the outstanding short-term loan amount of $9,000 was repaid.
In May 2010, the Company received a short-term loan from a shareholder in the amount of $100,000. The borrowing bears no interest and is due on demand. As of June 30, 2010, the total outstanding amount related to this short-term loan amounted to $100,000. On February 14, 2011, the outstanding balance of this short-term loan was converted into 1,000,000 shares of common stock. The remaining outstanding balance as of June 30, 2011 was $0.
On October 26, 2010, the Company entered into a loan agreement with Desmet Ballestra North America, Inc. under which the Company borrowed $75,000. Under the original terms of the agreement, the loan was interest-free and was repayable at $25,000 per month beginning January 25, 2011. On March 28, 2011, the terms of the loan agreement were revised to provide for monthly payments of $15,000 starting in April 2011. The loan bears no interest, unless the Company is late with a payment, at which point interest is accrued on the late amount at a rate of 10% compounded annually. As of June 30, 2011, the Company made one payment of $15,000, and the outstanding balance amounted to $60,000. Accrued interest on the late payments amounted to $125 as of June 30, 2011.
During fiscal 2011 and 2010, CTi had average borrowings of $648,644 and $619,045, respectively under its short-term obligations (bank loan, related party payable short term loans, convertible notes payable and short-term loans). The weighted average interest rate on the short-term obligations outstanding as of June 30, 2011 and June 30, 2010 was 6.7% and 5.8%, respectively.
Note 10 - Stockholders’ Equity
Common Stock
On September 24, 2009, the Company’s Board of Directors authorized an increase in authorized common shares from 100,000,000 to 1,000,000,000 as well as a 3 for 1 forward split of the Company’s common shares. The stock split resulted in a retroactive restatement of all historical shares outstanding. The accompanying consolidated statements of changes in stockholder’s deficit and references to the number of shares throughout the document were restated to give retroactive recognition of the forward stock split.
During the year ended June 30, 2010, the Company completed the following common stock transactions.
On June 1, 2010, the Company issued a note to Igor Gorodnitsky, the Company’s President, in the amount of $278,922 as payment for deferred salary owed to him. Concurrent with the issuance of the note payable, Mr. Gorodnitsky sold the note payable to Snapshot, Ltd., a third party company, for the face value of the note of $278,922. On June 1, 2010, Snapshot, Ltd., a note holder, agreed to convert the outstanding note payable into shares of the Company’s common stock at a conversion rate of $0.10 per share. As a result, the Company issued 2,789,217 shares of common stock as payment of the note payable of $278,922. A resulting charge on the conversion of the note payable of $223,137 was recorded, representing the difference between the market value of the stock issued and the book value of the note payable. This amount is reflected in interest expenses during the year ended June 30, 2010.
During the year ended June 30, 2010, the Company issued an aggregate of 29,637,462 shares of common stock as payment for services provided, which resulted in an aggregate total expense of $6,475,727. This amount is reflected in general and administrative and research and development expenses in the accompanying consolidated statements of operations during the year ended June 30, 2010. This total includes 2,825,000 shares of restricted common stock issued to members of senior management as compensation on July 24, 2009, which had a total value of $2,260,000. These shares vest over a period from June 25, 2009 through January 2, 2011. As of June 30, 2010, the total vested value of these restricted shares amounted to $1,473,725, which was included in the amount recorded in general and administrative expense above. The remainder of the shares vested during the year ended June 30, 2011, resulting in an additional $786,275 in general and administrative expenses during the year ended June 30, 2011.
During the year ended June 30, 2010, the Company sold an aggregate of 8,047,915 shares of restricted common stock for aggregate total proceeds of $1,231,947. Along with the purchase of the shares, the investors were also issued an aggregate of 6,922,915 warrants to purchase additional shares of the Company’s common stock. These warrants have an exercise price of $0.42 per share, a contractual life of 3 years, and were vested immediately upon the date of grant.
During the year ended June 30, 2011, the Company completed the following common stock transactions.
