UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended DecemberMarch 31, 20172019
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
For the transition period from N/A to N/A
Commission File No. 000-28745
Cipherloc Corporation
(Name of small business issuer as specified in its charter)
| Texas | 86-0837077 | |
| (State or other jurisdiction of | (IRS Employer | |
| incorporation or organization) | Identification No.) |
825 Main St, Suite 100
Buda, TX 78610
(Address of principal executive offices)
(702) 818-9011(512) 772-4237
Registrant’s telephone number, including area code
Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days:
Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | [ ] | Accelerated filer | [ ] |
| Non–Accelerated filer | [ ] | Smaller reporting company | [X] |
| Emerging growth company | [ ] |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of eachSecurities registered pursuant to Section 12(b) of the issuer’s classes of common stock, as of the latest practicable date.Act:
| Class | Name of each exchange on which registered | |||
| Common stock, $0.01 par value | OTCQB Venture Market |
As of May 30, 2019, 40,792,510 shares of the issuer’s common stock were outstanding.
CIPHERLOC CORPORATION
INDEX TO FORM 10-Q FILING
FOR THE THREE MONTHS ENDED DECEMBER 31, 2017 AND 2016
TABLE OF CONTENTS
| 2 |
The accompanying interim financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, they do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, cash flows, and stockholders’ equity in conformity with accounting principles generally accepted in the United States of America. Except as disclosed herein, there has been no material change in the information disclosed in the notes to the financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017.2018. In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations and financial position have been included, and all such adjustments are of a normal recurring nature. Operating results for the three and six months ended DecemberMarch 31, 20172019 are not necessarily indicative of the results that can be expected for the year ending September 30, 2018.2019 or any future period.
| 3 |
(UNAUDITED)
December 31, 2017 | September 30, 2017 | |||||||
| ASSETS | ||||||||
| Current Assets | ||||||||
| Cash | $ | 155,730 | $ | 227,396 | ||||
| Total Current Assets | 155,730 | 227,396 | ||||||
| Other assets | 12,217 | 12,218 | ||||||
| Fixed assets, net | 9,790 | 11,170 | ||||||
| Total Assets | $ | 177,737 | $ | 250,784 | ||||
| LIABILITIES & STOCKHOLDERS’ DEFICIT | ||||||||
| Current Liabilities | ||||||||
| Accounts payable and accrued liabilities | $ | 40,250 | $ | 59,763 | ||||
| Accrued compensation | 506,423 | 505,027 | ||||||
| Convertible notes payable, net of discount of $587,542 and $303,322 at December 31, 2017 and September 30, 2017, respectively | 42,458 | 26,678 | ||||||
| Deferred revenue-current | 200,606 | 308,412 | ||||||
| Derivative liability | 723,994 | — | ||||||
| Total Current Liabilities | 1,513,731 | 899,880 | ||||||
| Long-Term Liabilities | ||||||||
| Deferred revenue, net of current portion | — | 7,836 | ||||||
| Total Long-Term Liabilities | — | 7,836 | ||||||
| Total Liabilities | 1,513,731 | 907,716 | ||||||
| Commitments and Contingencies (Note 6) | ||||||||
| Series A Convertible Preferred stock, $0.01 par value, 10,000,000 shares authorized; 10,000,000 issued and outstanding as of December 31, 2017 and September 30, 2017 | 100,000 | 100,000 | ||||||
| Common stock, $0.01 par value, 650,000,000 shares authorized; 7,040,164 and 6,635,127 issued and outstanding as of December 31, 2017 and September 30, 2017, respectively | 70,401 | 66,351 | ||||||
| Additional paid-in capital | 50,108,483 | 49,378,447 | ||||||
| Accumulated deficit | (51,614,878 | ) | (50,201,730 | ) | ||||
| Total Stockholders’ Deficit | (1,335,994 | ) | (656,932 | ) | ||||
| Total Liabilities and Stockholders’ Deficit | $ | 177,737 | $ | 250,784 | ||||
| March 31, 2019 | September 30, 2018 | |||||||
| ASSETS | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | 11,090,605 | $ | 14,056,346 | ||||
| Prepaid expenses | 95,022 | — | ||||||
| Total current assets | 11,185,627 | 14,056,346 | ||||||
| Other assets | 12,216 | 12,218 | ||||||
| Note receivable | 401,000 | — | ||||||
| Fixed assets, net | 53,073 | 20,050 | ||||||
| Total assets | $ | 11,651,916 | $ | 14,088,614 | ||||
| LIABILITIES & STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities | ||||||||
| Accounts payable and accrued liabilities | $ | 36,812 | $ | 52,043 | ||||
| Accrued compensation | 149,616 | 72,489 | ||||||
| Total current liabilities | 186,428 | 124,532 | ||||||
| Commitments and contingencies (Note 4) | ||||||||
| Series A convertible preferred stock, $0.01 par value, 10,000,000 shares authorized; 1,000,000 issued and outstanding as of March 31, 2019 and September 30, 2018 | 10,000 | 10,000 | ||||||
| Common stock, $0.01 par value, 650,000,000 shares authorized; 40,792,510 and 40,743,917 issued and outstanding as of March 31, 2019 and September 30, 2018, respectively | 407,925 | 407,438 | ||||||
| Additional paid-in capital | 68,179,886 | 68,169,157 | ||||||
| Accumulated deficit | (57,132,323 | ) | (54,622,513 | ) | ||||
| Total stockholders’ equity | 11,465,488 | 13,964,082 | ||||||
| Total liabilities and stockholders’ equity | $ | 11,651,916 | $ | 14,088,614 | ||||
The accompanying notes are an integral part of these unaudited condensed financial statements.
| 4 |
CONDENSEDSTATEMENTS OF OPERATIONS
(UNAUDITED)
| Three Months Ended | Six Months Ended | |||||||||||||||
| March 31, | March 31, | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Revenues | $ | — | $ | 113,129 | $ | — | $ | 228,771 | ||||||||
| Cost of revenues | — | 45,506 | — | 75,806 | ||||||||||||
| Gross profit | — | 67,623 | — | 152,965 | ||||||||||||
| Operating expenses | ||||||||||||||||
| General and administrative | 505,807 | 230,366 | 1,038,781 | 414,286 | ||||||||||||
| Sales and marketing | 434,800 | 22,195 | 648,775 | 45,162 | ||||||||||||
| Research and development | 479,677 | 251,136 | 825,572 | 365,988 | ||||||||||||
| Settlement expense | — | 81,000 | — | 81,000 | ||||||||||||
| Total operating expenses | 1,420,284 | 584,697 | 2,513,128 | 906,436 | ||||||||||||
| Operating loss | (1,420,284 | ) | (517,074 | ) | (2,513,128 | ) | (753,471 | ) | ||||||||
| Other income (expense) | ||||||||||||||||
| Gain (loss) on extinguishment of convertible note | — | 66,912 | — | (291,126 | ) | |||||||||||
| Excess fair value of derivatives in convertible note | — | — | — | (486,745 | ) | |||||||||||
| Change in fair value of embedded conversion features in convertible notes | — | 256,669 | 120,737 | |||||||||||||
| Interest income (expense), net | 2,421 | (312,282 | ) | 3,318 | (508,318 | ) | ||||||||||
| Net loss | $ | (1,417,863 | ) | $ | (505,775 | ) | $ | (2,509,810 | ) | $ | (1,918,923 | ) | ||||
| Net loss per common share – basic and diluted | $ | (0.03 | ) | $ | (0.03 | ) | $ | (0.06 | ) | $ | (0.16 | ) | ||||
| Weighted average common shares outstanding – basic and diluted | 40,786,279 | 17,806,123 | 40,774,152 | 12,228,585 | ||||||||||||
The accompanying notes are an integral part of these condensed unaudited financial statements.
