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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _______________________ to _____________
Commission file number: 000-50355
HydroFlo, Inc.
(Name of small business issuer in its charter)
North Carolina 56-2171767
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3721 Junction Blvd., Raleigh, North Carolina 27603
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (919) 772-9925
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
$0.01 PAR VALUE COMMON VOTING STOCK
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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. [X] Yes [ ] No
Check if there is no disclosure of delinquent filers in response to ITEM 405 OF
REGULATION S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
State issuer's revenues for its most recent fiscal year.
$109,208
___________________________________
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of
September1, 2004 is $2,019,000
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 31,551,441 Issued common shares as of
September 1, 2004.
DOCUMENTS INCORPORATED BY REFERENCE - NOT APPLICABLE.
Transitional Small Business Disclosure Format (Check one): Yes [ ]; No [X]
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
BUSINESS
GENERAL
As a business development company, we provide long-term debt and equity
investment capital to support the expansion of companies in a variety of
industries. We generally invest in illiquid securities through privately
negotiated transactions. We generally invest in private small to middle market
companies. Our investment and lending activity is generally focused in private
finance.
Our investment portfolio consists primarily equity investments in companies,
which may or may not constitute a controlling equity interest. At June 30, 2004,
our investment portfolio totaled $2,011,000 at fair value. Our investment
objective is to achieve current income and capital gains.
CORPORATE HISTORY
(a) Business Development.
HydroFlo, Inc. ("the Company") was incorporated in North Carolina on December
30, 1999. We operate a website at http://www.hydroflo.us. The Company began
trading on the OTC Bulletin Board on May 23, 2003. Effective March 4, 2004, the
Company converted to a Business Development Company under the Investment Company
Act of 1940.
SUBSIDIARIES, THEIR PRODUCTS, SERVICES, AND MARKETS.
The Company had one subsidiary at the end of the reporting fiscal year:
1.) HydroFlo Water Treatment, Inc.
HydroFlo Water Treatment is a provider of wastewater treatment solutions for
industrial and governmental entity customers. They design, build, and install
aeration equipment used for pre-treatment of wastewater. They also provide a
full range of related services to companies and municipalities to treat their
wastewater at the treatment plant by the use of the energy efficient aeration
systems in treatment lagoons.
Using our patented HydroFlo Pressure Line Up Stream or PLUS pre-treatment
system, customers begin the treatment process at their pumping stations, prior
to the wastewater reaching a treatment plant.
DISTRIBUTION METHOD OF THE PRODUCTS AND SERVICES.
HydroFlo Water Treatment sells their products and services through a combination
of direct sales and sales through manufacturer's representatives. The
distribution is directed to both the private sector, such as the industrial food
processing plants, and the governmental sector, both domestic and foreign.
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COMPETITIVE BUSINESS CONDITIONS.
The wastewater treatment industry is increasingly competitive with competitors
using various technologies. We expect competition to become increasingly
intensified in the future. Therefore, competition is rapidly evolving and there
are no assurances that we can keep pace with the intense competition in this
market.
Many of our competitors have significantly greater brand recognition, customer
bases, operating histories and financial and other resources. In addition, many
companies have expanded the size of their operations by acquiring other
complimentary companies to form advantageous strategic alliances. We compete
with other wastewater treatment firms. In addition, many of our competitors
offer the less effective but similar services at less cost than us and have the
financial resources to create more attractive pricing.
Intellectual Property
US Patent # 6,284,138 "Method and arrangement for introduction of sewage
pre-treatment upstream of sewage treatment facility" was issued to HydroFlo in
September, 2001. This patent provides the company the protection for the
addition of air or oxygen to wastewater in the pipeline system for the purpose
of wastewater pre-treatment.
RESEARCH AND DEVELOPMENT
The Company currently has no research and development group. Periodically, we
make refinements to our products on a line production basis.
NUMBER OF EMPLOYEES.
As of the close of the reporting period, the Company had 1 employee and
HydroFlo Water Treatment had 4 employees.
RECENT DEVELOPMENTS
On August 4, 2004 the Company acquired Arsenic Removal Technologies, Inc, a
company holding the arsenic removal technology rights developed by the
University of Wyoming. The subsidiary company was purchased using 2,823,529
shares of restricted common stock of the Company. We hold 100% of the stock in
this subsidiary company and plan to develop and market the technology throughout
the world. After purchase, the company was re-incorporated in North Carolina
with a change of name to Metals & Arsenic Removal Technology, Inc.
REGULATION OF A BUSINESS DEVELOPMENT COMPANY
A business development company is defined and regulated by the 1940 Act. A
business development company must be organized in the United States for the
purpose of investing in or lending to primarily private companies and making
managerial assistance available to them. A business development company may use
capital provided by public shareholders and from other sources to invest in
long-term, private investments in businesses. A business development company
provides shareholders the ability to retain the liquidity of a publicly traded
stock, while sharing in the possible benefits, if any, of investing in primarily
privately owned companies.
As a business development company, we may not acquire any asset other than
"qualifying assets" unless, at the time we make the acquisition, the value of
our qualifying assets represent at least 70% of the value of our total assets.
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The principal categories of qualifying assets relevant to our business are:
o Securities purchased in transactions not involving any public offering, the
issuer of which is an eligible portfolio company;
o Securities received in exchange for or distributed with respect to securities
described in the bullet above or pursuant to the exercise of options,
warrants or rights relating to such securities; and
o Cash, cash items, government securities or high quality debt securities
(within the meaning of the 1940 Act), maturing in one year or less from the
time of investment.
An eligible portfolio company is generally a domestic company that is not an
investment company (other than a small business investment company wholly owned
by a business development company), and that:
o does not have a class of securities registered on an exchange or a class of
securities with respect to which a broker may extend margin credit;
o is actively controlled by the business development company and has an
affiliate of a business development company on its board of directors; or
o meets such other criteria as may be established by the SEC.
Control under the 1940 Act is presumed to exist where a business development
company beneficially owns more than 25% of the outstanding voting securities of
the portfolio company.
To include certain securities described above as qualifying assets for the
purpose of the 70% test, a business development company must make available to
the issuer of those securities significant managerial assistance such as
providing significant guidance and counsel concerning the management,
operations, or business objectives and policies of a portfolio company or making
loans to a portfolio company. We offer to provide managerial assistance to each
of our portfolio companies.
As a business development company, we are entitled to issue senior securities in
the form of stock or senior securities representing indebtedness, including debt
securities and preferred stock, as long as each class of senior security has an
asset coverage of at least 200% immediately after each such issuance.
We may also be prohibited under the 1940 Act from knowingly participating in
certain transactions with our affiliates without the prior approval of our board
of directors who are not interested persons and, in some cases, prior approval
by the SEC.
We are periodically examined by the SEC for compliance with the 1940 Act. As of
the date of this filing we have not been examined by the SEC and have not been
notified of a pending examination.
As with other companies regulated by the 1940 Act, a business development
company must adhere to certain substantive regulatory requirements. A majority
of our directors must be persons who are not interested persons, as that term is
defined in the 1940 Act. Additionally, we are required to provide and maintain a
bond issued by a reputable fidelity insurance company to protect us against
larceny and embezzlement. Furthermore, as a business development company, we are
prohibited from protecting any director or officer against any liability to the
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Company or our shareholders arising from willful malfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of such
person's office.
We maintain a code of ethics that establishes procedures for personal investment
and restricts certain transactions by our personnel. Our code of ethics
generally does not permit investment by our employees in securities that may be
purchased or held by us. The code of ethics is filed as an exhibit to this 10K
which will be on file at the SEC. You may read and copy the code of ethics at
the SEC's Public Reference Room in Washington, D.C. You may obtain information
on operations of the Public Reference Room by calling the SEC at (202) 942-8090.
In addition, the code of ethics is available on the EDGAR Database on the SEC
Internet site at http://www.sec.gov. You may obtain copies of the code of
ethics, after paying a duplicating fee, by electronic request at the following
email address: publicinfo@sec.gov, or by writing to the SEC's Public Reference
Section, 450 5th Street, NW, Washington, D.C. 20549. Additionally, the code of
ethics will be posted on our corporate website, www.hydroflo.us.
As a business development company under the 1940 Act, we are entitled to provide
loans to our employees in connection with the exercise of options. However, as a
result of provisions of the Sarbanes-Oxley Act of 2002, we are prohibited from
making new loans to, or materially modifying existing loans with, our executive
officers in the future.
We may not change the nature of our business so as to cease to be, or withdraw
our election as, a business development company unless authorized by vote of a
"majority of the outstanding voting securities," as defined in the 1940 Act, of
our shares. A majority of the outstanding voting securities of a company is
defined under the 1940 Act as the lesser of: (i) 67% or more of such company's
shares present at a meeting if more than 50% of the outstanding shares of such
company are present and represented by proxy or (ii) more than 50% of the
outstanding shares of such company. Since we made our business development
company election, we have not made any substantial change in the nature of our
business.
REGULATED INVESTMENT COMPANY STATUS. We have not elected to be taxed as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986.
RISK FACTORS
INVESTING IN HYDROFLO INVOLVES A NUMBER OF SIGNIFICANT RISKS RELATING TO OUR
BUSINESS AND INVESTMENT OBJECTIVE. AS A RESULT, THERE CAN BE NO ASSURANCE THAT
WE WILL ACHIEVE OUR INVESTMENT OBJECTIVE. IN ADDITION TO THE RISK FACTORS
DESCRIBED BELOW, OTHER FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY INCLUDE:
o GLOBAL ECONOMIC DOWNTURNS, COUPLED WITH WAR OR THE THREAT OF WAR;
o RISK ASSOCIATED WITH POSSIBLE DISRUPTION IN OUR OPERATIONS DUE TO TERRORISM;
o FUTURE REGULATORY ACTIONS AND CONDITIONS IN OUR OPERATING AREAS; AND
o OTHER RISKS AND UNCERTAINTIES AS MAY BE DETAILED FROM TIME TO TIME IN OUR
PUBLIC ANNOUNCEMENTS AND SEC FILINGS.
5
INVESTING IN PRIVATE COMPANIES INVOLVES A HIGH DEGREE OF RISK. Our portfolio
consists of primarily investments in private companies. Investments in private
businesses involve a high degree of business and financial risk, which can
result in substantial losses and accordingly should be considered speculative.
There is generally no publicly available information about the companies in
which we invest, and we rely significantly on the diligence of our employees and
agents to obtain information in connection with our investment decisions. In
addition, some smaller businesses have narrower product lines and market shares
than their competition, and may be more vulnerable to customer preferences,
market conditions or economic downturns, which may adversely affect the return
on, or the recovery of, our investment in such businesses.
OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID. We generally acquire our investments
directly from the issuer in privately negotiated transactions. The majority of
the investments in our portfolio may be subject to restrictions on resale or
otherwise have no established trading market. We typically exit our investments
when the portfolio company has a liquidity event such as a sale,
recapitalization, or initial public offering of the company. The illiquidity of
our investments may adversely affect our ability to dispose of debt and equity
securities at times when it may be otherwise advantageous for us to liquidate
such investments. In addition, if we were forced to immediately liquidate some
or all of the investments in the portfolio, the proceeds of such liquidation
would be significantly less than the current value of such investments.
