Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1.  Organization, Recent History, and Description of Businesses-Past and Present

Description of Businesses: Present and Recent Past

IronClad Encryption Corporation (formerly Butte Highlands Mining Corporation) is a company developing and licensing cyber software technology to secure data files (stored and at rest) and electronic communications (in motion from electronic transmission over the internet or through telephone systems).  Data at rest and in motion are both safeguarded from unauthorized access through the use of dynamic encryption and perpetual authentication.

InterLok Key Management, Inc. (“InterLok”, formerly InterLok Key Management, LLC) is the company that initially developed and maintained the patents and was formed in Texas on June 12, 2006 and incorporated ten years later on June 16, 2016.

On January 6, 2017 InterLok entered into a Share Exchange Agreement ("Share Exchange") with Butte Highlands Mining Company.  Under the terms of the agreement, the shareholders of InterLok Key Management, Inc. exchanged all 56,655,891 outstanding shares of InterLok’s common stock for 56,655,891 shares of Class A common stock of Butte Highlands Mining Company.

The Share Exchange was treated as a “reverse merger” with InterLok Key Management, Inc. which is deemed—for accounting recognition purposes—as the accounting acquirer and Butte Highlands Mining Company deemed the accounting acquiree under the acquisition method of accounting.  The reverse merger is deemed a recapitalization and the consolidated financial statements represent the substantive continuation of the operations and thus the prior year financial statements of operations are the operating results of its subsidiary InterLok Key Management, Inc., while the capital structure (in terms of authorized preferred and common stock) of its parent Butte Highlands Mining Company remains intact.

Subsequently, the company was renamed IronClad Encryption Corporation to better identify with IronClad’s products and services.

IronClad Encryption Corporation is a next-generation cyber defense company that secures digital assets and communications across a wide range of industries and technologies.  IronClad Encryption-powered solutions use our patented Dynamic Encryption and Perpetual Authentication technologies to make all known key-based encryption technologies virtually impossible to compromise.  Dynamic Encryption Technology eliminates vulnerabilities caused by exposure of any single encryption key by continuously changing encryption keys and keeping the keys synchronized in a fault-tolerant manner.

Perpetual Authentication Technology uses multiple virtual channels for encryption so that in the event one channel is compromised, the other channels maintain encryption integrity.  Together, these technologies not only eliminate the single point of failure problem created by having keys exposed through brute force, side channel, or other types of attack, but do so with very low latency and system performance overhead.  Developers, MSPs, MSSPs and IT organizations can now easily and effectively integrate ultra-secure authentication and encryption measures across essentially all mediums.  This includes the latest processors and operating systems, legacy hardware and software, within or between networks, and on compartmentalized data or entire databases.

History

The “Company” is the term used in these statements and notes to refer to the entity originally incorporated in the State of Delaware in 1929.  The registered name of the Company until early in 2017 was Butte Highlands Mining Company (“Butte”).

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Butte was formed to explore and mine primarily for gold in the Butte Highlands’ “Only Chance” mine, south of Butte, Montana.  Butte ceased operating as a mining company in 1942.  The Company was reorganized in October 1996 for the purpose of acquiring and developing additional mineral properties.  At the time of the 1996 reorganization, stockholders representing approximately 76% of the outstanding capital stock could not be located.  In order to obtain the voting quorum necessary for the special meetings of shareholders to authorize the reorganization, Butte obtained an order from the Superior Court of Spokane County, Washington appointing a trustee for the benefit of those stockholders who could not be located.

By May 17, 2007, eleven years after the reorganization and very limited results from its mining activities, the Company had disposed of all of its historical mineral properties or mining claims and eventually became a “shell company” under the rules of the Securities and Exchange Commission (“SEC”).

In 2009, Butte registered under the Securities Exchange Act of 1934, as amended, for the purpose of becoming a reporting company.  The Company’s common stock then became listed on the OTCBB, but in time the Company also listed its common stock to trade on the OTC QB electronic market, one of the OTC Markets Group over-the-counter markets, where the Company’s common stock is now listed.

Then, following ten years of being a shell company with only nominal activity and limited cash or other assets, the business focus of Butte changed early in 2017.  Most notably the Company raised significant capital to implement its new business and financial plans to further develop the licensing and commercial use of its patented encryption software.  The change caused Butte to lose its previous shell company status.

The Company also changed its state of incorporation to Nevada and its name to IronClad Encryption Corporation (“IronClad”) and changed the stock symbol from BTHI to IRNC to more appropriately reflect the fundamental change of its business to developing cyber encryption technology and away from its historical mining activities.  On October 16, 2017, the Company redomiciled in Delaware from Nevada and adopted a certificate of incorporation and bylaws as a Delaware corporation.  The terms “Company”, “IronClad” and “Butte” all refer to the same individual corporate entity, but the uses of the IronClad and Butte names are used to refer to different eras of the Company’s long history.  The historical eras generally coincide with the changes in business focus before and after the first weeks of 2017.

The business changes are a result of a common stock exchange transaction, accounted for as a “reverse merger”, between Butte and the owners of InterLok Key Management, Inc. (at the time an independent and privately-held Texas corporation) whereby InterLok became a wholly-owned subsidiary of Butte.  Butte issued shares of its common stock in exchange for acquiring all of the common stock of InterLok.  Through December 31, 2017, InterLok was the only subsidiary of the Company and InterLok’s patents and line of business now are the main basis of the business of the Company on a consolidated basis.  During the transition three month period ended March 31, 2018; the Company incorporated a new wholly owned subsidiary IronClad Pipeline IC, Inc. (“Pipeline”).

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of IronClad and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.  The above unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information

Accordingly, these unaudited interim consolidated financial statements do not include all of the disclosures required by generally accepted accounting principles in the United States of America for complete financial statements and the rules of the SEC.  These unaudited interim consolidated financial statements should

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

be read in conjunction with the Company’s audited financial statements for the three month transition period ended March 31, 2018 (or for the year ended December 31, 2017).

In the opinion of management, the unaudited interim consolidated financial statements furnished here include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.  Operating results for the nine month period ended December 31, 2018 are not necessarily indicative of the results that may be expected for the year ending March 31, 2019.

Note 2.  Summary of Significant Accounting Policies

This summary of significant accounting policies is presented to assist in understanding the Company’s consolidated financial statements.  The financial statements and notes are representations of the Company’s management which is responsible for their integrity and objectivity.  These accounting policies conform to accounting principles generally accepted in the United States and have been consistently applied in the preparation of the financial statements.