During the year ended June 30, 2011, the Company issued an aggregate of 16,203,655 shares of common stock as payment for services provided, which resulted in an aggregate total expense of $1,784,182, including $1,491,582 in general and administrative expenses and $292,600 in research and development expenses in the accompanying consolidated statements of operations during the year ended June 30, 2011. The 16,203,655 shares were issued at grant date fair market value.
During the year ended June 30, 2011, the Company sold an aggregate of 5,501,134 shares of restricted common stock for total proceeds of $572,741.
During the year ended June 30, 2011, the Company issued 513,364 shares of common stock to convert $30,602 of outstanding principal under the Tripod Notes (see Note 7).
On February 14, 2011, the Company issued 1,000,000 shares of common stock as payment of an outstanding short-term loan of $100,000 (see Note 9).
Preferred Stock
On March 17, 2009, the Company filed Amended and Restated Articles of Incorporation and created two new series of preferred stock, the first of which is designated Series A Preferred Stock and the second of which is designated as Series B Preferred Stock . The total number of shares of Common Stock which this corporation shall have authority to issue is 100,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock of which 5,000,000 shares are designated as Series A Preferred Stock, and 5,000,000 shares are designated as Series B Preferred Stock, with the rights, preferences and privileges of the Series B Preferred Stock to be designated by the Board of Directors. Each share of Common Stock and Preferred Stock has a par value of $0.001.
Series A Preferred Stock
The Company has 5,000,000 shares of Series A Preferred Stock authorized and 111,111 shares outstanding. Series A Preferred Stock is convertible into common stock at a rate of 3 shares of common stock per share of each Series A Preferred Stock held at any time at the option of the preferred shareholders. In the event of any liquidation, dissolution or winding up of the Company, the holders of Series A Preferred will have liquidation preferences prior to distributions made to any other class of stockholder. The Series A Preferred Stock is not redeemable. On the third anniversary date of the issuance of the preferred shares, any Series A Preferred shares outstanding are automatically converted into common stock, at the conversion rate described above.
The holders of the Series A Preferred Stock are entitled to receive out of any funds legally available dividends at the rate of 6% per annum payable on September 30 and March 30. Dividends shall accrue and be cumulative whether or not they have been declared. Dividends may be paid in cash or through the issuance of additional shares of Series A Preferred Stock at the Company’s option. During the years ended June 30, 2011 and 2010, cumulative dividends amounted to $13,733 and $7,733 respectively. As of June 30, 2010, none of the cumulative dividends have been paid.
Series B Preferred Stock
The Company has authorized 5,000,000 shares of Preferred Stock as Series B Preferred Stock. The Board of Directors can establish the rights, preferences and privileges of the Series B Preferred Stock. There are no shares of Series B Preferred Stock outstanding.
Stock Options
The Company has not adopted a formal stock option plan, however, it has assumed outstanding stock options resulting from the acquisition of its wholly-owned subsidiary, Hydrodynamic Technology, Inc. In addition, the Company has made periodic non-plan grants.
A summary of the stock option activity from January 29, 2007 (date of inception) through June 30, 2011 is as follows.
There were no stock options granted during the year ended June 30, 2011 or 2010. In addition, there were no unvested options as of June 30, 2011 or 2010. The intrinsic value of the outstanding options was $0 as of June 30, 2011 and 2010.
The following table summarizes additional information concerning options outstanding and exercisable at June 30, 2011.
Warrants
A summary of the Company’s warrant activity and related information from January 29, 2007 (date of inception) through June 30, 2011 is as follows.
The weighted average grant date fair value of warrants granted during the years ended June 30, 2011 and 2010 amounted to $0.08 and $0.19, respectively.
The following table summarizes additional information concerning warrants outstanding and exercisable at June 30, 2011.
Note 11 - Income Taxes
Total income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following:
Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the net deferred tax asset at June 30, 2011 and June 30, 2010 relate to the following:
The Company files income tax returns in the United States ("Federal") and California ("State") jurisdictions. The Company is subject to Federal and State income tax examinations by tax authorities for all years since its inception.
