Cavitation Technologies, Inc. - Quarter Report: 2014 December (Form 10-Q)

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

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CAVITATION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Six months ended December 31, 2014 and 2013

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 six months ended December 31, 2014 are not indicative of the results that may be expected for the fiscal year ending June 30, 2015. 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, 2014 filed on October 14, 2014. The condensed consolidated balance sheet as of June 30, 2014 has been derived from the audited financial statements included in the Form 10-K for that year.

Cavitation Technologies, Inc. (referred to herein, unless otherwise indicated, as "the Company," "CTi," "we," "us," and "our") is a Nevada corporation originally incorporated under the name Bio Energy, Inc. CTi has developed, patented, and commercialized proprietary technology that may be used in liquid processing applications. CTi's patented Nano Reactor® is the critical component of CTi Nano Neutralization® System which is commercially proven to reduce operating costs and increase yields in refining vegetable oils. CTi has two patented systems and has filed several national and international patents to employ its proprietary technology in applications including, vegetable oil refining, waste water treatment, biodiesel, algae oil extraction, and alcoholic beverage enhancement.

The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles which contemplate continuation of the Company as a going concern.  During the six months ended December 31, 2014, the Company incurred a net loss of $1,020,523. As of December 31, 2014, the Company had a working capital deficiency of $913,639 and a stockholders' deficit of $742,904.   These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. In addition, our independent auditors, in their report on our audited financial statements for the fiscal year ended June 30, 2014 expressed substantial doubt about our ability to continue as a going concern. The accompanying condensed 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.

Management's plan is to generate income from operations by continuing to license our technology globally through our strategic partner, the Desmet Ballestra Group (Desmet). Desmet has agreed to provide us monthly advances of $125,000 against future sales. During the six months ended December 31, 2014, advances received from Desmet amounted to $750,000. 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, 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.

The 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.

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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.

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.

At December 31, 2014 and June 30, 2014, the fair values of cash and cash equivalents, inventory and accounts payable and accrued expenses approximate their carrying values due to their short term nature.

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 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 from the sale of our Nano Reactor® Systems is recognized when persuasive evidence of an agreement exists; shipment 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.

The Company is also entitled to certain profit share from its distributor from the sale of the reactors. The profit share is non-refundable and is recorded upon shipment of the reactors to the distributor.

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. The Company has two patents issued in fiscal 2012 and another three in fiscal 2014. As of December 31, 2014, we have a total of 25 patents pending. The patents have duration of twenty years from filing date.

Based upon our estimate, we believe that our patents have an estimated life of four years before the next generation of reactors is developed or until other forms of competition appear. During the six months ended December 31, 2014 and 2013, we recorded amortization expense of $10,945 and $12,934 respectively.

As of December 31 and June 30, 2014 the Company had remaining unamortized patent costs of $56,528 and $67,473 respectively.

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Impairment of Intangible and Long-Lived Assets

In accordance with ASC 350-30 (General Intangibles Other than Goodwill), 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. Based on our impairment tests, management believes there is no impairment of its intangibles and long-lived assets as of December 31, 2014. 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.

The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non- employees in accordance with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date.

The fair value of the Company's common stock options and warrants grant is estimated using the Black-Scholes option pricing model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes option pricing model, and based on actual experience. The assumptions used in the Black-Scholes option pricing model could materially affect compensation expense recorded in future periods.

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.

The Company provides a limited warranty with every set of reactors sold, typically 2 years. The Company has not experienced significant claims under its warranty policy, and management determined no accrual for warranty reserve was necessary at December 31, 2014.

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Dependence on Desmet Ballestra

Our revenue is almost entirely dependent on Desmet Ballestra who is our exclusive distribution agent with regard to the CTi Nano Neutralization® System for edible oils. During fiscal 2014, 100% of our revenue was derived from Desmet sales efforts (see Note 3).

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 December 31, 2014, the Company had 13,611,815 stock options and 68,259,843 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.