Going Concern

As shown in the accompanying financial statements, the Company has incurred cumulative operating losses since inception. As of December 31, 2018, the Company has limited financial resources with which to achieve its objectives and attain profitability and positive cash flows from operations.  As shown in the accompanying balance sheets and statements of operations, the Company has an accumulated deficit of $24,650,338. The Company's working capital deficit is $4,981,513 (current assets minus current liabilities; current liabilities in this case being greater than current assets).

Achievement of the Company's objectives will depend on its ability to obtain additional financing, to generate revenue from current and planned business operations, and to effectively manage product and software development, operating and capital costs.  The Company is in a development stage and has generated no operating revenue, profits or positive cash flows from operations (except for operations related to IronClad Pipeline IC, Inc. which are now discontinued).

The Company plans to fund its future operations by potential sales of its common stock or by issuing debt securities.  However, there is no assurance that IronClad will be able to achieve these objectives, therefore substantial doubt about its ability to continue as a going concern exists.  The financial statements do not include adjustments relating to the recoverability of recorded assets nor the implication of associated bankruptcy costs should IronClad be unable to continue as a going concern.

Revenue Recognition and Trade Accounts Receivable

The Company recognizes revenue in accordance with ASC 606 — Revenue From Contracts With Customers .  We recognize revenue when we have identified a contract with a customer, identify the performance obligations in the contract, determine the transaction prices, when we allocate the transaction prices to the performance obligation in the contract and we recognize revenue when or as the Company satisfies the performance in the contract.  Revenues for the three and nine month periods were recognized as services were performed and invoiced to the customer based on the standard hourly rates agreed to in the terms of the contract.

We record trade accounts receivable at net realizable value where appropriate.  This value includes an appropriate allowance for estimated uncollectible accounts, if any, to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts.  While the Company does have an exposure to a concentration of credit risk (of one customer at this point) we view the risk is limited due the

Table of Contents

IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

financial strength and liquidity of the multi-billion dollar energy customer that has operated profitably for over a century.

Fair Value Measures

The Company's financial instruments, as defined by the Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) 825-10-50 Financial Instruments—Overall (and subtopics) , include cash, receivables, accounts payable and accrued liabilities.  All instruments are accounted for on an historical cost basis, which, due to the short maturity of these financial instruments, approximates their fair values at December 31, 2018 and March 31, 2018.

The standards under ASC 820 Fair Value Measurement define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements.  ASC 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

 Level 1. Observable inputs such as quoted prices in active markets; 

 Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and 

 Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. 

At December 31, 2018 and March 31, 2018, the Company did not have any assets measured at fair value other than cash and deposits.  The Company does have conversion features embedded in its convertible notes payable.  The fair value measurement of those features, using a Binomial options pricing valuation model at December 31, 2018, is $1,779,259, using a term of six months; stock value between $0.44 and $0.62; volatility between 164.9% and 214.3% and a risk free interest rate between 2.16% and 2.36%. The value at March 31, 2018 using a Black Scholes valuation model was $234,138. The amounts are reported as a derivative liability on the balance sheet.

Provision for Income Taxes

Income taxes are provided based upon the liability method of accounting pursuant to ASC 740-10- 25  Income Taxes – Recognition .  Under this approach, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis amounts of assets and liabilities and their financial reporting amounts at each period-end.  A valuation allowance is recorded against deferred tax asset amounts if management does not believe the Company has met the “more likely than not” standard imposed by ASC 740-10-25-5 to allow recognition of such an asset.  See Note 10.

Capitalization of Patent and Trademark Costs

The Company capitalizes its legal, patent agent and related filing fees and costs directly associated with the patents it holds and is developing.  The amounts are carried as an intangible asset in the financial statements.  The costs of the patents or trademarks are amortized ratably (expensed) over the expected useful technological or economic life of the individual assets.  The legal life of a patent is typically about 17 to 20 years. See Note 4.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified to provide greater line item detail for consistency with the current period presentation.  These reclassifications had no effect on the reported results of operations.  This change in classification has no effect on previously reported cash flows in the Condensed Consolidated

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Statement of Cash Flows and had no effect on the previously reported Condensed Consolidated Statements of Operations for any period .

New Accounting Requirements and Disclosures

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.  The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.

FASB issued standard ASU 2018-07 — Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting related to changes in stock compensation.  IronClad has early adopted this new standard in the current period and recognition of expenses for outstanding options were re-evaluated for compliance and will be recognized on a straight line basis through final vesting of the respective options.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses at the balance sheet date and for the period then ended.  We believe our estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates.  

Significant estimates and assumptions underlying these financial statements include:

 estimates in the calculation of share-based compensation expense, 

 estimates in the value of our embedded derivative liabilities, 

 estimates made in our income tax calculations, and 

 estimates in the assessment of possible litigation claims against the company. 

We are subject to claims and liabilities that arise in the ordinary course of business.  We accrue for losses when such losses are considered probable and the amounts can be reasonably estimated.

Note 3.  Accounts Receivable and Revenue

Customer Service

During the three month transition period ended March 31, 2018, IronClad formed a new wholly-owned subsidiary, Ironclad Pipeline IC, Inc. which began generating a modest level of revenue through a moderately profitable service contract with a major energy company in the eastern United States.  The services were to provide an array of services in support of an infrastructure project.

The $0 and $301,978 of receivables at December 31, 2018 and March 31, 2018 respectively are for $0 and $229,745, respectively, of services rendered (and fully collected prior to December 31, 2018) and the balance is for reimbursable costs incurred, approved by the customer, billed (and paid promptly).  Payment terms are for payment to be made within 30 days; the receivables were collected well within that period.  There were no billings subsequent to July 31, 2018.

In mid-July 2018 our customer notified the Company of its intent to exercise an option in its contract to end our services under the contract.  Consequently, our services were discontinued effective July 28, 2018.  

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Revenue earned and invoiced through that point in time was $200,975.  The customer also elected to retain the services of the individuals previously employed by IronClad Pipeline IC, Inc. on a going forward basis.  All invoiced amounts that were billed for services under the contract through the end-date of the contract were submitted, approved and paid promptly and in full by the customer.  No further services will be provided to this customer and thus no further revenue will be earned from this customer in the foreseeable future.

Amortization expenses for intangible assets during the nine month period ended December 31, 2018 and the nine month period ended December 31, 2017 were $0 and $30, respectively.  Costs at December 31, 2018 totaling $371,545 are for $142,358 for new patents and trademarks under development (but as yet not awarded) and for $229,187 for new patents issued in December 2018.

