NOTES
TO FINANCIAL STATEMENTS
FOR
THE THREE MONTHS ENDED DECEMBER 31, 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:
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Dramatically
enhances data security
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Can
be easily added to existing products
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Is
scalable and future-proof
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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, 2016 are not necessarily indicative of the results that may be expected for the
year ending September 30, 2017. 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, 2016 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,
2016 included within the Company’s Form 10-K as filed with the Securities and Exchange Commission.
NOTE
3 - GOING CONCERN
The
accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United
States of America, which contemplate continuation of the Company as a going concern. The Company has incurred losses from operations
and has an accumulated deficit at December 31, 2016 of $48,944,828. The Company intends to continue raising money through
a private placement memorandum and through the sale of products during the 2017 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 December
31, 2016 and September 30, 2016, 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 December 31, 2016, none of
the Company’s cash balance was uninsured, and at September 30, 2016, $94,138 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. As of December 31, 2016 and September
30, 2016, the Company had 10,000,000 shares of preferred stock outstanding, which are convertible into 15,000,000 shares of common
stock. The Company issued 123,000 shares of restricted common shares through a Private Placement Memorandum for proceeds totaling
$233,120 during the three months ended December 31, 2016. The Company also issued 25,000 shares of restricted stock pursuant to
Rule 144 to terminate a perpetual software license.
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 months ended December 31, 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 and rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription
period. When VSOE of fair value for 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 $671,022 as of December 31, 2016 and $783,522 as of September 30, 2016.
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 for the three months ended December 31, 2016 and 2015 were $599,959 and $154,650, 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 the 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.
NOTE
5 - COMMITMENTS AND CONTINGENCIES
Terminated
Employment Agreement with Former Chief Financial Officer
The
Company previously had an employment agreement with its Chief Financial Officer, which terminated in 2015. There were amounts
that were accrued and unpaid as of December 31, 2016 and September 30, 2016, totaling $302,654 and $291,715, respectively. According
to the original agreement, the unpaid salaries were to accrue interest at 15%, which has been accrued at each reporting date.
Interest expense was $10,939 during the three months ended December 31, 2016. Management believes that such amounts were previously
satisfied through the issuance of common stock and does not intend to pay such amounts.
Employment
Agreement with Chief Executive Officer
During
the three months ended December 31, 2016 and 2015, cash compensation amounted to $92,491 and $146,887, including
benefits, respectively. During the three months ended December 31, 2016 and 2015, stock-based compensation amounted to $1,629,000
and $0, respectively. As of December 31, 2016, the Chief Executive Officer was prepaid $52,244, which was included
within prepaid officer’s compensation on the accompanying balance sheet.
NOTE
6 - STOCKHOLDERS’ DEFICIT
As
of December 31, 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
Management
determines the fair value of stock issuances using the closing stock price on the grant date.
During
the three months ended December 31, 2016, there were 123,000 shares of common stock sold for $233,120, net of $16,880 in offering
costs.
Additionally,
the Company issued 25,000 shares of common stock with a fair value of $106,250 for a software termination settlement.
During
the three months ended December 31, 2016, the Company also issued 390,000 shares of common stock with a fair value of $2,121,700
to its officers, including 300,000 shares with a fair value of $1,633,000 to Michael De La Garza for his tenure as
Chairman of the Board and as a CEO stock award, 70,000 shares with a fair value of $380,100 to Eric Marquez for his tenure as
a Board Director and as a CFO stock award, and 20,000 shares with a fair value of $108,600 to Gino Mauriello for his tenure as
a Board Director.
Furthermore,
the Company issued 50,000 shares of common stock with a fair value of $271,500 to Albert Carlson as an employee bonus, 25,000
shares with a fair value of $135,750 to Robert LeBlanc for patent work, and 10,000 shares with a fair value of $54,300 to Michael
Hufnagel as an employee bonus. The Company also issued 10,146 shares of common stock with a fair value of $31,250 to Mike Salas
and 3,968 shares with a fair value of $15,000 to Mike Hufnagel as part of their quarterly compensation.
Preferred
Stock
The
Company’s Series A Preferred Stock is convertible into the Company’s common stock at a rate of 1 to 1.5 common shares.
As of December 31, 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
7 – SUBSEQUENT EVENTS
The
Company has continued to raise equity financing through a Private Placement Memorandum. After December 31, 2016, the Company has
sold 301,500 shares of common stock at $2.00 per share and received $589,600, net of $12,400 in offering costs.