NOTES TO FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS
ENDED JUNE 30, 2016 AND 2015
(Unaudited)
NOTE 1 - DESCRIPTION OF BUSINESS
Cipherloc Corporation (the “Company”)
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 by the Amended Certificate as of March 23, 2015.
Cipherloc is a data security solutions
company. 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:
• Dramatically enhances
data security
• Can be easily added to
existing products
• Is scalable and future-proof
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 nine months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending
September 30, 2016. 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,
2015
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, 2015 included within the Company’s Form 10-K/A as filed with the Securities and
Exchange Commission.
NOTE 3 - GOING CONCERN
The accompanying
financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America,
which contemplate continuation of the Company as a going concern. The Company has incurred losses from operations and has a net
total equity balance at June 30, 2016 of ($419,299). The Company will intend to continue raising money through a private placement
memorandum and also by the sale of products during the 2016 calendar year to fund operations.
These factors raise doubt about
the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments
that might result from the outcome of this uncertainty. The Company’s continued existence is dependent upon management’s
ability to develop profitable operations and the ability to obtain additional funding sources to explore potential strategic relationships
and to provide capital and other resources for the further development and marketing of the Company’s products and business.
NOTE 4
-
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. At June 30, 2016 and September 30,
2015, cash and cash equivalents include 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 June 30, 2016, $552,048 of the Company’s cash balance
was uninsured, and on September 30, 2015, $1,743,406 was uninsured. The Company has not experienced any losses in such accounts.
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.
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.
Concentration
of Credit Risk and Customer Concentrations
All of the Company’s cash
and cash equivalents are maintained in regional and national financial institutions. The Company has exposure to credit risk to
the extent that its cash and cash equivalents exceed amounts covered by the U.S. federal deposit insurance; however, the Company
has not experienced any losses in such accounts. In management’s opinion, the capitalization and operating history of the
financial institutions are such that the likelihood of material loss is remote.
During the three and nine months
ended June 30, 2016, one customer made up 100% of revenues. Management believes the loss of this customer would have a material
impact on the Company’s financial position, results of operations, and cash flows.
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.
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 will be recognized on a pro rata basis prospectively over the remaining 30 months
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 has deferred revenue
from one customer of $896,186 as of June 30, 2016 and $1,125,000 as of September 30, 2015.
Research and Development and
Software Development Costs
Capitalization of certain software
development costs are recorded after the determination of technological feasibility. Based on our product development process,
technological feasibility is determined upon the completion of a working model. To date, costs incurred by us from the completion
of the working model to the point at which the product is ready for general release do not have technological feasibility. Accordingly,
we have charged all such costs to research and development expense in the period incurred. Our research and development costs
incurred in our continuing operations for the three months ended June 30, 2016 and 2015 were $140,962 and $27,195, respectively,
and for the nine months ended June 30, 2016 and 2015 were $378,605 and $68,845, respectively.
Recent
Accounting Announcements
The Financial Accounting Standards
Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the authoritative literature in the
Accounting Standards Codification (“ASC”). There have been a number of ASUs to date that amend the original text of
ASC. 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 February
2016, the FASB issued ASU 201602, 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. The amendments
in this standard are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal
years, for a public entity. Early adoption of the amendments in this standard is permitted for all entities and the Company must
recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company
is currently in the process of evaluating the effect this guidance will have on its financial statements and related disclosures.
In June 2016, the FASB
issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326). This ASU requires financial assets (or groups
of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected, among other
provisions. The provisions of this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2019. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years. The Company should generally apply the amendment on a modified retrospective basis through a cumulative-effect
adjustment to retained earnings as of the beginning of the first reporting periods in which the amendment is effective. The Company
is currently in the process of evaluating the effect this guidance will have on its financial statements and related disclosures.
In March 2016, the FASB issued
ASU 2016-09, Compensation — Stock Compensation (Topic 718). This ASU simplifies several aspects of the accounting for
share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities,
and classification on the statement of cash flows. The provisions of this ASU are effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company should apply the amendment
using transition guidance for each aspect of the ASU. The Company is currently in the process of evaluating the effect this guidance
will have on its financial statements and related disclosures.
In January 2016, the FASB issued
ASU 2016-01, Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial
Liabilities. This ASU makes targeted improvements to the accounting for, and presentation and disclosure of, financial assets
and liabilities. The ASU further requires separate presentation of financial assets and financial liabilities by measurement category
on the balance sheet or the accompanying notes to the financial statements. The provisions of this ASU are effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted based upon
guidance issued within the ASU. The Company should apply the amendment prospectively, with a cumulative-effect adjustment to the
balance sheet as of the beginning of the fiscal year of adoption. 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
2014-09, Revenue from Contracts with Customers (Topic 606). On August 12, 2015, the FASB issued ASU 2015-14, Revenue
from Contracts with Customers (Topic 606) to defer the effective date to December 15, 2017 for annual reporting periods beginning
after that date. The FASB also permitted early adoption of the standard, but not before the original effective date of December
15, 2016. The amendments in ASU 2014-09 will be added to the Accounting Standards Codification as Topic 606, Revenue
from Contracts with Customers, and will supersede the revenue recognition requirements in Topic 605, Revenue Recognition,
as well as some cost guidance in Subtopic 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts.