On August 27, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-15, Disclosures of Uncertainties about an Entity's Ability to Continue as a Going Concern, which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity's ability to continue as a going concern within one year of the date the financial statements is issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity's ability to continue as a going concern. The ASU applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The Company is currently evaluating the impact of adopting ASU 2014-15 on its results of operations or financial condition.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers. ASU 2014-09 will eliminate transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, and early adoption is not permitted. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the impact the adoption of ASU 2014-09 and has not determined the effect of the standard on our ongoing financial reporting.

In April 2014, the FASB issued Accounting Standards Update No. 2014-08 (ASU 2014-08), Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360). ASU 2014-08 amends the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations or that have a major effect on the Company's operations and financial results should be presented as discontinued operations. This new accounting guidance is effective for annual periods beginning after December 15, 2014.

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.

On May 14, 2012, we signed a global Research and Development, Marketing and Technology License Agreement ("Agreement") with the n.v. Desmet Ballestra Group s.a. (Desmet), a Belgian company that is actively marketing the NANO Neutralization System, the key component of which is the Company's reactor to soybean and other vegetable oil refiners. Desmet, together with its affiliates, is a global engineering and equipment supply company engaged in the development, design and supply of process equipment for oils and fats processing facilities including vegetable oil refining, biofuel, oleo chemical, seed crushing, surfactant and detergent markets. Desmet supplies these markets with competitive services based on the latest globally sourced technologies.

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The Agreement provides Desmet (licensee) a limited, exclusive license and right to develop, design and supply Nano Reactor® systems which incorporate Nano Reactor® devices on a global basis but is limited to oils and fats and oleo chemical applications. CTi (licensor) remains owner of the current patents and patent applications but Desmet will be co-owner of any new process patent applications jointly developed. Desmet has agreed to provide, under certain conditions, limited monthly advance payments of $125,000 against future sales to CTi. Desmet shall be entitled to immediately terminate the present agreement in case the claims of current US Patent Application Number 12/484,981 are not granted as such or are cancelled. In addition, Desmet may terminate the agreement on August 1 of any particular year if they have not installed at least 6 Nano Reactor® devices in the previous 12 month period. CTi may terminate the Agreement for material default. This Agreement supersedes a previous agreement dated November 1, 2010, amended on June 1, 2011 and on September 2, 2011. As of the date of this report, the Company or Desmet has not indicated any intention to terminate the Agreement.

The Company and Desmet have worked together to determine the appropriate sales approach and installation process. The Company's Nano Neutralization is designed to be used as an add-on process to an existing neutralization system within soybean and other vegetable oil refineries. Desmet purchases Nano Reactor Systems from the Company and installs them at the refinery as part of an integrated neutralization system. We are therefore substantially dependent on Desmet to identify prospects, complete sales contracts, install the system and manage relationships with end-users.

During the six months ended December 31, 2014, we recorded no revenues from Desmet. During the six months ended December 31, 2013, we recorded $495,266 of revenues from Desmet. The Company received advances of $750,000 during the six months ended December 31, 2014 and $625,000 during the six months ended December 31, 2013. As of December 31, 2014, Desmet has advanced to us an excess of funds of $1,484,956 which is presented in the accompanying balance sheet as "Advances from distributor" and will be recognized as revenue in future periods upon shipment and acceptance of our reactors.

Property and equipment consisted of the following as of December 31, 2014 and June 30, 2014:

Depreciation expense for the six months ended December 31, 2014 and 2013 amounted to $32,388 and $35,258, respectively.

As of December 31, 2014 and June 30, 2014, the Company had accrued unpaid salaries due to current and former officers of the Company amounting to $936,866 and $950,674 respectively. In addition, the Company also accrued the estimated payroll taxes due to this unpaid payroll of $79,357 and $79,357 respectively. The accrued payroll is unsecured and is due upon demand.

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Note 6 - Stockholders' Deficit

In July 2014 we issued 5,193,329 shares of common stock at $0.08/share and warrants to purchase 5,193,329 shares of common stock at an exercise price of $0.12 per share, vesting immediately and expiring in 5 years from grant date to various entities and individuals in exchange for cash of $375,498, net of commission of $14,002. The shares were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. The shares were not offered via general solicitation to the public. The Company issued rule 144 shares in connection with these issuances.