| 5 |
CONDENSEDSTATEMENTS OF CASH FLOWS
(UNAUDITED)
| Six Months Ended | ||||||||
| March 31, | ||||||||
| 2019 | 2018 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ | (2,509,810 | ) | $ | (1,918,923 | ) | ||
| Adjustments to reconcile net loss to net cash flows used in operating activities: | ||||||||
| Depreciation | 4,036 | 2,608 | ||||||
| Stock-based compensation | 11,216 | 167,743 | ||||||
| Stock issued for services | 40,000 | — | ||||||
| Legal settlement | — | 81,000 | ||||||
| Loss on extinguishment of convertible notes | — | 291,126 | ||||||
| Excess fair value of derivatives in convertible note | — | 486,745 | ||||||
| Change in fair value of embedded conversion features in convertible notes | — | (120,737 | ) | |||||
| Debt discount amortization | — | 482,935 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Prepaid expenses and other | (95,020 | ) | — | |||||
| Accounts payable and accrued liabilities | (15,231 | ) | (107,138 | ) | ||||
| Accrued compensation | 77,127 | |||||||
| Deferred revenue | — | (228,771 | ) | |||||
| Net cash used in operating activities | (2,487,682 | ) | (863,412 | ) | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of fixed assets | (37,059 | ) | — | |||||
| Funding of note receivable | (401,000 | ) | — | |||||
| Net cash used in investing activities | (438,059 | ) | — | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Common stock issued for cash | — | 1,177,325 | ||||||
| Proceeds from convertible note, net | — | 242,600 | ||||||
| Repayment of convertible notes | — | (350,000 | ) | |||||
| Repayment of oversubscription | (40,000 | ) | — | |||||
| Net cash provided by (used in) financing activities | (40,000 | ) | 1,069,925 | |||||
| INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (2,965,741 | ) | 206,513 | |||||
| CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 14,056,346 | 227,396 | ||||||
| CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 11,090,605 | $ | 433,909 | ||||
| Non-cash investing and financing activities: | ||||||||
| Conversion of debt into common stock | $ | — | $ | 77,500 | ||||
| Conversion of preferred stock to common stock | $ | — | $ | 135,000 | ||||
The accompanying notes are an integral part of these condensed unaudited financial statements.
| 6 |
CONDENSEDSTATEMENTS OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
| Preferred Stock | Common Stock | Additional Paid-in | Accumulated | Stockholders’ | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Deficit | Equity | ||||||||||||||||||||||
| Balance at September 30, 2018 | 1,000,000 | $ | 10,000 | 40,743,917 | $ | 407,438 | $ | 68,169,157 | $ | (54,622,513 | ) | $ | 13,964,082 | |||||||||||||||
| Common stock issued for services | — | — | 20,000 | 200 | 39,800 | — | 40,000 | |||||||||||||||||||||
| Correction of shares outstanding | — | — | 19,247 | 193 | (193 | ) | — | — | ||||||||||||||||||||
| Net loss | — | — | — | — | — | (1,091,947 | ) | (1,091,947 | ) | |||||||||||||||||||
| Balance at December 31, 2018 | 1,000,000 | 10,000 | 40,783,164 | 407,831 | 68,208,764 | (55,714,460 | ) | 12,912,135 | ||||||||||||||||||||
| Common stock issued to an employee | — | — | 9,346 | 94 | 11,122 | — | 11,216 | |||||||||||||||||||||
| Refund of oversubscription | — | — | — | — | (40,000 | ) | — | (40,000 | ) | |||||||||||||||||||
| Net loss | — | — | — | — | — | (1,417,863 | ) | $ | (1,417,863 | ) | ||||||||||||||||||
| Balance at March 31, 2019 | 1,000,000 | $ | 10,000 | 40,792,510 | $ | 407,925 | $ | 68,179,886 | $ | (57,132,323 | ) | $ | 11,465,488 | |||||||||||||||
The accompanying notes are an integral part of these condensed unaudited financial statements.
| 7 |
CIPHERLOC CORPORATION
CONDENSEDSTATEMENTS OF OPERATIONS
(UNAUDITED)
| Three Months Ended | ||||||||
| December 31, | ||||||||
| 2017 | 2016 | |||||||
| Revenues | $ | 115,642 | $ | 112,500 | ||||
| Cost of revenues | 30,300 | 30,300 | ||||||
| Gross Profit | 85,342 | 82,200 | ||||||
| Operating Expenses | ||||||||
| General and administrative (includes stock-based expense of $0 and $2,117,700 for 2017 and 2016, respectively) | 183,920 | 2,430,937 | ||||||
| Sales and marketing (includes stock-based expense of $0 and $31,250 for 2017 and 2016, respectively) | 22,967 | 98,374 | ||||||
| Research and development (includes stock-based expense of $10,000 and $476,550 for 2017 and 2016, respectively) | 114,852 | 599,959 | ||||||
| Settlement expense | — | 106,250 | ||||||
| Total Operating Expenses | 321,739 | 3,235,520 | ||||||
| Operating Loss | (236,397 | ) | (3,153,320 | ) | ||||
| Other Expenses | ||||||||
| Loss on extinguishment | (358,038 | ) | — | |||||
| Excess fair value of derivatives in convertible note | (486,745 | ) | — | |||||
| Change in fair value of derivatives | (135,932 | ) | — | |||||
| Interest expense | (196,036 | ) | (10,939 | ) | ||||
| Net Loss | $ | (1,413,148 | ) | $ | (3,164,259 | ) | ||
| Net Loss per Common Share – Basic and Diluted: | $ | (0.21 | ) | $ | (0.56 | ) | ||
| Weighted Average Common Shares Outstanding – Basic and Diluted | 6,712,339 | 5,662,077 | ||||||
The accompanying notes are an integral part of these unaudited financial statements.
