UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 31, 2019

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT

 

For the transition period from N/A to N/A

 

Commission File No. 000-28745

 

Cipherloc Corporation

(Name of small business issuer as specified in its charter)

 

Texas   86-0837077
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)

 

825 Main St, Suite 100

Buda, TX 78610

(Address of principal executive offices)

 

(512) 649-7700

Registrant’s telephone number, including area code

 

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days:

Yes [  ] No [X]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer [  ] Accelerated filer [  ]
  Non–Accelerated filer [X] Smaller reporting company [X]
  Emerging growth company [  ]    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act). Yes [  ] No [X]

 

As of January 31, 2020, 40,792,510 shares of the issuer’s common stock were outstanding.

 

 

 

 
 

 

CIPHERLOC CORPORATION

INDEX TO FORM 10-Q FILING

FOR THE THREE MONTHS ENDED DECEMBER 31, 2019 AND 2018

TABLE OF CONTENTS

 

  PAGE
PART I - FINANCIAL INFORMATION  
   
Item 1. Financial Statements (Unaudited) 3
  Balance Sheets at December 31, 2019 and September 30, 2019 4
  Statements of Operations for the three months ended December 31, 2019 and 2018 5
  Statements of Cash Flows for the three months ended December 31, 2019 and 2018 6
  Statement of Stockholders’ Equity for the three months ended December 31, 2019 and 2018 7
  Notes to Financial Statements 8
Item 2. Management Discussion & Analysis of Financial Condition and Results of Operations 13
Item 3 Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 14
     
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Mining Safety Disclosures 16
Item 5 Other Information 16
Item 6. Exhibits 16
     
CERTIFICATIONS  
   
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act  
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act  

 

 2 
 

 

PART I

FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

The accompanying interim financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, they do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, cash flows, and stockholders’ equity in conformity with accounting principles generally accepted in the United States of America. Except as disclosed herein, there has been no material change in the information disclosed in the notes to the financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2019. In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations and financial position have been included, and all such adjustments are of a normal recurring nature. Operating results for the three months ended December 31, 2019 are not necessarily indicative of the results that can be expected for the year ending September 30, 2020.

 

 3 
 

 

CIPHERLOC CORPORATION

BALANCE SHEETS

(UNAUDITED)

 

  

December 31,

2019

   September 30,
2019
 
ASSETS          
Current assets          
Cash  $5,677,539   $7,839,472 
Prepaid expenses   64,730    121,371 
Total current assets   5,742,269    14,056,346 
           
Other assets   7,566    7,566 
Operating lease ROU asset   209,419     
Fixed assets, net   48,619    40,182 
Total assets  $6,007,873   $8,008,591 
           
LIABILITIES & STOCKHOLDERS’ EQUITY          
Current liabilities          
Accounts payable and accrued liabilities  $662,857   $650,681 
Accrued compensation       142,293 
Operating lease liability   102,251     
Deferred revenue   9,650    28,400 
Total current liabilities   774,758    821,374 
           
Operating long-term lease liability   102,413    - 
Total liabilities   817,732    821,374 
           
Commitments and contingencies (Note 5)          
           
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized; 1,000,000 issued and outstanding as of December 31, 2019 and September 30, 2019   10,000    10,000 
Common stock, $0.01 par value, 681,000,000 shares authorized; 40,792,510 and 40,792,510 issued and outstanding as of December 31, 2019 and September 30, 2019, respectively   407,925    407,925 
Additional paid-in capital   68,277,399    68,225,828 
Accumulated deficit   (63,564,622)   (61,456,536)
Total stockholders’ equity   5,130,702    7,187,217 
Total liabilities and stockholders’ equity  $6,007,873   $8,008,591 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 4 
 

 

CIPHERLOC CORPORATION

STATEMENTS OF OPERATIONS

(UNAUDITED)

 

   Three Months Ended 
   December 31, 
   2019   2018 
Revenues  $18,570   $ 
Cost of revenues        
Gross profit   18,750     
           
Operating expenses          
General and administrative   1,304,780    532,974 
Sales and marketing   256,044    213,975 
Research and development   566,015    345,895 
Total operating expenses   2,067,400    1,092,844 
Operating loss   (2,108,089)   (1,092,844)
           
Other income (expenses)          
Interest income (expense), net       897 
Net loss  $(2,108,089)  $(1,091,947)
           