In October of 2014, the Company issued 1,068,000 shares of common stock with a fair value of $0.06/share or $64,080 to a consultant for Investor Relation services. The shares of common stock were valued to market at the date of its issuance.

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 for the six months ended December 31, 2014 is as follows:

The intrinsic value of the outstanding options was $472,034 as of December 31, 2014. The following table summarizes additional information concerning options outstanding and exercisable at December 31, 2014.

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Warrants

On July 1 of 2014, the Company granted warrants to purchase 5,193,329 shares of common stock to the purchasers of common stock offering at an exercise price of $0.12 per share, vesting immediately and expiring in 5 years from grant date. Pursuant to the term of the grant, the underlying shares of common stock must be registered with the SEC within one year after its purchase otherwise, the underlying warrants at the time of exercise will be considered cashless.

During the six months ended on December 31, 2014, the Company recognized $220,064 of compensation costs as part of general and administrative expenses related to the vesting of warrants granted in prior periods. To compute compensation expense, the Company estimated the fair value of each warrant award on the date of grant using the Black-Scholes-Merton option pricing model for employees, and calculated the fair value of each warrant award at the end of the period for non-employees. The following average assumptions were used in the Black-Scholes-Merton valuation model: risk-free interest rate of 3.25%; dividend yield of 0%; volatility of 184%; and an expected life of 8.9 years.

A summary of the Company's warrant activity for the six months ended on December 31, 2014 is as follows.

As of December 31, 2014, total compensation cost related to non-vested warrant awards not yet recorded is approximately $31,973. The intrinsic value of the outstanding warrants was $1,081,997 as of December 31, 2014. The following table summarizes additional information concerning warrants outstanding and exercisable at December 31, 2014.

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Note 7 - Commitments and Contingencies

On July 1, 2008, our wholly owned subsidiary entered into Patent Assignment Agreements with two parties, our President as well as our former Chief Executive Officer (CEO) and current Chief Technology Officer (CTO), where certain devices and methods involved in the hydrodynamic cavitation processes invented by the President and former CEO/current CTO have been assigned to the Subsidiary.  In exchange, that Subsidiary agreed to pay a royalty of 5% of gross revenues to each of the CTO and President and former CEO 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 CTO and President both waived their rights to receive royalty payments that have accrued, or that may accrue, on any gross revenue generated through December 31, 2014.

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 December 31, 2014, no patents have been granted in which this person is the legally named inventor.

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ITEM 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

Cavitation Technologies, Inc. ("CTi"), a Nevada corporation, was originally incorporated under the name Bio Energy, Inc. We design and engineer environmentally friendly technology based systems that are designed to serve large, growing, global markets such as vegetable oil refining, renewable fuels, water treatment, algae oil extraction, biodiesel production, water-oil emulsions and crude oil yield enhancement.  Our systems are designed to process industrial liquids at a lower cost and higher yield than conventional technology. We are a process and product development firm that has developed, patented, and commercialized proprietary technology.

CTi has developed, patented, and commercialized proprietary technology that can be used for processing of industrial fluids. CTi's patented Nano Reactor® is the critical components of the CTi Nano Neutralization® System which is commercially proven to reduce operating costs and increase yields in processing oils and fats. CTi has two issued patents relating to our Nano Reactor® systems and has filed several national and international patents to employ its proprietary technology in applications including, vegetable oil refining, biodiesel production, waste water treatment, algae oil extraction, and alcoholic beverage enhancement.

During the six months ended December 31, 2014, we recorded no revenue and a net loss of $1,020,523. We generated net cash of $47,333 from our operating activities and financing activities provided an additional $375,498.