At June 30, 2011, the Company had Federal and State net operating loss carry forwards available to offset future taxable income of approximately $6.6 million and $6.7 million, respectively. These carry forwards will begin to expire in the years ending June 30, 2027 and June 30, 2017, respectively, subject to IRS limitations, including change in ownership.
The Company periodically evaluates the likelihood of the realization of deferred tax assets, and adjusts the carrying amount of the deferred tax assets by a valuation allowance to the extent the future realization of the deferred tax assets is not judged to be more likely than not. The Company considers many factors when assessing the likelihood of future realization of our deferred tax assets, including recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carry-forward periods available to us for tax reporting purposes, and other relevant factors.
At June 30, 2011, based on the weight of available evidence, including cumulative losses in recent years and expectations of future taxable income, the Company determined that it was more likely than not that its deferred tax assets would not be realized. Accordingly, the Company has recorded a valuation allowance for 100% of its cumulative deferred tax assets.
As a result of the implementation of certain provisions of ASC 740-10, the Company performed an analysis of its previous tax filings and determined that there were no positions taken that it considered uncertain. Therefore, there were no unrecognized tax benefits as of June 30, 2011.
Future changes in the unrecognized tax benefit are not expected to have an impact on the effective tax rate due to the existence of the valuation allowance. The Company estimates that the unrecognized tax benefit will not change within the next twelve months. The Company will continue to classify income tax penalties and interest, if any, as part of interest and other expenses in its consolidated statements of operations. There is no interest or penalties accrued as of June 30, 2011.
The following summarizes the open tax years for each major jurisdiction:
Jurisdiction Open Tax Years
Federal 2007 - 2010
California State 2006- 2010
The Company’s net operating loss carryforwards are subject to IRS examination until they are utilized and such tax years are closed.
Note 12 - Commitments and Contingencies
Lease Agreements
The Company leases approximately 5,000 square feet of office and warehouse space at 10019 Canoga Ave in Chatsworth, California under a lease agreement which extends through February 1, 2012. Monthly rent under the extended lease agreement is $4,378 per month. The Company has a security deposit of $9,500 associated with this lease.
Total rent expense was $47,388, $55,735, and $247,171 for the years ended June 30, 2011, 2010 and for the period from January 29, 2007 (date of inception) through June 30, 2011, respectively.
Future minimum lease payments under non-cancelable operating leases are as follows.
Royalty Agreements
On July 1, 2008, our wholly owned subsidiary entered into Patent Assignment Agreements with our President and former CEO, and current CTO, where certain devices and methods involved in the hydrodynamic cavitation processes invented by the President and CTO have been assigned to the Company. In exchange, the Company agreed to pay a royalty of 5% of gross revenues to each of the CTO and President for licensing of the technology and leasing of the related equipment embodying the technology. These agreements were subsequently assigned to Cavitation Technologies on May 13, 2010. The Company’s CTO and President both waived their rights to receive royalty payments that have accrued, or that may accrue, on any gross revenue generated through June 30, 2011.
On April 30, 2008 (as amended November 22, 2010), our wholly owned subsidiary entered into an employment agreement with Varvara Grichko who became a member of the Board of Directors in September 2010. Mrs. Grichko shall receive an amount equal to 5% of actual gross royalties received from the royalty stream in the first year in which the Company receives royalty payments from the patent which Mrs. Grichko was the legally named inventor, and 3% of actual gross royalties received by the Company from the patent in each subsequent year.