Net loss per common share – basic and diluted  $(0.05)  $(0.03)
           
Weighted average common shares outstanding – basic and diluted   40,792,510    40,762,159 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 5 
 

 

CIPHERLOC CORPORATION

STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Three Months Ended 
   December 31, 
   2019   2018 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net loss  $(2,108,089)  $(1,091,947)
Adjustments to reconcile net loss to net cash flows used in operating activities:          
Depreciation   5,404    1,781 
Stock-based compensation   51,574     
Stock issued for services       40,000 
Changes in operating assets and liabilities:          
Prepaid expenses and other assets   56,641    (56,995)
Accounts payable and accrued liabilities   7,423    39,739 
Accrued compensation   (142,295)   81,276 
Deferred revenue   (18,750)    
Net cash used in operating activities   (2,148,092)   (986,146)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchase of fixed assets   (13,841)   (17,719)
Net cash used in investing activities   (13,841)   (17,719)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Common stock issued for cash        
Proceeds from convertible note, net        
Net cash provided by financing activities        
           
DECREASE IN CASH   (2,161,933)   (1,003,865)
CASH, BEGINNING OF PERIOD   7,839,472    14,056,346 
CASH, END OF PERIOD  $5,677,539   $13,052,481 
           
NON-CASH INVESTING AND FINANCING ACTIVITIES:          
ROU asset  $209,419   $ 
ST operating lease liability  $102,251   $ 
LT operating lease liability  $102,413   $ 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 6 
 

 

CIPHERLOC CORPORATION

STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

   Preferred Stock   Common Stock   Additional Paid-in   Accumulated   Stockholders’ 
   Shares   Amount   Shares   Amount   Capital   Deficit  

Equity

 
Balance at September 30, 2019   1,000,000   $10,000    40,792,510   $407,925   $68,225,825   $(61,456,533)  $7,187,217 
Stock option expense issued to directors, officers and employees                   51,574        51,574 
Net loss                       (2,108,089)   (2,108,089)
Balance at December 31, 2019     1,000,000   $10,000      40,792,510   $  407,925   $  68,277,399   $(63,564,622)  $5,130,702 

 

   Preferred Stock   Common Stock   Additional Paid-in   Accumulated   Stockholders’ 
   Shares   Amount   Shares   Amount   Capital   Deficit  

Equity

 
Balance at September 30, 2018   1,000,000   $10,000    40,743,917   $407,438   $68,169,157   $(54,622,513)  $13,964,082 
Common stock issued for services           20,000    200    39,800        40,000 
Net loss                       (1,091,947)   (1,091,947)
Balance at December 31, 2018     1,000,000   $10,000      40,763,917   $  407,638   $  68,208,957   $(55,714,460)  $12,912,135 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 7 
 

 

CIPHERLOC CORPORATION

NOTES TO FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2018 AND 2017

(Unaudited)

 

NOTE 1 - DESCRIPTION OF BUSINESS

 

Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. Effective August 27, 2014, the Company changed its name to Cipherloc Corporation.

 

NOTE 2 - BASIS OF PRESENTATION OF INTERIM FINANCIAL STATEMENTS

 

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. The accompanying interim unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Operating results for the three months ended December 31, 2019 are not necessarily indicative of the results that may be expected for the year ending September 30, 2020. Notes to the unaudited interim financial statements that would substantially duplicate the disclosures contained in the audited financial statements for the year ended September 30, 2019 have been omitted; this report should be read in conjunction with the audited financial statements and the footnotes thereto for the fiscal year ended September 30, 2019 included within the Company’s 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, 2019 and September 30, 2019, cash includes cash on hand and cash in the bank. The balance of such accounts, at times, may exceed federally insured limits, as guaranteed by the Federal Deposit Insurance Corporation (“FDIC”). The FDIC insures these deposits up to $250,000. At December 31, 2019, $5,384,631 of the Company’s cash balance was uninsured.

 

Basic and Diluted Net Loss per Common Share

 

Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding. Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest, resulting in the issuance of common stock that could share in the earnings of the Company. As of December 31, 2019, and September 30, 2019, the Company had 1,000,000 shares of preferred stock outstanding, which are convertible into 1,500,000 shares of common stock.

 

Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss. During the three months ended December 31, 2019, 24,216,866 warrants and 1,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. During the three months ended December 31, 2018, 25,015,866 warrants and 1,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive.

