CVAT Cavitation Technologies Inc (QB)

ITEM 1 - Condensed Consolidated Financial Statements

See accompanying notes to the condensed consolidated financial statements

See accompanying notes to the condensed consolidated financial statements

See accompanying notes to the condensed consolidated financial statements

See accompanying notes to the condensed consolidated financial statements

CAVITATION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three months ended September 30, 2019 and 2018

Note 1 - Organization and Summary of Significant Accounting Policies

Cavitation Technologies, Inc. (the Company," "CTi," "we," "us," and "our") is a Nevada corporation originally incorporated under the name Bio Energy, Inc. The Company has developed, patented, and commercialized proprietary technology that may be used in liquid processing applications.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") as promulgated in the United States of America ("U.S.") and with instructions to Form 10-Q pursuant to the rules and regulations of Securities and Exchange Act of 1934, as amended (the "Exchange Act") and Article 8-03 of Regulation S-X under the Exchange Act. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, we have included all adjustments considered necessary (consisting of normal recurring adjustments) for a fair presentation. Operating results for the three months ended September 30, 2019 are not indicative of the results that may be expected for the fiscal year ending June 30, 2020. You should read these unaudited condensed consolidated financial statements in conjunction with the audited financial statements and the notes thereto included in the Company's annual report on Form 10-K for the year ended June 30, 2019 filed with the SEC on October 15, 2019. The condensed consolidated balance sheet as of June 30, 2019 has been derived from the audited financial statements included in the Form 10-K for that year.

Going Concern

The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As of September 30, 2019, the Company had a stockholders’ deficit of $781,000 and a working capital deficit of $886,000. The Company has also been dependent on certain aspects of its funding from technology and license agreements with its distributors, Desmet Ballestra (Desmet) and GEA Westfalia (GEA). These factors, among others, raise doubt about the Company's ability to continue as a going concern. In addition, our independent registered public accounting firm, in their report on our audited financial statements for the fiscal year ended June 30, 2019, expressed doubt about our ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include adjustments that might be necessary if the Company is unable to continue as a going concern.

Management’s plan is to generate income from operations by continuing to license its technology globally. Currently, we have a Research and Development (R&D) Marketing and Technology License agreements with two customers, Desmet and GEA, in which Desmet and GEA provide monthly advances to be applied to future gross profit revenues. Desmet provides advance of $50,000 per month through October 2021, and GEA provides advances to the Company of $25,000 per month through January 2020.

We may also attempt to raise additional debt and/or equity financing to fund operations and 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, that the Company will be able to achieve profitable operations 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.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Cavitation Technologies, Inc. and its wholly owned subsidiary Hydrodynamic Technology, Inc. Inter-company transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of the consolidated 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 include the in reserve for inventory obsolescence, impairment analysis for fixed assets, accrual of potential liabilities, valuation of deferred tax assets and assumptions used in valuing our stock options, warrants, and common stock issued for services, among other items. Actual results could differ from these estimates.

Revenue Recognition

The Company follows the guidance of Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. ASC 606 creates a five-step model that requires entities to exercise judgment when considering the terms of contracts, which includes (1) identifying the contracts or agreements with a customer, (2) identifying our performance obligations in the contract or agreement, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations, and (5) recognizing revenue as each performance obligation is satisfied. The Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration it is entitled to in exchange for the services it transfers to its clients

Revenue from sale of our Nano Reactors is recognized when products are shipped from our manufacturing facilities as this is our sole performance obligation under these contracts and we have no continuing obligation to the customer.

In addition, the Company recognizes revenue from its share of gross profit to be earned from distributors, as defined, which we treat as variable consideration and recognize using the most likely amount method. Estimates are available from our distributor which are considered in the determination of the most likely amount. However, given the lack of control over the sale to the end customer and the lack of history of prior sales, the amount of gross profit revenue recognized is limited to the actual amount of cash received under the contract which the Company has determined is not refundable and it is probable that a significant revenue reversal of cumulative product revenue under the contract will not occur.

