Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1. Organization, Recent History, and Description of Businesses-Past and Present

Description of Businesses: Present and Past

IronClad Encryption Corporation (formerly Butte Highlands Mining Corporation) is a company developing and licensing cyber software technology to secure data files (stored and at rest) and electronic communications (in motion from electronic transmission over the internet or through telephone systems).  Data at rest and in motion are both safeguarded from unauthorized access through the use of dynamic encryption and perpetual authentication.

InterLok Key Management, Inc. (formerly InterLok Key Management, LLC) is the company that initially developed and maintained the patents and was formed in Texas on June 12, 2006 and incorporated ten years later on June 16, 2016.

On January 6, 2017 InterLok entered into a Share Exchange Agreement ("Share Exchange") with Butte Highlands Mining Company. Under the terms of the agreement, the shareholders of InterLok Key Management, Inc. exchanged all 56,655,891 outstanding shares of InterLok’s common stock for 56,655,891 shares of Class A common stock of Butte Highlands Mining Company.

The Share Exchange was treated as a “reverse merger” with InterLok Key Management, Inc. which is deemed—for accounting recognition purposes—as the accounting acquirer and Butte Highlands Mining Company deemed the accounting acquiree under the acquisition method of accounting.  The reverse merger is deemed a recapitalization and the consolidated financial statements represent the substantive continuation of the operations and thus the prior year financial statements of operations are the operating results of its subsidiary InterLok Key Management, Inc., while the capital structure (in terms of authorized preferred and common stock) of its parent Butte Highlands Mining Company remains intact.

Subsequently, the company was renamed IronClad Encryption Corporation to better identify with IronClad’s products and services.

IronClad Encryption Corporation is a next-generation cyber defense company that secures digital assets and communications across a wide range of industries and technologies.  IronClad Encryption-powered solutions use our patented Dynamic Encryption and Perpetual Authentication technologies to make all known key-based encryption technologies virtually impossible to compromise.  Dynamic Encryption Technology eliminates vulnerabilities caused by exposure of any single encryption key by continuously changing encryption keys and keeping the keys synchronized in a fault-tolerant manner.

Perpetual Authentication Technology uses multiple virtual channels for encryption so that in the event one channel is compromised, the other channels maintain encryption integrity.  Together, these technologies not only eliminate the single point of failure problem created by having keys exposed through brute force, side channel, or other types of attack, but do so with very low latency and system performance overhead.  Developers, MSPs, MSSPs and IT organizations can now easily and effectively integrate ultra-secure authentication and encryption measures across essentially all mediums.  This includes the latest processors and operating systems, legacy hardware and software, within or between networks, and on compartmentalized data or entire databases.

History and Recent Transaction

The “Company” is the term used in these statements and notes to refer to the entity originally incorporated in the State of Delaware in 1929. The registered name of the Company until early in 2017 was Butte Highlands Mining Company (“Butte”).

Butte was formed to explore and mine primarily for gold in the Butte Highlands’ “Only Chance” mine, south of Butte, Montana.  Butte ceased operating as a mining company in 1942.  The Company was reorganized in October 1996 for the purpose of acquiring and developing additional mineral properties.  At the time of the 1996

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reorganization, stockholders representing approximately 76% of the outstanding capital stock could not be located. In order to obtain the quorum necessary for the special meetings of shareholders to authorize the reorganization, Butte obtained an order from the Superior Court of Spokane County, Washington appointing a trustee for the benefit of those stockholders who could not be located.

By May 17, 2007, eleven years after the reorganization and very limited results from its mining activities, the Company had disposed of all of its historical mineral properties or mining claims and eventually became a “shell company” under the rules of the Securities and Exchange Commission (“SEC”).

In 2009, Butte registered under the Securities Exchange Act of 1934, as amended, for the purpose of becoming a reporting company.  The Company’s common stock then became listed on the OTCBB, but in time the Company also listed its common stock to trade on the OTC QB electronic market, one of the OTC Markets Group over-the-counter markets, where the Company’s common stock is now listed.

Then, following ten years of being a shell company with only nominal activity and limited cash or other assets, the business focus of Butte changed early in 2017.  Most notably the Company raised significant capital to implement its new business and financial plans to further develop the licensing and commercial use of its patented encryption software.  The change caused Butte to lose its previous shell company status.

The Company also changed its state of incorporation to Nevada and its name to IronClad Encryption Corporation (“IronClad”) and changed the stock symbol from BTHI to IRNC to more appropriately reflect the fundamental change of its business to developing cyber encryption technology and away from its historical mining activities.  On October 16, 2017, the Company redomiciled in Delaware from Nevada and adopted a certificate of incorporation and bylaws as a Delaware corporation.  The terms “Company”, “IronClad” and “Butte” all refer to the same individual corporate entity, but the uses of the IronClad and Butte names are used to refer to different eras of the Company’s long history.  The historical eras generally coincide with the changes in business focus before and after the first weeks of 2017.

The business changes are a result of a common stock exchange transaction, accounted for as a “reverse merger”, between Butte and the owners of InterLok Key Management, Inc. (“InterLok”; at the time an independent and privately-held Texas corporation) whereby InterLok became a wholly-owned subsidiary of Butte.  Butte issued shares of its common stock in exchange for acquiring all of the common stock of InterLok.  Through December 31, 2017, InterLok was the only subsidiary of the Company and InterLok’s patents and line of business now are the main basis of the business of the Company on a consolidated basis.  During the transition three month period ended March 31, 2018; the Company incorporated a new wholly owned subsidiary IronClad Pipeline IC, Inc. (“Pipeline”).

Principles of Consolidation, Basis of Presentation, and Management Judgement

The accompanying consolidated financial statements include the accounts of IronClad and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.  The above unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information

Accordingly, these unaudited interim consolidated financial statements do not include all of the disclosures required by generally accepted accounting principles in the United States of America for complete financial statements and the rules of the SEC.  These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the year ended March 31, 2019.