CIPHERLOC CORPORATION
STATEMENTS OF CASH FLOWSSTOCKHOLDERS’ EQUITY
(UNAUDITED)
| Three Months Ended | ||||||||
| December 31, | ||||||||
| 2017 | 2016 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ | (1,413,148 | ) | $ | (3,164,259 | ) | ||
| Adjustments to reconcile net loss to net cash flows used in operating activities: | ||||||||
| Depreciation | 1,381 | 1,381 | ||||||
| Stock-based compensation | 10,000 | 2,625,500 | ||||||
| Termination of software license | — | 106,250 | ||||||
| Debt discount amortization | 183,345 | — | ||||||
| Loss on extinguishment | 358,038 | — | ||||||
| Excess fair value of derivatives in convertible note | 486,745 | — | ||||||
| Change in fair value of derivatives | 135,932 | — | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Prepaid officer compensation | — | (7,456 | ) | |||||
| Prepaid expenses and other assets | — | (5,000 | ) | |||||
| Deferred revenue | (115,642 | ) | (112,500 | ) | ||||
| Accounts payable and accrued liabilities | (18,117 | ) | 68,304 | |||||
| Net cash used in operating activities | (371,466 | ) | (487,780 | ) | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of fixed assets and software | — | (2,798 | ) | |||||
| Deposit with others | — | (373 | ) | |||||
| Net cash used in investing activities | — | (3,171 | ) | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Common stock issued for cash | 57,200 | 233,120 | ||||||
| Issuance of convertible note | 242,600 | — | ||||||
| Net cash provided by financing activities | 299,800 | 233,120 | ||||||
| DECREASE IN CASH | (71,666 | ) | (257,831 | ) | ||||
| CASH, BEGINNING OF PERIOD | 227,396 | 344,138 | ||||||
| CASH, END OF PERIOD | $ | 155,730 | $ | 86,307 | ||||
The accompanying notes are an integral part of these unaudited financial statements.
CIPHERLOC CORPORATION
STATEMENT OF STOCKHOLDERS’ DEFICIT
FOR THE THREE MONTHS ENDED DECEMBER 31, 2017
(UNAUDITED)
| Preferred Stock | Common Stock | |||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Additional Paid-in Capital | Accumulated Deficit | Stockholders’ Deficit | ||||||||||||||||||||||
| Balance at September 30, 2017 | 10,000,000 | $ | 100,000 | 6,635,127 | $ | 66,351 | $ | 49,378,447 | $ | (50,201,730 | ) | $ | (656,932 | ) | ||||||||||||||
| Common stock issued for cash | - | - | 37,000 | 370 | 56,830 | - | 57,200 | |||||||||||||||||||||
| Common stock issued to officers and employees | - | - | 5,537 | 55 | 9,945 | - | 10,000 | |||||||||||||||||||||
| Convertible notes – issuance of common stock | - | - | 362,500 | 3,625 | 498,875 | - | 502,500 | |||||||||||||||||||||
| Convertible note – issuance of warrants | - | - | - | - | 90,345 | - | 90,345 | |||||||||||||||||||||
| Convertible note – amendment of existing warrants | - | - | - | - | 74,041 | - | 74,041 | |||||||||||||||||||||
| Net loss | - | - | - | - | - | (1,413,148 | ) | (1,413,148 | ) | |||||||||||||||||||
| Balance at December 31, 2017 | 10,000,000 | $ | 100,000 | 7,040,164 | $ | 70,401 | $ | 50,108,483 | $ | (51,614,878 | ) | $ | (1,335,994 | ) | ||||||||||||||
| Preferred Stock | Common Stock | Additional Paid-in | Accumulated | Stockholders’ | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Deficit | Deficit | ||||||||||||||||||||||
| Balance at September 30, 2017 | 10,000,000 | $ | 100,000 | 6,635,127 | $ | 66,351 | $ | 49,378,447 | $ | (50,201,730 | ) | $ | (656,932 | ) | ||||||||||||||
| Common stock issued for cash | — | — | 37,000 | 370 | 56,830 | — | 57,200 | |||||||||||||||||||||
| Common stock issued to officers and employees | — | — | 5,537 | 55 | 9,945 | — | 10,000 | |||||||||||||||||||||
| Convertible notes – issuance of common stock | — | — | 362,500 | 3,625 | 498,875 | — | 502,500 | |||||||||||||||||||||
| Convertible note – issuance of warrants | — | — | — | — | 90,345 | — | 90,345 | |||||||||||||||||||||
| Convertible note – amendment of existing warrants | — | — | — | — | 74,041 | — | 74,041 | |||||||||||||||||||||
| Net loss | — | — | — | — | — | (1,413,148 | ) | (1,413,148 | ) | |||||||||||||||||||
| Balance at December 31, 2017 | 10,000,000 | 100,000 | 7,040,164 | 70,401 | 50,108,483 | (51,614,878 | ) | (1,335,994 | ) | |||||||||||||||||||
| Common stock issued for cash | — | — | 1,276,000 | 12,760 | 1,107,365 | — | 1,120,125 | |||||||||||||||||||||
| Common stock issued to officers and employees | — | — | 82,917 | 829 | 156,914 | — | 157,743 | |||||||||||||||||||||
| Settlement of convertible note | — | — | 50,000 | 500 | 77,000 | — | 77,500 | |||||||||||||||||||||
| Common stock issued for legal settlement | — | — | 50,000 | 500 | 80,500 | — | 81,000 | |||||||||||||||||||||
| Related party conversion of preferred stock | (9,000,000 | ) | (90,000 | ) | 13,500,000 | 135,000 | (45,000 | ) | — | — | ||||||||||||||||||
| Net loss | — | — | — | — | — | (505,775 | ) | (505,775 | ) | |||||||||||||||||||
| Balance at March 31, 2018 | 1,000,000 | $ | 10,000 | 21,999,081 | $ | 219,990 | $ | 51,485,262 | $ | (52,120,653 | ) | $ | (405,401 | ) | ||||||||||||||
The accompanying notes are an integral part of these condensed unaudited financial statements.
| 8 |
FOR THE THREE MONTHS ENDED DECEMBER 31, 2017 AND 2016
(Unaudited)
NOTE 1 - DESCRIPTION OF BUSINESS– THE COMPANY
Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. OnIn March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective by the Amended Certificate as of March 23, 2015.
Cipherloc is a data security solutions company. Our highly innovative, patented polymorphic encryption technology is designed to enable an iron-clad layer of protection to be added to existing solutions.
NOTE 2 - BASIS OF PRESENTATION OF INTERIM FINANCIAL STATEMENTS
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. The accompanying interim unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X. In ourthe opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.
Operating results for the three and six months ended DecemberMarch 31, 20172019 are not necessarily indicative of the results that may be expected for the year ending September 30, 2018.2019 or any future period. Notes to the unaudited interim financial statements that would substantially duplicate the disclosures contained in the audited financial statements for the year ended September 30, 20172018 have been omitted; this report should be read in conjunction with the audited financial statements and the footnotes thereto for the fiscal year ended September 30, 20172018 included within the Company’s Form 10-K, as filed with the Securities and Exchange Commission.
NOTE 3 - GOING CONCERN
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The Company has incurred losses from operations and has an accumulated deficit at December 31, 2017 of $51,614,878. The Company issued two convertible notes, which may be repaid within 180 days from issuance, on September 26, 2017 and December 14, 2017, respectively, aggregating $849,000. If not repaid, the conversion features become variable, hindering our ability to raise capital in the future on terms favorable to the Company. The Company’s continued existence is dependent upon our ability to obtain additional funding to explore potential strategic relationships, complete development and marketing of the Company’s technologies, and operate the business. These factors raise doubt about the Company’s ability to continue as a going concern.