Substantially all of our portfolio investments are recorded at fair value as
determined in good faith by our board of directors or as determined by a
business valuation expert and, as a result, there is uncertainty regarding the
value of our portfolio investments. At June 30, 2004, approximately 82% of our
total assets represented portfolio investments recorded at fair value. Pursuant
to the requirements of the 1940 Act, we value substantially all of our
investments at fair value as determined in good faith by our board of directors
on a quarterly basis and use a valuation expert for year-end . Since there is
typically no readily ascertainable market value for the investments in our
portfolio, our board of directors determines in good faith the fair value of
these investments pursuant to a valuation policy and a consistently applied
valuation process. For June 30, 2004, we used an independent valuation
specialist to assist us in our good faith estimate of the fair value of our
investment.
There is no single standard for determining fair value in good faith. As a
result, determining fair value requires that judgment be applied to the specific
facts and circumstances of each portfolio investment while employing a
consistently applied valuation process for the types of investments we make.
Unlike banks, we are not permitted to provide a general reserve for anticipated
loan losses; we are instead required by the 1940 Act to specifically value each
individual investment on a quarterly basis, and record unrealized depreciation
for an investment that we believe has become impaired, including where
collection of a loan or realization of an equity security is doubtful, or when
the enterprise value of the company does not currently support the cost of our
debt or equity investment. Conversely, we will record unrealized appreciation if
we believe that the underlying portfolio company has appreciated in value and,
therefore, our equity security has also appreciated in value. Without a readily
ascertainable market value and because of the inherent uncertainty of valuation,
the fair value of our investments determined in good faith by the board of
directors may differ significantly from the values that would have been used had
a ready market existed for the investments, and the differences could be
material.
We adjust quarterly the valuation of our portfolio to reflect the board of
directors' determination of the fair value of each investment in our portfolio.
Any changes in estimated fair value are recorded in our statement of operations
as "Net unrealized gains (losses)."
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ECONOMIC RECESSIONS OR DOWNTURNS COULD IMPAIR OUR PORTFOLIO COMPANIES AND HARM
OUR OPERATING RESULTS. Many of the companies in which we have made or will make
investments may be susceptible to economic slowdowns or recessions. An economic
slowdown may affect the ability of a company to engage in a liquidity event. Our
non-performing assets are likely to increase and the value of our portfolio is
likely to decrease during these periods. These conditions could lead to
financial losses in our portfolio and a decrease in our revenues, net income,
and assets.
Our business of making private equity investments and positioning them for
liquidity events also may be affected by current and future market conditions.
The absence of an active senior lending environment may slow the amount of
private equity investment activity generally. As a result, the pace of our
investment activity may slow. In addition, significant changes in the capital
markets could have an effect on the valuations of private companies and on the
potential for liquidity events involving such companies. This could affect the
amount and timing of gains realized on our investments.
OUR PRIVATE FINANCE INVESTMENTS MAY NOT PRODUCE CURRENT RETURNS OR CAPITAL
GAINS. Private finance investments are typically structured as debt securities
with a relatively high fixed rate of interest and with equity features such as
conversion rights, warrants, or options. As a result, private finance
investments are generally structured to generate interest income from the time
they are made and may also produce a realized gain from an accompanying equity
feature. We cannot be sure that our portfolio will generate a current return or
capital gains.
WE MAY BORROW MONEY WHICH MAGNIFIES THE POTENTIAL FOR GAIN OR LOSS ON AMOUNTS
INVESTED AND MAY INCREASE THE RISK OF INVESTING IN US. Borrowings, also known as
leverage, magnify the potential for gain or loss on amounts invested and,
therefore, increase the risks associated with investing in our securities. We
can borrow from and issue senior debt securities to banks, insurance companies,
and other lenders. Lenders of these senior securities would have fixed dollar
claims on our consolidated assets that are superior to the claims of our common
shareholders. If the value of our consolidated assets increases, then leveraging
would cause the net asset value attributable to our common stock to increase
more sharply than it would have had we not leveraged. Conversely, if the value
of our consolidated assets decreases, leveraging would cause net asset value to
decline more sharply than it otherwise would have had we not leveraged.
Similarly, any increase in our consolidated income in excess of consolidated
interest payable on the borrowed funds would cause our net income to increase
more than it would without the leverage, while any decrease in our consolidated
income would cause net income to decline more sharply than it would have had we
not borrowed.
CHANGES IN INTEREST RATES MAY AFFECT OUR COST OF CAPITAL AND NET INVESTMENT
INCOME. Because we can borrow money to make investments, our net investment
income before net realized and unrealized gains or losses, or net investment
income, can be dependent upon the difference between the rate at which we borrow
funds and the rate at which we invest these funds. As a result, there can be no
assurance that a significant change in market interest rates will not have a
material adverse effect on our net investment income. In periods of rising
interest rates, our cost of funds would increase, which would reduce our net
investment income. We can use a combination of long-term and short-term
borrowings and equity capital to finance our investing activities.
WE OPERATE IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES. We compete for
investments with a large number of private equity funds and mezzanine funds,
investment banks and other equity and non-equity based investment funds, and
other sources of financing, including traditional financial services companies
such as commercial banks. Some of our competitors have greater resources than we
do. Increased competition would make it more difficult for us to purchase or
7
originate investments at attractive prices. As a result of this competition,
sometimes we may be precluded from making otherwise attractive investments.
WE DEPEND ON KEY PERSONNEL. We depend on the continued services of our executive
officers and other key management personnel. If we were to lose any of these
officers or other management personnel, such a loss could result in
inefficiencies in our operations and lost business opportunities.
CHANGES IN THE LAW OR REGULATIONS THAT GOVERN US COULD HAVE A MATERIAL IMPACT ON
US OR OUR OPERATIONS. We are regulated by the SEC. In addition, changes in the
laws or regulations that govern business development companies, regulated
investment companies, real estate investment trusts, and small business
investment companies may significantly affect our business. Any change in the
law or regulations that govern our business could have a material impact on us
or our operations. Laws and regulations may be changed from time to time, and
the interpretations of the relevant laws and regulations also are subject to
change.
RESULTS MAY FLUCTUATE AND MAY NOT BE INDICATIVE OF FUTURE PERFORMANCE. Our
operating results will fluctuate and, therefore, you should not rely on current
or historical period results to be indicative of our performance in future
reporting periods. Factors that could cause operating results to fluctuate
include, among others, variations in the investment origination volume and fee
income earned, variation in timing of prepayments, variations in and the timing
of the recognition of realized and unrealized gains or losses, the degree to
which we encounter competition in our markets, and general economic conditions.
OUR COMMON STOCK PRICE MAY BE VOLATILE. The trading price of our common stock
may fluctuate substantially. The price of the common stock may be higher or
lower than the price you pay for your shares, depending on many factors, some of
which are beyond our control and may not be directly related to our operating
performance. These factors include the following:
o price and volume fluctuations in the overall stock market from time to time;
o significant volatility in the market price and trading volume of securities
of business development companies or other financial services companies;
o changes in regulatory policies or tax guidelines with respect to business
development companies or regulated investment companies;
o actual or anticipated changes in our earnings or fluctuations in our
operating results or changes in the expectations of securities analysts;
o general economic conditions and trends;
o loss of a major funding source; or
o departures of key personnel.
ITEM 2. DESCRIPTION OF PROPERTY.
We share our offices with HydroFlo Water Treatment.
8
Our offices are located at 3721 Junction Blvd., Raleigh, NC 27603. Our telephone
number is 919-772-9925.
Office space of 1,600 square feet is rented for $1,350 per month from Gary and
Theresa Schlotterer. We are now on a month-to-month lease. Our offices are in
good condition and are sufficient to conduct our operations.
We do not intend to renovate, improve, or develop properties. We are not subject
to competitive conditions for property and currently have no property in insure.
We have no policy with respect to investments in real estate or interests in
real estate and no policy with respect to investments in real estate mortgages.
Further, we have no policy with respect to investments in securities of or
interests in persons primarily engaged in real estate activities.
All of the manufacturing endeavors of the Company are accomplished by one of
three available suppliers.
ITEM 3. LEGAL PROCEEDINGS.
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock is traded over the counter and quoted on the OTC NASDAQ
Electronic Bulletin Board under the Signal "HYRF." That symbol became effective
on May 25, 2003. The following table represents the range of the high and low
bid prices of the Company's stock for each fiscal quarter time since trading
began. Such quotations represent prices between dealers and may not include
markups, markdowns, or commissions and may not necessarily represent actual
transactions.
Net Asset Range of Sales
Value per Prices
Year Quarter Share (1) High Low Close
2003 Third Quarter $N/A $ 2.25 $ 1.10 1.70
Fourth Quarter N/A 1.75 .25 0.55
2004 First Quarter 0.11 1.50 .35 1.25
Second Quarter 0.15 1.25 .10 .10
(1) Net asset value per share is determined as of the last day in the relevant
quarter and therefore may not reflect the net asset value per share on the
date of the high or low sales price. The net asset values shown are based
on outstanding common shares at the end of each period.
Our market has traded sporadically and is often thinly traded with large changes
in volume of shares traded on any particular day. Shareholders should consider
the possibility of the loss of the entire value of their shares.
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As of June 30, 2004 the authorized capital of the company is 500,000,000 shares
of common voting stock par value $.01 per share and 5,000,000 shares of
preferred stock. As of June 30, 2004 the Company has outstanding 28,277,912
shares of common stock and 4,000,000 shares of $.01 preferred stock.
Options
We granted options to purchase shares of common stock in conjunction with an
employment agreement with Mr. Barbee entered into during fiscal 2001. The
options vest over one year from the date of each grant and expire five years
after the grant date. All options issued to date have an exercise price of $0.22
per share. The weighted average fair value of the options is $2.03, $1.82 and
$1.77 per share for options granted during fiscal 2004, 2003 and 2002,
respectively. The weighted average remaining contractual lives of granted
options are approximately 4 years. The summary of stock option activity is shown
below:
o Options granted during fiscal 2004 - 337,500 @ $0.22
o Options exercised during fiscal 2004 - 3,000 @ $0.22
o Outstanding at June 30, 2004 - 1,347,000 @ $0.22
o Options exercisable at June 30, 2004 - 1,009,500
o Options granted during fiscal 2003 - 337,500 @ $0.22
o Outstanding at June 30, 2003 - 1,012,500 @ $0.22
o Options exercisable at June 30, 2003 - 675,000
o Options granted during fiscal 2002 - 337,500 @ $0.22
o Outstanding at June 30, 2002 - 675,000 @ $0.22
o Options exercisable at June 30, 2002 - 337,500 @ $0.22
Common Stock Warrants
Since inception, warrants to purchase 1,012,500 shares of common stock have been
granted to non-management stockholders. The warrants are exercisable at $.22 per
share for a five-year period beginning upon full satisfaction of the
shareholders' stock subscriptions. Of these warrants, 506,250 were cancelled due
to cancellation of a stock subscription agreement in fiscal year 2002. As of
June 30, 2003, no warrants have been exercised although all remaining warrants
are now exercisable.
