NOTES
TO FINANCIAL STATEMENTS
FOR
THE THREE MONTHS ENDED DECEMBER 31, 2021, AND 2020
(Unaudited)
NOTE
1 - DESCRIPTION OF BUSINESS
Cipherloc
Corporation (the “Company” or “Cipherloc”) was incorporated in the State of Texas on June 22, 1953, under the
name “American Mortgage Company.” Effective August 27, 2014, the Company changed its name to “Cipherloc Corporation.”
Prior to September 30, 2021, the Company was a Texas corporation. The Company became a Delaware corporation effective as of September
30, 2021.
The
Company’s headquarters is located at 6836 Bee Cave Road, Building 1, Suite279, Austin, Texas 78746. Its website is www.cipherloc.net.
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 the Company’s
opinion, it has included all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation.
Operating
results for the three months ended December 31, 2021 are not necessarily indicative of the results that may be expected for the year
ending September 30, 2022. The Company has omitted notes to the unaudited interim financial statements that would substantially duplicate
the disclosures contained in the audited financial statements for the fiscal year ended September 30, 2021 ; this report should
be read in conjunction with the audited financial statements and the footnotes thereto for the fiscal year ended September 30, 2021 included
within the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.
NOTE
3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The
Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America.
Significant accounting policies are as follows:
Cash
and Cash Equivalents
The
Company considers all highly liquid investments with a maturity at the time of purchase of three months or less to be cash equivalents.
At December 31, 2021, the Company’s cash includes cash on hand and cash in the bank. The balance of such accounts, at times, may
exceed federally insured limits, as guaranteed by the Federal Deposit Insurance Corporation (“FDIC”). The FDIC insures these
deposits up to $250,000. As of December 31, 2021, $5,071,588 of the Company’s cash balance was uninsured.
Basic
and Diluted Net Loss per Common Share
The
Company’s basic loss per share is computed by dividing the net loss available to common stockholders 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 that number by the amount of time that the applicable shares were outstanding. Diluted earnings per
share reflects the potential dilution that could occur if vested stock options, warrants, and other commitments of the Company to issue
common stock were exercised, resulting in the issuance of common stock that would share in the earnings of the Company. As of December
31, 2021, the Company had no shares of preferred stock outstanding.
The
Company’s diluted loss per share was the same as basic loss per share during the periods in which net losses were incurred since
the inclusion of potential common stock equivalents would be anti-dilutive due to the net loss. During the three months ended December
31, 2021, the Company excluded warrants to purchase 79,461,481 shares of common stock from the calculation of diluted loss per share
because the effect would be anti-dilutive. During the three months ended December 31, 2020, the Company excluded warrants to purchase
24,216,866 shares of common stock and 1,000,000 shares of convertible preferred stock from the calculation of diluted loss per share
because the effect would be anti-dilutive.
Research
and Development and Software Development Costs
The
Company expenses all research and development costs, including patent and software development costs. The research and development costs
incurred for the three months ended December 31, 2021 and 2020 were $129,639 and $121,793, respectively.
Revenue
Recognition
The
Company recognizes revenues in accordance with the provisions of Accounting Standards Update (“ASU”) 2014-09, “Revenue
from Contracts with Customers,” and a series of amendments, issued by the Financial Accounting Standards Board (“FASB”).
Central
to the revenue recognition guidance is a five-step revenue recognition model that requires reporting entities to:
1.
|
Identify
the contract,
|
2.
|
Identify
the performance obligations of the contract,
|
3.
|
Determine
the transaction price of the contract,
|
4.
|
Allocate
the transaction price to the performance obligations, and
|
5.
|
Recognize
revenue.
|
The
Company accounts for a promise to provide a customer with a right to access the Company’s intellectual property as a performance
obligation satisfied over time because the customer will simultaneously receive and consume the benefit from the Company’s providing
access to its intellectual property as the performance occurs.
Software
License Agreements
During
the fiscal year ended September 30, 2019, the Company entered into a one-year agreement with SoundFi LLC (“SoundFi”) that
automatically renews for subsequent one-year periods unless otherwise terminated by either party. The Company received $25,000 from SoundFi
during the fiscal year ended September 30, 2020. The Company has not received any payments from SoundFi so far in the current fiscal
year and is uncertain if such payments will resume.
The
Company executed a software licensing agreement with Castle Shield Holdings, LLC (“Castle Shield”) during the fiscal year
ended September 30, 2020, which agreement includes auto-renewing terms. The Company received a $10,000 payment from Castle Shield during
the fiscal year ended September 30, 2020. The Company did not receive any payments from Castle Shield during the fiscal year ended September
30, 2021, or during the first quarter of the current fiscal year, but anticipates receiving payments from Castle Shield during the remainder
of the fiscal year.
