NOTES
TO FINANCIAL STATEMENTS
FOR
THE THREE MONTHS ENDED DECEMBER 31, 2020 AND 2019
(Unaudited)
NOTE
1 - DESCRIPTION OF BUSINESS
Cipherloc
Corporation (the “Company” or “Cipherloc”) was incorporated in the State of Texas on June 22, 1953 under
the name “American Mortgage Company.” Effective August 27, 2014, we changed our name to “Cipherloc Corporation.”
Our headquarters are located at 6836 Bee Cave Road, Building 1, S#279, Austin, TX 78746. Our website is www.cipherloc.net.
NOTE
2 - GOING CONCERN
We
do not believe that our existing cash balances are sufficient to fund future operations for the next 12 months. We are considering
options to issue additional equity as a means to increase liquidity sufficient to fund operations into the start of calendar year
2022. If we are unsuccessful doing so, then the Company will cease operations.
At
December 31, 2020, the Company had not yet achieved profitable operations. We had a net loss of approximately $7.0 million for
the year ended September 30, 2020 and had an accumulated deficit in aggregate of approximately $69.2 million from our inception
through December 31, 2020. We expect to incur further losses in the development of our business. These conditions raise substantial
doubt about the Company’s ability to continue as a going concern.
The
Company’s ability to continue as a going concern is dependent on its ability to generate future profitable operations and/or
to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when
they come due. Management’s plan to address the Company’s ability to continue as a going concern includes: (1) obtaining
debt or equity funding from private placement or institutional sources; (2) generating cash flow from operations. Although management
believes that it will be able to obtain the necessary funding to allow the Company to remain a going concern through the methods
discussed above, there can be no assurances that such methods will prove successful.
These
financial statements have been prepared assuming that the Company will continue as a going concern and therefore, the financial
statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets
or the amount and classifications of liabilities that may result from the outcome of this uncertainty.
NOTE
3 - 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, 2020 are not necessarily indicative of the results that may be expected for the
year ending September 30, 2021. 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, 2020 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,
2020 included within the Company’s Form 10-K as filed with the Securities and Exchange Commission.
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 a maturity at the time of purchase of three months or less to be cash equivalents.
At December 31, 2020 and September 30, 2020, cash includes cash on hand and cash in the bank. The balance of such accounts, 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, 2020, $149,876 of the Company’s cash balance was uninsured.
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, 2020, and December
31, 2019, 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, 2020,
23,746,866 warrants, 800,000 stock options 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, 2019, 24,216,866
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.
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, 2020 and 2019 were $121,793 and $566,015, respectively.
Revenue
Recognition
The
Company recognizes revenues in accordance with the provisions of Accounting Standards Update 2014-09, “Revenue from Contracts
with Customers,” and a series of amendments which together we identify as “ASC Topic 606”.
Central
to the new revenue recognition guidance is a five-step revenue recognition model that requires reporting entities to:
1.
|
Identify
the contract,
|
2.
|
Identify
the performance obligations of the contract,
|
3.
|
Determine
the transaction price of the contract,
|
4.
|
Allocate
the transaction price to the performance obligations, and
|
5.
|
Recognize
revenue.
|
The
Company accounts for a promise to provide a customer with a right to access the Company’s intellectual property as a performance
obligation satisfied over time because the customer will simultaneously receive and consume the benefit from the entity’s
performance of providing access to its intellectual property as the performance occurs.
Software
License Agreements
During
fiscal the fiscal year ended September 30, 2019, the Company entered into a one-year agreement with SoundFi LLC (“SoundFi”)
which automatically renews for subsequent one-year periods unless otherwise terminated by either party. Cipherloc received $25,000
from SoundFi during the year ended September 30, 2020.
The
Company executed an annual software licensing agreement with Castle Shield during the year ended September 30, 2020 which also
include auto-renewing terms. Castle Shield made a $10,000 payment to the Company based on the terms of their agreement with Cipherloc.
During
the three-months ended December 31, 2020, the Company recognized $8,750 in licensing revenue from the SoundFi and Castle Shield
agreements.
Recent
Accounting Pronouncements
The
Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the
authoritative literature in the ASC. There have been several 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
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This
guidance removes certain exceptions to the general principles in Topic 740 and enhances and simplifies various aspects of the
income tax accounting guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is
not a business combination, ownership changes in investments, and interim-period accounting for enacted changes in tax law. This
standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020. Early
adoption is permitted. The Company are currently evaluating the impact of ASU 2019-12 on its financial statements, which is effective
for the Company in its fiscal year and interim periods beginning on October 1, 2021.
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 adopted ASU 2018-13 on October 1, 2020 and the adoption of this update did not have a material impact on the Company’s
financial position, results of operations and cash flows.