Holders
As of June 30, 2004, there were 28,277,912 shares of common stock issued and
outstanding held by 94 shareholders of record.
Dividends
We do not anticipate paying dividends in the foreseeable future. We plan to
retain any future earnings for use in our business. Any decisions as to future
payments of dividends will depend on our earnings and financial position and
such other facts as the Board of Directors deems relevant.
Penny Stock Considerations
Because our shares trade at less than $5.00 per share, they are "penny stocks"
as that term is generally defined in the Securities Exchange Act of 1934 to mean
equity securities with a price of less than $5.00. Our shares thus will be
subject to rules that impose sales practice and disclosure requirements on
broker-dealers who engage in certain transactions involving a penny stock.
Under the penny stock regulations, a broker-dealer selling a penny stock to
anyone other than an established customer or accredited investor must make a
special suitability determination regarding the purchaser and must receive the
purchaser's written consent to the transaction prior to the sale, unless the
broker-dealer is otherwise exempt. Generally, an individual with a net worth in
excess of $1,000,000 or annual income exceeding $100,000 individually or
$300,000 together with his or her spouse is considered an accredited investor.
In addition, under the penny stock regulations the broker-dealer is required to:
o Deliver, prior to any transaction involving a penny stock, a disclosure
schedule prepared by the Securities and Exchange Commissions relating to
the penny stock market, unless the broker-dealer or the transaction is
otherwise exempt;
o Disclose commissions payable to the broker-dealer and our registered
representatives and current bid and offer quotations for the securities;
o Send monthly statements disclosing recent price information pertaining to
the penny stock held in a customer's account, the account's value and
information regarding the limited market in penny stocks; and
o Make a special written determination that the penny stock is a suitable
investment for the purchaser and receive the purchaser's written agreement
to the transaction, prior to conducting any penny stock transaction in the
customer's account.
Because of these regulations, broker-dealers may encounter difficulties in their
attempt to sell shares of our common stock, which may affect the ability of
selling shareholders or other holders to sell their shares in the secondary
market and have the effect of reducing the level of trading activity in the
secondary market. These additional sales practice and disclosure requirements
could impede the sale of our securities, if our securities become publicly
traded. In addition, the liquidity for our securities may be decreased, with a
corresponding decrease in the price of our securities. Our shares in all
probability will be subject to such penny stock rules and our shareholders will,
in all likelihood, find it difficult to sell their securities.
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ITEM 6. SELECTED FINANCIAL DATA
The selected financial data should be read in conjunction with our "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and notes thereto. As discussed in Note A to the
Financial Statements, we converted to a Business Development Company effective
March 4, 2004. The results of operations for fiscal 2004 are divided into two
periods, the "Post-Conversion as a Business Development Company" period and
"Pre-Conversion prior to becoming a Business Development Company" period.
Different accounting principles are used in the preparation of financial
statements of a business development company under the Investment Company Act of
1940 and, as a result, the financial results for periods prior to March 4, 2004
are not comparable to the period commencing on March 4, 2004 and are not
expected to be representative of our financial results in the future. In
addition, the financial results for periods prior to July 1, 2003 are not
comparable to the period commencing on July 1, 2003 and are not expected to be
representative of our financial results in the future.
For the years ended June30,
March 4, July 1, December 8,
2004 to 2004 to 1999 to
June 30, March 3, June 30,
2004 2004 2003 2002 2001 2000
Financial Position:
Total Assets $2,434,125 $ 395,762 $ 181,180 $ 46,576 $ 85,732
Total Liabilities 1,781 247,626 157,884 68,688 5,432
Net Assets /
Stockholders'
Equity (Deficit) 2,432,344 148,136 23,296 (22,112) 80,290
Operations:
Operating Revenue $ 0 $ 109,208 244,243 5,001 0 0
Operating Expenses 589,304 1,407,058 1,403,144 930,320 313,468 42,607
Net Investment gain 2,592 N/A N/A N/A N/A N/A
Net Loss 589,656 1,297,848 1,153,876 924,504 311,277 41,602
Per Share Data:
Net Assets /
Book Value 0.09 0.03 0.001 0.001 0.005
Closing market Price 0.10 0.43 N/A N/A N/A N/A
Loss per share 0.03 0.08 0.07 0.06 0.02 0.003
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The information contained in this section should be read in conjunction with the
Selected Financial Data and our Financial Statements and notes thereto appearing
elsewhere in this 10K. The 10K, including the Management's Discussion and
Analysis of Financial Condition and Results of Operations, contains
forward-looking statements that involve substantial risks and uncertainties.
These forward-looking statements are not historical facts, but rather are based
on current expectations, estimates and projections about our industry, our
beliefs, and our assumptions. Words such as "anticipates", "expects", "intends",
"plans", "believes", "seeks", and "estimates" and variations of these words and
similar expressions are intended to identify forward-looking statements. These
statements are not guarantees of future performance and are subject to risks,
uncertainties, and other factors, some of which are beyond our control and
difficult to predict and could cause actual results to differ materially from
those expressed or forecasted in the forward-looking statements including
without limitation (1) any future economic downturn could impair our ability to
increase our non-performing assets, (2) a contraction of available credit and/or
an inability to access the equity markets could impair our investment
activities, (3) the risks associated with the possible disruption in the
Company's operations due to terrorism and (4) the risks, uncertainties and other
factors we identify from time to time in our filings with the Securities and
Exchange Commission, including our Form 10-Ks, Form 10-Qs and Form 8-Ks.
Although we believe that the assumptions on which these forward-looking
statements are based are reasonable, any of those assumptions could prove to be
inaccurate, and as a result, the forward-looking statements based on those
assumptions also could be incorrect. In light of these and other uncertainties,
the inclusion of a projection or forward-looking statement in this Annual Report
should not be regarded as a representation by us that our plans and objectives
will be achieved. You should not place undue reliance on these forward-looking
statements, which apply only as of the date of this Annual Report.
OVERVIEW
The following discussion should be read in conjunction with the financial statements
for the period ended June 30, 2004 included with this Form 10-K.
Effective March 4, 2004, we converted to a Business Development Company under
the Investment Company Act of 1940. Upon completion of this conversion, we
became an internally managed, diversified, closed-end investment company. Prior
to the conversion we were an operating company. Those operations were
transferred to HydroFlo Water Treatment, Inc., a wholly owned investment of
ours. HydroFlo Water Treatment, Inc., is an international provider of wastewater
pre-treatment solutions, treating wastewater for industrial and municipal
customers. HydroFlo designs, builds, and installs water and wastewater treatment
systems and provides a full range of related services to companies and
municipalities to treat their wastewater.
Because of our conversion to a Business Development Company ("BDC") the results
of operations for the year ended June 30, 2004 are split between the eight-month
period from July 1, 2003 through March 3, 2004 (pre conversion) and the
four-month period from March 4, 2004 through June 30, 2004 (post conversion
which includes a one-time conversion adjustment). The principal differences
between these two reporting periods are: (1) we no longer include the operations
of our operating ("portfolio") company in our financial statements, and (2) we
now value our ownership of the portfolio company at fair value.
12
POST-CONVERSION TO A BUSINESS DEVELOPMENT CORPORATION
PORTFOLIO COMPOSITION
Our primary business is investing in businesses with equity-based investments.
The total portfolio value of investments in non-publicly traded securities was
$2.011 million at fair value at June 30, 2004.
OPERATIONS
We generated no income during the period March 4, 2004 to June 30, 2004. We
incurred approximately $589,000 in expenses during this period. Approximately
$497,000 of these expenses were non-cash stock based expenses paid to
consultants. The remaining $92,000 represented management fees to our CEO, rent
and other cash expenses associated with operating the BDC and seeking additional
investments.
During the period March 4, 2004 to June 30, 2004, we incurred $2,944 in interest
expense and recorded an unrealized gain of $2,592 from our investment in
HydroFlo Water Treatment, Inc.
As a result of the foregoing, we incurred a net loss of approximately $590,000
for the period March 4, 2004 to June 30, 2004.
PRIOR TO CONVERTING TO A BUSINESS DEVELOPMENT CORPORATION
OPERATING INCOME
Our aggregate sales were $109,208 for the eight-months ended March 3, 2004. This
compares with revenues of $244,243 and $5,001 for the years ended June 30, 2003
and 2002 respectively. These sales numbers fluctuate, and are not very
comparable, due to the fact that we are just beginning to penetrate the market
place.
OPERATING EXPENSES
Employee compensation expenses were $489,333 for the eight-months ended March 3,
2004. This compares with expenses of $907,755 and $606,072 for the years ended
June 30, 2003 and 2002 respectively. On an annualized basis, we experienced a
19% decrease in compensation expense in 2004 from 2003. This decrease is the
result of a reduction in staff costs associated with lower than expected sales
during 2004.
Management fees (related-party) expenses were $32,200 for the eight-months ended
March 3, 2004. Annualized, this is comparable with expenses of $55,200 and
$55,200 for the years ended June 30, 2003 and 2002 respectively.
Research and development expenses were $7,018 for the eight-months ended March
3, 2004. This compares similiarly with expenses of $5,988 and $15,658 for the
years ended June 30, 2003 and 2002 respectively
Other General and Administrative expenses were $839,415 for the eight-months
ended March 3, 2004. This compares with expenses of $393,581 and $250,219 for
the years ended June 30, 2003 and 2002 respectively. On an annualized basis, we
experienced a 320% increase in 2004 from 2003. This increase is the result of
increased marketing efforts and the use of non-cash stock based compensation.
13
OTHER INCOME/EXPENSES
Interest income was $0 for the eight-months ended March 3, 2004. This
compares with income of $5,025 and $730 for the years ended June 30, 2003 and
2002, respectively. This decrease in 2004 is the result of our not having significant
amounts of cash on hand, while during 2003 we were raising cash to assist in our
business development.
NET LOSS
As a result of the foregoing, we incurred a loss of $1,297,848 for the
eight-months ended March 3, 2004 compared to losses of $1,153,876 and $924,504
for the years ended June 30, 2003 and 2002, respectively.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004 and June 30, 2003, we had $406,762 and $131,373, respectively,
in cash and cash equivalents. Our objective is to maintain a low cash balance,
while keeping sufficient cash on hand to cover current funding requirements and
operations.
For the next eight months, we expect our cash on hand and cash generated from
operations, to be adequate to meet our cash needs, including additional advances
to the companies we invest in. Management's plans regarding continued operation
include the possibility of raising additional equity capital via the sale of
stock which can now be accomplished due to the filing as a Business Development
Company. Aggressive sales efforts in our prtfolio companies will likely increase
sales of product by the subsidiaries in the coming year and may result in less
funding we need to provide to them or may even result in a cash return on our
investment.
During the year ended June 30, 2004, the Company has not engaged in:
o Material off-balance sheet activities, including the use of structured
finance or special purpose entities;
o Trading activities in non-exchange traded contracts; or
o Transactions with persons or entities that benefit from their
non-independent relationship with the Company.