Management is currently in the process of raising capital, which is expected to be completed by May 2018. Management intends to use the proceeds from this financing to repay the two outstanding convertible notes. There are no assurances that management will be successful in raising capital to be able to achieve the needs of the business. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
NOTE 43 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are as follows:
Cash and Cash Equivalents
The Company considers all highly liquid investments with an originala maturity at the time of purchase of three months or less to be cash equivalents. At DecemberMarch 31, 20172019 and September 30, 2017,2018, cash and cash equivalents includeincludes cash on hand and cash in the bank. The Company maintains its cash in accounts held by a large, globally recognized banks which,bank, and the balance of such accounts, at times, may exceed federally insured limits, as guaranteed by the Federal Deposit Insurance Corporation (FDIC)(“FDIC”). The FDIC insures these deposits up to $250,000. At DecemberMarch 31, 2017 and September 30, 2017, none2019, $10,840,605 of the Company’s cash balance was uninsured. The Company has not experienced any losses in such accounts.
Convertible Debt and Embedded Derivatives
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Convertible debt is accounted for under the guidelines established by Accounting Standards Codification (“ASC”) 470-20,Debt with Conversion and Other Options. ASC 470-20 governs the calculation of an embedded beneficial conversion, a derivative instrument, which is treated as an additional discount to the instruments where derivative accounting does not apply. This applies during the period for which embedded conversion features are either fixed, contingently convertible, or cash or net settlement is in control of the Company. When equity instruments, such as warrants, are issued with convertible debt, the net proceeds from the transaction are allocated to the convertible debt and equity instruments based on their relative fair values. The proceeds allocated to the equity instruments may reduce the carrying value of the convertible debt, and such discount is amortized to interest expense over the term of the debt. The amount of the warrants and beneficial conversion feature will reduce the carrying value of the debt instrument to zero, but no further. The Company has the option to pay the convertible notes at a premium ranging from 0% to 140% within the first six (6) months before they become convertible. The discount relating to the initial recording of the original issue discounts, issue costs, warrants and beneficial conversion feature are accreted, together with the premium, over the estimated term of the debt, which is generally 180 days from the date of issuance. We initially accounted for the embedded conversion feature in the FirstFire convertible note (see Note 5) in equity since management fully expected, at the time the loan was made, to repay the note upon its scheduled maturity.
Many of the conversion features embedded in the Company’s notes become variable upon the event of default or upon the passage of time in the event the Company does not repay the notes, at a premium, at 180 days from issuance of the note. If the conversion price is adjusted based on a discount to the market price of the Company’s common stock, the number of shares upon conversion is potentially unlimited. In the event we cannot control the net share settlement and cash settlement, we record the embedded conversion feature as a derivate instrument, at fair value. The excess of fair value of the embedded conversion feature, together with the original issue discounts, warrants, and issue costs over the face value of the debt, is recorded as an immediate charge in the accompanying statements of operations and cash flows. Each reporting period, the Company will compute the estimated fair value of derivatives and record changes to operations. The discounts are accreted over the term of the debt, which is generally nine months after the notes become convertible, using the effective interest method. We accounted for the embedded conversion features in the FirstFire and Peak One convertible notes (see Note 5) as derivative liabilities in December 2017, even though we fully expect to repay the notes upon their scheduled maturity, because we have lost control of that ability as a result of the issuance of the Peak One note, and the financial burden these notes have placed on the Company. We continue to believe we will repay these notes before they become convertible after 180 days.
ASC 470-50,Extinguishments, require entities to record an extinguishment when the terms of the original note are significantly modified, defined as a greater than 10% change in expected cash flows. As a result of modifications made to one of the Company’s convertible notes during the reporting period, we recorded a loss as reported in the accompanying statements of operations and cash flows.
Basic and Diluted Net Loss per Common Share
Basic net loss per share is computed by dividing net loss available to common shareholdersfor the period by the weighted averageweighted-average number of common shares outstanding during the reporting period. The weighted averageweighted-average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding. Diluted earningsnet loss per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest, resulting in the issuance of common stock that could share in the earnings of the Company. As of DecemberMarch 31, 20172019 and September 30, 2017,2018, the Company had 10,000,0001,000,000 shares of preferred stock outstanding, which are convertible into 15,000,0001,500,000 shares of common stock. The Company’s convertible notes are not yet convertible, and management expects to repay the notes.
Diluted net loss per share is the same as basic net loss per share during periods where net losses are incurred sincebecause the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss. During the three and six months ended March 31, 2019, 25,015,866 warrants and 1,500,000 shares of convertible preferred stock were excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive. During the three and six months ended March 31, 2018, 1,241,000 warrants to purchase common stock and 1,500,000 shares of convertible preferred stock were excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive.
Research and Development and Software Development Costs
Capitalization of certain software development costs are recorded after the determination of technological feasibility. Based on our product development process, technological feasibility is determined upon the completion of a working model. To date, costs incurred by us from the completion of the working model to the point at which the product is ready for general release do not have technological feasibility. Accordingly, we have chargedThe Company expenses all such costs to research and development expense in the period incurred. Our research and development costs, for the three months ended December 31, 2017including patent and 2016 were $114,852 and $599,959, respectively.
software development costs.
Adoption of Recent Accounting AnnouncementsStandard
TheIn May 2014, the Financial Accounting Standards Board (“FASB”) issuesissued Accounting Standards UpdatesUpdate (“ASU”) No. 2014-09,Revenue from Contracts with Customers (Topic 606). Under this guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The Company adopted ASU No. 2014-09 on October 1, 2018, and the adoption did not have a material impact on the Company’s financial statements or related disclosures.
Recent Accounting Pronouncements
The FASB issues ASUs to amend the authoritative literature in the Accounting Standards Codification (“ASC”).ASC. There have been a number of ASUs to date that amend the original text of the ASC. TheOther than those discussed below, the Company believes those updates issued-to-date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company, or (iv) are not expected to have a significant impact on the Company.
NOTE 5 – CONVERTIBLE NOTE PAYABLEIn February 2016, the FASB issued ASU No. 2016-02,Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Early adoption of the amendments in this standard is permitted for all entities, and the Company may recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11,Leases (Topic 842): Targeted Improvements, to provide a new transition method and practical expedient for separating components of a contract. The amendments in this standard are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently in the process of evaluating the effect this ASU will have but expect to record a right of use asset and a lease liability equal to the value of the lease payments, reduced by using the rate inferred in the lease.
