UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
Commission File Number: 000-28745
Cipherloc Corporation
(Name of small business issuer as specified in its charter)
| Texas | 86-0837077 | |
| State of Incorporation | IRS Employer Identification No. |
825 Main Street, Suite 100
Buda, TX 78610
(Address of principal executive offices)
(512) 772-4237
(Issuer’s telephone number)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.01 par value per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] Yes [X] No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. [ ] Yes [X] No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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 Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not 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]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | [ ] | Accelerated filer | [ ] |
| Non–Accelerated filer | [ ] | Small reporting company | [X] |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act). Yes [ ] No [X]
Aggregate market value of the voting stock held by non-affiliates: $31,058,087 as based on the closing price of the stock on December 27, 2018. The voting stock held by non-affiliates on that date consisted of 25,881,739 shares of common stock.
As of December 27, 2018, there were 40,783,164 shares of common stock, par value $0.01, and 1,000,000 shares of preferred stock, par value $0.01, issued and outstanding.
Documents Incorporated by Reference: None
CIPHERLOC CORPORATION
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEARS ENDED SEPTEMBER 30, 2018 AND 2017
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements
Some of our statements under “Business,” “Properties,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Notes to Financial Statements and elsewhere in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). In some cases, forward-looking statements are identified by terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “approximates,” “predicts,” “potential” or “continue” or the negative of such terms and other comparable terminology.
Although we believe that the expectations reflected in these forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor anyone else assumes responsibility for the accuracy and completeness of such statements and is under no duty to update any of the forward-looking statements after the date of this report.
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Our Company
Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective on March 23, 2015.
Description of Business
Cipherloc is a data security solutions company. We are developing a highly innovative, polymorphic encryption technology designed to enable an iron-clad layer of protection to be added to existing solutions. The Company plans to introduce an innovative and revolutionary new type of encryption technology with five international patents and four US patents. We expect to be the industry’s first “Polymorphic Cipher Engine”, called Cipherloc®. We expect to offer the first secure commercially viable advanced “Polymorphic Key Progression Algorithmic Cipher Engine” (“PKPA”). This morphing cipher can be used in any commercial data security industry and/or in sensitive applications.
Personnel
As of the date of this report, we have 11 full-time employees.
WHERE YOU CAN FIND MORE INFORMATION
You are advised to read this Form 10-K in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov.
In an effort to keep our stockholders and the public informed about our business, we may make “forward-looking statements.” Forward-looking statements usually relate to future events and anticipated revenues, earnings, cash flows or other aspects of our operations or operating results. As indicated previously, forward-looking statements are often identified by words, “will”, “may”, “should”, “continue”, “anticipate”, “believe”, “expect”, “plan”, “forecast”, “project”, “estimate”, “intend” and words of similar nature. Forward-looking statements generally include statements containing:
| ● | projections about accounting and finances; |
| ● | plans and objectives for the future; |
| ● | projections or estimates about assumptions relating to our performance; or |
| ● | our opinions, views or beliefs about the effects of current or future events, circumstances or performance. |
You should view those statements with caution. Those statements are not guarantees of future performance, circumstances or events. They are based on facts and circumstances known to us as of the date the statements are made. All phases of our business are subject to uncertainties, risks and other influences, many of which we do not control. Any of these factors either alone or taken together, could have a material adverse effect on us and could change whether any forward-looking statement ultimately turns out to be true. Additionally, we assume no obligation to update any forward-looking statement as a result of future events, circumstances or developments.
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Outlined below are some of the risks that we believe could affect our business and financial statements. An investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this Annual Report on Form 10-K, before investing in our common stock. If any of the events anticipated by the risks described below occur, our results of operations and financial condition could be adversely affected which could result in a decline in the market price of our common stock, causing you to lose all or part of your investment.
Because we are quoted on the OTC Markets, formerly known as “Pinks Sheets,” instead of an exchange or national quotation system, our investors may have a tougher time selling their stock or experience negative volatility on the market price of our stock.
Our common stock is traded on the OTCQB “OTC Markets”. The OTCQB “OTC Markets” is often highly illiquid, in part because it does not have a national quotation system by which potential investors can follow the market price of shares except through information received and generated by a limited number of broker-dealers that make markets in particular stocks. There is a greater chance of volatility for securities that trade on the OTCQB “OTC Markets” as compared to a national exchange or quotation system. This volatility may be caused by a variety of factors, including the lack of readily available price quotations, the absence of consistent administrative supervision of bid and ask quotations, lower trading volume, and market conditions. Investors in our common stock may experience high fluctuations in the market price and volume of the trading market for our securities. These fluctuations, when they occur, have a negative effect on the market price for our securities. Accordingly, our stockholders may not be able to realize a fair price from their shares when they determine to sell them or may have to hold them for a substantial period of time until the market for our common stock improves.
We depend significantly upon the continued involvement of our present management.
The Company’s success depends significantly upon the involvement of our present management, who is in charge of our strategic planning and operations. We may need to attract and retain additional talented individuals in order to carry out our business objectives. The competition for individuals with expertise in this industry could be intense and there are no assurances that these individuals will be available to us.
Our common stock is subject to penny stock regulation.
Our shares are subject to the provisions of Section 15(g) and Rule 15g-9 of the Exchange Act, as amended, commonly referred to as the “penny stock” rule. Section 15(g) sets forth certain requirements for transactions in penny stocks and Rule 15g-9(d)(1) incorporates the definition of penny stock as that used in Rule 3a51-1 of the Exchange Act. The Commission generally defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. Rule 3a51-1 provides that any equity security is considered to be penny stock unless that security is: registered and traded on a national securities exchange meeting specified criteria set by the Commission; authorized for quotation on the NASDAQ Stock Market; issued by a registered investment company; excluded from the definition on the basis of price (at least $5.00 per share) or the registrant’s net tangible assets; or exempted from the definition by the Commission. Since our shares are deemed to be “penny stock”, trading in the shares will be subject to additional sales practice requirements on broker/dealers who sell penny stock to persons other than established customers and accredited investors.
Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses and pose challenges for our management.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations promulgated there under, the Sarbanes-Oxley Act and SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the U.S. public markets. Our management team will need to devote significant time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
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The Company’s directors and officers may control the outcome of most matters submitted to a vote of shareholders.
The officers and directors have changes in control provisions that allows for the full payment of salary and stock in case the company is taken over by a third party. In addition to the ability of these directors and officers of the Company to vote, shares represent a significant majority of the total voting power of the Company’s common shares.
Under Texas law, common shares of the Company owned by the officers and directors may be voted in a manner in which those votes are determined by the directors. Those directors, should they choose to act together, will be able to control substantially all matters affecting the Company, and block a number of matters relating to any potential change of control of the Company. See Item 12–Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Risks Related To Our Industry
We face intense competition.
We continue to experience intense competition across all markets for our products and services. Although we believe our business and product portfolio will be a competitive advantage, our competitors that are focused on narrower product lines may be more effective in devoting technical, marketing, and financial resources to compete with us. In addition, barriers to entry in our businesses generally are low, and products, once developed, can be distributed broadly and quickly at a relatively low cost. Open source software vendors are devoting considerable efforts to developing software that mimics the features and functionality of our anticipated products. These competitive pressures may result in decreased sales volumes, price reductions, and/or increased operating costs, such as for marketing and sales incentives, resulting in lower revenue, gross margins, and operating income.
Our business depends on our ability to attract and retain talented employees.
Our business is based on successfully attracting and retaining talented employees. The market for highly skilled workers and leaders in our industry is extremely competitive. If we are less successful in our recruiting efforts, or if we are unable to retain key employees, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution.
Delays in product development schedules may adversely affect our revenues.
The development of software products is a complex and time-consuming process. New products can require long development and testing periods. Our increasing focus on innovative and new software presents new and complex development issues. Significant delays in new product releases or significant problems in creating new products could adversely affect our revenue.
Acquisitions and joint ventures may have an adverse effect on our business.
We expect to continue making acquisitions or entering into joint ventures as part of our long-term business strategy. These transactions involve significant challenges and risks including that the transaction does not advance our business strategy, that we don’t realize a satisfactory return on our investment, or that we experience difficulty in the integration of new employees, business systems, and technology, or diversion of management’s attention from our other businesses. These events could harm our operating results or financial condition.
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Risks Related to Our Securities
The market price for our common stock may be volatile, and you may not be able to sell our stock at a favorable price or at all.
Many factors could cause the market price of our common stock to rise and fall, including:
| ● | actual or anticipated variations in our quarterly results of operations; |
| ● | changes in market valuations of companies in our industry; |
| ● | changes in expectations of future financial performance; |
| ● | fluctuations in stock market prices and volumes; |
| ● | issuances of dilutive common stock or other securities in the future; |
| ● | the addition or departure of key personnel; |
| ● | announcements by us or our competitors of acquisitions, investments or strategic alliances; and |
| ● | it is possible that the proceeds from sales of our common stock may not equal or exceed the prices you paid for the shares after including the costs and fees of making the sales |
Substantial sales of our common stock, or the perception that such sales might occur, could depress the market price of our common stock.
We cannot predict whether future issuances of our common stock or resale in the open market will not decrease the market price of our common stock. The consequence of any such issuances or resale of our common stock on our market price may be increased as a result of the fact that our common stock is thinly, or infrequently, traded. The exercise of any options, or the vesting of any restricted stock that we may grant to directors, executive officers and other employees in the future, the issuance of common stock in connection with acquisitions and other issuances of our common stock, may decrease the market price of our common stock.
Holders of our common stock have a risk of potential dilution if we issue additional shares of common stock in the future.
The exercise of options and warrants and/or the conversion of preferred stock will dilute the shareholder’s ownership percentage. We may issue options to purchase or grant up to an aggregate of 3,000,000 shares of common stock under our 2019 Stock Grant/Option Plan. We also have outstanding warrants to purchase 25,015,866 shares of our common stock. In the future, we may grant additional stock options, warrants, or convertible securities. The exercise or conversion of stock options, warrants, preferred stock, or convertible securities will dilute the ownership percentage of our other stockholders. The dilutive effect of the exercise or conversion of these securities may adversely affect our ability to obtain additional capital. The holders of these securities may be expected to exercise or convert their securities when we are able to obtain additional equity capital on terms more favorable than these securities.