We are engaged in merchandising our Neutralization System which is designed to help refine vegetable oils such as soybean, canola, sunflower and rapeseed.  Our near term goal is to continue to merchandise our systems through our partner, Desmet Ballestra. We did not record any revenues and incurred a net loss of $1,020,523 for the six months ended December 31, 2014. As of December 31, 2014, the Company had a working capital deficiency of $913,639 and a stockholders' deficit of $742,904.   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 (Desmet). Desmet has agreed to provide us monthly advances of $125,000 against future sales. During the six months ended December 31, 2014, advances received from Desmet amounted to $750,000 and approximately $3,875,000 from May 2012 up to January 2015. These funds service a portion of operational expenses on a monthly basis. Desmet shall be entitled to immediately terminate the present agreement in case the claims of current US Patent Application Number 12/484,981 are not granted as such or are cancelled. In addition, Desmet may terminate the agreement on August 1 of any particular year if they have not installed at least 6 Nano Reactor® devices in the previous 12 month period. CTi may terminate the Agreement for material default. This Agreement supersedes a previous agreement dated November 1, 2010, amended on June 1, 2011 and on September 2, 2011. In addition to these advances, we anticipate that we will need additional funding, and we will 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 condensed 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. As a result of the aforementioned factors, our independent auditors, in their report on our audited financial statements for the fiscal year ended June 30, 2014, expressed substantial doubt about our ability to continue as a going concern.

CTi's critical accounting policies and estimates are included in its Annual Report on Form 10-K for the year ended June 30, 2014, and did not change for the six months ended December 31, 2014.

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Results of Operations

The following is a comparison of our results of operations for the three months ended December 31, 2014 and 2013.

We recorded no revenue in the second quarter of fiscal 2015, as opposed to $495,266 in the same period of fiscal 2014. In fiscal 2014, the Company shipped reactors to Desmet customers in Uruguay, South Korea and Ecuador. No similar transactions occurred in fiscal 2015, however, the Company is still awaiting instructions from Desmet to ship reactors to its customers in Mexico and India.

General and administrative expenses for the three months ended December 31, 2014 amounted to $498,329 compared with $1,094,438 for the same period in 2013, a decrease of $596,109, or 54.5%. In both periods, the major expense component was salaried compensation. Another major expense item was non-salaried compensation to officers and consultants issued in the form of common stock and stock warrants with a fair value of $104,776 in the second quarter of fiscal 2015, and $744,307 in the second quarter of fiscal 2014. This decrease in non-cash compensation in the second quarter of fiscal 2015 was attributable largely to the decrease in grant of warrants to officers and consultants. In the second quarter of fiscal 2015, total compensation amounted to $264,680 or 53% of total costs compared with $888,930 or 76% of total costs in the second quarter of fiscal 2014.

During the second quarter of 2015, the other major components of operating expense were professional service fees related to auditors, accounting, and legal services which amounted to $40,441 or 8% of total operating expenses, travel expenses of $33,969 and various insurance premiums totaling $26,879. The same expenses in the second quarter of fiscal 2014 amounted to $50,198 or 4.5% of total expense, $15,679 and 23,476 respectively.

Research and development (R&D) expenses remained relatively low as we continued to rely on Desmet Ballestra for support in R&D. It is our intention to pursue R&D as our cash position permits.

The Company did not incur any interest expense in the current quarter as all promissory notes were settled in fiscal 2014. Interest expense totaled $49,367 during the first three months of fiscal 2014 and was composed of non-cash expenses of $48,367 accrued on all outstanding loans, and a cash payment of $1,000 to a convertible note holder.

As of December 31, 2014, the Company had no outstanding debt. At December 31, 2013, the Company had an outstanding balance on short term loans payable of $219,521 and accrued interest on these loans totaling $44,771.

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Results of Operations for the Six Months Ended December 31, 2014 Compared to the Six Months Ended December 31, 2013

The following is a comparison of our results of operations for the six months ended December 31, 2014 and 2013.

We recorded no revenue in the first six months of fiscal 2015. During the six months ended December 31, 2013, our revenue of $495,266 consisted primarily of NANO Neutralization System reactor sales to Desmet customers in Uruguay, South Korea and Ecuador. No similar transactions occurred in fiscal 2015, however, the Company is still awaiting instructions from Desmet to ship reactors to its customers in Mexico and India.

During the six months ended December 31, 2013, our cost of sales amounted to $16,633 which was the result of the revenue transactions described above for the three of the units for which licensing revenue was recognized.

