---

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

þ	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended December 31, 2008

 

OR

 

¨	Transition Report pursuant to 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period                      to                     

 

Commission File Number 0-29901

 

CAVITATION TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

 

10019 Canoga Ave

Chatsworth, California 91311

(Address of principal executive offices)

 

818-718-0905

(Issuer’s telephone number,

including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days    YES   þ     NO   ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    YES  ¨     NO  þ

 

On February 14, 2009, the registrant had outstanding 28,380,178   shares of Common Stock, which is the registrant’s only class of common equity.

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,”

“accelerated filer” and “smaller reporting Company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer                                              ¨		Accelerated filer                    ¨
Non accelerated filer   (Do not check if a smaller reporting company) ¨		Smaller reporting company   þ

 

Transitional Small Business Disclosure Format (Check one):    Yes  ¨     No  þ

 

PART I

 

Item 1.    Financial Statements.

CAVITATION TECHNOLOGIES, INC.

Balance Sheets

		December 31,				June 30,
		2008				2008
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	78,528			$	310,929
Prepaid expenses and other current assets			2,343				1,445
Total current assets			80,871				312,374
Property and equipment, net			23,044				25,306
Other assets			9,500				9,500
Total assets		$	113,415			$	347,180
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses		$	91,901			$	56,706
Deferred revenue			26,000				-
Convertible notes payable, net of discounts			100,798				-
Line of credit			636,917				627,856
Total current liabilities			855,616				684,562
Commitments and contingencies
Stockholders' deficit:
Common stock, $0.001 par value, 100,000,000 shares authorized, 28,380,178 shares and  18,906,961 shares are issued and outstanding as of December 31, 2008 and June 30, 2008, respectively			28,380				18,907
Additional paid-in capital			3,219,232				2,373,372
Deficit accumulated during the development stage			(3,989,813	)			(2,729,661	)
Total stockholders' deficit			(742,201	)			(337,382	)
Total liabilities and stockholders' deficit		$	113,415			$	347,180

See accompanying notes, which are an integral part of these financial statements

 

 

4

---

 

CAVITATION TECHNOLOGIES, INC.

Statements of Operations (Unaudited)

 

		Three Months Ended								Six Months Ended								January 29, 2007, Inception, Through
		December 31,								December 31,								December 31,
		2008				2007				2008				2007				2008
General and administrative expenses		$	660,586			$	15,451			$	1,009,532			$	36,839			$	1,501,873
Research and development expenses			48,671				4,611				178,546				10,228				2,313,360
Total operating expenses			709,257				20,062				1,188,078				47,067				3,815,233
Loss from operations			(709,257	)			(20,062	)			(1,188,078	)			(47,067	)			(3,815,233	)
Interest expense			(11,681	)			(11,532	)			(21,318	)			(26,478	)			(75,945	)
Loss before income taxes			(720,938	)			(31,594	)			(1,209,396	)			(73,545	)			(3,891,178	)
Income tax expense			-				-				-				-				-
Net loss		$	(720,938	)		$	(31,594	)		$	(1,209,396	)		$	(73,545	)		$	(3,891,178	)
Dividend			(50,756	)			-				(50,756	)			-				(98,635	)
Net loss available to common stockholders		$	(771,694	)		$	(31,594	)		$	(1,260,152	)		$	(73,545	)		$	(3,989,813	)
Net loss available to common stockholders per share:
Basic and Diluted		$	(0.03	)		$	(0.00	)			(0.06	)		$	(0.01	)
Weighted average shares outstanding:
Basic and Diluted			25,805,380				14,331,210				22,356,170				14,331,210

 

See accompanying notes, which are an integral part of these financial statements

 

 

5

---

 

CAVITATION TECHNOLOGIES, INC.