 

 8 
 

 

Research and Development and Software Development Costs

 

The Company expenses all research and development costs, including patent and software development costs. Our research and development costs incurred for the three months ended December 31, 2019 and 2018 were $566,015 and $345,895, respectively.

 

Revenue Recognition

 

The Company recognizes revenues in accordance with the provisions of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers,” and a series of amendments which together we identify as “ASC Topic 606”. This new accounting standard, which we adopted on October 1, 2018 using the permitted modified retrospective method, outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. The new standard supersedes most previous revenue recognition guidance, including industry-specific guidance. The effect of the adoption of ASC Topic 606 on retained earnings as of October 1, 2018 was not material. The differences between our reported operating results for the three months ended December 31, 2019, which reflect the application of the new standard on our contracts, and the results that would have been reported if the accounting was performed pursuant to the accounting standards previously in effect, also were not material.

 

Central to the new revenue recognition guidance is a five-step revenue recognition model that requires reporting entities to:

 

1. Identify the contract,
2. Identify the performance obligations of the contract,
3. Determine the transaction price of the contract,
4. Allocate the transaction price to the performance obligations, and
5. Recognize revenue.

 

The Company accounts for a promise to provide a customer with a right to access the Company’s intellectual property as a performance obligation satisfied over time because the customer will simultaneously receive and consume the benefit from the entity’s performance of providing access to its intellectual property as the performance occurs.

 

SoundFi – Software License Agreement

 

On February 15, 2019, the Company entered into a one-year agreement renewable for up to 4 years for an annual $50,000 Shield license fee and $25,000 watermark base license fee with SoundFi LLC (“SoundFi”). Residual income to the Company is earned based on the number of audio files downloaded per year with residual earnings of $.012 per download exceeding 3,000,001 and scaling up to $.00075 per download exceeding 100,000,000. During the three months ended December 31, 2019, the Company recognized $18,750 in licensing revenue. The Company has determined the best method for measuring licensing revenue to be the passage of time and more specifically on a monthly basis. The recognition of residual income occurs on an annual basis based on download volume provided by SoundFi. A download is defined as an audio file downloaded to a mobile device from the SoundFi servers.

 

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the authoritative literature in the ASC. There have been several ASUs to date that amend the original text of the ASCs. Other than those discussed below, the Company believes those ASUs issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company or (iv) are not expected to have a significant impact on the Company.

 

In 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 is currently in the process of evaluating the effect this guidance will have on its financial statements and related disclosures.

 

 9 
 

 

In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting, to expand the scope of Topic 718, Compensation – Stock Compensation, which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Thus, accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted ASU 2018-07 on October 1, 2019 and the adoption of this update did not have a material impact on the Company’s financial position, results of operations and cash flows.

 

In February 2016, the FASB issued ASU 2016-02, Leases, which aims to make leasing activities more transparent and comparable and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset (ROU) and corresponding lease liability, including leases currently accounted for as operating leases. Leases of mineral reserves and related land leases have been exempted from the standard. We adopted ASU 2016-02, Leases, on October 1, 2019. We elected the “package of practical expedients” within the standard which permits us not to reassess prior conclusions about lease identification, lease classification and initial direct costs. We made an accounting policy election to not separate lease and non-lease components for all leases. The adoption of this standard resulted in the recognition of right-of-use assets and lease liabilities of $0.2 million, which were not previously recorded on our balance sheet.

 

NOTE 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.

 

A disgruntled former consultant has brought an action in Texas state court against the Company and its former chief executive officer, alleging fraud and misrepresentation pertaining to stock and payments alleged to be owed to the consultant. The Company believes it has made all required payments and delivered the stock to the consultant. The consultant has also included a claim of partial ownership of certain of the Company’s patents, which management believes is without merit. The case is currently being defended by the Company and costs relating thereto have been submitted to the Company’s insurance carrier.

 

In August 2019, the Board of Directors formed a special committee of independent directors (the “Special Committee”) to investigate certain activities of Michael De La Garza (“De La Garza”), our former chief executive officer. The Special Committee has retained legal counsel, and is authorized to retain forensic accountants, to assist the investigation.