The patents and trademarks under development will not be amortized until formally issued.  To the extent that a patent or trademark is not ultimately awarded the associated costs will be expensed accordingly at the time such an outcome is apparent.  Amortization of patents issued in mid-December will begin after December 31, 2018.

In addition to its three original patents, IronClad has also filed fourteen patent applications during the period ended December 31, 2018 (both in the US and internationally).  These patents expand upon the initial scope of the original “seminal” patents and provide up to twenty additional years of enforceable intellectual property rights regarding authentication, validation, and encryption for all electronic transmissions associated devices.  IronClad’s current and original patent portfolio includes three issued and granted US patents and each of those patents are now expired and were written off at September 30, 2018.

IronClad was recently granted five patents from the United States Patent and Trademark Office (“USPTO”) from its fourteen recent patent filings, and the remaining nine now continue under routine, formal examination and review. Based on previous process and timing, IronClad expects to have the remaining nine patents granted during 2019, likely the first half of the year.  International patent protection has also been filed for all fourteen of these granted and pending patents.

Amortization of the newly issued patents will be amortized over the life of the particular patent, usually twenty years starting in the first full month after the patent is issued.  In the case of the five patents issued in mid-December their amortization will begin on January 1, 2019.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5.  Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash deposits. Accounts at each institution are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000.  At December 31, 2018 and March 31, 2018, the Company had $0 and $0 on deposit in excess of the FDIC insured limit.

The Company did have a nominal exposure to a concentration of credit risk: all of our revenue was from one customer.  However, we viewed the risk as limited because of the financial strength and liquidity of the multi-billion dollar energy customer that has operated profitably for more than a century.

All invoice amounts that were billed for services under the contract through the end date of our contract with the customer were submitted, approved and were paid promptly and in full by the customer.  Our nominal credit risk to the one customer is now only in the past.

Note 6.  Related Party Transactions

At December 31, 2018 and March 31, 2018 the Company owed approximately $42,638 and $79,542 in accounts payable to management and related parties.  

During the three month transition period ended March 31, 2018, IronClad entered into a loan agreement to borrow up to $500,000 at 8.5% interest.  The Company had borrowed the full amount of the loan, repaid $100,000 and then amended the loan and reborrowed $100,000.  As of December 31, 2018 all $500,000 of the original principal and the subsequent $100,000 draw ($600,000 in cumulative repayments) were repaid and the only amount owed under the agreement is the cumulative accrued interest of $17,816.

The Company pledged 500,000 of its common stock as collateral under the terms of the Agreement.  In the event of default by the Company, the lender is entitled to receive one share of Company common stock for every one dollar in principle, interest, penalties, and fees that are owed and outstanding by the Company to the lender.

The Agreement is also supported by a personal $500,000 guarantee from the President of the Company.

See also Note 13 regarding stock option awards to management of the Company.

Note 7.  Notes Payable

Securities Purchase Agreement, Convertible Note 12%

On June 26, 2017 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $78,500 with the intent of meeting certain conditions precedent to closing and funding on or before July 7, 2017.  The closing conditions were met prior to that date and the convertible note payable was closed and funded on July 6, 2017.  The Company received cash proceeds of $75,000 net of transaction costs of $3,500.  The $3,500 was recorded as a discount amount on the note payable and was amortized as interest expenses over the life of the note. $1,226 was amortized in the three month period ended December 31, 2018; accrued interest payable at December 31, 2018 was zero.

The note matured on March 30, 2018 and interest costs accrue on the unpaid principal balance at 12% annually until March 30, 2018, and after that if not paid at maturity interest accrues annually at 22% until the principal amount and all interest accrued and unpaid are paid.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which is one hundred and eighty days following the date of the note (dated June 26, 2017) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued are a function of a variable conversion price which is 65% of a market price defined to be the lowest one day closing bid price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.  The Company will keep available authorized shares reserved, initially 289,846 shares, but in any event authorized shares equal to six times the number of shares that would be issuable upon full conversion of the note from time to time.

The conversion feature of the note represents an embedded derivative.  The derivative value at December 23, 2017 was determined using a Black-Scholes valuation model.  Accounting recognition of $126,578 for the fair value of the derivative liability, $73,272 (net of $4,116 of amortization) was recorded as a contra liability to the original $78,500 recorded liability of the underlying convertible note, and a $49,190 loss was recognized as a fair valuation adjustment to earnings.

Between January 10, 2018 and January 28, 2018, the note holder exercised its rights under the conversion provisions and through operation of the five conversion elections was issued, in total, 50,322 shares of stock which effectively repaid the loan balance.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

Commitment Note and Convertible Note

On August 24, 2017, IronClad entered into an Investment Agreement to establish an equity line of funding for the potential future issuance and purchase of IronClad’s shares of Class A common stock.  See Note 8.

As consideration for its commitment to purchase shares of IronClad’s Class A common stock pursuant to the Investment Agreement, IronClad issued to the counterparty of the agreement a seven-month 10% convertible promissory note (the “Commitment Note”) in the principal amount of $100,000.  The Commitment Note matures on March 24, 2018.  The Commitment Note is convertible into shares of IronClad’s Class A common stock at the fixed price of $3.25 per share; provided, however, that at any time and from time to time after a default (as of December 31, 2017, and to the date of the filing of this report, no events of default have occurred) occurs solely due to the fact the Commitment Note is not retired on or before the maturity date, all or any part of the Commitment Note is convertible into shares of Class A common stock of the Company at a per share price equal to the lower of: (a) $3.25 or (b) 65% of the average of the two lowest per share trading prices of the Class A common stock during the twenty consecutive trading days prior to the conversion date.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Commitment Note is included as a financing fee expense at the date of the transaction.  The Commitment Note was to finance the $100,000 cost of the commitment fee to the counterparty of the Investment Agreement and is accordingly included in the financing fee expenses for the period ended September 30, 2017.  The amount of the commitment fee could be reduced by $35,000 or $17,500 if a registration statement registering the shares that would be issued under the equity line becomes effective within 90 or 135 days, respectively, of August 24, 2017.

The registration statement was declared effective on December 18, 2017 a period less than 135 days (but more than 90 days) after August 24, 2017.  Consequently, the principal balance of the commitment fee was reduced by $17,500 and $100,000 of financing fee expenses originally recognized in the three-month period ended September 30, 2017 were adjusted to reflect a lower $82,500 financing fee expense.