Statement of Changes in Stockholders’ Deficit (Unaudited)

		Common Stock								Additional				Accumulated
		Shares				Amount				Paid-In   Capital				Deficit				Total
Issuance of common stock for services on January 29, 2007, inception			14,331,210			$	14,331			$	6,669			$	-			$	21,000
Net loss															(533,185	)			(533,185	)
Balance at December 31, 2007			14,331,210			$	14,331			$	6,669			$	(533,185	)		$	(512,185	)
Preferred stock sold for cash, as converted			1,119,199				1,119				498,881								500,000
Common stock issued as payment for services			3,456,551				3,457				1,819,943								1,823,400
Warrants issued in connection with sale of preferred stock											47,879				(47,879	)			-
Net loss															(2,148,597	)			(2,148,597	)
Balance at June 30, 2008			18,906,961			$	18,907			$	2,373,372			$	(2,729,661	)		$	(337,382	)
Stock option compensation											194,030								194,030
Net loss															(488,458	)			(488,458	)
Balance at September 30, 2008			18,906,961			$	18,907			$	2,567,402			$	(3,218,119	)		$	(631,810	)
Preferred stock sold for cash, as converted			279,800				280				124,720								125,000
Redemption of shares			(436,761	)			(437	)			437								-
Bio shares outstanding before reverse merger			9,280,178				9,280				(9,280	)							-
Common stock issued as payment for services			350,000				350				454,250								454,600
Warrants issued in connection with issuance of convertible debt											26,357								26,357
Dividend resulting from warrants issued in connection with sale of preferred stock, as converted											50,756				(50,756	)			-
Stock option compensation											4,590								4,590
Net loss															(720,938	)			(720,938	)
Balance at December 31, 2008			28,380,178			$	28,380			$	3,219,232			$	(3,989,813	)		$	(742,201	)

 

6

---

 

CAVITATION TECHNOLOGIES, INC.

Statements of Cash Flows (Unaudited)

										January 29,   2007,
										Inception,
										Through
		Six Months Ended December 31,								December 31,
		2008				2007				2008
Operating activities:
Net loss		$	(1,209,396	)		$	(73,545	)		$	(3,891,178	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			2,262				1,572				7,668
Warrants issued in connection with convertible notes payable			1,255				-				1,255
Common stock issued for services			454,600				-				2,298,990
Stock option compensation			198,620				-				198,620
Effect of changes in:
Prepaid expenses and other current assets			(898	)			-				(2,343	)
Deposits			-				(4,750	)			(9,500	)
Accounts payable and accrued expenses			35,195				(5,548	)			91,911
Deferred revenue			26,000				-				26,000
Net cash used in operating activities			(492,362	)			(82,271	)			(1,278,577	)
Investing activities:
Purchase of property and equipment			-				(5,147	)			(30,712	)
Net cash used in investing activities			-				(5,147	)			(30,712	)
Financing activities:
Proceeds from line of credit borrowings			9,061				87,500				636,917
Proceeds from sales of preferred stock			125,000				-				625,000
Proceeds from convertible notes payable			125,900				-				125,900
Net cash provided by financing activities			259,961				87,500				1,387,817
Net increase (decrease) in cash			(232,401	)			82				78,528
Cash, beginning of period			310,929				-				-
Cash, end of period		$	78,528			$	82			$	78,528
Supplemental disclosures of cash flow information:
Cash paid for interest		$	17,868			$	26,478			$	72,495
Cash paid for income taxes		$	-			$	-			$	1,850
Supplemental disclosure of non-cash investing and financing activities:
Dividend issued to preferred stockholders, as converted		$	50,756			$	-			$	98,635
Conversion of preferred to common shares in reverse merger		$	625,000			$	-			$	625,000

See accompanying notes, which are an integral part of these financial statements

 

7

---

 

CAVITATION TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 2008

 

1.   Organization and Business

Hydrodynamic Technology, Inc. dba Cavitation Technologies, Inc (“Hydro” or the “Company”) was incorporated on January 29, 2007, in California.  The Company has one office in Chatsworth, California.

The Company is a development stage enterprise and is primarily engaged in the development of a bio-diesel fuel production system (Bioforce 9000 and the Reactor Skid).  The initial result of the Company’s research and development will be the generation of products for our target market of United States and international bio-diesel producers.  The Company’s success will depend in part on its 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 the Company will not be challenged, invalidated, or circumvented, or that the rights granted hereunder will provide proprietary protection or competitive advantage to the Company.

