NOTES
TO FINANCIAL STATEMENTS
FOR
THE THREE AND SIX MONTHS ENDED MARCH 31, 2018 AND 2017
(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, polymorphic encryption technology is designed to enable an iron-clad
layer of protection to be added to existing solutions.
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 and six months ended March 31, 2018 are not necessarily indicative of the results that may be expected for
the year ending September 30, 2018. 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, 2017 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, 2017 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 March 31,
2018 of $52,120,653. The Company’s continued existence is dependent upon our ability to obtain additional funding
to explore potential strategic relationships, complete development and marketing of the Company’s technologies, and operate
the business. These factors raise doubt about the Company’s ability to continue as a going concern.
Management
is currently in the process of raising capital through sales of common stock. Management has used the proceeds from this
financing to repay the two convertible notes, one of which was repaid during the quarter, and the other repaid subsequent
to March 31, 2018. There are no assurances that management will be successful in raising capital to be able to achieve the needs
of the business. The accompanying financial statements do not include any adjustments that might result from the outcome of this
uncertainty.
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 March
31, 2018 and September 30, 2017, 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 March 31, 2018, $183,909
of the Company’s cash balance was uninsured, and at September 30, 2017, none of its cash balance was uninsured. The Company
has not experienced any losses in such accounts.
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, 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.
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.
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 March 31, 2018 and September 30, 2017,
the Company had 1,000,000 and 10,000,000 shares, respectively, of preferred stock outstanding, which are convertible into common
stock at a rate of 1 preferred share to 1.5 common shares. The Company issued 1,276,000 shares and 1,313,000 shares
of restricted common shares through Private Placement Memorandums for net proceeds totaling $1,120,125 and $1,177,325 during the
three and six months ended March 31, 2018, respectively.
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.
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. Research
and development costs were $251,136 and $365,988 for the three and six months ended March 31, 2018, respectively, and $156,536
and $756,495 for the three and six months ended March 31, 2017, 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.
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 – CONVERTIBLE NOTE PAYABLE
FirstFire
Global Opportunities Fund, LLC
On
September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC (“FirstFire”)
with a principal amount of $330,000, which includes an original issue discount of $30,000. The Company incurred $8,500 in direct
costs. The note accrued interest at 5% per annum and was to mature on March 26, 2018, six months following the issuance date.
The note was convertible at $2.00 per share, subject to adjustment. The Company 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 to $1.00 per share, subject to adjustment, reduced
the exercise price of the warrants from $4.50 to $2.00, and required the Company to issue an additional 87,500 shares of common
stock to FirstFire, which resulted in an extinguishment loss.
The
Company accounted for the amendment of the FirstFire note using derivative accounting and recognized a loss on extinguishment
of $358,038 during the three months ended December 31, 2017. The Company also recognized a derivative liability of $320,312 as
of the note’s amendment date. The Company valued the derivative liability with the Black-Scholes 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 three and six months ended March 31, 2018, the Company recognized a gain of $187,624 and $138,713, respectively, related to
the change in fair value of the FirstFire derivative liability. The Company valued the derivative liability with the Black-Scholes
valuation model as of March 21, 2018, immediately prior to the settlement of the note as described below, using an expected life
of 0.01 years, volatility of 150%, and risk-free rate of 1.71%.
Upon amendment of the FirstFire note, the
Company recorded a debt discount of $330,000. The Company amortized $275,000 and $312,813 of the debt discount to
interest expense during the three and six months ended March 31, 2018, respectively. Total interest expense related to the FirstFire
note, including the debt discount amortization prior to the amendment, was $275,000 and $453,700 for the three and
six months ended March 31, 2018, respectively.
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 derivative liability of $181,599 and the note payable in full. In connection
with the settlement of the First Fire note, the Company recognized a gain on extinguishment of $66,912.
Peak
One Opportunity Fund LP
On
December 14, 2017, the Company issued a convertible note to Peak One Opportunity Fund LP (“Peak One”) with a principal
amount of $300,000, which includes an original issue discount of $30,000. The Company incurred $27,400 in direct costs. The note
was to mature three years from the issuance date and provides 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.
Together
with the convertible note, 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. The Company accounted for the convertible note to
Peak One using derivative accounting and recognized a derivative liability of $267,750 as of the note’s issuance date. The
Company valued the derivative liability with the Black-Scholes 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 derivative in the convertible note and of the equity instruments issued with the convertible note.
During
the three and six months ended March 31, 2018, the Company recognized a gain of $69,045 and loss of $17,976, respectively,
related to the change in fair value of the Peak One derivative liability. The Company valued the derivative liability with
the Black-Scholes valuation model as of March 31, 2018 using an expected life of 1.25 years, volatility of 150%, and
risk-free rate of 1.63%.
The
Company recorded a debt discount of $300,000 upon issuance of the Peak One note. The Company amortized $24,590 and $29,235 of
the debt discount to interest expense during the three and six months ended March 31, 2018, respectively. The remaining debt discount
of $270,765 as of March 31, 2018 will be amortized to interest expense over the remaining term of the note. The Peak One note
was included in current liabilities as management subsequently repaid the note in April 2018.
Additionally,
the transaction with Peak One included a stock purchase agreement setting forth the details above, including the option for an
additional convertible note in the amount of $300,000 and an equity purchase agreement for up to $7,000,000 of the Company’s
common stock and related registration rights agreement, which will require a registration statement to be filed.
NOTE
6 - 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 March 31, 2018 and September 30, 2017, totaling $363,820 and $338,437, 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 $12,692 and $25,383 during the three and six months ended March 31, 2018, respectively. Management believes
that such amounts were previously satisfied through the issuance of common stock and does not intend to pay such amounts.
NOTE
7 - STOCKHOLDERS’ DEFICIT
As
of March 31, 2018, 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 March 31, 2018,
there were 1,276,000 shares of common stock sold for $1,120,125, net of $190,875 in offering costs. During the six months
ended March 31, 2018, there were 1,313,000 shares of common stock sold for $1,177,325, net of $207,675 in offering
costs.
During the three and six months ended March
31, 2018, the Company issued 82,917 and 88,454 shares of common stock with a fair value of $157,743 and $167,743, respectively,
to its employees as part of their compensation. The shares were valued using the closing stock price on the grant date and were
earned as of March 31, 2018.
During the three months ended March 31,
2018, the Company issued 50,000 shares of common stock with a fair value of $81,000 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.
Preferred
Stock
The
Company’s Series A Preferred Stock is convertible into the Company’s common stock at a rate of 1 preferred share to
1.5 common shares. As of March 31, 2018, there are a total of 1,000,000 shares of the Series A Preferred Stock authorized and
outstanding, which are convertible into a total of 1,500,000 shares of common stock. Each share of the Preferred Stock has 1.5
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.
Warrants
During the three months ended March 31, 2018,
the Company issued 1,241,000 warrants to Private Placement investors. Each warrant entitles the holder to purchase one
additional share of common stock. The warrants were issued with an exercise price of $1.20 and a term of five years.
See
Notes 5 and 8 for discussion regarding additional issuances.
NOTE
8 – RELATED PARTY TRANSACTIONS
In
February 2018, the Company’s Chief Executive Officer converted his 9,000,000 shares of preferred stock to 13,500,000 shares
of common stock.
NOTE
9
– SUBSEQUENT EVENTS
In
April 2018, the Company paid off the Peak One note at a redemption cost of $375,000.
Subsequent to March 31, 2018, there were 3,469,000
shares of common stock sold for net proceeds of $3,034,120.
There
have been no other reportable events that have occurred after March 31, 2018.