In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.  Operating results for the three month period ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending March 31, 2020.

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Note 2.  Summary of Significant Accounting Policies

This summary of significant accounting policies is presented to assist in understanding the Company’s consolidated financial statements.  The financial statements and notes are representations of the Company’s management which is responsible for their integrity and objectivity.  These accounting policies conform to accounting principles generally accepted in the United States and have been consistently applied in the preparation of the financial statements.

Going Concern

As shown in the accompanying financial statements, the Company has incurred cumulative operating losses since inception. As of June 30, 2019, the Company has limited financial resources with which to achieve its objectives and attain profitability and positive cash flows from operations.  As shown in the accompanying balance sheets and statements of operations, the Company has an accumulated deficit of $30,972,173. The Company's working capital deficit is $4,657,077 (current assets minus current liabilities; current liabilities in this case being greater than current assets).

Achievement of the Company's objectives will depend on its ability to obtain additional financing, to generate revenue from current and planned business operations, and to effectively manage product and software development, operating and capital costs.  The Company is in a development stage and has generated no operating revenue, profits or positive cash flows from operations.

The Company plans to fund its future operations by potential sales of its common stock or by issuing debt securities.  However, there is no assurance that IronClad will be able to achieve these objectives, therefore substantial doubt about its ability to continue as a going concern exists.  The financial statements do not include adjustments relating to the recoverability of recorded assets nor the implication of associated bankruptcy costs should IronClad be unable to continue as a going concern.

Revenue Recognition and Trade Accounts Receivable

The Company recognizes revenue in accordance with ASC 606 — Revenue From Contracts with Customers .  We recognize revenue when we have identified a contract with a customer, identify the performance obligations in the contract, determine the transaction prices, when we allocate the transaction prices to the performance obligation in the contract and we recognize revenue when or as the Company satisfies the performance We record trade accounts receivable at net realizable value.  This value includes an appropriate allowance for estimated uncollectible accounts, if any, to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts.  

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and  

 Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.  

At June 30, 2019 and March 31, 2019 the Company had conversion features embedded in its convertible notes payable.  The fair value measurements of those derivatives, using a binomial valuation model, was $1,389,113 at June 30, 2019 and $2,147,415 at March 31, 2019 and is reported as “convertible notes payable derivative liabilities” on the balance sheet.  The derivative liabilities are measured as Level 3 items.

Provision for Income Taxes

Income taxes are provided based upon the liability method of accounting pursuant to ASC 740-10- 25  Income Taxes – Recognition .  Under this approach, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis amounts of assets and liabilities and their financial reporting amounts at each period-end.  A valuation allowance is recorded against deferred tax asset amounts if management does not believe the Company has met the “more likely than not” standard imposed by ASC 740-10-25-5 to allow recognition of such an asset.  See Note 10.

Capitalization of Patent and Trademark Costs

The Company capitalizes its legal, patent agent and related filing fees and costs associated with the patents it holds and is developing.  The amounts are carried as an intangible asset in the financial statements.  The costs of the patents or trademarks are amortized ratably (expensed) over the expected useful technological or economic life of the individual assets, which the Company has determined to be ten years.  The legal life of a patent is typically about 17 years. See Note 3.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified to provide greater line item detail for consistency with the current period presentation.  These reclassifications had no effect on the reported results of operations.  This change in classification has no effect on previously reported cash flows in the Condensed Consolidated Statement of Cash Flows and had no effect on the previously reported Condensed Consolidated Statements of Operations for any period .

New Accounting Requirements and Disclosures

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.  The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.

FASB issued ASU No. 2016-02, Leases (Topic 842) , which establishes a comprehensive new lease accounting model. The new standard: (a) clarifies the definition of a lease; (b) requires a dual approach to lease classification similar to current lease classifications; and, (c) causes lessees to recognize leases on the balance sheet as a lease liability with a corresponding right-of-use asset for leases with a lease-term of more than twelve months.  The standard is effective for calendar years beginning after December 15, 2018; no material impact to the reporting in the financial statements of the Company is expected from the adoption of this standard.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses at the balance sheet date and for the period then ended.  We believe our

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Notes to Condensed Consolidated Financial Statements

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estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates. Significant estimates and assumptions underlying these financial statements include:

 estimates in the calculation of share-based compensation expense,  

 estimates in the value of our warrants derivative liability,  

 estimates made in our income tax calculations, and  

 estimates in the assessment of possible litigation claims against the company.  

We are subject to claims and liabilities that arise in the ordinary course of business.  We accrue for losses when such losses are considered probable and the amounts can be reasonably estimated.

Amortization expense for intangible assets during the period ended June 30, 2019 and year ended March 31, 2019 was $3,845 and $3,789, respectively.  Costs at June 30, 2019 totaling $371,545 are for $217,744 for new patents and trademarks under development (but as yet not awarded) and for $153,801 for new patents issued in December 2018 and January 2019. The patents and trademarks under development will not be amortized until formally issued.  To the extent that a patent or trademark is not ultimately awarded the associated costs will be expensed accordingly at the time such an outcome is apparent.

IronClad filed fourteen patent applications during the fiscal years ended March 31, 2019 and March 31, 2018.  These awarded and pending patents expand upon the initial scope of the original “seminal” patents and provide up to twenty additional years of enforceable intellectual property rights regarding authentication, validation, and encryption for all electronic transmissions associated devices.  IronClad’s original patent portfolio included three issued and granted US patents. Each of the three original patents had expired and was written off at September 30, 2018.

Note 4.  Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash deposits. Accounts at each institution are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000.  At June 30, 2019 and March 31, 2019, the Company had $45,241 and $0 on deposit in excess of the FDIC insured limit.

