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EX-32.2 - CIPHERLOC Corpex32-2.htm
EX-32.1 - CIPHERLOC Corpex32-1.htm
EX-31.2 - CIPHERLOC Corpex31-2.htm
EX-31.1 - CIPHERLOC Corpex31-1.htm
EX-10.35 - CIPHERLOC Corpex10-35.htm
EX-10.34 - CIPHERLOC Corpex10-34.htm
EX-10.33 - CIPHERLOC Corpex10-33.htm
EX-10.32 - CIPHERLOC Corpex10-32.htm
EX-10.31 - CIPHERLOC Corpex10-31.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended September 30, 2017

 

OR

 

(  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

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

 

Commission File Number: 000-28745

 

Cipherloc Corporation

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

 

Texas   86-0837077
State of Incorporation   IRS Employer Identification No.

 

825 Main Street, Suite 100

Buda, TX 78610

(Address of principal executive offices)

 

(512) 772-4237

(Issuer’s telephone number)

 

Securities registered under Section 12(b) of the Exchange Act:

None

 

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, $0.01 par value per share

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [  ] Yes [X] No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. [  ] Yes [X] No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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 [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

 

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

 

Large accelerated filer [  ] Accelerated filer [  ]
Non–Accelerated filer [  ] Small reporting company [X]

 

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

 

Aggregate market value of the voting stock held by non-affiliates: $10,293,766 as based on the closing price of the stock on January 10, 2018. The voting stock held by non-affiliates on that date consisted of 6,090,986 shares of common stock.

 

As of January 10, 2018, there were 6,982,411 shares of common stock, par value $0.01, and 10,000,000 shares of preferred stock, par value $0.01, issued and outstanding.

 

Documents Incorporated by Reference: None

 

 

 

   

 

 

CIPHERLOC CORPORATION

FORM 10-K ANNUAL REPORT

FOR THE FISCAL YEARS ENDED SEPTEMBER 30, 2017 AND 2016

TABLE OF CONTENTS

 

PART I    
     
ITEM 1. BUSINESS 2
     
ITEM 1A. RISK FACTORS 3
     
ITEM 1B. UNRESOLVED STAFF COMMENTS 7
     
ITEM 2. PROPERTIES 7
     
ITEM 3. LEGAL PROCEEDINGS 8
     
ITEM 4. REMOVED AND RESERVED 8
     
PART II    
     
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 8
     
ITEM 6. SELECTED FINANCIAL DATA 10
     
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10
     
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 13
     
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 14
     
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 29
     
ITEM 9A. CONTROLS AND PROCEDURES 29
     
ITEM 9B. OTHER INFORMATION 30
     
PART III    
     
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE 31
     
ITEM 11. EXECUTIVE COMPENSATION 32
     
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 33
     
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 36
     
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 36
     
PART IV    
     
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 36
     
  SIGNATURES 40
     
  CERTIFICATIONS  
     
  Exhibit 31 – Management certifications  
     
  Exhibit 32 – Sarbanes-Oxley Act  

 

   

 

 

Special Note Regarding Forward-Looking Statements

 

Some of our statements under “Business,” “Properties,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Notes to Financial Statements and elsewhere in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). In some cases, forward-looking statements are identified by terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “approximates,” “predicts,” “potential” or “continue” or the negative of such terms and other comparable terminology.

 

Although we believe that the expectations reflected in these forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor anyone else assumes responsibility for the accuracy and completeness of such statements and is under no duty to update any of the forward-looking statements after the date of this report.

 

1

 

 

PART I

 

ITEM 1. BUSINESS.

 

General

 

Cipherloc is a data security solutions company. Our highly innovative products - based on our patented polymorphic encryption technology - are designed to enable an iron-clad layer of protection to be added to existing solutions. Cipherloc has developed technology that:

 

Dramatically enhances data security
   
Can be easily added to existing products
   
Is scalable and future-proof

 

Our Company

 

Cipherloc Corporation (the “Company”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective by the Amended Certificate as of March 23, 2015. The name change and the 1-100 reverse split were announced March 20, 2015 in the Daily List and became effective on March 23, 2015.

 

Description of Business

 

Products and Services

 

Cipherloc is a data security solutions company. Our highly innovative products - based on our patented polymorphic encryption technology - are designed to enable an iron-clad layer of protection to be added to existing solutions. Cipherloc has developed technology that:

 

Dramatically enhances data security
   
Can be easily added to existing products
   
Is scalable and future-proof

 

Cipherloc Marketing

 

The foundation of modern security relies on encryption technology to protect sensitive information and maintain user privacy. However, modern encryption algorithms are “broken” – the massive amounts of computing horsepower available today have compromised existing algorithms and made them susceptible to attacks. Cipherloc is a data security solutions company. Our innovative technology can be used to overcome the flaws and inadequacies associated with today’s encryption algorithms in order to fully and securely protect the world’s data.

 

Personnel

 

As of the date of this report, we have seven full-time employees.

 

WHERE YOU CAN FIND MORE INFORMATION

 

You are advised to read this Form 10-K in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov.

 

 2 

 

 

In an effort to keep our stockholders and the public informed about our business, we may make “forward-looking statements.” Forward-looking statements usually relate to future events and anticipated revenues, earnings, cash flows or other aspects of our operations or operating results. As indicated previously, forward-looking statements are often identified by words, “will”, “may”, “should”, “continue”, “anticipate”, “believe”, “expect”, “plan”, “forecast”, “project”, “estimate”, “intend” and words of similar nature. Forward-looking statements generally include statements containing:

 

projections about accounting and finances;
   
plans and objectives for the future;
   
projections or estimates about assumptions relating to our performance; or
   
our opinions, views or beliefs about the effects of current or future events, circumstances or performance.

 

You should view those statements with caution. Those statements are not guarantees of future performance, circumstances or events. They are based on facts and circumstances known to us as of the date the statements are made. All phases of our business are subject to uncertainties, risks and other influences, many of which we do not control. Any of these factors either alone or taken together, could have a material adverse effect on us and could change whether any forward-looking statement ultimately turns out to be true. Additionally, we assume no obligation to update any forward-looking statement as a result of future events, circumstances or developments.

 

ITEM 1A. RISK FACTORS

 

Outlined below are some of the risks that we believe could affect our business and financial statements. An investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this Annual Report on Form 10-K, before investing in our common stock. If any of the events anticipated by the risks described below occur, our results of operations and financial condition could be adversely affected which could result in a decline in the market price of our common stock, causing you to lose all or part of your investment.

 

The report of our independent registered public accounting firm contains explanatory language that substantial doubt exists about our ability to continue as a going concern.

 

The independent auditor’s report on our financial statements for the year ended September 30, 2017 contains explanatory language that substantial doubt exists about our ability to continue as a going concern. We have an accumulated deficit at September 30, 2017 of $50,201,730. We will need additional cash flows to maintain our operations.

 

We depend upon equity financing provided by our active Private Placement Memorandum (PPM) and product sales to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business. If we are unable to obtain sufficient financing in the near term or achieve profitability, then we would, in all likelihood, experience severe liquidity problems and may have to curtail or cease our operations altogether.

 

A continued lack of profitability resulting from the lack of sales and high level of expenses has adversely impacted the value of our common shares. If we have to curtail our operations or cease our operations, we may be placed into bankruptcy or undergo liquidation, which will further adversely affect the value of our common shares.

 

Because we are quoted on the OTC Markets, formerly known as “Pinks Sheets,” instead of an exchange or national quotation system, our investors may have a tougher time selling their stock or experience negative volatility on the market price of our stock.

 

Our common stock is traded on the OTCQB “OTC Markets”. The OTCQB “OTC Markets” is often highly illiquid, in part because it does not have a national quotation system by which potential investors can follow the market price of shares except through information received and generated by a limited number of broker-dealers that make markets in particular stocks. There is a greater chance of volatility for securities that trade on the OTCQB “OTC Marketsas compared to a national exchange or quotation system. This volatility may be caused by a variety of factors, including the lack of readily available price quotations, the absence of consistent administrative supervision of bid and ask quotations, lower trading volume, and market conditions. Investors in our common stock may experience high fluctuations in the market price and volume of the trading market for our securities. These fluctuations, when they occur, have a negative effect on the market price for our securities. Accordingly, our stockholders may not be able to realize a fair price from their shares when they determine to sell them or may have to hold them for a substantial period of time until the market for our common stock improves.

 

 3 

 

 

We depend significantly upon the continued involvement of our present management.

 

The Company’s success depends significantly upon the involvement of our present management, who is in charge of our strategic planning and operations. We may need to attract and retain additional talented individuals in order to carry out our business objectives. The competition for individuals with expertise in this industry could be intense and there are no assurances that these individuals will be available to us.

 

Our common stock is subject to penny stock regulation.

 

Our shares are subject to the provisions of Section 15(g) and Rule 15g-9 of the Exchange Act, as amended, commonly referred to as the “penny stock” rule. Section 15(g) sets forth certain requirements for transactions in penny stocks and Rule 15g-9(d)(1) incorporates the definition of penny stock as that used in Rule 3a51-1 of the Exchange Act. The Commission generally defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. Rule 3a51-1 provides that any equity security is considered to be penny stock unless that security is: registered and traded on a national securities exchange meeting specified criteria set by the Commission; authorized for quotation on the NASDAQ Stock Market; issued by a registered investment company; excluded from the definition on the basis of price (at least $5.00 per share) or the registrant’s net tangible assets; or exempted from the definition by the Commission. Since our shares are deemed to be “penny stock”, trading in the shares will be subject to additional sales practice requirements on broker/dealers who sell penny stock to persons other than established customers and accredited investors.

 

Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses and pose challenges for our management.

 

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations promulgated there under, the Sarbanes-Oxley Act and SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the U.S. public markets. Our management team will need to devote significant time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.

 

The Company’s directors and officers may control the outcome of most matters submitted to a vote of shareholders.

 

The President/CEO, Director Mr. De La Garza controls 90% (9,000,000) of the Series A Preferred Stock. Each share of the Preferred Stock has 150 votes on all matters presented to be voted by the holders of common stock. The holders of the Series A Preferred Stock can only convert the shares to common shares, on a 1 to 1.5 basis, upon the agreement by 50.1% vote of all preferred shareholders.

 

Also, the officers and directors have changes in control provisions that allows for the full payment of salary and stock in case the company is taken over by a third party. In addition to the ability of these directors and officers of the Company to vote, shares represent a significant majority of the total voting power of the Company’s common shares.

 

Under Texas law, common shares of the Company owned by the officers and directors may be voted in a manner in which those votes are determined by the directors. Those directors, should they choose to act together, will be able to control substantially all matters affecting the Company, and block a number of matters relating to any potential change of control of the Company. See Item 12–Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

 4 

 

 

Risks Related To Our Industry

 

We face intense competition.

 

We continue to experience intense competition across all markets for our products and services. Although we believe our business and product portfolio is a competitive advantage, our competitors that are focused on narrower product lines may be more effective in devoting technical, marketing, and financial resources to compete with us. In addition, barriers to entry in our businesses generally are low and products. Open source software vendors are devoting considerable efforts to developing software that mimics the features and functionality of our products. These competitive pressures may result in decreased sales volumes, price reductions, and/or increased operating costs, such as for marketing and sales incentives, resulting in lower revenue, gross margins, and operating income.

 

Our business depends on our ability to attract and retain talented employees.

 

Our business is based on successfully attracting and retaining talented employees. The market for highly skilled workers and leaders in our industry is extremely competitive. We are limited in our ability to recruit internationally by restrictive domestic immigration laws. If we are less successful in our recruiting efforts, or if we are unable to retain key employees, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution.