 

In August 2019, the Company initiated litigation against De La Garza in the Discount Court of Travis Country, Texas (the “Court”) in order to stop him from misappropriating the company’s trade secrets, depleting its monies and other assets, damaging the value of the company in the marketplace, and holding himself out as the company’s CEO. On September 25, 2019, the Court entered a temporary injunction against De La Garza enjoining him from numerous acts including representing himself as the Company’s CEO and from interfering with the current CEO’s management of the company. This litigation is ongoing, and its resolution is unknown. The Special Committee is investigating certain activities of De La Garza, including the Ageos, LLC Operating Agreement, the QHCI/Noun note receivable, an advance/bonus, personal expenditures, and other items. All amounts expended have been expensed as of September 30, 2019. No amounts have been recorded in these financial statements as expected recoveries.

 

Leases

 

In March 2019, the Company guaranteed a lease on behalf of Ageos, LLC in McLean, Virginia. The lease has a term of three years for 4,359 square feet of space in McClean, Virginia. The initial rent cost is $7,991 per month and the lease agreement provides for annual rent increases of approximately 4.0%. The amount of future payments guaranteed is $267,389. The agreement with Ageos was terminated in August 2019 and the Company has made an unwritten offer to assume the lease. No amounts have been accrued for this commitment as of December 31, 2019.

 

 10 
 

 

In February 2019, the Company and the landlord for its leased office space in Buda, Texas entered into a new lease agreement, and the Company reduced its rented space from approximately 3,900 to 1,302 square feet. The new lease was effective February 1, 2019 and has a three-year term. The initial monthly rent is $2,566, and the lease agreement provides for annual rent increases of approximately 2.7%. The lease automatically renews for a three-year term, unless either party to the lease agreement notifies the other of the intent to terminate the lease in writing at least 180 days prior to the expiration of the current term. The amount of future payments guaranteed is $66,690.

 

In October 2018, the Company leased approximately 3,900 square feet of office space on North Scottsdale Road in Scottsdale, Arizona. The lease for this facility began on October 4, 2018 and continues until October 31, 2021. Annual rent of $77,180 was prepaid for the first year from November 1, 2018 to October 31, 2019, and the lease agreement provides for annual rent increases of approximately 5.0%. The amount of future payments guaranteed is $152,430.

 

Our significant accounting policies are detailed in Note 2 of our Annual Report on Form 10-K for the year ended September 30, 2019. Changes to our accounting policies as a result of adopting ASU 2016-02 are discussed below.

 

The Company has two lease agreements for facilities. Some leases include options to extend for one or more years. These options are included in the lease term when it is reasonably certain that the option will be exercised.

 

Leases with an initial term of 12 months or less are not recorded on our Balance Sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. Leases with initial terms in excess of 12 months are recorded as operating or financing leases in our Balance Sheet.

 

Lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use a secured incremental borrowing rates based on the information available at commencement date, including lease term, in determining the present value of future payments. The operating lease asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that the option will be exercised.

 

At inception, the Company determines if an arrangement contains a lease and whether that lease meets the classification criteria of a finance or operating lease. Some of the Company’s lease arrangements contain lease components (e.g. minimum rent payments) and non-lease components (e.g. maintenance, labor charges, etc.). The Company generally accounts for each component separately based on the estimated standalone price of each component. For certain leases the Company accounts for the lease and non-lease components as a single lease component.

 

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

 

Operating Leases

 

Operating leases are included in operating lease ROU lease assets, and operating lease liabilities and operating long-term lease liabilities on the Balance Sheets. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Variable lease expense is recognized in the period in which the obligation for those payments is incurred. Lease expense is included in general and administrative expense in the statements of operations and is reported net of lease income. Lease income is not material to the results of operations for the quarter ended December 31, 2019.

 

 11 
 

 

Cash Flows

 

An initial right-of-use asset of $209,419 was recognized as a non-cash asset addition with the adoption of the new lease accounting standard. Cash paid for amounts included in the present value of operating lease liabilities was $28,387 during first quarter 2020 and is included in operating cash flows.

 

The weighted average remaining lease terms and discount rates for all of our operating lease were as follows as of December 31, 2019:

 

Remaining lease term and discount rate:  December 31, 2019 
Weighted average remaining lease terms (years)     
Lease facilities   1.75 
      
Weighted average discount rate     
Lease facilities   4.62%

 

Significant Judgements

 

Significant judgements include the discount rates applied, the expected lease terms, and lease renewal options. There are two leases with a renewal options. Using the practical expedient the Company utilized existing lease classifications as of September 30, 2019. As a result the lease renewal options were not changed on implementation.