CONTRACTUAL OBLIGATIONS
Our contractual obligations as of June 30, 2004 are:
Payments Due by Period
Less than
Contractual Obligations Total 1 year 1-3 years 4-5 years After 5 years
Other Obligations $1,781 $1,781 - - -
PRIVATE PORTFOLIO COMPANY INVESTMENTS
The following is a list of the private companies in which we had an investment
and the cost and fair value of such securities at June 30, 2004:
Name of Company Nature of its Principal Business Cost Fair Value
HydroFlo Water Treatment, Inc. Waste Water Treatment Solutions $2,008,408 $2,011,000
RECENT DEVELOPMENTS
On August 4, 2004 the Company acquired Arsenic Removal Technologies, Inc, a
company holding the arsenic removal technology rights developed by the
University of Wyoming. The subsidiary company was purchased using 2,823,529
shares of restricted common stock of the Company. We hold 100% of the stock in
this subsidiary company and plan to develop and market the technology throughout
the world. After purchase, the company was re-incorporated in North Carolina
with a change of name to Metals & Arsenic Removal Technology, Inc.
CRITICAL ACCOUNTING POLICIES
The financial statements are based on the selection and application of
significant accounting policies, which require management to make significant
estimates and assumptions.
VALUATION OF INVESTMENTS
At June 30, 2004, our total assets represented investments recorded at fair
value. Value, as defined in Section 2(a)(41) of 1940 Act, is (i) the market
price for those securities for which a market quotation is readily available and
(ii) for all other securities and assets, fair value is as determined in good
faith by the board of directors. Since there is typically no readily
ascertainable market value for the investments in our portfolio, we value
substantially all of our investments at fair value as determined in good faith
by the board of directors pursuant to a valuation policy and a consistent
valuation process. Because of the inherent uncertainty of determining the fair
value of investments that do not have a readily ascertainable market value, the
fair value of our investments determined in good faith by the board of directors
may differ significantly from the values that would have been used had a ready
market existed for the investments, and the differences could be material.
There is no single standard for determining fair value in good faith. As a
result, determining fair value requires that judgment be applied to the specific
facts and circumstances of each portfolio investment. Unlike banks, we are not
permitted to provide a general reserve for anticipated loan losses. Instead, we
must determine the fair value of each individual investment on a quarterly
basis. We will record unrealized depreciation on investments when we believe
that an investment has become impaired, including where collection of a loan or
realization of an equity security is doubtful. Conversely, we will record
14
unrealized appreciation if we believe that the underlying portfolio company has
appreciated in value and, therefore, our investment has also appreciated in
value, where appropriate.
As a business development company, we invest primarily in illiquid equity
securities of private companies. The structure of each equity security is
specifically negotiated to enable us to protect our investment and maximize our
returns. Our investments generally have no established trading market. Because
of the type of investments that we make and the nature of our business, our
valuation process requires an analysis of various factors. Our fair value
methodology includes the examination of, among other things, the underlying
investment performance, financial condition and market changing events that
impact valuation.
VALUATION OF EQUITY SECURITIES
With respect to private equity securities, each investment is valued using
industry valuation benchmarks, and then the value is assigned a discount
reflecting the illiquid nature of the investment, as well as our minority,
non-control position. When an external event such as a purchase transaction,
public offering, or subsequent equity sale occurs, the pricing indicated by the
external event will be used to corroborate our private equity valuation.
New Accounting Pronouncements
We have reviewed all new accounting pronouncements issued through June 2004 and
have determined that none of them would have a material impact on our financial
position or results of operations.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our business activities contain elements of risk. We consider the principal
types of risk to be portfolio valuations. We consider the management of risk
essential to conducting our businesses. Accordingly, our risk management systems
and procedures are designed to identify and analyze our risks, to set
appropriate policies and limits and to continually monitor these risks and
limits by means of reliable administrative and information systems and other
policies and programs.
As a business development company, we invest in illiquid securities including
equity securities of primarily private companies. Our investments are generally
subject to restrictions on resale and generally have no established trading
market. We value substantially all of our investments at fair value as
determined in good faith by the board of directors in accordance with our
valuation policy. There is no single standard for determining fair value in good
faith. As a result, determining fair value requires that judgment be applied to
the specific facts and circumstances of each portfolio investment while
employing a consistently applied valuation process for the types of investments
we make.
We determine fair value to be the amount for which an investment could be
exchanged in an orderly disposition over a reasonable period of time between
willing parties other than in a forced or liquidation sale. Our valuation policy
considers the fact that no ready market exists for substantially all of the
securities in which we invest. Our valuation policy is intended to provide a
consistent basis for determining the fair value of the portfolio. We will record
15
unrealized depreciation on investments when we believe that an investment has
become impaired, including where collection of a loan or realization of an
equity security is doubtful, or when the enterprise value of the company does
not currently support the cost of our debt or equity investments. Conversely, we
will record unrealized appreciation if we believe that the underlying portfolio
company has appreciated in value and, therefore, our equity security has also
appreciated in value. The value of investments in public securities is
determined using quoted market prices discounted for restrictions on resale.
Without a readily ascertainable market value and because of the inherent
uncertainty of valuation, the fair value of our investments determined in good
faith by the board of directors may differ significantly from the values that
would have been used had a ready market existed for the investments, and the
differences could be material. In addition, the illiquidity of our investments
may adversely affect our ability to dispose of debt and equity securities at
times when it may be otherwise advantageous for us to liquidate such
investments. In addition, if we were forced to immediately liquidate some or all
of the investments in the portfolio, the proceeds of such liquidation would be
significantly less than the current value of such investments.
Impact of Inflation
We do not believe that our business is materially affected by inflation, other
than the impact that inflation may have on the securities markets, the
valuations of business enterprises and the relationship of such valuations to
underlying earnings, all of which will influence the value of our investments.
ITEM 8. FINANCIAL STATEMENTS.
HYDROFLO, INC.
Financial Statements
as of June 30, 2004 and 2003
and for the periods
March 4, 2004 (date of conversion to
a Business Development Company)
to June 30, 2004 and July 1, 2003 to March 3, 2004,
and for the years ended June 30, 2003 and 2002
and
Report of Independent Registered
Public Accounting Firm
16
HYDROFLO, INC.
TABLE OF CONTENTS
________________________________________________________________________________
Page
Report of Independent Registered Public Accounting Firm 18
Balance Sheets as of June 30, 2004 and 2003 19
Statements of Operations for the periods March 4, 2004 (date of
conversion to a Business Development Company - "BDC") to
June 30, 2004 and July 1, 2003 to March 3, 2004, and for the
years ended June 30, 2003 and 2002 20
Statements of Changes in Net Assets for the periods March 4, 2004
(date of conversion to a BDC) to June 30, 2004 and July 1, 2003
to March 3, 2004, and for the years ended June 30, 2003
and 2002 21
Statements of Cash Flows for the periods March 4, 2004 (date of
conversion to a BDC) to June 30, 2004 and July 1, 2003 to March
3, 2004, and for the years ended June 30, 2003 and 2002 22
Schedule of Investment(s) as of June 30, 2004 24
Notes to Financial Statements 25
________________________________________________________________________________
17
[Letterhead of Kingery & Crouse, P.A.]
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of HydroFlo, Inc.:
We have audited the accompanying balance sheet and statement of investment(s) of
HydroFlo, Inc. (the "Company") as of June 30, 2004, and the related statements
of operations, changes in net assets and cash flows for the periods March 4,
2004 (date of conversion to a Business Development Company - "BDC") to June 30,
2004 and July 1, 2003 to March 3, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.
As discussed in Note xx to the financial statements, an investment amounting to
$2,011,000 (83% of total assets) at June 30, 2004 has been valued at fair value
as determined by the Board of Directors. We have reviewed the procedures applied
by the Board of Directors in valuing such investment and have inspected
underlying documentation; , while in the circumstances the procedures appear to
be reasonable and the documentation appropriate, determination of fair value
involves subjective judgment which is not susceptible to substantiation by the
audit process.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of June 30,
2004, and the results of its operations and cash flows for the periods March 4,
2004 (date of conversion to a BDC) to June 30, 2004 and July 1, 2003 to March 3,
2004, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has suffered recurring losses from operations
and negative cash flows. These factors, among others, raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note A. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As discussed in Note A to the financial statements, accounting principles used
in the preparation of the financial statements as of and for the period March 4,
2004 (date of conversion to a BDC) to June 30, 2004) under the Investment
Company Act of 1940 are different than those used for prior periods and
therefore such statements are not directly comparable.
/s/ Kingery & Crouse, P.A.
October 11, 2004
Tampa, FL
18
HYDROFLO, INC.
BALANCE SHEETS AS OF JUNE 30, 2004 AND 2003
___________________________________________________________________________________
ASSETS 2004 2003
INVESTMENT IN AND ADVANCES TO CONTROLLED
COMPANY (at fair value with a cost of $2,008,408) $ 2,011,000 $ -
CASH 406,762 131,373
ACCOUNTS RECEIVABLE - 24,443
INVENTORY - 32,045
PREPAID EXPENSES - 76,995
PROPERTY AND EQUIPMENT (net of accumulated
depreciation of $13,892 and $23,138, respectively) 16,363 93,794
OTHER ASSETS - 37,112
TOTAL (including total current assets of $264,856 at
June 30, 2003) $ 2,434,125 $ 395,762
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
ACCOUNTS PAYABLE AND ACCRUED AND OTHER LIABILITIES $ 1,781 $ 75,877
ACCOUNTS PAYABLE ANDACCRUED AND OTHER LIABILITIES -
RELATED PARTY - 1,749
CONVERTIBLE NOTES PAYABLE - 170,000
Total liabilities (including total current
liabilities of $77,626 as of June 30, 2003 1,781 247,626
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $0.001 par value,
5,000,000 shares authorized; 4,000,000 and zero
shares issued and outstanding as of June 30, 2004
and 2003, respectively 4,000 -
Common stock, $0.01 par value, 500,000,000 shares
authorized; 28,277,912 and 15,811,050 shares issued
and outstanding as of June 30, 2004 and 2003,
respectively 282,780 158,111
Additional paid-in capital 2,590,344 2,330,471
Stock subscriptions receivable (2,958) (6,959)
Stock purchase warrants 147,834 147,834
Deferred compensation - (50,062)
Deficit (589,656) (2,431,259)
Total stockholders' equity 2,432,344 148,136
TOTAL $ 2,434,125 $ 395,762
============= =============
NET ASSET VALUE PER SHARE $ 0.09
=============
___________________________________________________________________________________
See notes to financial statements.
19
HYDROFLO, INC.