We do not intend to pay cash dividends to our stockholders, so you will not receive any return on your investment in our Company prior to selling your interest in the Company.
The Company has never paid any cash dividends to our stockholders. We currently intend to retain any future earnings for funding growth and, therefore, do not expect to pay any cash dividends in the foreseeable future. As a result, you will not receive any return on your investment prior to selling your shares in our Company, and for the other reasons discussed in this “Risk Factors” section, you may not receive any return on your investment even when you sell your shares in our Company.
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Certain shares of our common stock are restricted from immediate resale. The lapse of those restrictions, coupled with the sale of the related shares in the market, or the market’s expectation of such sales, could result in an immediate and substantial decline in the market price of our common stock.
Most of our shares of common stock are restricted from immediate resale in the public market. The restricted shares are restricted in accordance with Rule 144, which states that if unregistered, restricted securities are to be sold, a minimum of one year must elapse between the later of the date of acquisition of the securities from the issuer or from an affiliate of the issuer, and any resale of those securities in reliance on Rule 144. The Rule 144 restrictive legend remains on the stock until the holder of the stock holds the stock for longer than six months (unless an affiliate) and meets the other requirements of Rule 144 to have the restriction removed. The sale or resale of those shares in the public market, or the market’s expectation of such sales, may result in an immediate and substantial decline in the market price of our shares. Such a decline will adversely affect our investors, and make it more difficult for us to raise additional funds through equity offerings in the future.
Our common stock is subject to restrictions on sales by broker-dealers and penny stock rules, which may be detrimental to investors.
Our common stock is subject to Rules 15g-1 through 15g-9 under the Exchange Act, which imposes certain sales practice requirements on broker-dealers who sell our common stock to persons other than established customers and “accredited investors” (as defined in Rule 501(a) of the Securities Act). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of our common stock.
Additionally, our common stock is subject to SEC regulations applicable to “penny stocks.” Penny stocks include any non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock; a disclosure schedule proscribed by the SEC relating to the penny stock market must be delivered by a broker-dealer to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for our common stock. The regulations also require that monthly statements be sent to holders of a penny stock that disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.
Our Articles of Incorporation allow us to sell preferred stock without shareholder approval.
Our Board of Directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any additional vote or action by our shareholders. The rights of the holders of the common stock will be subject to, and could be materially adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. For example, we could issue preferred stock that has superior rights to dividends or is convertible into shares of common stock. This might adversely affect the market price of the common stock.
If we experience delays and/or defaults in customer payments, we could be unable to recover all expenditures.
Because of the nature of our contracts, at times we commit resources to projects prior to receiving payments from the customer in amounts sufficient to cover expenditures on projects as they are incurred. Delays in customer payments may require us to make a working capital investment. If a customer defaults in making their payments on a project in which we have devoted resources, it could have a material negative effect on our working capital and results of operations.
If we do not effectively manage our growth, our existing infrastructure may become strained, and we may be unable to increase revenue growth.
Our past growth that we have experienced, and in the future may experience, may provide challenges to our organization, requiring us to expand our personnel and our operations. Future growth may strain our infrastructure, operations and other managerial and operating resources. If our business resources become strained, our earnings may be adversely affected and we may be unable to increase revenue growth. Further, we may undertake contractual commitments that exceed our labor resources, which could also adversely affect our earnings and our ability to increase revenue growth.
SHOULD ONE OR MORE OF THE FOREGOING RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD THE UNDERLYING ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED, INTENDED OR PLANNED.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
This Item is not applicable to us as we are not an accelerated filer, a large accelerated filer, or a well-seasoned issuer.
The Company rents office space at 825 Main Street, Suite 100, Buda, Texas 78610 for its corporate headquarters. The Company also rents office space at 7320 East Butherus Drive, Suite 103, Scottsdale, Arizona 85260 for its sales and marketing, as well as research and development, functions.
See “Litigation” in Note 7 – Commitments and Contingencies of the Notes to the Financial Statements in Part II, Item 8 of this document.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded in the over-the-counter market, and quoted on the Over the Counter Bulletin Board and can be accessed on the Internet at OTCQB markets.com under the symbol “CLOK.”
At September 30, 2018, there were 40,743,917 shares of common stock of the Company outstanding, and there were 1,189 shareholders of the Company’s common stock.
The following table sets forth for the periods indicated the high and low bid quotations for Cipherloc’s common stock. These quotations represent inter-dealer quotations, without adjustment for retail markup, markdown or commission and may not represent actual transactions.
| Periods | High | Low | ||||||
| Fiscal Year 2018 | ||||||||
| First Quarter (October – December 2017) | $ | 1.83 | $ | 0.86 | ||||
| Second Quarter (January – March 2018) | $ | 1.91 | $ | 1.12 | ||||
| Third Quarter (April - June 2018) | $ | 1.91 | $ | 1.22 | ||||
| Fourth Quarter (July – September 2018) | $ | 2.63 | $ | 1.35 | ||||
| Fiscal Year 2017 | ||||||||
| First Quarter (October – December 2016) | $ | 6.00 | $ | 2.70 | ||||
| Second Quarter (January – March 2017) | $ | 4.70 | $ | 2.46 | ||||
| Third Quarter (April - June 2017) | $ | 3.02 | $ | 1.56 | ||||
| Fourth Quarter (July – September 2017) | $ | 3.00 | $ | 1.80 | ||||
Dividends
We did not declare any dividends for the year ended September 30, 2018. Our Board of Directors does not intend to declare dividends in the foreseeable future. The declaration, payment, and amount of any future dividends will be made at the discretion of the Board of Directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors as the Board of Directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend.
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Transfer Agent
Cipherloc’s Transfer Agent and Registrar for the common stock is Pacific Stock Transfer Corporation located in Las Vegas, Nevada.
Recent Sales of Unregistered Securities
Fiscal Year Ended September 30, 2018
Stock Issued for Cash
During the year ended September 30, 2018, through the utilization of Private Placement Memorandums (PPMs) and upon receipt of executed Subscription Agreements, the Company issued 18,909,900 shares of common stock for $16,625,238 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D. Of the 18,909,900 shares of common stock issued, 72,000 shares were issued each with a warrant to purchase two additional shares of common stock and 18,837,900 shares were issued each with a warrant to purchase one additional share of common stock.
Stock Issued to Officers and Employees
During the year ended September 30, 2018, the Company issued 766,033 shares of common stock with a fair value of $1,472,601 to its officers and other employees as part of their compensation.
Stock Issued for Services
During the year ended September 30, 2018, the Company issued 10,000 shares of common stock with a fair value of $15,000 to Magnolia Investor Relations for investor relations services rendered.
Stock Issued for Settlement
During the year ended September 30, 2018, the Company issued 50,000 shares of common stock with a fair value of $81,000 to settle a legal matter by two shareholders who claimed they were entitled to 125,000 shares of common stock because of funds allegedly paid to the Company and promises allegedly made by the Company. The Company denied these allegations and settled the matter for 50,000 shares of common stock.
Convertible Notes
On September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC (“FirstFire”) with a principal amount of $330,000, which included an original issue discount of $30,000. The Company incurred $8,500 in debt issuance costs. The note accrued interest at 5% per annum and was to mature on March 26, 2018. The note was convertible at $2.00 per share. Under the terms of the note, the Company also issued 50,000 shares of its common stock to FirstFire, 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 from $2.00 to $1.00 per share and the exercise price of the warrants from $4.50 to $2.00. The amendment also required the Company to issue an additional 87,500 shares of common stock to FirstFire. On March 21, 2018, the Company entered into a settlement agreement with FirstFire, under which FirstFire converted $77,500 of the note payable into 50,000 shares of common stock, and the Company paid $350,000 to satisfy the note payable in full.
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. The Company incurred $27,400 in debt issuance costs. The note was to mature on December 14, 2020. The note was convertible at $1.00 per share. Under the terms of the note, the Company also issued 275,000 shares of its common stock to Peak One, 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. On April 30, 2018, the Company redeemed the Peak One note for $375,000 prior to the maturity date and also issued 71,429 shares of common stock with a fair value of $103,572 to Peak One.
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Fiscal Year Ended September 30, 2017
Stock Issued for Cash
During the year ended September 30, 2017, through the utilization of a PPM and upon receipt of executed Subscription Agreements, the Company issued 724,000 shares of common stock for $1,383,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D. Of the 724,000 shares of common stock issued, 280,000 shares were issued each with a warrant to purchase two additional shares of common stock. These shares and warrants were issued for $534,985 in net cash proceeds.
Stock Issued to Officers and Employees
During the year ended September 30, 2017, the Company issued 542,268 shares of common stock with a fair value of $2,783,922 to its officers and other employees as part of their compensation.
Stock Issued for Services
During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $74,500 to StockVest for investor relations services.
Stock Issued for License Termination
During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $106,250 for a software termination settlement.
Preferred Stock
The Company has authorized 10,000,000 shares of preferred stock at $0.01 par value. There were 1,000,000 and 10,000,000 shares of preferred stock issued and outstanding as of September 30, 2018 and 2017, respectively. Each share of preferred stock is convertible into the Company’s common stock at a rate of one (1) preferred share to 1.5 common shares. Each share of preferred stock has 1.5 votes on all matters presented to be voted by the holders of common stock. The holders of preferred stock can only convert the shares if agreed to by the Board of Directors. If declared by the Board of Directors, holders of preferred 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.
The issuance of preferred stock by our board of directors could adversely affect the rights of holders of the common stock by, among other things, establishing preferential dividends, liquidation rights or voting powers. See “Risk Factors” above.
Common Stock
The Company has authorized 650,000,000 shares of common stock at $0.01 par value. There were 40,743,917 and 6,635,127 shares of common stock issued and outstanding as of September 30, 2018 and 2017, respectively. The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds. The dividend rights of our common stock are junior to any preferential dividend rights of any outstanding shares of preferred stock. The holders of our common stock also are entitled to receive distributions upon our liquidation, dissolution or winding up of our assets that are legally available for distribution, after payment of all debt and other liabilities and distribution in full of preferential amounts, if any, to be distributed to holders of our preferred stock.
The holders of our common stock are not entitled to preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of any series of preferred stock that we may designate and issue in the future.