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Note 5 – Related Party Transactions

At June 30, 2019 and March 31, 2019 the Company owed approximately $89,773 and $96,506 in accounts payable to management and related parties.  Of the $239,659 and $237,660 of accrued liabilities at June 30, 2019 and March 31, 2019, approximately $0 and $75,003 of those amounts are owed to the president of the Company; the costs primarily related to travel costs incurred in raising funds for the Company.

See also Note 13 regarding stock option awards to management of the Company.

Note 6.  Notes Payable

Commitment Note and Convertible Note, Equity Line with 10% Interest Rate

Commitment Note, $82,500 with 10% Interest Rate.  As consideration for its commitment to purchase shares of IronClad’s Class A common stock pursuant to the Investment Agreement, IronClad issued to the counterparty of the agreement a seven-month 10% convertible promissory note (the “Commitment Note”) in the principal amount of $100,000.

The Commitment Note was included as a financing fee expense at the date of the transaction.   The Commitment Note was to finance the $100,000 cost of the commitment fee to the counterparty of the Investment Agreement and was accordingly included in the financing fee expenses for the period ended September 30, 2017.  The amount of the commitment fee could be reduced by $35,000 or $17,500 if a registration statement registering the shares that would be issued under the equity line became effective within 90 or 135 days, respectively, of August 24, 2017.

Convertible Note, Initial Consideration: $165,000 First Tranche with 10% Interest Rate. On August 24, 2017, in connection with the entry into the Investment Agreement, IronClad also issued a 10% convertible note (the “Convertible Note”) in an aggregate principal amount of $330,000 with a 10% original issue discount (“OID”).  The initial consideration in the amount of $165,000 was funded on August 24, 2017.  The Company received net proceeds of $150,000 (which represents the deduction of the 10% original issue discount for the note holder’s due diligence and legal fees). The Company could make additional borrowings in such amounts and at such dates as

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

the note holder may choose in its sole discretion. The balance of an individual borrowing matured seven months from its funding date.

The Convertible Note also had an embedded beneficial conversion feature (“BCF”) based on a stated conversion price of $1.00 per share.  The market price of a share of IronClad’s common stock at the time of the first borrowing under the note was $3.50 thus establishing an intrinsic value of $2.50 on that date.

The Company received the first borrowing for $165,000 under the Convertible Note on August 24, 2017 and net cash proceeds of $150,000 were received after deducting for the original issue discount and lender transaction costs of $15,000.  An additional $12,000 of costs was incurred by IronClad directly relating to the note.  Both the $15,000 and the $12,000 were recorded as discount amounts on the $165,000 note payable and were amortized as interest expenses over the life of the borrowing.  The maturity date of this borrowing under the note was seven months from its funding date which was March 24, 2018.

Between March 26, 2018 and February 25, 2019, the note holder exercised its rights under the conversion provisions and through the operation of seven conversion elections were issued, in total, 4,588,586 shares of stock which effectively repaid the loan balance. Additionally, between March 14, 2019 and March 28, 2019, the note holder elected to convert approximately $37,698 of accrued interest into 7,683,614 shares of Class A common stock.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

The valuation of the BCF related to the $165,000 borrowing on the Convertible Note and with an intrinsic value of $2.50 per share (based on a $3.50 closing price less the $1.00 per share conversion price) was approximately $424,407 using a Black-Scholes valuation model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the beneficial conversion feature formally recorded was $138,000 ($165,000 net of $27,000) and was amortized as interest expense over the life of the loan.

Derivative Liabilities on Commitment and Convertible Notes (above). On March 24, 2018 both the Commitment Note ($100,000 contractually reduced to $82,500 in 2017) and the first tranche of the 10% Convertible Note for $165,000 (less the $10,000 conversion in late March) reached their maturity dates and, except for a $10,000 conversion by Tangiers on the Convertible Note, were not repaid in cash.  Consequently both notes were in “maturity date default” and, pursuant to the terms of the loans, were convertible at the lesser of $3.25 for the Commitment Note, and $1.00 for $165,000 note or 65% of the average lowest two trades for the prior 20 days, resulting in an initial recognition for derivative treatments for both notes.

The valuation of the derivative liability related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.70 per share (based on a $1.67 closing price less the $0.97 per share present value of the conversion price) was approximately $79,138 using a Black-Scholes valuation model.  That amount was recorded

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as a new contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable. This results in a net liability value of $3,362.  The amount was amortized as interest expense over an estimated “remaining” three month life of the already matured loan.

The valuation of the derivative liability related to the $165,000 (reduced to $155,000) borrowing on the Convertible Note and with an intrinsic value of $0.70 per share (based on a $1.67 closing price less the $0.97 per share present value of the conversion price) was approximately $158,276 using a Black-Scholes valuation model.  That amount was recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  Since the undiscounted (and unconverted) amount of the note was $155,000 the derivative valuation was recorded as $155,000.  The amount was amortized as interest expense over an estimated “remaining” three month life of the already matured loan.

During the three-month period ended June 30, 2019, $0 of regular interest and $0 of derivative liability was expensed because all amounts owed relating to the note were converted as of March 1, 2019. During the three-month period ended June 30, 2018, $7,400 of regular interest, $0 of original issue discount and $155,000 of beneficial conversion was expensed.

Convertible Note, Second Tranche, $82,500 with 10% Interest Rate.   On October 23, 2017, a second borrowing of $82,500 under the Convertible Note for $330,000 was closed and funded.  The Company received net proceeds of $75,000 after deducting for original issue discount and lender transaction costs of $7,500.  An additional $6,000 of costs was incurred by IronClad relating to the Convertible Note.  Both the $7,500 and the $6,000 were recorded as discount amounts on the $82,500 note payable and amortized as interest expenses over the life of the borrowing.

The maturity date of this borrowing under the Convertible Note was also defined to be seven months from its borrowing date which was May 24, 2018.  The market price of a share of IronClad’s common stock at the time of funding was $4.40 making the intrinsic value of the derivative $3.40.  The valuation of the BCF was estimated to be approximately $289,000 and was capped at $69,000, the otherwise undiscounted amount of the note payable.