 

Delays in product development schedules may adversely affect our revenues.

 

The development of software products is a complex and time-consuming process. New products and enhancements to existing products can require long development and testing periods. Our increasing focus on innovative and new software presents new and complex development issues. Significant delays in new product releases or significant problems in creating new products could adversely affect our revenue.

 

Acquisitions and joint ventures may have an adverse effect on our business.

 

We expect to continue making acquisitions or entering into joint ventures as part of our long-term business strategy. These transactions involve significant challenges and risks including that the transaction does not advance our business strategy, that we don’t realize a satisfactory return on our investment, or that we experience difficulty in the integration of new employees, business systems, and technology, or diversion of management’s attention from our other businesses. These events could harm our operating results or financial condition.

 

Risks Related to Our Securities

 

The market price for our common stock may be volatile, and you may not be able to sell our stock at a favorable price or at all.

 

Many factors could cause the market price of our common stock to rise and fall, including:

 

actual or anticipated variations in our quarterly results of operations;
   
changes in market valuations of companies in our industry;
   
changes in expectations of future financial performance;
   
fluctuations in stock market prices and volumes;
   
issuances of dilutive common stock or other securities in the future;

 

 5 

 

 

the addition or departure of key personnel;
   
announcements by us or our competitors of acquisitions, investments or strategic alliances; and
   
it is possible that the proceeds from sales of our common stock may not equal or exceed the prices you paid for the shares after including the costs and fees of making the sales

 

Substantial sales of our common stock, or the perception that such sales might occur, could depress the market price of our common stock.

 

We cannot predict whether future issuances of our common stock or resale in the open market will decrease the market price of our common stock. The consequence of any such issuances or resale of our common stock on our market price may be increased as a result of the fact that our common stock is thinly, or infrequently, traded. The exercise of any options, or the vesting of any restricted stock that we may grant to directors, executive officers and other employees in the future, the issuance of common stock in connection with acquisitions and other issuances of our common stock, may decrease the market price of our common stock.

 

Holders of our common stock have a risk of potential dilution if we issue additional shares of common stock in the future.

 

Although our Board of Directors intends to utilize its reasonable business judgment to fulfill its fiduciary obligations to our then existing stockholders in connection with any future issuance of our common stock, the future issuance of additional shares of our common stock would cause immediate, and potentially substantial, dilution to the net tangible book value of those shares of common stock that are issued and outstanding immediately prior to such transaction. Any future decrease in the net tangible book value of our issued and outstanding shares could have a material adverse effect on the market value of our shares.

 

Additionally, the Company issued a convertible note, which includes adjustments to the conversion price based on the market price of our common stock. The note does not contain a minimum conversion price or floor price per share, nor does it contain an explicit limit on the number of shares that may be issued upon conversion. If the Company is not able to repay the convertible note in cash, the conversion of the note by the holders could have a material adverse effect on the Company’s common stock.

 

We do not intend to pay cash dividends to our stockholders, so you will not receive any return on your investment in our Company prior to selling your interest in the Company.

 

The Company has never paid any cash dividends to our stockholders. We currently intend to retain any future earnings for funding growth and, therefore, do not expect to pay any cash dividends in the foreseeable future. As a result, you will not receive any return on your investment prior to selling your shares in our Company and, for the other reasons discussed in this “Risk Factors” section, you may not receive any return on your investment even when you sell your shares in our Company.

 

Certain shares of our common stock are restricted from immediate resale. The lapse of those restrictions, coupled with the sale of the related shares in the market, or the market’s expectation of such sales, could result in an immediate and substantial decline in the market price of our common stock.

 

Most of our shares of common stock are restricted from immediate resale in the public market. The restricted shares are restricted in accordance with Rule 144, which states that if unregistered, restricted securities are to be sold, a minimum of one year must elapse between the later of the date of acquisition of the securities from the issuer or from an affiliate of the issuer, and any resale of those securities in reliance on Rule 144. The Rule 144 restrictive legend remains on the stock until the holder of the stock holds the stock for longer than six months (unless an affiliate) and meets the other requirements of Rule 144 to have the restriction removed. The sale or resale of those shares in the public market, or the market’s expectation of such sales, may result in an immediate and substantial decline in the market price of our shares. Such a decline will adversely affect our investors, and make it more difficult for us to raise additional funds through equity offerings in the future.

 

Our common stock is subject to restrictions on sales by broker-dealers and penny stock rules, which may be detrimental to investors.

 

Our common stock is subject to Rules 15g-1 through 15g-9 under the Exchange Act, which imposes certain sales practice requirements on broker-dealers who sell our common stock to persons other than established customers and “accredited investors” (as defined in Rule 501(a) of the Securities Act). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of our common stock.

 

 6 

 

 

Additionally, our common stock is subject to SEC regulations applicable to “penny stocks.” Penny stocks include any non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock; a disclosure schedule proscribed by the SEC relating to the penny stock market must be delivered by a broker-dealer to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for our common stock. The regulations also require that monthly statements be sent to holders of a penny stock that disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.

 

Our Articles of Incorporation allow us to sell preferred stock without shareholder approval.

 

Our Board of Directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any additional vote or action by our shareholders. The rights of the holders of the common stock will be subject to, and could be materially adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. For example we could issue preferred stock that has superior rights to dividends or is convertible into shares of common stock. This might adversely affect the market price of the common stock.

 

If we experience delays and/or defaults in customer payments, we could be unable to recover all expenditures.

 

Because of the nature of our contracts, at times we commit resources to projects prior to receiving payments from the customer in amounts sufficient to cover expenditures on projects as they are incurred. Delays in customer payments may require us to make a working capital investment. If a customer defaults in making their payments on a project in which we have devoted resources, it could have a material negative effect on our results of operations.

 

If we do not effectively manage our growth, our existing infrastructure may become strained, and we may be unable to increase revenue growth.

 

Our past growth that we have experienced, and in the future may experience, may provide challenges to our organization, requiring us to expand our personnel and our operations. Future growth may strain our infrastructure, operations and other managerial and operating resources. If our business resources become strained, our earnings may be adversely affected and we may be unable to increase revenue growth. Further, we may undertake contractual commitments that exceed our labor resources, which could also adversely affect our earnings and our ability to increase revenue growth.

 

SHOULD ONE OR MORE OF THE FOREGOING RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD THE UNDERLYING ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED, INTENDED OR PLANNED.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

This Item is not applicable to us as we are not an accelerated filer, a large accelerated filer, or a well-seasoned issuer.

 

ITEM 2. PROPERTIES

 

The Company rents office space at 825 Main Street, Suite 100, Buda, Texas 78610 for its corporate headquarters.

 

 7 

 

 

ITEM 3. LEGAL PROCEEDINGS

 

As of September 30, 2017, the Company is not involved in any material litigation.

 

ITEM 4. NOT APPLICABLE

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is traded in the over-the-counter market, and quoted on the Over the Counter Bulletin Board and can be accessed on the Internet at OTCQB markets.com under the symbol “CLOK.”

 

At September 30, 2017, there were 6,635,127 shares of common stock of the Company outstanding, and there were 977 shareholders of the Company’s common stock.

 

The following table sets forth for the periods indicated the high and low bid quotations for Cipherloc’s common stock. These quotations represent inter-dealer quotations, without adjustment for retail markup, markdown or commission and may not represent actual transactions.

 

Periods  High   Low 
Fiscal Year 2017          
First Quarter (October – December 2016)  $6.00   $2.70 
Second Quarter (January – March 2017)  $4.70   $2.46 
Third Quarter (April - June 2017)  $3.02   $1.56 
Fourth Quarter (July – September 2017)  $3.00   $1.80 
Fiscal Year 2016          
First Quarter (October – December 2015)  $5.80   $2.00 
Second Quarter (January – March 2016)  $4.00   $1.70 
Third Quarter (April - June 2016)  $4.07   $2.48 
Fourth Quarter (July – September 2016)  $3.20   $2.60 

 

Dividends

 

We did not declare any dividends for the year ended September 30, 2017. Our Board of Directors does not intend to declare dividends in the near future. The declaration, payment and amount of any future dividends will be made at the discretion of the Board of Directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors as the Board of Directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend.

 

Transfer Agent

 

Cipherloc’s Transfer Agent and Registrar for the common stock is Pacific Stock Transfer Corporation located in Las Vegas, Nevada.

 

Recent sales of Unregistered Securities

 

Fiscal Year Ended September 30, 2017

 

Stock Issued for Cash

 

During the year ended September 30, 2017, through the utilization of a PPM and upon receipt of executed Subscription Agreements, the Company issued 724,000 shares of common stock for $1,383,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D. Of the 724,000 shares of common stock issued, 280,000 shares were issued each with a warrant to purchase two additional shares of common stock. These shares and warrants were issued for $534,985 in net cash proceeds. See Warrants below for further detail.

 

 8 

 

 

The Company also issued 50,000 shares of common stock with a relative fair value of $44,609 to FirstFire Global Opportunities Fund, LLC in connection with the convertible notes discussed below. Along with these shares, the Company issued warrants to purchase 165,000 shares of common stock. See Warrants below  for further detail.

 

Stock Issued to Officers and Employees

 

During the year ended September 30, 2017, the Company issued 300,000 shares of common stock with a fair value of $1,633,000 to the CEO and 242,268 shares of common stock with a fair value of $1,150,922 to its other officers and employees as part of their compensation.

 

Stock Issued for Services

 

During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $74,500 to StockVest for investor relations services.

 

Stock Issued for License Termination

 

During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $106,250 for a software termination settlement.

 

Convertible Note

 

On September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC with a principal amount of $330,000 and an original issue discount of $30,000. The note accrues interest at 5% per annum and matures on March 26, 2018, six months following the issuance date. The note provides the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a fixed conversion price of $2.00 per share. The note contains adjustments to the conversion price in the event of default, if shares of the Company trade below the fixed conversion price on the day following the conversion date, or if the Company consummates a registered or unregistered primary offering of its securities for capital raising purposes. Subsequent to September 30, 2017, the fixed conversion price was adjusted from $2.00 to $1.00 per share. Refer to Note 5 for further detail.

 

Fiscal Year Ended September 30, 2016

 

Stock Issued for Cash

 

During the year ended September 30, 2016, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 513,500 shares of common stock for $946,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act, as amended, afforded by Rule 506 of Regulation D.

 

Stock Issued to Officers

 

During the year ended September 30, 2016, the Company issued 10,677 shares of common stock with a fair value of $32,138 and accrued earned shares of common stock amounting to $41,456 as compensation to certain officers pursuant to their employment agreements.

 

Stock Issued for Services

 

During the year ended September 30, 2016, the Company issued 800 shares for marketing services valued at $1,600 and 5,000 shares for software development valued at $27,500. The Company also issued 75,000 shares for legal services valued at $210,000.

 

Stock Issued for License Termination

 

During the year ended September 30, 2016, the Company issued 307,141 shares of common stock with a fair value of $763,469 for the termination of software licenses related to seven separate licenses in that the software usage would possibly interfere with the Company’s future software development.

 

Preferred Stock

 

The Company has authorized 10,000,000 shares of Series A Preferred Stock, at $0.01 par value and all are issued and outstanding as of September 30, 2017. Each share of the preferred stock has 150 votes on all matters presented to be voted by the holders of our common stock. The CEO has been granted 9,000,000 shares of the preferred stock. The holders of the Preferred A shares can only convert the shares if agreed upon by 50.1% vote of all preferred shareholders.