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 adopted ASU 2018-07
on October 1, 2019 and the adoption of this update did not have a material impact on the Company’s financial position, results
of operations and cash flows.
In
February 2016, the FASB issued ASU 2016-02, Leases, which aims to make leasing activities more transparent and comparable and
requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset (ROU) and corresponding
lease liability, including leases currently accounted for as operating leases. Leases of mineral reserves and related land leases
have been exempted from the standard. We adopted ASU 2016-02, Leases, on October 1, 2019. We elected the “package of practical
expedients” within the standard which permits us not to reassess prior conclusions about lease identification, lease classification
and initial direct costs. We made an accounting policy election to not separate lease and non-lease components for all leases.
The adoption of this standard resulted in the recognition of right-of-use assets and lease liabilities of $0.2 million, which
were not previously recorded on our balance sheet.
NOTE
5 – COMMITMENTS AND CONTINGENCIES
Litigation
Other
than as set forth below, the Company is not currently involved in any litigation that it believes could have a material adverse
effect on its financial condition or results of operations.
In
December 2017, a disgruntled former consultant brought an action
in Texas state court against the Company and its former chief executive officer, alleging fraud and misrepresentation pertaining
to stock and payments alleged to be owed to the consultant. The Company believes it has made all required payments and delivered
the stock to the consultant. The consultant also included a claim of partial ownership of certain of the Company’s patents,
which the Company believes is without merit. The case is currently being defended by the Company.
In
August 2019, the Board of Directors formed a special committee of independent directors (the “Special Committee”)
to investigate certain activities of Michael De La Garza (“De La Garza”), our former chief executive officer. Also,
in that same month, the Company initiated litigation against De La Garza in the District Court of Travis Country, Texas (the “Court”).
On September 25, 2019, the Court entered a temporary injunction against De La Garza enjoining him from numerous acts. The Special
Committee investigated certain activities of De La Garza, including the Ageos, LLC Operating Agreement, the QHCI/Noun note receivable,
an advance/bonus, personal expenditures, and other items. All amounts expended have been expensed as of September 30, 2019.
The
Company also sued De La Garza, among others, in federal district court seeking to invalidate the issuance of Series A preferred
stock to him in 2015. The preferred shares were converted to 13.5 million shares of common stock by De La Garza during 2018.
All
litigation with De La Garza was settled on August 28, 2020 with De La Garza and the Company entering into a Settlement Agreement,
whereby De La Garza agreed to return 13.1 million shares of common stock to the Company and the Company agreed to pay De La Garza
$400,000 between September 30, 2020 and September 30, 2021. At December 31, 2020, Cipherloc owed $75,000 in settlement payments
which will be made in $25,000 equal payments on March 1, 2021, June 1, 2021, and September 1, 2021, respectively.
The
Company also sought to invalidate the issuance of 1 million shares of the Company’s Series A preferred stock in or around
2011 to former director and chief financial officer, Pamela Thompson, which stock was being held by the Carmel Trust II. As such,
the Company initiated an action against James LeGanke, as Trustee of Carmel Trust II, in federal district court as part of its
efforts to invalidate those shares. The Company alleged that Thompson failed to comply with both state law and the Company bylaws
when she De La Garza caused the Company to issue the preferred stock to themselves as purported compensation. The action was settled
on January 11, 2021, for $50,000 in exchange for the return of the 1,000,000 shares of Series A preferred stock and 127,500 shares
of the Company’s common stock. The settlement payment was included in the December 31, 2020 balance sheet as an accrued
liability.
In
October, 2020, Ageos, LLC, a Virginia limited liability company
(“Ageos”), filed a Third Party Complaint against the Company (Third Party Case No. GV20015643-00) in connection with
the pending action titled Scandium, LLC v. Ageos, LLC (Case No. GV20014313-00) in the General District Court for Fairfax County
in the Commonwealth of Virginia. The action relates to an operating agreement, by and between the Company and Ageos, whereby the
Company agreed to guarantee Ageos’s lease in order to enable the leasing of space in Fairfax County, VA. The Company’s
subsequently terminated the agreement with Ageos and offered to take over the space as an accommodation. Ageos declined. Ageos’s
third party complaint demands from the Company, among other things, all damages obtained by Scandium, LLC against Ageos; (ii)
other compensatory damages in connection with certain lease payments under the lease discussed above; and (iii) pre-judgment interest.
This lawsuit is ongoing, and its resolution is unknown.
Leases
As
of December 31, 2020, the Company had one lease agreement for facilities.
In
February 2020, the Company leased approximately 3,666 square feet of office space on 2107 Wilson Boulevard, Arlington, Virginia.