STATEMENTS OF OPERATIONS
___________________________________________________________________________________________________________
As a Prior to Converting to a
BDC Business Development Company ("BDC")
For the For the
Period March Period July For the For the
4, 2004 to 1, 2003 to Year ended Year ended
June 30, March 3, June 30, June 30,
2004 2004 2003 2002
REVENUES $ - $ 109,208 $ 244,243 $ 5,001
COST OF GOODS SOLD - 39,090 40,620 5,086
GROSS MARGIN - 70,118 203,623 (85)
OTHER OPERATING EXPENSES:
Employee compensation and benefits - 489,335 907,755 606,072
Management fee 18,400 32,200 55,200 53,200
Research and development - 7,018 5,988 15,658
Other general and administrative 570,904 839,415 393,581 250,219
Total other operating expenses 589,304 1,367,968 1,362,524 925,149
LOSS FROM OPERATIONS (589,304) (1,267,460) (1,158,901) (925,234)
OTHER INCOME (EXPENSE):
Interest income - - 5,025 730
Interest expense (2,944) - - -
Total other income (expense) (2,944) - 5,025 730
NET UNREALIZED GAIN ON INVESTMENT 2,592 - - -
NET LOSS $ (589,656) $(1,297,848) $(1,153,876) $ (924,504)
============= ============ ============ ============
NET LOSS PER SHARE - Basic and Diluted $ (0.03) $ (0.08) $ (0.07) $ (0.06)
============= ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING-
Basic and Diluted 21,982,800 15,916,800 15,740,316 16,222,518
============= ============ ============ ============
___________________________________________________________________________________________________________
See notes to financial statements.
20
HYDROFLO, INC.
STATEMENTS OF CHANGES IN NET ASSETS FOR THE PERIOD MARCH 4,
2004 (date of conversion to
a BDC) TO JUNE 30, 2004 AND JULY 1, 2003 TO MARCH 3,
2004, AND FOR THE YEARS ENDED JUNE 30, 2003 AND 2002
_____________________________________________________________________________________________________________________________________________________________________
Additional Stock Stock
Preferred Stock Common Stock Paid-In Subscriptions Purchase Deferred Accumulated
Shares Amount Shares Amount Capital Receivable Warrants Compensation Deficit Total
Balance, June 30, 2001 - - 16,406,400 $ 109,376 $ 571,657 $(642,808) $ 295,667 $ (3,125) $ (352,879) $ (22,112)
Common stock issued - - 416,250 2,775 552,225 - - - - 555,000
Stock subscription receipts - - - - - 67,349 - - - 67,349
Stock subscription cancelled - - (1,284,600) (8,564) (419,636) 428,200 - - - -
Stock options granted - - - - 375,750 - - (375,750) - -
Amortization of deferred compensation - - - - - - - 347,563 - 347,563
Stock purchase warrants cancelled - - - - 147,833 - (147,833) - - -
Stock split - - - 51,794 (51,794) - - - - -
Net loss - - - - - - - - (589,656) (924,504)
Balance, June 30, 2002 - - 15,538,050 155,381 1,176,035 (147,259) 147,834 (31,312) (1,277,383) 23,296
Common stock issued - - 273,000 2,730 543,270 - - - - 546,000
Stock subscription receipts - - - - - 140,300 - - - 140,300
Stock options granted - - - - 600,750 - - (600,750) - -
Amortization of deferred compensation - - - - - - - 582,000 - 582,000
Common stock to be issued for service - - - - 10,416 - - - - 10,416
Net loss - - - - - - - - (589,656) (1,153,876)
Balance, June 30, 2003 - - 15,811,050 158,111 2,330,471 (6,959) 147,834 (50,062) (2,431,259) 148,136
Stock issued for cash - - 90,500 905 84,180 - - - - 85,085
Stock issued for services - - 168,000 1,680 117,958 - - (68,000) - 51,638
Stock subscription receipts - - - - - 4,001 - - - 4,001
Stock options granted - - - - 681,000 - - (681,000) - -
Amortization of deferred compensation - - - - - - - 799,062 - 799,062
Repayment of debt 4,000,000 4,000 - - 462,000 - - (300,000) - 166,000
Net loss - - - - - - - - (589,656) (1,297,848)
Balance March 3, 2004 4,000,000 4,000 16,069,550 160,696 3,675,609 (2,958) 147,834 (300,000) (3,729,107) (43,926)
Transfer of Investment of Hydroflo Water
Treatment, Inc. - - - - (1,845,210) - - - 3,729,107 1,883,897
Stock issued for services - - 1,094,617 10,946 185,628 - - - - 196,574
Stock issued for cash - - 9,488,359 94,884 464,971 - - - - 559,855
Amortization of deferred compensation - - - - - - - 300,000 - 300,000
Repayment of Debt - - 1,625,386 16,254 109,346 - - - - 125,600
Net loss - - - - - - - - (589,656) (589,656)
Balance June 30, 2004 4,000,000 $4,000 28,277,912 $282,780 $2,590,344 $(2,958) $147,834 $ - $(589,656) $2,432,344
========= ===== ============ ========= =========== ======= ========= ========= =========== ===========
_____________________________________________________________________________________________________________________________________________________________________
See notes to financial statements
21
HYDROFLO, INC.
STATEMENTS OF CASH FLOWS
________________________________________________________________________________________________________________
As a BDC Prior to Converting to a
Business Development Company ("BDC")
For the
Period March
4, 2004 For the For the For the
Through Period July Year ended Year ended
June 30, 1, 2003 to June 30, June 30,
2004 March 3, 2004 2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (589,656) $ (1,297,848) $ (1,153,876) $ (924,504)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 13,892 15,770 14,613 5,975
Amortization of patent costs - 375 560 466
Net unrealized gain on investment (2,592) - - -
Stock-based compensation 196,574 47,638 10,416 -
Amortization of deferred compensation 300,000 799,062 582,000 347,563
Loss on impairment of patent costs - 5,949 - -
(Increase) decrease in accounts receivable - (68,707) (19,443) (5,000)
(Increase) decrease in inventory, net - (21,133) 4,695 (21,564)
Decrease (increase) in prepaid expenses - 75,064 (76,505) (280)
Increase in accounts payable and accrued
and other liabilities, and convertible notes
payable 1,261 286,184 89,742 89,196
NET CASH USED IN OPERATING ACTIVITIES (80,521) (157,646) (547,798) (508,148)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in Hydroflo Water Treatment, Inc. (128,807) - - -
Payments to acquire patents - - - (27,137)
Purchases of property and equipment (4,297) (2,688) (66,005) (39,410)
NET CASH USED IN INVESTING ACTIVITIES (133,104) (2,688) (66,005) (66,547)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuances of common stock, net of transaction
expenses 564,855 85,085 546,000 555,000
Stock subscription receipts - 4,000 140,300 67,349
Proceeds from convertible notes payable 50,000 55,000 - -
Repayments of related party borrowing (15,000) - - -
Proceeds from related party borrowing 20,000 15,000 - -
NET CASH PROVIDED BY FINANCING ACTIVITIES 619,855 159,085 686,300 622,349
NET CHANGE IN CASH 406,230 (1,249) 72,497 47,654
CASH AT BEGINNING OF PERIOD 532 717 58,876 11,222
CASH AT END OF PERIOD $ 406,762 $ 532 $ 131,373 $ 58,876
=========== ============= ============= ===========
(Continued)
22
HYDROFLO, INC.
STATEMENTS OF CASH FLOWS (Continued)
________________________________________________________________________________________________________________
As a BDC Prior to Converting to a
Business Development Company ("BDC")
For the
Period March
4, 2004 For the For the For the
Through Period July Year ended Year ended
June 30, 1, 2003 to June 30, June 30,
2004 March 3, 2004 2003 2002
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Income taxes paid $ - $ - $ - $ -
=========== ============= ============= ===========
Interest paid $ - $ - $ - $ -
=========== ============= ============= ===========
SUPPLEMENTAL DISCLOSURE OF CASH NON-
CASH INVESTING AND FINANCING ACTIVITES:
Common stock issued for related party note payable $ 105,000 $ - $ - $ -
=========== ============= ============= ===========
Conversion of related party advances to stock (including
interest) $ 20,600 $ - $ - $ -
=========== ============= ============= ===========
Preferred stock issued for related party accrued expenses
converted to note payable during the same period $ - $ 170,000 $ - $ -
=========== ============= ============= ===========
________________________________________________________________________________________________________________
See notes to financial statements.
23
HYDROFLO, INC.
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
________________________________________________________________________________
Title of Security Percentage of
Portfolio Company Industry Held by Company Class Held Fair Value
Hydroflo Water
Treatment, Inc. Manufacturing Common Stock 100% $ 2,011,000
________________________________________________________________________________
24
HYDROFLO, INC.
NOTES TO FINANCIAL STATEMENTS
________________________________________________________________________________
Note A - Summary of Significant Accounting Policies
Nature of Operations and Background
HydroFlo, Inc. (the "Company") was incorporated in North Carolina on December 8,
1999, to design and distribute aeration and oxygen mixing equipment specifically
designed for municipalities and industry requiring improved dissolved oxygen in
water.
From inception to June 30, 2002, the Company focused primarily on developing and
patenting this new technology for the sewage treatment industry. Beginning July
1, 2002, the Company emerged from the development stage and focused on marketing
and selling their technology to this industry.
Effective March 4, 2004, the Company became a diversified internally managed,
closed-end investment company that elected to be treated as a business
development company ("BDC") under the Investment Company Act of 1940, as
amended. As a BDC, the Company intends to provide long-term debt and equity
investment capital to support the expansion of companies in a variety of
industries. These investments are expected to generally be illiquid securities
negotiated through private transactions.
In connection with the Company's conversion to a BDC, the Company formed
Hydroflo Water Treatment, Inc., and simultaneously transferred substantially all
of its operating assets and liabilities (exclusive of cash and certain property
and equipment) to such entity. HydroFlo Water Treatment, Inc. is an
international provider of wastewater pre-treatment solutions, treating
wastewater for industrial and municipal customers. HydroFlo designs, builds, and
installs water and wastewater treatment systems and provides a full range of
related services to companies and municipalities to treat their wastewater.
As a result of the transfer, the Company's deficit at March 4, 2004 was
eliminated and the accompanying statements of operations reflect an allocation
of revenues and expenses during the periods before and subsequent to the
Company's conversion to a BDC.
Although the nature of the Company's operations and its reported financial
position, results of operations and cash flows are dissimilar for the periods
prior and subsequent to becoming a BDC, its financial position as of June 30,
2004 and 2003, and its operating results, cash flows, and changes in net assets
for each of the periods ended June 30, 2004, March 3, 2004, June 30, 2003 and
June 30, 2002 are presented in the accompanying financial statements pursuant to
Regulation S-X. In addition, the accompanying footnotes, although different in
the nature as to the required disclosures and information reported therein, are
also presented as they relate to each of the above referenced periods.
Basis of Presentation
In accordance with SEC rules and regulations for BDCs, the Company does not
consolidate or use the equity method to account for its controlling investment
in HydroFlo Water Treatment, Inc. Rather, the Company's investment in such
25
entity is reported at fair value, and the fluctuation in such fair value since
the date of the conversion to a BDC has been reflected as an unrealized gain on
investment in the accompanying statement of operations.