On August 24, 2017, in connection with the entry into the Investment Agreement, IronClad also issued a 10% convertible note (the “Convertible Note”) in an aggregate principal amount of $330,000 with a 10% original issue discount (“OID”).  The initial consideration in the amount of $165,000 was funded on August 24, 2017.  The Company received net proceeds of $150,000 (which represents the deduction of the 10% original issue discount for the note holder’s due diligence and legal fees). The Company may make additional borrowings in such amounts and at such dates as the note holder may choose in its sole discretion. The balance of an individual borrowing matures seven months from its funding date.

The Convertible Note also has an embedded beneficial conversion feature (“BCF”) based on a stated conversion price of $1.00 per share.  The market price of a share of IronClad’s common stock at the time of the first borrowing under the note was $3.50 thus establishing an intrinsic value of $2.50 on that date.

The Company received the first borrowing for $165,000 under the Convertible Note on August 24, 2017 and net cash proceeds of $150,000 were received after deducting for the original issue discount and lender transaction costs of $15,000.  An additional $12,000 of costs was incurred by IronClad directly relating to the note.  Both the $15,000 and the $12,000 are recorded as discount amounts on the $165,000 note payable and are amortized as interest expenses over the life of the borrowing.  The maturity date of this borrowing under the note is seven months from its funding date which is March 24, 2018.

On March 26, 2018 the Convertible Note holder elected to convert $10,000 of principal balance into 9,958 shares of Class A common stock.

On June 1, 2018 the Convertible Note holder elected to convert an additional $20,000 of principal balance into 32,219 shares of Class A common stock.

On July 17, 2018 the Convertible Note holder elected to convert an additional $20,000 of principal balance into 61,538 shares of Class A common stock.

On August 23, 2018 the Convertible Note holder elected to convert an additional $10,000 of principal balance into 73,260 shares of Class A common stock.

On September 14, 2018 the Convertible Note holder elected to convert an additional $20,000 of principal balance into 236,686 shares of Class A common stock.

The valuation of the BCF related to the $165,000 borrowing on the Convertible Note and with an intrinsic value of $2.50 per share (based on a $3.50 closing price less the $1.00 per share conversion price) was approximately $424,407 using a Black-Scholes valuation model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the beneficial

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

conversion feature formally recorded was $138,000 ($165,000 net of $27,000) and is being amortized as interest expense over the life of the loan.  The full amount of the conversion feature was amortized as interest expense through the March 24, 2018 maturity date of the note.

On October 23, 2017, a second borrowing of $82,500 under the Convertible Note for $330,000 was closed and funded.  The Company received net proceeds of $75,000 after deducting for original issue discount and lender transaction costs of $7,500.  An additional $6,000 of costs was incurred by IronClad relating to the Convertible Note.  Both the $7,500 and the $6,000 were recorded as discount amounts on the $82,500 note payable and amortized as interest expenses over the life of the borrowing.  The maturity date of this borrowing under the Convertible Note was also defined to be seven months from its borrowing date which was May 24, 2018.  The market price of a share of IronClad’s common stock at the time of funding was $4.40 making the intrinsic value of the derivative $3.40.  The valuation of the BCF was estimated to be approximately $289,000 and is capped at $69,000, the otherwise undiscounted amount of the note payable.  The full amount of the conversion feature was amortized as interest expense through the May 24, 2018 maturity date of the note.

On March 15, 2018, a third and final borrowing of $82,500 under the Convertible Note for $330,000 was closed and funded.  The Company received net proceeds of $75,000 after deducting for original issue discount and lender transaction costs of $7,500 and an additional $6,000 of loan closing costs incurred by IronClad.  The maturity date of this borrowing under the Convertible Note is also defined to be seven months from its borrowing date which is October 24, 2018.  The market price of a share of IronClad’s common stock at the time of funding was $1.85 making the intrinsic value of the derivative $0.85.

The valuation of the BCF related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.85 per share (based on a $1.85 closing price less the $1.00 per share conversion price) was approximately $109,861 using a Black-Scholes valuation model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the beneficial conversion feature formally recorded was $69,000 ($82,500 net of $13,500) and is being amortized as interest expense over the life of the loan.  The full amount of the conversion feature was amortized as interest expense through the October 15, 2018 maturity date of the note

On March 24, 2018 both the Commitment Note ($100,000 contractually reduced to $82,500 in 2017) and the first tranche of the 10% Convertible Note for $165,000 (less the $10,000 conversion in late March) reached their maturity dates and, except for a $10,000 conversion by the note holder on the Convertible Note, were not repaid in cash.  Consequently both notes were in “maturity date default” and, pursuant to the terms of the loans, were convertible at the lesser of $3.25 for the Commitment Note, and $1.00 for $165,000 note or 65% of the average lowest two trades for the prior 20 days, resulting in an initial recognition for derivative treatments for both notes.

The valuation of the derivative liability related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.70 per share (based on a $1.67 closing price less the $0.97 per share present value of the conversion price) was approximately $79,138 using a Black-Scholes valuation model.  That amount was recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable. This results in a net liability value of $3,362 at the time.  The amount was amortized as interest expense over an estimated “remaining” three month life of the already matured loan. At June 30, 2018, the $79,138 was fully amortized.

The valuation of the derivative liability related to the $165,000 (reduced to $155,000) borrowing on the Convertible Note and with an intrinsic value of $0.70 per share (based on a $1.67 closing price less the $0.97 per share present value of the conversion price) was approximately $158,276 using a Black-Scholes valuation

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

model.  That amount was recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  Since the undiscounted (and unconverted) amount of the note was $155,000 the derivative valuation was recorded as $155,000.  

The amount was amortized as interest expense over an estimated “remaining” three month life of the already matured loan. On June 1, 2018 $20,000 of the note was converted, reducing the outstanding balance to $135,000. During the quarter ended September 30, 2018 an additional $50,000 of the note was converted, reducing the outstanding balance to $85,000.  The full amount of the contra liability was amortized as interest expense through the three month amortization period that ended on June 24, 2018.

At May 23, 2018 the second tranche of the 10% Convertible Note for $82,500 reached its maturity date and was not repaid in cash. Consequently the note was in “maturity date default” and pursuant to the terms of the loan was convertible at the lesser of $1.00 or 65% of the average lowest two trades for the prior 20 days, resulting in initial recognition for derivative treatment.