During
the three months ended December 31, 2020, the Company recognized a total of $8,750 in licensing revenue from the Company’s agreements
with SoundFi and Castle Shield. The Company did not recognize any licensing revenues from these agreements during the three months ended
December 31, 2021.
Recent
Accounting Pronouncements
The
FASB issues ASUs to amend the authoritative literature in the Accounting Standards Codification (“ASC”). There have been
several ASUs to date that amend the original text of the ASC. Other than those discussed below, the Company believes the ASUs issued
to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company, or (iv) are
not expected to have a significant impact on the Company.
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This guidance
removed certain exceptions to the general principles in Topic 740 and enhances and simplifies various aspects of the income tax accounting
guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is not a business combination,
ownership changes in investments, and interim-period accounting for enacted changes in tax law. The Company adopted ASU 2019-12 on October
1, 2021, which adoption did not have a material impact on the Company’s financial position, results of operations and cash flows.
In
August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) – Disclosure Framework – Changes to the
Disclosure Requirements for Fair Value Measurement, to modify the disclosure requirements for fair value measurements. The ASU removes
certain disclosure requirements related to transfers between fair value hierarchy levels and valuation processes for Level 3 fair value
measurements. It modifies certain disclosure requirements for investments in entities that calculate net asset value. It adds certain
disclosure requirements regarding gains and losses for recurring Level 3 fair value measurements and unobservable inputs used to develop
Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2019.
The
Company adopted ASU 2018-13 on October 1, 2020, which adoption did not have a material impact on the Company’s financial position,
results of operations and cash flows.
In
July 2017, the FASB issued ASU 2017-11—Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), and
Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features and II. Replacement of
the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable
Noncontrolling Interests with a Scope Exception. ASU 2017-11 eliminates the requirement that a down round feature precludes equity classification
when assessing whether an instrument is indexed to an entity’s own stock. As a result, a freestanding equity-linked financial instrument
would no longer be accounted for as a derivative liability at fair value because of the existence of a down round feature. The Company
has adopted ASU 2017-11 and implemented the pronouncement retrospectively. The adoption of this guidance did not have an impact on the
Company’s financial statements.
As
a result, a freestanding equity-linked financial instrument is no longer accounted for as a derivative liability at fair value because
of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that
present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered.
That effect is treated as a dividend and as a reduction of income available to common stockholders in basic EPS.
During
March and April 2021, the Company issued warrants to purchase 63,882,054
shares of its common stock at an average
exercise price of $0.33
per share, which warrants have anti-dilution
rights that provide for adjustments in the exercise price and number of shares exercisable upon exercise if there is an issuance of common
stock or common stock equivalents at a lower price than the exercise price of the warrants (down round feature).
In
October 2021, the FASB amended guidance to recognize and measure contract assets and contract liabilities from contracts with customers
acquired in a business combination. Generally, this new guidance will result in the Company recognizing contract assets and contract
liabilities consistent with those reported by the acquiree immediately before the acquisition date. The Company retroactively adopted
the guidance in the fourth quarter of fiscal 2021 for all business combinations completed since the beginning of fiscal 2021. There was
no material impact on the Company’s Financial Statements.
In
January 2021, the FASB issued guidance to clarify that all derivative instruments affected by changes to the interest rates used for
discounting, margining or contract price alignment can apply certain optional expedients and exceptions mentioned in its reference rate
reform guidance even though they do not reference to LIBOR or a rate being discontinued. This guidance was effective upon issuance. The
Company adopted the guidance in the first quarter of fiscal 2021. There was no impact on the Company’s Financial Statements
upon such adoption.
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses, which requires a financial asset (or
a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance
for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net
carrying value at the amount expected to be collected on the financial asset. The guidance is effective for fiscal years beginning after
December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic
326), which pushes back the effective date for public business entities that are smaller reporting companies, as defined by the
SEC, to fiscal years beginning after December 15, 2022. Early adoption is permitted.
In
January 2020, the FASB issued guidance to clarify certain interactions between the guidance to account for equity securities, the guidance
to account for investments under the equity method of accounting, and the guidance to account for derivatives and hedging. The new guidance
clarifies the application of measurement alternatives and the accounting for certain forward contracts and purchased options to acquire
investments. The Company is required to adopt the guidance in the first quarter of fiscal 2022. Early adoption is permitted.
In
May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock
Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU addresses
an issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment
is effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years.