Between March 14, 2019 and April 22, 2019, the holder of the note elected to convert $82,500 of principal into 18,630,240 shares of Class A common stock.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

During the three month period ended June 30, 2019, $406 of regular interest, $0 of original issue discount, and $0 of derivative liability was expensed.  During the three month period ended June 30, 2018, $3,764 of regular interest, $20,916 of original issue discount and $23,443 of derivative liability was expensed.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Convertible Note, Third Tranche, $82,500 with 10% Interest Rate.   On March 15, 2018, a third and final borrowing of $82,500 under the Convertible Note for $330,000 was closed and funded.  The Company received net proceeds of $75,000 after deducting for original issue discount and lender transaction costs of $7,500 and an additional $6,000 of loan closing costs incurred by IronClad.  The maturity date of this borrowing under the Convertible Note was also defined to be seven months from its borrowing date which was October 24, 2018.  The market price of a share of IronClad’s common stock at the time of funding was $1.85 making the intrinsic value of the derivative $0.85.

The valuation of the BCF related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.85 per share (based on a $1.85 closing price less the $1.00 per share conversion price) is approximately $109,861 using a Black-Scholes valuation model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the beneficial conversion feature formally recorded was $69,000 ($82,500 net of $13,500) and was amortized as interest expense over the life of the loan.

During the three-month period ended June 30, 2019, $2,080 of regular interest, $0 of original issue discount, $0 of beneficial conversion and $0 of derivative liability and $134,308 of default interest was expensed.  During the three-month period ended June 30, 2018, $3,525 of regular interest, $5,930 of original issue discount and $29,205 of beneficial conversion was expensed.

Convertible Notes, Post Maturity Derivative Liabilities.   At May 23, 2018 the second tranche of the 10%  Convertible Note for $82,500 reached its maturity date and was not repaid in cash. Consequently the note was in “maturity date default” and pursuant to the terms of the loan was convertible at the lesser of $1.00 or 65% of the average lowest two trades for the prior 20 days, resulting in initial recognition for derivative treatment.

The valuation of the derivative liability related to the $82,500 borrowing on the Convertible Note and with an intrinsic value of $0.6912 per share is approximately $57,024 using a Binomial pricing model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs). The amount was amortized as interest expense over an estimated “remaining” three month life of the already matured loan.

At June 30, 2018 the prior period’s derivative liabilities were remeasured, as the notes were still outstanding, the derivative liability was revalued using a binomial pricing model. At period end the total valuation of new derivative liabilities related to three loans was approximately $262,086 for individual valuation amounts of $67,531, $120,993 and $73,561. There was no corresponding revaluation at June 30, 2019 because the underlying notes had been converted to common stock and were no longer outstanding.

Fiscal Year Ended March 31, 2018 Notes

Convertible Note, $88,000 with 12% Interest Rate. On January 25, 2018 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $88,000.  The Company received cash proceeds of $85,000 net of transaction costs of $3,000.  The $3,000 was recorded as a discount amount on the note payable and was amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, were identical to the initial 12% Convertible note entered into in 2017 and converted earlier in January 2018.

The note matured on October 30, 2018 and interest costs accrued on the unpaid principal balance at 12% annually until October 30, 2018, and after that if not paid at maturity interest accrued annually at 22% until the principal amount and all interest accrued and unpaid were paid.

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which was one hundred and eighty days following the date of the note (dated January 25, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

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The shares to be issued were a function of a variable conversion price which was 65% of a market price defined to be the lowest one day closing bid price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.  The Company would keep available authorized shares reserved, initially 289,846 shares, but in any event authorized shares equal to six times the number of shares that would be issuable upon full conversion of the note from time to time. At June 30, 2018 a derivative liability with an intrinsic value of $0.2404 was $57,990 using a binomial pricing model and was recorded as a discount to the note.

The note was repaid in mid-July, 2018; thus during the three-month period ended June 30, 2019 no interest was recorded on the note. During the three-month period ended June 30, 2018, $2,633 of regular interest and $1,025 of original issue discount was expensed.

Convertible Note, $53,000 with 12% Interest Rate.   On February 27, 2018 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $53,000.  The Company received cash proceeds of $50,000 net of transaction costs of $3,000.  The $3,000 was recorded as a discount amount on the note payable and was amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, were identical to the initial 12% Convertible note entered into in 2017 and converted earlier in January 2018.

The note matured on November 3, 2018 and interest costs accrued on the unpaid principal balance at 12% annually until November 30, 2018, and after that if not paid at maturity interest accrued annually at 22% until the principal amount and all interest accrued and unpaid were paid.

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which was one hundred and eighty days following the date of the note (dated February 27, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued were a function of a variable conversion price which was 65% of a market price defined to be the lowest one day closing bid price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.  The Company kept available authorized shares reserved, initially 289,846 shares, but in any event authorized shares equal to six times the number of shares that would be issuable upon full conversion of the note from time to time.

Derivative Liability.  The conversion feature of the note represented an embedded derivative.  The derivative liability with an intrinsic value of $0.2981 was $42,862 using a binomial pricing model and was recorded as a discount to the note. The loan principal plus accrued interest, together totaling $75,620, was repaid on August 21, 2018 and the note was fully retired.

Because the note was repaid in August, 2018 no interest was recorded on the note during the three-month period ended June 30, 2019. During the three-month period ended June 30,   2018, $1,586 of regular interest and $1,146 of original issue discount was expensed.

Working Capital Loan for Services to New Customer by IronClad Pipeline IC, Inc. with 8.5% Interest Rate.   On February 27, 2018, IronClad borrowed $255,000 gross proceeds as an initial advance on a Credit Agreement (the “Agreement”) with a lending party.  The Agreement, agreed to by both parties on February 1, 2018, enabled the Company, at its sole election, to borrow up to an aggregate amount of $500,000.  The outstanding balance of any advances accrued interest at an annual rate of 8.5%.  There was a transaction financing fee of 2% for any amount drawn under the facility.  Proceeds received net of the transaction fee were $250,000.