FirstFire Global Opportunities Fund, LLC
On September 26, 2017,In August 2018, the CompanyFASB issued a convertible noteASU No. 2018-13,Fair Value Measurements (Topic 820) – Disclosure Framework – Changes to FirstFire Global Opportunities Fund, LLC (“FirstFire”) with a principal amount of $330,000, which includes an original issue discount of $30,000.the Disclosure Requirements for Fair Value Measurement, to modify the disclosure requirements for fair value measurements. The ASU removes certain disclosure requirements related to transfers between fair value hierarchy levels and valuation processes for Level 3 fair value measurements. It modifies certain disclosure requirements for investments in entities that calculate net asset value. It adds certain disclosure requirements regarding gains and losses for recurring Level 3 fair value measurements and unobservable inputs used to develop Level 3 fair value measurements. ASU No. 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company incurred $8,500is currently in direct costs. The note accrues interest at 5% per annumthe process of evaluating the effect this ASU will have on its financial statements and matures on March 26, 2018, six months following the issuance date. The note was convertible at $2.00 per share, subject to adjustment. The Company issued 50,000 shares of its common stock, as well as warrants to purchase an additional 165,000 shares of common stock at $4.50 per share with a term of two years. The note was amended on December 20, 2017, which reduced the conversion price of the note to $1.00 per share, subject to adjustment, reduced the exercise price of the warrants from $4.50 to $2.00 and required the Company to issue an additional 87,500 shares of common stock to FirstFire, which resulted in an extinguishment loss (see below).
The note, as amended, provides the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a conversion price of $1.00 per share, subject to certain adjustments to the conversion price under certain circumstances. In the event of default, the conversion price shall equal the lower of $1.00 per share or 70% multiplied by the lowest bid price of the Company’s common stock during the 25 trading days preceding the conversion date. An event of default, among other events, is the non-payment of the note at maturity.related disclosures.
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If shares
In June 2018, the FASB issued ASU No. 2018-07,Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting, to expand the scope of the Company’s common stock trade below $1.00 per share on the day following the conversion date, the conversion price shallASC Topic 718,Compensation – Stock Compensation, which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Thus, accounting for share-based payments to nonemployees and employees will be retroactively adjusted to equal 75% multiplied by the lowest traded price on the day following the conversion date. If thesubstantially aligned. ASU No. 2018-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company consummates a registered or unregistered primary offering of its securities for capital raising purposes, the holder of the note shall have the right to demand repayment in full or convert the outstanding principal balance and accrued interest into shares of the Company’s common stock at the lower of $1.00 per share or a 20% discount to the offering price to investorsis currently in the primary offering.process of evaluating the effect this ASU will have on its financial statements and related disclosures.
NOTE 4 – NOTES RECEIVABLE
The Company accounted for the amendment of the FirstFire note using derivative accounting and recognized a loss on extinguishment of $358,038advanced $401,000 to Quality Health Care International, LLC (“QHC”) during the three monthsquarter ended DecemberMarch 31, 2017.2019. Subsequent to March 31, 2019, the Company advanced an additional $15,000. As of May 30, 2019, the Company executed a note receivable with QHC in the amount of $416,000. The Company also recognized a derivative liabilitynote provides that if the funds are repaid within one year of $320,312 as of the note’s amendment date. The Company valued the derivative liability with the Black-Scholes valuation model on the date of the amendment using an expected life ofnote any interest charge will be waived. Beyond one (1) year, volatility of 150%, and risk-freethe note will bear interest at the rate of 1.87%. On December 31, 2017, the Company recognized a loss of $48,911 related to the change in fair value4% annuum. The due date of the FirstFire derivative liability.note is on or before May 29, 2021. The change in fair value was calculated using the stock price as of December 31, 2017 of $1.18 and an exercise price of $0.70, which is 70% multiplied by the lowest bid priceeffect of the Company’s common stock during the preceding 25 trading days, per the termswaived interest is deemed to be de minimis. The purpose of the note.
Upon amendmentfunds is to expedite training and development of the FirstFire note, the Company recorded a debt discount of $330,000. The Company amortized $37,813 of the debt discountmarketing program within QHC to interest expense during the three months ending December 31, 2017. The remaining debt discount of $292,187 as of December 31, 2017 will be amortized to interest expense over the remaining term of the note. Total interest expense related to the FirstFire note, including the debt discount amortization prior to the amendment, was $178,700 for the three months ending December 31, 2017.
Peak One Opportunity Fund LP
On December 14, 2017, the Company issued a convertible note to Peak One Opportunity Fund LP (“Peak One”) with a principal amount of $300,000, which includes an original issue discount of $30,000. The Company incurred $27,400 in direct costs. The note matures three years from the issuance date and provides the holder with the right to convert all or a portion of the outstanding principal balance to shares ofsale the Company’s common stock at a conversion price of $1.00 per share, subjectproduct to certain adjustments to the conversion price under certain circumstances. If an event of default has occurred or if the conversion occurs more than 180 days from the issuance date, the conversion price shall equal the lower $1.00 per share or 70% of the lowest traded price of the Company’s common stock during the 20 trading days preceding the conversion date. However, if the Company’s common stock is not eligible for clearing through the Depository Trust Company’s Deposit Withdrawal Agent Commission system on the conversion date, the conversion price shall equal the lower of $1.00 per share or 65% of the lowest traded price of the Company’s common stock during the 20 trading days preceding the conversion date.
Together with the convertible note, the Company also issued 275,000 shares of its common stock, as well as warrants to purchase an additional 75,000 shares of common stock at $2.00 per share with a term of five years. The Company accounted for the convertible note to Peak One using derivative accounting and recognized a derivative liability of $267,750 as of the note’s issuance date. The Company valued the derivative liability with the Black-Scholes valuation model on the date of issuance using an expected life of 1.25 years, volatility of 150%, and risk-free rate of 1.82%.QHC’s hospital networks. The Company also recognizedentered into a loss of $486,745 resulting from the excess fair value of the derivative in the convertible note and of the equity instruments issuedReseller Agreement with the convertible note. On December 31, 2017, the Company recognized a loss of $87,021 related to the change in fair value of the Peak One derivative liability. The change in fair value was calculated using the stock priceQHC as of December 31, 2017 of $1.18 and an exercise price of $0.70, which is 70% multiplied by the lowest bid price of the Company’s common stock during the preceding 25 trading days, per the terms of the note.May 30, 2019.
The Company recorded a debt discount of $300,000 upon issuance of the Peak One note. The Company amortized $4,645 of the debt discount to interest expense during the three months ending December 31, 2017. The remaining debt discount of $295,355 as of December 31, 2017 will be amortized to interest expense over the remaining term of the note. The Peak One note was included in current liabilities as management intends to repay the loan within the next 12 months.
Additionally, the transaction with Peak One included a stock purchase agreement setting forth the details above, including the option for an additional convertible note in the amount of $300,000 and an equity purchase agreement for up to $7,000,000 of the Company’s common stock and related registration rights agreement, which will require a registration statement to be filed.
NOTE 6 -5 – COMMITMENTS AND CONTINGENCIES
Terminated Employment Agreement with Former Chief Financial OfficerLitigation
The Company previouslyis currently not involved in any litigation that it believes could have a material adverse effect on its financial condition or results of operations. A disgruntled former consultant has brought an action in Texas state court against the Company and its chief executive officer, alleging fraud and misrepresentation pertaining to stock and payments alleged to be owed to the consultant. The Company has made all required payments and delivered the stock to the consultant. The consultant has also included a claim of partial ownership of some of the Company’s patents, which is without merit in that any interest he may have had an employmenthas been assigned to the Company. The claim is frivolous and without merit. The case is being vigorously defended on the Company’s behalf by its insurance carrier.