 

 9 

 

 

The issuance of preferred stock by our board of directors could adversely affect the rights of holders of the common stock by, among other things, establishing preferential dividends, liquidation rights or voting powers. See “Risk Factors” above.

 

Common Stock

 

On April 11, 2011, the Company amended its articles of incorporation to increase the authorized shares to 650,000,000 shares, at $0.01 par value. On March 23, 2015, the common stock was reverse split on a 1 for 100 basis. There were 6,635,127 shares issued and outstanding as of September 30, 2017. The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds. The dividend rights of our common stock are junior to any preferential dividend rights of any outstanding shares of preferred stock. The holders of our common stock also are entitled to receive distributions upon our liquidation, dissolution or winding up of our assets that are legally available for distribution, after payment of all debt and other liabilities and distribution in full of preferential amounts, if any, to be distributed to holders of our preferred stock.

 

The holders of our common stock are not entitled to preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of any series of preferred stock that we may designate and issue in the future.

 

Warrants

 

During the year ended September 30, 2017, the Company issued warrants to purchase 165,000 shares of common stock in connection with the Convertible Note discussed above. The warrants were issued with an exercise price of $4.50 and a term of two years. Subsequent to September 30, 2017, the exercise price of these warrants was adjusted to $2.00 per share.

 

Additionally, during the year ended September 30, 2017, the Company issued 560,000 warrants to the Private Placement Investors. The Private Placement Investors were granted units, which consisted of one share of common stock and a warrant to purchase two additional shares of common stock, for $2 each. The warrants were issued with an exercise price of $4.50 and a term of two years.

 

ITEM 6. SELECTED FINANCIAL DATA

 

This Item is not required for smaller reporting companies and the company has elected to omit this information.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Report.

 

The following information contains certain forward-looking statements of our management. 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

 

Cipherloc is a data security solutions company. Our highly innovative products - based on our patented polymorphic encryption technology - are designed to enable an iron-clad layer of protection to be added to existing solutions. Cipherloc has developed technology that:

 

Dramatically enhances data security
   
Can be easily added to existing products
   
Is scalable and future-proof

 

 10 

 

 

The Company has introduced an innovative and revolutionary new type of encryption technology with five international patents and three US patents pending and is the industry’s first “Polymorphic Cipher Engine”, called Cipherloc®. It is the first secure commercially viable advanced “Polymorphic Key Progression Algorithmic Cipher Engine” (PKPA). This morphing cipher can be used in any commercial data security industry and/or in sensitive applications.

 

Critical Accounting Policies

 

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.

 

The methods, estimates, and judgment we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The SEC has defined “critical accounting policies” as those accounting policies that are most important to the portrayal of our financial condition and results, and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based upon this definition, our most critical estimates are litigation. Our most critical accounting policies applicable to the periods presented are noted below. For additional information see Note 3, “Significant Accounting Policies” in the notes to our financial statements appearing elsewhere in this report. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available, and actual results may differ significantly from these estimates.

 

Accounting for Convertible Debt and Embedded Derivatives

 

Convertible debt is accounted for under the guidelines established by ASC 470-20, Debt with Conversion and Other Options. ASC 470-20 governs the calculation of an embedded beneficial conversion, which is treated as an additional discount to the instruments where derivative accounting does not apply. The amount of the beneficial conversion feature may reduce the carrying value of the instrument. The discounts relating to the initial recording of the derivatives or beneficial conversion features are accreted over the term of the debt.

 

When equity instruments, such as common stock or warrants, are issued with convertible debt, the net proceeds from the transaction are allocated to the convertible debt and equity instruments based on their relative fair values. The proceeds allocated to the equity instruments may reduce the carrying value of the convertible debt, and such discount is amortized to interest expense over the term of the debt.

 

Conversion features in our convertible notes are contingent upon certain events. In these cases, we do not evaluate the embedded conversion feature until the contingencies are removed. In cases where the embedded conversion feature is no longer contingently convertible, we evaluate its terms to determine if the host instrument is clearly and closely related to it. One of the considerations is whether there is an explicit limit on the number of shares by which the note is convertible into common stock. If there is no explicit limit, we account for the embedded derivative as a liability to be reported at estimated fair value at each reporting period. As of the balance sheet date, the embedded conversion feature in our convertible note is contingently convertible, thus this derivative is not separately reported as a liability at fair value in accordance with ASC 815, Accounting for Derivative Financial Instruments and Hedging Activities.

 

Software Revenue Recognition

 

Software license revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.” VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.

 

Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.

 

Stock Issued to Employees and Non-Employees

 

The Company measures the compensation cost using the fair value based method. This method uses the fair value at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. Grants to vendors are recorded at fair value at each reporting period.

 

Results of Operations

 

Fiscal Year Ended September 30, 2017, Compared to Fiscal Year Ended September 30, 2016

 

Revenue increased to $467,274 from $341,478 for the years ended September 30, 2017 and 2016, respectively. Revenue increased primarily as a result of ratably recognizing a software license sale over twelve months during the year ended September 30, 2017, as compared to approximately nine months for the year ended September 30, 2016. Correspondingly, cost of revenue increased to $121,200 from $90,900 for the years ended September 30, 2017 and 2016, respectively. Cost of revenue is comprised of salaries and maintenance costs related to the Company’s core Cipherloc products.

 

 11 

 

 

General and administrative expenses increased to $3,166,471 from $1,167,466 for the years ended September 30, 2017 and 2016, respectively. General and administrative expenses increased primarily as a result of higher stock-based compensation related to the Company’s issuance of shares to the CEO and former CFO as a bonus, and to a Board member for his tenure on the Board.

 

Sales and marketing expenses increased to $354,005 from $218,722 for the years ended September 30, 2017 and 2016, respectively. Sales and marketing expenses increased primarily as a result of hiring sales and marketing personnel during the year.

 

Research and development expenses increased to $1,087,372 from $755,159 for the years ended September 30, 2017 and 2016, respectively. Research and development expenses increased primarily as a result of higher stock-based compensation related to the issuance of shares to employees for patent work and as employee bonuses.

 

Settlement expense was $106,250 for the year ended September 30, 2017, as compared to $763,469 for the year ended September 30, 2016. Settlement expense for the year ended September 30, 2017 was due to the issuance of 25,000 shares of common stock for a software license termination settlement related to the Company retiring its medical software offering and shifting its focus to cyber security. Settlement expense for the year ended September 30, 2016 was due to the issuance of 327,500 shares of common stock related to a legal settlement and software license termination.

 

Interest expense, net of interest income, increased to $53,137 from $47,117 for the years ended September 30, 2017 and 2016, respectively. The increase relates primarily to interest expensed towards unpaid accrued benefits and salaries related to the former Chief Financial Officer of the Company in accordance with the employment agreement.

 

Liquidity and Capital Resources

 

We have an accumulated deficit at September 30, 2017 of $50,201,730. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At September 30, 2017, the Company had cash of $227,396. We believe that our existing cash balances are insufficient to fund future operations for the next 12 months. These factors raise doubt about the Company’s ability to continue as a going concern.

 

We depend upon the continued participation of our active Private Placement Memorandum (PPM) to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business. The Company has raised money in the form of a private placement memorandum totaling $1,383,320, net of offering costs. In addition, subsequent to September 30, 2017, the Company raised approximately $77,000 in equity financing, net of offering costs.

 

In September 2017, the Company raised $300,000 from the issuance of convertible notes with a face value of $330,000 during the year ended September 30, 2017 due within 180 days from issuance. In December 2017, the Company also raised a net amount of $242,600 from a convertible note with a face value of $300,000, which is due within three years from issuance and becomes convertible 180 days from issuance. These notes become due 180 days and three years, respectively, from issuance of the note at significant premiums. After 180 days, these notes become convertible at various rates which could cause a rapid decline in the price of our common stock.

 

There is no assurance that such funding, if required will be available to us or, if available, will be available upon terms favorable to us. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our independent registered public accounting firm has included an explanatory paragraph in their opinion regarding substantial doubt about Cipherloc’s ability to continue as a going concern.

 

 12 

 

 

Cash Flows

 

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

 

   Year Ended September 30, 
   2017   2016 
         
Net cash (used in) provided by:          
Operating activities  $(1,788,764)  $(2,567,341)
Investing activities  $(2,798)  $(28,247)
Financing activities  $1,674,820   $946,320 

 

Operating Activities

 

Cash used in operating activities was $1,788,764 and $2,567,341 for the years ended September 30, 2017 and 2016, respectively. The decrease in cash used for operating activities was due to lower salaries and consulting fees in 2017 versus 2016.

 

Investing Activities

 

Cash used in investing activities was $2,798 and $28,247 for the years ended September 30, 2017 and 2016, respectively. The decrease in cash used for investing activities was due to fewer fixed asset purchases and a decrease in deposits held to secure leases and contracts.

 

Financing Activities

 

Cash provided by financing activities was $1,674,820 and $946,320 for the years ended September 30, 2017 and 2016, respectively. The increase in cash provided by financing activities was due to the issuance of a convertible note and more issuances of common stock for cash.

 

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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We do not hold any derivative instruments and do not engage in any hedging activities.

 

 13 

 

 

ITEM 8. FINANCIAL STATEMENTS

 

CIPHERLOC CORPORATION

 

TABLE OF CONTENTS   Page
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   15
     
FINANCIAL STATEMENTS:    
     
Balance Sheets at September 30, 2017 and 2016   16
     
Statements of Operations for the years ended September 30, 2017 and 2016   17
     
Statements of Stockholders’ Deficit for the years ended September 30, 2017 and 2016   18
     
Statements of Cash Flows for the years ended September 30, 2017 and 2016   19
     
NOTES TO FINANCIAL STATEMENTS   20

 

 14 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders

Cipherloc Corporation

 

We have audited the accompanying balance sheets of Cipherloc Corporation (the “Company”) as of September 30, 2017 and 2016, and the related statements of operations, stockholders’ deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2017 and 2016, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As more fully explained in Note 2 to the financial statements, the Company has incurred losses and has a working capital deficit as of September 30, 2017. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with respect to these factors are also described on Note 2. The Company’s financial statements do not include any adjustments that might result from the outcome of these uncertainties should the Company be unable to continue as a going concern.

 

As discussed in Notes 2 and 5, the Company issued a convertible note, which if not paid upon maturity, has no explicit limit on the number of shares that may be issued since the conversion prices are based on a discount to the market prices of the Company’s common stock, with no floor price per share. In the event the Company does not repay this convertible note, the holders, upon conversion, may cause a significant adverse impact on the Company’s common stock. Also see Note 10 for subsequent amendments to the terms of the convertible note, and related common stock and warrants previously issued in connection therewith, which will be accounted for as an extinguishment with a loss recorded to operations.