On March 21, 2018, IronClad borrowed an additional $245,000 gross proceeds as a second advance under the Agreement.  Proceeds received net of the transaction fee were $240,000.

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During the period ended June 30, 2018, the Company repaid $125,000 of the principal, and then redrew another $100,000.  The outstanding principal balance of this loan at June 30, 2018 was $475,000 and was subsequently repaid in full by a series of cash payments through September 11, 2018.

Interest is to be paid annually in cash on March 1, 2019 and 2020.  Outstanding interest of $17,816 was not paid at March 1, 2019. The Company is negotiating with the lender to issue common stock in exchange for the accrued amount of interest owed. There was no penalty for any of the early principal repayments.  The Company has pledged 500,000 of its common stock as collateral under the terms of the Agreement.  In the event of default by the Company, the lender is entitled to receive one share of Company common stock for every one dollar in principle, interest, penalties, and fees that are owed and outstanding by the Company to the lender.

The Agreement is also supported by a personal $500,000 guarantee from an officer of the Company. IronClad owed the officer a 5% guarantee fee of $25,000; $15,000 was paid shortly after June 30, 2019 and the remaining $10,000 is to be paid at such time as the Board of Directors determines the Company has sufficient liquidity to pay the balance owed.  The guarantee fee was reviewed and approved by the Compensation Committee of the Board which determined that the 5% fee was an appropriate market-based rate for guarantees of loans of this nature and comparable risk.

Terms of the Agreement specified that the uses of funds were to be limited to only supporting the operations of the service contract and loan repayment.  The terms of the Agreement were amended, effective June 11, 2018, to also permit the use of funds for certain new patent application filings of IronClad.

Insurance Financing Note with 6% Interest Rate.   On March 16, 2018, IronClad purchased several lines of corporate insurance coverage for a set of annual premiums that totaled $30,719.  To pay for the coverage, IronClad paid $2,631 down on the coverages and entered into a financing agreement to borrow the $28,087 balance owed for the coverage.  Interest on the loan was approximately 6% and the loan was to be repaid by eleven monthly principal and interest installment payments of $2,631 each.  The cost of the insurance was recorded as a prepaid asset and was amortized monthly over the annual period of the coverages.

On July 14, 2018 the outstanding loan principal balance was repaid plus accrued interest, both totaling $10,195, and the note was fully retired.

Fiscal Year Ended March 31, 2019:  New Loan Agreements including Convertible Notes

Convertible Note, $250,000 with 10% Interest Rate.   On June 26, 2018 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $250,000.  The Company received cash proceeds of $235,000 net of transaction costs of $15,000.  The $15,000 was recorded as a discount amount on the note payable and was amortized as interest expenses over the life of the note.  The general terms of the note, except for the principal amount borrowed, were nearly identical to the initial 10% Convertible note entered into in 2017.

The note matured on December 26, 2018 and interest costs accrued on the unpaid principal balance at 10% annually until December 26, 2018, and after that if not paid at maturity interest accrued annually at 24% until the principal amount and all interest accrued and unpaid were paid.

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time on or following the date of the Note from the and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued were a function of a fixed conversion price of $1.00 per share, or an alternate variable conversion price, triggered by events such as stock splits, stock dividends or rights offerings which is 70% of a market price defined to be the lowest five day closing bid price for the Company’s common stock during the

17

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

twenty-day trading period ending on the last trading day prior to exercising the conversion right.  The Company kept available authorized shares reserved, initially 3,081,854 shares, but in any event authorized shares equal to five times the number of shares that would be issuable upon full conversion of the note from time to time.

Derivative Liability.  The conversion feature of the note represented an embedded derivative.  A derivative liability with an intrinsic value of $0.03281 was $189,211 using a binomial pricing model and was calculated as a discount to the note. That amount was recorded as a new contra-note payable amount (similar to the recorded OID and transaction costs and amounts discussed immediately below), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable. The amount of the derivative liability formally recorded was $26,014 ($250,000 net of $223,986) and was amortized as interest expense over the life of the loan. The remaining $163,197 was expensed as financing fees at the inception of the note.

As a commitment fee for the Note, the Company issued the holder 240,384 shares of common stock to be held in escrow until the Note was repaid. The holder kept the shares, if the Note was not retired prior to its maturity date. The shares were valued at $165,865 and were recorded as a discount on the note and amortized through repayment of the note on November 1, 2018. Upon repayment of the note the shares were returned and the $165,865 expense was reversed.

Warrants and “Down Round” Feature.  Included in the share purchase agreement was a common stock purchase warrant issued by the Company to the holder to purchase 62,500 shares of common stock at $3.00 per share, exercisable for four years. The warrants were valued at $43,121 using a Black Scholes option pricing model and were recorded as a discount on the note. The warrants included a down round feature in January 2019.

The warrant included a down round feature that would reduce the exercise price of the warrant if the Company sold or granted any option to purchase, or sell or grant any right to reprice, or otherwise disposed of or issued common stock or securities entitling any person or entity to acquire shares of common stock (upon conversion, exercise or otherwise) at an effective price per share less than the then exercise price. On January 17, 2019, the down round feature was triggered and the exercise price was reduced to $0.0195 and the number of warrants exercisable was increased to 9,615,385. As a result, the original valuation of $43,121 was increased to $164,132 and a reduction to retained earnings was recorded for the difference, similar to a dividend, in the amount of $121,011.

Because the note was repaid in November, 2018 no interest was recorded on the note during the three-month period ended June 30, 2019. During the three-month period ended June 30, 2018, $274 of regular interest and $328 of original issue discount was expensed.

On October 11, 2018 the holder of the note converted $100,000 of the principal into 3,076,923 shares of Class A capital stock. On November 1, 2018 the Company paid off the remaining $150,000 of principal in cash.