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Warrants
During the year ended September 30, 2018, the Company issued warrants to purchase 75,000 shares of common stock in connection with the Peak One convertible note discussed above. These warrants were issued with an exercise price of $2.00 and a term of five years. Additionally, in connection with shares purchased through a PPM, the Company issued warrants to purchase 144,000 shares of common stock. These warrants were issued with an exercise price of $4.50 and a term of two years. Lastly, in connection with shares purchased through another PPM, the Company issued warrants to purchase 18,837,900 shares of common stock. These warrants were issued with an exercise price of $1.20 and a term of five years. The Company issued an additional 5,398,970 warrants, with a cashless conversion provision, at an exercise price of $1.00 and a term of ten years to the investment agent as part of its fees.
During the year ended September 30, 2017, the Company issued warrants to purchase 165,000 shares of common stock in connection with the FirstFire convertible note discussed above. These warrants were issued with an exercise price of $4.50 per share and a term of two years. Additionally, in connection with shares purchased through a PPM, the Company issued warrants to purchase 560,000 shares of common stock. These warrants were issued with an exercise price of $4.50 and a term of two years.
ITEM 6. SELECTED FINANCIAL DATA
This Item is not required for smaller reporting companies, and the Company has elected to omit this information.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Report.
The following information contains certain forward-looking statements of our management. 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 is a data security solutions company. We are developing a highly innovative, polymorphic encryption technology designed to enable an iron-clad layer of protection to be added to existing solutions. The Company plans to introduce an innovative and revolutionary new type of encryption technology with five international patents and four US patents. We expect to be the industry’s first “Polymorphic Cipher Engine”, called Cipherloc®. We expect to offer the first secure commercially viable advanced “Polymorphic Key Progression Algorithmic Cipher Engine” (“PKPA”). This morphing cipher can be used in any commercial data security industry and/or in sensitive applications.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.
The methods, estimates, and judgment we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The SEC has defined “critical accounting policies” as those accounting policies that are most important to the portrayal of our financial condition and results, and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based upon this definition, our most critical estimates are accounting for convertible debt and embedded derivatives, software revenue recognition, and stock issued to employees and non-employees. Our most critical accounting policies applicable to the periods presented are noted below. For additional information see Note 2, “Significant Accounting Policies” in the notes to our financial statements appearing elsewhere in this report. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available, and actual results may differ significantly from these estimates.
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Accounting for Convertible Debt and Embedded Derivatives
Convertible debt is accounted for under the guidelines established by Accounting Standards Topic (“ASC”) 470-20, Debt with Conversion and Other Options. ASC 470-20 governs the calculation of an embedded beneficial conversion feature, 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 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.
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.
Software Revenue Recognition
Software license revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.” VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.
Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.
Stock Issued to Employees and Non-Employees
The Company measures the compensation cost using the fair value based method. This method uses the fair value at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. Grants to vendors are recorded at fair value at each reporting period.
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Results of Operations
Fiscal Year Ended September 30, 2018, Compared to Fiscal Year Ended September 30, 2017
Revenue decreased to $316,248 from $467,274 for the years ended September 30, 2018 and 2017, respectively. Revenue decreased primarily as a result of the term on the Company’s only software license ending in June 2018. As a result, revenue was ratably recognized over nine months during the year ended September 30, 2018, as compared to twelve months during the year ended September 30, 2017. Correspondingly, cost of revenue decreased to $89,230 from $121,200 for the years ended September 30, 2018 and 2017, respectively. Cost of revenue is comprised of salaries and maintenance costs.
General and administrative expenses decreased to $1,844,903 from $3,166,471 for the years ended September 30, 2018 and 2017, respectively. General and administrative expenses decreased primarily as a result of lower stock-based compensation of $1,241,944 and lower salaries of $407,954, partially offset by higher legal costs of $196,508.
Sales and marketing expenses increased to $545,250 from $354,005 for the years ended September 30, 2018 and 2017, respectively. Sales and marketing expenses increased primarily as a result of higher stock-based compensation of $185,752.
Research and development expenses decreased to $873,107 from $1,087,372 for the years ended September 30, 2018 and 2017, respectively. Research and development expenses decreased primarily as a result of lower stock-based compensation of $293,470, partially offset by higher salaries of $69,111.
Settlement expense was $81,000 for the year ended September 30, 2018, as compared to $106,250 for the year ended September 30, 2017. Settlement expense for the year ended September 30, 2018 was due to the issuance of 50,000 shares of common stock to settle a legal claim. Settlement expense for the year ended September 30, 2017 was due to the issuance of 25,000 shares of common stock to terminate a software license.
Total other expenses, net, increased to $1,303,541 from $53,137 for the years ended September 30, 2018 and 2017, respectively. The increase was due to the following:
| 1. | Net loss on extinguishment of convertible notes totaling $317,268. The Company recognized a $358,038 loss on extinguishment related to the amendment of the convertible note with FirstFire Global Opportunities Fund, LLC (“FirstFire”) in December 2017, as well as a $153,621 loss on extinguishment related to the redemption of the convertible note with Peak One Opportunity Fund LP (“Peak One”) in April 2018. These losses were partially offset by a $194,391 gain on extinguishment related to the settlement of the amended FirstFire convertible note in March 2018. | |
| 2. | The Company recognized a loss of $486,745 in December 2017, resulting from the excess fair value of the embedded conversion feature in the Peak One convertible note and of the equity instruments issued with the Peak One convertible note. | |
| 3. | Changes in the fair value of the embedded conversion features in the FirstFire and Peak One convertible notes during the year ended September 30, 2018, totaling $8,536. | |
| 4. | An increase in interest expense, net, to $490,992 from $53,137 for the years ended September 30, 2018 and 2017, respectively, due to interest incurred on the Company’s convertible notes with FirstFire and Peak One that were outstanding during the year ended September 30, 2018. |
Liquidity and Capital Resources
We have an accumulated deficit at September 30, 2018 of $54,622,513. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At September 30, 2018, the Company had cash of $14,056,346. We believe that our existing cash balances are sufficient to fund future operations for the next 12 months.
Cash Flows
The following table summarizes, for the periods indicated, selected items in our Statements of Cash Flows:
| Year Ended September 30, | ||||||||
| 2018 | 2017 | |||||||
| Net cash (used in) provided by: | ||||||||
| Operating activities | $ | (2,299,459 | ) | $ | (1,788,764 | ) | ||
| Investing activities | $ | (14,429 | ) | $ | (2,798 | ) | ||
| Financing activities | $ | 16,142,838 | $ | 1,674,820 | ||||
Operating Activities
Cash used in operating activities was $2,299,459 and $1,788,764 for the years ended September 30, 2018 and 2017, respectively. The increase in cash used for operating activities was primarily due to lower stock-based compensation.
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Investing Activities
Cash used in investing activities was $14,429 and $2,798 for the years ended September 30, 2018 and 2017, respectively. The increase in cash used for investing activities was due to an increase in fixed asset purchases.
Financing Activities
Cash provided by financing activities was $16,142,838 and $1,674,820 for the years ended September 30, 2018 and 2017, respectively. The increase in cash provided by financing activities was due to an increase in the issuances of common stock for cash.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not hold any derivative instruments and do not engage in any hedging activities.
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CIPHERLOC CORPORATION
| 15 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Cipherloc Corporation
Opinion on the Financial Statements
We have audited the accompanying balance sheet of Cipherloc Corporation (the “Company”) as of September 30, 2018, and the related statements of operations, stockholders’ equity, and cash flows for the year ended September 30, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2018, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Armanino LLP
We have served as the Company's auditor since 2018.
San Francisco, California
December 31, 2018
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Cipherloc Corporation
We have audited the accompanying balance sheet of Cipherloc Corporation (the “Company”) as of September 30, 2017, and the related statements of operations, stockholders’ deficit and cash flows for the year then ended. 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). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2017, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements were prepared assuming the Company will continue as a going concern. The Company has incurred losses and had a working capital deficit as of September 30, 2017. Those factors raised substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with respect to these factors were previously described in Note 2. The Company’s financial statements did not include any adjustments that might have resulted from the outcome of those uncertainties had the Company been unable to continue as a going concern.
/s/ dbbmckennon
Newport Beach, California
January 12, 2018
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CIPHERLOC CORPORATION
As of September 30, |
||||||||
| 2018 | 2017 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | 14,056,346 | $ | 227,396 | ||||
| Total current assets | 14,056,346 | 227,396 | ||||||
| Other assets | 12,218 | 12,218 | ||||||
| Fixed assets, net | 20,050 | 11,170 | ||||||
| Total assets | $ | 14,088,614 | $ | 250,784 | ||||
| LIABILITIES & STOCKHOLDERS’ EQUITY (DEFICIT) | ||||||||
| Current liabilities: | ||||||||
| Accounts payable and accrued liabilities | $ | 52,043 | $ | 59,763 | ||||
| Accrued compensation | 72,489 | 505,027 | ||||||
| Convertible note payable | — | 26,678 | ||||||
| Deferred revenue-current | — | 308,412 | ||||||
| Total current liabilities | 124,532 | 899,880 | ||||||
| Long term liabilities: | ||||||||
| Deferred revenue, net of current portion | — | 7,836 | ||||||
| Total long term liabilities | — | 7,836 | ||||||
| Total liabilities | 124,532 | 907,716 | ||||||
| COMMITMENTS AND CONTINGENCIES (NOTE 7) | ||||||||
| STOCKHOLDERS’ EQUITY (DEFICIT) | ||||||||
| Series A convertible preferred stock, $0.01 par value, 10,000,000 shares authorized; 1,000,000 and 10,000,000 issued and outstanding as of September 30, 2018 and 2017, respectively | 10,000 | 100,000 | ||||||
| Common stock, $0.01 par value, 650,000,000 shares authorized; 40,743,917 and 6,635,127 issued and outstanding as of September 30, 2018 and 2017, respectively | 407,438 | 66,351 | ||||||
| Additional paid-in capital | 68,169,157 | 49,378,447 | ||||||
| Accumulated deficit | (54,622,513 | ) | (50,201,730 | ) | ||||
| Total stockholders’ equity (deficit) | 13,964,082 | (656,932 | ) | |||||
| Total liabilities and stockholders’ equity (deficit) | $ | 14,088,614 | $ | 250,784 | ||||
The accompanying notes are an integral part of these financial statements.