2. Basis of Presentation

On October 24, 2008, the Company effected a transaction with Bio Energy, Inc., a non-operating shell company (“Bio”) (the “Transaction”).  Under the terms of the Transaction, Bio performed a 7.5-to-1 forward stock split of its outstanding shares of common stock.  Bio issued 18,750,000 (post forward split) of its shares of common stock and assumed 410,000 warrants and 675,000 common stock options in exchange for 100% of the outstanding shares of the Company.  Immediately after the Transaction, there were a total of 28,030,178 shares of common stock outstanding, consisting of 18,750,000 shares owned by previous stockholders of the Company, as well as an additional 9,280,178 owned by others. The warrants converted to 279,800 Bio Common Stock warrants and the options converted to options to purchase 460,646 shares of Bio Common Stock.

The exchange of Hydro options and warrants for Bio options and warrants constituted a modification of their original grants as defined in SFAS No. 123(R). Accordingly, the Company made an assessment of the difference in their fair values immediately prior to, and immediately after the Transaction. Due to the relatively short period of time between the original issuance date and the Transaction date, as well as the fact that the holders received fewer options in Bio than they had in Hydro, there was no additional compensation expense recognized as a result of this modification.

From a legal perspective, Bio acquired Hydro. However from an accounting perspective, the Transaction is viewed as a recapitalization of Hydro accompanied by an issuance of stock by Hydro for the net assets of Bio. This is because Bio did not have operations immediately prior to the merger, and following the merger, Hydro is the operating company.  Hydro's officers and directors serve as the officers and directors of the new combined entity. Additionally, Hydro's stockholders own over 80% of the outstanding shares of Bio after the completion of the transaction.

Given these circumstances, the Transaction is accounted for as a capital transaction rather than as a business combination.  That is, the Transaction is equivalent to the issuance of stock by Hydro for the net assets of Bio, accompanied by a recapitalization.  The accounting is identical to that resulting from a reverse acquisition. Because the Transaction is accounted for as a capital transaction, and it occurred prior to the filing of this Form 10-Q, these financial statements represent the financial condition and results of operations of Hydro.

The accompanying unaudited financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements 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 10 of Regulation S-X under the Exchange Act. Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. In the opinion of management, all adjustments considered necessary (consisting of normal recurring adjustments) for a fair presentation are included herein. Operating results for the three month period December 31, 2008 are not indicative of the results that may be expected for the fiscal year ending June 30, 2009.  These unaudited financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Form 8-K filed November 14, 2008.

 

8

---

 

 

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates.  The Company uses estimates in valuing stock options, warrants and common stock issued for services, among other items.

 

Revenue Recognition

The Company recognizes revenues in accordance to the Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition , as amended by SAB 104.  As of December 31, 2008, the Company received a deposit from a customer of $26,000 relating to a sales order not yet completed.  This amount has been reflected in deferred revenue on the accompanying balance sheet as of December 31, 2008.  As of December 31, 2008, the Company has not recognized any revenue from the sales of its bio-diesel fuel production systems.

3. Management’s Plan

The accompanying financial statements have been prepared under the assumption that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Historically, the Company has no revenue, has incurred significant losses, and has not demonstrated the ability to generate sufficient cash flows from operations to satisfy its liabilities and sustain operations.

The Company has no significant operating history and, from January 29, 2007 (inception) through December 31, 2008, has generated a cumulative net loss of $3,891,178.  The Company also has negative cash flow from operations and a stockholders’ deficit. The accompanying financial statements for the three months and six months ended December 31, 2008 have been prepared in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern.

Management’s plan regarding this uncertainty is 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.

The accompanying financial statements do not include any 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.

4. Recent Accounting Standards

Accounting standards promulgated by the Financial Accounting Standards Board (“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 accounting developments.

In May 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 162, The Hierarchy of Generally Accepted Accounting Principles .  SFAS No, 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements for nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 will be effective 60 days following the SEC’s approval. The Company does not expect that this statement will result in a change in current practice.

 

9

---

 

In April 2008, the Financial Accounting Standards Board, or FASB issued FASB Staff Position (“FSP”) No. FAS 142-3 “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007), “Business Combinations” and other U.S. generally accepted accounting principles (GAAP). This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company will adopt this FSP beginning July 1, 2009 and it is not believed that this will have an impact on the Company’s financial position, results of operations or cash flows.