Going Concern
The Company has suffered recognized net losses and negative cash flows from
operations since its inception. These losses have been funded through the sale
of common stock, primarily to related parties. Until such time that the Company
can generate sustained profitable operations (for which no assurance can be
given), the Company will require additional funding to implement its business
plan. Management believes it will be able to raise any additional capital it may
need; however there can be no assurance that the Company will be successful in
any such efforts, or that any such financing will be on terms favorable, or
acceptable, to the Company.
The accompanying financial statements do not include any adjustments relating to
the recoverability and classification of asset carrying amounts or the amount
and classification of liabilities that might result should the Company be unable
to continue as a going concern.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statement and the reported amounts of revenues and
expenses during the reporting period. Estimates that are critical to the
accompanying financial statements arise from the determination of the fair value
of the Company's investment. Because such determination involves subjective
judgment, it is at least reasonably possible that the Company's estimates could
change in the near term with respect to this matter.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
investments purchased with maturities of three months or less to be cash
equivalents.
Long-Lived Assets
Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" requires that long-lived assets,
including certain identifiable intangibles, be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of the
assets in question may not be recoverable. Management evaluated its long-lived
assets as of June 30, 2004 and believes they are recoverable.
Property and Equipment
Property and equipment, which are stated at cost, are being depreciated using
the straight-line method over the estimated useful lives of the assets which
range from five to seven years. Expenditures for maintenance and repairs are
charged directly to expense.
Earnings (Loss) Per Share
In accordance with the provisions of SFAS No. 128, "Earnings Per Share," basic
earnings (loss) per share is computed by dividing net income (loss) by the
number of weighted-average common shares outstanding during the year. Diluted
earnings per share is computed by dividing net income (loss) by the number of
weighted average common shares outstanding adjusted to include the number of
26
additional common shares that would have been outstanding if the dilutive
potential common shares resulting from common stock equivalents granted had been
issued. The effect of options and warrants outstanding were not included in the
computation of diluted earnings per share because the effect on net loss per
share would have been antidilutive. Accordingly, basic and diluted net loss per
share are identical for each of the periods in the accompanying statements of
operations.
Income Taxes
The Company computes income taxes in accordance with Financial Accounting
Standards Statement No. 109 "Accounting for Income Taxes". Under SFAS 109,
deferred taxes are recognized for the tax consequences of temporary differences
by applying enacted statutory rates applicable to future years to differences
between the tax bases of assets and liabilities and their financial statement
carrying amounts. Also, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that included the enactment date. Significant
temporary and permanent differences between financial and taxable reporting
result primarily from certain stock based compensation expenses arising from the
grant of certain options and shares of stock.
Stock-Based Compensation
The Company has adopted Statement of Financial Accounting Standards No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure". This
statement amends FASB statement No. 123, "Accounting for Stock Based
Compensation". It provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for employee
stock based compensation. It also amends the disclosure provision of FASB
statement No. 123 to require prominent disclosure about the effects on reported
net income of an entity's accounting policy decisions with respect to
stock-based employee compensation. As permitted by SFAS No. 123 and amended by
SFAS No. 148, the Company continues to apply the intrinsic value method under
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," to account for its stock-based employee compensation
arrangements.
Advertising Expense
The Company expenses advertising costs as incurred. Advertising expenses
approximated $3,000, $27,300, $19,500 and $21,200 for the respective periods
ended June 30, 2004, March 3, 2004, June 30, 2003 and June 30, 2002.
Valuation of Investments and Revenue Recognition (After conversion to a BDC)
As required by the SEC's Accounting Series Release ("ASR") 118, the investment
committee of the Company is required to assign a fair value to all investments.
To comply with Section 2(a)(41) of the Investment Company Act of 1940 (the
"Act") and Rule 2a-4 under the Act, it is incumbent upon the board of directors
to satisfy themselves that all appropriate factors relevant to the value of
securities for which market quotations are not readily available have been
considered and to determine the method of arriving at the fair value of each
such security. To the extent considered necessary, the board may appoint persons
to assist them in the determination of such value, and to make the actual
calculations pursuant to the board's direction. The board must also, consistent
with this responsibility, continuously review the appropriateness of the methods
used in valuing each issue of security in the Company's portfolio. The directors
must recognize their responsibilities in this matter and whenever technical
assistance is requested from individuals who are not directors, the findings of
such intervals must be carefully reviewed by the directors in order to satisfy
themselves that the resulting valuations are fair.
27
Where there is not a readily available source for determining the market value
of an investment, either because the investment is not publicly traded, or is
thinly traded, and in absence of a recent appraisal, the value of the investment
shall be based on the following criteria:
- Total amount of the Company's actual investment ("AI"). This amount
shall include all loans, purchase price of securities, and fair value
of securities given at the time of exchange.
- Total revenues for the preceding twelve months ("R").
- Earnings before interest, taxes and depreciation ("EBITD")
- Estimate of likely sale price of investment ("ESP")
- Net assets of investment ("NA")
- Likelihood of investment generating positive returns (going concern).
The estimated value of each such investment shall be determined as follows:
- Where no or limited revenues or earnings are present, then the value
shall be the greater of the investment's a) net assets, b) estimated
sales price, or c) total amount of actual investment.
- Where revenues and/or earnings are present, then the value shall be
the greater of one time (1x) revenues or three times (3x) earnings,
plus the greater of the net assets of the investment or the total
amount of the actual investment.
- Under both scenarios, the value of the investment shall be adjusted
down if there is a reasonable expectation that the Company will not be
able to recoup its investment or if there is reasonable doubt about
the investee's ability to continue as a going concern.
Concentration of Credit Risk (after conversion to a BDC)
At June 30, 2004, financial instruments, which potentially subject the Company
to significant concentrations of credit risk, consist primarily of the
investment in a controlled company and cash and cash equivalents. Since the
Company has only one investment at such date, it is at least reasonably possible
that the Company could experience a severe impact on its operations and
financial position if the fair value of this investee declines.
With respect to cash and cash equivalents, at June 30, 2004, the Company
maintained all of its cash and cash equivalents in deposit accounts with one
high quality financial institution, which deposit accounts exceeded federally
insured limits. The Company has not experienced any losses in such accounts.
28
Allowance for Doubtful Accounts (Prior to Becoming a BDC)
We evaluate the allowance for doubtful accounts on a regular basis through
periodic reviews of the collectibility of the receivables in light of historical
experience, adverse situations that may affect our customers' ability to repay,
and prevailing economic conditions. This evaluation is inherently subjective as
it requires estimates that are susceptible to significant revision as more
information becomes available. Accounts receivable are determined to be past due
based on how recently payments have been received and those considered
uncollectible are charged against the allowance account in the period they are
deemed uncollectible.
Inventory (Prior to Becoming a BDC)
Inventory, consisting primarily of production units available for sale, is
stated at the lower of cost or market.
Patent Costs (Prior to Becoming a BDC)
Patent costs consist of expenditures incurred for various patent applications.
These costs are amortized over the life of the patent. On September 4, 2001, the
first patent was issued to the Company. The Company recorded $375, $560 and $466
of amortization expense during the period July 1, 2003 to March 3, 2004 and the
fiscal years ended June 30, 2003 and 2002, respectively.
Revenue Recognition (Prior to Becoming a BDC)
Revenue in the accompanying statements of operations consists of direct sales or
leases to customers and paid demonstrations of the Company's product. Sales are
recognized when products are shipped to the customers, with provisions for
discounts and rebates to customers and returns and other adjustments, if any,
provided for in the period the related sales are recorded. No amounts have been
recorded for such provisions during the periods presented. Rental income is
recognized over the period the related equipment is provided to the customer.
Customer Concentrations (Prior to Becoming a BDC)
One customer comprised 100% and 40.7% of the accounts receivable balance and
revenues, as of and for the year ended June 30, 2003, respectively. A second
customer comprised approximately 56.2% of the remaining revenues for the year
then ended.
In addition, one customer comprised 80% of the accounts receivable balance and
revenues as of and for the year ended June 30, 2002. A second customer accounted
for the remaining 20% of revenues for the year then ended.
Research and Development Costs (Prior to Becoming a BDC)
The Company expenses research and development costs as incurred.
Reclassifications
Certain amounts in the 2003 and 2002 financial statements have been reclassified
to conform to the 2004 presentation.
29
New Accounting Pronouncements
We have reviewed all new accounting pronouncements issued through October 11,
2004 and have determined that none of them would have a material impact on our
financial position or results of operations other than as described previously.
Note B - Stockholders' Equity
Common Stock
The Company announced a three-for-two stock split effective July 8, 2002, with
the issuance of 5,179,344 shares of common stock and the transfer of $51,794
from additional paid-in capital to the common stock account. All share amounts
in the accompanying financial statements reflect the stock split.
The Company has entered into stock subscriptions on several of their funding
commitments whereby the Company issues stock in exchange for the investors'
promise to fund their aggregate purchase price of the stock over a period of two
years without interest. As of June 30, 2004 and 2003, the subscriptions
receivables totaled $2,959 and $6,959, respectively. The Company had stock
subscription receipts of $4,000 and $140,300 during fiscal 2004 and 2003,
respectively, and cancelled stock subscriptions of $428,200 during fiscal 2002.
The Company entered into an agreement with its external legal counsel for
certain legal services over a two-year period beginning once the Company became
a public registrant in exchange for 125,000 shares of the Company's common
stock. These shares had a fair value of approximately $60,100 at the date of the
agreement, and accordingly, this amount was recognized as stock based
compensation on a pro-rata basis during the fiscal years ended June 30, 2004 and
2003 ($10,416 in 2003 and the remainder in 2004).
The Company entered into an agreement with an unrelated party during June 2003
for assistance in re-writing and editing the Company's business plan during the
period from July 2003 to December 2003. In exchange for these services, the
Company issued 37,500 shares of its common stock to the unrelated party in June
2003. Such amounts have been recorded as prepaid expenses in the accompanying
balance sheet.
Series A Preferred Stock
The Company is authorized to issued 5,000,000 shares of preferred stock. On
March 1, 2004, the Company designated 4,000,000 shares of this stock as Series A
and issued 3,800,000 shares of Series A Preferred Stock in consideration of a
$170,000 non-interest bearing note payable issued in June 2003 to Free Harbor
LLC (a company controlled by the Company's CEO) and 200,000 shares to Nicholas
Investment Company, Inc in consideration of services valued at $300,000 (which
amount has been reflected as stock based compensation).
The Series A Preferred Stock has no preference in liquidation over common stock,
is convertible into three (3) shares of common stock at the election of the
individual holders after twelve months following the date of issuance, shall not
be entitled to receive dividends and distributions, has no voting rights, and
are entitled, as a class, to elect two members of the Board of Directors.
30
Common Stock Warrants
As an incentive to purchase the Company's stock, certain shareholders have been
granted stock purchase warrants. Since inception, warrants to purchase 1,012,500
shares have been granted. The warrants are exercisable at $.22 per share for a
five-year period beginning upon full satisfaction of the shareholders' stock
subscriptions. Due to the cancellation of some stock subscriptions during fiscal
2002, 506,250 of these stock purchase warrants were also cancelled. The Company
has allocated the total amount received from the shareholders to common stock
and stock purchase warrants based on the relative fair values of each component.