Leases
In March 2019, the Company guaranteed a lease on behalf of Ageos, LLC, a sales representative assisting the Company with securing contracts with agencies of the United States government. The lease has a term of three years for 4,359 square feet of space in McClean, Virginia. The initial rent cost is $7,991 per month and the lease agreement provides for annual rent increases of approximately 4.0%. The amount of future payments guaranteed is $291,364. The nature of the guarantee and the operating agreement with Ageos, as discussed below, makes Cipherloc primarily responsible for the lease. As such, lease payments and lease obligations will be shown in the financial statements of Cipherloc.
In February 2019, the Company and the landlord for its Chief Financial Officer, which terminatedleased office space in 2015. There were amounts that were accruedBuda, Texas entered into a new lease agreement, and unpaid asthe Company reduced its rented space from approximately 3,900 to 1,302 square feet. The new lease was effective February 1, 2019 and has a three-year term. The initial monthly rent is $2,566, and the lease agreement provides for annual rent increases of December 31, 2017 and September 30, 2017, totaling $351,128 and $338,437, respectively. Accordingapproximately 2.7%. The lease automatically renews for a three-year term, unless either party to the originallease agreement notifies the unpaid salaries wereother of the intent to accrue interestterminate the lease in writing at each reporting date.least 180 days prior to the expiration of the current term.
In February 2019, the Company terminated its lease agreement for 1,005 square feet of office space on Butherus Drive in Scottsdale, Arizona effective March 1, 2019. In exchange for the lease termination, the Company relinquished its right to payments it had made to prepay rent through October 31, 2019. As a result of the termination, the Company recorded a charge to rent expense of approximately $13,000.
In October 2018, the Company leased approximately 3,900 square feet of office space on North Scottsdale Road in Scottsdale, Arizona. The lease for this facility began on October 4, 2018 and continues until October 31, 2021. Annual rent of $77,180 was prepaid for the first year from November 1, 2018 to October 31, 2019, and the lease agreement provides for annual rent increases of approximately 5.0%.
Ageos, LLC Operating Agreement
In the quarter ended March 31, 2019, the Company paid Ageos, LLC, a newly formed separate entity, approximately $700,000. The purpose of the funds was to establish an office in McLean, Virginia and to develop the resources and personnel to market the Company’s products to governmental sources, primarily requiring advanced security clearances that the Company does not currently have. On April 24, 2019 the Company entered into an Operating Agreement with Ageos that provides for how revenues will be shared from sales derived from the Company’s products. The advances through March 31, 2019 have been expensed as incurred in the accompanying statements of operations.
As Ageos is a newly formed venture, designed primarily to work with the Company in marketing its products, management is in the process of determining if Ageos represents a Variable Interest expense relatedEntity that must be consolidated with the operations of the Company. The Company has expensed all advances to this matter was $12,691date, which largely represent non-capitalizable expenditures, and $10,939 during the three months ended December 31, 2017 and 2016, respectively. Managementconsequently believes that such amounts were previously satisfied throughconsolidation would not change the issuancereported results of common stock and does not intend to pay such amounts.operations for the quarter ended March 31, 2019.
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NOTE 76 - STOCKHOLDERS’ DEFICITEQUITY
As of December 31, 2017, theThe Company wasis authorized to issue 650,000,000 common shares and 10,000,000 preferred shares at a par value of $0.01.$0.01 per share.
Common Stock
Management determines the fair value of stock issuances using the closing stock price on the grant date.
During the threesix months ended DecemberMarch 31, 2017, there were 37,000 shares of common stock sold for $57,200, net of $16,800 in offering costs.
During the three months ended December 31, 2017,2019, the Company issued 5,53720,000 shares of common stock with a fair value of $10,000$40,000 to its employeesPycnocline, LLC for management consulting services, which was recorded in research and development expense.
During the six months ended March 31, 2019, the Company issued 9,346 shares of common stock with a fair value of $11,216 to an employee, which was recorded as partstock-based compensation expenses in research and development expense in the statement of their compensation.operations.
During the six months ended March 31, 2019, the Company refunded $40,000 for common stock, due to these funds exceeding the latest private placement offering maximum requirement allowed.
Preferred Stock
The Company’s Series A Preferred StockEach share of preferred stock is convertible into the Company’s common stock at a rate of 1one preferred share to 1.5 common shares. As of December 31, 2017, there are a total of 10,000,000 shares of the Series A Preferred Stock authorized and outstanding which are convertible into a total of 15,000,000 shares of common stock. Each share of the Preferred Stockpreferred stock has 1501.5 votes on all matters presented to be voted by the holders of common stock. The holders of the Series A Preferred Stockpreferred stock can only convert the shares if agreed upon approval of the Company’s board of directors. If declared by 50.1% votethe board of alldirectors, holders of preferred shareholders.stock are entitled to receive dividends prior and in preference to any declaration or payment of any dividend on the common stock of the Company. In the event of liquidation or dissolution of the Company, holders of preferred stock shall be paid out of the assets of the Company prior and in preference to any payment or distribution to holders of common stock of the Company.
NOTE 8 –7- SUBSEQUENT EVENTS
On January 22, 2018,April 24, 2019 the Board of Directors authorized Michael De La Garza, Chief Executive OfficerCompany entered into an Operating Agreement with Ageos, LLC a Virginia Limited Liability Company. The Operator has the required expertise, clearances and credentials to work with certain US government departments, agencies and affiliates; and the Operator will assist the Company in securing sales to the US Government and other contracts. The Company’s products will be sold to the Government at our normal pricing and the Company agreed to guarantee the lease for the secured facility in Virginia and to advance the cost at an amount not to exceed $1.6 million annually including the lease guarantee. The advanced funds will be reimbursed to the Company from Ageos’ profits generated by Ageos sales of the Company’s products. The Company chose to convert his 9,000,000 preferred shares,report payments to Ageos, LLC as an operational expense but did give separate disclosure consideration to reporting it as a Variable Interest Entity relationship.
On June , 2019 the Company executed an exclusive Reseller Agreement with Quality Health Care International, LLC a Nevada Limited Liability Company a very experienced supplier of software to the healthcare industry in the United States and in other countries. The agreement is for a five year period with automatic renewals unless cancelled by either party. The market is the Healthcare industry in the United States and its territories. Other countries may be added in the future. The products to be licensed are those designed for commercial use, which are beneficial for the healthcare industry and will be sold at our normal pricing. The Company advanced cost in the amount of $416,000 to the Reseller which is evidenced by a conversion rate of 1 to 1.5 common shares, to 13,500,000 common shares, restricted pursuant to Rule 144. On February 15, 2018, Michael De La Garza converted his 9,000,000 preferred shares to 13,500,000 common shares.two-year promissory note executed by the Reseller.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this Quarterly Report, “Cipherloc,” “Company,” “our company,” “us,” and “our” refer to Cipherloc Corporation, and its subsidiaries, unless the context requires otherwiseotherwise.