 

/s/ dbbmckennon

Newport Beach, California

January 12, 2018

 

 15 

 

 

CIPHERLOC CORPORATION

BALANCE SHEETS

 

   September 30, 
   2017   2016 
         
ASSETS          
Current assets:          
Cash  $227,396   $344,138 
Prepaid officer compensation   -    44,788 
Other prepaid expenses   -    2,500 
Total current assets   227,396    391,426 
           
Other assets   

12,218

    12,218 
Fixed assets, net   

11,170

    13,897 
Total assets  $250,784   $417,541 
           
LIABILITIES & STOCKHOLDERS’ DEFICIT          
Current liabilities:          
Accounts payable and accrued liabilities  $59,763   $62,270 
Accrued compensation   505,027    420,334 
Convertible note payable, net of discount of $303,322   26,678    - 
Deferred revenue-current   308,412    442,000 
Total current liabilities   899,880    924,604 
           
Long term liabilities:          
Deferred revenue, net of current portion   7,836    341,522 
Total long term liabilities   7,836    341,522 
Total liabilities   907,716    1,266,126 
           
COMMITMENTS AND CONTINGENCIES (NOTE 7)          
           
STOCKHOLDERS’ DEFICIT          
Series A Convertible Preferred stock, $0.01 par value, 10,000,000 shares authorized; 10,000,000 issued and outstanding as of September 30, 2017 and 2016, respectively   100,000    100,000 
Common stock, $0.01 par value, 650,000,000 shares authorized; 6,635,127 and 5,268,859 issued and outstanding as of September 30, 2017 and 2016, respectively   66,351    52,688 
Additional paid-in capital   49,378,447    44,779,296 
Accumulated deficit   (50,201,730)   (45,780,569)
Total stockholders’ deficit   (656,932)   (848,585)
Total liabilities and stockholders’ deficit  $250,784   $417,541 

 

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

 

 16 

 

 

CIPHERLOC CORPORATION

STATEMENTS OF OPERATIONS

 

   Year Ended 
   September 30, 
   2017   2016 
Revenues  $467,274   $341,478 
           
Cost of revenues   121,200    90,900 
Gross profit   346,074    250,578 
           
Operating expenses:          
General and administrative (includes stock-based expense of $2,192,200 for 2017 and $211,600 for 2016)   3,166,471    1,167,466 
Sales and marketing (includes stock-based expense of $93,748 for 2017 and $54,803 for 2016)   354,005    218,722 
Research and development (includes stock-based expense of $536,515 for 2017 and $46,291 for 2016)   1,087,372    755,159 
Settlement expenses   106,250    763,469 
Total operating expenses   4,714,098    2,904,816 
           
Operating loss   (4,368,024)   (2,654,238)
           
Other (expenses) income:          
Gain on extinguishment   -    59,612 
Interest expense   (53,137)   (47,117)
Total other (expenses) income   (53,137)   12,495 
           
Net loss  $(4,421,161)  $(2,641,743)
           
Net loss per common share - Basic and diluted:  $(0.71)  $(0.56)
           
Weighted average common shares outstanding - Basic and diluted   6,183,909    4,744,815 

 

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

 

 17 

 

 

CIPHERLOC CORPORATION

STATEMENTS OF STOCKHOLDERS’ DEFICIT

FOR THE YEARS ENDED SEPTEMBER 30, 2017 AND 2016

 

   Preferred Stock   Common Stock       Additional         
   Shares   Amount   Shares   Amount   Subscription
Receivable
   Paid-in Capital   Accumulated
Deficit
   Stockholders'
Deficit
 
Balance at September 30, 2015   10,000,000   $100,000    4,356,741   $43,567   $(50,000)  $42,815,934   $(43,138,826)  $(229,325)
                                         
Common stock issued to officers   -    -    10,677    107    -    73,487    -    73,594 
                                         
Common stock issued for cash   -    -    513,500    5,135    -    941,185    -    946,320 
                                         
Common stock issued for license termination   -    -    307,141    3,071    -    760,398    -    763,469 
                                         
Common stock issued for services   -    -    80,800    808    -    238,292    -    239,100 
                                         
Reversal of subscription receivable   -    -    -    -    50,000    (50,000)   -    - 
                                         
Net loss   -    -    -    -    -    -    (2,641,743)   (2,641,743)
                                         
Balance at September 30, 2016   10,000,000   $100,000    5,268,859   $52,688   $-   $44,779,296   $(45,780,569)  $(848,585)
                                         
Common stock issued for services   -    -    25,000    250    -    74,250    -    74,500 
                                         
Common stock issued for cash   -    -    724,000    7,240    -    1,376,080    -    1,383,320 
                                         
Common stock issued for license termination   -    -    25,000    250    -    106,000    -    106,250 
                                         
Common stock issued to officers and employees   -    -    542,268    5,423    -    2,778,499    -    2,783,922 
                                         
Common stock issued with convertible note   -    -    50,000    500    -    44,109    -    44,609 
                                         
Issuance of warrants   -    -    -    -    -    84,227    -    84,227 
                                         
Beneficial conversion feature on convertible note   -    -    -    -    -    135,986    -    135,986 
                                         
Net loss   -    -    -    -    -    -    (4,421,161)   (4,421,161)
                                         
Balance at September 30, 2017   10,000,000   $100,000    6,635,127   $66,351   $-   $49,378,447   $(50,201,730)  $(656,932)

 

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

 

 18 

 

 

CIPHERLOC CORPORATION

STATEMENTS OF CASH FLOWS

 

    Year Ended  
    September 30,  
    2017     2016  
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net loss   $ (4,421,161 )   $ (2,641,743 )
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:                
Depreciation     5,524       2,132  
Stock-based compensation    

2,858,422

      312,694  
Gain on settlements     -       (59,612 )
Termination of software license     106,250       763,469  
Changes in operating assets and liabilities:                
Prepaid officer compensation     44,788       (44,788 )
Prepaid expenses and other assets     2,501       732  
Deferred revenue     (467,274 )     (341,478 )
Accounts payable and accrued liabilities     82,186       (558,747 )
Net cash used in operating activities     (1,788,764 )     (2,567,341 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES                
Purchase of fixed assets and software     (2,798 )     (16,029 )
Other assets     -       (12,218 )
Net cash used in investing activities     (2,798 )     (28,247 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES                
Common stock issued for cash, net of offering costs     1,383,320       946,320  
Proceeds from related party notes     70,000       -  
Repayment of related party notes     (70,000 )     -  
Issuance of convertible note     291,500       -  
Net cash provided by financing activities     1,674,820       946,320  
                 
DECREASE IN CASH     (116,742 )     (1,649,268 )
CASH, BEGINNING OF YEAR     344,138       1,993,406  
CASH, END OF YEAR   $ 227,396     $ 344,138  
                 
CASH PAID FOR:                
Interest paid    $ -     $ -  
Income taxes paid   $ -     $ -  

 

 

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

 

 19 

 

 

CIPHERLOC CORPORATION

NOTES TO FINANCIAL STATEMENTS

FOR THE YEARS ENDED SEPTEMBER 30, 2017 AND 2016

 

NOTE 1- DESCRIPTION OF BUSINESS

 

Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective through the Amended Certificate as of March 23, 2015.

 

Cipherloc is a data security solutions company. Our highly innovative products - based on our patented polymorphic encryption technology - are designed to enable an iron-clad layer of protection to be added to existing solutions.

 

NOTE 2 – RISKS AND UNCERTAINTIES

 

Going Concern

 

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which contemplate continuation of the Company as a going concern. However, the Company has incurred losses from operations, has an accumulated deficit at September 30, 2017 of $50,201,730 and needs additional cash to maintain its operations.

 

These factors raise doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company’s continued existence is dependent upon management’s ability to develop profitable operations, continued contributions from the Company’s executive officers to finance its operations and the ability to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of the Company’s products and business.

 

Convertible Notes

 

In September 2017, the Company issued a convertible note with a principal amount of $330,000 which includes an original issue discount of $30,000. The note accrues interest at 5% per annum and matures six months following the issuance date. The note provides the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a fixed conversion price. The note includes adjustments to the conversion price based on the market price of the Company’s common stock after 180 days if the note is not repaid on the maturity date. Refer to Note 5 for further details. After the maturity date, the note does not contain a minimum conversion price or floor price per share, nor does it contain an explicit limit on the number of shares that may be issued upon conversion. If the Company is not able to repay the convertible note in cash at maturity, the conversion of the note by the holders could have a material adverse effect on the Company’s common stock.

 

In December 2017, the Company issued an additional convertible note in the amount of $300,000 payable in three years. Refer to Note 10 for further details.

 

NOTE 3 – 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:

 

Use of Estimates and Assumptions

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, actual results could differ from these estimates. The Company’s most significant estimates relate to the valuation of its convertible note and the valuation of its common stock.

 

Legal

 

The Company is subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. The Company accrues for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred.

 

Cash and Cash Equivalents and Concentration of Credit Risk

 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At September 30, 2017 and 2016, cash and cash equivalents include cash on hand and cash in the bank. The Company maintains its cash in accounts held by large, globally recognized banks which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures these deposits up to $250,000. The Company has not experienced any losses in such accounts.

 

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Website and Software Costs

 

The Company’s accounting for software development costs complies with Accounting Standards Codification (“ASC”) 985-20, Costs of Software to be Sold, Leased or Marketed, whereby capitalization begins when the Company has a working prototype and has been tested, thereby achieving technological feasibility. This occurs very late in the development stage of the software product. The Company has determined the software costs do not fall under ASC 350-40, Internal-Use Software, based on the guidance in ASC 985-605-55-119 through 125 which covers guidance for hosting agreements. The Company’s product will generally not be hosted and will reside on the technology platform available to the user.

 

Fixed Assets

 

Fixed assets are recorded at cost and depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The estimated life of equipment is three (3) years. The estimated life of our leasehold improvements is the lesser of the term of the related lease and useful life.

 

Long-Lived Assets

 

Long-lived assets are evaluated for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value.

 

Fair Value of Financial Instruments

 

The Company's financial instruments consisted primarily of cash, accounts payable and accrued expenses, deferred revenue, convertible note payable, as well as embedded conversion features. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments. The embedded conversion feature in the convertible note payable will have to be re-evaluated when the convertible note payable first becomes convertible, which is after six months. At which time, it is probable that the embedded convertible feature will become a derivative which requires bifurcation and is separately recorded as a derivative liability at its estimated fair value.

 

Fair value is focused on an exit price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Within the measurement of fair value, the use of market-based information is prioritized over entity specific information and a three-level hierarchy for fair value measurements is used based on the nature of inputs used in the valuation of an asset or liability as of the measurement date.

 

The three-level hierarchy for fair value measurements is defined as follows:

 

  Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; liabilities in active markets;
     
  Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability other than quoted prices, either directly or indirectly, including inputs in markets that are not considered to be active; or directly or indirectly including inputs in markets that are not considered to be active;
     
  Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

Convertible Debt

 

Convertible debt is accounted for under the guidelines established by ASC 470-20, Debt with Conversion and Other Options. ASC 470-20 governs the calculation of an embedded beneficial conversion, a derivative instrument, which is treated as an additional discount to the instruments where derivative accounting does not apply. This applies during the period for which embedded conversion features are either fixed or not yet available to the holder. The amount of the beneficial conversion feature may reduce the carrying value of the instrument. The discounts relating to the initial recording of the derivatives or beneficial conversion features are accreted over the term of the debt.

 

When equity instruments, such as common stock and/or warrants, are issued with convertible debt, the net proceeds from the transaction are allocated to the convertible debt and equity instruments based on their relative fair values. The proceeds allocated to the equity instruments may reduce the carrying value of the convertible debt, and such discount is amortized to interest expense over the term of the debt.

 

In the event a convertible note has an embedded conversion feature which, among other features, allows an unlimited number of common shares to be issued upon conversion since the conversion price is based on the quoted market price of the Company’s common stock, the Company records a derivative liability, which is marked to market at each reporting period and charged to the statement of operations in accordance with ASC 815, Accounting for Derivative Financial Instruments and Hedging Activities.

 

Customer Concentration

 

During the years ended September 30, 2017 and 2016, one customer accounted for 100% of revenues. The loss of this customer will have a significant impact on operations.