 

The Company will reassess the lease terms and purchase options when there is a significant event of change in circumstances or when the Company elects to exercise an option that had previously been determined that it was not reasonably certain to do so.

 

Future annual minimum lease obligations at December 31, 2019 are as follows:

 

Year Ending December 30,  Amount 
2020  $84,438 
2021   87,433 
2022   47,249 
   $219,120 

 

Rent expense totaled $22,744 and $107,542 for the three months ended December 31, 2019 and 2018, respectively.

 

NOTE 5 - STOCKHOLDERS’ EQUITY

 

The Company is authorized to issue 681,000,000 common shares and 1,000,000 preferred shares at a par value of $0.01 per share.

 

Common Stock

 

During the three months ended December 31, 2019, the Company issued 620,000 shares of stock options to the employees with a fair value of $459,019, of which $12,751 was recorded as stock-based compensation expenses in research and development, marketing and general administration expense. Options will vest over a three-year period ratably. Of the 620,000 options, 500,000 options have a strike price of $0.78 and the remaining 120,000 have a strike price of $0.81. Total stock compensation expense was $51,574 for the quarter ended December 31, 2019.

 

During the three months ended December 31, 2018, the Company issued 20,000 shares of common stock with a fair value of $40,000 to Pycnocline, LLC for management consulting services.

 

NOTE 6 – SUBSEQUENT EVENTS

 

On January 17, 2020, a decision was made to form a new company to be incorporated in the state of Nevada. The new entity will be a wholly owned subsidiary of Cipherloc Corporation and will become the commercial enterprise of the consolidated entity following the completion of a trademark search before the end of the Company’s second quarter.

 

On January 31, 2020, a commercial lease for office space in the state of Virginia between 2111 Wilson Boulevard Inc. and Cipherloc Corporation was executed with a commencement date of February 1, 2020.

 

On February 1, 2020, Cipherloc Corporation hired Ryan Polk as its Chief Financial Officer.

 

 12 
 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In this Quarterly Report, “Company,” “our company,” “us,” and “our” refer to Cipherloc Corporation and its subsidiaries, unless the context requires otherwise.

 

Forward-Looking Statements

 

The following information contains certain forward-looking statements. Forward-looking statements are statements that estimate the happening of future events and are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as “may,” “could,” “expect,” “estimate,” “anticipate,” “plan,” “predict,” “probable,” “possible,” “should,” “continue,” or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.

 

Our Business

 

We are developing products and services around its patented polymorphic encryption technology designed to enable a more efficient and stronger layer of protection to be added to existing solutions which we believe could be the industry’s first “Polymorphic Cipher Engine”, which we call Cipherloc®. We anticipate offering the first secure commercially viable advanced “Polymorphic Key Progression Algorithmic Cipher Engine” (“PKPA”). We believe this morphing cipher can be used in any commercial data security industry and/or in sensitive applications.

 

Our innovative and patented polymorphic technology eliminates the flaws and inadequacies associated with today’s encryption algorithms. Instead of dealing with large monolithic blocks of data, our approach decomposes the information to be protected into multiple segments. These individual segments each have a unique encryption key, utilize different encryption algorithms, are randomly grouped into different lengths, and can be further re-encrypted. Since segments are independent from each other and are individually protected, our technology is not susceptible to computational attacks. In fact, the strength of our technology improves as compute power increases.

 

Results of Operations for the three months ended December 31, 2019 and 2018

 

Revenue increased to $18,750 for the three months ended December 31, 2019 from $0 for the three months ended December 31, 2018. The increase in revenue is related to the SoundFi license contract.

 

General and administrative expenses increased to $1,304,780 for the three months ended December 31, 2019 from $532,974 for the three months ended December 31, 2018. General and administrative expenses increased primarily as a result of higher legal fees of $470,000, higher headcount related costs of $195,000, higher professional fees, consulting fees and contract services of $107,000.

 

Sales and marketing expenses increased to $256,044 for the three months ended December 31, 2019 from $213,975 for the three months ended December 31, 2018. Sales and marketing expenses increased primarily as a result of higher headcount related costs of $151,000.

 

Research and development costs increased to $566,015 for the three months ended December 31, 2019 from $345,895 for the three months ended December 31, 2018. Research and development expenses increased primarily as a result of higher consulting costs of $203,000 and higher headcount related costs of $17,000.

 

Interest income, net, was $897 for the three months ended December 31, 2018.