The valuation of the derivative liability related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.6912 per share is approximately $57,024 using a Binomial pricing model.  That amount is recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs). The amount will be amortized as interest expense over an estimated “remaining” three month life of the already matured loan

At October 15, 2018 the third tranche of the 10% Convertible Note for $82,500 reached its maturity date and was not repaid in cash. Consequently the note was in “maturity date default” and pursuant to the terms of the loan was convertible at the lesser of $1.00 or 65% of the average lowest two trades for the prior 20 days, resulting in initial recognition for derivative treatment.

The valuation of the derivative liability related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.2432 per share is approximately $20,064 using a Binomial pricing model.  That amount is recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs). The amount will be amortized as interest expense over an estimated “remaining” three month life of the already matured loan

Convertible Notes, 12%

On January 25, 2018 IronClad entered into a Securities Purchase Agreement to issue a new 12% convertible note payable for an aggregate principal amount of $88,000.  The Company received cash proceeds of $85,000 net of transaction costs of $3,000.  The $3,000 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, are identical to the initial 12% Convertible note entered into in 2017 and converted earlier in January 2018.

The note matures on October 30, 2018 and interest costs accrue on the unpaid principal balance at 12% annually until October 30, 2018, and after that if not paid at maturity interest accrues annually at 22% until the principal amount and all interest accrued and unpaid are paid.

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which is one hundred and eighty days following the date of the note (dated January 25, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The shares to be issued are a function of a variable conversion price which is 65% of a market price defined to be the lowest one day closing bid price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.  The Company would keep available authorized shares reserved, initially 289,846 shares, but in any event authorized shares equal to six times the number of shares that would be issuable upon full conversion of the note from time to time. At June 30, 2018 a derivative liability with an intrinsic value of $0.2404 was $57,990 using a binomial pricing model and was recorded as a discount to the note.

On July 14, 2018 the loan principal was repaid plus accrued interest, both totaling $124,268, and the note was fully retired.

On February 27, 2018 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $53,000.  The Company received cash proceeds of $50,000 net of transaction costs of $3,000.  The $3,000 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, are identical to the initial 12% Convertible note entered into in 2017 and converted earlier in January 2018.

The note matures on November 03, 2018 and interest costs accrue on the unpaid principal balance at 12% annually until November 30, 2018, and after that if not paid at maturity interest accrues annually at 22% until the principal amount and all interest accrued and unpaid are paid.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is one hundred and eighty days following the date of the note (dated February 27, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued are a function of a variable conversion price which is 65% of a market price defined to be the lowest one day closing bid price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.  The Company will keep available authorized shares reserved, initially 289,846 shares, but in any event authorized shares equal to six times the number of shares that would be issuable upon full conversion of the note from time to time.

The conversion feature of the note represents an embedded derivative.  The derivative liability with an intrinsic value of $0.2981 was $42,862 using a binomial pricing model and was recorded as a discount to the note.

On August 21, 2018 the loan principal was repaid plus accrued interest, both totaling $75,620, and the note was fully retired.

New Convertible Note, 10%

On June 26, 2018 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $250,000.  The Company received cash proceeds of $235,000 net of transaction costs of $15,000.  The $15,000 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, are nearly identical to the initial 10% Convertible note entered into in 2017.

The note matures on December 26, 2018 and interest costs accrue on the unpaid principal balance at 10% annually until December 26, 2018, and after that if not paid at maturity interest accrues annually at 24% until the principal amount and all interest accrued and unpaid are paid.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time on or following the date of the Note from the and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued are a function of a fixed conversion price of $1.00 per share, or an alternate variable conversion price, triggered by events such as stock splits, stock dividends or rights offerings which is 70% of a market price defined to be the lowest five day closing bid price for the Company’s common stock during the twenty-day trading period ending on the last trading day prior to exercising the conversion right.  The Company will keep available authorized shares reserved, initially 3,081,854 shares, but in any event authorized shares equal to five times the number of shares that would be issuable upon full conversion of the note from time to time.

The conversion feature of the note represents an embedded derivative.  A derivative liability with an intrinsic value of $0.03281 was $189,211 using a binomial pricing model and was calculated as a discount to the note.  That amount is recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs and amounts discussed immediately below), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.

As a commitment fee for the Note, the Company issued the holder 240,384 shares of common stock to be held in escrow until the Note is repaid. The holder will keep the shares, if the Note is not retired prior to its maturity date. The shares were valued at $165,865 and were recorded as a discount on the note.

Included in the share purchase agreement was a common stock purchase warrant issued by the Company to the holder to purchase 62,500 shares of common stock at $3.00 per share, exercisable for four years. The warrants were valued at $43,121 using a Black Scholes option pricing model and were recorded as a discount on the note.

The sum of the $14,672 unamortized original issue discount ($15,000 at the outset of the loan) plus the $43,121 recorded value of the warrants, plus the $165,865 valuation of the commitment fee related to the 240,384 shares plus the $189,211 valuation of the derivative related to the conversion feature total $412,869 which is in excess of the $250,000 value of the loan principal.  Total amounts to be recorded as contra loan amounts cannot exceed the $250,000 nominal amount of the loan.

Because of the derivative nature of the $189,211 valuation of the conversion feature, $162,869 of the total $412,869 amount is recorded as an expense in the current period and reported as a financing expense.

On October 11, 2018 the Holder elected to convert $100,000 of the principal amount into 1,210,654 shares of restricted common stock.

On November 1, 2018 the remaining loan principal of $150,000 was repaid plus accrued interest, both totaling $158,873.28 and the note was fully retired.

Working Capital Loan for Services to New Customer by IronClad Pipeline IC, Inc.

On February 27, 2018, IronClad borrowed $255,000 gross proceeds as an initial advance on a Credit Agreement (the “Agreement”) with a lending party.  The Agreement, agreed to by both parties on February 1, 2018, enabled the Company, at its sole election, to borrow up to an aggregate amount of $500,000.  The outstanding balance of any advances accrues interest at the annual rate of 8.5%.  There is a transaction financing fee of 2% for any amount drawn under the facility.  Proceeds received net of the transaction fee were $250,000.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

On March 21, 2018, IronClad borrowed an additional $245,000 gross proceeds as a second advance under the Agreement.  Proceeds received net of the transaction fee were $240,000.

During the period ended June 30, 2018, the Company repaid $100,000 of the principal, and then redrew another $100,000.  On June 30, 2018, the Company repaid $25,000.  The outstanding balance of this loan at June 30, 2018 is $475,000.