Licensing Agreement
On November 1, 2010 we signed a Technology License, Marketing &Collaboration Agreement with N.V. Desmet Ballestra Group S.A. (“Desmet”). The agreement gives Desmet the exclusive worldwide license to market the CTI Nano Reactor System (“CTI System”) in the field of vegetable oil processing (the “Licensed Field”). Under this Agreement, Desmet is responsible for marketing the CTI System to end users in the Licensed Field, as well as the construction, installation and maintenance of the system. In consideration for services rendered, we agreed to pay Desmet a fee. We intend to generate revenues from the licensing of systems. This agreement supersedes a previous agreement between the parties signed January 15, 2010. In subsequent amendments (attached hereto as exhibits) to the agreement dated November 1, 2010, Desmet agreed to guaranty results to end-users. We rely exclusively on our strategic partnership with Desmet to market, and distribute our Reactors to new customers.
Note 13 - Subsequent Events
On June 24, 2011 we entered into a convertible promissory note with GEL Properties, LLC, under which we issued a $52,500 convertible promissory note to GEL Properties, LLC. The note is due June 24, 2012 and bears interest at a rate of six percent per annum. The note is convertible into shares of our common stock at a conversion price equal to 65% of the average day’s lowest closing bid out of the 5 trading days prior to conversion. The transaction was funded July 12, 2011. The note was issued in reliance on Section 4(2) of the Securities Act of 1933. The note was not offered via general solicitation to the public but solely to the aforementioned purchaser. No sales commissions or other remuneration was paid in connection with the issuance of this note.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
In accordance with rule 13a-15(a), CTi management must maintain disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities and Exchange Act of 1934, or the Exchange Act, to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
In accordance with Rule 13a-15(b) and (c), management must also evaluate the effectiveness of these disclosure control and procedures at the end of each fiscal year. As of June 30, 2011, the Company carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the Company’s principal executive officer and principal financial officer concluded that these disclosure controls and procedures were effective as of June 30, 2011.
Report of Management on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed under the supervision of our principal executive and principal financial officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
In accordance Rule 13a-15(c), as of the end of each fiscal year, management must evaluate the effectiveness of internal control over financial reporting. Under the supervision and with the participation of our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2011. We evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework. Based on these criteria, management concluded that our internal control over financial reporting was effective as of June 30, 2011.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2011 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Attestation
Pursuant to Item 308(b) of Regulation S-K, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Wall Street Reform Act), this report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. The Wall Street Reform Act permanently exempts small public companies from the requirement to obtain an external audit on the effectiveness of internal financial reporting controls.
ITEM 9B.
ITEM 9B. Other Information
Not applicable
Part III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Person
Age
Position
Mr. Todd Zelek
CEO, Secretary & Director
Mr. Igor Gorodnitsky
President & Director
Mr. R.L. Hartshorn
CFO and Director
James Fuller
Director
Varvara Grichko
Director
We have an audit committee, but do not have a compensation committee. We anticipate forming compensation, governance, and other committees.
Todd Zelek. Mr. Zelek has been our Chairman and CEO since June 14, 2011. Prior to joining the Company, Mr. Zelek was formerly a private investor and former Investment Banker. Mr. Zelek was formerly Managing Director, Internet Group Head and Co-Head of the Los Angeles Investment Banking office for Lehman Brother, Inc. from 1995 through 2001. Prior to that he was a Managing Director and head of the Thrift Industry practice at Salomon Brothers in Los Angeles and New York. He began his career as an Investment Banker at Smith Barney in 1982. Mr. Zelek earned a Master's degree from the Sloan School at MIT in 1982 and graduated with Distinction from Cornell University in 1979. He was a member of Phi Beta.
Igor Gorodnitsky. Mr. Gorodnitsky has been our President and member of the Board of Directors since September 26, 2008. Mr. Gorodnitsky developed expertise in handling and processing hazardous waste material. As a Senior Haz-Mat Specialist, he coordinated and successfully completed more than 500 emergency response Haz-mat clean-ups over the past 20 years. He coordinated and supervised Haz Mat projects, emergency and routine spill clean-ups, and confined space entry tasks. He coordinated and scheduled manpower and purchased and scheduled equipment and materials for containment and treatment of spills. He successfully managed, coordinated and supervised projects including Hazscanning, sampling, lab-packing, manifesting, profiling, labeling, and other special procedures for a variety of commercial clients and municipalities. He is a chemist by training and holds numerous certifications and licenses including Hazwoper Training Program, Confined Space Entry and Gas Vapour HazCating, Certified Uniform Waste Manifest Training, Basic and Intermediate HazCating, On-Scene Incident Commander Emergency, Site Remediation Methods, Underground Storage Tank Removal, Health & Safety Supervisor Certification, Hazardous Certification, and Tosco Refinery Safety. Mr. Gorodnitsky was president of Express Environmental Corp. since its inception in 1980 until he sold his interest in January 2009.