 

Liquidity and Capital Resources

 

We had an accumulated deficit at December 31, 2019 of $63,564,622. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At December 31, 2019, we had cash of $5,327,539. We believe that our existing cash balances are sufficient to fund future operations for the next 9 to 12 months. We may need to raise additional capital to increase liquidity and extend the period of time until we have positive cashflow from operations. We believe the additional funding required can be obtained on terms acceptable to us, although there can be no assurance that we will be successful.

 

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Cash Flow

 

The following table summarizes, for the periods indicated, selected items in our condensed Statements of Cash Flows:

 

   Three Months Ended 
   December 31, 
   2019   2018 
Net cash (used in):          
Operating activities  $(2,148,092)  $(986,146)
Investing activities  $(13,841)  $(17,719)
Financing activities  $   $ 

 

Operating Activities

 

Cash used in operating activities was $2,148,092 and $986,146 for the three months ended December 31, 2019 and 2018, respectively. The change in cash used in operating activities was primarily due to the increase in the net loss during 2019.

 

Investing Activities

 

Cash used in investing activities was $13,841 and $17,719 for the three months ended December 31, 2019 and 2018, respectively. The cash used in investing activities was the result of fixed asset purchases.

 

Financing Activities

 

Cash provided by financing activities was $0 and $0 for the three months ended December 31, 2019 and 2018, respectively.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements, including arrangements that would affect the liquidity, capital resources, market risk support, and credit risk support or other benefits.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable

 

ITEM 4. CONTROLS AND PROCEDURES 

 

This report includes the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). See Exhibits 31.1 and 31.2. This Item 4 includes information concerning the controls and control evaluations referred to in those certifications.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures were designed to provide reasonable assurance that the controls and procedures would meet their objectives.

 

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As required by SEC Rule 13a-15(b), our Cheif Executive Officer and Chief Financial Officer need to carry out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report.

 

Management’s Report on Internal Control over Financial Reporting

 

Our Principal Executive Officer and the Principal Financial Officer are responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of our internal control over financial reporting. Internal control over financial reporting (as defined in Rules 13a-15(f) and 15d(f) under the Exchange Act) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets, (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, (c) provide reasonable assurance that receipts and expenditures are being made only in accordance with appropriate authorization of management and the Board of Directors, and (d) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

 

In connection with the preparation of our Annual Report on Form 10-K for the year ended September 30, 2019, our Principal Executive Officer and Principal Financial Officer evaluated the effectiveness of our internal control over financial reporting as of September 30, 2019 and concluded that we did not maintain effective internal control over financial reporting as of September 30, 2019 due to the identification of material weaknesses. Certain transactions that occurred from October 1, 2018 through August 31, 2019 validated that the material weakness had not been remedied as of September 30, 2019. We intend to remediate these material weaknesses during the 2020 fiscal year.

 

Changes in Internal Control over Financial Reporting

 

We intend to begin implementing a remediation plan to address the material weaknesses identified during the year ended September 30, 2020. The remediation efforts will focus on:

 

  Enhancing monitoring and review controls over financial reporting and disclosures;
     
  Enhancing review and approval controls around transaction processing;
     
  Enhancing controls around proving the delivery of software; and
     
  Enhancing and maintaining written policies and procedures for accounting and financial reporting.

 

We expect that remediation, including testing of related controls, will be completed during the balance of the 2020 fiscal year.

 

Inherent Limitations on Internal Controls

 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the control system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of certain events. Limitations inherent in any control system include the following:

 

  Judgments in decision-making can be faulty, and control and process breakdowns can occur because of simple errors or mistakes;
     
  Controls can be circumvented by individuals, acting alone or in collusion with others, or by management override;
     
  The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions;
     
  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures; and
     
  The design of a control system must reflect the fact that resources are constrained, and the benefits of controls must be considered relative to their costs.

 

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

 

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PART II

OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

See “Litigation” in Note 5 – Commitments and Contingencies of the Notes to the Financial Statements in Part I, Item I of this document.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINING SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

31.1   Certification of Principal Executive Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of Principal Financial Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Registrant Cipherloc Corporation
   
Date: February 14, 2020 By: /s/ Andrew Borene
    Andrew Borene
    Chief Executive Officer

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Registrant Cipherloc Corporation
   
Date: February 14, 2020 By: /s/ Ryan Polk
    Ryan Polk
    Chief Financial Officer

 

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