Lease

Prior to July 1, 2019, start of our fiscal year, the Company accounted for leases under Accounting Standards Codification (“ASC”) 840, Accounting for Leases. Effective July 1, 2019, the Company adopted the guidance of ASC 842, Leases (“ASC 842”), which requires an entity to recognize a right-of-use asset and a lease liability for virtually all leases. The Company adopted ASC 842 using a modified retrospective approach. As a result, the comparative financial information has not been updated and the required disclosures prior to the date of adoption have not been updated and continue to be reported under the accounting standards in effect for those periods. Leases with an initial term of 12 months or less are not recorded on the balance sheet. The Company accounts for the lease and non-lease components of its office lease as a single lease component. Lease expense is recognized on a straight-line basis over the lease term. The adoption of ASC 842 on July 1, 2019 resulted in the initial recognition of operating lease right-of-use assets of $325,000, lease liabilities for operating leases of $325,000, and a zero cumulative-effect adjustment to accumulated deficit (see Note 3).

Fair Value Measurement

The Company follows the guidance of ASC 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”), with respect to financial assets and liabilities that are measured at fair value. 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.

ASC 820-10 establishes a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value as follows:

On September 30, 2019 and June 30, 2019, the fair values of cash and cash equivalents, accounts receivable, inventory and accounts payable and accrued expenses approximate their carrying values due to their short-term nature.

Concentrations

Cash is deposited in one financial institution. The balances held at this financial institution at times may be in excess of Federal Deposit Insurance Corporation (“FDIC”) insurance limits of up to $250,000.

The Company’s revenue was mainly derived from sales of its Nano Reactor® and Nano Neutralization® System to Desmet. During the three months ended September 30, 2019 and 2018, 100% of recorded revenues, respectively, were derived from Desmet (see Note 2).

At September 30, 2019 and June 30, 2019, 100% of accounts receivable, respectively, were due from Desmet.

As of September 30, 2019, three vendors and/or professional consultants accounted for 58%, 22% and 17%, respectively, of accounts payable. As of June 30, 2019, three vendors and/or professional consultants accounted for 49%, 33% and 11%, respectively, of accounts payable.

Earnings (Loss) Per Share

The Company’s computation of earnings (loss) per share (EPS) includes basic and diluted EPS. Basic EPS is calculated by dividing the Company’s net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Shares of restricted stock subject to vesting are included in basic weighted average common shares outstanding from the time they vest. Diluted EPS reflects the potential dilution, using the treasury stock method that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income (loss) of the Company. In computing diluted loss per share, the treasury stock method assumes that outstanding options, and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants.

As of September 30, 2019, the Company had 11,000,000 stock options and 79,263,176 stock warrants outstanding to purchase shares of common stock that were not included in the diluted net income per common share because their effect would be anti-dilutive.

As of September 30, 2018, the Company had 11,000,000 stock options and 75,926,510 stock warrants outstanding to purchase shares of common stock that were not included in the diluted net loss per common share because their effect would be anti-dilutive.

Segments

The Company operates in one segment, its nano reactor technology business.  In accordance with the “Segment Reporting” Topic of the ASC, the Company’s chief operating decision maker has been identified as the Chief Executive Officer and President, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Existing guidance, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products and services, major customers, and the countries in which the entity holds material assets and reports revenue. All material operating units qualify for aggregation under “Segment Reporting” due to their similar customer base and similarities in: economic characteristics; nature of products and services; and procurement, manufacturing and distribution processes. Since the Company operates in one segment, all financial information required by “Segment Reporting” can be found in the accompanying consolidated financial statements.

Recent Accounting Pronouncements

In September 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326), which replaces the incurred-loss impairment methodology and requires immediate recognition of estimated credit losses expected to occur for most financial assets, including trade receivables. Credit losses on available-for-sale debt securities with unrealized losses will be recognized as allowances for credit losses limited to the amount by which fair value is below amortized cost. ASU 2016-13 is effective for the Company beginning July 1, 2023 and early adoption is permitted. The Company does not believe the potential impact of the new guidance and related codification improvements will be material to its financial position, results of operations and cash flows.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

Note 2 – Contracts with Customers

Desmet Ballestra Agreement

In October 2018, we signed a three-year global R and D, Marketing and Technology License Agreement with Desmet for the sale and licensing of our reactors. This agreement is a continuation of an original agreement we signed with Desmet in 2012, and amended in 2016. As part of the October 2018 agreement, Desmet agreed to provide us monthly advances of $50,000 through October 1, 2022 to be applied against gross profit share from future sales.