Early adoption is permitted.
In
November 2021, the FASB issued guidance to increase the transparency of government assistance received by an entity by requiring disclosures
relating to accounting policy, nature of the assistance, and the effect of the assistance on the financial statements. The Company is
required to adopt the guidance in the first quarter of its fiscal 2023. Early adoption is permitted. The Company is currently evaluating
the impact of this guidance on its Financial Statements.
In
August 2020, the FASB issued ASU 2020-06—Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives
and edging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an
Entity’s Own Equity (“ASU 2020-06”) to simplify the accounting for convertible instruments by removing certain
separation models in Subtopic 470- 20, Debt with Conversion and Other Options, for convertible instruments. Under the amendments
in ASU 2020-06, the embedded conversion features no longer are separated from the host contract for convertible instruments with conversion
features that are not required to be accounted for as derivatives under Topic 815, Derivatives and Hedging, or that do not result in
substantial premiums accounted for as paid-in capital. Consequently, a convertible debt instrument will be accounted for as a single
liability measured at its amortized cost and a convertible preferred stock will be accounted for as a single equity instrument measured
at its historical cost, as long as no other features require bifurcation and recognition as derivatives. By removing those separation
models, the interest rate of convertible debt instruments typically will be closer to the coupon interest rate when applying the guidance
in Topic 835, Interest. The amendments in ASU 2020-06 provide financial statement users with a simpler and more consistent starting point
to perform analyses across entities. The amendments also improve the operability of the guidance and reduce, to a large extent, the complexities
in the accounting for convertible instruments and the difficulties with the interpretation and application of the relevant guidance.
Additionally,
for convertible debt instruments with substantial premiums accounted for as paid-in capital, amendments in ASU 2020-06 added disclosures
about (1) the fair value amount and the level of fair value hierarchy of the entire instrument for public business entities and (2) the
premium amount recorded as paid-in capital.
The
amendments in ASU 2020-06 are effective for public business entities, excluding entities eligible to be smaller reporting companies,
as defined by the SEC, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all
other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those
fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods
within those fiscal years. Entities should adopt the guidance as of the beginning of its annual fiscal year and are allowed to adopt
the guidance through either a modified retrospective method of transition or a fully retrospective method of transition. In applying
the modified retrospective method, entities should apply the guidance to transactions outstanding as of the beginning of the fiscal year
in which the amendments are adopted. Transactions that were settled (or expired) during prior reporting periods are unaffected. The cumulative
effect of the change should be recognized as an adjustment to the opening balance of retained earnings at the date of adoption. If an
entity elects the fully retrospective method of transition, the cumulative effect of the change should be recognized as an adjustment
to the opening balance of retained earnings in the first comparative period presented. The Company is evaluating the impact of the revised
guidance and believes that it will not have a significant impact on its financial statements.
NOTE
4– COMMITMENTS AND CONTINGENCIES
Litigation
The
Company is currently not involved in any litigation that it believes could have a material adverse effect on its financial condition
or results of operations.
In
December 2017, Robert LeBlanc, a disgruntled former consultant of the Company, filed a petition against the Company and Michael De La
Garza, the Company’s former Chief Executive Officer and President, in the 20th Judicial District for Hays County, Texas (Cause
No. 18-0005). The petition (which has been amended) alleges causes of action against us for alleged violation of the Texas Securities
Act (based on the allegation that the defendants sold securities by means of untrue statements of material facts), common law fraud against
Mr. De La Garza (for alleged misrepresentations alleged made by Mr. De La Garza); breach of fiduciary duty against Mr. De La Garza; breach
of contract; as well as declaratory relief. Damages sought exceed $1,000,000 but are less than $10,000,000. The Company believes it has
made all required payments and delivered the stock to the plaintiff and that the plaintiff’s claims are without merit. Mr. LeBlanc
also made a claim of partial ownership of certain of the Company’s patents, which the Company believes is without merit. The case
is currently being defended by the Company. The Company believes it has meritorious defenses to the allegations, and the Company intends
to continue to vigorously defend against the litigation.