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CIPHERLOC CORPORATION
| For The Year Ended | ||||||||
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| Revenues | $ | 316,248 | $ | 467,274 | ||||
| Cost of revenues | 89,230 | 121,200 | ||||||
| Gross profit | 227,018 | 346,074 | ||||||
| Operating expenses: | ||||||||
| General and administrative | 1,844,903 | 3,166,471 | ||||||
| Sales and marketing | 545,250 | 354,005 | ||||||
| Research and development | 873,107 | 1,087,372 | ||||||
| Settlement expenses | 81,000 | 106,250 | ||||||
| Total operating expenses | 3,344,260 | 4,714,098 | ||||||
| Operating loss | (3,117,242 | ) | (4,368,024 | ) | ||||
| Other (expenses) income: | ||||||||
| Loss on extinguishment of convertible notes | (317,268 | ) | — | |||||
| Excess fair value of derivatives in convertible note | (486,745 | ) | — | |||||
| Change in fair value of embedded conversion features in convertible notes | (8,536 | ) | — | |||||
| Interest expense, net | (490,992 | ) | (53,137 | ) | ||||
| Total other expenses, net | (1,303,541 | ) | (53,137 | ) | ||||
| Net loss | $ | (4,420,783 | ) | $ | (4,421,161 | ) | ||
| Net loss per common share - Basic and diluted: | $ | (0.20 | ) | $ | (0.71 | ) | ||
| Weighted average common shares outstanding - Basic and diluted | 22,502,166 | 6,183,909 | ||||||
The accompanying notes are an integral part of these financial statements.
| 19 |
CIPHERLOC CORPORATION
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED SEPTEMBER 30, 2018 AND 2017
| Preferred Stock | Common Stock | |||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Additional Paid-in Capital |
Accumulated Deficit |
Stockholders' Equity (Deficit) |
||||||||||||||||||||||
| Balance at September 30, 2016 | 10,000,000 | $ | 100,000 | 5,268,859 | $ | 52,688 | $ | 44,779,296 | $ | (45,780,569 | ) | $ | (848,585 | ) | ||||||||||||||
| Common stock issued for services | — | — | 25,000 | 250 | 74,250 | — | 74,500 | |||||||||||||||||||||
| Common stock issued for cash, net of offering costs of $69,680 | — | — | 724,000 | 7,240 | 1,376,080 | — | 1,383,320 | |||||||||||||||||||||
| Common stock issued for license termination | — | — | 25,000 | 250 | 106,000 | — | 106,250 | |||||||||||||||||||||
| Common stock issued to officers and employees | — | — | 542,268 | 5,423 | 2,778,499 | — | 2,783,922 | |||||||||||||||||||||
| Common stock issued with convertible note | — | — | 50,000 | 500 | 44,109 | — | 44,609 | |||||||||||||||||||||
| Issuance of warrants | — | — | — | — | 84,227 | — | 84,227 | |||||||||||||||||||||
| Beneficial conversion feature on convertible debt | — | — | — | — | 135,986 | — | 135,986 | |||||||||||||||||||||
| Net loss | — | — | — | — | — | (4,421,161 | ) | (4,421,161 | ) | |||||||||||||||||||
| 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, net of offering costs of $2,356,662 | — | — | 18,909,900 | 189,099 | 16,436,139 | — | 16,625,238 | |||||||||||||||||||||
| Common stock issued to officers and employees | — | — | 766,033 | 7,660 | 1,464,941 | — | 1,472,601 | |||||||||||||||||||||
| Common stock issued for services | — | — | 10,000 | 100 | 14,900 | — | 15,000 | |||||||||||||||||||||
| Common stock issued for legal settlement | — | — | 50,000 | 500 | 80,500 | — | 81,000 | |||||||||||||||||||||
| Common stock issued for warrant exercise | — | — | 388,928 | 3,889 | (3,889 | ) | — | — | ||||||||||||||||||||
| 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 | |||||||||||||||||||||
| Settlement of convertible note | — | — | 121,429 | 1,214 | 179,858 | — | 181,072 | |||||||||||||||||||||
| Related party conversion of preferred stock | (9,000,000 | ) | (90,000 | ) | 13,500,000 | 135,000 | (45,000 | ) | — | — | ||||||||||||||||||
| Net loss | — | — | — | — | — | (4,420,783 | ) | (4,420,783 | ) | |||||||||||||||||||
| Balance at September 30, 2018 | 1,000,000 | $ | 10,000 | 40,743,917 | $ | 407,438 | $ | 68,169,157 | $ | (54,622,513 | ) | $ | 13,964,082 | |||||||||||||||
The accompanying notes are an integral part of these financial statements.
| 20 |
CIPHERLOC CORPORATION
| For The Year Ended | ||||||||
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ | (4,420,783 | ) | $ | (4,421,161 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation | 5,548 | 5,524 | ||||||
| Stock-based compensation | 1,472,601 | 2,783,922 | ||||||
| Stock issued for services | 15,000 | 74,500 | ||||||
| Settlement expenses | 81,000 | — | ||||||
| Loss on extinguishment of convertible notes | 317,268 | — | ||||||
| Termination of software license | — | 106,250 | ||||||
| Excess fair value of derivatives in convertible note | 486,745 | — | ||||||
| Change in fair value of embedded conversion features in convertible notes | 8,536 | — | ||||||
| Debt discount amortization | 491,132 |
— | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Prepaid officer compensation | — | 44,788 | ||||||
| Prepaid expenses and other assets | — | 2,501 | ||||||
| Accounts payable and accrued liabilities | (7,720 | ) | (2,507 | ) | ||||
| Accrued compensation | (432,538 |
) | 84,693 |
|||||
| Deferred revenue | (316,248 | ) | (467,274 | ) | ||||
| Net cash used in operating activities | (2,299,459 | ) | (1,788,764 | ) | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Purchase of fixed assets | (14,429 | ) | (2,798 | ) | ||||
| Net cash used in investing activities | (14,429 | ) | (2,798 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Common stock issued for cash, net of offering costs of $2,356,662 and $69,680, respectively | 16,625,238 | 1,383,320 | ||||||
| Proceeds from related party notes | — | 70,000 | ||||||
| Repayment of related party notes | — | (70,000 | ) | |||||
| Proceeds from convertible notes, net | 242,600 | 291,500 | ||||||
| Repayment of convertible notes | (725,000 | ) | — | |||||
| Net cash provided by financing activities | 16,142,838 | 1,674,820 | ||||||
| INCREASE (DECREASE) IN CASH | 13,828,950 | (116,742 | ) | |||||
| CASH, BEGINNING OF YEAR | 227,396 | 344,138 | ||||||
| CASH, END OF YEAR | $ | 14,056,346 | $ | 227,396 | ||||
| CASH PAID FOR: | ||||||||
| Interest paid | $ | — | $ | — | ||||
| Income taxes paid | $ | — | $ | — | ||||
| NON-CASH FINANCING ACTIVITIES: | ||||||||
| Issuance of common stock with convertible notes | $ | 502,500 | $ | — | ||||
| Issuance of warrants with convertible note | $ | 90,345 | $ | — | ||||
| Amendment of warrants issued with convertible note | $ | 74,041 | $ | — | ||||
| Settlement of convertible note | $ | 181,072 | $ | — | ||||
The accompanying notes are an integral part of these financial statements.
| 21 |
CIPHERLOC CORPORATION
FOR THE YEARS ENDED SEPTEMBER 30, 2018 AND 2017
NOTE 1- DESCRIPTION OF BUSINESS
Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective on March 23, 2015.
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Significant accounting policies are as follows:
Use of Estimates and Assumptions
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, actual results could differ from these estimates. The Company’s most significant estimate relates to the valuation of its convertible note.
Legal
The Company is subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. The Company accrues for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred.
Cash and Cash Equivalents and Concentration of Credit Risk
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company did not have any cash equivalents as of September 30, 2018 and 2017. At September 30, 2018 and 2017, cash includes cash on hand and cash in the bank. The Company maintains its cash in accounts held by large, globally recognized banks which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures these deposits up to $250,000. As of September 30, 2018, $13,806,346 of the Company’s cash balance was uninsured. The Company has not experienced any losses on cash.
| 22 |
Fixed Assets
Fixed assets are recorded at cost and depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. Equipment and furniture are depreciated over an estimated useful life of three (3) to five (5) years. Leasehold improvements are depreciated over the lesser of the related lease term or a useful life of ten (10) years. Software is depreciated over an estimated useful life of three (3) years.
Long-Lived Assets
Long-lived assets are evaluated for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value. There was no impairment recorded during the years ended September 30, 2018 and 2017.
Fair Value of Financial Instruments
The Company’s financial instruments consisted primarily of cash, accounts payable and accrued expenses, deferred revenue, convertible note payable, as well as embedded conversion features. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments.
Fair value is focused on an exit price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Within the measurement of fair value, the use of market-based information is prioritized over entity specific information and a three-level hierarchy for fair value measurements is used based on the nature of inputs used in the valuation of an asset or liability as of the measurement date.
The three-level hierarchy for fair value measurements is defined as follows:
| ● | Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; | |
| ● | Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability other than quoted prices, either directly or indirectly, including inputs in markets that are not considered to be active; | |
| ● | Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
The fair values of the embedded conversion features in the Company’s convertible notes and of the warrants issued by the Company were determined using level 2 measurements and are discussed in further detail in Notes 5 and 8, respectively.
Convertible Debt
Convertible debt is accounted for under the guidelines established by 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 or not yet available to the holder. The amount of the beneficial conversion feature may reduce the carrying value of the instrument. The discounts relating to the initial recording of the derivatives or beneficial conversion features are accreted over the term of the debt.
When equity instruments, such as common stock and/or 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.
In the event a convertible note has an embedded conversion feature which, among other features, allows an unlimited number of common shares to be issued upon conversion since the conversion price is based on the quoted market price of the Company’s common stock, the Company records a derivative liability, which is marked to market at each reporting period and charged to the statement of operations in accordance with ASC 815, Accounting for Derivative Financial Instruments and Hedging Activities.
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Customer Concentration
During the years ended September 30, 2018 and 2017, one customer accounted for 100% of revenues. The loss of this customer will have a significant impact on operations.