 

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Revenue Recognition

 

Software license revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis, and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.” VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period. When the fair value of VSOE of post contract customer support cannot be determined, the revenue is recognized ratably over the contract period. In June 2014, the Company entered into an agreement to provide software and support to a third party for which no VSOE for any elements is known. Delivery of the use of the license was not achieved until December 2015; the only remaining undelivered element was post contract support services, and accordingly, the revenues will be recognized on a pro rata basis prospectively over the remaining 30 months of the related contracts. Deferred revenue results from fees billed to or collected from customers for which revenue has not yet been recognized.

 

The Company has deferred revenue of $316,248 and $783,522 as of September 30, 2017 and 2016, respectively.

 

Research and Development and Software Development Costs

 

Capitalization of certain software development costs are recorded after the determination of technological feasibility. Based on our product development process, technological feasibility is determined upon the completion of a working model. To date, costs incurred by us from the completion of the working model to the point at which the product is ready for general release do not have technological feasibility. Accordingly, we have charged all such costs to research and development expense in the period incurred. Our research and development costs incurred for the years ended September 30, 2017 and 2016 were $1,087,372 and $755,159, respectively.

 

Share-Based Compensation

 

The Company measures the cost of services provided by employees in exchange for an award of an equity instrument based on the grant-date fair value of the award. Compensation cost is recognized over the vesting or requisite service period. The Black-Scholes option-pricing model is used to estimate the fair value of options or warrants granted. Performance-based grants should be recognized prior to completion if the assessment is that it is probable that the performance condition will be met.

 

For non-employees, the Company uses the fair value at each reporting date over the service period, which is usually the vesting period.

 

Income Taxes

 

The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carry-forwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized.

 

The Company uses the two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company’s tax positions and tax benefits, which may require periodic adjustments. The Company did not record any liabilities for uncertain tax positions for the years ended September 30, 2017 or 2016.

 

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Basic and Diluted Net Loss per Common Share

 

Basic income (loss) per share is computed by dividing net income (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 September 30, 2017 and 2016, the Company had 10,000,000 shares of preferred stock outstanding which are convertible into 15,000,000 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.

 

Recent Accounting Announcements

 

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

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) – Accounting for Certain Financial Instruments with Down Round Features, to change the classification analysis of certain equity-linked financial instruments with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity-classified instruments, the amendments require the effect of the down round feature to be recognized in earnings per share when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. ASU 2017-11 is effective in annual periods beginning after December 15, 2019 and in interim periods within annual periods beginning after December 15, 2020. The Company early adopted ASU 2017-11 during the year ended September 30, 2017.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 840), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this standard are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for a public entity. Early adoption of the amendments in this standard is permitted for all entities and the Company must recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company is currently in the process of evaluating the effect this guidance will have on its financial statements and related disclosures.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). Under this guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The updated standard will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard will be effective for the Company beginning January 1, 2018. The Company is currently evaluating the effect that the updated standard will have on its financial statements and related disclosures.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40), which requires management to evaluate, at each annual and interim reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and provide related disclosures. ASU No. 2014-15 is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early application is permitted. The Company is currently evaluating the effect that the updated standard will have on its financial statements and related disclosures.

 

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes (Topic 740), which requires deferred tax liabilities and assets to be classified as noncurrent in a classified statement of financial position. ASU No. 2015-17 will align the presentation of deferred income tax assets and liabilities with International Financial Reporting Standards. The new standard will be effective for fiscal years beginning after December 15, 2016, including interim periods within those annual years, and early application is permitted. The Company is currently evaluating the effect that the updated standard will have on its financial statements and related disclosures.

 

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NOTE 4 – SOFTWARE LICENSES

 

Gawk

 

On June 14, 2014, the Company entered into a license agreement with Gawk to use the Cipherloc engine for $1,125,000 for a period of four (4) years. This customer licensed the CipherShop-Cipherloc encryption software technology and support services. The Company was not required to make significant modifications at the time the contract was executed. The Company has never sold or licensed the CipherShop-Cipherloc encryption software, nor any support services for such. Under the license agreement, the Company is to provide access to its software on an operational basis and provide training. The Company will also provide unspecified upgrades, if and when available, and 24/7 support over the license term. No Vendor-Specific Objective Evidence was known for any of the elements. After the agreement was executed, the licensee requested modifications to the software because they could not use the software with the requested modifications. The Company made the newly requested modifications to the software. Management delivered the finished product in late December 2015, thus delivery had not deemed to have occurred until such date. The contract termination date was not extended beyond the initial date of June 2018. Revenues are being recorded from the date of delivery over the remaining term of the agreement or approximately 30 months. For these reasons, revenue is recognized ratably from December 2015 until June 2018. During the years ended September 30, 2017 and 2016, the Company recognized revenues of $467,274 and $341,478, and had deferred revenue balances of $316,248 and $783,522, respectively.

 

NOTE 5 – CONVERTIBLE NOTE PAYABLE

 

On September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC with a principal amount of $330,000 which includes an original issue discount of $30,000. The Company incurred $8,500 in direct costs. The note accrues interest at 5% per annum and matures on March 26, 2018, six months following the issuance date. The note provides the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a conversion price of $2.00 per share, subject to certain adjustments to the conversion price under certain circumstances. In the event of default, the conversion price shall equal the lower of $2.00 per share or 70% multiplied by the lowest bid price of the Company’s common stock during the 25 trading days preceding the conversion date. An event of default, among other events, is the non-payment of the note at maturity.

 

If shares of the Company’s common stock trade below $2.00 per share on the day following the conversion date, the conversion price shall be retroactively adjusted to equal 75% multiplied by the lowest traded price on the day following the conversion date. If the Company consummates a registered or unregistered primary offering of its securities for capital raising purposes, the holder of the note shall have the right to demand repayment in full or convert the outstanding principal balance and accrued interest into shares of the Company’s common stock at the lower of $2.00 per share or a 20% discount to the offering price to investors in the primary offering.

 

Together with the convertible note, the Company also issued 50,000 shares of its common stock, as well as warrants to purchase an additional 165,000 shares of common stock at $4.50 per share, to FirstFire Global Opportunities Fund, LLC. The relative fair value of the common stock and warrants were $44,609 and $84,227, respectively. Refer to Note 8 below for further discussion of the common stock and warrants that were issued with the convertible note. Based on this allocation, the Company concluded that the convertible note contained a beneficial conversion feature, which was valued at $135,986 and recorded as an additional discount and within additional paid-in capital on the balance sheet, resulting in an aggregate discount of $303,322. The Company is amortizing the discount over the term of the note to interest expense using the effective interest method, commencing October 1, 2017.

 

See Note 10 for a subsequent amendment to the convertible note, which reduced the conversion price of the convertible note, reduced the exercise price of the warrants, and also specified additional shares to be issued.

 

NOTE 6 – RELATED PARTY TRANSACTIONS

 

Notes Payable to Chief Executive Officer

 

In September 2017, the Company’s Chief Executive Officer (“CEO”) issued four notes with an aggregate principal amount of $70,000 to the Company. The notes bore interest at 3% per annum and matured one year from the issuance date. The Company repaid all four notes in full at the end of September. As of September 30, 2017, there were no outstanding notes payable to the Company’s CEO.

 

See Note 8 for additional related party transactions.

 

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NOTE 7 – COMMITMENTS AND CONTINGENCIES

 

Litigation

 

As of September 30, 2017, the Company is not involved in any material litigation.

 

The Company has settled all litigation in which it was involved. The matter that was pending in the United States Federal District Court for the Southern District of Mississippi was settled and dismissed on July 12, 2016 and the matter pending in Chancery Court of Rankin County Mississippi was settled and dismissed on July 18, 2016. The Company repurchased its stock with the $45,580 it held in escrow as the Company’s contribution to the settlements and all other expenses and costs were covered by the Company’s insurance carrier. The repurchased stock had a fair market value of $61,281 resulting in a gain on settlement.

 

Employment Contracts

 

The Company entered into an employment agreement with its Chief Executive Officer on January 1, 2013. The employment agreement will expire on January 1, 2018 and shall automatically renew for another five years unless terminated in accordance with the provisions of the employment agreement. The employment agreement provides for:

 

  i. A monthly salary of $20,833 per month subject to an annual increase of 10% per year and consistent with the Company policy applicable to other senior executives and officers and approval by the Board of Directors. During the year ended September 30, 2017, the base salary was $360,000.
     
  ii. A cash bonus of 25% of his annual base salary each year if the Company reaches the following milestones:

 

  a. The Company posts annual gross revenues on a consolidated basis of at least $5,000,000;
     
  b. The Company’s earnings before the deduction of income taxes and amortization expenses (“EBITA”), including cash extraordinary items but before officer’s bonuses, on a consolidated basis for any year is at least $1,000,000;

 

  iii. An automobile allowance of $1,500 per month.
     
  iv. A medical insurance allowance of $1,500 per month.
     
  v. In the event the executive’s employment is terminated without cause he will receive the entire contract remaining on the agreement.

 

The Company has removed other provisions from the original employment agreement.

 

During the years ended September 30, 2017 and 2016, cash compensation amounted to $390,278 and $397,854 including benefits, respectively. Of the total compensation at September 30, 2017, $96,885 was unpaid. The Chief Executive Officer was prepaid $52,244 in compensation in 2016 which was offset by a $60,000 bonus in 2017. The Chief Executive Officer is still due the remainder of this bonus, which is included in accrued compensation, as of September 30, 2017. During the years ended September 30, 2017 and 2016, stock-based compensation amounted to $1,633,000 and $0, respectively.

 

As of September 30, 2017, we also have employment agreements with Michael Salas and Michael Hufnagel (the “Agreements”). The Agreements are for a term of one year, with Mr. Salas’s Agreement commencing on April 25, 2016 and expiring on April 24, 2017, and Mr. Hufnagel’s commencing on June 27, 2016 and expiring on June 26, 2017. Both Agreements have three successive one-year extensions and were extended. Mr. Salas has an annual salary of $175,000 and quarterly stock issuances equal to $125,000 per year. Mr. Hufnagel has an annual salary of $145,000, an initial sign-on bonus of $10,000 and quarterly stock issuances equal to $60,000 per year. As of September 30, 2017, these individuals were owed common shares for services, but for which shares have not yet been issued. An accrual has been recorded to equity totaling $46,250 to accrue the common shares earned.

 

The Agreement provides that, in addition to receiving paid vacation in accordance with the Company’s policies as well as other customary benefits and provisions, Mr. Salas and Mr. Hufnagel shall receive an annual base salary, a signing bonus and a stock grant. If, at any time during the term of the Agreement, Mr. Salas or Mr. Hufnagel is terminated “without cause,” they will be entitled to receive a cash payment equal to the aggregate compensation payable to them during the remaining term of the Agreement.

 

Terminated Employment Agreement with Former Chief Financial Officer

 

The Company previously had an employment agreement with its Chief Financial Officer, which terminated in 2015. There were amounts that were accrued and unpaid as of September 30, 2017 and 2016, totaling $338,437 and $291,715, respectively. According to the original agreement, the unpaid salaries were to accrue interest at each reporting date. Interest expense was $46,722 and $47,119 for the years ended September 30, 2017 and 2016, respectively. Management believes that such amounts were previously satisfied through the issuance of common stock and does not intend to pay such amounts.

 

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Commission Agreement

 

The Company entered into an agreement with BrokerBank Securities, Inc. to raise up to $40 million from the issuance of common stock. In connection therewith, the Company agreed to pay a commission of 8% in cash. During the year ended September 30, 2017, the Company paid cash commissions of $73,680. During the year ended September 30, 2016, the Company paid cash commissions of $20,680 and 28,000 shares of common stock. These amounts were netted against the proceeds received.