In
April 2020, Eric Marquez, the former Secretary/Treasurer and Chief Financial Officer of the Company, and certain other plaintiffs, filed
a lawsuit against the Company and Michael De La Garza, the Company’s former Chief Executive Officer and President, in the 20th
Judicial District for Hays County, Texas (Cause No. 20-0818). The lawsuit alleges causes of action for fraud against Mr. De La
Garza (for misrepresentations alleged made by Mr. De La Garza), breach of contract, for alleged breaches of Mr. Marquez’s employment
agreement, which provided for the Company pay him cash and shares of stock; unjust enrichment; quantum meruit; and rescission of certain
stock purchases made by certain of the plaintiffs, as well as declaratory relief and fraud. Damages sought exceed $1,000,000. The Company
believes it has made all required payments and delivered all required shares of stock to the plaintiffs. The case is currently being
defended by the Company. The Company believes it has meritorious defenses to the allegations, and the Company intends to continue to
vigorously defend against the litigation.
Leases
All
of the Company’s leases that were in place during the fiscal year ended September 30, 2020 have been terminated. As of December
31, 2021, the Company has no financial obligations for facility lease agreements, except as set forth below.
Tom
Wilkinson, the Company’s Chairman of the Board of Directors, provides the Company the use of office space which he rents, at 6836
Bee Caves Road, Building 1, Suite 279, Austin, TX 78746, for its corporate headquarters. There is a sublease agreement with Mr. Wilkinson
and Mr. Wilkinson charges the Company $500 a month rental fee.
This
lease agreement does not contain any material residual value guarantees or material restrictive covenant.
Cash
Flows
The
Company recognized an initial right-of-use asset of $233,751 as a non-cash asset addition with the adoption of the new lease accounting
standard. Cash the Company paid for amounts included in the present value of operating lease liabilities was $80,402 during the fiscal
year ended September 30, 2021, and is included in operating cash flows.
The
Company’s rent expense totaled $500 and $38,279 for the three months ended December 31, 2021, and 2020, respectively.
NOTE
5 – DEBT
On
April 6, 2020, the Company submitted its application for a $365,430 Paycheck Protection Program (“PPP”) loan sponsored by
the U.S. Small Business Administration (the “SBA Loan”). On April 12, 2020, the SBA Loan application was approved, and the
Company received the loan proceeds on April 22, 2020. The SBA Loan had an interest rate of 1% and was scheduled to mature on April 12,
2022.
As
of September 30, 2020, the SBA Loan balance was $365,430. The Company filed for partial loan forgiveness on January 29, 2021, which was
approved on June 11, 2021 in the amount of $192,052. The Company’s staff reductions that occurred in 2020 prevented the Company
from qualifying for full forgiveness of the principal balance of the SBA Loan.
The
Company placed the full principal balance of the SBA Loan, plus $1,000 of interest, in an escrow account on April 15, 2021. Upon receipt
of the partial loan forgiveness, the Company paid the remaining amount of the SBA Loan, using funds in the escrow account, and the remaining
balance was returned to the Company’s operating account. The balance of the SBA Loan was $0 as of September 30, 2021.
NOTE
6 - STOCKHOLDERS’ EQUITY
The
Company is authorized to issue 681,000,000 shares of common stock and 10,000,000 shares of Series A convertible preferred stock, each
with a par value of $0.001 per share.
Common
Stock
During
the three months ended December 31, 2020, and the three months ended December 31, 2021, the Company did not issue any shares of its common
stock or preferred stock, except as set forth below.
Beginning
with the last quarter during the Company’s fiscal year ending September 30, 2021, its Board of Directors elected to begin receiving
one-half of their quarterly Board compensation in shares of common stock instead of cash. At its April, 2021 meeting, the Company’s
Board of Directors also approved a one time award of 100,000 shares of common stock to each director, subject to approval of the Company’s
Equity Incentive Compensation Plan by its stockholders, which was received at the annual meeting of stockholders in September 2021. To
date, the directors have received a total of 522,224 shares of the Company’s common stock through the one-time grant and two quarterly
compensation payments. The one-time award and the fiscal year 2021 fourth quarter award of a total of 411,112 shares was made on January
13, 2022. The fiscal year 2022 first quarter awards were made on January 31, 2022.
Restricted
Common Stock Units
On
October 22, 2021, the Company entered into restricted stock unit award agreements with five separate individuals. The Company granted
a total of 2,000,001 shares of restricted stock to these individuals, which shares vest in equal tranches on the next three anniversary
dates of the award. The value of the shares of restricted stock on the grant date was $260,000, based upon the then current market price
of the Company’s common stock of $0.13 per share on October 22, 2021. During the three months ended December 31, 2021, the Company
recorded $22,561 in stock compensation expense related to these award agreements.
NOTE
7 – SUBSEQUENT EVENTS
On
February 14, 2022 the Company announced the launch of Cipherloc Enclave, a new micro-segmentation product, through a press release and
a Form 8-K. Cipherloc Enclave is further discussed in Item 2 of this Form 10-Q.