Forward-Looking Statements
The following information contains certain forward-looking statements. Forward-looking statements are statements that estimate the happening of future events and are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as “may,” “could,” “expect,” “estimate,” “anticipate,” “plan,” “predict,” “probable,” “possible,” “should,” “continue,” or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.
Our Business
Cipherloc Corporation is a data security solutions company. We are developing a highly innovative, polymorphic encryption technology and services solutions company for the rapidly expanding cloud-based cyber security industry. Cipherloc is based in Buda, Texas.
designed to enable an iron-clad layer of protection to be added to existing solutions. The Company has introducedplans to introduce an innovative and revolutionary new type of encryption technology with five international patents and twofour US patents pending and ispatents. We expect to be the industry’s first “Polymorphic Cipher Engine”,Engine,” called CipherLoc®Cipherloc®. It isWe expect to offer the first secure commercially viable advanced “Polymorphic Key Progression Algorithmic Cipher Engine” (PKPA)(“PKPA”). This morphing cipher can be used in any commercial data security industry and/or in sensitive applications.
The Company’s initial products are focused on protecting “data in motion” and will consist of three different offerings: CipherLoc EDGE (for mobile platforms), CipherLoc ENTERPRISE (for desktops, laptops, and tablets), and CipherLoc GATEWAY (for servers). Summaries for each of these products can be found on the Company’s website. The end goal with the release of these products is to offer end-to-end data security (i.e., data can be securely sent to/from any mobile device, any PC, and any server).
With a business-to-business model, the Company will directly pursue businesses that will embed Cipherloc’s technology within their own product offering. We will be offering these potential clients a fairly standard software licensing-maintenance model, under which they will license our software for use within their own products. Any company today that is currently using encryption technology becomes a potential customer for us. By targeting companies who are already building solutions that have encryption built-in to their products, we are planning to achieve scale much faster.
Financial Results and Trends
Results of Operations for the three and six months ended DecemberMarch 31, 20172019 and 20162018
Revenue increaseddecreased to $115,642zero from $112,500$113,129 and $228,771 for the three and six months ended DecemberMarch 31, 20172019 and 2016,2018, respectively. Revenue is comprisedSimilarly, cost of revenue decreased to zero from $45,506 and $75,806 for the three and six months ended March 31, 2019 and 2018, respectively. The decrease in revenue and cost of revenue for each of the periods was a result of a software license sale that is being recognized ratably through June 2018.
Cost of revenue remained the same at $30,300 for both the three months ended December 31, 2017 and 2016. Cost of revenue is comprised of salaries and maintenance costs related to the Company’s core Cipherloc products. The current software license contract is being recognized ratably throughending in June 2018.
General and administrative expenses decreased to $183,920 from $2,430,937were $505,087 and $230,366 for the three months ended DecemberMarch 31, 20172019 and 2016,2018, respectively. General and administrative expenses decreasedwere $1,038,781 and $414,286 for the six months ended March 31, 2019 and 2018, respectively. The increases in general and administrative expenses for the three and six-month periods primarily resulted from higher professional fees, including for legal and accounting, higher consulting and contract services, higher salaries and higher rent expense.
Sales and marketing expenses increased to $434,800 from $22,195 for the three months ended March 31, 2019 and 2018, respectively. Sales and marketing expenses increased to $648,775 from $45,162 for the six months ended March 31, 2019 and 2018, respectively. Sales and marketing expenses increased for the three and six-month periods ended March 31, 2019 primarily due to higher consulting fees to outside sales representation companies and sales consultants. We paid approximately $325,000 of consulting fees to Ageos, LLC (Ageos) for Ageos to establish operations to assist us with securing contracts with agencies of the United States government. In addition, we paid approximately $401,000 to Quality Health Care to establish operations to resell our products in the Health Care industry in the United States and its territories. The advanced funds are evidenced by a Promissory note in favor of the Company. The funds paid to these sales representatives will expectantly be recovered and remitted to us from profits generated by sales of our products by these representatives. We also have increased the number of sales consultants in the United States during 2019.
Research and development costs were $479,677 and $251,136 for the three months ended March 31, 2019 and 2018, respectively. Research and development costs were $825,572 and $365,988 for the six months ended March 31, 2019 and 2018, respectively. Research and development expenses increased for the three and six-month periods ended March 31, 2019 primarily as a result of higher salaries and consulting costs, partially offset by lower stock-based compensation.
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Sales
Interest income, net, was $2,241 and marketing expenses decreased to $22,967 from $98,374$3,318 for the three and six months ended DecemberMarch 31, 20172019, respectively. Interest expense, net, was $312,282 and 2016, respectively. Sales and marketing expenses decreased as a result of lower stock-based compensation and lower payroll expenses.
Research and development costs decreased to $114,852 from $599,959$508,318 for the three and six months ended DecemberMarch 31, 2017 and 2016,2018, respectively. Research and development costs decreased as a result of lower stock-based compensation.
Settlement expense decreased to $0 from $106,250 the three months ended December 31, 2017 and 2016, respectively. Settlement expense for the three months ended December 31, 2016 related to the issuance of 25,000 shares of common stock for a software termination settlement.
Interest expense increased to $196,036 from $10,939 for the three months ended December 31, 2017 and 2016, respectively. Interest expense increasedThe change in interest income (expense), net, was due to the issuance of convertible debt tonotes with FirstFire Global Opportunities Fund, LLC and Peak One Opportunity Fund LP.LP, which were outstanding during the six months ended March 31, 2018 and settled in March 2018 and April 2018, respectively.
Liquidity and Capital Resources
We havehad an accumulated deficit at DecemberMarch 31, 20172019 of $51,614,878.$57,132,323. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At DecemberMarch 31, 2017,2019, the Company had cash of $155,730.$11,090,605. We believe that our existing cash balances are insufficientwill be sufficient to fund future operations for at least the next 12 months. These factors raise doubt about the Company’s ability to continue as a going concern.
On September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC with a principal amount of $330,000, and on December 14, 2017, the Company issued a convertible note to Peak One Opportunity Fund LP with a principal amount of $300,000. The notes require a premium of 130% to 140% (if paid by the 180th day) in an aggregate amount of $849,000. Non-payment by the Company on either or both of these notes could result in the creditors receiving an unlimited amount of the Company’s stock in order to satisfy the notes, adversely impacting our ability to raise capital on more favorable terms. It is the intent of the Company to repay these notes before through funds received from Private Placement Memorandums.
We depend upon the continued participation of Private Placement Memorandums (PPM) and the issuance of debt to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business.
There is no assurance that such funding, if required, will be available to us or, if available, will be available upon terms favorable to us. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Cash Flow
The following table summarizes, for the periods indicated, selected items in our condensed Statementsstatements of Cash Flows:cash flows:
| Three Months Ended | Six Months Ended | |||||||||||||||
| December 31, | March 31, | |||||||||||||||
| 2017 | 2016 | 2019 | 2018 | |||||||||||||
| Net cash (used in) provided by: | ||||||||||||||||
| Operating activities | $ | (371,466 | ) | $ | (487,780 | ) | $ | (2,487,682 | ) | $ | (863,412 | ) | ||||
| Investing activities | $ | — | $ | (3,171 | ) | $ | (438,059 | ) | $ | — | ||||||
| Financing activities | $ | 299,800 | $ | 233,120 | $ | (40,000 | ) | $ | 1,069,925 | |||||||
Operating Activities
Cash used in operating activities was $371,466 and $487,780 for the threesix months ended DecemberMarch 31, 20172019 primarily resulted from the net loss of $2,509,810 and 2016, respectively. The decreasea net change of $33,124 in cashoperating assets and liabilities, which was partially offset by the effects of non-cash charges of $55,252. Cash used in operating activities wasfor the six months ended March 31, 2018 primarily due to lowerresulted from the net loss of $1,918,923 and a net change of in operating assets and liabilities of $335,909, which was partially offset by higher working capital usage.the effects of non-cash charges of $1,391,420.
Investing Activities
Cash used in investing activities was $0 and $3,171 for the threesix months ended DecemberMarch 31, 20172019 was for the purchase of fixed assets and 2016, respectively. The decreasefor the cash the Company advanced to Quality Health Care International, LLC in cash used in investing activities was the resultamount of no fixed asset purchases during the three months ended December 31, 2017.$401,000.
Financing Activities
Cash used in financing activities for the six months ended March 31, 2019 was for refunds to investors of proceeds from the financing completed in August 2018. Cash provided by financing activities was $299,800 and $233,120 for the threesix months ended DecemberMarch 31, 20172018 included $1,177,325 in proceeds from the issuance of common stock and 2016, respectively. The increase$242,600 in cash provided by financing activities was primarily due toproceeds from the issuance of convertible debt,notes, which was partially offset by fewer issuances$350,000 in repayments of common stock for cash.convertible notes.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements, including arrangements that would affect the liquidity, capital resources, market risk support, and credit risk support or other benefits.
WHERE YOU CAN FIND MORE INFORMATION
You are advised to read this Quarterly Reportquarterly report on Form 10-Q in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reportsquarterly reports on Form 10-Q, Annual Reportannual report on Form 10-K, and Current Reportscurrent reports on Form 8-K that we file from timefile. Our website address is www.cipherloc.net. The information in our website is not incorporated by reference into this report. Through a link on the Investor section of our website, we make available our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to time.those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission, or SEC. You may obtain copies of these reports directly fromcan also read any materials submitted electronically by us or fromto the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549,on its website (www.sec.gov), which contains reports, proxy and you may obtain information about obtaining access to the Reference Room by callingstatements, and other information regarding issuers that file electronically with the SEC, at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its websitehttp://www.sec.gov.including us.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We had no material changes in market risk from those described in “Part II, Item 7A — Quantitative and Qualitative Disclosures about Market Risk” of our Annual Report on Form 10-K for the year ended September 30, 2017.Not applicable
ITEM 4. CONTROLS AND PROCEDURES
This report includes the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). See Exhibits 31.1 and 31.2. This Item 4 includes information concerning the controls and control evaluations reveredreferred to in those certifications.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms and that such information is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures were designed to provide reasonable assurance that the controls and procedures would meet their objectives.
As required by SEC Rule 13a-15(b), our Chief Executive Officer and Chief Financial Officer need to carry out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2017 due to 1) no formal evaluation has been performed by us and 2) the existence of the material weaknesses in internal control over financial reporting described below (which we view as an integral part of our disclosure controls and procedures). Based on the performance of additional procedures designed to ensure the reliability of our financial reporting, we believe that the financial statements included in this Quarterly Report fairly present, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods, presented, in conformity with U.S. GAAP.
Management’s Report on Internal Control over Financial Reporting
Our Chief Executive Officer and the Chief Financial Officer are responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of our internal control over financial reporting. Internal control over financial reporting (as defined in Rules 13a-15(f) and 15d(f) under the Exchange Act) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets, (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, (c) provide reasonable assurance that receipts and expenditures are being made only in accordance with appropriate authorization of management and the Board of Directors, and (d) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
In connection with the preparation of our Annual Report on Form 10-K for the year ended September 30, 2017,2018, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our internal control over financial reporting as of September 30, 20172018 and concluded that we did not maintain effective internal control over financial reporting as of September 30, 20172018 due to the identification of material weaknesses. TheseWe intend to remediate these material weaknesses remain as of December 31, 2017.during the 2019 fiscal year.
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Management identified a number of deficiencies in the design and operating effectiveness of the Company’s internal controls as of September 30, 2017 that represent material weaknesses in our internal control over financial reporting. These deficiencies are the result of management’s failure to design, implement and maintain adequate operational and internal controls and processes, including a lack of sufficient accounting staff which resulted in inadequate segregation of duties, the inability to prove delivery of software, an insufficient number of personnel familiar with financial and SEC reporting requirements, inadequate monitoring and review controls over financial reporting and disclosures as well as transaction processing, and insufficient written policies and procedures for accounting and financial reporting.
Remediation PlanChanges in Internal Control over Financial Reporting
Management has executedWe intend to begin implementing a remediation plan intended to address the material weaknesses discussed above. Theseidentified during the year ended September 30, 2018. The remediation efforts are focusedwill focus on:
| ● | ||
| ● | Enhancing review and approval controls around transaction processing; | |
| ● | Enhancing controls around proving the delivery of software; | |
| ● | Enhancing and maintaining written policies and procedures for accounting and financial reporting. |
During the three months ended December 31, 2017, management engaged additional resources to support the remediation efforts outlined above. In addition, management has continued to train key accounting staff to improve controls that will ultimately eliminate the material weaknesses discussed above, as well as improve the accounting and financial reporting process.
We expect that remediation, including testing of related controls, will be completed by the end of third quarter 2018.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, other thanbalance of the remediation actions discussed above.2019 fiscal year.
Inherent Limitations on Internal Controls
It should be noted that any system of controls, however well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the control system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of certain events. Limitations inherent in any control system include the following:
| ● | Judgments in decision-making can be faulty, and control and process breakdowns can occur because of simple errors or mistakes; | |
| ● | Controls can be circumvented by individuals, acting alone or in collusion with others, or by management override; | |
| ● | The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; | |
| ● | Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures; and | |
| ● | The design of a control system must reflect the fact that resources are constrained, and the benefits of controls must be considered relative to their costs. |
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
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AsSee “Litigation” in Note 4 – Commitments and Contingencies of December 31, 2017, the Company is not involvedNotes to the Financial Statements in any material litigation.Part I, Item I of this document.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company has unregistered sales of securities through an active Private Placement Memorandum. During the three months ending December 31, 2017, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company sold and issued 37,000 shares of common stock for $57,200 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended (the “Act”), afforded by Rule 506 of Regulation D.None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There were no defaults upon senior securities during the three months ended December 31, 2017.None
ITEM 4. MINING SAFETY DISCLOSURES
Not applicable.
There is no information with respect to which information is not otherwise called for by this form.
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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, thereunto duly authorized.
| Registrant | Cipherloc Corporation | |
| Date: | By: | /s/ Michael De La Garza |
| Michael De La Garza | ||
| Chairman, Chief Executive Officer (Principal Executive Officer), President | ||
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