In May 2008, the FASB issued FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).”  FSP APB 14-1 addresses instruments commonly referred to as Instrument C from Emerging Issues Task Force No.  90-19, which requires the issuer to settle the principal amount in cash and the conversion spread in cash or net shares at the issuer's option.  FSP APB 14-1 requires that issuers of these instruments account for their liability and equity components separately by bifurcating the conversion option from the debt instrument, classifying the conversion option in equity, and then accreting the resulting discount on the debt as additional interest expense over the expected life of the debt. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years, and requires retrospective application to all periods presented. Early application is not permitted. Management is currently evaluating the impact of the adoption of this statement; however, but believes any impact with respect to future debt transactions could be material.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities , an amendment of FASB Statement No. 133.  SFAS No. 161 requires enhanced disclosures about a company's derivative and hedging activities. These enhanced disclosures will discuss (a) how and why a company uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect a company's financial position, results of operations and cash flows. SFAS No. 161 is effective for fiscal years beginning on or after November 15, 2008, with earlier adoption allowed. We do not anticipate that the adoption of this accounting pronouncement will have a material effect on our financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements . SFAS No.157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the Company for fiscal years beginning January 29, 2007.   In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. We do not anticipate that the adoption of this accounting pronouncement will have a material effect on our  financial statements.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 .  SFAS No. 160 establishes accounting and reporting standards for the non--controlling interest in a subsidiary and for the deconsolidation of a subsidiary.  SFAS No. 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests, of which the Company currently has none.  All other requirements of SFAS No. 160 shall be applied prospectively.  SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company anticipates that SFAS No. 160 will not have any significant impact on the Company’s financial statements.

 

10

---

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), Business Combinations , which revises current purchase accounting guidance in SFAS 141, Business Combinations . SFAS No. 141R requires most assets acquired and liabilities assumed in a business combination to be measured at their fair values as of the date of acquisition. SFAS No. 141R also modifies the initial measurement and subsequent remeasurement of contingent consideration and acquired contingencies, and requires that acquisition related costs be recognized as expense as incurred rather than capitalized as part of the cost of the acquisition. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively to business combinations occurring after adoption. The impact of SFAS No. 141R on the Company’s financial statements will depend on the nature and extent of the Company’s future acquisition activities.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option of Financial Assets and Financial Liabilities .  SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective as of the beginning of the entity’s first fiscal year that begins after November 15, 2007.  The adoption of SFAS No. 159 did not have any significant impact on the Company’s financial statements.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans . FAS-158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. The provisions of SFAS No. 158 are effective for the Company as of the end of the fiscal year ending June 30, 2008. The adoption of SFAS No. 158 did not have any significant impact on the Company’s financial statements.

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

5. Net Loss per Common Share – Basic and Diluted

The Company computes loss per common share using SFAS No. 128, 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 by the weighted average shares outstanding assuming all dilutive potential common shares were issued.  As of December 31, 2008, the Company had 545,646 stock options and 359,800 warrants outstanding to purchase common stock that were not included in the diluted net loss per common share due to the options and warrants being anti-dilutive.  In addition, the Company had $125,000 of convertible notes payable outstanding (see Note 8) which are convertible into common stock of the Company that were not included in the diluted net loss per common share due to the amounts being anti-dilutive.  As such, the basic and diluted loss per common share equals the net loss, as reported, divided by the weighted average common shares outstanding for the respective periods.

6. Property and equipment

Property and equipment consisted of the following as of December 31, 2008 and June 30, 2008.

 

Depreciation expense for the three months ended December 31, 2008 and 2007 amounted to $1,131 and $786, respectively.  Depreciation expense for the six months ended December 31, 2008 and 2007 amounted to $2,262 and $1,572, respectively.

7. Line of Credit

On February 2, 2007, the Company contracted a $700,000 revolving line of credit from National Bank of California.  The line of credit bears interest at Prime plus 1%, which was 4.25% (1% plus 3.25% prime rate) at December 31, 2008 and June 30, 2008.  The balance outstanding under this line of credit was $636,917 at December 31, 2008 and $627,856 at June 30, 2008.  The maturity date of this loan was July 2, 2008, but was extended to January 2, 2009.  The loan has since expired and the Company is in the process of renegotiating the terms and conditions with the bank. This line of credit is personally guaranteed by the Company’s major shareholders and Board members, and secured by the assets of the Company.