R.L. Hartshorn. Mr. Hartshorn has served as Chief Financial Officer and member of the Board of Directors of the Company since September 26, 2008. He previously served as a consultant to the company beginning in December 2007. He served 15 years in a variety of leadership and operational positions in international banking with Chase Manhattan, the Swiss National bank (Foundation) and other banks in Europe, New York, and Latin America. He speaks German, Portuguese, and Spanish. As a vice president at Chase and other banks, he was largely responsible for cultivating credit and marketing relationships with corporate clients across a variety of industries. He also held sales and sales management positions for 8 years with two public companies in the IT domain including seven years as Marketing & International Sales Manager for a software and advertising company. Overall, Mr. Hartshorn’s operational experience includes 13 years with a sales quota and seven years with P&L responsibility. He has been involved in the start-up of four business units and a turn-around of a business unit. He earned a B.S from the U.S. Naval Academy in 1971and an MBA from The Thunderbird School of Global Management in 1977.
James Fuller. Mr. Fuller is an independent director, and has been Chairman of our Audit Committee and Independent Financial Expert since February, 2010. He was formerly a Vice President of the New York Stock Exchange and director of the Securities Investor Protection Corporation. In addition to his over 30 years experience in the securities markets, Mr. Fuller sat on the Board of Trustees of the University of California, Santa Cruz and previously served as Chairman of their Audit Committee and Independent Financial Expert. Jim is a partner at Baytree Capital Associates, LLC. He received his BS in Political Science from San Jose State University and his MBA from California State University- Fresno.
Varvara Grichko. Ms. Grichko has been a member of our board of directors since September, 2010. Ms. Grichko began her career at the Institute of Organic Chemistry. Varvara received her B.S. and M.S degrees in chemistry and catalysis at Novosibirsk University in Russia. Among her other professional achievements, Ms. Grichko worked at Marquette University and Novozymes, Inc., where she was involved in the development of a new process for Bioethanol production. Ms. Grichko holds a Ph.D. in Chemistry from the Russian Academy of Science and a Ph.D. in biology from the University of Waterloo in Canada.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that applies to all officers, directors and employees. A copy may also be obtained free of charge by mailing a request in writing to: Cavitation Technologies, Inc., 10019 Canoga Ave., Chatsworth, CA 91311 USA. If we make any substantive amendments to the Code of Business Conduct and Ethics or grant any waiver from a provision of the Code to any executive officer or director, we will promptly disclose the nature of the amendment or waiver in a current report on Form 8-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
The following table summarizes the compensation earned by each named executive officer of the Company for the past two fiscal years, determined on the basis of rules adopted by the SEC relating to smaller reporting companies.
(1)
Stock awards are disclosed at the expense recorded based on their aggregate grant date fair values as calculated under ASC 718, Share-Based Payments. All share amounts disclosed include the impact of a 3 for 1 forward stock split which was effective as of October 29, 2009.
(2)
For the year ended June 30, 2011, Mr. Gordon earned a base salary of $195,000. However, Mr. Gordon received only $157,500, and the unpaid $37,500 is recorded as accrued payroll as of June 30, 2011.