Revenue Recognition
Software license revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis, and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.” VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period. When the fair value of VSOE of post contract customer support cannot be determined, the revenue is recognized ratably over the contract period. In June 2014, the Company entered into an agreement to provide software and support to a third party for which no VSOE for any elements is known. Since the customer requested additional modifications to the software before it could be used, delivery of the use of the license was not achieved until December 2015. The only remaining undelivered element was post contract support services, and accordingly, the revenues were recognized on a pro rata basis prospectively over the 30 months ending June 10, 2018 per the terms of the related contracts. Deferred revenue results from fees billed to or collected from customers for which revenue has not yet been recognized.
The Company had deferred revenue of $0 and $316,248 as of September 30, 2018 and 2017, respectively.
Research and Development and Software Development Costs
The Company expenses all research and development costs, including patent and software development costs. Our research and development costs incurred for the years ended September 30, 2018 and 2017 were $873,107 and $1,087,372, respectively.
Stock-Based Compensation
The Company measures the cost of services provided by employees and non-employees in exchange for an award of an equity instrument based on the grant-date fair value of the award. All equity awards granted to employees and non-employees during the years ended September 30, 2018 and 2017 were fully vested upon grant. As such, compensation cost was recognized at the time of the grant.
Income Taxes
The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carry-forwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized.
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The Company uses the two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company’s tax positions and tax benefits, which may require periodic adjustments. The Company did not record any liabilities for uncertain tax positions during the years ended September 30, 2018 or 2017.
Basic and Diluted Net Loss per Common Share
Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted 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 earnings 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 September 30, 2018 and 2017, the Company had 1,000,000 and 10,000,000 shares, respectively, of preferred stock outstanding, which are convertible into 1,500,000 and 15,000,000 shares, respectively, of common stock.
Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss. During the year ended September 30, 2018, 25,015,866 warrants and 1,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. During the year ended September 30, 2017, 725,000 warrants and 10,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive.
Going Concern Considerations
The Company has incurred losses and may incur additional losses for the foreseeable future. As of September 30, 2017, the Company required capital to fund losses and repay indebtedness, which raised substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements did not include any adjustments that might result from the outcome of this uncertainty. In 2018, the Company raised capital as discussed in Note 8. Management believes the cash on hand is sufficient to enable the Company to continue in operation through calendar 2019.
Recent Accounting Announcements
The Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the authoritative literature in the ASC. There have been a number of ASUs to date that amend the original text of the ASCs. Other than those discussed below, the Company believes those ASUs 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.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) – Disclosure Framework – Changes to 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 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently in the process of evaluating the effect this guidance will have on its financial statements and related disclosures.
In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting, to expand the scope of 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 substantially aligned. ASU 2018-07 is 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 guidance will have on its financial statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 840), 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 2018-11, Leases (Topic 840): 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 guidance will have on its financial statements and related disclosures.
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In May 2014, the FASB issued 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 updated standard will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. ASU 2014-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently in the process of evaluating the effect that this guidance will have on its financial statements and related disclosures.
NOTE 3 – FIXED ASSETS, NET
As of September 30, 2018 and 2017, fixed assets consisted of the following:
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| Equipment and furniture | $ | 11,042 | $ | 3,355 | ||||
| Leasehold improvements | 10,542 | 10,541 | ||||||
| Software | 9,538 | 2,798 | ||||||
| 31,122 | 16,694 | |||||||
| Accumulated depreciation | (11,072 | ) | (5,524 | ) | ||||
| Fixed assets, net | $ | 20,050 | $ | 11,170 | ||||
Depreciation expense for the years ended September 30, 2018 and 2017 was $5,548 and $5,524, respectively.
NOTE 4 – SOFTWARE LICENSES
Gawk
On June 14, 2014, the Company entered into a license agreement with Gawk to use the Cipherloc engine for $1,125,000 for a period of four (4) years. This customer licensed the CipherShop-Cipherloc encryption software technology and support services. The Company was not required to make significant modifications at the time the contract was executed. Prior to this, the Company had never sold or licensed the CipherShop-Cipherloc encryption software, nor any support services for such. Under the license agreement, the Company was to provide access to its software on an operational basis and provide training. The Company would also provide unspecified upgrades, if and when available, and 24/7 support over the license term. No VSOE was known for any of the elements. After the agreement was executed, the licensee requested modifications to the software because they could not otherwise use the software. The Company made the requested modifications to the software and delivered the finished product in late December 2015, thus delivery had not deemed to have occurred until such date. The contract termination date was not extended beyond the initial date of June 2018. Revenues were recorded from the date of delivery over the remaining term of the agreement or approximately 30 months. For these reasons, revenue is recognized ratably from December 2015 until June 2018. During the years ended September 30, 2018 and 2017, the Company recognized revenues of $316,248 and $467,274, respectively.
NOTE 5 – CONVERTIBLE NOTES PAYABLE
FirstFire Global Opportunities Fund, LLC
On September 26, 2017, the Company issued a convertible note payable to FirstFire Global Opportunities Fund, LLC (“FirstFire”) with a principal amount of $330,000, which included an original issue discount of $30,000. The Company incurred $8,500 in debt issuance costs. The note accrued interest at 5% per annum and was to mature on March 26, 2018. The note was convertible at $2.00 per share, subject to adjustment due to ratchet or down round protection, among other adjustments. The Company also 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 from $2.00 to $1.00 per share and the exercise price of the warrants from $4.50 to $2.00. The amendment also required the Company to issue an additional 87,500 shares of common stock to FirstFire. The Company also received the right to prepay the convertible note at any time from the 151st through the 180th day following September 26, 2017, then the Company could repay FirstFire at 130% multiplied by the outstanding principal amount plus accrued and unpaid interest.
The reduction of the conversion price from $2.00 to $1.00 was deemed to create a beneficial conversion feature, therefore, the Company accounted for the amendment of the FirstFire note using ASC 815, Derivatives and Hedging, and recognized a loss on extinguishment of $358,038 during the three months ended December 31, 2017. The Company also recognized a beneficial conversion feature derivative liability of $320,312 as of the note’s amendment date. The Company valued the beneficial conversion feature derivative liability with the Black-Scholes-Merton valuation model on the date of the amendment using an expected life of one (1) year, volatility of 150%, and risk-free rate of 1.87%.
During the year ended September 30, 2018, the Company recognized a gain of $11,234 related to the change in fair value of the FirstFire beneficial conversion feature derivative liability. The Company valued the beneficial conversion feature derivative liability with the Black-Scholes-Merton valuation model as of March 21, 2018, immediately prior to the settlement of the note as described below, using an expected life of 0.78 years, volatility of 150%, and risk-free rate of 1.71%.
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Additionally, upon the December 20, 2017 amendment of the FirstFire note, the Company recorded a debt discount of $330,000. The Company amortized $312,813 of the debt discount to interest expense during the year ended September 30, 2018. Total interest expense related to the FirstFire note, including the debt discount amortization, was $453,700 for the year ended September 30, 2018.
On March 21, 2018, the Company entered into a settlement agreement with FirstFire, under which FirstFire converted $77,500 of the note payable into 50,000 shares of common stock, and the Company paid $350,000 to satisfy the convertible note payable in full. In connection with the settlement of the FirstFire note, the Company recognized a gain on extinguishment of $194,391.
Peak One Opportunity Fund LP
On December 14, 2017, the Company issued a convertible note payable to Peak One Opportunity Fund LP (“Peak One”) with a principal amount of $300,000. The Company incurred $27,400 in debt issuance costs. The note was to mature on December 14, 2020. The note was convertible at $1.00 per share. 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 at the time of note issuance.
The Company accounted for the Peak One note using ASC 815, Derivatives and Hedging, and recognized a beneficial conversion feature derivative liability of $267,750 as of the note’s issuance date. The Company valued the beneficial conversion feature derivative liability with the Black-Scholes-Merton 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%. The Company also recognized a loss of $486,745 resulting from the excess fair value of the beneficial conversion feature derivative in the Peak One note and of the equity instruments issued with the convertible note.
During the year ended September 30, 2018, the Company recognized a loss of $19,770 related to the change in fair value of the beneficial conversion feature derivative liability. The Company valued the beneficial conversion feature derivative liability with the Black-Scholes-Merton valuation model as of April 30, 2018, immediately prior to the redemption of the note as described below, using an expected life of 1.17 years, volatility of 150%, and risk-free rate of 1.65%.
Additionally, upon issuance of the Peak One note, the Company recorded a debt discount of $300,000. The Company amortized $37,432 of the debt discount to interest expense during the year ended September 30, 2018.
On April 30, 2018, the Company settled the Peak One note for $375,000 and issued 71,429 shares of common stock with a fair value of $103,572 to Peak One. The Company recognized a loss on extinguishment of $153,621.
NOTE 6 – RELATED PARTY TRANSACTIONS
Notes Payable to Chief Executive Officer
In September 2017, the Company’s Chief Executive Officer (“CEO”) issued four notes with an aggregate principal amount of $70,000 to the Company. The notes bore interest at 3% per annum and matured one year from the issuance date. The Company repaid all four notes in full during September 2018. As of September 30, 2018 and 2017, there were no outstanding notes payable to the CEO.
See Note 8 for additional related party transactions.
NOTE 7 – COMMITMENTS AND CONTINGENCIES
Litigation
We are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. A disgruntled former contracted consultant has brought an action in Texas state court against the CEO and the Company, alleging fraud and misrepresentation pertaining to stock and payments, all of which have been paid, and all stock has been delivered to him. He 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 has been assigned to the Company. The claim is frivolous and without merit. The case is being vigorously defended on our behalf by our insurance carrier.
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Leases
The Company leases 3,906 square feet of office space in Buda, Texas. The lease for the Buda office began on March 15, 2016 and continues until March 31, 2019. The current monthly rent payment of $7,542 continues until February 28, 2019. On March 1, 2019, the monthly rent payment increases to $7,705. The lease shall be automatically renewed for two one-year periods at a rate of $7,705 per month from April 1, 2019 through March 31, 2020 and a rate of $7,867 per month from April 1, 2020 until March 31, 2021, unless either party to the lease agreement notifies the other of the intent to terminate the lease in writing at least 180 days prior to the expiration of the current term.