8. Convertible Notes Payable

In December 2008, the Company entered into a Note and Warrant Purchase Agreement (the “Agreement”), where the Company issued an aggregate of $125,000 of notes payable which accrue interest a rate of 12% per annum and are due on April 30, 2009.  Under the terms of the Agreement, the lenders may convert all principal and accrued interest into shares of the Company’s common stock at a conversion rate equal to the average closing price of the Company’s closing stock for the 10 days immediately preceding the conversion request.

In addition, in accordance with the Agreement, the Company issued to the lenders warrants to purchase an aggregate of 83,333 shares of the Company’s common stock at an exercise price of $1.50 per share.  The warrants are vested immediately and have a contractual life of 4 years.  The fair value of each warrant was estimated on the date of grant using the Black-Scholes valuation model with input assumptions of (1) volatility of 64%, (2) expected life of 2 years, (3) risk free rates ranging from 0.68% to 0.74%, and (4) expected dividends of zero.  The total fair value of the warrants issued amounted to $26,357, which was recorded as a discount to the face value of the convertible notes payable.  As of December 31, 2008 (unaudited), the remaining discount amounted to $24,202 and the carrying value of the convertible notes payable amounted to $100,798.

9. Stockholders’ Equity

Authorized shares – As a result of the merger with Bio (see Note 2) the Company is currently authorized under its Amended and Restated Certificate of Incorporation to issue Common Stock only. The total number of shares of Common Stock which this corporation shall have authority to issue is 100,000,000 shares. Each share of Common Stock has a par value of $.001.

Series A-1 Preferred Stock – As a result of the merger with Bio (see Note 2) the Company no longer has any Preferred Stock authorized or issed. Following is a discussion about Preferred Stock issuances prior to the Bio merger.

On March 31, 2008, the Company issued 200,000 units comprised of five shares of its Series A-1 Preferred Stock (total of 1,000,000 preferred shares) and one warrant to purchase one share of common stock at $0.75 per share for a total consideration of $500,000.

On October 3, 2008, the Company issued 210,000 units comprised of five shares of its Series A-1 Preferred Stock (total of 1,050,000 preferred shares) and one warrant to purchase one share of common stock at $0.75 per share for total proceeds of $525,000, which were placed in escrow.  Upon the closing of escrow on October 3, 2008, $400,000 was used to purchase 50.5% of the outstanding shares of Bio (see Note 2), and the remaining $125,000 was distributed to the Company.

On October 24, 2008, in connection with the reverse merger (see Note 2), all shares of Series A-1 Preferred Stock were converted to common shares of Bio. The accompanying financial statements have retroactively shown the recapitalization for all periods presented. As a result, there is no Preferred stock shown in the balance sheets or statements of stockholders’ deficit.

Dividends – The holders of the Series A Preferred Stock and Series A-1 Preferred Stock were entitled to receive , out of any funds legally available therefore, dividends at the rate of $0.12 and $0.05 per share per annum, respectively, payable in preference to any payment of any dividend on Common Stock. After payment of such dividends, any additional dividends declared shall be payable entirely to the holders of Common Stock. The right of the holders of Series A Preferred Stock to receive dividends shall be cumulative, and shall accrue to holders of Series A Preferred Stock if such dividends are not paid in any prior year.

 

Stock Split - In March 2008, the board of directors approved a 2,100-to-1 forward stock split of the Corporation’s common stock, which was distributed on March 31, 2008 to stockholders of record on January 29, 2007.

On October 24, 2008, the Company entered into a share exchange agreement with Bio in which Bio acquired all of the outstanding shares of the Company’s shareholders (see Note 2).  Under the terms of the share exchange agreement, Bio performed a 7.5-to-1 forward stock split of its outstanding shares of common stock.

The common stock activity for all periods presented in the accompanying financial statements have been restated to give retroactive recognition to these stock splits and the conversion to Bio shares. In addition, all references in the financial statements and notes to financial statements to weighted average number of shares, per share amounts, and market prices of the Company’s common stock have been restated to give retroactive recognition to the stock split.