(3)
For the year ended June 30, 2010, Mr. Gorodnitsky earned a base salary of $195,000, of which a total of $44,048 remains unpaid and recorded as accrued payroll as of June 30, 2011. For the year ended June 30, 2011, Mr. Gorodnitsky earned a base salary of $195,000. However, Mr. Gorodnitsky received only $157,500, and the unpaid $37,500 is recorded as accrued payroll as of June 30, 2011. As of June 30, 2011, accrued payroll for Mr. Gorodnitsky totals $81,548.
(4)
In July 2009, the Company issued Mr. Gordon 3,000,000 shares of restricted common stock as payment for services. On the date of grant, the shares had an aggregate fair value of $800,000. The shares vest through January 2, 2011 and were expensed in the financial statements over that time. During the years ended June 30, 2011 and June 30, 2010, the Company recorded a total of $278,327 and $521,673, respectively, of expense associated with this grant.
(5)
In July 2009, the Company issued Mr. Gorodnitsky 3,000,000 shares of restricted common stock as payment for services. On the date of grant, the shares had an aggregate fair value of $800,000. The shares vest through January 2, 2011 and were expensed in the financial statements over that time. During the years ended June 30, 2011 and June 30, 2010, the Company recorded a total of $278,327 and $521,673, respectively, of expense associated with this grant.
(6)
As compensation during the year ended June 30, 2010, Mr. Hartshorn received an aggregate total of 350,000 shares of common stock with an aggregate grant date fair value of $63,750. For the year ended June 30, 2011, Mr. Hartshorn received an aggregate total of 375,000 shares of common stock with an aggregate grant date fair value of $56,250 as compensation.
(7)
In July 2009, the Company issued Mr. Hartshorn 750,000 shares of restricted common stock as payment for services. On the date of grant, the shares had an aggregate fair value of $200,000. The shares vest through January 2, 2011 and were expensed in the financial statements over that time. During the years ended June 30, 2011 and June 30, 2010, the Company recorded a total of $69,582 and $130,418, respectively of expense associated with this grant.
*
On June 14, 2011 Roman Gordon resigned as a member of the Board of Directors, Chief Executive Officer and Secretary of the Company and was subsequently appointed as the Chief Technology Officer. Concurrently with Mr. Gordon’s resignation, the Company appointed Todd Zelek as Chairman of the Board of Directors and Chief Executive Officer. In addition, on June 17, 2011, Mr. Zelek was appointed as Secretary of the Company. The aforementioned change to our key executives and Board of Directors is contained in our current report on Form 8-K filed with the SEC on June 20, 2011.
Outstanding Equity Awards at Fiscal Year-End
The following table shows the outstanding equity-based awards that were held by our named executive officers as of June 30, 2011.
(1)
All share amounts disclosed include the impact of a 3 for 1 forward stock split which was effective as of October 29, 2009.
Director Compensation
The following table sets forth certain information with respect to the compensation paid to our directors for the past fiscal year, determined on the basis of rules adopted by the SEC relating to smaller reporting companies.
(1)
Stock awards above are disclosed at their aggregate grant date fair values as calculated under FASB ASC 718.
(2)
Mr. Fuller received an aggregate total of 150,000 shares of common stock with an aggregate grant date fair value of $19,875 as compensation for director services.
(3)
Ms. Grichko received an aggregate total of 30,000 shares of common stock with an aggregate grant date fair value of $3,100 as compensation for director services. As of June 30, 2011, Ms. Grichko has 174,021 stock option awards outstanding and exercisable.
Retirement or Change of Control Arrangements
We do not offer retirement benefit plans to our executive officers, nor have we entered into any contract, agreement, plan or arrangement, whether written or unwritten, that provides for payments to a named executive officer at or in connection with the resignation, retirement or other termination of a named executive officer, or a change in control of the company or a change in the named executive officer's responsibilities following a change in control.