During the period ended September 30, 2018, the Company repaid all of the outstanding principal balance of the loan, however the accrued interest remains outstanding in the amount of $17,816.

Interest is to be paid annually in cash on March 1, 2019 and 2020.  There is no penalty for any early principal repayments.  The Company has pledged 500,000 of its common stock as collateral under the terms of the Agreement.  In the event of default by the Company, the lender is entitled to receive one share of Company common stock for every one dollar in principle, interest, penalties, and fees that are owed and outstanding by the Company to Layer 3 Communications.

The Agreement is also supported by a personal $500,000 guarantee from an officer of the Company.

Terms of the Agreement specify the use of funds to be limited to only supporting the operations of its new service contract.  The terms of the Agreement were amended, effective June 11, 2018, to also permit the use of funds for certain new patent application filings of IronClad.

On March 16, 2018, IronClad purchased several lines of corporate insurance coverage for a set of annual premiums that totaled $30,719.  To pay for the coverage, IronClad paid $2,631 down on the coverages and entered into a financing agreement to borrow the $28,087 balance owed for the coverage.  Interest on the loan is approximately 6% and the loan is repaid by eleven monthly principal and interest installment payments of $2,631 each.  The cost of the insurance is recorded as a prepaid asset and is being amortized monthly over the annual period of the coverages. During the period ended September 30, 2018 this note was paid in full.

New Loan Agreements including Convertible Notes, 9%, 12% and 9%

On July 11, 2018 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 9% convertible note payable for an aggregate principal amount of $270,000 comprised of the first note (“First Note”) being in the amount of $135,000.00, and the remaining note in the amount of $135,000.00, (a “Back End Note”). The Company received cash proceeds of $126,500 from the First Note net of transaction costs of $8,500. The $8,500 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.

The First Note matures on July 11, 2019 and interest costs accrue on the unpaid principal balance at 9% annually until July 11, 2019, and after that if not paid at maturity interest accrues annually at 24% until the principal amount and all interest accrued and unpaid are paid.

The Back End Note carries the same terms as the First Note, except it may not be repaid, but only converted. The Company is under no obligation to accept the Back End Note, but may do so at its sole discretion, following 180 days from the date of the note (dated July 11, 2018). As part of the SPA, the Holder issued the Company a collateralized secured promissory note in the amount of $131,500 that may be exchanged for cash against the Back End Note.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(dated July 11, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued are a function of a fixed conversion price of $1.00 per share for six months, and thereafter until maturity at a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right. The Company will keep available authorized shares reserved, initially 1,730,000 shares, but in any event the number of reserved shares at least equals 400% of the number of shares of Company common stock issuable upon conversion of the Note.

The valuation of the derivative liability related to the $135,000 borrowing on the First Note and with an intrinsic value of $0.54 per share is approximately $248,386 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $126,500 ($135,000 net of $8,500) and will be amortized as interest expense over the life of the loan. The remaining $121,886 is expensed as financing fees.

On July 17, 2018 (transaction documents were originally dated June 29, but amended for action taken on July 17), IronClad issued a 12% convertible note (the “Convertible Note”) to a lender (the “Holder”) in an aggregate principal amount of $115,500. The Company received cash proceeds of $101,500 net of transaction costs of $14,000 that included $3,500 for attorneys’ fees. The note matures on July 18, 2019. Interest costs accrue on the unpaid principal balance at 12% annually until maturity, and after that if not paid, interest accrues annually at 18% until any unpaid principal amount and unpaid interest accrued are paid.

The Holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is one hundred and eighty days following the date of the note (dated July 18, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest one (1) trading price for the Company’s common stock during the fifteen (15) day trading period ending on the last trading day prior to the conversion date. The Company will keep available authorized shares reserved, initially 1,500,000 shares.

The valuation of the derivative liability related to the $115,500 borrowing on the Convertible Note and with an intrinsic value of $0.4751 per share is approximately $187,624 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $101,500 ($115,500 net of $14,000) and will be amortized as interest expense over the life of the loan. The remaining $86,124 is expensed as financing fees.

On July 19, 2018 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 9% convertible note payable for an aggregate principal amount of $315,000 comprised of the first note (“First Note”) being in the amount of $157,500.00, and the remaining note in the amount of $157,500.00, (a “Back End Note”). The Company received cash proceeds of $142,500 from the First Note net of transaction costs of $15,000 that included $7,500 for attorneys’ fees.

The First Note matures on July 19, 2019 and interest costs accrue on the unpaid principal balance at 9% annually until July 19, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid. The Back End Note carries the same terms as the First Note, except it may not be repaid in cash, but only converted. The Company is under no obligation to

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

accept the Back End Note, but may do so at its sole discretion following 180 days from the date of the note (dated July 19, 2018). As part of the SPA, the Holder issued the Company a collateralized secured promissory note in the amount of $150,000 that may be exchanged for cash against the Back End Note.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note (dated July 19, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.  The shares to be issued are a function of a fixed conversion price of $1.00 per share for six months, and thereafter until maturity at a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.

The valuation of the derivative liability related to the $157,500 borrowing on the First Note and with an intrinsic value of $0.5482 per share is approximately $295,227 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $142,500 ($157,500 net of $15,000) and will be amortized as interest expense over the life of the loan. The remaining $152,727 is expensed as financing fees.

New Convertible Notes, 10% and 12%

On October 24, 2018 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $107,000.  The Company received cash proceeds of $102,000 net of transaction costs of $5,000.  The $5,000 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matures on July 19, 2019 and interest costs accrue on the unpaid principal balance at 10% annually until October 24, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid.

The Holder of the note is entitled, at any time after cash payment, to convert all or any amount of the principal face amount of the Note then outstanding into shares of the Company's common stock.  The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period ending on the last trading day prior to the conversion date. The Company will keep available authorized shares reserved, initially 2,993,000 shares.

The valuation of the derivative liability related to the $107,000 borrowing with an intrinsic value of $0.1759 per share is approximately $131,617 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $102,000 ($107,000 net of $5,000) and will be amortized as interest expense over the life of the loan. The remaining $29,617 is expensed as financing fees.

On October 26, 2018 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $181,170.  The Company received cash proceeds of $150,346 net of transaction costs of $30,824.  The $30,824 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matures on July 26, 2019 and interest costs accrue on the unpaid principal balance at 12% annually until July 26, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid.