The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for
those goods or services. To achieve this core principle, the guidance provides that an entity should apply the following steps:
(1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction
price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as,
the entity satisfies a performance obligation. Notably, the existing requirements for the recognition of a gain or loss on the
transfer of non-financial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, Property,
Plant, and Equipment, and intangible assets within the scope of Topic 350, Intangibles — Goodwill and Other) are amended
to be consistent with the guidance on recognition and measurement in ASU 2014-09. The new standard allows for two methods of adoption:
(a) full retrospective adoption, meaning the standard is applied to all periods presented, or (b) modified retrospective adoption,
meaning the cumulative effect of applying the new standard is recognized as an adjustment to the fiscal 2017 opening retained
earnings balance. In March 2016 through May 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606):
Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers
(Topic 606): Consensuses of the FASB Emerging Issues Task Force and ASU 2016-12, Revenue from Contracts with Customers (Topic
606): Narrow-Scope Improvements and Practical Expedients. ASU 2016-08, 2016-10 and 2016-12 clarify implementation guidance and
introduce practical expedients, and are effective upon adoption of ASU 2014-09. The Company is currently in the process of evaluating
the effect this guidance will have on its financial statements and related disclosures.
NOTE 5 - RELATED PARTY TRANSACTIONS
The advances
from the CEO are due on demand and do not accrue interest. These advances are included in accounts payable and accrued liabilities
on the balance sheet. The Company had advances from the CEO of $0 and $1,205 as of June 30, 2016 and September 30, 2015, respectively.
NOTE 6 - DISCONTINUED OPERATIONS
Cloud MD Sale
The Company’s Board of Directors
believed that it was in the best interest of the Company to discontinue the former business operation Cloud MD. During September
2015, the Cloud MD business segment was discontinued and a plan of sale of the segment was approved. The Cloud MD sale occurred
in October 2015 as a $250,000 note payable from a former employee of Cloud MD. The note receivable has five annual payments of
$50,000 and carries interest of 3% a year. We reviewed the need for an allowance for loan loss and estimation of impairment of
the note receivable based on professional relationship and experience with the buyer and the specifics of the agreements. As it
was determined that collectability of the cash was not reasonably assured, the Company has fully reserved the receivable, and
the Company will record the gain from the sale of assets of discontinued operations in the future when and if cash is received.
NOTE 7 - EQUITY
As of June 30, 2016, the Company
was authorized to issue 650,000,000 common shares and 10,000,000 preferred shares at a par value of $0.01.
Common Stock
During the three months
ended June 30, 2016, there were 315,500 shares of common stock sold for $613,320, net of $17,680 in offering costs. During
the nine months ended June 30, 2016, 448,000 shares of common stock were sold for $875,321, net of $20,680 in
offering costs.
On April 1, 2016, the Company issued
28,000 shares of common stock to BrokerBank having a market value of $56,000 as the stock portion of the fees due pursuant to
the fee agreement BrokerBank is a registered broker dealer . On April 8, 2016, the Company issued 800 shares of common stock to
Pamela Kafka for the design of the Company’s logo. The shares had a value of $1,600. On June 17 2016, the Company also issued
315,000 shares of common stock, with a fair market value of $803,250 to six individual licensees as consideration for their relinquishing
all rights they had in a perpetual license to use the Company’s server. The fair market value of the shares issued was used
to measure the transaction as this was the most reliably measureable amount.
Preferred Stock
As of June 30, 2016, the Series
A Preferred Stock is convertible into the Company’s common stock at a rate of 1 to 1.5 common shares. As of June 30, 2016,
there are a total of 10,000,000 shares of the Series A Preferred Stock authorized and outstanding which are convertible into a
total of 15,000,000 shares of common stock. Each share of the Preferred Stock has 150 votes on all matters presented to be voted
by the holders of common stock. The holders of the Series A Preferred Stock can only convert the shares if agreed upon by 50.1%
vote of all preferred shareholders.
NOTE 8 - COMMITMENTS AND
CONTINGENCIES
Litigation
The Company is involved in a
litigation as the plaintiff and counter defendant. While the outcome and impact of this currently pending legal proceeding
cannot be predicted with certainty, based on the current status of the matters, we believe that the resolution of this
proceeding through settlement or judgment will not have a material adverse effect on our operating results, financial
position or cash flow. There is a $45,580 deposit in escrow to repurchase common stock as a settlement of pending litigation.
Subsequent
to quarter end, the Company received the common shares, and litigation was dismissed.
NOTE 9
–
RECENT COMPANY ACTIVITIES
The Company hired Michael Hufnagel
as Director of Engineering on June 27, 2016. The employment contract grants an annual salary of $145,000, a $10,000 signing bonus
and restricted-common stock with an annual value of $60,000. One quarter of the stock shall be granted at the end of the first
quarter anniversary of employment and a like amount each quarter as long as the contract is in effect.
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