Convertible Note, $135,000 with 9% Interest Rate. On July 11, 2018 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 9% convertible note payable for an aggregate principal amount of $270,000 comprised of the first note (“First Note”) being in the amount of $135,000.00, and the remaining note in the amount of $135,000.00, (a “Back End Note”). The Company received cash proceeds of $126,500 from the First Note net of transaction costs of $8,500. The $8,500 was recorded as a discount amount on the note payable and was amortized as interest expenses over the life of the note.

The First Note matured on July 11, 2019 and interest costs accrued on the unpaid principal balance at 9% annually until July 11, 2019, and after that if not paid at maturity interest accrued annually at 24% until the principal amount and all interest accrued and unpaid were paid.

The Back End Note carried the same terms as the First Note, except it could not be repaid, but only converted. The Company was under no obligation to accept the Back End Note, but could do so at its sole discretion, following 180 days from the date of the note (dated July 11, 2018). As part of the SPA, the Holder

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

issued the Company a collateralized secured promissory note in the amount of $131,500 that could be exchanged for cash against the Back End Note. On January 25, 2019, the holder of the note chose to cancel the Back End Note.

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which was 180 days following the date of the note (dated July 11, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued were a function of a fixed conversion price of $1.00 per share for six months, and thereafter until maturity at a variable conversion price which was 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right. The Company kept available authorized shares reserved, initially 1,730,000 shares, but in any event the number of reserved shares at least equals 400% of the number of shares of Company common stock issuable upon conversion of the Note. From February 4, 2019 thru April 17, 2019 the holder of the note elected to convert $135,000 of principal and accrued interest into common stock.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

Derivative Liability.  The valuation of the derivative liability related to the $135,000 borrowing on the First Note and with an intrinsic value of $0.54 per share was approximately $248,386 using a binomial pricing model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $126,500 ($135,000 net of $8,500) and was amortized as interest expense over the life of the loan. The remaining $121,886 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $(697) of regular interest, $2,375 of unamortized original issue discount, and $35,351 of unamortized derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $115,500 with 12% Interest Rate. On July 17, 2018 (transaction documents were originally dated June 29, but amended for action taken on July 17), IronClad issued a 12% convertible note (the “Convertible Note”) to a lender (the “Holder”) in an aggregate principal amount of $115,500. The Company received cash proceeds of $101,500 net of transaction costs of $14,000 that included $3,500 for attorneys’ fees. The note matured on July 18, 2019. Interest costs accrued on the unpaid principal balance at 12% annually until maturity, and after that, if not paid, interest accrued annually at 18% until any unpaid principal amount and unpaid interest accrued were paid.

19

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which is one hundred and eighty days following the date of the note (dated July 18, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued upon conversion were a function of a variable conversion price which is 65% of a market price defined to be the lowest one (1) trading price for the Company’s common stock during the fifteen (15) day trading period ending on the last trading day prior to the conversion date. The Company kept available authorized shares reserved, initially 1,500,000 shares. From January 22, 2019 thru April 4, 2019 the holder of the note elected to convert $115,500 of principal, $4,500 of financing fees and $8,448 of accrued interest into 14,646,896 shares of Class A common stock.

The dates, shares issued, and principal amounts repaid at each conversion event are as follows:

Derivative Liability.  The valuation of the derivative liability related to the $115,500 borrowing on the Convertible Note and with an intrinsic value of $0.4751 per share was approximately $187,624 using a binomial pricing model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $101,500 ($115,500 net of $14,000) and was amortized as interest expense over the life of the loan. The remaining $86,124 was expensed as financing fees at the inception of the note.

Convertible Note, $157,500 with 9% Interest Rate, First Note (and Back End Note).   On July 19, 2018 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 9% convertible note payable for an aggregate principal amount of $315,000 comprised of the first note (“First Note”) being in the amount of $157,500.00, and the remaining note in the amount of $157,500.00, (a “Back End Note”). The Company received cash proceeds of $142,500 from the First Note net of transaction costs of $15,000 that included $7,500 for attorneys’ fees.

The First Note matured on July 19, 2019 and interest costs accrued on the unpaid principal balance at 9% annually until July 19, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid. The Back End Note carries the same terms as the First Note, except it may not be repaid in cash, but only converted. The Company accepted the Back End Note on March 19, 2019. As part of the SPA, the Holder issued the Company a collateralized secured promissory note in the amount of $150,000 that was exchanged for cash against the Back End Note (discussed below).

The holder of the note, at its sole election, could convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note (dated July 19, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount,

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IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

if any.  The shares to be issued are a function of a fixed conversion price of $1.00 per share for six months, and thereafter until maturity at a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right. From January 24, 2019 thru April 1, 2019 the holder of the note elected to convert $157,500 of principal into 19,011,529 shares of Class A common stock.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

Derivative Liability.  The valuation of the derivative liability related to the $157,500 borrowing on the First Note and with an intrinsic value of $0.5482 per share was approximately $295,227 using a binomial pricing model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $142,500 ($157,500 net of $15,000) and was amortized as interest expense over the life of the loan. The remaining $152,727 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $(291) of regular interest, $0 of original issue discount, and $0 of derivative liability was expensed on the First Note, There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $157,500 with 9% Interest Rate, Back End Note. The Back End Note was accepted on March 14, 2019 and matured on July 19, 2019. Interest costs accrued on the unpaid principal balance at 9% annually until July 19, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid. The Back End Note carries the same terms as the First Note, except it may not be repaid in cash, but only by converting to common stock.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note (dated March 14, 2019) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.  The shares to be issued are a function of a fixed conversion price of $1.00 per share for six months, and thereafter until maturity at a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right.

Derivative Liability.  The valuation of the derivative liability related to the $157,500 borrowing on the Back End Note and with an intrinsic value of $0.0096 per share was approximately $352,448 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and

21

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $142,500 ($157,500 net of $15,000) and will be amortized as interest expense over the life of the loan. The remaining $209,948 was expensed as financing fees as of the inception date of the note.