During the three months ended September 30, 2019, the Company recorded sales of $207,000 from reactor sales and $144,000 from gross profit share for a total revenue of $351,000 from Desmet.

At June 30, 2019, advances from Desmet totaled $33,000. During the three months ended September 30, 2019, the Company received advances of $250,000, of which, $144,000 was recorded as revenues. As of September 30, 2019, advances from Desmet totaled $139,000.

During the three months ended September 30, 2018, the Company recorded sales of $55,000 from reactor sales to Desmet. There was no gross profit share recorded during that period.

GEA Westfalia Agreement

In January 2017 we entered into a global technology license, R&D and marketing agreement with respect to our patented Nano Reactor™ technology, processes and applications with GEA Westfalia (GEA). Under the agreement, GEA has been granted a worldwide exclusive license to integrate our patented technology into water treatment application, milk and juice pasteurization, and certain food related processes. The license agreement between us and GEA has a three-year term and provides us monthly advances of $25,000 through January 2020 to be applied to future license fees or share of gross profit, as defined.

As of June 30, 2019, outstanding advances from GEA to be applied to share in gross profit in future period amounted to $727,000. During the period ended September 30, 2019, we received additional advances totaling $75,000 from GEA. As of September 30, 2019, outstanding advance from GEA amounted to $802,000. There were no reactor sales or gross profit or margin revenue recognized during the period ended September 30, 2019.

Disaggregation of revenues

The following table provides information about disaggregated revenue based on revenue by service lines:

Advances from distributors

Our contract balances include advances from distributors deferred revenue. For contracts where the performance obligation is not completed, advances are recorded for any payments received in advance of the performance obligation.

Changes in advances from distributors were as follows at September 30, 2019 and 2018:

Note 3 – Operating Lease

The Company leases certain warehouse and corporate office space under lease agreement with monthly payments over a period of 67 months. We determine if an arrangement is a lease at inception. Lease assets are presented as operating lease right-of-use assets and the related liabilities are presented as lease liabilities in our consolidated balance sheets.

Operating lease right-of-use (“ROU”) assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Generally, the implicit rate of interest in lease arrangements is not readily determinable and the Company utilizes its incremental borrowing rate in determining the present value of lease payments. The Company’s incremental borrowing rate is a hypothetical rate based on its understanding of what its credit rating would be. The operating lease ROU asset includes any lease payments made and excludes lease incentives.

The components of lease expense and supplemental cash flow information related to leases for the period are as follows:

The supplemental balance sheet information related to leases for the period is as follows:

Note 4 - Stockholders' Deficit

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 during the three months ended September 30, 2019 is as follows:

As of September 30, 2019, all outstanding options are fully vested. As of September 30, 2019, the intrinsic value of the outstanding options was $110,000. The following table summarizes additional information concerning options outstanding and exercisable at September 30, 2019.

As of September 30, 2019, all outstanding warrants are fully vested. As of September 30, 2019, the intrinsic value of the outstanding warrants was $204,000. The following table summarizes additional information concerning warrants outstanding and exercisable at September 30, 2019.

Note 5 - Commitments and Contingencies

Royalty Agreements

On July 1, 2008, our wholly owned subsidiary entered into Patent Assignment Agreements with two parties, our President and Technology Development Supervisor, where certain devices and methods involved in the hydrodynamic cavitation processes invented by the President and the Technology Development Supervisor have been assigned to the Subsidiary.  In exchange, the Subsidiary agreed to pay a royalty of 5% of gross revenues to each of the President and Technology Development Supervisor for licensing of the technology and leasing of the related equipment embodying the technology. These agreements were subsequently assumed by Cavitation Technologies on May 13, 2010 from its subsidiary. The Company's President and Global Technology Manager both waived their rights to receive royalty payments that have accrued, or that may accrue, on any gross revenue generated through September 30, 2019.

On April 30, 2008 and as amended on November 22, 2010, our wholly owned subsidiary entered into an employment agreement with our former Director of Chemical and Analytical Department (the "Inventor") to 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 the Inventor was the legally named inventor, and 3% of actual gross royalties received by the Company resulting from the patent in each subsequent year. As of September 30, 2019, no patents have been granted in which this person is the legally named inventor.