Operating expenses for the six months ended December 31, 2014 amounted to $1,020,523 compared with $1,434,222 for the same period in 2013, a decrease of $413,699, or 29%. The decrease was attributable largely to a $400,936 decrease in General and Administrative Expenses (G&A) (attributable mostly to non-cash costs of $744,307 relating to the vesting of options and warrants issued for services recorded in the second quarter of fiscal 2014) and $12,763 decrease in R&D expenses.

The primary expenditures during the first half of fiscal 2015 were $87,286 for professional service fees such as auditors, attorneys, and SEC related services, $64,080 in share based compensation, $50,316 in insurance expense; $263,599 in salaries and salary related expenses and $272,598 in consulting fees of which $220,064 were related to the vesting of warrants issued for services. The primary expenditures during the first half of fiscal 2014 were approximately $127,000 for professional service fees such as auditors, attorneys, and SEC related services, $66,000 in consulting fees, $75,000 in interest expenses, $46,000 in insurance expense; $183,000 in salaries and salary related expenses and $744,000 relating to the vesting of options and warrants issued for services.

The Company did not incur any interest expense in fiscal 2015 as all promissory notes were settled in fiscal 2014. Interest expense totaled $75,346 during the same period of fiscal 2014 and consisted of a non-cash expense of $55,174 relating to convertible notes, $13,171 in mostly non-cash, accrued interest relating primarily to short term loans, and cash interest paid to convertible note holders in the amount of $5,000.

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Liquidity and Capital Resources

The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles which contemplate continuation of the Company as a going concern.  During the six months ended December 31, 2014, the Company incurred a net loss of $1,020,523. As of December 31, 2014, the Company had a working capital deficiency of $913,639 and a stockholders' deficit of $742,904.   These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. In addition, our independent auditors, in their report on our audited financial statements for the fiscal year ended June 30, 2014 expressed substantial doubt about our ability to continue as a going concern. The accompanying condensed 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.

Management's plan is to generate income from operations by continuing to license our technology globally through our strategic partner, the Desmet Ballestra Group (Desmet). Desmet has agreed to provide us monthly advances of $125,000 against future sales. During the six months ended December 31, 2014, advances received from Desmet amounted to $750,000. In July 2014, we also received approximately $375,000 from the sale of our shares of common stock and warrants. 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, 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.

On December 31, 2014, we had cash on hand in the amount of $1,649,339. In addition to the funds on hand, we will require additional funds to continue to operate our business. This includes expenses we will incur in connection with costs to manufacture and ship our products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, we have contractual commitments for salaries to our executive officers. In light of our financial commitments over the next several months and its liquidity constraints, we have implemented cost reduction measures in all areas of operations. We intend to review these measures on an ongoing basis and make additional decisions as may be required.

Net cash provided by operating activities during the six months ended December 31, 2014 amounted to $47,333, compared with $129,190 used in these activities for the same period in fiscal 2014. Funding for the operating activities was provided by $750,000 in advances from our distributor. For the first half of fiscal 2015, we paid $263,599 in employees' compensation, $25,200 in fees associated with financing activities, $43,920 in professional services fees, $45,658 in various insurance premiums, and $349,000 in fixed operating costs and other obligations. For the first six months of fiscal 2014, we paid approximately $183,000 in compensation, $210,000 in fixed operating costs, $127,000 in professional services fees, $46,000 in various insurance premiums, and $5,000 in interest payments, and other obligations, including consulting fees, of about $200,000.

There was no cash used in investing activities in the current fiscal year. Net cash used in investing activities during the six months ended December 31, 2013 was relating to $15,776 in capitalized patents and $22,867 for property, plant, and equipment.

For the period ended December 31, 2014, financing activities provided a net cash of $375,498. For the first six months of fiscal 2014, the Company did not perform any financing activities.

Not applicable for smaller reporting companies.

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ITEM 4.  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 controls and procedures at the end of each fiscal year. As of December 31, 2014, 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 not effective as of December 31, 2014.

There were no changes in internal control over financial reporting during the first quarter of fiscal 2015 that have materially affected or are reasonably likely to materially affect the company's internal control over financial reporting.

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.

None.

None

None

None

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Item 6 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES

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SIGNATURES

Pursuant to the requirements of the securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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