The Holder shall have the right at any time following the 180th calendar day after the issue date

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(October 26, 2018), and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any, to convert all or any amount of the principal face amount of the Note then outstanding into shares of the Company's common stock.  The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period ending on the last trading day prior to the conversion date. The Company will keep available authorized shares reserved, initially 6,500,000 shares. In connection with the issuance of the Note, the Company issued a common stock purchase warrant to the Holder to purchase up to 30,195 shares of the Company’s common stock at an exercise price of $3.00 per share with an exercise period of five years.

The valuation of the derivative liability related to the $181,170 borrowing with an intrinsic value of $0.2674 per share is approximately $220,204 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $150,346 ($181,170 net of $30,824) and will be amortized as interest expense over the life of the loan. The remaining $69,858 is expensed as financing fees.

Derivative Liabilities

At December 31, 2018 the prior period’s derivative liabilities were re-measured, as the notes were still outstanding, the derivative liabilities were revalued using a binomial pricing model.   At period end the total valuation of derivative liabilities related to nine loans was approximately $1,779,259 for individual valuation amounts of $157,561, $176,838, $151,289, $195,635, $224,348, $263,765, $184,116, $287,134 and 138,573.

Note 8. Common Stock

During the three-month period ended June 30, 2017, the Company issued i) 240,333 shares of Class A common stock at $0.15 per share for cash in the amount of $36,050 pursuant to a Section 4(a)2 private placement offering, ii) 25,000 shares at $0.15 per share for the conversion of stock options (see Note 12), and iii) 75,000 shares at $2.90 per share for investment banking services valued at $217,500.

During the three-month period ended September 30, 2017, the Company issued i) 100,000 shares of Class A common stock at $3.49 per share for consulting services in the amount of $349,000 and ii) 37,500 shares at $3.50 per share for investment banking services valued at $131,250.

During the three-month period ended December 31, 2017, the Company issued 157,500 shares of Class A common stock at $4.10 per share to seven parties for consulting services in the amount of $660,750.

On August 24, 2017 IronClad entered into an Investment Agreement for the potential future issuance and purchase of shares of its Class A common stock to establish an equity line of funding to IronClad.  The agreement enables IronClad to issue stock to the counterparty of the agreement in exchange for cash amounts under certain defined conditions for the purchase of IronClad’s stock.  In addition to the equity line, the agreement also included IronClad entering into the Commitment Note in the principal amount of $100,000 to finance the commitment fee of the Investment Agreement and the Convertible Note to borrow up to $330,000 (of which $165,000 was borrowed on August 24, 2017 and a subsequent $82,500 was borrowed on October 23, 2017).  See Notes 5 and 14.

On January 24, 2018 IronClad issued, under the terms of the Investment Agreement, 14,331 shares of its Class A stock in exchange for receipts totaling $25,823 ($1.80 per share) from the counterparty of the Investment Agreement.  Similarly, on February 16, 2018 24,265 shares were issued in exchange for proceeds of

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

$38,824 ($1.60 per share).  On March 26, 2018 9,958 shares of Class A common stock were issued for the conversion of $10,000 of the $165,000 referred to above.

On January 23, 2018, the Company issued 10,000 shares of its Class A common stock at $2.25 per share to two advisors for services in the amount of about $22,500.

During the period ended June 30, 2018, the Company approved for issuance 50,000 shares of Class A common stock priced at $1.69 for accounts payable of $84,500; 20,000 shares of Class A common stock priced at $1.15 for accounts payable of $16,791 and services of $6,209; 32,219 shares of Class A common stock priced at $0.62 for conversion of $20,000 of convertible debt; 240,384 shares of Class A common stock priced at $0.69 in relation to the June 26, 2018 Convertible Note, the shares were valued at $166,105 and  have been recorded on the balance sheet as a contra account to the Note.  

At the close of March 31, 2018 there were 55,000 shares valued at $101,750 that were recorded and reported as “to be issued”.  Those shares were issued during the three month period ended June 30, 2018.

During the three month period ended September 30, 2018, the Company approved for issuance 2,000 shares of Class A common stock priced at $0.45 for services  of $900; 140,000 shares of Class A common stock for the exercise of stock options priced at $0.15 per share for cash in the amount of $21,000; 61,538 shares of Class A common stock priced at $0.325 for conversion of $20,000 of convertible debt; 73,260 shares of Class A common stock priced at $0.1365 for conversion of $10,000 of convertible debt; 236,686 shares of Class A common stock priced at $0.0845 for conversion of $20,000 of convertible debt.

During the three month period ended December 31, 2018, the Company approved for issuance 50,000 shares of Class A common stock priced at $0.32 for accounts payable of $16,000; 1,210,654 shares of Class A common stock priced at $0.0826 for conversion of $100,000 of convertible debt. At the close of December 31, 2018 there were 10,000 shares valued at $3,200 that were recorded and reported as “to be issued”.

Note 9.  General and Administrative Expenses

General and administrative expenses recognized for the three-month period ended December 31, 2018 and 2017 were $690,572 and $939,554, respectively of which $562,724 and $274,250 were recognized as compensation expenses in connection with the issuance of stock options or warrants.

General and administrative expenses recognized for the nine-month period ended December 31, 2018 and 2017 were $1,985,301 and $1,413,641, respectively of which $1,684,958 and $592,083 were recognized as compensation expenses in connection with the issuance of stock options or warrants.

Note 10.  Income Taxes

Federal and state income taxes are not currently due since IronClad has had losses since inception.  Since the Company provided services to a customer in Virginia, IronClad is also subject to Virginia state income tax reporting.

Income taxes are provided based upon the liability method of accounting pursuant to ASC 740-10-25 Income Taxes – Recognition. Under this approach, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end.  A valuation allowance is recorded against deferred tax assets if management does not believe the Company has met the “more likely than not” standard required by ASC 740-10-25-5.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Deferred income tax amounts reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes.  Because of the near breakeven point of operational profitability in providing our services in Virginia, IronClad’s estimate of net income and related net income taxes for the period of the contract are not considered to be material.

Significant components of the deferred tax asset amounts at an anticipated tax rate of 21% for the period ended December 31, 2018 and March 31, 2018 are as follows:

At December 31, 2018, the Company has net operating loss carryforwards of $3,419,129 which will begin to expire in the year 2033.  The increase in the allowance account amount (and also in the deferred tax asset amount) from March 31, 2018 to December 31, 2018 was $145,398.