The Company has reserved these shares for issuance. As of June 30, 2004, no
warrants have been exercised although all outstanding warrants are exercisable.
Weighted
Average
Warrants Exercise
Outstanding Price
Outstanding at July 1, 2001 1,012,500 0.22
Warrants granted during fiscal 2002 - 0.22
Warrants cancelled during fiscal 2002 (506,250) 0.22
Outstanding at June 30, 2002, 2003 and 506,250 0.22
2004 ===========
Warrants exercisable at June 30, 2004 506,250 0.22
===========
Common Stock Options
The Company has granted options to purchase shares of common stock in
conjunction with an employment agreement entered into during fiscal 2001. The
options vest one year from the date of each grant and expire five years after
the grant date. All options issued to date have an exercise price of $0.22 per
share. The weighted average fair value of the options is $2.03, $1.82 and $1.77
per share for options granted during fiscal 2004, 2003 and 2002, respectively.
The weighted average remaining contractual lives of granted options are
approximately 4 years. The summary of stock option activity is shown below:
Weighted
Average
Options Exercise
Outstanding Price
Outstanding at July 1, 2001 337,500 $ 0.22
Options granted during fiscal 2002 337,500 0.22
Outstanding at June 30, 2002 675,000 0.22
Options granted during fiscal 2003 337,500 0.22
Outstanding at June 30, 2003 1,012,500 0.22
Options granted during fiscal 2004 337,500 0.22
Options exercised during fiscal 2004 (3,000) 0.22
Outstanding at June 30, 2004 1,347,000 0.22
===========
Options exercisable at June 30, 2004 1,009,500 0.22
===========
We account for our stock-based compensation using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees". Had our compensation expense for stock-based compensation
plans been determined based upon fair values at the grant dates for awards under
this plan in accordance with SFAS No. 123, "Accounting for Stock-Based
31
Compensation," our net loss and proforma net loss per share amounts would have
increased as follows:
March 4, 2004 July, 1, 2003
to June 30, to March 3, Years ended June 30,
2004 2004 2003 2002
Net loss, as reported $ 589,656 $ 1,297,848 $ 1,153,876 $ 924,503
Increased compensation
expense 1,125 2,250 11,646 25,269
Pro forma net loss $ 590,781 $ 1,300,098 $ 1,165,552 $ 949,772
=========== =========== ============= ==========
Pro forma loss per share $ 0.03 $ 0.08 $ 0.07 $ 0.06
=========== =========== ============= ==========
Because the SFAS No. 123 method of accounting has not been applied to options
granted, the resulting pro forma compensation cost may not be representative of
that to be expected in future years. The Company used the Black-Scholes Option
Pricing Model to estimate the fair value of stock options granted in fiscal
2004, 2003 and 2002 with the following assumptions:
2004 2003 2002
Expected dividend yield 0.00% 0.00% 0.00%
Risk-free interest rates 2.40% 2.76% 6.05%
======== ========= =========
Note C - Income Taxes
During each of the periods presented in the accompanying statements of operation
we recognized losses for both financial and tax reporting purposes. Accordingly,
no provisions for income taxes and/or deferred income taxes payable have been
provided for in the accompanying financial statements. The significant
components of the net deferred income tax assets and liabilities as of June 30,
2004 and 2003 (assuming an effective income tax rate of approximately 41%) are
approximately as follows:
2004 2003
Deferred income tax assets related to net operating
loss carryforwards for income tax reporting purposes $ 34,000 $474,335
Deferred income tax assets related to stock options - 371,598
Deferred income tax assets related to other temporary
differences (1,000) 94,559
Deferred income tax liability related to book and tax
depreciation differences 3,000 (5,489)
Less - Valuation allowance (36,000) (935,003)
Net deferred income tax asset $ - $ -
========== =========
As of June 30, 2004, the Company (post conversion) has available approximately
$90,000 of federal and state net operating loss carryforwards. The carryforwards
will expire periodically beginning in 2024. The criteria for recording a
deferred income tax asset is whether the asset "more likely than not" will be
realized. Due to the uncertainty about the Company's ability to generate future
taxable income, a valuation allowance as of June 30, 2004 and 2003, has been
recorded to offset the full amount of the Company's net deferred income tax
assets.
32
Note D - Other Commitments and Contingencies
The Company has a lease for office facilities in Raleigh, North Carolina, with
one month remaining under a non-cancelable agreement. The space is shared with
HWTI and the expense is allocated proportionately between the Company and HWTI.
Minimum payments under noncancelable operating leases are $1,454 for the year
ending June 30, 2004. Lease expense under noncancelable operating facility
leases was approximately $18,000 for each of the fiscal years ended June 30,
2004, and June 30, 2003 and approximately $11,400 for the year ended June 30,
2002. Subsequent to year end, the Company's facility lease expired and the
Company is now on month-to-month lease terms at $1,350 per month.
In connection with the management agreement with Free Harbor LLC (discussed in
Note D), the Company has agreed to pay Free Harbor LLC 10% of pretax profits as
long as the management agreement is in effect. Additionally, in connection with
one employment agreement, the Company has agreed to pay that employee 5% of
pretax profits so long as he remains an employee of the Company.
Note E - Other Related-party Transactions
At June 30, 2004, and June 30, 2003, the Company had amounts payable of $0 and
$170,500, respectively, due to Free Harbor LLC for management services. A
director of the Company is the managing partner of Free Harbor LLC. Expenses
incurred under this arrangement totaled $55,200, $55,200 and $53,200,
respectively, for the years ended June 30, 2004, 2003 and 2002. During the year
ended June 30, 2004, $170,000 of the payable balance was satisfied through the
issuance of 3,800,000 non-voting preferred shares of the Company (see Note B).
Note F - Subsequent Event
On August 4, 2004 the Company acquired Arsenic Removal Technologies, Inc, a
company holding the arsenic removal technology rights developed by the
University of Wyoming. The subsidiary company was purchased using 2,823,529
shares of restricted common stock of the Company. The Company owns 100% of the
stock in this subsidiary company and plan to develop and market the technology
throughout the world. After purchase, the company was re-incorporated in North
Carolina with a change of name to Metals & Arsenic Removal Technology, Inc.
________________________________________________________________________________
33
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There were no disagreements with our independent accounting firm during our last
fiscal year.
On January 23, 2004 we filed an 8K to announce that the Company has engaged
Kingery & Crouse, P.A. as its principal accountant to replace its former
principal accountant, Grant Thornton LLP . The former accountant resigned
effective January 20, 2004. The resignation of Grant Thornton LLP was accepted
and the decision to retain Kingery & Crouse, P.A. was approved by the
Board of Directors of the Company.
During the Company's most recent two fiscal years and during any subsequent
interim periods preceding the date of resignation, the Company has had no
disagreements with Grant Thornton LLP on any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Grant Thornton LLP, would
have caused them to make reference to the subject matter in their reports. Grant
Thornton LLP's reports on the financial statements of the Registrant as of and
for each of the years ended June 30, 2002 and 2003were modified as to
uncertainty that the Registrant will continue as a going concern; other than
this, Grant Thornton LLP's reports on the above referenced financial statements
neither contained an adverse opinion nor a disclaimer of opinion nor were they
qualified or modified as to audit scope or accounting principles.
By letter to the Board of Directors of the Registrant dated November 14, 2003,
Grant Thornton LLP notified the Registrant of certain significant continuing
internal control deficiencies that Grant Thornton LLP concluded to be material
weaknesses in the design and operation of internal control under standards
established by the American Institute of Certified Public Accountants. As
reported in our report filed on Form 10-QSB for the period ending September 30,
2003, management is confident that its financial statements for the three months
ended September 30, 2003 fairly present, in all material respects, the financial
condition and results of operations of the Company.
The material weaknesses have been discussed in detail among HydroFlo's Board of
Directors and Grant Thornton LLP. Management has assigned high priority to the
correction of these material weaknesses, and management is committed to
addressing and resolving them fully. As the corporation continues its growth and
strives to achieve financial stability, management intends to devote additional
resources to further develop its financial accounting, analysis and reporting
functions.
In addition, Grant Thornton LLP did not advise the Company with regard to any of
the following:
1. That information has come to the attention of Grant Thornton LLP, which made
them unwilling to rely on management's representations, or unwilling to be
associated with the financial statements prepared by management; or
2. That the scope of the audit should be expanded significantly, or information
has come to the attention of Grant Thornton LLP that they have concluded will,
or if further investigated might, materially impact the fairness or reliability
of a previously issued audit report or the underlying financial statements, or
the financial statements issued or to be issued covering the fiscal periods
subsequent to the date of the most recent audited financial statements, and the
issue was not resolved to Grant Thornton LLP's satisfaction prior to its
resignation.
34
During the most recent two fiscal years and during any subsequent interim
periods preceding the date of engagement, the registrant has not consulted
Kingery & Crouse, P.A. regarding any matter requiring disclosure under
Regulation S-K, Item 304(a)(2).
ITEM 9A CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Corporation maintains disclosure controls and procedures designed to ensure
that information required to be disclosed in reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the specified time periods. As of the end of the period covered
by this report, the Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the effectiveness of the Corporation's disclosure controls and
procedures. Based on the evaluation, which disclosed no significant deficiencies
or material weaknesses, the Corporation's Chief Executive Officer and Chief
Financial Officer concluded that the Corporation's disclosure controls and
procedures are effective as of the end of the period covered by this report.
Changes in Internal Controls
There have been no changes in the Corporation's internal control over financial
reporting that occurred during the Corporation's most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Corporation's internal control over financial reporting. However, we intend to
continue to refine our internal controls on an ongoing basis with a view towards
continuous improvements. Grant Thornton LLP ("GT"), our previous independent
accountants, had reported to our Board of Directors certain matters involving
internal controls that GT considered to be material weaknesses under standards
established by the American Institute of Certified Public Accountants. The
identified material weaknesses related to a lack of segregation of duties within
our accounting and financial management functions and inadequate dedication of
resources to the financial review and analysis functions. Due to the size of our
organization, the early stage of our operations and significant financial
constraints, the Corporation has not been able to employ the necessary resources
for proper internal financial review and analysis.
Given the material weaknesses identified above, management devoted additional
resources to resolving questions that arose during the quarterly reporting
cycle. Significant adjustments were necessary to convert management's internal
financial records to the final reported amounts in the Form 10Q. As a result,
management is confident that its financial statements fairly present, in all
material respects, the financial condition and results of operations of the
Company.
The material weaknesses have been discussed in detail among our Board of
Directors and GT. We have assigned high priority to the correction of these
material weaknesses, and we are committed to addressing and resolving them
fully. As the Corporation continues its growth and strives to achieve financial
stability, management intends to devote additional resources to further develop
its financial accounting, analysis and reporting functions.
ITEM 9B OTHER INFORMATION
NONE
35
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. IDENTIFICATION OF DIRECTORS
AND EXECUTIVE OFFICERS.