During the three-month period ended June 30, 2019, $3,534 of regular interest, $10,748 of original issue discount, and $102,106 of derivative liability was expensed on the Back End Note. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $107,000 with 10% Interest Rate. On October 24, 2018 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $107,000.  The Company received cash proceeds of $102,000 net of transaction costs of $5,000.  The $5,000 was recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matures on October 24, 2019 and interest costs accrue on the unpaid principal balance at 10% annually until October 24, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid.

The Holder of the note is entitled, at any time after cash payment, to convert all or any amount of the principal face amount of the Note then outstanding into shares of the Company's common stock.  The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period ending on the last trading day prior to the conversion date. The Company kept available authorized shares reserved, initially 2,993,000 shares. From April 17, 2019 thru May 16, 2019 the holder of the note elected to convert $107,000 of principal into 23,378,328 shares of Class A common stock.

The dates, shares issued and principal amounts repaid at each conversion event are as follows:

Derivative Liability.  The valuation of the derivative liability related to the $107,000 borrowing with an intrinsic value of $0.1759 per share was approximately $131,617 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $102,000 ($107,000 net of $5,000) and was amortized as interest expense over the life of the loan. The remaining $29,617 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $816 of regular interest, $2,836 of original issue discount, and $57,847 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $181,170 with 12% Interest Rate. On October 26, 2018 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $181,170.  The Company received cash proceeds of $150,346 net of transaction costs of $30,824.  The $30,824 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matured on July 26, 2019 and interest costs accrue on the unpaid principal balance at 12% annually

22

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

until July 26, 2019, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid.

The Holder shall have the right at any time following the 180th calendar day after the issue date (October 26, 2018), and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any, to convert all or any amount of the principal face amount of the Note then outstanding into shares of the Company's common stock.  The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period ending on the last trading day prior to the conversion date.  From May 7, 2019 thru June 10, 2019 the holder of the note elected to convert $33,342 of principal into 19,011,529 shares of Class A common stock.

The dates, shares issued, and principal amounts repaid at each conversion event are as follows:

The Company will keep available authorized shares reserved, initially 6,500,000 shares. In connection with the issuance of the Note, the Company issued a common stock purchase warrant to the Holder to purchase up to 30,195 shares of the Company’s common stock at an exercise price of $3.00 per share with an exercise period of five years. The warrants were valued at $10,265 using a Black Scholes option pricing model and were recorded as a financing expense.

Warrants and “Down Round” Feature.  The warrant included a down round feature that would reduce the exercise price of the warrant, if the Company sold or granted any option to purchase, or sell or grant any right to reprice, or otherwise disposed of or issued common stock or securities entitling any person or entity to acquire shares of common stock (upon conversion, exercise or otherwise) at an effective price per share less than the then exercise price. During the year ended March 31, 2019, there were multiple events that triggered the down round provision, the cumulative effect reduced the exercise price to $0.004485 and the number of warrants exercisable was increased to 20,197,324. As a result, the valuation of the warrants increased to $123,067 and a reduction to retained earnings was recorded for the difference, similar to a dividend, in the amount of $112,587.

During the three-month period ended June 30, 2019, there were also multiple events that caused the down round feature to be triggered again. The cumulative effect reduced the exercise price to $0.0024 and the number of warrants exercisable was increased to 37,743,750.  As a result, the valuation of the warrants increased to $201,663 and a reduction to retained earnings was recorded for the difference, similar to a dividend, in the amount of $78,596.

Derivative Liability.  The valuation of the derivative liability related to the $181,170 borrowing with an intrinsic value of $0.2674 per share is approximately $220,204 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $150,346 ($181,170 net of $30,824) and was amortized as interest expense over the life of the loan. The remaining $69,858 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $4,143 of regular interest, $10,275 of original issue discount, and $50,115 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

23

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Convertible Note, $57,500 with 12% Interest Rate.   On February 14, 2019 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $57,500.  The Company received cash proceeds of $52,500 net of transaction costs of $7,750.  The $7,750 was recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.

The note matures on February 14, 2020. Interest costs accrue on the unpaid principal balance at 12% annually until maturity, and after that if not paid, interest accrues annually at 18% until any unpaid principal amount and unpaid interest accrued are paid.

The Holder of the note, at its sole election, may convert the note into shares of common stock of Company the six month anniversary of the note, the conversion price shall be equal to 65% of the lowest trading price for the fifteen prior trading days including the day upon which a notice of conversion is received.

Derivative Liability.  The conversion feature of the note represents an embedded derivative.  The valuation of the derivative liability related to the $57,750 borrowing on the Convertible Note and with an intrinsic value of $.039 per share was approximately $115,500 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $50,000 ($57,750 net of $7,750) and will be amortized as interest expense over the life of the loan. The remaining $65,500 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $1,728 of regular interest, $1,932 of original issue discount, and $12,466 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $107,000 with 10% Interest Rate.   On February 14, 2019 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $107,000.  The Company received cash proceeds of $102,000 net of transaction costs of $5,000.  The $5,000 was recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matures on February 14, 2020 and interest costs accrue on the unpaid principal balance at 10% annually until February 14, 2020, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid.

The Holder of the note is entitled, at any time after cash payment, to convert all or any amount of the principal face amount of the Note then outstanding into shares of the Company’s common stock.  The shares to be issued upon conversion are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period including the day upon which the notice of conversion is received conversion date. The Company will keep available authorized shares reserved, initially 11,551,000 shares.