Note 11.  Share Exchange Agreement

On January 6, 2017, the Company entered into a Share Exchange Agreement with InterLok Key Management, Inc. wherein Butte agreed to issue 56,655,891 restricted shares of Butte’s common stock in exchange for 100% of the outstanding shares of InterLok Key Management, Inc. common stock.  InterLok Key Management, Inc. is engaged in the business of developing and licensing its patented key-based encryption methods.

On January 6, 2017, Butte completed its Share Exchange Agreement with the owners of InterLok and issued 56,655,891 restricted shares of Butte’s common stock to 29 persons and entities in exchange for all of the outstanding shares of InterLok Key Management, Inc.’s common stock.  Immediately following completion of the share exchange agreement, the Company’s new board of directors elected, through a series of board resolutions and regulatory filings, to change the Company’s name to IronClad Encryption Corporation from Butte, to move the Company to Nevada from Delaware, and to change its stock trading symbol to IRNC from BTHI.

The Share Exchange was treated as a reverse merger with InterLok Key Management, Inc. deemed, for accounting recognition purposes, the accounting acquirer and Butte Highlands Mining Company deemed the accounting acquiree under the acquisition method of accounting.  The reverse merger is deemed a recapitalization and the unaudited pro forma consolidated financial statements of operations represent the substantive continuation of the operations and thus the financial statements of InterLok Key Management, Inc., while the capital structure (with respect to authorized, issued and outstanding shares of preferred and common stock) of Butte Highlands Mining Company--now using the name IronClad--remains intact.

Note 12.  Share Based Compensation

Equity Incentive Plan

The Board of Directors adopted, and the Company’s stockholders subsequently approved, the IronClad Encryption Corporation 2017 Equity Incentive Plan (the “Plan”) effective as of January 6, 2017.  The purpose of

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

the Plan is to foster and promote the long-term financial success of the Company and thereby increase stockholder value.  The Plan provides for the award of equity incentives to certain employees, directors, or officers of, or key advisers or consultants to, the Company and its subsidiaries who are responsible for or contribute to the management, growth or success of the Company or any of its subsidiaries.

The maximum number of shares available for issuance under the Plan is thirty million (30,000,000) shares of Class A common stock.  On October 17, 2017, in connection with the change of the Company’s jurisdiction of incorporation from the State of Nevada to the State of Delaware, the Board of Directors adopted the Amended and Restated IronClad Encryption Corporation 2017 Equity Incentive Plan (the “Amended Plan”).

Additionally, from time to time, we issue non-compensatory warrants, such as warrants issued to investors.

Restricted Stock

The fair value of restricted stock awards classified as equity awards is based on the Company’s stock price as of the date of grant.  Such awards do not grant any rights as a shareholder of the company until a certificate for the vested shares of common stock has been issued.  During the year ended December 31, 2017, 287,500 shares were granted for services, none were forfeited (none were issued prior to 2017).  Expenses of approximately $709,000 were recorded in connection with the stock issued as grants for services; $349,000 for business development and $360,000 for investor relations.

Other stock grants were awarded for services, but the underlying stock was issued as unrestricted stock because it was otherwise registered under our S-8 and effective on November 28, 2017 and our S-1 as amended and effective on December 19, 2017.

Note 13.  Stock Options and Warrants

During the three-month period ended March 31, 2017, the Company awarded 1,045,000 stock options and warrants for services and conversions of convertible notes valued at $1,305,565 and 9,000,000 stock options to officers of IronClad valued at $622,045.  Of the total 10,145,000 options and warrants awarded, 1,045,000 vested immediately and received full expense recognition in the three-month period ended March 31, 2017.  The remaining 9,883,470 options vest periodically over the subsequent three years and will be expensed on a straight line basis.

In addition, 25,000 stock options that were awarded during the three-month period ending March 31, 2017 were exercised for cash in the amount of $3,750.

During the three-month period ended June 30, 2017, the Company awarded 2,945,000 stock options for services valued at $4,657,850 (using the Black-Scholes option pricing model) and 500,000 stock options to an officer of IronClad valued at $731,659 (using the Black-Scholes option pricing model).  Of the total 3,445,000 options recorded as awarded during the period 85,000 vested immediately and received full expense recognition during the three-month period ended June 30, 2017.  The remaining 3,360,000 options vest periodically over the next two to four years and will be expensed on a straight line basis.

During the three-month period ended September 30, 2017, the Company recorded the award of 372,500 stock options for services valued at $261,991 (using the Black-Scholes option pricing model) and 82,500 stock warrants for financing fees valued at $287,629 (using the Black-Scholes option pricing model).  Of the total 455,000 options and warrants awarded during the period 155,000 vested immediately and received full expense recognition during the three-month period ended September 30, 2017.  The remaining 300,000 options vest periodically over the next four years and will be expensed on a straight line basis.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

During the three-month period ended December 31, 2017, the Company recorded the award of 37,500 stock options for services valued at $161,921 (using the Black-Scholes option pricing model).  All of the options vested immediately and received full expense recognition during the three-month period ended December 31, 2017.

During the three-month period ended March 31, 2018, the Company awarded 2,700,000 stock options for services valued at $4,873,048 (using the Black-Scholes option pricing model) and 1,500,000 stock options to officers of IronClad valued at $2,700,000 (using the Black-Scholes option pricing model).  Of the total 4,200,000 options recorded as awarded during the period 50,000 vested immediately and received full expense recognition during the three-month period ended March 31, 2018.  The remaining 4,150,000 options vest periodically over the next three to seven years and will be expensed on a straight line basis.

During the three-month period ended June 30, 2018 the Company awarded 122,500 stock options and warrants for services valued at $123,719.  Of the total 122,500 options and warrants awarded, 102,500 vested during the period and received full recognition in the three-month period ended June 30, 2018.  The remaining 20,000 options vest during the subsequent quarter and will be expensed at that time.

During the three-month period ended December 31, 2018 the Company awarded 700,195 stock options and warrants for services valued at $137,058.  Of the total 700,195 options and warrants awarded, 200,195 vested during the period and received full expense recognition in the three-month period ended December 31, 2018.  The remaining 500,000 options vest during subsequent quarters and will be expensed at that time.

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IronClad Encryption Corporation and Subsidiaries

(Previously named Butte Highlands Mining Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The fair value of stock options and warrants is estimated on the date of each award using the Black-Scholes option pricing model to value the stock option or warrant based on its terms and conditions.  There was one exercise of 25,000 options during 2017.  The tables below summarize the assumptions used to estimate the fair values of the options and warrants at December 31, 2018: