UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

 

FORM S-1

Amendment NO.1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

 

 

 

CIPHERLOC CORPORATION

(Exact name of registrant as specified in its charter)

 

(State or other jurisdiction of   (Primary Standard Industrial   (I.R.S. Employer
incorporation or organization)   Classification Code Number)   Identification No.)
Texas   518210   86-0837077

 

{Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

825 Main St, Suite 100

Buda, TX 78610

Telephone (512)-772-4245

 

Michael De La Garza

President/CEO

825 Main St, Suite100

Buda, TX 78610

Telephone: (512)-772-4245

 

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies of all communications, including communications sent to agent for service, should be sent to:

Carl P. Ranno, Esq.

2733 East Vista Dr.

Phoenix, AZ 85032

Telephone 602-402-3615   Email carlranno@cipherloc.net

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective
date of this Registration Statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. [X]

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [  ]

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [  ]

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [  ]

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “ smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]   Accelerated filer [  ]
Non-accelerated filer [  ]   Smaller reporting company [X]
(Do not check if a smaller reporting company) Emerging growth company [  ]    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised accounting standards provided to Section 7(a)(2)(B) of the Securities Act. [  ]

 

CALCULATION OF REGISTRATION FEE

 

TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED   AMOUNT TO BE
REGISTERED (1)
    PROPOSED MAXIMUM OFFERING PRICE PER SHARE (2)     PROPOSED MAXIMUM
AGGREGATE OFFERING PRICE
    AMOUNT OF
REGISTRATION FEE
 
Common Stock, $0.01 par value     18,897,400     $ 1.195     $ 22,582,393.00     $ 2,736.99  
Common Stock underlying warrants     24,226,866     $ 1.195     $ 28,951,104.87     $ 3,508.87  
                                 
Total     43,124,266             $ 51,533,497.87     $ 6,245.86  

 

(1) Pursuant to Rule 416 under the Securities Act, the shares of common stock offered hereby also include an indeterminate number of additional shares of common stock as may from time to time become issuable by reason of stock splits, stock dividends, recapitalizations or other similar transactions.

(2) Estimated at $1.195 per share, the average of the high and low prices as reported on the OTC Bulletin Board regulated quotation service on February 4, 2019, for the purpose of calculating the registration fee in accordance with Rule 457(c) under the Securities Act.

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission acting pursuant to said Section 8(a), may determine.

 

 

 

 
 

 

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED FEBRUARY 5, 2019

 

PRELIMINARY PROSPECTUS

 

43,124,266 Shares

 

CIPHERLOC CORPORATION

Common Stock

 

 

 

This prospectus relates to the sale by the selling stockholders identified in this prospectus of up to 43,124,266 shares of our common stock, par value $0.01 per share. These shares consist of the following.

 

A private placement pursuant to Regulation D, ending in August of 2018 wherein 18,827,900 Units were sold to accredited investors for $1.00 per unit. Each Unit consisted of one (1) share of common stock and a warrant to purchase one (1) additional share of Common Stock at $1.20 per share. The Warrant will expire 60 months from date of purchase. There are 18,827,900 Warrant Shares and 18,897,400 Common Shares which includes 69,500 converted warrant shares. The Company issued an additional 5,398, 966 Warrants, with a cashless conversion provision, at $1.20 with a ten (10) year expiration date to the investment agent as part of the its fee. The transaction totaled 43,124,266 common shares.

 

The prices at which the selling stockholders may sell shares will be determined by the prevailing market price for the shares or in privately negotiated transactions. We will not receive any proceeds from the sale of these shares by the selling shareholders. All expenses of registration incurred in connection with this offering are being borne by us, however all selling and other expenses incurred by the selling stockholders will be borne by the selling stockholders.

 

Our common stock is quoted on the regulated quotation service of the OTC Bulletin Board under the symbol “CLOK”. On February 4, 2019, the last reported sale price of our common stock as reported on the OTC Bulletin Board was $1.20 per share.

 

Investing in our common stock is highly speculative and involves a high degree of risk. You should carefully consider the risks and uncertainties in the section entitled “Risk Factors” beginning on page 6 of this prospectus before deciding to purchase our stock.

 

The date of this Prospectus is February 5, 2019

 

 
 

 

TABLE OF CONTENTS

 

Page
   
PART I. PROSPECTUS  
   
PROSPECTUS SUMMARY 4
RISK FACTORS 6
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS 9
USE OF PROCEEDS 9
SELLING STOCKHOLDERS 9
PLAN OF DISTRIBUTION 19
DESCRIPTION OF SECURITIES 20
INTERESTS OF NAMED EXPERTS AND COUNSEL 20
DESCRIPTION OF OUR BUSINESS 21
ORGANIZATION WITHIN THE LAST FIVE YEARS 23
DESCRIPTION OF PROPERTIES 23
LEGAL PROCEEDINGS 23
MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS 23
SELECTED FINANCIAL DATA 24
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 24
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 28
EXECUTIVE COMPENSATION 30
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE 31
AVAILABLE INFORMATION 31
FINANCIAL STATEMENTS 32
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES 60
   
PART II – INFORMATION NOT REQUIRED IN PROSPECTUS  
   
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION 61
INDEMNIFICATION OF DIRECTORS AND OFFICERS 61
RECENT SALES OF UNREGISTERED SECURITIES 61
EXHIBITS TO THE REGISTRATION STATEMENT

63

UNDERTAKINGS 64
SIGNATURES 65

 

  3  
 

 

PROSPECTUS SUMMARY

 

You should read the following summary together with the more detailed information and the financial statements appearing elsewhere in this Prospectus. This Prospectus contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors” and elsewhere in this Prospectus. Unless the context indicates or suggests otherwise, references to “we,” “our,” “us,” the “Company,” or the “Registrant” refer to Cipherloc Corporation, a Texas corporation. If anyone provides you with different or inconsistent information, you should not rely on it. We are not making an offer to sell these securities in any jurisdiction where offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

 

Cipherloc Corporation

 

Cipherloc Corporation is a technology and services solutions company for the rapidly expanding cloud-based cyber security industry. Cipherloc is based in Buda, Texas.

 

The Company has introduced an innovative and revolutionary new type of encryption technology with five international patents and two US patents pending and is the industry’s first “Polymorphic Cipher Engine”, called CipherLoc®. It is 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.

 

The Company’s initial products are focused on protecting “data in motion” and will consist of three different offerings: CipherLoc EDGE (for mobile platforms), CipherLoc ENTERPRISE (for desktops, laptops, and tablets), and CipherLoc GATEWAY (for servers). Summaries for each of these products can be found on the Company’s website. The end goal with the release of these products is to offer end-to-end data security (i.e., data can be securely sent to/from any mobile device, any PC, and any server).

 

With a business-to-business model, the Company will directly pursue businesses that will embed Cipherloc’s technology within their own product offering. We will be offering these potential clients a fairly standard software licensing-maintenance model, under which they will license our software for use within their own products. Any company today that is currently using encryption technology becomes a potential customer for us. By targeting companies who are already building solutions that have encryption built-in to their products, we are planning to achieve scale much faster.

 

The Company was incorporated in Texas on June 22, 1953 as American Mortgage Company. During 1996, the Company acquired the operations of Eden Systems, Inc. (“Eden”) as a wholly owned subsidiary. Eden was engaged in water treatment and the retailing of cleaning products. Eden’s operations were sold on October 1, 1997. From September 30, 1997 through the year ended September 30, 2001, the company aimed our efforts in the research and development of semiconductor proprietary technology and processes and in raising capital to fund its operations and research. On May 16, 1996, the Company changed its name to National Scientific Corporation and since January of 2000 traded on the OTC Bulletin Board under the symbol NSCT. On March 15, 2015, the Company changed its name to Cipherloc Corporation and reversed its stock on a 100 to 1 basis. The name change became effective by the Amended Certificate as of March 23, 2015 and the stock has been trading under the symbol CLOK.

 

Our principal executive offices are located at 825 Main Street, Suite 100, Buda, TX 78610. Our telephone number is (512) 772-4245. Our website is www.cipherloc.net. Information on or accessed through our website is not incorporated into this prospectus and is not a part of this prospectus.

 

  4  
 

 

SUMMARY OF THE OFFERING

 

Common stock offered by the Stockholders:   43,124,266 shares of our common stock, which is the total of 18,897,400 issued common shares and 24,226,866 shares issuable upon the exercise of outstanding warrants
     
Common stock outstanding before and after this offering :   40,783,164 and 65,010,030 (1)
     
Use of proceeds:   We will not receive any proceeds from the sale of shares in this offering by the selling stockholders
     
OTC Bulletin Board symbol :   CLOK
     
Risk Factors:   The Common Shares offered involves a high degree of risk and should not be purchased by investors who cannot afford the loss of their entire investment. See “Risk Factor.”

 

  (1) The number of outstanding shares before the offering is based upon 40,783,164 common shares outstanding as of February 4, 2019 and the number of shares outstanding after this offering includes 24,226,866 shares of common stock issuable upon the exercise of the outstanding warrants.

 

Risk factors: You should carefully consider the information set forth in this prospectus and, in particular, the specific factors set forth in the “Risk Factors” section beginning on page 6 of this prospectus before deciding whether or not to invest in shares of our common stock.

 

  5  
 

 

RISK FACTORS

 

Investing in our common stock involves a high degree of risk. Before investing in our common stock, you should carefully consider the following risks, together with the financial and other information contained in this prospectus. If any of the following risks actually occurs, our business, prospects, financial condition and results of operations could be adversely affected. In that case, the trading price of our common stock would likely decline, and you may lose all or a part of your investment.

 

Risks Relating to Our Business

 

Risks Relating to our Organization and our Common Stock

 

Exercise of options and warrants and/or conversion of preferred stock will dilute your percentage of ownership. 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 warrants to purchase 25,015,866 shares of our common stock. In the future, we may grant additional stock options, warrants and convertible securities. The exercise or conversion of stock options, warrants, preferred stock or convertible securities will dilute the percentage ownership 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 them when we would be able to obtain additional equity capital on terms more favorable than these securities.

 

Difficulties we may encounter managing our growth could adversely affect our results of operations. As our business needs expand, we may need to hire a significant number of employees. This expansion may place a significant strain on our managerial and financial resources. To manage the potential growth of our operations and personnel, we will be required to:

 

  improve existing, and implement new, operational, financial and management controls, reporting systems and procedures;
  install enhanced management information systems; and
  train, motivate and manage our employees.

 

We may not be able to install adequate management information and control systems in an efficient and timely manner, and our current or planned personnel, systems, procedures and controls may not be adequate to support our future operations. If we are unable to manage growth effectively, our business would be seriously harmed.

 

If we lose key personnel or are unable to attract and retain additional qualified personnel, we may not be able to successfully manage our business and achieve our objectives.

 

We believe our future success will depend upon our ability to retain our key management, including Mr. De La Garza, our Chief Executive Officer, President, and Director, and Dr. Carlson, our Chief Scientist. We may not be successful in attracting, assimilating and retaining our employees in the future.

 

Our stock price may be volatile.

 

The stock market in general has experienced volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which are beyond our control, including the following:

 

  changes in our industry;
  competitive pricing pressures;
  our ability to obtain working capital financing;
  additions or departures of key personnel;
  limited “public float” in the hands of a small number of persons who sales or lack of sales could result in
  positive or negative pricing pressure on the market prices of our common stock;
    sales of our common stock;
  our ability to execute our business plan;
  operating results that fall below expectations;
  Joss of any strategic relationship;
  regulatory developments;
  economic and other external factors; and
  period-to-period fluctuations in our financial results.

 

  6  
 

 

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.

 

We have never paid nor; do we expect in the near future to pay dividends. We have never paid cash dividends on our capital stock and do not anticipate paying any cash dividends on our common stock for the foreseeable future. Investors should not rely on an investment in our Company if they require income generated from dividends paid on our capital stock. Any income derived from our common stock would only come from rise in the market price of our common stock, which is uncertain and unpredictable.

 

We cannot predict how liquid the market for our common stock might become. The market liquidity for our common stock is not predictable. Since January of 2000, our common stock has been quoted for trading on the OTC Bulletin Board as National Scientific Corporation with the symbol NSCT and since April of 2015 as Cipherloc Corporation trading on the OTC Bulletin Board under the symbol CLOK, as soon as is practicable, we intend to apply for listing of our common stock on The Nasdaq Capital Market or other national securities exchange, assuming that we can satisfy the initial listing standards for such exchange. We currently do not satisfy the initial listing standards and cannot ensure that we will be able to satisfy such listing standards or that our common stock will be accepted for listing on any such exchange. Should we fail to satisfy the initial listing standards of such exchanges, or our common stock is otherwise rejected for listing and remain listed on the OTC Bulletin Board or suspended from the OTC Bulletin Board, the trading price of our common stock could suffer and the trading market for our common stock may be less liquid and our common stock price may be subject to increased volatility. Furthermore, for companies whose securities are traded on the OTC Bulletin Board, it is more difficult (I) to obtain accurate quotations, (2) to obtain coverage for significant news events because major wire services generally do not publish press releases about such companies, and (3) to obtain needed capital.

 

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-l 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 50l(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 bas 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 proscribe d 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 common stock may be affected by limited trading volume and price fluctuation which could adversely impact the value of our common stock.

 

There has been limited trading in our common stock and there can be no assurance that an active trading market in our common stock will either develop or be maintained. Our common stock has experienced, and is likely to experience in the future, significant price and volume fluctuations which could adversely affect the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and changes in the overall economy or the condition of the financial markets could cause the price of our common stock to fluctuate substantially. These fluctuations may also cause short sellers to periodically enter the market in the belief that we will have poor results in the future. We cannot predict the actions of market participants and, therefore, can offer no assurances that the market for our common stock will be stable or appreciate over time.

 

  7  
 

 

Offers or availability for sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.

 

If our stockholders sell substantial amounts of our common stock in the public market upon the expiration of any statutory holding period, under Rule 144, or issued upon the exercise of outstanding options or warrants or upon the conversion of our Preferred Stock, it could create an “overhang” and in anticipation of which the market price of our common stock could fall. The existence of an overhang, whether or not sales have occurred or are occurring, also could make more difficult our ability to raise additional financing through the sale of equity or equity related securities in the future at a time and price that we deem reasonable or appropriate.

 

Investor relations activities, nominal “float” and supply and demand factors may affect the price of our stock.

 

The Company expects to utilize various techniques such as non-deal road shows and investor relations campaigns in order to create investor awareness for the Company. These campaigns may include personal, video and telephone conferences with investors and prospective investors in which our business practices are described. The Company may provide compensation to investor relations firms and pay for newsletters, websites, mailings and email campaigns that are produced by third-parties based upon publicly-available information concerning the Company. The Company does not intend to review or approve the content of such analysts’ reports or other materials based upon analysts’ own research or methods. Investor relations firms should generally disclose when they are compensated for their efforts, but whether such disclosure is made or complete is not under our control. in addition, investors in the Company may, from time to time, also take steps to encourage investor awareness through similar activities that may be undertaken at the expense of the investors. Investor awareness activities may also be suspended or discontinued which may impact the trading market of our common stock.

 

The SEC and FINRA enforce various statutes and regulations intended to prevent manipulative or deceptive devices in connection with the purchase or sale of any security and carefully scrutinize trading patterns and company news and other communications for false or misleading information, particularly in cases where the hallmarks of “pump and dump” activities may exist, such as rapid share price increases or decreases. We and our shareholders may be subject ed to enhanced regulatory scrutiny due to the small number of shareholders who initially will own the registered shares of our common stock publicly available for resale, and the limited trading markets in which such shares may be offered or sold which have often been associated with improper activities concerning penny-stocks, such as the OTC Bulletin Board or the OTCQB Marketplace (Pink OTC) or pink sheets. Until such time as our restricted shares are registered or available for resale under Rule 144, there will continue to be a small percentage of shares held by a small number of investors, many of whom acquired such shares in privately negotiated purchase and sale transactions, which will constitute the entire available trading market. The Supreme Court has stated that manipulative action is a term of art connoting intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities. Often times, manipulation is associated by regulators with forces that upset the supply and demand factors that would normally determine trading prices. Since a small percentage of the outstanding common stock of the Company will initially be available for trading, held by a small number of individuals or entities, the supply of our common stock for sale will be extremely limited for an indeterminate amount of time, which could result in higher bids, asks or sales prices than would otherwise exist. Securities regulators have often cited factors such as thinly-traded markets, small numbers of holders, and awareness campaigns as hallmarks of claims of price manipulation and other violations of law when combined with manipulative trading, such as wash sales, matched orders or other manipulative trading timed to coincide with false or touting press releases. There can be no assurance that the Company’s or third-parties’ activities, or the small number of potential sellers or small percentage of stock in the “float,” or determinations by purchasers or holders as to when or under what circumstances or at what price s they may be willing to buy or sell stock will not artificially impact (or would be claimed by regulators to have affected) the normal supply and demand factors that determine the price of the stock.

 

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 is 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 end products. Open source software vendors are devoting considerable efforts to developing software that mimics the features and functionality of our 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.

 

  8  
 

 

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. We are limited in our ability to recruit internationally by restrictive domestic immigration laws. 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 and enhancements to existing 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.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements. Such statements include statements regarding our expectations, hopes, beliefs or intentions regarding the future, including but not limited to statements regarding our market, strategy, competition, development plans (including acquisitions and expansion), financing, revenues, operations, and compliance with applicable laws. Forward-looking statements involve certain risks and uncertainties, and actual results may differ materially from those discussed in any such statement. Factors that could cause actual results to differ materially from such forward-loo king statements include the risks described in greater detail in the following paragraphs. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward- looking statement. Market data used throughout this prospectus is based on published third party reports or the good faith estimates of management, which estimates are based upon their review of internal surveys, independent industry publications and other publicly available information.

 

You should review carefully the section entitled “Risk Factors” beginning on page 6 of this prospectus for a discussion of these and other risks that relate to our business and investing in shares of our common stock.

 

USE OF PROCEEDS

 

The selling stockholders will receive all of the proceeds from the sale of the shares offered by them under this prospectus. We will not receive any proceeds from the sale of the shares by the selling stockholders covered by this prospectus.

 

SELLING STOCKHOLDERS

 

Up to 43,120,266 shares of common stock are being offered by this prospectus, all of which are being registered for sale for the account of the selling stockholders and consist of 18,897,400 shares of common stock issued to certain investors in the private placements ending in August 2018 and 24,226,866 shares of common stock issuable upon the conversion of outstanding warrants to the investors in the private placements ending in August 2018 which includes 5,398,966 warrants as a portion of the commissions paid to the Placement Agent and issued to the Agent’s designees.

 

  9  
 

 

Each of the transactions by which the selling stockholders acquired their securities from us was exempt under the registration provisions of the Securities Act.

 

The 43,120,266 shares of common stock referred to above are being registered to permit public sales of the shares, and the selling stockholders may offer the shares for resale from time to time pursuant to this prospectus. The selling stockholders may also sell, transfer or otherwise dispose of all or a portion of their shares in transactions exempt from the registration requirements of the Securities Act or pursuant to another effective registration statement covering those shares. We may from time to time include additional selling stockholders in supplements or amendments to this prospectus.

 

Except as otherwise provided, the following table sets forth certain information with respect to the beneficial ownership of our common stock including the names of the selling stockholders, the number of shares of our Common Stock owned beneficially by the selling stockholders as of February 4, 2019 the number of shares of our common stock being offered by each selling stockholder and the number and percentage of shares of Common stock that will be owned by each selling stockholder following the completion of this offering. The selling stockholders have not had a material relationship with us within the past three years other than as described in the footnotes to the table below or as a result of acquisition of our shares or other securities.

 

The selling stockholders’ percentage of ownership of our outstanding shares in the table below is based upon 40,783,164 shares of common stock outstanding as of February 4, 2019.

 

    Ownership Before Offering     Ownership After Offering (1)  
Selling Stockholder   Number of Shares of Common Stock Beneficially Owned     Number of Shares Offered     Number of Shares of Common Stock Beneficially Owned     Percentage of Common Stock Beneficially Owned  
                         
3NT Management, LLC     100,000       100,000       0       0  
Aaron Lehman     100,000       100,000       0       0  
Adam Ofstad     120,000       120,000       0       0  
Advanta IRA Services FBO Nicole Rhodes IRA     16,000       16,000       0       0  
Advanta IRA Services LLC FBO David Rhodes IRA 8007173     60,000       60,000       0       0  
Advanta IRA Services LLC FBO Fazal Dasankop IRA 8003     60,000       60,000       0       0  
Albert Arciero     200,000       200,000       0       0  
Aldolfo and Donna Carmona     200,000       200,000       0       0  
Allen Gabriel     200,000       200,000       0       0  
Alvin Fund     400,000       400,000       0       0  
Amin and Rubina Chikhalia, TBE     100,000       100,000       0       0  
Amy Stern     50,000       50,000       0       0  
Andara Capital, LP     200,000       200,000       0       0  
Anna Michalczyk     50,000       50,000       0       0  
Anthony and Angela Reed Family Trust     100,000       100,000       0       0  
Anthony and Angela Reed Family Trust, Tony Reed Trustee     50,000       50,000       0       0  

 

  10  
 

 

Ashit and Minaxi Vijapura TBE     100,000       100,000       0       0  
Ashwin and Achala Patel TBE     100,000       100,000       0       0  
Asian Gateway Ltd     200,000       200,000       0       0  
Asian Gateway Ltd     200,000       200,000       0       0  
Asian Gateway Ltd.     100,000       100,000       0       0  
Barrett M. Miller     100,000       100,000       0       0  
Barrett Share Trust     500,000       500,000       0       0  
Beacon Investments     200,000       200,000       0       0  
Bennett Yanowitz Credit Shelter Trust, Alan Yanowitz, Trustee     100,000       100,000       0       0  
Beth McChesney     30,000       30,000       0       0  
BMM Capital, LLC     200,000       200,000       0       0  
BMM Capital, LLC, Brian Mark Miller Control Person     200,000       200,000       0       0  
Boston Light Advisors, LLC, Roney, Managing Member     200,000       200,000       0       0  
Bradley and Belinda Karp, Tenents in Common     100,000       100,000       0       0  
Brian Kline     200,000       200,000       0       0  
Brian Skillern     50,000       50,000       0       0  
Bruce and Nancy Inglis JTWROS     100,000       100,000       0       0  
Bruce McFadden     20,000       20,000       0       0  
C D Walker LLC     200,000       200,000       0       0  
C.D. Walker, LLC     200,000       200,000       0       0  
Caisson Breakwater Global Opportunity Fund, LP     1,400,000       1,400,000       0       0  
Calcott Family Trust, George Calcott Trustee     50,000       50,000       0       0  
Calvin Klotz     20,000       20,000       0       0  
Candioty Werth Living Trust, Linda Candioty, Trustee     50,000       50,000       0       0  
Charles M. Johnson Jr.     200,000       200,000       0       0  
Chitayat-Mahboubian Family Trust     200,000       200,000       0       0  
Chris Merten     50,000       50,000       0       0  
Christopher Gutek     50,000       50,000       0       0  
Clayton A. Struve     100,000       100,000       0       0  
Clayton Struve     300,000       300,000       0       0  
Clint Duty     50,000       50,000       0       0  
Colin McIntyre     100,000       100,000       0       0  
Currie Family Trust     100,000       100,000       0       0  
Daniel and Delita Camilleri     50,000       50,000       0       0  
Daniel and Delita Camilleri     50,000       50,000       0       0  
Daniel and Delita Camilleri JTWROS     60,000       60,000       0       0  

 

  11  
 

 

Daniel and Delita Camilleri JTWROS     60,000       60,000       0       0  
Daniel Wray     50,000       50,000       0       0  
David and Bonnie White     40,000       40,000       0       0  
David and Elizabeth Kocyba JTWROS     50,000       50,000       0       0  
David S. Nagelberg 2003 Revocable Trust David Nagelberg, Trustee     200,000       200,000       0       0  
David Wells     200,000       200,000       0       0  
David Wells     200,000       200,000       0       0  
Devin Wate     400,000       400,000       0       0  
Devon Brown     50,000       50,000       0       0  
Donald Sesterhenn     50,000       50,000       0       0  
Douglas Harnar, LLC     200,000       200,000       0       0  
Dr. Brinda Thimmappa     100,000       100,000       0       0  
Dr. Naveen Ahuja     50,000       50,000       0       0  
Dwain H. Quandt Trust     50,000       50,000       0       0  
Dyke Roger     500,000       500,000       0       0  
Edward O’Rouke     20,000       20,000       0       0  
EEJ Millennium, FLP     50,000       50,000       0       0  
Eileen and John Wenschlog     100,000       100,000       0       0  
Eileen and John Wenschlog Revocable Trust     50,000       50,000       0       0  
EKM Capital, LLC     50,000       50,000       0       0  
Eldoret, LLC Nitesh Patel Sole Member     100,000       100,000       0       0  
Elliott L. Messing Revocable Trust, Elliott Messing Trustee     50,000       50,000       0       0  
Eric Shank     100,000       100,000       0       0  
Eric Shank     100,000       100,000       0       0  
Esther M. Harpe Trust     100,000       100,000       0       0  
Eugeen and Laura Webb, JTWROS     100,000       100,000       0       0  
Eugene and Laura Webb JTWROS     150,000       150,000       0       0  
Felix Frayman     150,000       150,000       0       0  
FirstFire Global Opportunities Fund, LLC     800,000       800,000       0       0  
Flying S Ranch Trust, Ryan and Diane Shay Trustees     200,000       200,000       0       0  
Frank Koza     50,000       50,000       0       0  
G & D Conniff, LLC     50,000       50,000       0       0  
Gary and Katherine Alexander JTWROS     16,000       16,000       0       0  
Gary Levine     50,000       50,000       0       0  

 

  12  
 

 

Gary Ray Alexander and Katherine Cheri Alexander, JTWROS     8,000       8,000       0       0  
Gary Ray and Katherine Cheri Alexander JTWROS     14,000       14,000       0       0  
Gary Roy Alexander     40,000       40,000       0       0  
Gary W. Levine     50,000       50,000       0       0  
Gary Zoellner     100,000       100,000       0       0  
GBS Trust George B. Stewart Trustee     50,000       50,000       0       0  
George and Janice Geldin Family Trust, George Geldin, Trustee     50,000       50,000       0       0  
George Mokan     30,000       30,000       0       0  
Gerald A. Tomsic 1995 Trust, Gerald A. Tomsic, Trustee     50,000       50,000       0       0  
Greg W. Hennessy     200,000       200,000       0       0  
Gregg Buffington     200,000       200,000       0       0  
Gregg Buffington     100,000       100,000       0       0  
GTS Summitt, FLP     50,000       50,000       0       0  
Harnar, LLC     200,000       200,000       0       0  
Harry Gordon     100,000       100,000       0       0  
Harvey R. Boshart     150,000       150,000       0       0  
Iroquois capital Investment Group     300,000       300,000       0       0  
Iroquois Master Fund     200,000       200,000       0       0  
 J & S Investments     100,000       100,000       0       0  
Jack B. Campbell II     20,000       20,000       0       0  
Jack Cavin Holland 1979 Trust, Jack Holland, Trustee t     40,000       40,000       0       0  
James Adams     25,000       25,000       0       0  
James Alderman     80,000       80,000       0       0  
James and Theresa Bailey JTWROS     50,000       50,000       0       0  
James Besser     200,000       200,000       0       0  
James Besser     400,000       400,000       0       0  
Jane Kantor 2011 Trust     200,000       200,000       0       0  
Jayesh K. Patel and Bela J. Patel TBE     100,000       100,000       0       0  
JEB Partners, LP     1,000,000       1,000,000       0       0  
JEB Partners, LP     1,600,000       1,600,000       0       0  
Jeffrey David Weiner     100,000       100,000       0       0  
Jill Wickersham     64,800       64,800       0       0  
Jimmi Dixon Jr.     100,000       100,000       0       0  

 

  13  
 

 

JJCC Investments, LLC     100,000       100,000       0       0  
John and Laura Maring     100,000       100,000       0       0  
John Cavin Holland 1979 Trust     80,000       80,000       0       0  
John M. Talone     40,000       40,000       0       0  
Joseph Cardin     100,000       100,000       0       0  
Joseph Kawley     50,000       50,000       0       0  
Joseph Manzi     50,000       50,000       0       0  
Joseph Michalczyk     150,000       150,000       0       0  
Joseph R. Yacison     50,000       50,000       0       0  
Kadi Family Trust, William Kadi Trustee     100,000       100,000       0       0  
KAM, LLC     50,000       50,000       0       0  
Kamaljit Khara     50,000       50,000       0       0  
Kathleen A. Lannert Family Trust, Robert Lannert Trustee     50,000       50,000       0       0  
Keith and Jeanne Fishback TIC     100,000       100,000       0       0  
Keith Wright     100,000       100,000       0       0  
Kenny Borin     40,000       40,000       0       0  
Kevin Nini     50,000       50,000       0       0  
Kim Marie Timothy     600,000       600,000       0       0  
Ladd Hill Development, LLC     100,000       100,000       0       0  
Larry Lindstrom     100,000       100,000       0       0  
Larry Lindstrom     100,000       100,000       0       0  
Lewis Dowdy     50,000       50,000       0       0  
Lonnie B. Kester     30,000       30,000       0       0  
Lonnie B. Kester     20,000       20,000       0       0  
Lonnie Kestor     40,000       40,000       0       0  
LRFA, LLC     200,000       200,000       0       0  
Mainstar Trust FOB Robert Brett Snyder IRA     72,000       72,000       0       0  
Mainstar Trust FOB Vrnon Rogr Harbough, Roth IRA     50,000       50,000       0       0  
Manchester Exploer, LP     2,000,000       2,000,000       0       0  
Manchester Explorer, LP     2,000,000       2,000,000       0       0  
Marc Cohen     60,000       60,000       0       0  
Mark and Debbie Lucas, JTWROS     50,000       50,000       0       0  
Mark and Debbie Lucas, JTWROS     100,000       100,000       0       0  
Mark Bloom     100,000       100,000       0       0  
Mark Gaibler     100,000       100,000       0       0  
Mark Herman     100,000       100,000       0       0  
Matthew Campbell     100,000       100,000       0       0  
Matthews Weiss     50,000       50,000       0       0  
Michael Zimmerman     50,000       50,000       0       0  
Millennium Investment Services 401K FBO Tony Reed     50,000       50,000       0       0  

 

  14  
 

 

MIS Equity Strategies LP     200,000       200,000       0       0  
MIS Equity Strategies, LP     400,000       400,000       0       0  
MIS Equity Strategies, LP, Tony Keys Mgr.     100,000       100,000       0       0  
Mitchell and Marcee Weiss Family Trust, Mitchell Weiss, Trustee     100,000       100,000       0       0  
Mitchell Tracy     100,000       100,000       0       0  
Mohamed Samy lhammady and Amany Awad, TB     100,000       100,000       0       0  
Munaf S. and Sarya Kapadi,a TBE     100,000       100,000       0       0  
Nancy Cowgill Trust, Nancy Cowgill, Trustee     100,000       100,000       0       0  
Nicholas Adams     100,000       100,000       0       0  
Nicholas Adams     250,000       250,000       0       0  
Nick Panayotou     100,000       100,000       0       0  
NJK Ventures, LLC     100,000       100,000       0       0  
Northern Refuge, LLC     200,000       200,000       0       0  
Northern Refuge, LLC     5,000       5,000       0       0  
Patrick Carney     100,000       100,000       0       0  
Paul Hermanson     50,000       50,000       0       0  
Paul Traxler     200,000       200,000       0       0  
Pensco Trust Company, LLC Custodian FOB Robert L. Dunn IRA     400,000       400,000       0       0  
Peter Reynolds     100,000       100,000       0       0  
Philip M. Cannella     100,000       100,000       0       0  
Praful Patel     100,000       100,000       0       0  
Quartini PLC Defined Benefit Plan and Trust, John Quartini, Trustee     75,800       75,800       0       0  
Quartrini PLC Defined Benefit Plan and Truct John Quartrini, Trustee     24,200       24,200       0       0  
Ralph N. Wharton     50,000       50,000       0       0  
Rameshchandra Dabbi     50,000       50,000       0       0  
Randall Yeomans     50,000       50,000       0       0  
RBC Capital Markets LLC, CUST FBO David S. Perry, sep IRA     200,000       200,000       0       0  
RBC Capital Markets LLC, CUST FBO Michael Zupan, IRA     150,000       150,000       0       0  
RBC Capital Markets LLC, CUST FBO Thomas C. Rolfstad,IRA     200,000       200,000       0       0  
RBC Capital Markets, LLC CUST FOB Brayden Clark IRA     100,000       100,000       0       0  
RBC Capital Markets, LLC CUST FOB Gerald Clavette IRA     50,000       50,000       0       0  
RBC Capital Markets, LLC CUST FOB Kerri Carmony, IRA     50,000       50,000       0       0  

 

  15  
 

 

RBC Capital Markets, LLC CUST FOB Terry Mitchell, IRA     62,000       62,000       0       0  
RBC Capital Markets, LLC CUST FOB Thomas C. Rolfstad, Seg. IRA     100,000       100,000       0       0  
RBC Capital Markets, LLC, CUST FBO Alexander Tosi, IRA     200,000       200,000       0       0  
RBC Capital Markets, LLC, CUST FBO Alexander Tosi, IRA     100,000       100,000       0       0  
RBC Capital Markets, LLC, CUST FOB David S. Perry Sep. IRA     100,000       100,000       0       0  
RBC Capital Markets, LLC, CUST FOB David S. Perry Sep. IRA     200,000       200,000       0       0  
Regina Wate     80,000       80,000       0       0  
Richard Carney     200,000       200,000       0       0  
Richard Reiter     85,000       85,000       0       0  
Robert Aldridge     210,000       210,000       0       0  
Robert Biederman     50,000       50,000       0       0  
Robert Dodge     200,000       200,000       0       0  
Robert Dodge     200,000       200,000       0       0  
Robert Johnson     50,000       50,000       0       0  
Robert Johnson     30,000       30,000       0       0  
Robert L. Monroe     50,000       50,000       0       0  
Robert Lamphere, Jr.     410,000       410,000       0       0  
Robert Radway     20,000       20,000       0       0  
Robert Rathbone     50,000       50,000       0       0  
Robert Swartwood     50,000       50,000       0       0  
Robert Swartwood     20,000       20,000       0       0  
Roger and Joyce Langeliers     200,000       200,000       0       0  
Roger and Joyce Langeliers     200,000       200,000       0       0  
Ross Pearson     100,000       100,000       0       0  
S. Bruce Lansky Revocable Trust, Bruce Lansky, Trustee     30,000       30,000       0       0  
S. Bruce Lansky Revocable Trust, Bruce Lansky, Trustee     20,000       20,000       0       0  
S. Bruce Lansky Rvocable Trust, Bruce Lansky     50,000       50,000       0       0  
S. Justin Devinney     50,000       50,000       0       0  
Sabi and Ronit Bivas     40,000       40,000       0       0  
Sargan Partners, Ltd     200,000       200,000       0       0  
Sargon Partners, Ltd.     200,000       200,000       0       0  
Satterfield Vintage Investments, LP     1,000,000       1,000,000       0       0  
Scott Bowles     50,000       50,000       0       0  
Sean and CeCille Coleman JTWROS     50,000       50,000       0       0  

 

  16  
 

 

Sharon Walker     50,000       50,000       0       0  
Sheldon Miller     120,000       120,000       0       0  
Stephen Shumpert     200,000       200,000       0       0  
Steve Boyd     98,000       98,000       0       0  
Steve Collins     80,000       80,000       0       0  
Steve Wietsma     50,000       50,000       0       0  
Steven and Kaye Yost Family Trust     20,000       20,000       0       0  
Steven and Kaye Yost Family Trust, Steven Yost Trustee     20,000       20,000       0       0  
Steven Rothstein     60,000       60,000       0       0  
Syeda S. Rizvi and Mairaj Uddin TBE     100,000       100,000       0       0  
Tara Holbrook     50,000       50,000       0       0  
TD Ameritrade CUST FOB Stefan Brink, IRA     40,000       40,000       0       0  
Terry and Amy Milam, JTWROS     40,000       40,000       0       0  
Terry Mitchell     20,000       20,000       0       0  
The Childers Living Trust     50,000       50,000       0       0  
The Clemetson Family Trust, Donald Clemetson Trustee     50,000       50,000       0       0  
The Feldman Family Trust, Andrew Feldman Trustee     70,000       70,000       0       0  
Tim Barbnecht     50,000       50,000       0       0  
Troy O’Bryan     100,000       100,000       0       0  
Troy Stevens     100,000       100,000       0       0  
Velcro, LLC Mark Miller Manager     200,000       200,000       0       0  
Veronica Marano and Thomas M. Volkening JTWROS     60,000       60,000       0       0  
Veronica Marano and Thomas M. Volkening, JTWROS     100,000       100,000       0       0  
Veronica Marano and Thomas M. Volkening, JTWROS     200,000       200,000       0       0  
Vijay and Teja Patel TBE     100,000       100,000       0       0  
Wamoh, LLC     100,000       100,000       0       0  
Wayne Newkumet     300,000       300,000       0       0  
William Gainey     100,000       100,000       0       0  
William Gainey     60,000       60,000       0       0  
William Green     50,000       50,000       0       0  
William Green     40,000       40,000       0       0  
William H. Costigan     50,000       50,000       0       0  
William H. Costigan     20,000       20,000       0       0  
William Murphy     200,000       200,000       0       0  
William Stocker III     50,000       50,000       0       0  
William Stocker III     50,000       50,000       0       0  
William Truxal     70,000       70,000       0       0  
William Winkenbach     50,000       50,000       0       0  
Zachary Mock     50,000       50,000       0       0  

 

  17  
 

 

Albert Landstrom*     52,575       52,575       0       0  
Basil Christakos*     30,861       30,861       0       0  
Brady Clark*     1,500       1,500       0       0  
Christopher Clark*     1,082,813       1,082,813       0       0  
Christopher Quandt*     500       500       0       0  
Dmitry Aksenov*     5,950       5,950       0       0  
Erik Poldroo*     500       500       0       0  
Eugene Webb*     187,507       187,507       0       0  
Gary Saccaro*     75,100       75,100       0       0  
Jared Berg*     1,000       1,000       0       0  
John Nole*     6,400       6,400       0       0  
Jonathan Henrich*     760       760       0       0  
Lorraine Maxfield*     45,861       45,861       0       0  
Malcolm Alexander Winks*     121,722       121,722       0       0  
Mark Finkle**     69,500       69,500       0       0  
Marshall Brown*     3,000       3,000       0       0  
Millard Tydings*     1,500       1,500       0       0  
Paulson Investment Company, LLC*     1,205,445       1,205,445       0       0  
Peter Fogarty*     22,950       22,950       0       0  
Robert Setteducati*     1,082,813       1,082,813       0       0  
Rodney Baber*     213,750       213,750       0       0  
Ronald Coby*     48,478       48,478       0       0  
Starla Goff*     2,813       2,813       0       0  
Tanya Urbach*     109,505       109,505       0       0  
Thomas Endres*     11,100       11,100       0       0  
Thomas Parigian*     1,082,813       1,082,813       0       0  
Timothy Dabulis*     1,750       1,750       0       0  

 

(1) Represents the amount of shares including those shares issuable upon the conversion of outstanding warrants that will be held by the selling stockholders after completion of this offering based on the assumptions that (a) all shares registered for sale by the registration statement of which this prospectus is part will be sold and (b) that no other shares of our common stock beneficially owned by the selling stockholders are acquired or are sold prior to completion of this offering by the selling stockholders.
(*) Represents warrants as a portion of the commissions paid to the Placement Agent and issued to the Agent’s designees convertible to shares of common stock.
(**) Represents shares of common stock that have been converted on a cashless basis by a designee of the Placement Agent.

 

  18  
 

 

PLAN OF DISTRIBUTION

 

We will not receive any of the proceeds from any sale by the Selling Shareholders. We are not offering any of the Selling Shareholders’ securities. These shares may be sold by the Selling Shareholders from time to time at prevailing market prices. The Selling Shareholders may sell or distribute their shares in transactions through underwriters, brokers dealers or agents from time to time or through privately negotiated transactions, including in distributions to shareholders or partners or other persons affiliated with the Selling Shareholders. If the Selling Shareholder enters into an agreement after the date of this prospectus to sell their shares to a broker-dealer as a principal and that broker-dealer is acting as an underwriter, we will file a post-effective amendment to the registration statement containing this prospectus identifying the broker-dealer and disclosing required information on the plan of distribution. Additionally, prior to any involvement of any broker-dealer in the offering, such broker-dealer must seek and obtain clearance of the underwriting compensation and arrangements from the Financial Industry Regulatory Agency.

 

Penny Stock Rules/ Section I5(g) of the Exchange Act

 

As previously mentioned under Risk Factors, our shares may be considered penny stock covered by Section 15(g) of the Securities Exchange Act of 1934, as a mended, and Rules 15g-l through 15g-6 promulgated thereunder. They impose additional sales practice requirements on broker/dealers who sell our securities to persons other than established customers and accredited investors who are generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 (including spouse’s net worth and may include the fair market value of home furnishings and automobiles, but excluding the value of any primary residence and the related amount of any indebtedness on primary residence up to the fair market value of the primary residence (any indebtedness that exceeds the fair market value of the primary residence must be deducted from net worth calculation) or annual income exceeding $200,000 or $300,000 jointly with their spouses.

 

Rule l5g-1 exempts a number of specific transactions from the scope of the penny stock rules. Rule l Sg-2 declares unlawful broker/dealer transactions in penny stocks unless the broker/dealer has first provided to the customer a standardized disclosure document.

 

Rule I5g-3 provides that it is unlawful for a broker /dealer to engage in a penny stock transaction unless the broker/dealer first discloses and subsequently confirms to the customer current quotation prices or similar market information concerning the penny stock in question.

 

Rule l5g-4 prohibits broker/dealers from completing penny stock transactions for a customer unless the broker/dealer first discloses to the customer the amount of compensation or other remuneration received as a result of the penny stock transaction.

 

Rule 15g-5 requires that a broker/dealer executing a penny stock transaction, other than one exempt under Rule l 5g-1, disclose to its customer, at the time of or prior to the transaction, information about the sales person’s compensation.

 

Rule l5g-6 requires broker/dealers selling penny stocks to provide their customers with monthly account statements.

 

Rule l5g-6 requires broker/dealers to approved the transaction for the customer’s account; obtain a written agreement from the customer setting forth the identity and quantity of the stock being purchased; obtain from the customer information regarding his investment experience; make a determination that the investment is suitable for the investor; deliver to the customer a written statement for the basis for the suitability determination and that it is unlawful to effect the transaction without written authorization for the transaction from the customer.

 

The application of the penny stock rules may affect your ability to resell your shares due to broker-dealer reluctance to undertake the above-described regulatory burdens.

 

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DESCRIPTION OF SECURITIES

 

Our authorized capital stock consists 650,000,000 shares of common stock at a par value of $0.01 and 10,000,00 shares of preferred stock at a par value of $0.01.

 

Common Stock

 

On April 11, 2011, the Company amended its articles of incorporation to increase the authorized shares to 650,000,000 shares, at $0.01 par value. On March 23, 2015, the common stock was reverse split on a 1 for 100 basis. There were 40,783,164 common shares issued and outstanding as of February 9, 2019 held by 1,182 stockholders. There is no cumulative voting with respect to the election of directors or any other matter. 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 Series A Preferred Stock, at $0.01 par value and 1,000,000 are issued and outstanding as of February 4, 2019. Each share of the preferred stock has 1.5 votes on all matters presented to be voted by the holders of our common stock. The holders of the Preferred A shares can only convert the shares if agreed upon by the Board of Directors.

 

Warrants

 

During the year ended September 30, 2017, the Company issued warrants to purchase 165,000 shares of common stock. The warrants were issued with an exercise price of $4.50 and a term of two years. Additionally, during the year ended September 30, 2017, the Company issued 560,000 warrants to the Private Placement Investors. The Private Placement Investors were granted units, which consisted of one share of common stock and a warrant to purchase two additional shares of common stock, for $2 each. The warrants were issued with an exercise price of $4.50 and a term of two years. There is a total of 725,000 warrants that will expire in fiscal year ending 2019.

 

During the year ended September 30, 2018, the Company issued warrants to purchase 18,827,900 to accredited investors for $1.00 per unit. Each Unit consisted of one (1) share of common stock and a warrant to purchase one (1) additional share of Common Stock at $1.20 per share. The warrant will expire 60 months from date of purchase. The Company issued an additional 5,398,970 warrants, with a cashless conversion provision, at $1.00 with a ten (10) year expiration date to the investment agent as part of the its fee.

 

INTERESTS OF NAMED EXPERTS AND COUNSEL

 

The validity of the shares of common stock offered hereby will be opined for the Company by Jeffery A. McKee Esq. of the law firm of Davis, McKee P.L.L.C. located at 1650 North 1 st Avenue, Phoenix, AZ 85003.

 

The financial statements included in this prospectus and the registration statement have been audited by Armanino LLP of San Francisco, California, to the extent and for the periods set forth in their report appearing elsewhere herein and in the registration statement and are included in reliance upon such report given upon the authority of said firm as experts in auditing and accounting. The auditor for the prior year is dbbmckennon of Newport Beach, California.

 

  20  
 

 

DESCRIPTION OF OUR BUSINESS

 

Cipherloc Corporation is a technology and services solutions company for the rapidly expanding cloud-based cyber security industry. Cipherloc is based in Buda, Texas. Our website is www.cipherloc.net

 

The foundation of modern security relies on encryption technology to protect sensitive information and maintain user privacy. However, ubiquitous use of encryption has been hampered by several factors: encryption is slow, key sizes need to be continually increased, it is increasingly possible to “break” into encrypted files using plaintext-recovery techniques, and encryption algorithms will be irreparably compromised when quantum computing becomes mainstream in the near-future. The Cipherloc mission is to eliminate these flaws and inadequacies to fully and securely protect the world’s data.

 

The Company has introduced an innovative and revolutionary new type of encryption technology with four international patents and two US patents pending and is the industry’s first “Poly morphic Cipher Engine”, called CipherLoc®. It is 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. Our highly innovative solutions are based on our patented polymorphic encryption technology which is designed to make encryption faster, stronger, and massively scalable.

 

Our key technology is Polymorphic encryption engine (U.S. Patent No. 9,178,514)

 

Our products for data-in- motion are:

 

EDGE – for use on mobile devices

ENTERPRISE – for use on desktops, laptops, tablets

GATEWAY – for use on servers

 

Our product for data-at-rest is:

 

SHIELD – for use on databases and other storage devices

 

Summaries for each of these products can be found on the Company’s website. The end goal with the release of these products is to offer end-to-end data security (i.e., data can be securely sent to/from any mobile device, any PC and any server).

 

Our highly innovative products - based on our patented polymorphic encryption technology are designed to enable an iron-clad layer of protection to be added to existing solutions. Cipherloc has developed technology that:

 

Cuts encryption processing time by over 50%

Dramatically enhances data security strength

Scalable, future-proof technology

Easily added to existing solutions

 

Go-to-Market Strategy:

 

With a business-to-business model, the Company will directly pursue businesses that will embed Cipherloc’s technology within their own product offering. We will be offering these potential clients a fairly standard software licensing-maintenance model, under which they will license our software for use within their own products. Any company today that is currently using encryption technology becomes a potential customer for us. By targeting companies who are already building solutions that have encryption built-in to their products we are planning to achieve scale much faster.

 

ln June 2018, the Company hired a Vice President of Sales and Marketing who is now the COO, to oversee the Comp any’s sales and business development.

 

  21  
 

 

Intellectual Property

 

Cipherloc holds a number of Patents and Trademarks, both U.S. and international, with several patents pending:

 

Patents   Trademarks
         
  1. U.S. Patent Number 9,178,514   1. Cipherloc®
  2. U.S. Patent Number 6,424,227   2. CipherShop
  3. U.S. Patent Number 6,423,990   3. CipherShop
  4. U.S. Patent Number 6,301,147    

 

The Competition

 

Conventional wisdom currently assumes modern encryption algorithms (such as AES) are safe because it would take an impractical amount of time for a brute force attack to successfully crack the encryption key used to protect data. This has been, and still is, an accurate statement. However, it can be demonstrably shown that it is possible to “break” into encrypted files using plaintext-recovery techniques that do not rely on brute force attacks thus exposing weaknesses and vulnerabilities in modern encryption algorithms. Because these encryption software engines have been used in the industry for well over 30 years, our primary competition are not other companies but rather the freely available, open-source encryption software that is currently used to protect data. One of our biggest challenges is convincing companies that their existing approaches that utilize these well-known encryption algorithms are no longer sufficient which means that the single biggest competitor we have is the status quo.

 

Two competitors are Palo Alto Networks (PANW) and FireEye (FEYE), which are highly indicative of the premium placed on firms in the business of cyber-security even though they don’t provide identical services or protection. Both firms have been brought public within the last 2 years and are experiencing exponential growth in revenues. Cipherloc is not expected to have a sizable need to upgrade and improve its encryption methodology and cipher engine as it is currently implemented because of the use of Set Theoretic Estimation mathematics.

 

Marketing

 

The Company’s COO heads up a marketing and sales organization consisting of professional consultants and licensees with extensive experience in the various markets where our products can be sold. Those markets are governmental, commercial and consumer. We attend trade shows, conferences and call on leaders in each market. Our products are sold through non-exclusive licensing agreements

 

Manufacturing

 

Our products are licensed software with very minimal development costs that is done in house.

 

Government Regulations

 

We are not subjected to government regulations in the sale or development of our products. All regulations that may be applicable are the responsibility of our customers.

 

Employees

 

We currently have 14 employees.

 

  22  
 

 

ORGANIZATION WITHIN THE LAST FIVE YEARS

 

The Company was incorporated in Texas on June 22, 1953 as American Mortgage Company. During 1996, the Company acquired the operations of Eden Systems, Inc. (“Eden”) as a wholly owned subsidiary. Eden was engaged in water treatment and the retailing of cleaning products. Eden’s operations were sold on October 1, 1997. From September 30, 1997 through the year ended September 30, 2001, the company aimed our efforts in the research and development of semiconductor proprietary technology and processes and in raising capital to fund its operations and research. On May 16, 1996, the Company changed its name to National Scientific Corporation and since January of 2000 traded on the OTC Bulletin Board under the symbol NSCT. On March 15, 2015, the Company changed its name to Cipherloc Corporation and reversed its stock on a 100 to 1 basis. The name change became effective by the Amended Certificate as of March 23, 2015 and the stock has been trading under the symbol CLOK

 

DESCRIPTION OF PROPERTIES

 

The Company rents office space at 825 Main Street, Suite 100, Buda, Texas 78610 for its corporate headquarters. It is our intention to use this facility for research and development. The Company leases offices at 7320 E. Butherus Drive, Suite 103, Scottsdale, Arizona 85260 primarily for sales and marketing. The Company has leased property at 21819 N. Scottsdale, AZ 85255 Scottsdale, Arizona 85260, which will be used for operation and accounting as well as the future headquarters.

 

LEGAL PROCEEDINGS

 

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 the 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 patent 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. The Company’s motion to dismiss is pending on appeal.

 

MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

 

Market Information

 

Our common stock has been publicly traded since April 1, 2015 on the OTC Bulletin Board. Our common stock is quoted under the symbol CLOK. Prior to that, our common stock was quoted under the symbol NSCT. The following table sets forth for the periods indicated the range of high and low bid quotations per share as reported by the OTC Bulletin Board. These quotations represent inter-dealer prices, without retail markups, markdowns or commissions and may not necessarily represent actual transactions.

 

  High     Low  
Fiscal Year 2017            
First Quarter (October - December 20I6)   $ 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  
                 
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 2019                
First Quarter (October - December 2018)   $ 2.20     $ 1.03  

 

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Holders

 

On February 4, 2019 the closing price of our common stock as reported on the Over-the-Counter Bulletin Board was $1.20 per s hare. On February 4, 2019, we had approximately 1,182 holders of record of common stock. As of February 4, 2019, 40,783,164 shares of our common stock were issued and outstanding and 1,000,000 shares of preferred stock were issued and outstanding. As of February 4, 2019, we had outstanding warrants to purchase 25,206,866 shares of common stock including 188,000 warrants not being registered with this registration statement.

 

Dividend Policy

 

We have not paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We intend to retain any earnings to finance the growth of the business. We cannot assure you that we will ever pay cash dividends. Whether we pay any cash dividends in the future will depend on the financial condition, results of operations and other factors that the Board of Directors will consider.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

On August 27, 2018 our Board of Director’s adopted a Stock Option/Stock Issuance Plan for the employees, non-employee directors, consultants and other independent advisors who provide services to the Corporation. The Plan allows 3 million shares to be allocated to be used for either as a grant or option to purchase not to exceed 100% of the recipient’s annual revenue. It shall be administered by the Board of Directors or a committee created by the Board and became effective October 1, 20 I8. No shares have been issued pursuant to the plan.

 

SELECTED FINANCIAL DATA

 

This Item is not required for smaller reporting companies, and the Company has elected to omit this information.

 

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.

 

  24  
 

 

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.

 

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.

 

Many of the conversion features embedded in the Company’s notes become variable upon the event of default or upon the passage of time in the event the Company does not repay the notes, at a premium, at 180 days from issuance of the note. If the conversion price is adjusted based on a discount to the market price of the Company’s common stock, the number of shares upon conversion is potentially unlimited. In the event we cannot control the net share settlement and cash settlement, we record the embedded conversion feature as a derivate instrument, at fair value. The excess of fair value of the embedded conversion feature, together with the original issue discounts, warrants, and issue costs over the face value of the debt, is recorded as an immediate charge in the accompanying statements of operations and cash flows. Each reporting period, the Company will compute the estimated fair value of derivatives and record changes to operations. The discounts are accreted over the term of the debt, which is generally nine months after the notes become convertible, using the effective interest method. We accounted for the embedded conversion features in the FirstFire and Peak One convertible notes as derivative liabilities in December 2017, even though we fully expect to repay the notes upon their scheduled maturity, because we have lost control of that ability as a result of the issuance of the Peak One note, and the financial burden these notes have placed on the Company. We continue to believe we will repay these notes before they become convertible after 180 days.

 

ASC 470-50, Extinguishments , require entities to record an extinguishment when the terms of the original note are significantly modified, defined as a greater than 10% change in expected cash flows. As a result of modifications made to one of the Company’s convertible notes during the reporting period, we recorded a loss as reported in the accompanying statements of operations and cash flows.

 

  25  
 

 

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.

 

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.

 

  26  
 

 

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.

 

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.

 

  27  
 

 

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.

 

  28  
 

 

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.

 

  29  
 

 

EXECUTIVE COMPENSATION

 

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”):

 

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 Officer     2017     $ 360,000     $ 60,000     $ 1,633,000     $ 54,000 (i)         $ 2,107,000  
                                                         
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 Officer     2017                                      

 

(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 a 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.

 

We have an employment agreement with Milton Mattox, Ed. D, our former Vice President of Sales and Marketing, as our Chief Operating Officer. The Agreement is for a term of one year, commencing on October 1, 2018 and initially expiring on September 30, 2019 with three automatic 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. Mattox shall receive an annual base salary of $175,000. If, at any time during the term of the Agreement, Dr. Mattox 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 26, 2018.

 

  30  
 

 

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.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

None.

 

AVAILABLE INFORMATION

 

You are advised to read this Form S-1 in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Annual Reports on Form 10-K and 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 at 825 Main Street, Suite 100, Buda, TX 78610, our website, www.cipherloc.net 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.

 

  31  
 

 

FINANCIAL STATEMENTS

 

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

 

  32  
 

 

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

 

  33  
 

 

CIPHERLOC CORPORATION

BALANCE SHEETS

 

    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.

 

  34  
 

 

CIPHERLOC CORPORATION

STATEMENTS OF OPERATIONS

 

    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.

 

  35  
 

 

CIPHERLOC CORPORATION

STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

FOR THE YEARS ENDED SEPTEMBER 30, 2018 AND 2017

 

    Preferred Stock     Common Stock     Additional Paid-in       Accumulated     Stockholders’
Equity 
 
    Shares     Amount     Shares     Amount    

Capital

    Deficit     (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 and warrants 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.

 

  36  
 

 

CIPHERLOC CORPORATION

STATEMENTS OF CASH FLOWS

 

    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.

 

  37  
 

 

CIPHERLOC CORPORATION

NOTES TO FINANCIAL STATEMENTS

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.

 

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.

 

  38  
 

 

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 Accounting Standards Codification (“ASC”) 470-20, Debt with Conversion and Other Options . ASC 470-20 governs the calculation of an embedded beneficial conversion, a derivative instrument, which is treated as an additional discount to the instruments where derivative accounting does not apply. This applies during the period for which embedded conversion features are either fixed, contingently convertible, or cash or net settlement is in control of the Company. When equity instruments, such as warrants, are issued with convertible debt, the net proceeds from the transaction are allocated to the convertible debt and equity instruments based on their relative fair values. The proceeds allocated to the equity instruments may reduce the carrying value of the convertible debt, and such discount is amortized to interest expense over the term of the debt. The amount of the warrants and beneficial conversion feature will reduce the carrying value of the debt instrument to zero, but no further. In the event the Company has the option to pay the convertible note at a premium ranging within the first six (6) months before they become convertible, the Company will record the prepayment if intended. The discount relating to the initial recording of the original issue discount, issue cost, warrant and beneficial conversion feature are accreted, together with the premium, over the estimated term of the debt, which is generally 180 days from the date of issuance.

 

The conversion feature embedded in the Company’s note may become variable upon the event of default or upon the passage of time in the event the Company does not repay the notes, at a premium, at 180 days from issuance of the note. If the conversion price is adjusted based on a discount to the market price of the Company’s common stock, the number of shares upon conversion is potentially unlimited. In the event we cannot control the net share settlement and cash settlement, we record the embedded conversion feature as a derivate instrument, at fair value. The excess of fair value of the embedded conversion feature, together with the original issue discounts, warrants, and issue costs over the face value of the debt, is recorded as an immediate charge in the accompanying statements of operations and cash flows. Each reporting period, the Company will compute the estimated fair value of derivatives and record changes to operations. The discounts are accreted over the term of the debt, which is generally nine months after the notes become convertible, using the effective interest method.

 

ASC 470-50, Extinguishments , require entities to record an extinguishment when the terms of the original note are significantly modified, defined as a greater than 10% change in expected cash flows. As a result of modifications made to one of the Company’s convertible notes during the reporting period, we recorded a loss as reported in the accompanying statements of operations and cash flows.

 

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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.

 

The Company uses the two-step approach to recognize 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.

 

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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.

 

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 July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) – Accounting for Certain Financial Instruments with Down Round Features , to change the classification analysis of certain equity-linked financial instruments with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity-classified instruments, the amendments require the effect of the down round feature to be recognized in earnings per share when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. ASU 2017-11 is effective in annual periods beginning after December 15, 2019 and in interim periods within annual periods beginning after December 15, 2020. The Company early adopted ASU 2017-11 during the year ended September 30, 2017.

 

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.

 

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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.

 

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.

 

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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. 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 note, as amended, provided the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a conversion price of $1.00 per share, subject to certain adjustments to the conversion price under certain circumstances. In the event of default, the conversion price equaled the lower of $1.00 per share or 70% multiplied by the lowest bid price of the Company’s common stock during the 25 trading days preceding the conversion date. An event of default, among other events, was the non-payment of the note at maturity.

 

If shares of the Company’s common stock traded below $1.00 per share on the day following the conversion date, the conversion price was to be retroactively adjusted to equal 75% multiplied by the lowest traded price on the day following the conversion date. If the Company consummated a registered or unregistered primary offering of its securities for capital raising purposes, the holder of the note had the right to demand repayment in full or convert the outstanding principal balance and accrued interest into shares of the Company’s common stock at the lower of $1.00 per share or a 20% discount to the offering price to investors in the primary offering.

 

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. Upon the December 20, 2017 amendment of the FirstFire note, the Company reduced the note to zero and recognized an embedded conversion feature derivative liability of $320,312. The Company valued the embedded conversion feature as 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 embedded conversion feature derivative liability. The Company valued the embedded 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%.

 

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.

 

Total interest expense related to the FirstFire note, including the debt discount amortization, was $453,700 for the year ended September 30, 2018.

 

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 and provided the holder with the right to convert all or a portion of the outstanding principal balance to shares of the Company’s common stock at a conversion price of $1.00 per share, subject to certain adjustments to the conversion price under certain circumstances. If an event of default had occurred or if the conversion occurred more than 180 days from the issuance date, the conversion price shall equal the lower $1.00 per share or 70% of the lowest traded price of the Company’s common stock during the 20 trading days preceding the conversion date. However, if the Company’s common stock was not eligible for clearing through the Depository Trust Company’s Deposit Withdrawal Agent Commission system on the conversion date, the conversion price would have equaled the lower of $1.00 per share or 65% of the lowest traded price of the Company’s common stock during the 20 trading days preceding the conversion date. 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.

 

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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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Employment Contracts

 

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, 2017, 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.

 

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.

 

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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.

 

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.

 

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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. The Company valued these warrants at $28,609,542 with the Black-Scholes-Merton valuation model using an expected life of five years, volatility of 150%, and risk-free rates ranging from 2.56% to 2.95%. The Company also issued warrants to purchase 5,398,966 shares of common stock to the placement agents for this PPM. These warrants were issued with an exercise price of $1.00 and a term of ten years. The Company valued these warrants at $10,952,342 with the Black-Scholes-Merton valuation model using an expected life of ten years, volatility of 150%, and a risk-free rate of 3.05%.

 

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. The Company valued these warrants at $963,337 with the Black-Scholes-Merton valuation model using an expected life of two years, volatility of 150%, and risk-free rates ranging from 1.27% to 1.45%.

 

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  

 

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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   $     $  

 

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.

 

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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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FORM 10-Q FILING

FOR THE THREE MONTHS ENDED DECEMBER 31, 2018 AND 2017

 

CIPHERLOC CORPORATION

BALANCE SHEETS

(UNAUDITED)

 

   

December 31, 2018

    September 30, 2018  
ASSETS                
Current assets                
Cash   $ 13,052,481     $ 14,056,346  
Prepaid expenses     56,995        
Total current assets     13,109,476       14,056,346  
                 
Other assets     12,218       12,218  
Fixed assets, net     35,988       20,050  
Total assets   $ 13,157,682     $ 14,088,614  
                 
LIABILITIES & STOCKHOLDERS’ EQUITY                
Current liabilities                
Accounts payable and accrued liabilities   $ 91,782     $ 52,043  
Accrued compensation     153,765       72,489  
Total current liabilities     245,547       124,532  
                 
Commitments and contingencies (Note 5)                
                 
Series A convertible preferred stock, $0.01 par value, 10,000,000 shares authorized; 1,000,000 issued and outstanding as of December 31, 2018 and September 30, 2018     10,000       10,000  
Common stock, $0.01 par value, 650,000,000 shares authorized; 40,763,917 and 40,743,917 issued and outstanding as of December 31, 2018 and September 30, 2018, respectively     407,638       407,438  
Additional paid-in capital     68,208,957       68,169,157  
Accumulated deficit     (55,714,460 )     (54,622,513 )
Total stockholders’ equity     12,912,135       13,964,082  
Total liabilities and stockholders’ equity   $ 13,157,682     $ 14,088,614  

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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CIPHERLOC CORPORATION

STATEMENTS OF OPERATIONS

(UNAUDITED)

 

    Three Months Ended  
    December 31,  
    2018     2017  
Revenues   $     $ 115,642  
Cost of revenues           30,300  
Gross profit           85,342  
                 
Operating expenses                
General and administrative     532,974       183,920  
Sales and marketing     213,975       22,967  
Research and development     345,895       114,852  
Total operating expenses     1,092,844       321,739  
Operating loss     (1,092,844 )     (236,397 )
                 
Other income (expenses)                
Loss on extinguishment of convertible notes           (358,038 )
Excess fair value of derivatives in convertible note           (486,745 )
Change in fair value of embedded conversion features in convertible notes           (135,932 )
Interest income (expense), net     897       (196,036 )
Net loss   $ (1,091,947 )   $ (1,413,148 )
                 
Net loss per common share – basic and diluted   $ (0.03 )   $ (0.21 )
                 
Weighted average common shares outstanding – basic and diluted     40,762,159       6,712,339  

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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CIPHERLOC CORPORATION

STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

    Three Months Ended  
    December 31,  
    2018     2017  
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net loss   $ (1,091,947 )   $ (1,413,148 )
Adjustments to reconcile net loss to net cash flows used in operating activities:                
Depreciation     1,781       1,381  
Stock-based compensation           10,000  
Stock issued for services     40,000        
Loss on extinguishment of convertible notes           358,038  
Excess fair value of derivatives in convertible note           486,745  
Change in fair value of embedded conversion features in convertible notes           135,932  
Debt discount amortization           183,345  
Changes in operating assets and liabilities:                
Prepaid expenses     (56,995 )      
Accounts payable and accrued liabilities     39,739       (19,513 )
Accrued compensation     81,276       1,396  
Deferred revenue           (115,642 )
Net cash used in operating activities     (986,146 )     (371,466 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:                
Purchase of fixed assets     (17,719 )      
Net cash used in investing activities     (17,719 )      
                 
CASH FLOWS FROM FINANCING ACTIVITIES:                
Common stock issued for cash           57,200  
Proceeds from convertible note, net           242,600  
Net cash provided by financing activities           299,800  
                 
DECREASE IN CASH     (1,003,865 )     (71,666 )
CASH, BEGINNING OF PERIOD     14,056,346       227,396  
CASH, END OF PERIOD   $ 13,052,481     $ 155,730  

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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CIPHERLOC CORPORATION

STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED DECEMBER 31, 2018

(UNAUDITED)

 

    Preferred Stock     Common Stock     Additional Paid-in     Accumulated     Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Deficit    

Equity

 
Balance at September 30, 2018     1,000,000     $ 10,000       40,743,917     $ 407,438     $ 68,169,157     $ (54,622,513 )   $      13,964,082  
Common stock issued for services                 20,000       200       39,800             40,000  
Net loss                                   (1,091,947 )     (1,091,947 )
Balance at December 31, 2018     1,000,000     $ 10,000       40,763,917     $ 407,638     $ 68,208,957     $ (55,714,460 )   $ 12,912,135  

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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CIPHERLOC CORPORATION

NOTES TO FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2018 AND 2017

(Unaudited)

 

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 - BASIS OF PRESENTATION OF INTERIM FINANCIAL STATEMENTS

 

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. The accompanying interim unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Operating results for the three months ended December 31, 2018 are not necessarily indicative of the results that may be expected for the year ending September 30, 2019. Notes to the unaudited interim financial statements that would substantially duplicate the disclosures contained in the audited financial statements for the year ended September 30, 2018 have been omitted; this report should be read in conjunction with the audited financial statements and the footnotes thereto for the fiscal year ended September 30, 2018 included within the Company’s Form 10-K as filed with the Securities and Exchange Commission.

 

NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are as follows:

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company did not have any cash equivalents as of December 31, 2018 or September 30, 2018. At December 31, 2018 and September 30, 2018, 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. At December 31, 2018, $12,802,481 of the Company’s cash balance was uninsured. The Company has not experienced any losses in cash.

 

Convertible Debt and Embedded Derivatives

 

Convertible debt is accounted for under the guidelines established by Accounting Standards Codification (“ASC”) 470-20, Debt with Conversion and Other Options . ASC 470-20 governs the calculation of an embedded beneficial conversion, 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.

 

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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 .

 

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 December 31, 2018 and September 30, 2018, the Company had 1,000,000 shares of preferred stock outstanding, which are convertible into 1,500,000 shares 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 three months ended December 31, 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 three months ended December 31, 2017, 874,000 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.

 

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 three months ended December 31, 2018 and 2017 were $345,895 and $114,852, respectively.

 

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 ASC. Other than those discussed below, the Company believes those updates issued-to-date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company, or (iv) are not expected to have a significant impact on the Company.

 

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.

 

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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.

 

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 adoption of ASU 2014-09 did not have a material impact on the Company’s financial statements or related disclosures.

 

NOTE 4 – CONVERTIBLE NOTE PAYABLE

 

FirstFire Global Opportunities Fund, LLC

 

On September 26, 2017, the Company issued a convertible note payable to FirstFire Global Opportunities Fund, LLC (“FirstFire”). This convertible note was settled in March 2018. The note was issued 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, after which 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 using the Black-Scholes-Merton valuation model on the date of the amendment with an expected life of one (1) year, volatility of 150%, and risk-free rate of 1.87%.

 

During the three months ended December 31, 2017, the Company recognized a loss of $48,911 related to the change in fair value of the FirstFire beneficial conversion feature. The change in fair value was calculated using the stock price as of December 31, 2017 of $1.18 and an exercise price of $0.70, which is 70% multiplied by the lowest bid price of the Company’s common stock during the preceding 25 trading days, per the terms of the note.

 

Additionally, upon the December 20, 2017 amendment of the FirstFire note, the Company recorded a debt discount of $330,000. The Company amortized $37,813 of the debt discount to interest expense during the three months ended December 31, 2017. Total interest expense related to the FirstFire note, including the debt discount amortization prior to the amendment, was $178,700 for the three months ended December 31, 2017.

 

Peak One Opportunity Fund LP

 

On December 14, 2017, the Company issued a convertible note payable to Peak One Opportunity Fund LP (“Peak One”). This convertible note was settled in April 2018. The note was issued 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.

 

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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 using the Black-Scholes-Merton valuation model on the date of issuance with 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 in the Peak One note and of the equity instruments issued with the convertible note.

 

During the three months ended December 31, 2017, the Company recognized a loss of $87,021 related to the change in fair value of the Peak One beneficial conversion feature. The change in fair value was calculated using the stock price as of December 31, 2017 of $1.18 and an exercise price of $0.70, which is 70% multiplied by the lowest bid price of the Company’s common stock during the preceding 25 trading days, per the terms of the note.

 

Additionally, upon issuance of the Peak One note, the Company recorded a debt discount of $300,000. The Company amortized $4,645 of the debt discount to interest expense during the three months ended December 31, 2017.

 

NOTE 5 – 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.

 

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.

 

In October 2018, the Company leased an additional 3,859 square feet of office space in Scottsdale, Arizona. The lease for the new Scottsdale office began on October 4, 2018 and continues until October 31, 2021. Annual rent of $77,180 was prepaid for the first year from November 1, 2018 to October 31, 2019. After the first year, the lease requires monthly rent payments of $6,753 from November 1, 2019 to October 31, 2020 and $7,075 from November 1, 2020 to October 31, 2021.

 

NOTE 6 - STOCKHOLDERS’ EQUITY

 

The Company is authorized to issue 650,000,000 common shares and 10,000,000 preferred shares at a par value of $0.01 per share. As of December 31, 2018, the Company had 40,763,917 shares of common stock and 1,000,000 shares of preferred stock outstanding. As of September 30, 2018, the Company had 40,743,917 shares of common stock and 1,000,000 shares of preferred stock outstanding.

 

Common Stock

 

Management determines the fair value of stock issuances using the closing stock price on the grant date.

 

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During the three months ended December 31, 2018, the Company issued 20,000 shares of common stock with a fair value of $40,000 to Pycnocline, LLC for management consulting services.

 

During the three months ended December 31, 2017, the Company issued 5,537 shares of common stock with a fair value of $10,000 to its officers and other employees as part of their compensation, which was recorded in research and development expenses.

 

Preferred Stock

 

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.

 

NOTE 7 – SUBSEQUENT EVENTS

 

There have been no reportable events that have occurred after December 31, 2018.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In this Quarterly Report, “Company,” “our company,” “us,” and “our” refer to Cipherloc Corporation and its subsidiaries, unless the context requires otherwise.

 

Forward-Looking Statements

 

The following information contains certain forward-looking statements. Forward-looking statements are statements that estimate the happening of future events and are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as “may,” “could,” “expect,” “estimate,” “anticipate,” “plan,” “predict,” “probable,” “possible,” “should,” “continue,” or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.

 

Our Business

 

Cipherloc 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.

 

Results of Operations for the three months ended December 31, 2018 and 2017

 

Revenue decreased to $0 from $115,642 for the three months ended December 31, 2018 and 2017, respectively. Similarly, cost of revenue decreased to $0 from $30,300 for the three months ended December 31, 2018 and 2017, respectively. The decrease in revenue and cost of revenue is a result of the Company’s only software license contract ending in June 2018.

 

General and administrative expenses increased to $532,974 from $183,920 for the three months ended December 31, 2018 and 2017, respectively. General and administrative expenses increased primarily as a result of higher professional fees of $86,000, higher legal costs of $74,000, higher consulting and contract services of $64,000, higher salaries of $47,000, and higher rent expense of $22,000.

 

Sales and marketing expenses increased to $213,975 from $22,967 for the three months ended December 31, 2018 and 2017, respectively. Sales and marketing expenses increased primarily as a result of higher consulting costs of $151,000.

 

Research and development costs increased to $345,895 from $114,852 for the three months ended December 31, 2018 and 2017, respectively. Research and development expenses increased primarily as a result of higher salaries of $167,000 and higher consulting costs of $74,000, partially offset by lower stock-based compensation of $10,000.

 

Interest income, net, was $897 for the three months ended December 31, 2018, as compared to interest expense, net, of $196,036 for the three months ended December 31, 2017. The change in interest income (expense), net, was due to the convertible notes with FirstFire Global Opportunities Fund, LLC and Peak One Opportunity Fund LP, which were outstanding during the three months ended December 31, 2017 and subsequently settled prior to the three months ended December 31, 2018.

 

Liquidity and Capital Resources

 

We have an accumulated deficit at December 31, 2018 of $55,714,460. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At December 31, 2018, the Company had cash of $13,052,481. We believe that our existing cash balances are sufficient to fund future operations for the next 12 months.

 

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Cash Flow

 

The following table summarizes, for the periods indicated, selected items in our condensed Statements of Cash Flows:

 

    Three Months Ended  
    December 31,  
    2018     2017  
Net cash (used in) provided by:                
Operating activities   $ (986,146 )   $ (371,466 )
Investing activities   $ (17,719 )   $  
Financing activities   $     $ 299,800  

 

Operating Activities

 

Cash used in operating activities was $986,146 and $371,466 for the three months ended December 31, 2018 and 2017, respectively. The increase in cash used in operating activities was primarily due to lower non-cash expenses, partially offset by changes in working capital usage.

 

Investing Activities

 

Cash used in investing activities was $17,719 and $0 for the three months ended December 31, 2018 and 2017, respectively. The increase in cash used in investing activities was the result of fixed asset purchases.

 

Financing Activities

 

Cash provided by financing activities was $0 and $299,800 for the three months ended December 31, 2018 and 2017, respectively. The decrease in cash provided by financing activities was primarily due to no issuances of common stock or notes payable during the three months ended December 31, 2018.

 

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.

 

DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES

 

Our Bylaws, as amended, provides that to the fullest extent permitted by law, directors, officers, employees and agents may be indemnified by the Corporation against any and all expenses, liabilities or other matters. Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the “Act”) may be permitted as to directors, officers, employees, controlling persons and agents of the small business issuer pursuant to the above-stated language, or otherwise, the small business issuer has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as set out in the Act and is therefore unenforceable.