Our directors, executive officers and key employees and their respective ages
and positions are set forth below. Biographical information is also presented
below. Our executive officers are appointed by our Board of Directors and serve
at its discretion.
Dennis L. Mast - Chief Executive Officer, Chairman - Age: 45
From 1988 to 1997 Mr. Mast held the position of President / Chief Executive
Officer at Environmental Aspecs, Inc., where he was responsible for the
development and oversight of all facets of the environmental engineering company
employing approximately 55 professionals. Services included engineering,
geological studies, testing, consulting and remediation of properties containing
regulated hazardous wastes. During his time with Environmental Aspecs, Mr. Mast
grew the company from start-up to eight million dollars annual revenues and was
the recipient of the Triangle Fast 50 Award as one of 50 fastest growing
companies in the Triangle North Carolina area in 1993, 1994, 1995, and 1997.
His accomplishments at Environmental Aspecs, Inc. also won him the Future 30
Award as one of 30 fastest growing companies in the Raleigh area in 1995 and
1997, the North Carolina Technology Award as one of 50 fastest growing
technological companies in the North Carolina area in 1995 and 1996, and
qualified the company as a North Carolina Qualified Business Venture with the
Secretary of State
Thomas Barbee - President - Age: 55
Mr. Barbee's overall responsibilities include managing product development and
new product research. In addition, he will oversee integrating HydroFlo, Inc.
systems and products into additional markets throughout the country and world
starting with both domestic and European markets. As deregulation of the
electrical energy industry continues through-out the U.S., HydroFlo's products
and processes will play an increasingly important role in assisting
municipalities in keeping treatment costs in line. Barbee comes to HydroFlo,
Inc. with over 30 years experience in directing, operating and developing
companies engaged in providing environmental goods and consulting and
engineering services. Previously, he served as Vice President at Brownfields
Redevelopment International, LLC and he brings extensive experience in sales and
marketing to both industry and government. Additional achievements include
providing technical services in the water and waste treatment industry,
engineering services, various business startups, company turnarounds, and
mergers and acquisitions of companies providing environmental goods and
services.
Board Committees
We currently have no compensation committee or other board committee performing
equivalent functions. Currently, all members of our board of directors
participate in discussions concerning executive officer compensation.
Family Relationships
There are no family relationships among our officers or directors.
36
Legal Proceedings
Except as set forth above, no officer, director, or persons nominated for such
positions, promoter or significant employee has been involved in legal
proceedings that would be material to an evaluation of our management.
Code of Ethics
The Company has adopted a code of ethics which applies to, among others, its
senior officers, including its Chief Executive Officer and its Chief Financial
Officers, as well as every employee of the Company. The Company's code can be
accessed via its website at http://www.brantleycapital.com. The Company intends
to disclose amendments to or waivers from a required provision of the code on
Form 8-K.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the officers and
directors of the Company and persons who beneficially own more than 10% of the
Company's common stock to file reports of securities ownership and changes in
such ownership with the SEC. Officers, directors and 10% stockholders are also
required by the rules promulgated by the SEC to furnish to the Company copies of
all Section 16(a) reports they file.
Based solely upon a review of the copies of such forms furnished to the Company,
the Company believes that each of its officers and directors complied with all
Section 16(a) filing requirements applicable to them during the fiscal year
ended December 31, 2003.
ITEM 11. EXECUTIVE COMPENSATION.
Executive Compensation
The following table sets forth summary information concerning the compensation
received for services rendered to us during the fiscal years ended June 30,
2002, 2003 and 2004 respectively by our Chief Executive Officer and President.
_______________________________________________________________
Name Position Year Salary Dollar Value of
Stock-Based
Compensation
Dennis Mast (1) CEO 2002 $53,200 0
2003 $55,200 0
2004 $55,200 0
Thomas Barbee (2) President 2002 $100,000 $348,000
2003 $100,000 $582,000
2004 $100,000 $728,000
_______________________________________________________________
(1) Mr. Mast's services are provided under an agreement with his affiliate, Free
Harbor, LLC. These amounts have not yet been paid. These numbers reflect that in
June 2002, the management fee was reduced to $2,600 due to some time off and
that for the other 11 months of fiscal year 2002 and fiscal years 2003 and 2004,
the management fee was $4,600 per month.
(2) Mr. Barbee has a written memorandum of employment with us.
The value of Mr. Barbee's stock-based compensation, as described more fully
below, totaled approximately $348,000, $582,000, and $728,000 during fiscal
years 2002, 2003 and 2004 respectively. respectively. Such amounts were
estimated in the stock option pricing models at each grant date.
Both agreements are terminable at will by either party without notice.
No other annual compensation, including a bonus or other form of compensation;
and no long-term compensation, including restricted stock awards, securities
underlying options, LTIP payouts, or other form of compensation, were paid to
Mr. Mast during these periods.
Compensation Agreements
At June 30, 2003, and June 30, 2004, the Company had amounts payable of $170,500
and $0, respectively, due to Free Harbor LLC for management services. Mr.
37
Mast is the managing partner of Free Harbor LLC. Expenses incurred under this
arrangement totaled $55,200 and $55,200, respectively, for the years ended June
30, 2003 and 2004. As of June 30, 2004, $170,000 of the payable balance has been
transferred for the acquisition of 3,800,000 non-voting preferred stock of the
Company.
We initially agreed to pay Mr. Barbee $86,000 per year for a four day work week
prior to 2001, increased by amendment to $100,000 per year for a five day work
week commencing in 2001. Stock options granted to him under terms of his
employment memorandum amount to 337,500 shares per year for 6 years beginning
August 2000, exercisable annually beginning August 2001 and expiring 6 years
after each annual grant at a price of $0.22 per share. Upon profitability after
deduction for all business expenses, depreciation and amortization, Barbee is
entitled to a bonus of up to 5% of our pre-tax profits after deduction for all
business expenses, depreciation and amortization annually so long as he remains
an employee of HydroFlo. So long as he remains an employee of HydroFlo, we have
agreed to grant him 337,500 options to purchase shares of common stock at $0.22
per share annually in August through 2006.
Board Compensation
Members of our Board of Directors do not receive cash compensation for their
services as Directors, although some Directors are reimbursed for reasonable
expenses incurred in attending Board or committee meetings. In the future, we
may have to consider compensating any outside directors that become members of
our board.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The following table sets forth information as of June 30, 2004, regarding the
beneficial ownership of our common stock, Preferred Warrants, and the Note (i)
by each person or group known by our management to own more than 5% of the
outstanding shares of each such class, (ii) by each director, the chief
executive officer and each of the other four executive officers that were paid
more than $100,000 during the last fiscal year, and (iii) by all directors and
executive officers as a group. Unless otherwise noted, each person has sole
voting and investment power over the shares indicated below, subject to
applicable community property laws.
Except as otherwise stated, the mailing address for each person identified below
is 3721 Junction Blvd., Raleigh, North Carolina 27603.
Shares
Name Class Owned
Capital Access, Inc. Common 13,460,000
Dennis L. Mast, Managing Partner
This table is based upon information derived from our stock records. Unless
otherwise indicated in the footnotes to this table and subject to community
property laws where applicable, it believes that each of the shareholders named
in this table has sole or shared voting and investment power with respect to the
shares indicated as beneficially owned. Applicable percentages are based upon
31,551,441 shares of common stock outstanding as of September 1, 2004.
38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
At June 30, 2004, and June 30, 2003, the Company had amounts payable of $ 0 and
$170,500, respectively, due to Free Harbor LLC for management services. A
director of the Company is the managing partner of Free Harbor LLC. Expenses
incurred under this arrangement totaled $55,200 and $55,200, respectively, for
the years ended June 30, 2004 and 2003. As of June 30, 2004, $170,000 of the
payable balance has been transferred for the acquisition of 3,800,000 non-voting
preferred stock of the Company.
Other than the above transactions, we have not entered into any material
transactions in 2004 with any director, executive officer, and nominee for
director, beneficial owner of five percent or more of our common stock, or
family members of such persons. Also, we have not had any transactions with any
promoter. We are not a subsidiary of any company.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth fees billed to us by our auditors during the
fiscal years ended June 30, 2004 and June 30, 2003 for: (i) services rendered
for the audit of our annual financial statements and the review of our quarterly
financial statements, (ii) services by our auditor that are reasonably related
to the performance of the audit or review of our financial statements and that
are not reported as Audit Fees, (iii) services rendered in connection with tax
compliance, tax advice and tax planning, and (iv) all other fees for services
rendered.
(i) Audit Fees
2003 2004
Kingery & Crouse, P.A. $0 $16,475
Grant Thornton, LLP. $0 $27,179
(ii) Audit Related Fees
None
(iii) Tax Fees
2003 2004
Kingery & Crouse, P.A. $0 $0
Grant Thornton, LLP. $0 $0
(iv) All Other Fees
None
TOTAL FEES
2003 2004
Kingery & Crouse, P.A. $0 $16,475
Grant Thornton, LLP. $0 $27,179
AUDIT FEES. Consists of fees billed for professional services rendered for the
audit of our consolidated financial statements and review of the interim
consolidated financial statements included in quarterly reports and services
that are normally provided in connection with statutory and regulatory filings
or engagements.
AUDIT-RELATED FEES. Consists of fees billed for assurance and related services
that are reasonably related to the performance of the audit or review of our
consolidated financial statements and are not reported under "Audit Fees." There
were no Audit-Related services provided in fiscal 2004 or 2003.
39
TAX FEES. Consists of fees billed for professional services for tax compliance,
tax advice and tax planning.
ALL OTHER FEES. Consists of fees for products and services other than the
services reported above.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT
SERVICES OF INDEPENDENT AUDITORS
The Company currently does not have a designated Audit Committee, and
accordingly, the Company's Board of Directors' policy is to pre-approve all
audit and permissible non-audit services provided by the independent auditors.
These services may include audit services, audit-related services, and tax
services and other services. Pre-approval is generally provided for up to one
year and any pre-approval is detailed as to the particular service or category
of services and is generally subject to a specific budget. The independent
auditors and management are required to periodically report to the Company's
Board of Directors regarding the extent of services provided by the independent
auditors in accordance with this pre-approval, and the fees for the services
performed to date. The Board of Directors may also pre-approve particular
services on a case-by-case basis.
ITEM 15. EXHIBITS AND REPORTS ON FORM 8K
(a) Financial Statements. - Included at Item 8
(b) Exhibits.
14 Code of Ethics
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
and Chief Financial Officer, Dennis Mast
32.1 Section 1350 Certification, Dennis Mast
(c) Reports on Form 8-K. None.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, there unto duly authorized.
HYDROFLO, INC.
Title Name Date Signature
Principal Executive,
Accounting
And Financial Dennis Mast 10-13-2004 /s/Dennis Mast
Officer
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
date indicated.
SIGNATURE NAME TITLE DATE
/s/Dennis Mast Dennis Mast Director 10-13-2004
/s/Ross Smith Ross Smith Director 10-13-2004
/s/Shane Traveller Shane Traveller Director 10-13-2004
41