Warrants – On March 31, 2008 in conjunction with the issuance of 1,000,000 shares of preferred stock, the Company issued 200,000 warrants to purchase shares of common stock at an exercise price of $0.75 per share.  The warrants vest immediately and have a contractual life of 5 years.  The total value of the warrants issued amounted to $47,879, which has been reflected as a dividend to preferred stockholders in the accompanying financial statements.  The value was determined using the Black-Scholes valuation model with input assumptions of (1) volatility of 148%, (2) expected life of 2.5 years, (3) risk free rate of 1.79%, and (4) expected dividends of zero.

On October 3, 2008, in conjunction with the issuance of a total of 1,050,000 shares of Series A-1 Preferred Stock, the Company issued 210,000 warrants to purchase shares of common stock at an exercise price of $0.75 per share.  The warrants vest immediately and have a contractual life of 5 years.  The total value of the warrants issued amounted to $50,291, which has been reflected as a dividend to preferred shareholders in the accompanying financial statements.  The value was determined using the Black-Scholes valuation model with input assumptions of (1) volatility of 148%, (2) expected life of 2.5 years, (3) risk free rate of 1.86%, and (4) expected dividends of zero.

On October 24, 2008, in connection with the Bio transaction (see Note 2), 410,000 warrants in Hydro converted to 279,800 warrants in Bio.

In December 2008, the Company issued an aggregate of 80,000 warrants to purchase shares of the Company’s common stock at an exercise price of $1.50 per share (see Note 8).

10. Share Based Compensation

On July 21, 2008, the Company adopted the 2008 Stock Option Plan (the “Plan”) that provides for the granting of stock options to certain key employees.  The Plan reserves 4,000,000 shares of common stock. Options under the Plan are to be granted at no less than fair market value of the shares at the date of grant.

 On August 1, 2008, the Company issued 660,000 stock options to purchase shares of the Company’s common stock at a weighted average exercise price of $1.68 per share.  The options vested immediately and have a contractual life of 10 years.  The total value of the options issued on August 1, 2008 amounted to $194,030, which is included in general and administrative expenses in the accompanying statement of operations.

On October 1, 2008, the Company issued 15,000 stock options to purchase shares of the Company’s common stock at an exercise price of $1 per share.  The options vest immediately and have a contractual life of 10 years.  The total value of the options issued on October 1, 2008 amounted to $4,590, which is included in general and administrative expenses in the accompanying statement of operations.

On October 24, 2008, 675,000 options in Hydro converted to 460,646 options in Bio (see Note 2).

On October 28, the Company issued 85,000 stock options to purchase shares of the Company’s common stock at an exercise price of $2 per share.  The options vest immediately. Of the 85,000 options issued, 50,000 have a contractual life of nine months from issuance and the remaining 35,000 have a contractual life of ten years.  The total value of the options issued on October 28, 2008 amounted to $21, which is included in general and administrative expenses in the accompanying statement of operations.

The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model The expected volatility was based on volatilities of other publicly traded development stage companies in the Company’s industry.  The expected term of the options granted was estimated to represent the period of time that options granted are expected to be outstanding.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  Assumptions used to calculate the fair value of the options issued are as follows.

 

The following summarizes the activity of the Company’s stock options for the six months ended December 31, 2008:

 

There were no options exercised as of December 31, 2008.  There is no unvested compensation as of December 31, 2008.  The weighted average grant date fair value of options granted during the six months ended December 31, 2008 amounted to $0.26 per share.

11. Income Taxes

Under Accounting Principles Board Opinion No. 28, Interim Financial Reporting , the Company is required to adjust its effective tax rate each quarter to be consistent with the estimated annual effective tax rate. The Company is also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings versus annual projections.

Hydro, in its capacity as the operating company taking over Bio’s income tax positions in addition to its own positions after October 24, 2008 (see Note 2), has estimated its annual effective tax rate to be zero. This is based on an expectation that the combined entity will generate net operating losses in the year ending June 30, 2009, and it is not more likely than not that those losses will be recovered using future taxable income. Therefore, no provision for income tax has been recorded as of and for the period ended December 31, 2008.