The Company also leases 1,005 square feet of office space in Scottsdale, Arizona. The lease for the Scottsdale office began on July 15, 2018 and continues until July 31, 2021. The current monthly rent payment of $1,608 continues until July 31, 2019. From August 1, 2019 to July 31, 2020, the monthly rent payment increases to $1,656, and from August 1, 2020 to July 31, 2021, the monthly rent payment increases to $1,705.
Future annual minimum lease obligations at September 30, 2018 are as follows:
| Year Ending September 30, | Amount | |||
| 2019 | $ | 111,034 | ||
| 2020 | 113,405 | |||
| 2021 | 64,259 | |||
| $ | 288,698 | |||
Rent expense totaled $99,209 and $91,246 for the years ended September 30, 2018 and 2017, respectively.
NOTE 8 - STOCKHOLDERS’ EQUITY (DEFICIT)
Common Stock
As of September 30, 2018 and 2017, the Company had 40,743,917 and 6,635,127 shares of common stock outstanding, respectively, and was authorized to issue 650,000,000 shares of common stock at a par value of $0.01.
Common Stock Issued for Cash
During the year ended September 30, 2018, through the utilization of PPMs and upon receipt of executed Subscription Agreements, the Company issued 18,909,900 shares of common stock for $16,625,238 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D.
During the year ended September 30, 2017, through the utilization of PPMs and upon receipt of executed Subscription Agreements, the Company issued 724,000 shares of common stock for $1,383,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D.
Common Stock Issued to Officers and Employees
During the year ended September 30, 2018, the Company issued 766,033 fully vested shares of common stock with a fair value of $1,472,601 to its officers and other employees as part of their compensation. Of this amount, $950,056 was recorded in general and administrative expenses, $279,500 was recorded in sales and marketing expenses, and $243,045 was recorded in research and development expenses.
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During the year ended September 30, 2017, the Company issued 542,268 fully vested shares of common stock with a fair value of $2,783,922 to its officers and other employees as part of their compensation. Of this amount, $2,192,200 was recorded in general and administrative expenses, $93,748 was recorded in sales and marketing expenses, and $536,515 was recorded in research and development expenses.
Common Stock Issued for Services
During the year ended September 30, 2018, the Company issued 10,000 shares of fully vested common stock with a fair value of $15,000 to Magnolia Investor Relations for investor relations services rendered.
During the year ended September 30, 2017, the Company issued 25,000 shares of fully vested common stock with a fair value of $74,500 to StockVest for investor relations services.
Common Stock Issued for Settlement
During the year ended September 30, 2018, the Company issued 50,000 shares of fully vested common stock with a fair value of $81,000 for to settle a legal matter by two shareholders who claimed that they were entitled to 125,000 shares of common stock because of funds allegedly paid to the Company and promises allegedly made by the Company. The Company denied these allegations and settled the matter for 50,000 shares of common stock.
Common Stock Issued for License Termination
During the year ended September 30, 2017, the Company issued 25,000 shares of fully vested common stock with a fair value of $106,250 for a software termination settlement.
Common Stock Issued with Convertible Notes
During the year ended September 30, 2018, the Company issued 275,000 and 71,429 shares of fully vested common stock in connection with the issuance and redemption, respectively, of the Peak One note. The Company also issued 87,500 and 50,000 shares of common stock in connection with the amendment and conversion, respectively, of the FirstFire note. Refer to Note 5 for further discussion.
During the year ended September 30, 2017, the Company issued 50,000 shares of fully vested common stock in connection with the issuance of the FirstFire note. Refer to Note 5 for further discussion.
Preferred Stock
As of September 30, 2018 and 2017, the Company had 1,000,000 and 10,000,000 shares of restricted preferred stock outstanding, respectively, and was authorized to issue 10,000,000 shares of preferred stock at a par value of $0.01. Each share of preferred stock is convertible into the Company’s common stock at a rate of one (1) preferred share to 1.5 common shares. Each share of preferred stock has 1.5 votes on all matters presented to be voted by the holders of common stock. The holders of preferred stock can only convert the shares if agreed to by the Board of Directors. If declared by the Board of Directors, holders of preferred 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.
During the year ended September 30, 2018, the Company’s Chief Executive Officer converted 9,000,000 shares of preferred stock into 13,500,000 shares of common stock.
Warrants
During the year ended September 30, 2018, the Company issued warrants to purchase 75,000 shares of common stock in connection with the Peak One convertible note discussed in Note 5. These warrants were issued with an exercise price of $2.00 and a term of five years. The Company valued these warrants at $90,345 with the Black-Scholes-Merton valuation model using an expected life of five years, volatility of 150%, and risk-free rate of 2.14%.
Additionally, in connection with shares sold through a PPM, the Company issued warrants to purchase 144,000 shares of common stock. These warrants were issued with an exercise price of $4.50 and a term of two years. The Company valued these warrants at $93,198 with the Black-Scholes-Merton valuation model using an expected life of two years, volatility of 150%, and risk-free rates ranging from 1.89% to 2.27%.
Lastly, in connection with shares sold through an additional PPM, the Company issued warrants to purchase 18,837,900 shares of common stock. These warrants were issued with an exercise price of $1.20 and a term of five years.
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During the year ended September 30, 2017, the Company issued warrants to purchase 165,000 shares of common stock in connection with the FirstFire convertible note discussed in Note 5. These warrants were issued with an exercise price of $4.50 per share with a term of two years. In December 2017, the FirstFire convertible note was amended to, among other things, lower the warrants’ exercise price to $2.00 per share. The Company re-valued the warrants at $158,268 with the Black-Scholes-Merton valuation model using an expected life of two years, volatility of 150%, and risk-free rate of 1.87%.
Additionally, during the year ended September 30, 2017, in connection with shares purchased through a PPM, the Company issued warrants to purchase 560,000 shares of common stock. These warrants were issued with an exercise price of $4.50 and a term of two years.
Warrant activity for the years ended September 30, 2018 and 2017 is as follows:
| Number of Warrants | Weighted Average Exercise Price | Weighted Average Remaining Life | ||||||||||
| Outstanding at September 30, 2016 | — | $ | — | — | ||||||||
| Granted | 725,000 | 4.50 | 2.00 | |||||||||
| Exercised | — | — | — | |||||||||
| Canceled/Forfeited | — | — | — | |||||||||
| Outstanding at September 30, 2017 | 725,000 | 4.50 | 1.88 | |||||||||
| Granted | 25,033,366 | 1.18 | 5.99 | |||||||||
| Exercised | (742,500 | ) | 1.20 | 1.50 | ||||||||
| Canceled/Forfeited | — | — | — | |||||||||
| Outstanding at September 30, 2018 | 25,015,866 | $ | 1.27 | 5.83 | ||||||||
NOTE 9 - INCOME TAXES
The provision (benefit) for income taxes from continued operations for the years ended September 30, 2018 and 2017 consist of the following:
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| Current: | ||||||||
| Federal | $ | — | $ | — | ||||
| State | — | — | ||||||
| $ | — | $ | — | |||||
| Deferred: | ||||||||
| Federal | $ | (2,558,000 | ) | $ | (781,817 | ) | ||
| State | — | — | ||||||
| (2,558,000 | ) | (781,817 | ) | |||||
| Valuation allowance | 2,558,000 | 781,817 | ||||||
| Provision (benefit) for income taxes, net | $ | — | $ | — | ||||
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The difference between income tax expense computed by applying the federal statutory corporate tax rate and actual income tax expense is as follows:
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| Statutory federal income tax rate | 21.0 | % | 34.0 | % | ||||
| Non-deductible stock-based compensation | (7.0 | ) | (16.0 | ) | ||||
| Change in statutory tax rate | (19.0 | ) | — | |||||
| Valuation allowance | 5.0 | (18.0 | ) | |||||
| Effective tax rate | 0.0 | % | 0.0 | % | ||||
Deferred income taxes result from temporary differences in the recognition of income and expenses for the financial reporting purposes and for tax purposes. The tax effect of these temporary differences representing deferred tax asset and liabilities result principally from the following:
| September 30, | ||||||||
| 2018 | 2017 | |||||||
| Net operating loss carry forward | $ | 3,536,000 | $ | 4,725,000 | ||||
| Deferred compensation | 3,747,000 | — | ||||||
| Valuation allowance | (7,283,000 | ) | (4,725,000 | ) | ||||
| Deferred income tax asset | $ | — | $ | — | ||||
The Company has a net operating loss carry forward of $16.8 million available to offset future taxable income. Of which, $2.6 million will expire within the next five years, and the remaining $14.2 million will expire thereafter. For income tax reporting purposes, the Company’s aggregate unused net operating losses were subject to the limitations of Section 382 of the Internal Revenue Code, as amended. The Company has provided a valuation reserve against the full amount of the net operating loss benefit, because in the opinion of management based upon the earning history of the Company; it is more likely than not that the benefits will not be realized. For income tax reporting purposes, Management has determined that net operating losses prior to February 5, 2015 are subject to an annual limitation of approximately $600,000.
For the years ended September 30, 2018 and 2017, the difference between the amounts of income tax expense or benefit that would result from applying the statutory rates to pretax income to the reported income tax expense of $0 is the result of the net operating loss carry forward and the related valuation allowance, as well as non-deductible stock-based compensation.
The Company anticipates it will continue to record a valuation allowance against the losses of certain jurisdictions, primarily federal and state, until such time as it is able to determine it is “more-likely-than-not” the deferred tax asset will be realized. Such position is dependent on whether there will be sufficient future taxable income to realize such deferred tax assets. The Company’s effective tax rate may vary from period to period based on changes in estimated taxable income or loss by jurisdiction, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction.
The Company has not filed its federal income tax returns since 2012, which is through the fiscal year ending September 30, 2013. The Company is preparing the 2013 through 2016 filings, which report activity for the fiscal years ending September 30, 2014 through 2017. The September 30, 2018 tax return is not due at this time. The Company intends to remediate the lack of filing timely tax returns immediately. There are currently no ongoing tax examinations.
On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was signed into law in the U.S. The Tax Act has resulted in significant changes to the U.S. corporate income tax system. These changes include a federal statutory rate reduction from 35% to 21%, the elimination or reduction of certain domestic deductions and credits, and limitations on the deductibility of interest expense and executive compensation. These changes were effective beginning in 2018.
NOTE 10 - SUBSEQUENT EVENTS
On October 4, 2018, the Company executed a lease for 3,859 square feet of office space in Scottsdale, Arizona. The lease has a term of three years, commencing on November 1, 2018. The monthly rent is $6,432 for the first year and increases to $6,753 for the second year and $7,075 for the third year. The Company will, within the next fiscal year, move its corporate headquarters to this location from its current location in Buda, Texas. The Company has reduced the size of its Buda, Texas facility and will continue to maintain the facility for its research and development activities. The lease for the existing office space in Scottsdale, Arizona will not be renewed.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
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 have not been formally designed and evaluated 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 September 30, 2018, 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 Annual 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, 2018, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our internal control over financial reporting as of September 30, 2018 and concluded that we did not maintain effective internal control over financial reporting as of September 30, 2018 due to the lack of a formal evaluation that has been performed by us and the identification of material weaknesses.
Management has still identified some deficiencies in the design and operating effectiveness of the Company’s internal controls as of September 30, 2018 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 inadequate monitoring and review controls over financial reporting and disclosures, leading to a delinquent quarterly filing, inadequate monitoring and review controls over transaction processing, the inability to prove delivery of software, and insufficient written policies and procedures for accounting and financial reporting.
Remediation Plan
Management executed a remediation plan to address the material weaknesses discussed above. These remediation efforts are focused on:
| ● | Enhancing monitoring and review controls over financial reporting and disclosures; | |
| ● | Enhancing review and approval controls around transaction processing; | |
| ● | Enhancing controls around proving the delivery of software; and | |
| ● | Enhancing and maintaining written policies and procedures for accounting and financial reporting. |
During the year ended September 30, 2018, management retained appropriate resources familiar with financial and SEC reporting requirements and added additional accounting resources to provide adequate segregation of duties.
Subsequent to September 30, 2018, management designed and implemented review and approval controls around transaction processing, including written policies and procedures. In addition, management has continued to train key accounting staff to improve controls that will 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 during the 2019 fiscal year.
Changes in Internal Control over Financial Reporting
During the year ended September 30, 2018, there were no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, other than the remediation actions discussed above.
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; |
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| ● | 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.
There are no events required to be disclosed by this Item.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Directors and Executive Officers
Set forth below is information regarding the Company’s current directors and executive officers. There are no family relationships between any of our directors or executive officers. The directors are elected annually by stockholders. The executive officers serve at the pleasure of the Board of Directors.
| Name | Age | Title | ||
| Michael De La Garza | 60 | Chairman, Chief Executive Officer | ||
| Albert Carlson, PhD | 59 | Director, Chief Scientific Officer | ||
| Sammy Davis DrPH | 71 | Director | ||
| Milton Mattox | 56 | Chief Operating Officer |
The Chief Executive Officer, directors, and officers of the Company will hold office until additional members or officers are duly elected and qualified. The background and principal occupations of the directors and officers of the Company are as follows:
Michael De La Garza, 60 years of age, is the Company’s Chairman and Chief Executive Officer. Mr. De La Garza has 25 years’ experience in the software industry as an executive officer and founder of numerous companies both private and publicly traded. His career started in 1991 as the COO of a medical imaging company and subsequently founded or co-founded three other software companies where he served as President and/or CEO. Michael studied computer science at Southwest Texas State University and received a Computer Science Technical degree from Danforth Technical College in 1980.
Albert Carlson, PhD, 59 years of age, serves as a Director and the Company’s Chief Scientific Officer. Dr. Carlson oversees the development of the Company’s Cipherloc suite of products and reports directly to the Chief Executive Officer. Dr. Carlson created and led teams advancing the state-of-the-art in more than six embedded, computer, and electrical engineering sectors, creating new markets, products, and value for exploitation. He has extensive experience in on-time design to delivery while remaining under budget at all levels of engineering. Additionally, he has worked in many areas of engineering and has focused extensive world knowledge, as well as deep algorithmic, set theory, mathematical, and design expertise. Dr. Carlson holds a PhD in Computer Science from the University of Idaho.
Sammy Davis DrPH, 71 years of age, serves as a Director of the Company. Dr. Davis has over 20 years’ experience in operations, finance, budgeting, financial reporting, revenue cycle management, inventory, payroll, accounts receivable and payable, and information systems in the healthcare industry. He has held numerous managerial positions as the Chief Executive Officer and Administrator. Dr. Davis holds a Doctor of Public Health degree from the University of Texas.
Milton Mattox, 56 years of age, serves as the Company’s Chief Operating Officer. Mr. Mattox is an experienced, senior technology executive with an extensive background in software engineering, application development, IT infrastructure, and offshore research and development team management. His accomplishments include transforming and accelerating technology development and delivery in alignment with worldwide business goals. His professional experience includes an executive vice president position at Lucent Technologies with executive-level experience at Intuit, Mitel, SHPS, Narus India, Signa, and CGI. Mr. Mattox holds a Doctorate in Organization and Leadership from the University of San Francisco, an MBA from City University of Seattle, and a Bachelor of Science in Electronic Engineering Technology from DeVry University.
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Audit Committee
The Company does not have an audit committee.
Conflicts of Interest
Members of our management are associated with other firms involved in a range of business activities. Consequently, there are potential inherent conflicts of interest in their acting as officers and directors of our company. Although the directors are engaged in other business activities, we anticipate they will devote an important amount of time to our affairs.
Our officers and directors are now and may in the future become shareholders, officers or directors of other companies, which may be formed for the purpose of engaging in business activities similar to ours. Accordingly, additional direct conflicts of interest may arise in the future with respect to such individuals acting on behalf of us or other entities. Moreover, additional conflicts of interest may arise with respect to opportunities which come to the attention of such individuals in the performance of their duties or otherwise. Currently, we do not have a right of first refusal pertaining to opportunities that come to their attention and may relate to our business operations.
Our officers and directors are, so long as they are our officers or directors, subject to the restriction that all opportunities contemplated by our plan of operation which come to their attention, either in the performance of their duties or in any other manner, will be considered opportunities of, and be made available to us and the companies that they are affiliated with on an equal basis. A breach of this requirement will be a breach of the fiduciary duties of the officer or director. If we or the companies with which the officers and directors are affiliated both desire to take advantage of an opportunity, then said officers and directors would abstain from negotiating and voting upon the opportunity. However, all directors may still individually take advantage of opportunities if we should decline to do so. Except as set forth above, we have not adopted any other conflict of interest policy with respect to such transactions.
Code of Ethics
We have adopted a code of ethics that applies to all of our executive officers, directors and employees. Code of ethics codifies the business and ethical principles that govern all aspects of our business. This document will be made available in print, free of charge, to any shareholder requesting a copy in writing from the Company. A form of the code of conduct and ethics was filed as Exhibit 14.1 to the Annual Report on Form 10-K for the year ended September 30, 2004.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following tables set forth certain information concerning all compensation paid, earned or accrued for service by (i) our Principal Executive Officer and Principal Financial Officer and (ii) all other executive officers who earned in excess of $100,000 in the fiscal years ended September 30, 2018 and 2017, and each of the other two most highly compensated executive officers of the Company who served in such capacity at the end of the fiscal year whose total salary and bonus exceeded $100,000 (collectively, the “Named Executive Officer”):
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2018 AND 2017 SUMMARY COMPENSATION TABLE
| Name and Position | Year | Salary ($) | Bonus ($) | Stock Awards ($) | All Other Compensation ($) | Change in Pension Value and Nonqualified Deferred Compensation Earnings ($) | Total ($) | |||||||||||||||||||||
| Michael De La Garza | ||||||||||||||||||||||||||||
| Chairman & | 2018 | $ | 360,000 | $ | 60,000 | $ | 600,000 | $ | 40,200 | (i) | — | $ | 1,060,200 | |||||||||||||||
| Chief Executive | 2017 | $ | 360,000 | $ | 60,000 | $ | 1,633,000 | $ | 54,000 | (i) | — | $ | 2,107,000 | |||||||||||||||
| Officer | ||||||||||||||||||||||||||||
| Albert Carlson, PhD | ||||||||||||||||||||||||||||
| Director & | 2018 | $ | 150,000 | $ | 20,000 | $ | 100,000 | — | — | $ | 270,000 | |||||||||||||||||
| Chief Scientific Officer | 2017 | $ | 150,000 | — | — | — | — | $ | 150,000 | |||||||||||||||||||
| Sammy Davis, DrPH | 2018 | — | — | $ | 20,000 | — | — | $ | 20,000 | |||||||||||||||||||
| Director | 2017 | — | — | — | — | — | — | |||||||||||||||||||||
| Milton Mattox | 2018 | $ | 30,000 | — | — | — | — | $ | 30,000 | |||||||||||||||||||
| Chief Operating | 2017 | — | — | — | — | — | — | |||||||||||||||||||||
| Officer | ||||||||||||||||||||||||||||
(i) All other compensation consists primarily of remunerations for auto and health insurance costs.
Compensation of Directors
Our current compensation policy for directors is to compensate them through common stock as consideration for their joining our board and/or providing continued services as a director. We do not currently provide our directors with cash compensation, although we do reimburse their expenses, with exception for the chairman of the board. No additional amounts are payable to the Company’s directors for committee participation or special assignments. There are no other arrangements pursuant to which any directors were compensated during the Company’s last completed fiscal year for any service provided except as follows:
Employment Contracts
We have an employment agreement with Albert Carlson as our Chief Scientific Officer. The agreement is for a term of one year, commencing on September 1, 2015 and initially expiring on August 31, 2016 with three one-year extensions. The Agreement provides that, in addition to receiving paid vacation in accordance with the Company’s policies as well as other customary benefits and provisions, Dr. Carlson shall receive an annual base salary of $150,000. If, at any time during the term of the Agreement, Dr. Carlson is terminated “without cause,” he will be entitled to receive a cash payment equal to the aggregate compensation payable to him during the remaining term of the Agreement. The terms of the employment agreement are incorporated by reference and was filed with our Form 8-K on September 4, 2015.
The Company entered into an employment agreement with its Chief Executive Officer on January 1, 2013. The employment agreement will expire on January 1, 2018 and shall automatically renew for another five years unless terminated in accordance with the provisions of the employment agreement. The employment agreement provides for:
| i. | A monthly salary of $20,833 per month subject to an annual increase of 10% per year and consistent with the Company policy applicable to other senior executives and officers and approval by the Board of Directors. During the year ended September 30, 2018, the base salary was $360,000. | |
| ii. | A cash bonus of 25% of his annual base salary each year if the Company reaches the following milestones: |
| a. | The Company posts annual gross revenues on a consolidated basis of at least $5,000,000; | ||
| b. | The Company’s earnings before the deduction of income taxes and amortization expenses (“EBITA”), including cash extraordinary items but before officer’s bonuses, on a consolidated basis for any year is at least $1,000,000; |
| iii. | An automobile allowance of $1,500 per month. | |
| iv. | A medical insurance allowance of $1,500 per month. | |
| v. | In the event the executive’s employment is terminated without cause he will receive the entire contract remaining on the agreement. |
The Company has removed other provisions from the original employment agreement.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table lists stock ownership of our common stock as of September 30, 2018 based on 40,743,917 shares of common stock issued and outstanding. The information includes beneficial ownership by (i) holders of more than 5% of our Common Stock, (ii) each of our directors and executive officers, and (iii) all of our directors and executive officers as a group. Except as noted below, to our knowledge, each person named in the table has sole voting and investment power with respect to all shares of our common stock beneficially owned by them.
| Name and Address of Beneficial Owners (1) | Nature
of Beneficial Ownership (2) | Amount | Percent Ownership | |||||||
| Michael De La Garza | Common Stock | 14,430,000 | 35.9 | % | ||||||
| Including MSR, LLC | Common Stock | 207,757 | ||||||||
| c/o Cipherloc | ||||||||||
| 825 Main St, Suite 100 | ||||||||||
| Buda, TX 78610 | ||||||||||
| Albert Carlson, PhD | Common Stock | 153,668 | 0.4 | % | ||||||
| c/o Cipherloc | ||||||||||
| 825 Main St, Suite 100 | ||||||||||
| Buda, TX 78610 | ||||||||||
| Sammy Davis, DrPH | Common Stock | 10,000 | 0.0 | % | ||||||
| c/o Cipherloc | ||||||||||
| 825 Main St, Suite 100 | ||||||||||
| Buda, TX 78610 | ||||||||||
| Milton Mattox | Common Stock | — | 0.0 | % | ||||||
| c/o Cipherloc | ||||||||||
| 825 Main St, Suite 100 | ||||||||||
| Buda, TX 78610 | ||||||||||
| All Officers and Directors | ||||||||||
| As a Group (4 persons) | Common Stock | 14,801,425 | 36.3 | % | ||||||
1. C/o our address, 825 Main Street, Suite 100, Buda, TX 78610 unless otherwise noted.
2. Except as otherwise indicated, we believe that the beneficial owners of common stock listed above, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants but are not deemed outstanding for purposes of computing the percentage of any other person. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities.
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Changes in Control
We are not aware of any arrangements that may result in a change in control of the Company.
Description of Securities
General
On April 11, 2011, the Company amended its articles of incorporation to increase the authorized common shares to 650,000,000 shares, at $0.01 par value. There were 40,743,917 shares of common stock issued and outstanding as of September 30, 2018.
Common Stock
The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds. The dividend rights of our common stock are junior to any preferential dividend rights of any outstanding shares of preferred stock. The holders of our common stock also are entitled to receive distributions upon our liquidation, dissolution or winding up of our assets that are legally available for distribution, after payment of all debt and other liabilities and distribution in full of preferential amounts, if any, to be distributed to holders of our preferred stock.
The holders of our common stock are not entitled to preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of any series of preferred stock that we may designate and issue in the future.
Preferred Stock
The Company has authorized 10,000,000 shares of preferred stock, at $0.01 par value and 1,000,000 shares were issued and outstanding as of September 30, 2018. The Corporation established and designates the rights and preferences of a Series A Convertible Preferred Stock. Each share of the Preferred Stock shall have 1.5 votes on all matters presented to be voted by the holders of our common stock.
The issuance of preferred stock by our board of directors could adversely affect the rights of holders of the common stock by, among other things, establishing preferential dividends, liquidation rights or voting powers. See “Risk Factors” in Item 1A above.
Voting Rights
Each holder of common stock is entitled to one vote for each share of common stock held on all matters submitted to a vote of stockholders. Preferred A shareholders are entitled to 1.5 votes per share.
Dividends
Subject to preferences that may be applicable to any then-outstanding shares of Preferred Stock, if any, and any other restrictions, holders of common stock are entitled to receive ratably those dividends, if any, as may be declared from time to time by the Company’s board of directors out of legally available funds. The Company and its predecessors have not declared any dividends in the past. Further, the Company does not presently contemplate that there will be any future payment of any dividends on common stock.
Amendment of our Bylaws
Our bylaws may be amended or repealed by the affirmative vote of a majority of our outstanding shares. Subject to applicable law, our bylaws also may be amended or repealed by our board of directors.
Transfer Agent
Pacific Stock Transfer serves in the capacity of the Company’s transfer agent. Their mailing address is Pacific Stock Transfer, 4045 South Spencer #403, Las Vegas, NV 89119, and their telephone number is (702) 361-3033.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
None.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. The aggregate fees billed by dbbmckennon for the audit of the Company’s annual financial statements were $60,209 and $54,500 for the fiscal years ended September 30, 2018 and 2017, respectively.
Audit-Related Fees. The aggregate fees billed by dbbmckennon, for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements for the fiscal years ended September 30, 2018 and 2017 and that are not disclosed in the paragraph captioned “Audit Fees” above, were $0.
Tax Fees. The aggregate fees billed by dbbmckennon for professional services rendered for tax compliance, tax advice and tax planning for the fiscal years ended September 30, 2018 and 2017 were $0.
All Other Fees. The aggregate fees billed by dbbmckennon for products and services, other than the services described in the paragraphs “Audit Fees,” “Audit-Related Fees,” and “Tax Fees” above for the fiscal year ended September 30, 2018 and 2017 were $0.
The Board of Directors has received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and has discussed with its auditors its independence from the Company. The Board of Directors has considered whether the provision of services other than audit services is compatible with maintaining auditor independence.
Based on the review and discussions referred to above, the Board of Directors approved the inclusion of the audited financial statements be included in the Company’s Annual Report on Form 10-K for its 2018 fiscal year for filing with the SEC.
The Board of Directors pre-approved all fees described above.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| 3.1 | Articles of Incorporation Incorporated by reference to the Registrant’s Form 10-SB filed on or about January 3, 2000. | |
| 3.2 | Bylaws Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended December 31, 2000 and filed on or about February 14, 2001. | |
| 3.3 | Amendment to the Articles of Incorporation indicating name change and reverse stock split as set out in Registrant’s Form 8-K dated and filed on March 23, 2015. | |
| 4.1 | S-8 Registration Filed on June 2, 2014 and by reference incorporated herein. | |
| 4.2 | S-8 Registration Filed on October 27, 2016 and by reference incorporated herein. | |
| 5.1 | Legal opinion of Carl P. Ranno included in the S-8 Registration filed on June 2, 2014. | |
| 5.2 | Legal opinion of Carl P. Ranno included in the S-8 Registration filed on October 27, 2016. |
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| 40 |
| 41 |
| 42 |
In accordance with 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.
| Registrant | Cipherloc Corporation | |
| Date: December 31, 2018 | By: | /s/ Michael De La Garza |
| Michael De La Garza | ||
| Chairman, Chief Executive Officer (Principal Executive Officer), President | ||
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
| Date: December 31, 2018 | By: | /s/ Michael De La Garza |
| Michael De La Garza | ||
| Chairman |
| Date: December 31, 2018 | By: | /s/ Albert Carlson |
| Albert Carlson | ||
| Director |
| Date: December 31, 2018 | By: | /s/ Sammy Davis |
| Sammy Davis | ||
| Director |
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EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO THE SECURITIES EXCHANGE ACT OF 1934
RULES 13A-14 AND 15D-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES–OXLEY ACT OF 2002
In connection with the Annual Report of Cipherloc Corporation (the “Company”) on Form 10-K for the fiscal year ending September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael De La Garza, Chief Executive Officer and President of the Company, certify, pursuant to Rules 13a-14 and 15-d14 of the Securities Exchange Act of 1934 (the “Exchange Act”), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, that:
I have reviewed this annual report on Form 10-K of Cipherloc Corporation,
| 1. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 2. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; |
| 3. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the small business issuer and have: |
| a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | |
| b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | |
| c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and | |
| d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and | |
| 4. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| 1. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and | |
| 2. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| By: | /s/ Michael De La Garza | |
| Michael De La Garza | ||
| Chief Executive Officer (Principal Executive Officer) | ||
| December 31, 2018 |
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO THE SECURITIES EXCHANGE ACT OF 1934,
RULES 13a-14 AND 15d-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Cipherloc Incorporated (the “Company”) on Form 10-K for the fiscal year ending September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael De La Garza, Acting Chief Financial Officer of the Company, certify, pursuant to Rules 13a-14 and 15-d14 of the Securities Exchange Act of 1934 (the “Exchange Act”), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, that:
| I have reviewed this annual report on Form 10-K of Cipherloc Corporation | |
| 1. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 2. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; |
| 3. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the small business issuer and have: |
| a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | |
| b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | |
| c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and | |
| d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and | |
| 4. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| 1. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and | |
| 2. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. | |
| By: | /s/ Michael De La Garza | |
| Michael De La Garza | ||
| Acting Chief Financial Officer (Principal Financial Officer) | ||
| December 31, 2018 |
Exhibit 32.1
CERTIFICATION
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Cipherloc Corporation (the “Company”) on Form 10-K for the year ended September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael De La Garza, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| (1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| By: | /s/ Michael De La Garza | |
| Michael De La Garza | ||
| Chief Executive Officer (Principal Executive Officer) | ||
| December 31, 2018 |
Exhibit 32.2
CERTIFICATION
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Cipherloc Corporation (the “Company”) on Form 10-K for the year ended September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael De La Garza, Acting Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| (1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| By: | /s/ Michael De La Garza | |
| Michael De La Garza | ||
| Acting Chief Financial Officer (Principal Financial Officer) | ||
| December 31, 2018 |