Derivative Liability.  The valuation of the derivative liability related to the $107,000 borrowing with an intrinsic value of $0.03099 per share was approximately $169,554 using a binomial pricing model.  That amount was recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded was $102,000 ($107,000 net of $5,000) and will be amortized as interest expense over the life of the loan. The remaining $67,554 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $2,668 of regular interest, $1,247 of original issue discount, and $25,430 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

24

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Convertible Note, $86,250 with 12% Interest Rate, First Note (and Back End and Collateralized Notes).   On March 28, 2019 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 12% convertible note payable for an aggregate principal amount of $172,500 comprised of the first note (“First Note”) being in the amount of $86,250, and the remaining note in the amount of $86,250 (a “Back End Note”). The Company received cash proceeds of $75,000 from the First Note net of transaction costs of $11,250 that included $3,750 for attorneys’ fees.

The First Note matures on March 28, 2020 and interest costs accrue on the unpaid principal balance at 12% annually until March 28, 2020, and after that if not paid at maturity interest accrues annually at up to 24% until the principal amount and all interest accrued and unpaid are paid. The Back End Note carries the same terms as the First Note, except it may not be repaid in cash, but only by a conversion to Class A common stock. As part of the SPA, the Holder issued the Company a collateralized secured promissory note in the amount of $78,750 that may be exchanged for cash against the Back End Note.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note (dated March 28, 2019) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.  The shares to be issued are a function of a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen-day trading period ending on the last trading day prior to exercising the conversion right. The Company will keep available authorized shares reserved, initially 130,000,000 shares.

Derivative Liability.  The valuation of the derivative liability related to the $86,250 borrowing with an intrinsic value of $0.009 per share is approximately $112,500 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $75,000 ($86,250 net of $11,250) and was amortized as interest expense over the life of the loan. The remaining $37,500 was expensed as financing fees at the inception of the note.

During the three-month period ended June 30, 2019, $2,616 of regular interest, $2,797 of original issue discount, and $18,648 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $43,200 with 8% Interest Rate, First Note (and Back End and Collateralized Notes).   On April 12, 2019 IronClad entered into a Securities Purchase Agreement (SPA) to issue a 8% convertible note payable for an aggregate principal amount of $86,400 comprised of the first note (“First Note”) being in the amount of $43,200, and the remaining note in the amount of $43,200, (a “Back End Note”). The Company received cash proceeds of $38,000 from the First Note net of transaction costs of $5,200. The $5,200 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.

The First Note matures on April 12, 2020 and interest costs accrue on the unpaid principal balance at 8% annually until February 14, 2020, and after that if not paid at maturity interest accrues annually at 24% until the principal amount and all interest accrued and unpaid are paid.

The Back End Note carries the same terms as the First Note, except it may not be repaid, but only converted. The Company is under no obligation to accept the Back End Note, but may do so at its sole discretion, following 180 days from the date of the note (dated April 12, 2019). As part of the SPA, the Holder issued the Company a collateralized secured promissory note in the amount of $40,000 that may be exchanged for cash against the Back End Note.

The holder of the note, at its sole election, may convert the note into shares of common stock of the Company at any time during the period beginning on the date which is 180 days following the date of the note

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IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(dated July 11, 2018) and ending on the later of i) the maturity date, or ii) the date of payment of a default amount, if any.

The shares to be issued are a function of a fixed conversion price of $0.50 per share for six months, and thereafter until maturity at a variable conversion price which is 65% of a market price defined to be the lowest trading price for the Company’s common stock during the fifteen day trading period ending on the last trading day prior to the conversion date. The Company will keep available authorized shares reserved, initially 2,100,000 shares.

Derivative Liability.  The conversion feature of the note represents an embedded derivative. The valuation of the derivative liability related to the $43,200 borrowing with an intrinsic value of $.0076 per share is approximately $76,531 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $38,000 ($43,200 net of $5,200) and will be amortized as interest expense over the life of the loan. The remaining $38,531 is expensed as a loss on the issuance of the note during the three month period ended June 30, 2019.

During the three-month period ended June 30, 2019, $758 of regular interest, $1,122 of original issue discount, and $8,202 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $57,750 with 12% Interest Rate.   On April 23, 2019 IronClad entered into a Securities Purchase Agreement to issue a 12% convertible note payable for an aggregate principal amount of $57,750.  The Company received cash proceeds of $50,000 net of transaction costs of $7,750.  The $7,750 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  

The note matures on April 23, 2020. Interest costs accrue on the unpaid principal balance at 12% annually until maturity, and after that if not paid, interest accrues annually at 18% until any unpaid principal amount and unpaid interest accrued are paid.

The Holder of the note, at its sole election, may convert the note into shares of common stock of the Company after the six month anniversary of the note; the conversion price shall be equal to 65% of the lowest trading price for the fifteen prior trading days including the day upon which a notice of conversion is received.

Derivative Liability.  The conversion feature of the note represents an embedded derivative.  The valuation of the derivative liability related to the $57,750 borrowing on the Convertible Note and with an intrinsic value of $.025 per share is approximately $317,308 using a binomial pricing model.  That amount is recorded as a contra-note payable amount (similar to the recorded OID and transaction costs), but only for an amount not in excess of and thus capped by the otherwise undiscounted amount of the note payable.  The amount of the derivative liability formally recorded is $50,000 ($57,750 net of $7,750) and will be amortized as interest expense over the life of the loan. The remaining $267,308 is expensed as a loss on the issuance of the note during the three month period ended June 30, 2019.

During the three-month period ended June 30, 2019, $1,272 of regular interest, $1,419 of original issue discount, and $9,153 of derivative liability was expensed. There was no corresponding expense during the three-month period ended June 30, 2018.

Convertible Note, $150,000 with 10% Interest Rate.   On May 15, 2019 IronClad entered into a Securities Purchase Agreement to issue a 10% convertible note payable for an aggregate principal amount of $150,000.  The Company received cash proceeds of $142,500 net of transaction costs of $7,500.  The $7,500 is recorded as a discount amount on the note payable and will be amortized as interest expenses over the life of the note.  The note matures on May 15, 2020 and interest costs accrue on the unpaid principal balance at 10% annually until May 15,

26

IronClad Encryption Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)