 

Leases

 

The Company leases 3,906 square feet of office space Buda, Texas. The lease for the Buda facility began on April 1, 2016 and continues until March 31, 2019. The current monthly rent payment of $7,379 continues until March 31, 2018. On April 1, 2018, the monthly rent payment increases to $7,542 and continues until March 31, 2019. The lease shall be automatically renewed for two one-year periods - $7,705 per month through March 31, 2020 and $7,867 per month until March 31, 2021 unless either party to the lease agreement notifies the other in writing at least 180 days prior to the expiration of the current term.

 

Future annual minimum lease obligations at September 30, 2017 are as follows:

 

Year Ending September 30,  Amount 
2018  $89,520 
2019   45,252 
   $134,772 

 

NOTE 8 - STOCKHOLDERS’ DEFICIT

 

Common Stock

 

As of September 30, 2017 and 2016, the Company had 6,635,127 and 5,268,859 shares of common stock outstanding, respectively, and was authorized to issue 650,000,000 shares of common stock at a par value of $0.01.

 

Common Stock Issued for Cash

 

During the year ended September 30, 2017, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 724,000 shares of common stock for $1,383,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended, afforded by Rule 506 of Regulation D.

 

During the year ended September 30, 2017, the Company also issued 50,000 shares of common stock with a relative fair value of $44,609 to FirstFire Global Opportunities Fund, LLC based on the relative fair value of the convertible debt and warrants issued. See Note 5 for additional information. 

 

During the year ended September 30, 2016, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 513,500 shares of common stock for $946,320 in net cash proceeds.

 

Common Stock Issued to Officers and Employees

 

During the year ended September 30, 2017, the Company issued 300,000 shares of common stock with a fair value of $1,633,000 to the CEO and 242,268 shares of common stock with a fair value of $1,150,922 to its other officers and employees as part of their compensation. The shares were valued on the date of issuance based upon the closing market price of the Company’s common stock as the performance was complete.

 

During the year ended September 30, 2016, the Company issued 10,677 shares of common stock with a fair value of $32,138 and accrued earned shares of common stock amounting to $41,456 as compensation to certain officers pursuant to their employment agreements. The shares were valued on the date of issuance based upon the closing market price of the Company’s common stock as the performance was complete.

 

Common Stock Issued for Services

 

During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $74,500 to StockVest for investor relations services. The shares were valued on the date of issuance based upon the closing market price of the Company’s common stock as the performance was complete.

 

During the year ended September 30, 2016, the Company issued 800 shares for marketing services valued at $1,600 and 5,000 shares for software development valued at $27,500. The Company also issued 75,000 shares for legal services valued at $210,000. The shares for these issuances were valued using the closing market price of the Company's common stock on the commitment date.

 

Common Stock Issued for License Termination

 

During the year ended September 30, 2017, the Company issued 25,000 shares of common stock with a fair value of $106,250 for a software termination settlement. The shares were valued on the date of agreement based upon the closing market price of the Company’s common stock.

 

During the year ended September 30, 2016, the Company issued 307,141 shares of common stock with a fair value of $763,469 for the termination of software licenses related to seven separate licenses in that the software usage would possibly interfere with the Company’s future software development. The shares were valued on the date of agreement based upon the closing market price of the Company’s common stock.

 

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Preferred Stock

 

As of both September 30, 2017 and 2016, there are a total of 10,000,000 shares of the Series A Preferred Stock authorized and outstanding, which are convertible into a total of 15,000,000 shares of common stock. Each share of the Preferred Stock has 150 votes on all matters presented to be voted by the holders of common stock. The holders of the Preferred A shares can only convert the shares if agreed upon by 50.1% vote of all preferred shareholders.

 

Warrants

 

During the year ended September 30, 2017, the Company issued warrants to FirstFire Opportunities Fund LLC to purchase 165,000 shares of common stock valued at $84,227 based on the relative fair value of the convertible debt and common stock. See Note 5 for additional information. The warrants have an exercise price of $4.50 and a term of two years, subject to adjustment in the event of a lower price per share offered, similar to a ratchet provision.

 

Additionally, during the year ended September 30, 2017, the Company issued 560,000 warrants to the Private Placement Investors. The Private Placement Investors were granted units, which consisted of one share of common stock and a warrant to purchase two additional shares of common stock, for $2 each. The warrants were issued with an exercise price of $4.50 and a term of two years. The fair value of these warrants was $313,192; however, no entry was required to be recorded in equity related to these warrants.

 

Warrant activity for the years ended September 30, 2017 and 2016 is as follows:

 

   Number of Warrants   Weighted Average
Exercise Price
   Weighted Average Remaining Life 
Outstanding at September 30, 2015   -   $-    - 
Granted   -    -    - 
Exercised   -    -    - 
Canceled/Forfeited   -    -    - 
Outstanding at September 30, 2016   -    -    - 
Granted   725,000    4.50    1.78 
Exercised   -    -    - 
Canceled/Forfeited   -    -    - 
Outstanding at September 30, 2017   725,000   $4.50    1.78 
Vested at September 30, 2017   725,000   $4.50    1.78 
Exerciseable at September 30, 2017   725,000   $4.50    1.78 

 

The Company valued the warrants using the Black-Scholes pricing model on the date of grant using the following inputs:

 

Expected life (years)   2.00 
Risk-free interest rate   1.45%
Expected volatility   150%
Annual dividend yield   0%

 

NOTE 9 - INCOME TAXES

 

The provision (benefit) for income taxes from continued operations for the years ended September 30, 2017 and 2016 consist of the following:

 

   September 30, 
   2017   2016 
Current:          
Federal  $-   $- 
State   -    - 
   $-   $- 
           
Deferred:          
Federal  $(781,817)  $(603,753)
State   -    - 
    (781,817)   (603,753)
Valuation allowance   781,817    603,753 
Provision (benefit) for income taxes, net  $-   $- 

 

The difference between income tax expense computed by applying the federal statutory corporate tax rate and actual income tax expense is as follows:

 

   September 30, 
   2017   2016 
Statutory federal income tax rate   34.0%   34.0%
State income taxes and other   0.0    0.0 
Non-deductible stock-based compensation   

-16.0

    

-11.0

 
Valuation allowance   (18.0)   (23.0)
Effective tax rate   0.0%   0.0%

 

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Deferred income taxes result from temporary differences in the recognition of income and expenses for the financial reporting purposes and for tax purposes. The tax effect of these temporary differences representing deferred tax asset and liabilities result principally from the following:

 

   September 30, 
   2017   2016 
Net operating loss carry forward  $

4,725,000

   $

3,943,000

 
Valuation allowance   (4,725,000)   (3,943,000)
Deferred income tax asset  $-   $- 

 

The Company has a net operating loss carry forward of $13.9 million available to offset future taxable income. For income tax reporting purposes, the Company’s aggregate unused net operating losses were subject to the limitations of Section 382 of the Internal Revenue Code, as amended. The Company has provided a valuation reserve against the full amount of the net operating loss benefit, because in the opinion of management based upon the earning history of the Company; it is more likely than not that the benefits will not be realized. For income tax reporting purposes, Management has determined that net operating losses prior to February 5, 2015 are subject to an annual limitation of approximately $600,000.

 

For the years ended September 30, 2017 and 2016, the difference between the amounts of income tax expense or benefit that would result from applying the statutory rates to pretax income to the reported income tax expense of $0 is the result of the net operating loss carry forward and the related valuation allowance, as well as non-deductible stock-based compensation.

 

The Company anticipates it will continue to record a valuation allowance against the losses of certain jurisdictions, primarily federal and state, until such time as it is able to determine it is “more-likely-than-not” the deferred tax asset will be realized. Such position is dependent on whether there will be sufficient future taxable income to realize such deferred tax assets. The Company’s effective tax rate may vary from period to period based on changes in estimated taxable income or loss by jurisdiction, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction.

 

The Company has not filed its federal income tax returns since 2012, which is through the fiscal year ending September 30, 2013. The Company is preparing the 2013 through 2015 filings, which report activity for the fiscal years ending September 30, 2014 through 2016. The September 30, 2017 tax return is not due at this time. The Company intends to remediate the lack of filing timely tax returns immediately. There are currently no ongoing tax examinations.

 

In December 2017, the Tax Cuts and Jobs Act, which provides tax relief for certain corporations, effective January 1, 2018, was passed. Management is currently evaluating the impact of the effects of the regulations.

 

NOTE 10 - SUBSEQUENT EVENTS

 

The Company has continued to raise equity financing through a Private Placement. After September 30, 2017, the Company has sold 42,000 shares of common stock for approximately $77,000, net of offering costs.

 

On October 18, 2017, the Company received a letter of resignation from Michael Salas, Vice President of Marketing and Sales, with an effective date of October 27, 2017.

 

On October 27, 2017, Mike Hufnagel was appointed Chief Operating Officer by the Board of Directors with an effective date of November 1, 2017.

 

On December 14, 2017, the Company entered into the following agreements with Peak One Opportunity Fund L.P. (“Peak One”). The agreements became effective on December 22, 2017.

 

  1.

A convertible note in the amount of $300,000 payable in three years in common stock and convertible into common shares at $1.00 per share at Peak One’s option. If an Event of Default has occurred or the date of conversion is on or after the date that is one hundred eighty (180) days after the Issuance Date, the lesser of (a) $1.00 or (b) Seventy percent (70%) of the lowest traded price (as reported by Bloomberg LP) of the Common Stock for the twenty (20) Trading Days immediately preceding the date of the date of conversion of the Debentures (provided, further, that if either the Company is not DWAC Operational at the time of conversion or the Common Stock is traded on the OTC Pink (“OTCP”) at the time of conversion, then Seventy percent (70%) shall automatically adjust to Sixty Five percent (65%) of the lowest traded price (as reported by Bloomberg LP) of the Common Stock for the twenty (20) Trading Days immediately preceding the date of conversion of the Debentures), subject in each case to equitable adjustments resulting from any stock splits, stock dividends, recapitalizations or similar events. The net cash received from the note was $242,600, and will be accounted for as an original issue discount, together with the relative fair value of the warrant and debt.

  2. A warrant agreement wherein Peak One may purchase up to 75,000 shares of common stock of the Company for $2.00 per share with an expiration date of five years from the date of the warrant agreement.
  3. A stock purchase agreement setting forth the details of the above stated agreements, including an additional convertible debenture in the amount of $300,000.
  4.

An equity purchase agreement for up to $7,000,000 of the Company’s common stock and related registration rights agreement, which will require a registration statement to be filed, both dated December 14, 2017, by and among the Company and Peak One, as well an agreement to issue 275,000 shares of the Company’s common stock as commitment shares to Peak One or it’s designee in connection therewith.

 

On December 20, 2017, the Company entered into a Memorandum of Understanding with FirstFire Global Opportunities Fund, LLC (“FirstFire”), acknowledging that the following adjustments have been triggered due to the Company’s intent to consummate a corporate finance transaction with Peak One Opportunity Fund L.P.

 

  1. FirstFire waives its rights under Section 3.20 of the Senior Convertible Promissory Note (with respect to the enforcement of an event of default) and Sections 4(d) and Section 4(q) of the Securities Purchase Agreement, with respect to the intended transaction with Peak One only.
  2. The fixed conversion price of the convertible note shall be reduced from $2.00 to $1.00 pursuant to Section 4.14 of the Senior Convertible Promissory Note.
  3. The terms of the warrant shall automatically be adjusted as a result of the intended transaction with Peak One, pursuant to the terms of the warrant.
  4. The total commitment shares shall be increased to 137,500 shares of the Company’s common stock pursuant to Section 4.14 of the Senior Convertible Promissory Note, such that the Company shall issue an additional 87,500 shares of the Company’s common stock to FirstFire within three days after December 20, 2017.
  5. Section 1.9 of the Senior Convertible Promissory Note shall be adjusted, such that if the Company exercises its right to prepay the convertible note at any time from the 151st through the 180th day following September 26, 2017, then the Company shall pay to FirstFire 130% multiplied by the outstanding principal amount plus accrued and unpaid interest.
  6. The warrant exercise price is adjusted to $2.00 per the terms of the original agreement.

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

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 Securities and Exchange Commission’s (the “SEC”) 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 have not been formally designed and evaluated to provide reasonable assurance that the controls and procedures would meet their objectives.

 

As required by SEC Rule 13a-15(b), our Chief 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. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2017, due to 1) no formal evaluation has been performed by us and 2) the existence of the material weaknesses in internal control over financial reporting described below (which we view as an integral part of our disclosure controls and procedures). Based on the performance of additional procedures designed to ensure the reliability of our financial reporting, we believe that the financial statements included in this Annual Report fairly present, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods, presented, in conformity with U.S. GAAP.

 

Management’s Report on Internal Control over Financial Reporting

 

Our Chief Executive Officer and the Chief 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, 2017, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our internal control over financial reporting as of September 30, 2017, and concluded that we did not maintain effective internal control over financial reporting as of September 30, 2017, due to the lack of a formal evaluation that has been performed by us and the identification of material weaknesses.

 

Management has still identified some deficiencies in the design and operating effectiveness of the Company’s internal controls as of September 30, 2017 that represent material weaknesses in our internal control over financial reporting. These deficiencies are the result of management’s failure to design, implement and maintain adequate operational and internal controls and processes including a lack of sufficient accounting staff which resulted in inadequate segregation of duties, the inability to prove delivery of software, an insufficient number of personnel familiar with financial and SEC reporting requirements, inadequate monitoring and review controls over financial reporting and disclosures as well as transaction processing, and insufficient written policies and procedures for accounting and financial reporting.

 

Remediation Plan

 

Management has executed a remediation plan intended to address the material weaknesses discussed above. These remediation efforts are focused on:

 

  Additional accounting staff to provide adequate segregation of duties;
     
  Enhancing controls around proving the delivery of software;
     
  Retaining appropriate resources familiar with financial and SEC reporting requirements;
     
  Monitoring and reviewing controls over financial reporting and disclosures as well as transaction processing; and
     
  Enhancing and maintaining written policies and procedures for accounting and financial reporting.

 

During the year ended September 30, 2017, management engaged additional resources to support the remediation efforts outlined above. In addition, management has continued to train key accounting staff to improve controls that will ultimately eliminate the material weaknesses discussed above, as well as improve the accounting and financial reporting process.

 

We expect that remediation, including testing of related controls, will be completed by the end of third quarter 2018. 

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the year ended September 30, 2017 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, other than the remediation actions discussed above.

 

29

 

 

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.

 

ITEM 9B. OTHER INFORMATION

 

There are no events required to be disclosed by this Item.

 

30

 

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

 

Directors and Executive Officers

 

Set forth below is information regarding the Company’s current directors and executive officers. There are no family relationships between any of our directors or executive officers. The directors are elected annually by stockholders. The executive officers serve at the pleasure of the Board of Directors.

 

Name   Age   Title
         
Michael De La Garza   59   Chairman, Chief Executive Officer
         
Albert Carlson, PhD   58   Director, Chief Scientific Officer
         
Sammy Davis DrPH   70   Director

 

The Chief Executive Officer, directors, and officers of the Company will hold office until additional members or officers are duly elected and qualified. The background and principal occupations of the directors and officers of the Company are as follows:

 

Michael De La Garza, 59 years of age, is the Company’s Chairman and Chief Executive Officer. Mr. De La Garza has 27 years’ experience in the software industry as an executive officer and founder of numerous companies both private and publicly traded. His career started in 1991 as the COO of a medical imaging company and subsequently founded or co-founded three other software companies where he served as President and/or CEO. Michael studied computer science at Southwest Texas State University and received a Computer Science Technical degree from Danforth Technical College in 1980.

 

Albert Carlson, PhD, 58 years of age, serves as a Director and the Company’s Chief Scientific Officer. Dr. Carlson oversees the development of the Company’s Cipherloc suite of products and reports directly to the Chief Executive Officer. Dr. Carlson created and led teams advancing the state-of-the-art in more than six embedded, computer, and electrical engineering sectors, creating new markets, products, and value for exploitation. He has extensive experience in on-time design to delivery while remaining under budget at all levels of engineering. Additionally, he has worked in many areas of engineering and has focused extensive world knowledge, as well as deep algorithmic, set theory, mathematical, and design expertise. Dr. Carlson holds a PhD in Computer Science from the University of Idaho.

 

Sammy Davis DrPH, 70 years of age, serves as a Director of the Company. Dr. Davis has over 20 years’ experience in operations, finance, budgeting, financial reporting, revenue cycle management, inventory, payroll, accounts receivable and payable, and information systems in the healthcare industry. He has held numerous managerial positions as the Chief Executive Officer and Administrator. Dr. Davis holds a Doctor of Public Health degree from the University of Texas.

 

Audit Committee

 

The Company does not have an audit committee.

 

Conflicts of Interest

 

Members of our management are associated with other firms involved in a range of business activities. Consequently, there are potential inherent conflicts of interest in their acting as officers and directors of our company. Although the directors are engaged in other business activities, we anticipate they will devote an important amount of time to our affairs.

 

Our officers and directors are now and may in the future become shareholders, officers or directors of other companies, which may be formed for the purpose of engaging in business activities similar to ours. Accordingly, additional direct conflicts of interest may arise in the future with respect to such individuals acting on behalf of us or other entities. Moreover, additional conflicts of interest may arise with respect to opportunities which come to the attention of such individuals in the performance of their duties or otherwise. Currently, we do not have a right of first refusal pertaining to opportunities that come to their attention and may relate to our business operations.

 

31

 

 

Our officers and directors are, so long as they are our officers or directors, subject to the restriction that all opportunities contemplated by our plan of operation which come to their attention, either in the performance of their duties or in any other manner, will be considered opportunities of, and be made available to us and the companies that they are affiliated with on an equal basis. A breach of this requirement will be a breach of the fiduciary duties of the officer or director. If we or the companies with which the officers and directors are affiliated both desire to take advantage of an opportunity, then said officers and directors would abstain from negotiating and voting upon the opportunity. However, all directors may still individually take advantage of opportunities if we should decline to do so. Except as set forth above, we have not adopted any other conflict of interest policy with respect to such transactions.

 

Code of Ethics

 

We have adopted a code of ethics that applies to all of our executive officers, directors and employees. Code of ethics codifies the business and ethical principles that govern all aspects of our business. This document will be made available in print, free of charge, to any shareholder requesting a copy in writing from the Company. A form of the code of conduct and ethics was filed as Exhibit 14.1 to the Annual Report on Form 10-K for the year ended September 30, 2004.

 

ITEM 11. EXECUTIVE COMPENSATION

 

Summary Compensation Table

 

The following tables set forth certain information concerning all compensation paid, earned or accrued for service by (i) our Principal Executive Officer and Principal Financial Officer and (ii) all other executive officers who earned in excess of $100,000 in the fiscal years ended September 30, 2017 and 2016, and each of the other two most highly compensated executive officers of the Company who served in such capacity at the end of the fiscal year whose total salary and bonus exceeded $100,000 (collectively, the “Named Executive Officer”):

 

2017 AND 2016 SUMMARY COMPENSATION TABLE

 

Name and Position   Year     Salary ($)     Bonus ($)     Stock Awards ($)     All Other Compensation ($)     Change in Pension Value and Nonqualified Deferred Compensation Earnings ($)     Total ($)  
Michael De La Garza                                                        
Chairman &     2017     $ 360,000       60,000     $ 1,633,000     $ 54,000 (ii)     -     $ 2,107,000  
Chief Executive     2016     $ 360,000 (i)     -       -     $ 37,854 (ii)     -     $ 397,854  
Officer                                                        
                                                         
Albert Carlson, PhD                                                        
Director &     2017     $ 150,000       -       -       -       -     $ 150,000  
Chief Scientific Officer     2016     $ 150,000       -       -       -       -     $ 150,000  
                                                         
Sammy Davis, DrPH     2017       -       -       -       -       -       -  
Director     2016       -       -       -       -       -       -  

 

(i) Excludes $44,788 of prepaid compensation.
(ii) All other compensation consists of remunerations for auto and health insurance costs.

 

32

 

 

Compensation of Directors

 

Our current compensation policy for directors is to compensate them through common stock as consideration for their joining our board and/or providing continued services as a director. We do not currently provide our directors with cash compensation, although we do reimburse their expenses, with exception for a chairman of the board. No additional amounts are payable to the Company’s directors for committee participation or special assignments. There are no other arrangements pursuant to which any directors were compensated during the Company’s last completed fiscal year for any service provided except as follows:

 

Employment Contracts

 

We have an employment agreement with Albert Carlson as our Chief Scientific Officer. The Agreement is for a term of one year, commencing on September 1, 2015 and initially expiring on August 31, 2016 with three one-year extensions. The Agreement provides that, in addition to receiving paid vacation in accordance with the Company’s policies as well as other customary benefits and provisions, Dr. Carlson shall receive an annual base salary of $150,000. If, at any time during the term of the Agreement, Dr. Carlson is terminated “without cause,” he will be entitled to receive a cash payment equal to the aggregate compensation payable to him during the remaining term of the Agreement. The terms of the employment agreement are incorporated by reference and was filed with our Form 8-K on September 4, 2015.

 

The Company entered into an employment agreement with its Chief Executive Officer on January 1, 2013. The employment agreement will expire on January 1, 2018 and shall automatically renew for another five years unless terminated in accordance with the provisions of the employment agreement. The employment agreement provides for:

 

  i. A monthly salary of $20,833 per month subject to an annual increase of 10% per year and consistent with the Company policy applicable to other senior executives and officers and approval by the Board of Directors. During the year ended September 30, 2017, the base salary was $360,000.
     
  ii. A cash bonus of 25% of his annual base salary each year if the Company reaches the following milestones:

 

  a. The Company posts annual gross revenues on a consolidated basis of at least $5,000,000;
     
  b. The Company’s earnings before the deduction of income taxes and amortization expenses (“EBITA”), including cash extraordinary items but before officer’s bonuses, on a consolidated basis for any year is at least $1,000,000;

 

  iii. An automobile allowance of $1,500 per month.
     
  iv. A medical insurance allowance of $1,500 per month.
     
  v. In the event the executive’s employment is terminated without cause he will receive the entire contract remaining on the agreement.

 

The Company has removed other provisions from the original employment agreement.

 

During the years ended September 30, 2017 and 2016, cash compensation amounted to $390,278 and $397,854 including benefits, respectively. The Chief Executive Officer was prepaid $52,244 in compensation in 2016 which was offset by a $60,000 bonus in 2017. The Chief Executive Officer is still due the remainder of this bonus ($7,756) as of September 30, 2017. During the years ended September 30, 2017 and 2016, stock-based compensation amounted to $1,633,000 and $0, respectively.