Compensation of Directors
We do not have any standard arrangement for compensation of our directors for any services provided as director; including services for committee participation or for special assignments.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information concerning the number of shares of our common stock known by us to be owned beneficially as of June 30, 2011 and the date hereof by: (i) each person (including any group) that owns more than 5% of any class of the voting securities of our company; (ii) each director and officer of our company; and (iii) directors and officers as a group. Unless otherwise indicated, the stockholders listed possess sole voting and investment power with respect to the shares shown. The address for all directors and officers, unless otherwise indicated, is 10019 Canoga Avenue, Chatsworth, CA 91311.
(1)
Based upon 153,799,715 issued and outstanding shares of common stock as of June 30, 2011, which includes the impact of 3 for 1 forward stock split which was effective as of October 29, 2009.
*
Less than 1%.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Certain Related Party Transactions
Other than compensation agreements and other arrangements with our executive officers and directors and the transactions described below, during our last two fiscal years, there has not been, and there is not currently proposed, any transaction or series of similar transactions to which we were or will be a party in which the amount involved exceeded or will exceed the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two completed fiscal years and in which any of our directors, executive officers, holders of more than five percent of any class of our voting securities or any member of the immediate family of the foregoing persons had or will have a direct or indirect material interest.
On June 17, 2011we granted 3,000,000 shares valued at $254,595 to Bioworld Management Ltd. as compensation for research and development related engineering and consulting services. As of the date of the transaction, the total number of shares recorded by the transfer agent owned by Bioworld Management Ltd., and its beneficial owner, Maxim Promtov, amounted to 10,226,183, or 6.65% of the then outstanding 153,836,471 shares. As a result, Bioworld Management and Maxim Promtov are considered related parties. Bioworld had an existing relationship with the Company by virtue of a Consulting Agreement dated November 1, 2010 and the payment of these shares was for additional services provided.
Refer to Footnote 8, Related Party Short-Term Loans, and Note 12, Commitments and Contingencies, Royalty Agreements, for a description of our related party transactions with our executive officers during the fiscal year ended June 30, 2011.
Director Independence
As our common stock is currently traded on the OTC Bulletin Board, we are not subject to the rules of any national securities exchange which require that a majority of a listed company’s directors and specified committees of the board of directors meet independence standards prescribed by such rules. For the purpose of preparing the disclosures in this Report on Form 10-K regarding director independence, we have used the definition of “independent director” set forth in the Marketplace Rules of The NASDAQ, which defines an “independent director” generally as a person other than an executive officer or employee of the Company or any other individual having a relationship which, in the opinion of the Company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Consistent with these standards, we believe that James Fuller is an independent director.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit
Our principal auditing firm is Rose, Snyder, and Jacobs. During fiscal 2011 and 2010, we incurred expenses of $57,950 and $97,113, respectively, for professional services rendered for the audit of our annual financial statements and review of financial statements included on Form 10-Q.
Tax Fees
The aggregate fees billed in fiscal 2011 and fiscal 2010 for professional services rendered by the principal accountant for tax preparation amounted to $6,800 and $10,300, respectively.
Audit Committee
The charter of the Audit Committee provides that the Audit Committee pre-approves all audit services and permitted non-audit services to be performed for CTi by its independent public accounting firm, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(1)(B) of the Exchange Act.
Part IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this annual report on Form 10-K:
1.
Financial Statements
The financial statements are filed as part of this report under Item 8 “Financial Statements and Supplementary Data”.
2.
Financial Statement Schedules
All other schedules are omitted because they are not applicable or the required information is presented in the financial statements and notes thereto.
3.
Exhibits
The exhibits required by Item 601 of Regulation S-K are included in Item 15(b) below.
(b) - Exhibits.
(c) - Financial Statement Schedules
See Item (a) 2 above.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED
SIGNATURE
TITLE
DATE
/s/ Todd J. Zelek
Chairman of the Board, Chief Executive Officer and Secretary
September 28, 2011
Todd J. Zelek
(Principal Executive Officer)
/s/ R.L. Hartshorn
Chief Financial Officer
September 28, 2011
R.L. Hartshorn
(Principal Financial Officer)
/s/ Igor Gorodnitsky
Director
September 28, 2011
Igor Gorodnitsky