The lease for this facility began on February 1, 2020 and continues until July 31, 2025. The base annual rent is $159,471, a $100,000
security deposit was paid, and abatement of monthly rent payments was provided until August 1, 2020, and the lease provides for
annual rent increases of approximately 2.5%. The amount of future payments guaranteed is $782,214.
As
the result of restructuring actions intended to conserve cash during the COVID-19 crisis, the landlord of the Wilson Boulevard
space was notified that the Company no longer needed the space and is seeking an amicable and reasonable termination of the lease
agreement.
The
Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenant.
Operating
Leases
Operating
leases are included in operating lease ROU lease assets, and operating lease liabilities and operating long-term lease liabilities
on the Balance Sheets. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Variable
lease expense is recognized in the period in which the obligation for those payments is incurred. Lease expense is included in
general and administrative expense in the statements of operations and is reported net of lease income. Lease income is not material
to the results of operations for the three months ended December 31, 2020.
Cash
Flows
An
initial right-of-use asset of $233,751 was recognized as a non-cash asset addition with the adoption of the new lease accounting
standard. In February 2020, the Company’s new lease in Arlington, Virginia added approximately $746,000 in new lease obligations.
Cash paid for amounts included in the present value of operating lease liabilities was $39,868 during first quarter 2021 and is
included in operating cash flows.
The
weighted average remaining lease terms and discount rates for all of our operating lease were as follows as of December 31, 2020:
Remaining lease term and discount rate:
|
|
December 31, 2020
|
|
Weighted average remaining lease terms (years)
|
|
|
|
|
Lease facilities
|
|
|
4.58
|
|
|
|
|
|
|
Weighted average discount rate
|
|
|
|
|
Lease facilities
|
|
|
4.35
|
%
|
Significant
Judgements
Significant
judgements include the discount rates applied, the expected lease terms, and lease renewal options.
Future
annual minimum lease obligations at December 31, 2020 are as follows:
Year ending September 30
|
|
Amount
|
|
2021
|
|
$
|
122,267
|
|
2022
|
|
|
166,180
|
|
2023
|
|
|
170,322
|
|
2024
|
|
|
174,575
|
|
2025
|
|
|
148,870
|
|
|
|
$
|
782,214
|
|
Rent
expense totaled $38,279 and $22,744 for the three months ended December 31, 2020 and 2019, respectively.
NOTE
6 – DEBT
On
April 6, 2020, to supplement its cash balance, the Company submitted their application for a Paycheck Protection Program (“PPP”)
loan (the “SBA loan”) sponsored by the U.S. Small Business Administration in the amount of $365,430. On April 12,
2020, Company’s SBA loan application was approved, and the Company received loan proceeds on April 22, 2020. The SBA loan
has an interest rate of 1% and matures on April 12, 2022.
Section
1106 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) provides for forgiveness of up to the
full principal amount of qualifying loans guaranteed under the PPP. The PPP and loan forgiveness are intended to provide economic
relief to small businesses, such as the Company, that are adversely impacted under the COVID-19 Emergency Declaration issued by
President Donald J. Trump on March 13, 2020.
As
a result of staff reductions during 2020, the Company expects the ultimate amount of loan forgiveness to be less the original
principal of the PPP SBA loan.
The
PPP loan balance at December 31, 2020 was $365,430. The Company filed for partial loan forgiveness on January 29, 2021 but has
not received approval of its forgiveness application as of the time of this filing.
NOTE
7 - STOCKHOLDERS’ EQUITY (DEFICIT)
The
Company is authorized to issue 681,000,000 common shares and 1,000,000 preferred shares, each at a par value of $0.01 per share.
Common
Stock
During
the three months ended December 31, 2020, there were no issuances of common stock.
During
the three months ended December 31, 2019, the Company issued 620,000 shares of stock options to the employees with a fair value
of $459,019, of which $12,751 was recorded as stock-based compensation expenses in research and development, marketing and general
administration expense. Options will vest over a three-year period ratably. Of the 620,000 options, 500,000 options have a strike
price of $0.78 and the remaining 120,000 have a strike price of $0.81. Total stock compensation expense was $51,574 for the quarter
ended December 31, 2019.
Series
A Preferred Stock
Each
outstanding share of Series A preferred stock is convertible into the Company’s common stock at a rate of one 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 upon approval of the Company’s 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
8 – SUBSEQUENT EVENTS
On
January 11, 2021, settlement was reached in relation to suit filed by the Company against James LeGanke, as Trustee of Carmel
Trust II, and was settled for $50,000 in exchange for the return of 1,000,000 shares of Series A Preferred Stock and 127,500 shares
of common stock to the Company.
On
February 5, 2021 the Company filed amendments to its Articles of Incorporation with the Texas Secretary of State.