 

As of September 30, 2017, we also have employment agreements with Michael Salas and Michael Hufnagel (the “Agreements”). The Agreements are for a term of one year, with Mr. Salas’s Agreement commencing on April 25, 2016 and expiring on April 24, 2017, and Mr. Hufnagel’s commencing on June 27, 2016 and expiring on June 26, 2017. Both Agreements have three successive one-year extensions and were extended. Mr. Salas has an annual salary of $175,000 and quarterly stock issuances equal to $125,000 per year. Mr. Hufnagel has an annual salary of $145,000, an initial sign-on bonus of $10,000 and quarterly stock issuances equal to $60,000 per year. As of September 30, 2017, these individuals were owed common shares for services, but for which shares have not yet been issued. An accrual has been recorded to equity totaling $46,250 to accrue the common shares earned.

 

The Agreement provides that, in addition to receiving paid vacation in accordance with the Company’s policies as well as other customary benefits and provisions, Mr. Salas and Mr. Hufnagel shall receive an annual base salary, a signing bonus and a stock grant. If, at any time during the term of the Agreement, Mr. Salas or Mr. Hufnagel is terminated “without cause,” they will be entitled to receive a cash payment equal to the aggregate compensation payable to them during the remaining term of the Agreement.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The following table lists stock ownership of our common stock as of December 26, 2017 based on 6,947,127 shares of common stock issued and outstanding on a fully diluted basis. The information includes beneficial ownership by (i) holders of more than 5% of our Common Stock, (ii) each of our directors and executive officers, and (iii) all of our directors and executive officers as a group. Except as noted below, to our knowledge, each person named in the table has sole voting and investment power with respect to all shares of our common stock beneficially owned by them.

 

33

 

 

Name and Address of Beneficial Owners (1)  Nature of Beneficial Ownership (2)  Amount   Percent Ownership 
            
Michael De La Garza (3)  Common Stock   630,000    12.1%
Including MSR, LLC  Common Stock   207,757      
c/o Cipherloc  Preferred Stock   9,000,000      
825 Main St, Suite 100             
Buda, TX 78610             
              
Albert Carlson, PhD  Common Stock   53,668    0.8%
c/o Cipherloc             
825 Main St, Suite 100             
Buda, TX 78610             
              
Sammy Davis, DrPH  Common Stock   -    0.0%
c/o Cipherloc             
825 Main St, Suite 100             
Buda, TX 78610             
              
All Officers and Directors             
As a Group (3 persons)  Common Stock   891,425    12.8%

 

1. C/o our address, 825 Main Street, Suite 100, Buda, TX 78610 unless otherwise noted.

 

2. Except as otherwise indicated, we believe that the beneficial owners of common stock listed above, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants, but are not deemed outstanding for purposes of computing the percentage of any other person. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities.

 

3. Preferred stock has voting rights of 150 per share. MSR, LLC holds 3,000,000 of the 9,000,000 preferred shares that are all controlled by Michael De La Garza.

 

Changes in Control

 

We are not aware of any arrangements that may result in a change in control of the Company.

 

Description of Securities

 

General

 

On April 11, 2011, the Company amended its articles of incorporation to increase the authorized common shares to 650,000,000 shares, at $0.01 par value. There were 6,635,127 shares of common stock issued and outstanding as of September 30, 2017.

 

Common Stock

 

The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds. The dividend rights of our common stock are junior to any preferential dividend rights of any outstanding shares of preferred stock. The holders of our common stock also are entitled to receive distributions upon our liquidation, dissolution or winding up of our assets that are legally available for distribution, after payment of all debt and other liabilities and distribution in full of preferential amounts, if any, to be distributed to holders of our preferred stock.

 

34

 

 

The holders of our common stock are not entitled to preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of any series of preferred stock that we may designate and issue in the future.

 

Preferred Stock

 

The Company has authorized 10,000,000 shares of preferred stock, at $0.01 par value and 10,000,000 shares are issued and outstanding as of September 30, 2017. The Corporation established and designates the rights and preferences of a Series A Convertible Preferred Stock. Each share of the Preferred Stock shall have 150 votes on all matters presented to be voted by the holders of our common stock.

 

The issuance of preferred stock by our board of directors could adversely affect the rights of holders of the common stock by, among other things, establishing preferential dividends, liquidation rights or voting powers. See “Risk Factors” above.

  

Voting Rights

 

Each holder of common stock is entitled to one vote for each share of common stock held on all matters submitted to a vote of stockholders. Preferred A shareholders are entitled to 150 votes per share.

 

Dividends

 

Subject to preferences that may be applicable to any then-outstanding shares of Preferred Stock, if any, and any other restrictions, holders of common stock are entitled to receive ratably those dividends, if any, as may be declared from time to time by the Company’s board of directors out of legally available funds. The Company and its predecessors have not declared any dividends in the past. Further, the Company does not presently contemplate that there will be any future payment of any dividends on common stock.

 

Convertible Securities

 

On September 26, 2017, the Company issued a convertible note to FirstFire Global Opportunities Fund, LLC with a principal amount of $330,000 and an original issue discount of $30,000. The note accrues interest at 5% per annum and matures on March 26, 2018, six months following the issuance date. The note provides the holder with the right, at any time on or after the note’s maturity date, to convert all or a portion of the outstanding principal balance and accrued interest to shares of the Company’s common stock at a fixed conversion price of $2.00 per share. The note contains adjustments to the conversion price in the event of default, if shares of the Company trade below the fixed conversion price on the day following the conversion date, or if the Company consummates a registered or unregistered primary offering of its securities for capital raising purposes. Subsequent to September 30, 2017, the fixed conversion price was adjusted from $2.00 to $1.00 per share.

 

Amendment of our Bylaws

 

Our bylaws may be adopted, amended or repealed by the affirmative vote of a majority of our outstanding shares. Subject to applicable law, our bylaws also may be adopted, amended or repealed by our board of directors.

 

Transfer Agent

 

Pacific Stock Transfer serves in the capacity of the Company’s transfer agent. Their mailing address is Pacific Stock Transfer, 4045 South Spencer #403, Las Vegas, NV 89119, and their telephone number is (702) 361-3033.

 

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

None.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Audit Fees. The aggregate fees billed by dbbmckennon for the audit of the Company’s annual financial statements were $54,500 and $75,000 for the fiscal years ended September 30, 2017 and 2016, respectively.

 

Audit-Related Fees. The aggregate fees billed by dbbmckennon, for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements for the fiscal years ended September 30, 2017 and 2016 and that are not disclosed in the paragraph captioned “Audit Fees” above, were $0.

 

Tax Fees. The aggregate fees billed by dbbmckennon for professional services rendered for tax compliance, tax advice and tax planning for the fiscal years ended September 30, 2017 and 2016 were $0.

 

All Other Fees. The aggregate fees billed by dbbmckennon for products and services, other than the services described in the paragraphs “Audit Fees,” “Audit-Related Fees,” and “Tax Fees” above for the fiscal year ended September 30, 2017 and 2016 were $0.

 

The Board of Directors has received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), and has discussed with its auditors its independence from the Company. The Board of Directors has considered whether the provision of services other than audit services is compatible with maintaining auditor independence.

 

Based on the review and discussions referred to above, the Board of Directors approved the inclusion of the audited financial statements be included in the Company’s Annual Report on Form 10-K for its 2017 fiscal year for filing with the SEC.

 

The Board of Directors pre-approved all fees described above.

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

3.1   Articles of Incorporation Incorporated by reference to the Registrant’s Form 10-SB filed on or about January 3, 2000.
     
3.2   Bylaws Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended December 31, 2000 and filed on or about February 14, 2001.
     
3.3   Amendment to the Articles of Incorporation indicating name change and reverse stock split as set out in Registrant’s Form 8-K dated and filed on March 23, 2015
     
4.1   S-8 Registration Filed on June 2, 2014 and by reference incorporated herein
     
4.2   S-8 Registration Filed on October 27, 2016 and by reference incorporated herein
     
5.1   Legal opinion of Carl P. Ranno included in the S-8 Registration filed on June 2, 2014
     
5.2   Legal opinion of Carl P. Ranno included in the S-8 Registration filed on October 27, 2016

 

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10.1   Employment Agreement between National Scientific Corporation and Michael A. Grollman dated January 2001 Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended March 31, 2001 and filed on or about May 15, 2001.
     
10.2   Employment Agreement between National Scientific Corporation and Graham L. Clark dated January 2003 Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended June 30, 2004 and filed on or about August 16, 2004.
     
10.3   NSC Consulting Agreement dated August 2001, and Amendments dated August 2002 and July 2003, with Dr. El-Badawy El-Sharawy Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended June 30, 2004 and filed on or about August 16, 2004.
     
10.4   Amended and Restated 2000 Stock Option Plan Incorporated by reference to the Registrant’s Form 10-KSB for the year ended September 30, 2000 and filed on or about December 19, 2000.
     
10.5   Form of 2004 Stock Retainage Plan Agreement Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.6   Agreement Regarding Management Consulting Services with Stanton Walker of New York dated May 2003 Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.7   Agreement Regarding Distribution and Marketing of Gotcha!® Child Safety Product and other products dated December 2002 with FutureCom Global, Inc. Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.8   Purchase Order from Verify Systems, Inc., dated March 2003 for IBUSTM School Child Tracking Systems. Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.9   Letter of Understanding and Agreement dated April 2004 Regarding Sales and Distribution of Verify School safety products, and an Unlimited Software License with Anthony Grosso and CIS Services, LLC. Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.10   Letter of Intent from Positus, Inc. dba Bike & Cycle Trak, dated February 2003 for Design of Power Sports Tracking System. Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.11   Purchase Order from Positus, Inc. dba Bike & Cycle Trak, for Design of Power Sports Tracking System dated March 2003. Incorporated by reference to the Registrant’s Form SB-2 filed on or around June 24, 2004.
     
10.12   Employment agreement of Michael De La Garza. Incorporated by reference to the Registrant’s Form 10-K for the year ended September 30, 2011 and filed on October 10, 2013
     
10.13   Employment Agreement of Pamela Thompson Incorporated by reference to the Registrant’s Form 10-K for the year ended September 30, 2011 and filed on October 10, 2013.
     
10.14   Licensing Agreement of Code Robert, LLC and Sunset Angel Productions, LLC. Incorporated by reference to the Registrant’s Form 8-K filed on April 25, 2015.
     
10.15   Employment Agreement of Dr. Albert Carlson, incorporated by reference to Form 8-K filed on September 4, 2015

 

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10.16   Asset Purchase Agreement and Promissory Note re sale of MD Software dated September 29, 2015. Incorporated by reference to the Registrant’s Form 10-K for the year ended September 30, 2015 and filed on February 2, 2016.
     
10.17   Asset Purchase Agreement with Isaiah Eichen dated October 22, 2015, incorporated by reference to the Registrant’s Form 10-Q for the quarter ending December 31, 2015 and filed on February 22, 2016.
     
10.18   Sisco Product Development Agreement dated November 6, 2015, incorporated by reference to the Registrant’s Form 10-Q for the quarter ending December 31, 2015 and filed on February 22, 2016.
     
10.19   Cloud Medical Doctors Software Corporation 48-month Licensing Agreement with Gawk dated June 11, 2014, incorporated by reference to the Registrant’s Form 10-Q for the quarter ending December 31, 2015 and filed on February 22, 2016.
     
10.20   Employment agreement of Patrick Doherty dated January 16, 2016, incorporated by reference to the Registrant’s Form 10-Q for the quarter ending March 30, 2016 and filed on June 6, 2016.